Virginia’s most significant tax developments 

By Ilya Lipin and Elil Shunmugavel Arasu 

As we approach the middle of 2019, it is important to reflect on recent legislative, administrative, and judicial state tax developments in Virginia. This article will look at some of the most significant developments in the Virginia and discuss their prospective impacts. 

Response to Tax Cuts and Jobs Act of 2017 (TCJA) 

• On Feb. 15, 2019, Virginia Gov. Ralph Northam signed S.B. 1372 and H.B. 2529, updating the state’s conformity to the U.S. Internal Revenue Code (IRC) provisions as of Dec. 31, 2018. The effect and significance of this legislation is as follows:  
• Generally updates conformity retroactively for tax years beginning on or after Jan. 1, 2018. 
• Expands existing subtraction for Subpart F income to comprise any amount included in income under Sec. 951A, global intangible low-taxed income (GILTI) for corporate taxpayers. This subtraction is allowed only if GILTI was “included in and not otherwise subtracted from the federal taxable income.” To prevent double dipping, “taxpayers may report a subtraction equal to the net inclusion of GILTI after taking into account the offset of any deduction under IRC § 250 or any other section of the Internal Revenue Code.” No similar deduction is provided to individual taxpayers. 
• Conforms with the federal business interest limitation under Sec. 163(j). Additionally, for tax years beginning on or after Jan. 1, 2018, the bills provide for an individual or corporate income tax deduction equal to 20 percent of the amount of business interest that is disallowed as a deduction pursuant to the business interest limitation. 
• Expands Sec. 179 small business expensing. 
• Expands the universe of taxpayers who can use the cash method of accounting. 
• Imposes an 80 percent of taxable income limitation on the net operating loss deduction, generally repealing the ability to carry back losses, and providing the ability to indefinitely carry forward losses.
• Repeals the Sec. 199 domestic production activities deduction. 

The bills do not update the state’s nonconformity from the following IRC sections: 

• Sec. 168(k-m), 1400L, 1400N: Bonus depreciation allowed for certain assets 
• Sec. 172(b)(1)(H): Five-year carryback of certain net operating losses (NOLs) generated in taxable years 2008 and 2009 
• Sec. 163(e)(5)(F): Tax exclusions related to income from cancellation of debt 
• Sec. 108(i): Tax deductions related to the application of the applicable high yield debt obligation rules 

Additional information about Virginia’s reaction to TCJA and conformity may be found in recently issued Tax Bulletin 19-1 and Tax Bulletin 17-11. 

Virginia’s cost of performance actually means cost of performance  

In Corp. Exec. Bd. v. Virginia Dept. of Taxn., Va. S. Ct., Dkt. No. 171627, (02/07/2019), the Virginia Supreme Court held that the Virginia Department of Taxation’s use of the Commonwealth’s statutory apportionment formula and cost of performance sourcing methodology of service receipts did not violate the “dormant” Commerce Clause and the Due Process Clause of the U.S. Constitution, and denied the taxpayer’s request to use the alternative apportionment for sourcing its sales.  

Headquartered in Virginia, the taxpayer provided advisory, subscription-based research and executive education services to organizations in 50+ countries. Over 95 percent of the taxpayer’s sales occurred outside Virginia, and less than 5 percent of the taxpayer’s gross revenue came from Virginia. However, based on Virginia’s cost of performance methodology of sourcing service receipts, nearly 100 percent of the taxpayer’s gross receipts were apportioned to Virginia. Such apportionment occurred because the service was developed in the state by Virginia employees, and the product was stored on the servers also located in Virginia. Having most of its property and workforce in the state further increased the taxpayer’s Virginia apportionment formula. Since the taxpayer filed returns in jurisdictions with market-based sourcing methodology, the taxpayer paid tax on a multistate basis on an apportioned amount of income that exceeded 120 percent of its nationwide income. Nevertheless, the court concluded that the taxpayer “did not suffer from an unconstitutional apportionment of its income” and nothing in the jurisprudence interpreting the dormant Commerce Clause or the Due Process Clause requires one of two taxing states to “recede simply because both have lawful tax regimes reaching the same income.”  

