Could a Virginia resident subtract Canadian and German income after the foreign-source subtraction was repealed?

Subject

Taxpayer appeals the repeal of foreign source income subtraction in 2003

Plain-English summary

Virginia denied a resident's subtraction for income earned in Canada and Germany and upheld the paid 2006 assessment. Virginia starts with federal adjusted gross income, and the General Assembly had repealed the state's subtraction for certain foreign-source income effective for tax years beginning on or after January 1, 2003.

The Commissioner rejected the argument that Canadian and German taxation made Virginia's tax impermissible double taxation. The cited treaties limited their U.S. coverage to federal income taxes and did not restrict taxes imposed by states such as Virginia. The ruling also relied on established constitutional precedent that double taxation of a resident's income does not by itself violate due process or equal protection.

Because the foreign income was included in federal adjusted gross income and no Virginia subtraction applied, the Department properly disallowed the subtraction. The requested refund was denied.

What this means for you

• Virginia residents generally include foreign income that is part of federal adjusted gross income unless a current Virginia modification applies.
• Virginia's former subtraction for certain foreign-source income did not apply to tax years beginning in 2003 or later.
• The Canada and Germany treaties discussed here governed specified federal taxes, not Virginia income tax.
• Paying tax to both a foreign country and Virginia did not by itself invalidate the Virginia assessment.

Common questions

Q: Why was the foreign-income subtraction unavailable for 2006?
A: The General Assembly repealed it effective for tax years beginning on or after January 1, 2003.

Q: Did the treaties with Canada and Germany prevent Virginia from taxing the income?
A: No. The ruling said those treaties' U.S. coverage was limited to federal income taxes and did not affect state taxes.

Q: Did the potential double taxation violate the Constitution?
A: No. The Commissioner cited Supreme Court precedent recognizing a state's authority to tax its residents' income despite taxation elsewhere.

Q: What was the result?
A: The assessment was upheld and the refund request was denied.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322.
• Chapter 980, 2003 Acts of Assembly.
• Convention Between the United States of America and the Federal Republic of Germany, Article 2 (1)(a)(aa).
• Convention Between the United States of America and Canada, Article II (2)(b).
• Guaranty Trust Co. of New York v. Commonwealth of Virginia, 305 U.S. 19 (1938).
• P.D. 96-228 and P.D. 07-39.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-103

Original ruling text

June 18, 2008

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 "Taxpayer") for the 2006 taxable year. I note the assessment has been paid.

FACTS

The Taxpayer, a Virginia resident, subtracted income earned from Canada and Germany on his 2006 individual income tax return. Upon review, the Department disallowed the subtraction and issued an assessment. The Taxpayer appeals the assessment, contending that the income was taxable in the respective foreign countries under federal tax treaties and Virginia's taxation of such income constitutes prohibited double taxation.

DETERMINATION

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code unless a different meaning is clearly required. For individual income tax purposes, Virginia conforms to federal law in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). Income included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Va. Code § 58.1-322.

For many years, Va. Code § 58.1-322 provided individual income taxpayers a subtraction from FAGI for certain foreign source income. However, the General Assembly repealed the subtraction effective for taxable years beginning on and after January 1, 2003. See Chapter 980, 2003 Acts of Assembly .

The Taxpayer contends that Virginia's taxation of the foreign income constitutes double taxation because Canada and Germany have already taxed this income under international tax treaties. The tax treaties with both Canada and Germany include a provision setting forth the taxes to which they apply. Both treaties, in the case of the United States, limit the taxes to which they apply to federal income taxes imposed by the Internal Revenue Code. See Article 2 (1)(a)(aa) of the Convention Between the United States of America and The Federal Republic of Germany and Article II (2)(b) of the Convention Between the United States of America and Canada. As such, these conventions apply only to certain taxes imposed at the federal level by the governments of the United States, Canada, and Germany. Taxes imposed by provincial and state governments, including Virginia, are unaffected by the conventions. See Public Document (P.D.) 96-228 (9/9/1996) and P.D. 07-39 (4/20/2007).

Further, the courts have long recognized that the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event. It is also a long established principle that the risk of double taxation does not violate a taxpayer's constitutional rights. In Guaranty Trust Co. of New York v. Commonwealth of Virginia , 305 US 19 (1938), the United States Supreme Court held that the imposition of an income tax under Virginia laws on income received as beneficiary of trust established in New York did not violate the Due Process Clause of the Constitution, notwithstanding that the trust was also subject to tax in New York. Nor did such treatment deny equal protection under the United States Constitution.

Given the clear precedent established by the courts and the provisions of the treaties, the Department can only conclude that any double taxation of income earned by a resident of Virginia is not prohibited. The power to execute tax treaties with foreign nations rests with the government of the United States. Accordingly, the Commonwealth has not entered into tax agreements with Canada or Germany.

CONCLUSION

Virginia's authority to tax such income of its residents is not prohibited by the United States Constitution or United States tax treaties. The General Assembly, therefore, was well within its authority when it exercised its right to repeal the foreign source income subtraction in 2003. As such, because the foreign source income from Canada and Germany was included in the Taxpayer's FAGI and Virginia's statutes do not permit a subtraction for such income, the Department was correct in disallowing the subtraction on the 2006 income tax return. Accordingly, the assessment issued to the Taxpayer for the 2006 taxable year is upheld. The Taxpayer's request for refund is denied.

The Code of Virginia sections and public documents cited, along with other reference documents, are available on-line 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 * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1994992211.o