Can a Virginia taxpayer add previously unreported net Virginia modifications to a net operating loss carryforward after the loss years are closed, and does the unrelated-member exception excuse the related-party royalty add-back?

Plain-English summary

This appeal packs together two separate Virginia corporate-tax problems for a franchise group. The taxpayer is the corporate owner of a multi-tiered pass-through structure: at the bottom are limited partnerships (LPs) that run national chains of service-provider stores (both company-owned and franchised) and license the group's trademarks from an affiliated entity (call it the "IP affiliate"). The taxpayer added back 100% of the intercompany royalties on its Virginia returns and claimed no exception at the time. Separately, it had a 2003 net operating loss (NOL) it carried forward. On appeal it sought a refund for 2008–2011. The Commissioner denied everything. Here are the two issues:

Net operating loss modifications — claimed too late

On audit, the Department found the taxpayer had not properly elected to forgo the two-year carryback of its 2003 NOL, so the loss was carried back and used up in 2001 and 2002 — shrinking the carryforward available for later years and producing extra tax for 2008 and 2009. On appeal, the taxpayer wanted to add net Virginia modifications it had never reported on its original 2004–2007 returns, carrying them forward with the losses to cut the later-year tax.

The problem was timing. Under Va. Code § 58.1-1823 you generally have three years to file an amended return, and § 58.1-1824 gives three years from assessment to file a protective refund claim. For self-assessed years (returns the taxpayer filed itself), the clock is the same. The last day to amend any of the 2004–mid-2007 years was October 15, 2011, but the taxpayer didn't ask until April 2012 — too late.

The Commissioner explained the governing rule: net Virginia modifications follow the NOL deduction proportionally (23 VAC 10-120-100 B 5 (iii)) — if 50% of a loss is used in a year, 50% of the modifications go with it. But unlike the loss deduction itself (which flows from federal taxable income and so must be corrected to conform to the IRC under § 58.1-301 even in closed years), the modifications don't change federal income. So once the statute of limitations on the loss year closes, the only adjustment allowed is changing the percentage of modifications to match the loss deduction actually used — you cannot add new additions or subtractions you never reported.

Unrelated-member exception — failed on the second prong

Virginia makes companies add back intangible expenses (like royalties) paid to related members and deducted federally (Va. Code § 58.1-402 B 8). The taxpayer's protective claim invoked the unrelated-member exception (§ 58.1-402 B 8 a 2), arguing the IP affiliate indirectly earned over one-third of its revenue from independent franchisees.

The exception has two prongs: (1) the related member earns at least one-third of gross revenue from licensing to unrelated parties, and (2) the intercompany terms are comparable to the terms of the related member's agreements with unrelated parties. Even accepting the Wendy's International circuit-court reading that indirect licensing can satisfy the one-third test, the second prong sank the claim: the IP affiliate had no agreements with any unrelated third party for the Department to compare against. And the terms weren't comparable anyway — the franchisees' agreements with the LPs bundled far more than a trademark license (business operations, accounting, uniforms, insurance, confidentiality, training, non-competes, marketing, advertising), the affiliate's licenses to the LPs covered only trademark use, and the royalty rates ran on different bases and percentages. So the exception failed and the royalties had to be added back.

Bottom line: the refund for 2008–2011 is denied. The late modification adjustment is barred by the statute of limitations, and the unrelated-member exception doesn't apply.

What this means for you

Companies carrying NOLs across years

If you want net Virginia modifications to travel with a loss carryforward, report them on the original return for the loss year — and watch the clock. Once the amend window on the loss year closes (generally three years), you can adjust only the proportion of already-reported modifications to match how much of the loss you actually use; you cannot go back and add modifications you never claimed. Also make the two-year-carryback forgo election correctly, because a misfired election can force your loss backward into earlier years and quietly reduce the carryforward you were counting on.

