Can a company avoid Virginia's add-back of intercompany interest it paid to an affiliate if the loans had a real business purpose?

Plain-English summary

Virginia makes a corporation add back (that is, not deduct) certain interest it pays to a related company when computing its Virginia taxable income. This ruling is a useful example of a taxpayer successfully escaping that add-back by proving a genuine business reason for the payments.

Why the interest was caught by the add-back. The taxpayer, a wholly owned subsidiary, paid interest to its parent under an intercompany loan that was part of the group's centralized cash-management system (subsidiaries deposit their cash with the parent; when a subsidiary is short, the parent advances a loan). Virginia requires adding back intercompany interest that is directly or indirectly connected to transactions involving intangible property (§ 58.1-402 B 9 a; § 58.1-302). Because the parent also collected royalties for affiliates' use of a sister company's intangibles, the cash moving through the system could have been tied to those intangibles — and without a detailed transaction-by-transaction accounting, the Department could not carve out any interest as unconnected. So the interest was subject to the add-back.

How the taxpayer got out of it — the "valid business purpose" exception. Virginia law (§ 58.1-402 B 8 b) lets a taxpayer avoid the add-back if it first reports the addition and pays the tax, then petitions the Commissioner and proves, by clear and convincing evidence, that the related-party transactions had a valid business purpose other than avoiding or reducing tax. The taxpayer cleared that high bar: it showed the centralized cash-management system genuinely pooled cash and cut costs across a very large number of subsidiaries (improving efficiency and profitability), and that the affiliate's matching interest income was taxed in other states — so there was no tax-avoidance motive.

Result: The Commissioner allowed the taxpayer to file an amended return excluding the interest add-back, provided it does so within one year of the ruling date. A win for the taxpayer.

What this means for you

Corporations with related-party (intercompany) loans

If you pay interest to an affiliate and any of it is tied — even indirectly — to intangible property somewhere in your corporate group, Virginia's default rule is that you must add it back. Centralized cash-management/treasury systems are squarely within reach when the same group also moves royalty income around, and the burden is on you to separate connected from unconnected interest.

Businesses relying on the valid-business-purpose exception

The exception is real but demanding. You must (1) file reporting the add-back and pay the tax, penalty, and interest first, then (2) petition and prove a genuine, non-tax business purpose by clear and convincing evidence. Evidence that the structure exists for operational reasons (cost savings, efficiency) — and that the affiliate's corresponding income is actually taxed somewhere — is what carried the day here. If you win, the amended return must be filed within one year of the ruling.

Tax professionals

This is a helpful contrast to the intangible-expense add-back rulings that come out the other way (for example, P.D. 26-10, where no exception applied). Note the mechanics: the § 58.1-402 B 9 a interest add-back is limited by § 58.1-302 to interest connected to intangible-property transactions; the § 58.1-402 B 8 b business-purpose relief is a pay-first, prove-later petition on a clear-and-convincing standard; and evidence that the affiliate's income was taxed by other states helps rebut a tax-avoidance motive.

Common questions

Q: Does Virginia let me deduct interest I pay to my own affiliate?
A: Often not. If the intercompany interest is directly or indirectly connected to transactions involving intangible property, Virginia requires you to add it back to taxable income (§ 58.1-402 B 9 a).

Q: How can I avoid the add-back?
A: Through the valid-business-purpose exception (§ 58.1-402 B 8 b): report the addition and pay the tax first, then petition the Commissioner and show by clear and convincing evidence that the transactions had a real business purpose other than reducing tax.

Q: What convinced the Commissioner here?
A: That the parent's centralized cash-management system genuinely centralized cash and cut costs across many subsidiaries, and that the affiliate's matching interest income was taxed in other states — together showing a real business purpose and no tax-avoidance intent.

Q: I qualify — what do I do now?
A: You may file an amended return removing the interest add-back, but it must be filed within one year of the date of the ruling.

Citations and references

Statutes:

• Va. Code § 58.1-402 B 9 a — corporations must add back intercompany interest expenses and costs
• Va. Code § 58.1-302 — limits the interest add-back to interest directly or indirectly related to transactions involving intangible property
• Va. Code § 58.1-402 B 8 b — valid-business-purpose exception; pay-first petition procedure, clear-and-convincing standard, and one-year amended-return window

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 26-6

Original ruling text

January 26, 2026

Re: Ruling Request: Corporate Income Tax

Dear *:

This will respond to your letter in which you request an exemption for * (the “Taxpayer”) from the requirement to add back intercompany interest expense for the taxable year ended December 31, 2013.

