An interesting tax case with implications for beneficiaries of the Virgin Islands Economic Development Program is currently being fought in U.S. Tax Court.  On April 1, 2010, Arthur I. Appleton filed a Petition with the Tax Court to challenge as void the tax assessments leveled against him by the Internal Revenue Service (“IRS”) because, he argued, the assessments were imposed after the expiration of the statute of limitations.

Under Section 932 of the Internal Revenue Code, Virgin Islands residents, like Appleton, are required to pay income tax directly to the Bureau of Internal Revenue (“BIR”), not the IRS, pursuant to the “mirror code”, where the term “Virgin Islands” is substituted for the “United States” in the Internal Revenue Code. Yet, the IRS retains audit and assessment powers. 

Congress also enacted a specific provision directing that if a taxpayer’s income is “derived from sources within the Virgin Islands or income effectively connected with the conduct of a trade or business within the Virgin Islands,” the taxpayer is entitled to certain tax credits pursuant to the Virgin Islands Economic Development Program (“EDP”), which is authorized by 26 U.S.C. § 934.

Mr. Appleton took advantage of the credits available through the Economic Development Program when calculating his income tax liability to the BIR for the tax years 2002-2004.  In 2009, the IRS delivered a notice of deficiency to Mr. Appleton for these tax years, despite the existence of § 6501(a), the three-year statute of limitations on assessments. The IRS has taken the position, pursuant to a “Chief Counsel Advice” memorandum, that the “statute of limitations on assessment in section 6501(a) does not begin to run until a return is filed with the IRS,” not the BIR.

The Government of the Virgin Islands had attempted to intervene in this matter, arguing that a ruling in favor of the IRS on the statute of limitations issue would have a chilling effect on the Territory’s Economic Development Program, as it would leave open to question and subject to audit the tax returns of those taking advantage of the program for an extended period of time.

Though the Tax Court denied the Government’s motion to intervene, the matter was appealed to the United States Court of Appeals for the Third Circuit, which on June 10, 2011 granted the Government of the Virgin Islands’ request to intervene. This matter will now proceed in U.S. Tax Court with the Government as a party.