Does a later acquisition disqualify Virginia's long-term capital-gain subtraction when the original company qualified at the time of investment, and what proof must the investor provide?

Plain-English summary

Virginia's capital-gain subtraction can survive a later acquisition of the original company. P.D. 17-108 explains that Va. Code § 58.1-322 C 35 ties the subtraction to an investment in a qualified business; it does not expressly require the business to remain qualified when the investor later sells the replacement stock.

The taxpayer nevertheless lost at this stage because he did not prove that Corporation A was qualified when he invested. The Department upheld the assessment but gave him one last 30-day opportunity to document either qualification under Va. Code § 58.1-339.4 or approval by the Secretary of Technology.

The transaction and the legal issue

The taxpayer bought Corporation A stock in August 2010. Corporation B acquired Corporation A in May 2011, converting his Corporation A shares into Corporation B shares. He sold the Corporation B shares in 2013 and claimed Virginia's subtraction for qualifying long-term capital gain.

The Department held that the acquisition did not automatically break the required connection to the original investment. What mattered was whether Corporation A qualified when the investment was made.

What the taxpayer still had to prove

Va. Code § 58.1-339.4's quoted requirements included a qualifying technology field, no more than $3 million in annual gross revenue, a principal office or facility in Virginia, substantial Virginia business or production, and no more than $3 million in specified aggregate investment proceeds. Alternatively, the business could qualify through Secretary of Technology approval under the conditions described in Va. Code § 58.1-322 C 35.

The taxpayer supplied neither form of proof after the Department's February 17, 2017 request. Because Va. Code § 58.1-205 presumes an assessment correct, the missing documentation meant the assessment had to be upheld.

What this means for investors

• A merger or acquisition after a qualifying investment is not necessarily fatal to the subtraction.
• Qualification must be established as of the investment date, not merely asserted after the sale.
• Investors should preserve contemporaneous revenue, location, business-activity, financing, and approval records.
• This ruling did not finally grant the subtraction; it allowed a last chance to substantiate it.

Common questions

Did the Department say the acquisition disqualified the gain?

No. It said a later merger or acquisition does not disqualify the investor if the original entity was qualified when the investment was made.

Why was the assessment upheld?

The taxpayer had not shown that Corporation A met Va. Code § 58.1-339.4 or had been approved by the Secretary of Technology.

Was the taxpayer's claim finally denied?

The assessment remained upheld, but the Department gave him 30 days from the ruling date to submit adequate qualification documents for review.

Citations and references

• Va. Code § 58.1-301 — Virginia conformity terminology
• Va. Code § 58.1-322 C 35 — qualifying capital-gain subtraction
• Va. Code § 58.1-339.4 — qualified-business criteria
• Va. Code § 58.1-205 — presumption that an assessment is correct
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Law No. 82-0846 (Roanoke Cir. Ct. Oct. 27, 1983)

Subject

Taxpayer claimed a subtraction for a long-term capital gain resulting from an investment in a qualified technology business without proper documentation.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-108

Original ruling text

June 21, 2017

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 assessments issued to * (the “Taxpayer”) for the 2013 taxable year.

FACTS

The Taxpayer was an officer in a Virginia corporation (Corporation A). He acquired stock in Corporation A in August 2010. Corporation A was purchased in May 2011 by another Corporation (Corporation B) which was located in * (State A). As a result of the purchase, the Taxpayer's shares of Corporation A were converted into shares of Corporation B. In 2013, the Taxpayer sold shares of Corporation B realizing a capital gain. Pursuant to Va. Code § 58.1-322 C 35, the Taxpayer claimed a subtraction for a long-term capital gain on his 2013 Virginia income tax return.

Under review, the Department denied the subtraction because the Taxpayer had not shown that the gains were attributable to investments in a qualified business. The Taxpayer filed an appeal, contending that the long-term capital gain was eligible for the subtraction because it met the statutory requirements.

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 (IRC) 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.

By reason of their character as legislative grants, statutes relating to deductions and subtractions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell's Motor Freight, Inc., et al. v. Virginia Dep't of Taxation , Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983).

Virginia Code § 58.1-322 C 35 provides a subtraction for any income taxed as a long-term capital gain for federal income tax purposes, or any income taxed as investment services partnership income (otherwise known as investment partnership carried interest income) resulting from an investment in a “qualified business.” Pursuant to Va. Code § 58.1-322 C 35, the investment must be made between April 1, 2010, and June 30, 2020, in a “qualified business” as defined under Va. Code § 58.1-339.4 [describing certain technology businesses], or in any other technology business approved by the Secretary of Technology, provided the business has its principal office or facility in the Commonwealth and less than $3 million in annual revenues in the fiscal year prior to the investment. [Insert added.] In order to be a qualified business under Va. Code § 58.1-339.4, an entity must:

be primarily engaged, or is primarily organized to engage, in the fields of advanced computing, advanced materials, advanced manufacturing, agricultural technologies, biotechnology, electronic device technology, energy, environmental technology, information technology, medical device technology, nanotechnology, or any similar technology-related field

have annual gross revenues of no more than $3 million in its most recent fiscal year,

have its principal office or facility in the Commonwealth,

be engaged in business primarily in or do substantially all of its production in the Commonwealth, and

not have obtained during its existence more than $3 million in aggregate gross cash proceeds from the issuance of its equity or debt investments (not including commercial loans from chartered banking or savings and loan institutions).

Under circumstances indicated by the Taxpayer, an investment was made in a qualified business within the required time period. Subsequent to the investment, the qualified business (Corporation A) merged or was acquired by a nonqualified business (Corporation A). As a result, the Taxpayer's investment in Corporation A was converted to shares of Corporation B stock, which were later sold resulting in the gain.

The long-term gain subtraction is tied to income attributable to an investment in a qualified business. The statute contains no express requirement that the business be qualified at the time the stock is sold. Thus, for purposes of the long-term gain subtraction, so long as the entity was a qualified business at the time the investment was made, a subsequent merger or acquisition will not disqualify an investor from claiming the long-term gain subtraction when the stock is later sold.

By letter dated February 17, 2017, the Department requested evidence showing that Corporation A was either a qualified business pursuant to Va. Code § 58.1-339.4 or had been approved by the Secretary of Technology. To date, the Taxpayer has failed to provide the requested documentation.

Virginia Code § 58.1-205 provides that in any proceeding relating to the interpretation of the tax laws of Virginia, an “assessment of a tax by the Department shall be deemed prima facie correct”. As such, the burden of proof is on the Taxpayer to show he was not subject to income tax in Virginia. Without evidence that Corporation A was either a qualified business pursuant to Va. Code § 58.1-339.4 or had been approved by the Secretary of Technology, the assessment must be upheld.

The Taxpayer, however, will be granted one last opportunity to provide adequate documentation with regard to whether Corporation A was a qualified business or a technology business approved by the Secretary of Technology. The documentation should be submitted within 30 days from the date of this letter to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23161-7203, Attention: *. Upon receipt, the documentation will be reviewed and assessment will be adjusted, as appropriate. If the documentation is not received within the allotted time, the assessment will be considered to be correct as issued and collection actions may result.

The Code of Virginia sections cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions 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,

Craig M. Burns

Tax Commissioner

AR/856.B