Kohl's Dep't Stores, Inc. v. Va. Dep't of Taxation, 803 S.E.2d 336

Background

Kohl’s Department Stores (Delaware) paid large royalties (≈$442M in 2009; $482M in 2010) to an affiliate, Kohl’s Illinois, which holds and licenses intangible IP. Kohl’s deducted the royalties federally; Kohl’s Illinois reported them as income.
Kohl’s Illinois functioned as an intangible holding company (IHC); much of the royalty income was not apportioned to, and therefore not actually taxed by, states where Kohl’s Illinois filed returns.
Virginia enacted an “add-back” statute, Va. Code § 58.1-402(B)(8)(a), requiring corporations to add back intangible expenses paid to related members unless the corresponding income received by the related member is “subject to a tax based on or measured by net income or capital imposed by... another state.”
The Department audited Kohl’s Virginia returns and allowed only a partial subject-to-tax exception corresponding to the portion of royalties actually taxed by other states; it assessed additional tax and interest.
The circuit court granted summary judgment for the Department; the Supreme Court of Virginia reversed in part and remanded to determine precisely what portion of the royalties was actually taxed by other states and therefore excepted from the add-back.

Issues

Issue	Plaintiff's Argument (Kohl’s)	Defendant's Argument (VA Dept. of Taxation)	Held
Whether the subject-to-tax exception applies pre- or post-apportionment	Exception applies pre-apportionment: inclusion of income on related member's returns means it is “subject to a tax,” so no add-back required	Exception applies post-apportionment: only the portion of income actually apportioned and taxed by other states qualifies	Court: applies post-apportionment — only amounts actually taxed by other states fall within the exception
Whether the tax must be paid by the related member to qualify	Not required; statute looks to whether the corresponding item of income is taxed, not who pays	Department: look only to related member’s returns — the related member must be the entity taxed on that item	Court: related member need not be the entity that paid the tax; amounts taxed (even if tax paid by another group member via combined returns or add-backs) qualify
Proper measure of the exception when related-member income appears on combined returns	Kohl’s: royalties apportioned and taxed in combined-return states and add-back states should reduce Virginia add-back	Department: only consider taxes shown on the related member’s separate returns	Court: agree with Kohl’s alternative — include royalties actually taxed in Separate Return, Combined Return, and Addback States when measuring exception; remand to quantify
Deference to Department’s interpretation of ambiguous tax statutes	Kohl’s: statute’s plain meaning favors pre-apportionment or, if ambiguous, resolve in taxpayer’s favor	Department: its construction entitled to great weight when statute is doubtful	Court: statute ambiguous on pre/post apportionment; gives deference to Department for primary issue (post-apportionment), but limits Department’s view on who must pay the tax

Key Cases Cited

Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159 (constitutional limits on state taxation; only apportionable income may be taxed)
Allied-Signal, Inc. v. Dir., Div. of Taxation, 504 U.S. 768 (state may tax apportionable share of multistate income)
Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (four-part test for state tax validity under Commerce Clause)
Department of Taxation v. Delta Air Lines, Inc., 257 Va. 419 (statutory plain-meaning rule)
Webster Brick Co. v. Department of Taxation, 219 Va. 81 (deference to Department interpretation of tax statutes)
Crown Central Petroleum Corp. v. Hill, 254 Va. 88 (legislative intent from statute text)
Verizon Online LLC v. Horbal, 293 Va. 176 (affording great weight to Department interpretation when statute doubtful)