August 12, 2019
Re: § 58.1-1824 Application: Individual Income Tax
Dear *****:
This will respond to your letter in which you seek a refund of individual income tax paid by your clients, ***** (the “Taxpayers”), for the taxable years ended December 31, 2012 and 2013. I apologize for the delay in responding to your request.
FACTS
The Taxpayers were Virginia residents and shareholders in a Subchapter S corporation that paid corporate franchise tax to the District of Columbia for the 2012 and 2013 taxable years. The Taxpayers claimed a credit for payment of the D.C. corporate franchise tax on each of their 2012 and 2013 Virginia individual income tax returns. Under review, the credits were denied. As a result, the Taxpayers’ refund for the 2012 taxable year was reduced, and an assessment was issued for additional tax due in the 2013 taxable year. The Taxpayers paid the assessment and filed a claim for refund, contending that they were eligible to claim credit against their Virginia income tax liability for payment of the D.C. corporate franchise tax.
DETERMINATION
Protective Claim
Virginia Code § 58.1-1824 permits any person who has paid an assessment of taxes administered by the Department of Taxation to file a protective claim for refund within three years of the date of an assessment. Self-assessments made by a taxpayer upon the filing of a return are considered assessments for purposes of applying the protective claim provisions. See Va. Code § 58.1-1820. In the case of taxes requiring an annual or monthly return, self-assessments are deemed made when the return is filed. In addition, a return filed or tax paid before the last day prescribed by law for the timely filing of the return shall be deemed to be filed or paid on such last day.
In this case, the Taxpayers filed their 2012 Virginia income tax return in July 2013. However, because the Taxpayers had already paid the full amount of tax due prior to the original due date of May 1, 2013, their return was considered timely filed during the extension period which lasted until November 1, 2013. See Va. Code § 58.1-344. The Taxpayers, therefore, had until November 1, 2016, to file their protective claim for refund as to the 2012 taxable year. Because they filed their protective claim in May 2016, it was timely filed as to the 2012 taxable year. In addition, the assessment for the 2013 taxable year was issued in October 2015, and the Taxpayers paid the remaining balance due in full in April 2016. Therefore, the protective claim as to the 2013 taxable year was also timely filed.
Pursuant to the authority granted the Department under Va. Code § 58.1-1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Va. Code § 58.1-1821. As permitted by statute, the Taxpayers’ request has been treated as an appeal under Va. Code § 58.1-1821.
D.C. Corporate Franchise Tax
Virginia Code § 58.1-332 A allows Virginia residents a credit on their Virginia return for income taxes paid to another state provided the income is either earned or business income or any gain on 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.
The credit is limited to taxes imposed on income. Pursuant to Va. Code § 58.1-332 A, no franchise tax, license tax, excise tax, unincorporated business tax, occupation tax or any tax characterized as such by the taxing jurisdiction, although applied to earned or business income, shall qualify for a credit, nor shall any tax which, if characterized as an income tax or a commuter tax, would be illegal and unauthorized under such other state’s controlling or enabling legislation qualify for a credit under this section.
The Department has a longstanding policy, based on Virginia statutes, that the D.C. corporate franchise tax does not qualify for the out-of-state credit on an individual’s Virginia income tax return. See Public Document (P.D.) 88-87 (5/10/1988), P.D. 95-257 (10/6/1995), and P.D. 06-15 (2/6/2006). The Taxpayers assert that two cases, Joseph J. Mathy, et al. v. Commonwealth of Virginia Department of Taxation, 253 Va. 356, 483 S.E.2d 802 (1997) and Bishop v. District of Columbia, 401 A.2d 955 (D.C. 1979), aff'd en banc, 411 A.2d 997 (1980), support their position that Virginia should allow a credit for D.C. corporate franchise tax paid. The Department has previously addressed these cases in the context of determining whether a taxpayer was eligible to claim credit for the D.C. corporate franchise tax. In P.D. 06-15 (2/6/2006), the Department did not find either of these cases persuasive. The Department observed that Mathy involved the D.C. unincorporated business franchise tax, and the court in Bishop considered the D.C. corporate franchise tax to be a tax for the privilege of doing business that is applied to income.
More on point to the Taxpayer’s situation is the decision by the Circuit Court of Fairfax County in Hans D. and Patricia A. Giesecke v. Department of Taxation, 34 Va. Cir. 455 (1994). In this case, the plaintiffs litigated the retroactive application of the General Assembly's 1991 amendment to Va. Code § 58.1-332 A regarding the D.C. corporate franchise tax and whether payment of such tax qualifies for the credit under that section. In its decision, the Circuit Court of Fairfax County ruled in favor of the Department, finding that the amendment denying the plaintiffs the credits claimed on their returns for corporate franchise tax paid to D.C. did not deny the taxpayers due process rights. In so deciding, the court upheld the General Assembly’s amendment. The Virginia Supreme Court declined to hear the appeal in Giesecke, finding there was no reversible error in the circuit court’s decision. These actions by the courts indicate agreement with the Department’s position that the D.C. corporate franchise tax is not eligible for the credit under Va. Code § 58.1-332 for taxes paid to other states.
In addition, since the publication of P.D. 06-15, the Commonwealth has further codified its policy regarding what types of taxes qualify for the credit under Va. Code § 58.1-332. In 2012, the General Assembly enacted Senate Bill 681 (Chapter 292, 2012 Acts of Assembly), effective for taxable years beginning on or after January 1, 2007, to clarify and restore the Department’s longstanding policy of allowing a credit only for income taxes that are similar to Virginia’s individual income tax. See P.D. 12-108 (7/1/2012). Virginia Code § 58.1-332.2 B clarifies the circumstances in which a franchise, license, business, or occupational tax will not qualify as an income 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 District of Colombia’s Unincorporated Business Franchise Tax, the Texas Margin Tax, and the Ohio Commercial Activity Tax. See P.D. 12-108. In this case, the D.C. corporate franchise tax is considered a franchise tax, and it does not tax all of the D.C. source income of a nonresident S corporation shareholder. As such, it fails to qualify as an income tax for purposes of the credit allowed under Va. Code § 58.1-332.
Commerce Clause
The Taxpayers also contend that the Department must grant a credit for the D.C. corporate franchise tax to avoid violating the Commerce Clause of the United States Constitution. They have cited Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787 (2015) in support of this contention.
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, however, 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 well 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 the District of Columbia, 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 D.C. corporate franchise tax is attributable to the fact that the District of Columbia has imposed a tax that is 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. In addition, the District of Columbia already has a broad-based net income tax for which Virginia would allow a credit under the appropriate circumstances. See P.D. 16-41 (3/31/2016).
CONCLUSION
Pursuant to the Department’s longstanding policy and Virginia statutes, the D.C. corporate franchise tax is not considered an income tax for which the Taxpayers could claim a credit on their 2012 and 2013 Virginia income tax returns. In addition, in the Department’s opinion, denial of the credit does not violate the Commerce Clause of the U.S. Constitution. Accordingly, the Taxpayers’ claim for refunds for Virginia income tax paid for the 2012 and 2013 taxable years is denied.
The Code of Virginia sections and public documents cited are available on-line in the Laws, Rules and Decisions section of the Department’s website, located at www.tax.virginia.gov. If you have any questions regarding this determination, you may contact ***** in the Department’s Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/779.M