In a case of first impression, the Richmond City Circuit has determined that Virginia’s “subject to tax” exception to intangible expense addback only applies to the portion of the royalty that the recipient included in its income subject to tax in another state, after apportionment.1

The taxpayer argued that because the royalties were reported on another state’s return, and included in computing the tax due in that state, they were subject to tax in that state and qualified for the subject to tax exception. The Department countered that a taxpayer is only entitled to an exception to the addback to the extent that the intangible expense payments made by the taxpayer were subject to tax in another state on a post-apportionment basis.

Relying on Alabama precedent, the court found that the plain language of the “subject to tax” exception tracks the Department’s interpretation.2 However, the decision did not address the differences between the Alabama statute and the Virginia statute, or the unique legislative history surrounding the Virginia statute. Considering the amount of tax at issue, and the basis of the trial court’s decision, we anticipate that the taxpayer will appeal to the Virginia Supreme Court.

Pursuant to a stipulation between the taxpayer and the Department, the controversial 2014 amendments to the addback exception (that made it retroactive for up to 10 years) were not at issue in this case. For more information on the controversial 2014 amendments, see our April 3, 2014 alert