Va. Dep't of Taxation v. R.J. Reynolds Tobacco Co.

Decision Date10 February 2022
Docket Number201263
CourtVirginia Supreme Court


PRESENT All the Justices[1]



In this appeal, we consider whether the calculation of the apportionment of a multistate corporation's Virginia taxable income should include the value of raw materials that age while being stored in Virginia, when those materials are processed and used in manufacturing in another state.


Lorillard Tobacco Company (Lorillard) is a Delaware corporation with its principal place of business in North Carolina.[2] Lorillard is a multistate business that manufactures cigarettes in North Carolina and sells those cigarettes throughout the United States. It engages in business activities within Virginia and maintains warehouses and facilities in Danville, Virginia (the Danville Facilities).

Lorillard purchases leaf tobacco from third-party suppliers and receives the leaf tobacco at its Danville Facilities. The leaf tobacco is stored in the Danville Facilities for an aging period of 13 to 23 months, depending on the type and grade of the leaf tobacco. The aging is a natural process that occurs without human intervention or specialized equipment. Once Lorillard's production and manufacturing team in North Carolina determines that the leaf tobacco has reached the target drying age, it instructs the Danville Facilities to ship the leaf tobacco to North Carolina for processing and manufacturing into cigarettes.

As a multistate corporation, Lorillard earns income from business activities taxable within and without Virginia. The Virginia Department of Taxation (the Department) requires multistate businesses to apportion their income to determine the amount of their income which is taxable in Virginia. The apportionment of a multistate corporation's income requires multiplying the multistate corporation's overall income by a fraction which attempts to capture the percentage of that income produced in Virginia. Multistate corporations, such as Lorillard, must calculate their Virginia taxable income using the Virginia apportionment methodology.[3]Code §§ 58.1-408-409.

For all tax years relevant to this appeal, on its original Virginia corporation income tax returns, Lorillard included the value of its entire leaf tobacco inventory which was aging in its Danville Facilities, in calculating its Virginia property factor. Doing so increased Lorillard's purported Virginia tax liability.

In 2011, for the tax years ending in June 2008, [4] December 2008, and December 2009 (collectively, the First Assessments), Lorillard filed a request with the Department to recalculate the apportionments used in the First Assessments. Lorillard claimed that including the value of its stored leaf tobacco in the property factor resulted in apportionments that overstated the amount of Lorillard's business in Virginia, because the calculation improperly included the value of the leaf tobacco which was stored, but not used in Virginia.

The Department denied Lorillard's request. Lorillard sought reconsideration of the Department's decision. Lorillard also timely filed amended tax returns for the First Assessments, removing the value of all stored leaf tobacco from the property factor; correspondingly, Lorillard requested a refund of $4, 632, 117. The Department denied Lorillard's motion for reconsideration and refused Lorillard's amended tax returns and refund claims.

Consequently, on September 25, 2013, Lorillard filed an "Application for Correction of Erroneous Assessment of Corporation Income Taxes" in the Circuit Court of the City of Danville, challenging the denial of its refund claims. Lorillard sought an order declaring that it is not required to include leaf tobacco, merely stored in Virginia, in its property factor; that the Department's denial of its refund claim was erroneous; and that it is entitled to a refund in the amount of $4, 632, 117, plus interest.

In its application, Lorillard asserted that Code § 58.1-409 does not require it to include the leaf tobacco in its property factor because the stored leaf tobacco is not "used" by Lorillard during the taxable year. Lorillard also asserted that its leaf tobacco is analogous to property under construction and to mineral rights, both of which are specific types of property that a Department regulation, 23 VAC § 10-120-160(A)(4) (the Regulation), deems as property that is not being "used."[5]

While Lorillard's application concerning the First Assessments was pending before the circuit court, Lorillard filed amended tax returns and refund claims regarding the Department's tax assessments for the tax years ending in December 2010, December 2011, and December 2012 (collectively, the Second Assessments). In its amended tax returns, Lorillard removed the value of the leaf tobacco stored at its Danville Facilities from the property factors used to determine its income tax liability. Lorillard requested a refund of $6, 389, 390, based upon the amended Second Assessments tax returns. The Department did not timely respond to Lorillard's filing of the refund claims. Thus, by operation of Code § 58.1-1823, the Second Assessments refund claims were deemed denied.