The court also upheld the denial of the taxpayer’s request to use the alternative apportionment. The taxpayer argued that the assessments were “inequitable” and offered to recalculate its tax liability by sourcing its sales using the market-based methodology, i.e., customer’s billing address, instead of the cost of performance. Virginia regulation 23 VAC § 10-120-280(B)(4)(b) provides that the statutory method is “inequitable” when “(1) it results in double taxation of the income, or a class of income, of the taxpayer; and (2) the inequity is attributable to Virginia, rather than to the fact that some other state has a unique method of allocation and apportionment.” 

The taxpayer satisfied the first prong of the test because varying apportionment methods used by the states subjected the taxpayer’s income to double taxation. However, the court held the taxpayer failed to meet the second prong because inequitable apportionment causing the double taxation was not attributable to Virginia, which used the cost of performance formula for nearly 60 years, but was attributed to other states that recently adopted market-based sourcing methodology. The court found that the record presented by the taxpayer did not establish whether the other states’ market-based apportionment methods were unique.  

Response to Wayfair 

On June 21, 2018, the U.S. Supreme Court in South Dakota v. Wayfair, 138 S. Ct. 2080 (2018), overturned its rulings in National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), and Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and held that physical presence is no longer a prerequisite for a state to require businesses to collect its sales tax. Since the Wayfair decision, more than 35 states have abandoned the physical presence standard in favor of economic nexus.  

On March 26, 2019, Gov. Northam signed into law H.B. 1722 and S.B. 1083, which provide that effective July 1, 2019, remote sellers are subject to collection and remittance requirements if they meet either of the following criteria: 

• Receives more than $100,000 in gross revenue, or other minimum amount as may be required by federal law, from retail sales in the Commonwealth in the previous or current calendar year, or 
• The seller engaged in 200 or more separate retail transactions in the state in the previous or current calendar year. 

In determining the gross revenues and transaction amounts, sales made by commonly controlled persons, member(s) of the same controlled group of corporations, as defined in IRC Sec. 1563(a) are aggregated.  

The bills also impose sales tax collection requirements on marketplace facilitators, which are defined as “a person that contracts with a marketplace seller to facilitate, for consideration and regardless of whether such consideration is deducted as fees from transactions, the sale of such marketplace seller's products through a physical or electronic marketplace operated by such person.” 

The marketplace facilitator will be deemed to have nexus with Virginia if they meet the following requirements:  

1. Satisfies economic nexus requirements applicable to remote sellers; 
2. Transmits or communicates an offer or acceptance between a purchaser and a marketplace seller; owns or operates the infrastructure, whether electronic or physical, or technology that brings purchasers and marketplace sellers together; or provides a virtual currency that purchasers are allowed or required to use to purchase products from the marketplace seller; 
3. Engages in any of the following activities regarding a marketplace seller’s products: payment processing; fulfillment or storage; listing products for sale; setting prices; branding sales as those of the marketplace facilitator; advertising or promotion; or providing customer service or accepting or assisting with returns or exchanges.  

On May 17, 2019, the Virginia Department of Taxation issued guidelines for the new sales and use tax laws. (See Guidelines for Remote Sellers and Marketplace Facilitators, Virginia Dept. of Taxation, 05/17/2019). 

Takeaway 

In the last six months, Virginia had significant state developments with respect to conformity and non-conformity to TCJA, nexus provisions, and sourcing of receipts. Taxpayers and practitioners should review and understand the applicability of these important recent developments in Virginia to ensure a successful 2019 and beyond.  

Ilya A. Lipin, JD, LLM, MBA is a managing director of state and local tax at BDO USA, LLP in Philadelphia, Pa. Elil Shunmugavel Arasu, JD, LLM is a managing director of state and local tax at BDO USA, LLP in McLean.