Franchise and IP-holding structures

Expect Virginia to add back royalties you pay a related trademark affiliate. The unrelated-member exception is a two-part test, strictly construed against the taxpayer. It is not enough that unrelated franchisees ultimately fund the royalty stream — the related member generally needs actual, comparable licenses with unrelated parties the Department can examine. Bundled franchise agreements (which cover operations, training, insurance, advertising, and more) are usually not comparable to a bare trademark license, and different rate bases defeat comparability.

Tax professionals

This determination is useful for two propositions at once: the mechanics of carrying Virginia modifications with an NOL after the loss year has closed (percentage-only adjustments under 23 VAC 10-120-100 B 5 (iii)), and the Department's continued insistence on the second ("comparable rates and terms") prong of the unrelated-member exception, narrowing the broader Wendy's reading.

Common questions

Q: I forgot to report Virginia modifications with an old loss year — can I add them now on the year I use the loss?
A: Not once the loss year is closed under the statute of limitations. You can only change the percentage of already-reported modifications to match the loss deduction you actually use; you can't add previously unreported additions or subtractions.

Q: How long do I have to amend or file a protective claim?
A: Generally three years — to amend a return under Va. Code § 58.1-1823, or to file a protective refund claim under § 58.1-1824 (three years from the date of assessment). For self-assessed years the date of assessment is essentially when you filed/paid, so the deadlines line up.

Q: My related trademark company's revenue really does come from unrelated franchisees. Doesn't that meet the unrelated-member exception?
A: Only if the related member also has comparable licensing terms with unrelated parties for the Department to examine. Here the affiliate had no unrelated-party agreements at all, and the franchise terms weren't comparable to its bare trademark license, so the exception failed.

Q: Was any part of this a win for the taxpayer?
A: No. Both the late-modification argument and the unrelated-member exception failed, and the refund for 2008–2011 was denied.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-402 B 8 — add-back of intangible expenses and costs paid to related members
• Va. Code § 58.1-402 B 8 a 2 — unrelated-member exception (one-third unrelated licensing and comparable rates and terms)
• Va. Code § 58.1-1821 — application to the Tax Commissioner for correction of an assessment
• Va. Code § 58.1-1823 — three-year window to file an amended return
• Va. Code § 58.1-1824 — protective claim for refund (three years from assessment)
• Va. Code § 58.1-1820 — definition of the date of assessment (including self-assessments)
• Va. Code § 58.1-1812 — statute of limitations for assessments
• Va. Code § 58.1-301 — Virginia terminology conforms to the Internal Revenue Code unless a different meaning is required
• 23 VAC 10-120-100 B 5 (iii) — net Virginia modifications follow the NOL deduction proportionally

Case law and prior documents (described here rather than linked): Wendy's International v. Virginia Dep't of Taxation, CL09-3757 (Richmond Cir. Ct. 2012) (indirect licensing can satisfy the one-third test, overruling P.D. 09-14); Howell's Motor Freight (exemptions strictly construed against the taxpayer); Platt v. Union Pacific R. Co., 99 U.S. 48 (1878) and PSINet, Inc. v. Chapman, 362 F.3d 227 (4th Cir. 2004) (avoid interpretations that render statutory language superfluous); and Department determinations P.D. 09-14, 94-154, 08-193, 13-213, and 24-8 (cited by the taxpayer for adjusting NOLs in years outside the assessment-limitations period).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 26-8

Original ruling text

February 24, 2026

Re: § 58.1-1821 Application: Corporate Income Tax

Dear *:

This will reply to your letter in which you seek a refund of corporate income taxes paid by * (the “Taxpayer”) for the taxable years ended December 31, 2008, through 2011.

FACTS

For the taxable years at issue, the Taxpayer filed consolidated federal and separate Virginia corporate income tax returns. On its Virginia returns, the Taxpayer added back intercompany royalty expenses to federal taxable income for purposes of computing its Virginia taxable income. These expenses had been passed through to the Taxpayer, which was a corporate owner of a multi-tiered pass-through entity structure, the bottom tier of which included partnerships (LPs) that had entered into licensing agreements with an affiliated entity (“***”) for the use of its trademarks. The LPs operated national chains of service providers through both company-owned and franchised stores. The Taxpayer did not claim any exception to the add-back. In addition, the Taxpayer reported a net operating loss (NOL) in the 2003 taxable year that it carried forward and utilized to claim a net operating loss deduction (NOLD) against federal taxable income (FTI) for the 2008 and 2009 taxable years.

