September 6, 2016
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek correction of the individual income tax assessment issued to ***** (the “Taxpayers”) for the taxable year ended December 31, 2012.
FACTS
The Taxpayers filed a Virginia resident income tax return for the 2012 taxable year and claimed credit for both the New Hampshire Business Enterprise Tax (NHBET) and the New Hampshire Business Profits Tax (NHBPT). Under review, the Department denied the credits and issued an assessment. The Taxpayers appealed, contending they were eligible to claim credits for both the NHBET and the NHBPT because those taxes were out of state taxes based on income and denial of the credits would result in double taxation.
DETERMINATION
Virginia Code § 58.1-332 A allows Virginia residents a credit against their income tax liability when they pay income tax to another state on earned or business income, or any gain from the sale of a capital asset. The intent of the credit is to grant Virginia residents relief in situations when they are taxed by both Virginia and another state on these types of income.
Classification of Tax
Virginia Code § 58.1-332.2 A defines an “income tax” as a term of art that refers to a specific type of tax levied on all of a resident's earned and unearned income, and all income of a nonresident from sources within the jurisdiction, which is similar to the income tax that Virginia imposes on resident and nonresident individuals. Virginia Code § 58.1-332.2 B includes examples of taxes that do not qualify for the credit, even though they may be measured, in part, by income. Taxes do not qualify because (i) they are labeled as a franchise or license tax, and (ii) they do not tax all income of the individual. Examples of taxes that do not qualify for the credit pursuant to Va. Code § 58.1-332.2 include the DC Unincorporated Business Franchise Tax, the Texas Margin Tax, and the Ohio Commercial Activity Tax. See Public Document (P.D.) 12-108 (7/1/2012).
Virginia Code § 58.1-332.2 C further provides that “[t]he credits in §§ 58.1-332 and 58.1-332.1 shall apply only when the tax imposed in the other state or foreign country is substantially similar to the tax imposed by Article 2 (§ 58.1-320 et seq.), as defined by this section.” (Emphasis added.) Thus, a tax, regardless of type, must still be substantially similar to the Virginia individual income tax imposed under Va. Code § 58.1-320 et seq., which applies generally to all of the income of Virginia residents and all of the income of nonresidents sourced to Virginia.
The Taxpayers claimed the credit against the NHBET and the NHBPT. The NHBET is imposed on the taxable enterprise value base of every profit or nonprofit corporation, partnership, limited liability company, proprietorship, association or trust, with the exception of those exempt under Internal Revenue Code (IRC) §501(c)(3) that do not engage in any unrelated activity, conducting business activities in the state. See N.H. Rev. Stat. Ann. § 77-E:2. The NHBET is assessed on the enterprise value tax base, which is the sum of all compensation paid or accrued, interest paid or accrued, and dividends paid, before special adjustments and apportionment. See N.H. Rev. Stat. Ann. § 77-E:1. Because the NHBET is based on expenditures made by a business enterprise, it is not an income tax substantially similar to Virginia's individual income tax. See P.D. 15-109 (5/29/2015).
The NHBPT is imposed on the taxable business profits of every business organization. See N.H. Rev. Stat. Ann. § 77-A:2. The Department's longstanding policy has been that certain franchise taxes or other taxes using various types of income as their measure, e.g., profits from business, dividends, interest, rents and royalties, are not substantially similar enough to Virginia's income tax to qualify for the credit. That is because they are not broad-based net income taxes like Virginia's income tax. It is the Department's longstanding policy that the NHBPT does not qualify for the credit for this reason. See P.D. 89-348 (12/20/1989).
Commerce Clause
The Taxpayers also contend that decisions of the United States Supreme Court, most recently Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787, 191 L. Ed. 2d 813 (2015), prohibit the double taxation of income of an individual or business. It is well established that a state may tax all the income of a resident, even income from outside the taxing jurisdiction. In People of State of New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937), the United States Supreme Court explained “[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized.” In Wynne, the Supreme Court also recognized that a state's taxation of a resident's income may be subject to constitutional scrutiny under the Commerce Clause of the U.S. Constitution.
