On April 1, 2014, Virginia Governor Terry McAuliffe signed HB 5001. This law imposes severe restrictions on the existing exceptions to intangible expense addback to Virginia taxable income.1 Specifically, the new law limits the “subject to tax” exception to post-apportioned tax payments made in other jurisdictions on affiliate royalty payments. This change is contrary to the plain language of the original law. HB 5001 also limits the exception for intangible expenses paid to a related member that also licenses the intangibles to unrelated parties to receipts “derived from licensing agreements for which the rates and terms are comparable to the rates and terms of agreements that the related member has actually entered into with unrelated entities.” This limitation is contrary to the Richmond City Circuit’s decision in Wendy’s International, Inc. v. Virginia Department of Taxation in which the “unrelated party” exception was determined to apply to a licensing arrangement where the unrelated parties sublicensed the intangible property from the taxpayer, rather than licensing it directly from the related member that owned the intangibles.2 Both of these revisions were made retroactive to January 1, 2004.
Retroactively applying changes to a law over such a lengthy period likely constitutes a violation of Due Process. As Supreme Court Justice O’Connor observed, “[t]he government interest in revising the tax laws must at some point give way to the taxpayer’s interest in finality and repose. . . . A period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise . . . serious constitutional questions.”3 In fact, a recent Virginia case considering retroactive tax legislation applied Justice O’Connor’s formula and found that a three-year retroactive period for tax legislation “is longer than generally found acceptable.”4 So it stands to reason that the 10-year retroactivity period for the addback changes in HB 5001 violates Due Process.
If your company has claimed either of the addback exceptions on its Virginia returns, or has filed any returns in which the company has added back any intangible expenses in computing Virginia taxable income, you should contact one of the authors of this alert or the Reed Smith attorney with whom you regularly work to determine how this radical change will impact your Virginia income tax liability.
1. Virginia HB 5001, 2014 Special Session I, § 3-5.11.
2. CL09-3757 (Richmond City Circuit Apr. 25, 2012).
3. United States v. Carlton, 512 U.S. 26, 37-38 (1994) (O’Connor, J., concurring).
4. Giesecke v. Department of Taxation, 34 Va. Cir. 455 (Fairfax City Circuit Sept. 22, 1994).
Client Alert 2014-106