Under audit, the Department concluded that the Taxpayer had failed to properly make an election to forgo the two-year carryback for the NOL incurred in 2003. As such, the 2003 NOL was carried back two years and fully utilized in the 2001 and 2002 taxable years. This adjustment had the effect of reducing the Taxpayer’s accumulated NOLD carryforward available for taxable years subsequent to 2003. Such carryforward, as reduced, was applied in full for the 2008 taxable year, and no carryforward remained to be applied for the 2009 taxable year. Further, Virginia modifications that had been reported along with the NOLs for the 2004 through 2006 taxable years and for the first part of the 2007 taxable year (a short year for filing purposes) were applied proportionally along with the NOLD carryforwards for the second 2007 short taxable year and the 2008 taxable year. As a result of these NOLD-related adjustments, the Taxpayer was assessed additional tax due for each of the 2008 and 2009 taxable years.

The Taxpayer paid the assessments and appealed, contending that it should be permitted to adjust the net Virginia modifications carried forward with the NOLs incurred in the 2004 through 2007 taxable years even though it did not claim such modifications on its original returns for those years. It also filed a protective claim for refunds of corporate income taxes paid for the 2008 through 2011 taxable years claiming that it was eligible for an exception to the add-back of the royalties because *** indirectly received at least one third of its intangible licensing revenue from independently-owned franchisees.

DETERMINATION

Protective Claim

Pursuant to the authority granted the Department under Virginia Code § 58.1-1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Virginia Code § 58.1-1821. As permitted by statute, the Taxpayer’s request has been treated as an application for correction under Virginia Code § 58.1-1821.

Timeliness of Request to Adjust Modifications

Pursuant to Virginia Code § 58.1-1823, taxpayers generally must file amended returns within three years of the last day prescribed by law for timely filing of the return. Virginia Code § 58.1-1823 also provides certain exceptions to the general rule that are not relevant in this case.

In addition, Virginia Code § 58.1-1824 provides that “[a]ny person who has paid an assessment of taxes administered by the Department of Taxation may preserve his judicial remedies by filing a claim for refund with the Tax Commissioner . . . within three years of the date such tax was assessed.” The date of assessment for assessments made by the Department is the date the notice of assessment is delivered, and for self-assessments made by a taxpayer upon filing a return is the date the tax is paid or the return is filed. See Virginia Code § 58.1-1820 2. For self-assessments where the return is filed or the tax is paid before the last day prescribed by law for filing or payment, the date of assessment is such last day. Id .

In April 2012, in response to the audit staff’s proposed adjustment to its NOLDs, the Taxpayer requested that the Department take into account previously unreported net Virginia modifications for the 2004 through 2006 taxable years and for the first short return part of the 2007 taxable year. Under the general rule, the last day to file an amended return for any of those years was October 15, 2011, three years after the due date for the taxable year ended July 24, 2007.

Each assessment for the 2004 through 2006 taxable years and for the first short return part of the 2007 taxable year was a self assessment made with the original or amended return filed by the Taxpayer. Accordingly, the last day for filing a protective claim for any of those assessments was the same as the date for filing an amended return under Virginia Code § 58.1-1823.

The Taxpayer’s request to take into account the modifications was made in April 2012, after the statute of limitations to file an amended return or a protective claim for those years had expired.

Modification Carryback and Carryforward

The Taxpayer contends it should be permitted to adjust net Virginia modifications for the 2004 through 2006 taxable years and for the first short return part of the 2007 taxable year to claim an exception to the add-back of royalties and a deduction of foreign source income attributable to years prior to the audit period even though the request was untimely.