On August 31, 2017, Lorillard filed a second "Application for Correction of Erroneous Assessment of Corporation Income Taxes" in the Circuit Court of the City of Danville, challenging the denial of its refund claims for the Second Assessments. Lorillard's second application raised arguments identical to the first application, and asserted that it was entitled to an additional refund in the amount of $6, 389, 390, plus interest.

The circuit court consolidated Lorillard's first and second applications and heard Lorillard's arguments concerning the First Assessments and the Second Assessments (collectively, the Years in Issue) together.

Lorillard's first witness was Dennis Juan Burge, a former product development manager for Lorillard. He testified that the operations at the Danville Facilities merely received shipments of boxed leaf tobacco and kept the stacked boxes of leaf tobacco in storage until the boxes are shipped to Lorillard's North Carolina processing and manufacturing facilities. Burge stated that, once stored, "absolutely nothing" is done to the boxed leaf tobacco; "[i]t just sits there." He said that the leaf tobacco ages under ambient temperatures and weather-Lorillard does not need to introduce temperature controls, heat, or air conditioning. Burge also testified that the leaf tobacco is never processed into cigarettes in the same year that the leaf tobacco is purchased.

Lorillard also called Dr. Anthony Gerardi, a former employee of R.J. Reynolds Tobacco Company, who explained that during the aging process the leaf tobacco's chemicals undergo a naturally occurring equilibration process which results in uniformity in each leaf tobacco strip's flavor. He explained that this aging process is accomplished by storing the dried-down leaf tobacco in stacked boxes in a moist environment.

Lorillard's third, and final, witness was Patrick Z. Messick, who held the position of Director of Income Taxes at Lorillard. Messick explained that the only difference between the original tax returns and the amended returns for the Years in Issue was that in the amended returns, the value of the leaf tobacco inventory in the Danville Facilities was removed from both the numerator and denominator of the property factor.

After Lorillard's case-in-chief, the Department noted that the documents it previously submitted to the circuit court were submitted pursuant to a stipulation, and that it had no additional evidence to present. The parties submitted post-trial briefs in lieu of making closing arguments.

In its subsequent letter opinion, the circuit court found that Lorillard had not "used" the leaf tobacco as that term is employed in Code § 58.1-409, and that the value of the stored leaf tobacco, therefore, should not be included in determining Lorillard's Virginia corporation income tax liability.

It found that the evidence that Lorillard's manner of storing the leaf tobacco is not necessary to the aging process was uncontroverted, and it concluded that the simple placement of the leaf tobacco into the warehouse did not constitute "use" of the tobacco, as alleged by the Department. The circuit court held that the plain meaning of "used," i.e., "to employ for the accomplishment" of a purpose or "to avail oneself of," did not support the Department's interpretation and application of the Code. It observed that it "requires logic gymnastics" to see "how Lorillard's simple placement of the leaf tobacco into [the Danville Facilities] constitutes use" because the record does not show that the aging process is prompted or initiated as a result of the leaf tobacco's entry into and storage at the Danville Facilities.

Although both the Department and Lorillard claimed that analogies to the examples stated in the Regulation supported their interpretation of Code § 58.1-409, the circuit court concluded that, absent ambiguity, recourse to the Regulation's interpretation of the term "used" was unnecessary because the plain language of the Code controls. Further, it held that upon a plain reading of the aspect of the Regulation cited by the parties, in relevant part, the Regulation was not applicable in this instance. The circuit court noted that it "render[ed] no opinion on whether the [R]egulation is plainly inconsistent with [Code § 58.1-409] in all circumstances," but opined that to the extent that the Regulation requires Lorillard to include the value of the...

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