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