United States

Virginia: State Supreme Court Grants Review of Dispute Involving Application of “Subject to Tax” Exception

Nov 07, 2016
From KPMG TaxWatch

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On October 31, 2016, the Virginia Supreme Court granted discretionary review of a case addressing the deductibility of royalties paid by a retailer to a related party. Under Virginia law, certain types of intangibles expenses paid to related parties that are deducted for federal income tax purposes are required to be added back in determining a corporation’s Virginia taxable income. The addback is not required if the taxpayer qualifies for one of the statutory exceptions to the addback rules. The taxpayer at issue argued that none of its royalties were required to be added back because the affiliate to whom it paid royalties was subject to tax on its royalty income in certain states. The Commissioner, however, asserted that the “subject to tax” exception applied only to the amount of the affiliate’s royalty income actually taxed in other states, as evidenced by apportionment percentages shown on the tax returns filed in those states. Thus, the Commissioner argued that the “subject to tax” exception did not apply if the income was included in filings in other states, but was not actually taxed in those states, for example, because the taxpayer and its affiliates filed a combined or consolidated return. The matter eventually went to trial and the court, agreeing with the Commissioner, held that the exception applied only to the portion of the royalty income upon which tax was actually imposed in the other state. The court noted that the purpose of the addback statute was to close certain corporate loopholes and therefore its ruling advanced the legislature’s purpose in adopting the addback provision in 2004. Interestingly, the court did not address 2014 amendments to the expense disallowance statute that adopted the Department’s interpretation of the addback exception retroactively to 2004. For more information on Kohl's Department Stores, Inc. v. Virginia Department of Taxation, please contact Diana Smith at 703-286-8214.


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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.