June 26, 2018
Re: § 58.1-1821 Application: Corporate Income Tax
Dear *****:
This will reply to your letter in which you seek correction of the corporate income tax assessments issued to your client, ***** (the “Taxpayer”), for the taxable years ended April 30, 2012, through 2014. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer and its affiliates filed consolidated Virginia corporate income tax returns for the taxable years at issue. Under audit, the Department removed certain entities from the consolidated returns, resulting in adjustments to the Taxpayer’s Virginia apportionment factors. The Department also made certain fixed date conformity adjustments in computing the Taxpayer’s net operating losses (NOLs). The Taxpayer does not contest these adjustments.
The Taxpayer, however, argues that Virginia must allow a subtraction for foreign source income to be carried forward for Virginia income tax purposes to the extent it was not allowed to be subtracted in the year earned because of net operating loss deductions (NOLDs) already taken. The Taxpayer also argues that the Department’s adjusted NOL schedules did not account for special provisions under Internal Revenue Code (IRC) § 965 applicable to the taxable year ended April 30, 2006. In addition, the Taxpayer contends that it should be permitted to claim NOLs carried forward by certain affiliates that were liquidated during the taxable years at issue. Further, the Taxpayer contends that there were various discrepancies between its figures and those used by the audit staff that affect the NOLD carryforwards in the audit period.
DETERMINATION
Net Operating Losses
Generally, Virginia income tax law does not address the NOLD. Nonetheless, Virginia Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the IRC unless a different meaning is clearly required. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia. For corporate income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income (VTI) with federal taxable income (FTI). Income properly included in the FTI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Virginia Code § 58.1-402. Because Virginia starts its computation of corporate income tax with FTI, the Department allows an NOLD to the extent it is allowable in computing FTI as calculated for Virginia income tax purposes.
Fixed date conformity additions (FDCA) and subtractions (FDCS) are not considered to be Virginia modifications. Rather, these exceptions identified in Virginia Code § 58.1-301 are added to or subtracted from FTI as computed under the IRC in order to determine a corporation’s FTI for Virginia income tax purposes. A corporation’s Virginia FTI is calculated by starting with FTI as reported on the federal income tax return, adding the FDCA, and then subtracting any FDCS. The formula for determining Virginia FTI would be as follows:
FTI + FDCA — FDCS = Virginia FTI
For Virginia income tax purposes, a corporation will have an NOL only if the formula results in a number that is less than zero. If FDCA exceeds the total of a loss reported on a federal return plus FDCS, the corporation will not have an NOL for Virginia income tax purposes. Conversely, if FDCS exceeds FTI plus FDCA, the taxpayer will have NOL for Virginia even if it does not report an NOL on its federal return. Such an NOL can be carried back and forward in accordance with the rules established under IRC § 172, except for the five year carryback allowed under IRC § 172(b)(1)(H). See Virginia Code § 58.1-301 B 2 and Public Document (P.D.) 16-22 (3/8/2016).
Title 23 of the Virginia Administrative Code (VAC) 10-120-325 provides the methodology that a corporation must use to calculate the NOLD carrybacks and carryforwards for purposes of corporate income tax. Under this regulation, a Virginia NOLD modification must be determined for the taxable year in which an NOL occurred. This Virginia NOLD modification must be carried back and forward in the same manner as the NOLD.
IRC § 965 Deduction
The American Jobs Creation Act of 2004 (P.L. 108-357) created a one-time dividends received deduction for United States corporations in an amount equal to 85% of the cash dividends received as a shareholder in controlled foreign corporations. See IRC § 965(a)(1). The taxable income of such shareholder, however, could not be less than the nondeductible 15% portion. See IRC § 965(e)(2)(A). In addition, the nondeductible portion could not be taken into consideration in determining the corporation’s NOL for the taxable year in which the deduction was taken, nor could it be taken into account in computing the amount of taxable income that could be offset by an NOL carryback. See IRC § 965(e)(2)(B). Practically, the nondeductible portion became a taxable income floor in the taxable year in which the deduction was taken. That floor could not be reduced by NOLs, either carried forward or carried back, and it was also ignored for purposes of computing the NOL for that year.
