United States: Virginia Enacts Retroactive Legislation That Significantly Limits Intangible Addback Exceptions

On April 1, Virginia Governor Terry McAuliffe signed into law H.B. 5001, enacting Virginia's budget bill "caboose," including a provision imposing retroactive limitations on the intangible expense addback exceptions.1

Limiting the Intangible Expense Addback Exceptions

Under the original version of the addback provision enacted in 2004, Virginia taxpayers were required to add back intangible expenses paid to a related member (defined to include certain related parties) to the extent such expenses were deducted by the taxpayer in calculating federal taxable income for Virginia income tax purposes.2 Exceptions to this addback requirement were provided for taxpayers meeting certain conditions. Specifically, two of these exceptions were commonly referred to as the "subject to tax" and "unrelated third-party revenues" exceptions.3

The originally enacted addback exceptions were perceived by some individuals as being too lenient, since the provisions failed to include language similar to that used by other jurisdictions to limit the exceptions. As a result, this legislation sought to impose a retroactive solution to limit the exceptions for adding back intangible expenses. The modifications are effective retroactively to tax years beginning on or after January 1, 2004.4 "

"Subject to Tax" Exception

Under the "subject to tax" exception, a taxpayer under prior law was excluded from adding back intangible expenses to the extent that the income received by the related party was "subject to a tax based on or measured by net income or capital imposed by Virginia, another state, or a foreign government that has entered into a comprehensive tax treaty with the United States government."5 Since its inception, taxpayers have interpreted this exception as applying on an unapportioned basis, thus expanding the amount of intangible expenses subject to the exception. The Commissioner, however, consistently took the position that the amount subject to the exception only included the apportioned amount subject to tax in other jurisdictions.6

With enactment of the current legislation, this exception has been modified to apply only to the portion of intangible income received by the related member that has been "attributed to a state or foreign government in which the related member has sufficient nexus to be subject to such taxes."7

"Unrelated Third-Party Revenues" Exception

Under the original form of the "unrelated third-party revenues" exception, a taxpayer was not required to add back intangible expenses to the extent that the related member derived at least one-third of its gross revenues from the licensing of intangible property to unrelated third parties.8 Taxpayers understood that this exception applied regardless of whether the terms and conditions governing the licensing agreements of unrelated and related parties were comparable.9 The Virginia Department of Taxation attempted to limit the use of this exception to royalties earned directly from unrelated parties,10 but was overruled in this pursuit at the circuit court level.11 The circuit court held that the exception as written simply required that the related member derive at least one-third of its gross revenues from the licensing of intangible property to unrelated parties, and did not distinguish as to whether the gross revenues were directly or indirectly licensed to an intangible holding company. Therefore, the court allowed the exception from the addback rule to apply to an intangible holding company indirectly licensing its intangible property to independent franchisees through an operating company.

With enactment of the current legislation, Virginia has modified the exception to apply only to the portion of the intangible income received by the related member 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."12

Other Provisions

Other material tax provisions included in the caboose legislation are: (i) adjustments to the maximum amount of qualified equity and subordinated debt investment credit for various tax years;13 (ii) changes to the accelerated sales tax payment provisions;14 (iii) a change in the dealer discount provisions;15 and (iv) an exemption from sales and use tax for certain Internet services.16


Practitioners anticipate that the Department will attempt to impose these newly enacted limitations on the intangible expense addback exceptions to tax years as early as 2004. Nonetheless, there exist several viable bases on which taxpayers and businesses can challenge these limitations. First and foremost, the Virginia Code imposes a three-year statute of limitations from the date a return is filed.17 Therefore, the Commonwealth cannot attempt to audit and reassess the liability with respect to any returns filed prior to April 2011 unless other conditions have caused such returns to remain open for audit purposes.

Furthermore, practitioners expect the newly enacted provision to be challenged as unconstitutional. It is possible that these provisions could be found unconstitutional due to the considerably lengthy 10-year period of retroactivity, taking the position found in Justice O'Connor's U.S. Supreme Court concurrence in Carlton v. U.S., which allowed a limited retroactive reach: "[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."18 Given the one-year guideline for retroactive laws prescribed by the U.S. Supreme Court, it is possible that the 10-year period of retroactivity of these Virginia provisions could be found to violate the Constitution. A Virginia court, however, has upheld a three-year retroactive period for tax legislation which formalized Department policy, despite noting that the period "is longer than generally found acceptable."19 The Virginia court specifically examined whether the retrospective tax law at issue was "arbitrary and does not disturb vested rights, impair contractual obligations, or violate due process," as well as considered the practices governing the legislative body's ability to timely respond to the need for tax law amendments and the nature of the tax in making this determination.

Currently, the "subject to tax" exception is the subject of litigation in Kohl's Department Stores, Inc. v. Virginia Department of Taxation,20 and this venue could provide an early forum to debate Virginia's retroactive policy regarding the intangible expense addback exceptions. In this action, the taxpayer has challenged the Department's policy of limiting the amount of the addback exception to the portion of the taxpayer's expense payments to affiliates which correspond to the portion of the affiliate's income subjected to tax in other states, as evidenced by apportionment percentages shown on the affiliate's tax returns filed with other states.21

While it is likely that businesses and taxpayers will challenge the retroactive imposition of these limitations, taxpayers who have relied on the "subject to tax" or "unrelated third party revenues" exceptions to Virginia's intangible expense addback requirement should determine the extent of their potential exposure if the retroactive legislation is ultimately sustained upon challenge.


