Could Virginia residents claim the credit for taxes paid to another state for Canadian federal income tax on wages?

Subject

Out-of-state tax credit is not applicable for the taxes paid to Canada

Plain-English summary

A Virginia resident worked for the Canadian embassy in Washington, D.C. and paid Canadian federal income tax and a Canadian federal surtax on her wages. She and her husband claimed those payments as tax paid to another state on their 2005 Virginia resident return.

Virginia denied the credit. Va. Code § 58.1-332 and 23 VAC 10-110-220 limited the benefit to qualifying income tax paid to another state and expressly excluded tax paid to a foreign country, including Canada and its provinces.

The couple also argued that taxing the same income in Virginia and Canada created impermissible double taxation. The ruling concluded that the cited U.S.-Canada convention applied to specified federal taxes, not Virginia or provincial taxes, and that the risk of double taxation did not invalidate Virginia's authority to tax. The assessment and interest remained due.

What this means for you

• Virginia's credit for tax paid to another state did not include Canadian federal or provincial tax under the rule applied here.
• A bilateral federal tax treaty did not necessarily restrict a U.S. state's income tax.
• This ruling did not decide whether a separate federal foreign-tax benefit was available.

Citations and references

• Va. Code § 58.1-332, credit for qualifying tax paid to another state.
• 23 VAC 10-110-220, exclusion of foreign-country taxes.
• U.S.-Canada Income Tax Convention, art. II(2)(b).
• Guaranty Trust Co. of New York v. Commonwealth of Virginia, 305 U.S. 19 (1938).
• P.D. 96-228 (September 9, 1996).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-39

Original ruling text

April 20, 2007

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessment issued to * (the "Taxpayers") for the taxable year ended December 31, 2005.

FACTS

The Taxpayers, a husband and wife, are Virginia residents who filed a joint Virginia resident income tax return for the 2005 taxable year. The wife is a citizen of both the United States and Canada. During the 2005 taxable year, she worked for the Canadian embassy in Washington, D.C. She paid both Canadian federal income tax and a Canadian federal surtax on the income she earned. On the Taxpayers' Virginia income tax return, they claimed a credit for taxes paid to another state for the taxes paid to Canada.

The Department audited the Taxpayers' 2005 return, and the credit for taxes paid to another state was disallowed. The Taxpayers contest the assessment and contend that the credit should be allowed because the payment of tax to both Virginia and Canada constitutes double taxation.

DETERMINATION

Virginia Code § 58.1-332 allows Virginia residents a credit against their income tax liability when they pay income tax to another state on earned or business income, or on any gain from the sale of a capital asset. The intent of the credit is to grant Virginia residents relief in situations in which they are taxed by both Virginia and another state on these types of income during the same taxable year.

Title 23 of the Virginia Administrative Code (VAC) 10-110-220 provides that the credit "is applicable only to income tax paid to another state and does not apply to taxes paid to any foreign country". As such, the out-of-state tax credit is not applicable for the taxes paid to Canada or any Canadian province.

The Taxpayers contend that Virginia's taxation of the wife's income constitutes double taxation because Canada has already taxed this income. Article II (2)(b) of the Convention Between the United States of America and Canada With Respect to Taxes on Income and on Capital (the "Convention") states in pertinent part. "The existing taxes to which the Convention shall apply are . . . in the case of the United States, the Federal income taxes imposed by the Internal Revenue Code."

Pursuant to this article, the Convention applies only to certain taxes imposed at the federal level by the U.S. and Canadian national governments. Taxes imposed by provincial and state governments, including Virginia, are unaffected by the Convention. See Public Document (P.D.) 96-228 (9/9/1996). In addition, it is well-established policy that the risk of double taxation does not invalidate a taxing sovereignty's right to tax. See Guaranty Trust Co. of New York v. Commonwealth of Virginia , 305 U.S. 19 (1938).

As such, the credit for taxes paid to another state claimed by the Taxpayers on their 2005 Virginia income tax return was properly denied. The Taxpayers should remit payment of the assessed tax and updated interest, as shown on the enclosed schedule, to the Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attn: *. Payment must be made within 30 days of the date of this letter to avoid the accrual of additional interest.

The Code of Virginia section, regulation, and public document cited are available online at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this determination, you may contact * at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1192138395B