By Kathryn Pittman and Timothy Gustafson

The Virginia Tax Commissioner ruled a taxpayer’s licensing arrangements with a subsidiary intangible holding company (IHC) did not meet the unrelated party exception to Virginia’s intangible expense add-back statute. The taxpayer, a national operator and franchisor of fast food restaurants, created the IHC to hold its intangible property and entered into licensing agreements with the IHC for the use of such property. In turn, the taxpayer paid the IHC a 4% royalty based on each franchisee’s or restaurant’s gross sales. The taxpayer also entered into sublicensing agreements with its various franchisees, under which the franchisees paid the taxpayer a percentage of their receipts in exchange for the use of the intangibles. Virginia law provides for an exception to intangible expense add-back if the related member to whom the expenses are paid derives at least one-third of its gross revenues from the licensing of intangible property to persons who are not related members and the transaction giving rise to the expenses was made at rates and terms comparable to rates and terms in licensing agreements with such unrelated persons. After noting the first requirement can be met by the related member’s direct or indirect revenues, the Tax Commissioner examined the second requirement and found that since the IHC did not have any transactions with unrelated parties, no comparable arrangements existed for purposes of the exception. Furthermore, the Tax Commissioner noted that even if the licensing agreement between the IHC and the taxpayer was an indirect agreement between the IHC and the taxpayer’s franchisees, the arrangements between the IHC and the taxpayer and the arrangements between the taxpayer and its franchisees were substantially different and therefore could not form a basis for comparison for purposes of the add-back exception. Va. Pub. Doc. No. 13-239 (Dec. 19, 2013). This is Virginia’s fourth ruling issued in recent months to address application of its add-back statute. For additional coverage, see our previous post, “Unlike Sandals Resorts, Virginia Add-Back Exception Not All-Inclusive.”