January 31, 2020
Re: Request for Ruling: Corporate Income Tax
Dear *****:
This will reply to your letter in which you seek a ruling on behalf of ***** (the “Taxpayer”) regarding the Virginia income tax treatment of the undistributed capital gains of a regulated investment company (RIC).
FACTS
The Taxpayer, a RIC for federal income tax purposes, requests a ruling regarding whether it is permitted to subtract its shareholders’ portion of undistributed capital gains for purposes of computing its Virginia taxable income or in the alternative, whether its shareholders are permitted to claim a credit for the amount of Virginia income tax the Taxpayer pays on such undistributed capital gains.
RULING
Virginia’s conformity to federal income tax law is set forth in Virginia Code § 58.1-301, which provides that the terms used in the Virginia income tax statutes will have the same meaning as used in the Internal Revenue Code (IRC). Further, conformity does not extend to terms, concepts, or principles specifically provided for in Title 58.1 of the Code of Virginia. For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). Income properly included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Virginia Code § 58.1-322.01 through § 58.1-322.04.
For corporate income tax purposes, Virginia also conforms to federal law in that it starts the computation of Virginia taxable income with federal taxable income (FTI). Virginia Code § 58.1-402 provides that a corporation’s Virginia taxable income for any given taxable year is the FTI and any other income taxable to the corporation under federal law for such year, adjusted and modified by certain specified additions, subtractions, and exemptions. For purposes of this statute, the term “federal taxable income” means all income from whatever source derived and however named on which a federal tax is imposed. See Title 23 of the Virginia Administrative Code (VAC) 10-120-100 A.
For regulated investment companies, Virginia taxable income means “investment company taxable income” plus capital gains and any other income taxable to the corporation under federal law, subject to the adjustments as described in Virginia Code § 58.1-402. See also Title 23 of the Virginia Administrative Code (VAC) 10-120-100 B 1.
RICs are essentially treated as pass-through entities for federal income tax purposes as long as they meet certain income sourcing, diversification and minimum distribution requirements not at issue in this ruling. See IRC §§ 851-855. RICs, however, must pay tax on their undistributed capital gains. See IRC § 852 (b)(3)(A). Shareholders must also include their respective amount of an RIC’s undistributed capital gains in their own computation of long-term capital gain. See IRC § 852 (b)(3)(D)(i). Shareholders, however, are credited with the amount of tax the RIC paid on such undistributed capital gains. See IRC § 852(b)(3)(D)(ii). Because the undistributed capital gains of a RIC would be included in the Virginia taxable income of both the Taxpayer and any Virginia resident shareholders by way of Virginia’s conformity with federal law, both the Taxpayer and any Virginia resident shareholders would be subject to Virginia income tax on such undistributed capital gains.
Double taxation of income that is attributable to a business entity and passed down to shareholders is not constitutionally prohibited. See Howell’s Motor Freight, Inc., et al. v. Virginia Dep’t of Taxation, Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983). As the court observed, shareholders of a certain type of corporation, a C corporation, are already effectively subject to double taxation, once on income earned at the entity level and again on dividends passed through to them.
The Taxpayer asks for a ruling that it be permitted to subtract its income attributable to undistributed long term capital gains for purposes of computing its Virginia taxable income. Alternatively, the Taxpayer asks that Virginia resident shareholders be permitted to claim a credit for Virginia income tax paid by the Taxpayer on its undistributed long term capital gain income. Neither mechanism is currently permitted under Virginia law. The Department has no authority to administratively grant either of the proposed remedies requested.
The Code of Virginia sections and regulation cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site. If you have any questions regarding this ruling, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/2049.M