FACTS

For the taxable year at issue, the Taxpayer, a wholly owned subsidiary of * (the “Parent”) paid interest pursuant to an intercompany loan agreement that was part of a centralized cash management system used by the Taxpayer and many other subsidiaries of the Parent. One of these subsidiaries, (the “”), held intangible property. According to the Taxpayer, royalty payments for the use of such intangible property were paid by other affiliates, including the Taxpayer, to the Parent.

The Taxpayer added the interest expense back to federal taxable income for purposes of computing its Virginia taxable income pursuant to Virginia Code § 58.1-402 B 9 a. The Taxpayer subsequently applied to the Department requesting relief from the add-back on the basis that the intercompany loans served a valid business purpose.

RULING

Intercompany Interest Expenses

Virginia Code § 58.1-402 B 9 a requires a taxpayer to add back intercompany interest expenses and costs. For this purpose, Virginia Code § 58.1-302 limits interest expenses and costs to those that are directly or indirectly related or connected to transactions involving intangible property. For example, an interest expense add-back is required when intercompany license fees generated by a corporation holding an intangible asset are used to make loans to related corporations.

The affiliated group’s centralized cash management system required subsidiaries to deposit their cash with the Parent. Depending on what intercompany payments were owed to the Parent, a subsidiary would then either be in a net payable or net receivable position. If it was in a net payable position, the Parent would advance an intercompany loan at a certain interest rate to cover the difference. In this case, the Taxpayer was in a net payable position for the taxable year at issue.

Because the Parent was receiving royalty income from the use of intangibles by other affiliates, at least some of that income could have been used to make intercompany loans. In addition, at least part of the loan being advanced could have been used to pay royalties still owed to the Parent. Without a more detailed accounting of the transactions at issue, the Department is unable to determine what part, if any, of the interest was not directly or indirectly connected to transactions involving intangible property, and thus not subject to the add-back.

Valid Business Purpose

The Taxpayer contends that it should be allowed to exclude the interest expense from the add-back requirement because the intercompany transactions had a valid business purpose other than the avoidance or reduction of tax.

In order to apply to the Commissioner for relief based upon the existence of a valid business purpose, a taxpayer must file its Virginia income tax return reporting the addition in accordance with the statute and remit all taxes, penalties, and interest due for the taxable year. A taxpayer may then petition the Commissioner to consider evidence relating to any transactions between it and related members that resulted in its taxable income being increased. The Commissioner may permit the taxpayer to file an amended return if the application demonstrates by clear and convincing evidence that the transactions resulting in such increase in taxable income had a valid business purpose other than the avoidance or reduction of the tax.

The Taxpayer’s request was made in accordance with the procedure for claiming the business purpose exception from the addition for intangible and interest expenses paid related entities pursuant to Virginia Code § 58.1-402 B 8 b. Accordingly, the question now before the Department is whether the Taxpayer has demonstrated by clear and convincing evidence that the intercompany transactions resulting in the addition to taxable income had a valid business purpose other than the avoidance or reduction of tax due.

The Taxpayer has demonstrated by clear and convincing evidence that its cash-management system had the valid business purpose of managing cash deposits centrally and minimizing costs among a very large number of subsidiaries. Specifically, the Taxpayer has presented evidence that, by consolidating its banking arrangements, it was able to enhance efficiency, decrease costs, and increase profitability. The Taxpayer also demonstrated that the corresponding items of interest income received by the affiliate were subject to tax in other states, and thus there does not appear to have been an intention to avoid tax.

Because the Taxpayer demonstrated that the intercompany loan transactions had a valid business purpose other than the avoidance or reduction of tax due, the Taxpayer may file an amended return excluding the addition of the interest expense paid pursuant to such transactions. Pursuant to Virginia Code § 58.1-402 B 8 b, the amended return must be filed within one year from the date of this ruling.

The Code of Virginia sections cited are available online at law.lis.virginia.gov. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy and Legal Affairs, Tax Adjudication and Resolution Division, at or **.

Sincerely,

Kristin L. Collins
Tax Commissioner
Commonwealth of Virginia

AR/595.X