Par Mark L. Nachbar
In a 4-3 decision, the Virginia Supreme Court (“Court”) held that the Virginia exception to the Virginia addback statute, Code § 58.1-402(B)(8)(a)(1), was to be applied on a post-apportionment basis.1 Kohl’s Department Stores, Inc. (“Kohl’s”) operates department stores throughout the United States. Kohl’s Illinois, Inc. (“Kohl’s Illinois”) operates stores in selected states. Kohl’s Illinois also manages and licenses certain intellectual property. Kohl’s licenses this property from Kohl’s Illinois.
In the years at issue, Kohl’s did not add back royalties paid to Kohl’s Illinois, asserting that the payments met the “subject to” exception of the addback statute. That section states that “addition shall not be required for any portion of the intangible expenses and costs if . . . [t]he corresponding item of income received by the related member is subject to a tax based on or measured by net income or capital imposed by . . . another state.” Code § 58.1-402(B)(8)(a)(1). Kohl’s Illinois included the royalties in its income in each state in which it filed an income tax return. The Department of Revenue asserted that although Kohl’s Illinois paid tax in several states, much of the royalty income went untaxed based on Kohl’s Illinois’s apportionment factor.
Finding that the term “subject to tax” was ambiguous, the Court then analyzed the case based on whether the Legislature intended the exception to be applied on pre- or post-apportioned basis. The majority of the Court found that the purpose of the statute was to close down the “Delaware intangible holding company loophole.” Therefore, the logical reading of the statute should be that the exception is to be applied on a post-apportionment basis. The Court held that Kohl’s should add back the royalties that were not actually taxed to its tax base.
The dissent reasoned that since the term “subject to tax” was not clear, the term had to be read in the taxpayer’s favor. In addition, since the Legislature did not incorporate an apportionment element into the statute, the Court could not impose an apportionment limitation. The dissent noted that budget bills enacted in 2014 and 20162 contained provisions putting in place apportionment limitations on the addback exception. These actions would not have been necessary if the original language incorporated an apportionment provision to the addback exception.
1 Kohl's Dep't Stores, Inc. v. Dep't of Tax'n, Va., [No. 160681, 08/31/17].
2 2014 Acts Ch. 2, § 3-5.10 (effective for the biennium ending June 30, 2016); 2016 Acts Ch. 780, § 3-5.09 (effective for the biennium ending June 30, 2018).
TECHNICAL INFORMATION CONTACT: