Does selling a financial-planning company that uses proprietary spreadsheets and software qualify for Virginia's technology-business capital-gain subtraction?

Plain-English summary

Virginia residents claimed a subtraction for long-term capital gain from an installment sale of their S corporation, a financial-planning and investment-management business. They argued that proprietary computer programs included in the sale made the company an advanced-computing or technology business.

The Commissioner disagreed. A qualified business had to be primarily engaged in, or organized to engage in, a listed technological field. The company used custom spreadsheets, forms, charts, graphs, and other technology in its financial-services business, but using technology did not transform the business's primary activity.

The taxpayers also failed the investment requirement. The relevant date was when the investment that later generated the gain was made, not when the business sale began or installment payments were received. The Department also required qualifying equity or subordinated debt, and the taxpayers produced no evidence of such an investment during the April 1, 2010 through June 30, 2020 statutory period.

The Commissioner upheld the assessment. Financial hardship could be addressed through an offer in compromise based on doubtful collectibility or a payment agreement, not by expanding the subtraction.

What this means for you

Owners of businesses that use proprietary software

Technology must be the business's primary field, not simply a tool used to deliver a conventional service. Ownership of custom software or intellectual property is not enough by itself.

Investors claiming the capital-gain subtraction

Keep evidence of the original investment date and form. The sale date and gain-recognition date do not establish that the underlying investment was qualifying equity or subordinated debt made within the statutory window.

Common questions

Q: Did the company's proprietary programs qualify it as advanced computing?
A: No. The company primarily provided financial-planning and investment-management services and merely used technology in that business.

Q: Is the sale date the investment date?
A: No. The Commissioner looked to when the investment that produced the gain was originally made.

Q: What additional proof was missing?
A: Evidence of qualifying equity or subordinated debt invested during the statutory period.

Citations and references

• Va. Code § 58.1-322.02(24) (long-term capital-gain subtraction and investment window)
• Va. Code § 58.1-339.4 (qualified business)
• Va. Code § 58.1-301 and §§ 58.1-322.01 through 58.1-322.04 (conformity and Virginia modifications)
• P.D. 16-83 (qualifying investment must be equity or subordinated debt)
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation (strict construction of subtractions)

Subject

Qualified Technology Business and Long-Term Capital Gain

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 18-220

Original ruling text

December 28, 2018

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, 2015.

FACTS

A subchapter S corporation (the “Company”) performed financial planning and investment management services. On their 2015 Virginia resident income tax return, the Taxpayers claimed a subtraction for long-term capital gain from an installment sale of the Company. Upon review, the Department denied the subtraction and issued an assessment. The Taxpayers appealed, contending the Company was a technology business, investments in which qualified for the long-term capital gain subtraction.

DETERMINATION

Virginia Code § 58.1-301 provides, with certain exceptions, 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. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . 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 properly 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 Virginia Code § 58.1-322.01 through § 58.1-322.04.

For individual income tax purposes, Virginia Code § 58.1-322.02 24 provides for a subtraction for any income taxed as a long-term capital gain for federal income tax purposes. The following restrictions apply:

To qualify for a subtraction . . . , such income shall be attributable to an investment in a “qualified business,” as defined in 58.1-339.4, or in any other technology business approved by the Secretary of Technology, provided that 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. To qualify for a subtraction . . . , the investment shall be made between the dates of April 1, 2010, and June 30, 2020. No taxpayer who has claimed a tax credit for an investment in a “qualified business” under 58.1-339.4 shall be eligible for the subtraction under this subdivision for an investment in the same business.

To be a qualified business, a business must meet the requirements of Virginia Code § 58.1-339.4. One of the requirements is that the business must be primarily engaged in, or be primarily organized to be engaged in, technological fields such as advanced computing, advanced materials, advanced manufacturing, agricultural technologies, biotechnology, electronic device technology, energy, environmental technology, information technology, medical device technology, or nanotechnology.

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).

The Company performed financial planning and investment management services. When the Company was sold, certain proprietary computer programs that were used in the business were included in the sale. Such programs included custom spreadsheets, forms, charts and graphs. The Taxpayers argue that these proprietary programs qualified the Company as an advanced computing business eligible for the subtraction.

The mere fact that computer programs or other intellectual property are included in a sale of business assets does not mean that the business was primarily engaged in, or was primarily organized to be engaged in, a technological field. Because the use of technology has become so pervasive in the modern business world, virtually any business could claim that it was a technology business using the Taxpayers’ reasoning. The Company, however, was a financial planning and investment management company that happened to use technology just as most modern businesses do. As such, it did not satisfy the statutory definition of a qualified business under Virginia Code § 58.1-339.4.

Even if the Company was a qualified business, the information provided does not indicate that the investment that created the long-term capital gain was made between April 2010 and June 2010. The Taxpayers believe this element is satisfied because the sale of the business was commenced in December 2013 with payments received in both 2014 and 2015. The test, however, is not when the capital gain accrued, it is when the investment that eventually resulted in the capital gain was made. Further, the Department has ruled that the investment must be in the form of equity or subordinated debt to qualify for the subtraction. See Public Document (P.D.) 16-83 (5/16/2016). The Taxpayers have provided no evidence that they made such an investment within the specified time period.

Accordingly, the assessment is upheld. The Taxpayers will receive an updated bill which will include accrued interest to date. The Taxpayers should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest.

If the assessment creates a financial hardship, the Taxpayers may pursue an offer in compromise based on doubtful collectibility. To begin that process, the Taxpayers should complete the enclosed Offer in Compromise Form and Financial Information Statement. The completed form and statement will allow the Department to review and analyze the Taxpayers’ financial situation. Upon completion of that review, a response will be issued to the Taxpayers. The Taxpayers also have the option to request a payment agreement with the Department’s Collections Unit. The Collections Unit may be contacted at (804) 367-8045.

The Code of Virginia sections and public document 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/1860.M