The Department computed the Taxpayer’s FTI for the taxable year ended April 30, 2006, by reducing the IRC § 965 floor by the loss attributable to an affiliated company. On a consolidated return, however, the affiliated group is considered to be one shareholder under IRC § 965(c)(5)(A). The consolidated group’s FTI for that year, therefore, could not be reduced below the 15% nondeductible portion. In addition, the Department applied a NOLD, reducing the Taxpayer’s FTI for that year to zero. The FTI floor created by the nondeductible portion, however, was not permitted to be reduced by NOLDs.
Liquidations
To the extent that such NOLDs carried over as a result of a liquidation made pursuant to IRC § 332 or through a corporate reorganization made through IRC § 368(a) are allowable for federal income tax purposes if federal returns had been filed, they would be allowable for Virginia income tax purposes. See P.D. 07-120 (7/31/2007). Such NOLDs are allowed even if the liquidated entities did not have nexus with Virginia. See id.
The Taxpayer liquidated certain affiliated corporations during the taxable years at issue. The Taxpayer contends that it acquired these corporations’ NOLDs and was permitted to use them during the taxable year ended April 30, 2014. The documentation provided, however, is insufficient to substantiate what amount of NOLDs the Taxpayer acquired.
Foreign Source Income Modification from Loss Year
The Taxpayer explains that it had sufficient NOLDs in carryover years to bring FTI to zero but did not have sufficient amounts of Virginia addition modifications to offset the subtractions it was eligible to take for foreign dividends under Virginia Code § 58.1-402 C 8. As a result, the Taxpayer effectively lost the benefit of the subtractions to the extent they carried forward with the NOLDs and were unused. The Taxpayer argues that Virginia law discriminates against foreign commerce in violation of the Commerce Clause of the United States Constitution because had the foreign source dividends been domestic dividends, the Taxpayer would have been able to deduct them for federal income tax purposes and such deduction would have resulted in a greater federal NOLD with no loss of benefit.
In support of its position, the Taxpayer cites the case of Kraft General Foods, Inc. v. Comptroller of the Treasury, 2001 Md. Tax LEXIS 2 (June 8, 2001), in which the Maryland Tax Court held that similar disparate treatment of foreign and domestic dividends in determining NOLDs under Maryland law unconstitutionally discriminated against foreign commerce. The Maryland Tax Court relied on Kraft General Foods, Inc. v. Iowa Dep’t of Revenue and Finance, 505 U.S. 71, 112 S.Ct. 2365 (1992) (hereinafter, Kraft), in which the Supreme Court of the United States held that an Iowa statute providing for the taxation of dividends received by foreign subsidiaries but not domestic subsidiaries unconstitutionally discriminated against foreign commerce.
Because dividends received from foreign subsidiaries are included in the definition of foreign source income eligible for a subtraction under Virginia Code § 58.1-408 C 8, Virginia statutes address the disparate income taxation of foreign and domestic dividends that was at issue in Kraft. Whereas Kraft involved the fundamental question whether certain income could constitutionally be subject to state taxation at all, as deductions, NOLDs are granted as a matter of legislative grace. As such, the potentially different treatment of foreign and domestic dividends in determining a NOLD carryover in the computation of VTI raises issues that are beyond the scope of Kraft.
Although the Maryland Tax Court extended Kraft to encompass disparate treatment of foreign and domestic dividends in computing NOLDs for Maryland income tax purposes, courts in other states have expressly declined to follow the Maryland decision. In Colgate-Palmolive Co. v. Fla. Dep’t of Revenue, 988 So.2d 1212 (Fla. Dist. Ct. App. 2008), a Florida court considered a statutory scheme similar to Virginia’s. Florida’s statutes permitted a subtraction for federal NOLDs, foreign dividends, and the foreign dividend “gross up.” Although Virginia’s statutes do not specify a subtraction for NOLDs, as explained above, NOLDs are nevertheless incorporated into a corporation’s computation of VTI through the corporation’s FTI. Subtractions for foreign dividends and the foreign dividend “gross up” are permitted under Virginia Code § 402 C 5 and 8, respectively.
In Colgate-Palmolive, the Taxpayer argued that because the federal deduction for domestic dividends could always be carried over through NOLDs and the federal foreign tax credit could not, Florida’s income tax scheme unconstitutionally discriminated against foreign commerce. The court held, however, that no disparate treatment of the dividends existed when Florida did not include foreign source dividends in its income calculation, and corporations could carry over NOLDs as a result of the federal provision permitting a deduction for foreign taxes paid under IRC § 164 and the possibility of deducting foreign dividends under IRC sec. 245(b). See 988 So.2d 1212 at 1224.
Similarly, the court in Ind. Dep’t of State Revenue v. Caterpillar, Inc., 15 N.E.2d 579 (Ind. 2014), declined to apply Kraft’s holding to the NOL context. The court observed that the constitutional defect identified in Kraft did not exist because Indiana’s statutes, like Virginia’s, allowed corporate taxpayers a deduction for foreign source dividends. See id. at 587. Because it appears that the Indiana Supreme Court is the highest level of judicial review the issue has been subject to and was a unanimous decision, in the Department’s opinion it should be afforded the most weight out of the cited cases. The Department understands, however, that it is not bound by the Indiana court’s decision.
By asking that the foreign source income subtraction increase the amount of the NOLDs the Taxpayer can claim for Virginia income tax purposes even in years FTI has already been reduced to zero, the Taxpayer is effectively asking for a Virginia NOL. Because there is no provision in the Code of Virginia allowing a Virginia NOL, it is the Department’s longstanding policy that subtractions may not be used to create one. See P.D. 95-144 (6/6/1995). The Department, therefore, declines to adjust the assessments to allow greater NOLDs resulting from the Taxpayer’s foreign source income subtractions.
Unspecified Discrepancies
The Taxpayer states there are various small differences between its figures and the Department’s audit adjustments that impact the NOLD carryforward available during the audit period. Title 23 VAC 10-20-165 D 1 f requires a taxpayer’s appeal to set forth each alleged error in the assessment, the grounds upon which the taxpayer relies and all facts relevant to the taxpayer’s contention. On appeal, the Taxpayer does not specifically describe which of the Department’s figures it believes are erroneous and why. As such, any such discrepancies, to the extent they exist, will not be addressed in this response.
CONCLUSION
By asking that the foreign source income subtraction increase the amount of the NOLDs the Taxpayer can claim for Virginia income tax purposes even in years FTI has already been reduced to zero, the Taxpayer is effectively asking for a Virginia NOL. It is the Department’s longstanding policy that because there is no provision in the Code of Virginia allowing a Virginia NOL, subtractions may not be used to create one. The Department, therefore, declines to adjust the assessments to allow greater NOLDs resulting from the Taxpayer’s foreign source income subtractions.
The case, however, will be returned to the audit staff to revise the Taxpayer’s NOL schedule to conform to IRC § 965, in accordance with the explanation set forth in this determination. In addition, the Taxpayer should submit documentation within 30 days of the date of this determination supporting the amount of NOLDs it is claiming as a result of the liquidation of affiliates. At the same time, the Taxpayer may also specifically describe the additional discrepancies it believes exist between its figures and those used by the Department and submit additional documentation to the audit staff to support its position, as necessary. Once this submission is received, the audit staff will adjust the assessments as warranted. If this submission is not received within the time allotted, however, no further adjustments will be made other than those required as a result of IRC § 965. Once all revisions are complete, updated bills or refunds will be issued as warranted.
The Code of Virginia sections, regulations 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/1307.M