Indiana Supreme Court Refuses To Apply A Company’s Foreign Source Dividend Deduction To Its NOL Calculations

by Faegre Baker Daniels
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Indiana Supreme Court refuses to apply a company’s foreign source dividend deduction to its NOL calculations

On August 25, 2014, the Indiana Supreme Court issued its decision in Indiana Department of State Revenue v. Caterpillar, Inc., holding that the plain meaning of the Indiana tax statutes prohibited the company from increasing its net operating losses (NOLs) by deducting foreign source dividend income.  The Court first outlined the multi-step process for determining an Indiana corporate taxpayer’s adjusted gross income as follows:  the taxpayer (1) makes “expressly enumerated” adjustments to its federal taxable income based on Ind. Code § 6-3-1-3.5(b); (2) makes additional adjustments based on provisions outside of Section 3.5(b), including the foreign source dividend deduction statute (which allows a corporate taxpayer to deduct a percentage of its dividend income earned from foreign subsidiaries, see Ind. Code § 6-3-2-12(b)); (3) determines how much income is apportioned or allocated to Indiana, using Ind. Code § 6-3-2-2; and (4) applies allowable NOL deductions, relying on a three-step formula found in Ind. Code § 6-3-2-2.6(c).

We previously posted a summary of the Tax Court’s decision here.  In reviewing that decision, the Supreme Court concluded:  “[W]e find that the Indiana NOL statute is unambiguous and thus apply the statutory terms as written . . . .”  Slip op. at 5.  The Court explained that none of the three statutory steps for determining Indiana NOLs reference or incorporate the foreign source dividend deduction.  Slip op. at 6.  The Court therefore would not “apply the [company’s] foreign source dividend deduction to its NOL calculations.”  Slip op. at 10.

The Court also held that the company failed to show that disallowing the deduction discriminates against foreign commerce under the Foreign Commerce Clause of the Federal Constitution.  The company argued that Indiana’s tax statutes facially discriminate against foreign commerce by disallowing the foreign source deduction in the Indiana NOL calculation but incorporating the federal domestic source dividend deduction in that calculation.  All statutes are presumed constitutional, and the company had the burden to overcome that presumption.  Slip op. at 10 (citations omitted).  The company’s argument centered on the United States Supreme Court’s decision in Kraft Gen. Foods, Inc. v. Iowa Dep’t of Revenue & Fin., 505 U.S. 71 (1992), which involved the state tax treatment of foreign source dividend income in calculating taxable income – not NOLs.  Without more, the Court would not “extend the Kraft holding to the NOL context.”  Slip op. at 11.

Procedural Note:  In footnote 2, the Court granted the company’s motion to strike the Department’s affidavit regarding the fiscal impact of the Tax Court’s decision, because the Department did not designate its affidavit before the Tax Court.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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