The Commerce Clause grants Congress power to “regulate Commerce . . . among the several States.” Art. I, § 8, cl. 3. Although the Clause is framed as a positive grant of power to Congress, the Court has consistently held this language to contain a further, negative command, known as the dormant Commerce Clause. Wynne, 135 S. Ct. at 1794. The dormant Commerce Clause prohibits state taxation discriminating against interstate commerce, even when Congress has failed to legislate on the subject. Id. To help identify state tax schemes that discriminate against interstate commerce, the Court uses something known as “the internal consistency test.” Id. at 1803. The test “looks to the structure of the tax at issue to see whether its identical application by every State in the Union would place interstate commerce at a disadvantage as compared with commerce intrastate.” Wynne, 135 S. Ct. at 1803 (citations and internal quotation marks omitted).
Accordingly, a state is within its authority to impose income tax on all of the income of a resident of that state. A state need only ensure that the income tax, to the extent that it substantially affects interstate commerce, does not discriminate against such commerce. While granting a credit against a resident's income tax may cure an otherwise discriminatory tax, the Supreme Court in Wynne did not order that. In fact, the Court noted that alternative remedies existed, one of which would be for the state to refrain from taxing nonresidents on certain income. Wynne, 135 S. Ct. at 1806.
Critically, not all situations of double taxation are a result of discriminatory tax schemes. The Court explained:
By hypothetically assuming that every State has the same tax structure, the internal consistency test allows courts to isolate the effect of a defendant State's tax scheme. This is a virtue of the test because it allows courts to distinguish between (1) tax schemes that inherently discriminate against interstate commerce without regard to the tax policies of other States, and (2) tax schemes that create disparate incentives to engage in interstate commerce (and sometimes result in double taxation) only as a result of the interaction of two different but nondiscriminatory and internally consistent schemes...The first category of taxes is typically unconstitutional; the second is not.
Id. (citations omitted).
If a court were to subject Virginia's credit to the internal consistency test it would assume that all states, including New Hampshire, imposed a broad-based income tax like Virginia's and would not analyze the actual taxes imposed by each of the other states. Under that assumption Virginia would grant the credit for income taxes imposed by the other states and no discrimination would be found to exist that could be attributed to Virginia's tax structure. The fact that a credit has been denied for the NHBET and NHBPT is attributable to the fact that New Hampshire has imposed taxes that are significantly different from Virginia's income tax. This situation fits into the second type of result of the internal consistency test, which does not violate the Commerce Clause of the U.S. Constitution.
CONCLUSION
Under Virginia statutes, the Taxpayers were not eligible to claim a credit for the New Hampshire Business Enterprise Tax or the New Hampshire Business Profits Tax because neither is the type of broad-based income tax for which Virginia allows a credit. In addition, contrary to assertions by the Taxpayers, the denial of credits in this case does not violate the Commerce Clause of the United States Constitution.
Accordingly, the assessment is upheld. The Taxpayers will receive an updated bill with accrued interest to date. The Taxpayers should remit the balance within 30 days of the date of this letter to avoid the accrual of additional interest and further collection actions.
Alternatively, if the assessment creates a financial hardship for the Taxpayers, they may pursue an offer in compromise based on doubtful collectibility. If the Taxpayers decide to request an offer in compromise, they should complete an Offer in Compromise Individual Request for Settlement, and Financial Information Statement (enclosed). The completed forms should be mailed to Virginia Department of Taxation, Attn: CICT, P.O. Box 2475, Richmond, Virginia 23218-2475. If the Taxpayers have any questions about making an offer, they may contact a member of the Collections Team at (804) 367-8045. Upon completion of that review, a response will be issued to the Taxpayers. Alternatively, the Taxpayers may contact that number and arrange for a payment plan.
The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-6303453844.M