The Taxpayer believes such treatment is appropriate because the Department has found it proper to examine NOLs for taxable years outside the limitations period for assessments under Virginia Code § 58.1-1812 and make positive or negative adjustments to the amount of the available NOL. See Public Document (P.D.) 94-154 (5/23/1994), P.D. 08-193 (12/4/2008), P.D. 13-213 (11/18/2013), and P.D. 24-8 (2/28/2024).

Virginia income tax laws do not address carryover deductions, including NOLDs, capital losses, and charitable contributions. Nonetheless, Virginia Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the Internal Revenue Code (IRC), unless a different meaning is clearly required. Because the starting point in computing Virginia taxable income is FTI, Virginia allows a NOLD to the extent that it is allowable in computing FTI. For taxable years open under the statute of limitations for assessments, the amount of any federal carryover deductions used to determine FTI must conform to the IRC as it applies to the Virginia taxpayer. Thus, adjustments to the amount of a NOLD are required in order to ensure that a taxpayer’s FTI reported for a taxable year within the statute of limitations conforms to the IRC in accordance with Virginia Code § 58.1-301.

Pursuant to Title 23 of the Virginia Administrative Code (VAC)10-120-100 B 5 (iii), net Virginia additions and subtractions (net Virginia modifications) reported for a taxable year in which an NOL occurred must follow the NOL to the year a NOLD is claimed and must be reported to the same extent as the NOLD. For example, if 50% of a NOLD is carried forward to a taxable year, then 50% of the net Virginia modifications will also be carried to the same taxable year.

Unlike a NOLD, however, net Virginia modifications that follow the NOLD do not impact the FTI for the taxable year to which they are carried. Thus, once the statute of limitations to file an amended income tax return for the taxable year in which the NOL occurred has expired, no adjustments can be made to the additions and subtractions that are included in the net Virginia modifications. The only adjustment that can be made to net Virginia modifications would be to change the percentage of the modifications claimed to correspond proportionally with the amount of a NOLD used to reduce FTI.

Unrelated Member Exception

The Taxpayer filed Schedule 500AB with its original 2008 through 2011 Virginia corporate income tax returns, adding back 100% of the royalties deducted on its federal income tax returns. The Taxpayer requests a refund of corporate income taxes paid on the basis that it is entitled to an exception to the add-back because *** indirectly received more than one-third of its gross revenues from the LPs’ independently owned franchisees.

Virginia Code § 58.1-402 B 8 provides that there shall be added back:

[T]he amount of any intangible expenses and costs directly or indirectly paid, accrued, or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with one or more related members to the extent such expenses and costs were deductible or deducted in computing federal taxable income for Virginia purposes.

The statute provides several exceptions to the general rule that an add-back is required. The exception at issue is Virginia Code § 58.1-402 B 8 a 2, which states:

This addition shall not be required for any portion of the intangible expenses and costs if one of the following applies: . . . (2) The related member derives at least one-third of its gross revenues from the licensing of intangible property to parties who are not related members, and the transaction giving rise to the expenses and costs between the corporation and the related member was made at rates and terms comparable to the rates and terms of agreements that the related member has entered into with parties who are not related members for the licensing of intangible property.

In Public Document (P.D.) 09-14 (2/4/2009), the Department determined that the licensing agreements for the use of intangible property must be between an unrelated party and the related entity that owns the intangible property. As such, the exception for licensing at least one third of its gross revenues to an unrelated member was not met in that case because the related member did not receive the intangible property revenue directly from the unrelated franchisees.

The City of Richmond Circuit Court, however, overruled P.D. 09-14 in Wendy’s International v. Virginia Department of Taxation , CL09-3757 (3/29/2012). The court held that the exception merely requires that the related member derive at least one third of its gross revenues from the licensing of intangible property to parties that are not related members because the statute does not distinguish as to whether the gross revenues were directly or indirectly licensed to an intangible holding company. Therefore, the exception could be claimed when intangible holding companies indirectly license intangible property to independent franchisees through operating companies.