1.H.B. 5001, 2014 Special Session I, § 3-5.11 (effective Jan. 1, 2004). Because the provisions in the bill simply fund Virginia through June 30, 2014 (the end of the current fiscal year), rather than including the budget for an entire fiscal period, the bill is referred to as the budget bill "caboose."

2 VA. CODE ANN. § 58.1-402(B)(8) (prior version).

3 Id. This version of the law allowed an exception from the addback for taxpayers if: (i) the corresponding item of income received by the related member was subject to a net income or capital-based tax imposed by Virginia, another state, or qualified foreign government; (ii) the related member derived at least one-third of its gross revenues from the licensing of intangible property to nonrelated parties and the transaction was made at comparable rates and terms as those involving the nonrelated parties; or (iii) expenses and costs were paid by the related member during the same taxable year to a nonrelated party and the transaction giving rise to the expenses/costs between the taxpayer and the related member was not undertaken for the principal purpose of avoiding tax.

4 H.B. 5001, § 3-5.11.

5.VA. CODE ANN. § 58.1-402(B)(8)(a)(1).

6 Ruling of Commissioner, P.D. 09-49, Virginia Department of Taxation (Apr. 27, 2009); Ruling of Commissioner, P.D. 09-96, Virginia Department of Taxation (Jun. 11, 2009); Ruling of Commissioner, P.D. 07-217, Virginia Department of Taxation (Dec. 20, 2007); and Ruling of Commissioner, P.D. 07- 153, Virginia Department of Taxation (Oct. 2, 2007).

7 H.B. 5001, § 3-5.11(i).

8 VA. CODE ANN. § 58.1-402(B)(8)(a)(2).

9 See, however, Ruling of Commissioner, P.D. 13-140, Virginia Department of Taxation (Jul. 19, 2013), addressing exceptions to the addback requirement. VA. CODE ANN. § 58.1-446 permits the Department to equitably adjust tax if any intercompany arrangements improperly reflect the business done or Virginia taxable income earned from business in the Commonwealth. The statutory addback exception provided by VA. CODE ANN. § 58.1-402(A)(8)(b) for intangible intercompany expenses incurred for a valid business purpose other than the avoidance or reduction of tax includes specific qualification procedures.

10 Ruling of Commissioner, P.D. 09-14, Virginia Department of Taxation (Feb. 4, 2009).

11 Wendy's International, Inc. v. Virginia Department of Taxation, Circuit Court, 13th Judicial Circuit, No. CL09-3757 (Mar. 29, 2012).

12 H.B. 5001, § 3-5.11(ii).

13 The amount of the qualified equity and subordinated debt investment credit is limited to $3 million for calendar years beginning in 2006. The credit amount limit for tax years beginning in 2009 is as follows: $5 million for tax year 2010, $3 million for tax year 2011, $4 million for tax year 2012, $4.5 million for tax year 2013, and $5 million for tax year 2014.

14 Beginning with the tax payment remitted in June 2014, the accelerated sales tax payment provisions are adjusted to only apply to those dealers or permit holders with taxable sales and purchases of at least $48.5 million for the 12-month period beginning July 1 and ending June 30 of the previous calendar year. Previously, the provisions applied to dealers or permit holders meeting a $26 million threshold. It is the intent of the legislature that the accelerated sales tax payment requirement be phased out beginning with this fiscal year and eliminated by 2021.

15 Beginning with the June 2010 sales tax return, dealer discounts are unavailable to any dealer required to remit payment by electronic funds transfer. Compensation available to other dealers is limited to a percentage of the first 3 percent of sales and use tax levied, based on monthly taxable sales.

16 For purchases made on or after July 1, 2006, any sales and use tax exemption applicable to production, distribution, and other equipment used by Internet service providers to provide Internet access services must be claimed as a refund request. A similar provision was included in previous budget bills.

17 VA. CODE ANN. § 58.1-104.

18 United States v. Carlton, 512 U.S. 26, 37-38 (1994) (O'Connor, J., concurring).

19 Giesecke v. Department of Taxation, 34 Va. Cir. 455 (Fairfax City Circuit Court, Sep. 22, 1994).

20 Case No. 760CL 12-1774 (City of Richmond Circuit Court, 2014).

21 Ruling of Commissioner, P.D. 07-153, Virginia Department of Taxation (Oct. 2, 2007). In this decision, the Department determined that the "subject to tax" addback exception did not apply to the gross amount of payments that a taxpayer made to an affiliate merely because the gross amount was shown on another state's tax return. Instead, the Department limited the exception to apply to only the portion of the taxpayer's intangible expense payments to its affiliates which corresponded to the portion of the affiliate's income subjected to tax in other states, as evidenced by the apportionment percentages shown on the affiliate's tax returns filed in other states.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.