United States: Reissued Virginia Supreme Court Decision In Addback Case Leaves Result Unchanged; Some Taxpayers May Still Benefit

At a Glance...

On March 22, 2017, the Virginia Supreme Court reissued its decision in Kohl's Department Stores, Inc. v. Virginia Department of Taxation, limiting the "subject to tax" exception to Virginia's intangible expense addback to the portion of the expense that is included in the apportioned tax base of the related member in another state. This conclusion was unchanged from the court's original decision issued in August 2017. The revised decision did not change the portion of the original decision that interpreted the "subject to tax" exception as applying to situations in which the taxpayer was denied a deduction for the intangible expense in another state or the related party paid tax on its income in a combined reporting state.

On August 31, 2017, the Virginia Supreme Court issued its original decision in Kohl's Department Stores v. Virginia Department of Taxation.1 In that decision, the court held that a taxpayer could only claim the "subject to tax" exception to Virginia's intangible expense addback statute to the extent that tax was actually paid to other states on the intangible payment made to the related member. But in a concession to taxpayers, the court also held that the "subject to tax" exception applies "[t]o the extent that the royalties were actually taxed by Separate Return States, Combined Return States, or Addback States," thus rejecting the argument by the Virginia Department of Taxation (the "Department) that the exception applied only if the related member included the intangible payment in income reported on a separate company return. In reaching its earlier decision, the Virginia Supreme Court gave "great weight" to the Department's interpretation of the "subject to tax" exception in order to resolve the alleged ambiguity in the statutory language. Three of the seven justices joined in a strong dissenting opinion arguing that the statutory language for the "subject to tax" exception was unambiguous. (See our earlier alert on the original decision.)2

On September 25, 2017, the taxpayer filed a petition for rehearing, arguing that the Virginia Supreme Court erred by deferring to the Department's position because Virginia statute prohibits courts from giving weight to the Department's interpretation when that position has not been reduced to a regulation. Recognizing that it had improperly relied on the Department's interpretation of Va. Code Sec. 58.1-402(B)(8)(a)(1) in its earlier decision, the Virginia Supreme Court granted the taxpayer's petition for rehearing.

In its revised decision, the Virginia Supreme Court omitted language from the original decision affording deference to the Department's interpretation of the addback statute and focused its statutory construction analysis on deciphering the legislative intent. Based on its revised analysis, the Virginia Supreme Court reached the same conclusion that it reached in its earlier decision; that is, that the "subject to tax" exception is limited to the portion of the intangible expense actually taxed in the other state. In doing so, as three justices pointed out in a revised dissenting opinion, the majority disregarded the canon of statutory construction that an ambiguity in a taxing statute be resolved in the taxpayer's favor. Importantly, the revised decision leaves intact the concession to taxpayers allowing the exception for intangible expenses paid to related members in combined reporting states.

Although this decision may mark the end of the litigation regarding Virginia's "subject to tax" exception, taxpayers with active appeals on this issue should consider whether they have any other arguments that would support an exception to addback. For instance, taxpayers may be able to benefit from the court's interpretation of what it means to be "subject to tax." In that regard, taxpayers with pending appeals should quantify the tax paid on royalties in combined reporting and addback states because the court's revised decision continues to allow an exception for these amounts.

For more information on the "subject to tax" exception to Virginia's intangible addback, see our August 31, 2017, November 1, 2016, February 9, 2016 and April 3, 2014 alerts.


1. Record No. 160681 (Aug. 31, 2017).

2. Kohl's involves tax years ending January 31, 2009, and January 30, 2010. The Virginia General Assembly ultimately revised the statutory language governing the "subject to tax" exception in its 2014 and 2016 appropriation acts to unambiguously limit the exception to reflect the Department's interpretation. These revisions were described by the General Assembly as applying on a retroactive basis to all tax years since the original enactment of Virginia's intangible expense addback statute. The parties had stipulated that the revisions to the exception made in the appropriation acts were not to be considered in Kohl's.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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