However, Virginia Code § 58.1-402 B 8 a 2 also requires that:

the transaction giving rise to the expenses and costs between the corporation and the related member was made at rates and terms comparable to the rates and terms of agreements that the related member has entered into with parties who are not related members for the licensing of intangible property. [Emphasis added.]

The City of Richmond Circuit Court’s decision in Wendy’s did not analyze whether this second statutory requirement was met. The language of Virginia Code § 58.1-402 B 8 a 2 requires an examination of the terms of the agreements “that the related member has entered into with parties who are not related members.” The statute thus clearly anticipates that there will be contracts directly between the related member and an unrelated member available for the Department to examine.

By reason of their character as legislative grants, statutes relating to exemptions 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, No. 82-0846 (Roanoke Cir. Ct. Oct. 27, 1983). In addition, it has been a longstanding principle of statutory construction that every part of a statute should be interpreted so as to give it some effect, and that interpretations that render words or phrases in a statute superfluous or repetitious should be avoided. See Platt v. Union P.R. Co. , 99 U.S. 48, 58-59 (1878) and PSINet, Inc. v. Chapman, 362 F.3d 227, 232 (4th Cir. 2004). The court’s determination in Wendy’s effectively renders superfluous the language of Virginia Code § 58.1-402 B 8 a 2 that requires an examination of the terms of the agreements “that the related member has entered into with parties who are not related members.”

In this case, ’s gross license revenue was derived from royalties paid by unrelated third-party franchisees through the LPs. *** does not have any agreements with any unrelated third parties. Under such circumstances, the specific language of the statute was not met because , the related member, did not have any contracts with unrelated members, the terms of which the Department could review.

Even if the court’s opinion in Wendy’s is interpreted to mean that licensing agreements between the LPs and franchisees were indirect agreements between *** and the franchisees, the rates and terms would not be the same. The franchisees’ agreements with the LPs incorporated a license of intangible assets with terms for business operations, accounting, uniforms, insurance, confidentiality, training, covenants not to compete, marketing, and advertising. ***’s agreements with the LPs were limited to the licensure, maintenance, and protection of tradenames and trademarks. Further, while the franchise agreements acknowledged *** as the owner of the trademarks, the franchise agreements did not specify a royalty rate. Instead, the franchisees were required to pay the LPs a franchise fee based on a percentage of total revenue. The LPs then paid a royalty based on a percentage of revenue that was realized by the franchisees, which was a different percentage from the rate paid for company-owned stores.

In addition, the licensing agreements granted the LPs certain powers over the use and protection of the trademarks not granted to the franchisees. Under the agreements, the LPs were permitted to allow franchisees to use ***’s trademarks. None of the franchisees were granted similar rights or privileges with regard to the trademarks.

As stated above, Virginia Code § 58.1-402 B 8 a 2 requires that the rates and terms between a taxpayer and related member be comparable to the rates and terms between the related member and unrelated third parties. Not only does *** not have agreements with independent franchisees, based on the evidence provided, the rates and terms of the trademark licensing agreements between *** and the LPs were substantially different from the LPs’ franchise agreements with the independent franchisees. Accordingly, the Taxpayer does not meet the unrelated member exception under Virginia Code § 58.1-402 B 8 a 2.

CONCLUSION

For the reasons discussed above, the Taxpayer could not carry previously unclaimed modifications forward from the 2004 through the first 2007 short taxable year because such years were outside the statute of limitations for assessment. In addition, it did not meet the unrelated member exception under Virginia Code § 58.1-402 B 8 a 2 and therefore was required to add back the royalty expenses as reported on its original Virginia corporate income tax returns. Accordingly, Taxpayer’s request for refunds of corporate income tax paid for the taxable years ended December 31, 2008, through 2011, is denied.

The Code of Virginia sections and regulation cited are available online at law.lis.virginia.gov . The public documents cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, 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/524.X

Related Documents

94-154

08-193

09-14

13-213

24-8