Delaware State Court Strikes Down NOL Limitation, Presenting Refund Opportunity

Pillsbury Winthrop Shaw Pittman LLP

TAKEAWAYS

  • A Delaware state court struck down as unconstitutional a longstanding policy of the state’s taxing authority limiting NOL deductions of corporate taxpayers who file federal consolidated income tax returns.
  • The Delaware Division of Revenue’s policy, which limited the separately computed NOL deduction a corporate taxpayer could take to the consolidated NOL reported by on its consolidated federal income tax return, violated the Uniformity Clause of the Delaware Constitution.
  • Delaware corporate taxpayers that were impacted by the Division of Revenue’s now-invalid policy should consider whether they may be entitled to a refund.

ADelaware state court invalidated the Delaware Division of Revenue’s policy limiting net operating loss (NOL) deductions for members of federal consolidated groups, holding that the policy violated the Uniformity Clause of the state constitution. Verisign, Inc. v. Director of Revenue, No. N19C-08-093 JRJ (Del. Super. Ct. Dec. 17, 2020). The decision presents a potential refund opportunity for Delaware corporate taxpayers who were members of a federal consolidated group, and for Delaware corporate income tax purposes had their separate-company NOL deductions limited to the group’s consolidated NOL.

Under Delaware law, a corporation that claims a consolidated NOL deduction on its federal consolidated return may claim an NOL deduction for Delaware corporate income tax purposes by computing its NOL on a separate-company basis. However, according to the Division’s now-invalid policy, the corporation’s separate-company NOL deduction was limited to the consolidated NOL claimed on the federal consolidated return. This limitation did not apply if every member of the consolidated group filed a Delaware income tax return.

Verisign, Inc. filed federal consolidated returns and generated NOLs on a separate-company basis. For the tax years 2015 and 2016, the company had NOL carryovers that reduced its federal taxable income to zero. For Delaware corporate income tax purposes, however, the Division limited Verisign’s NOL deduction each year to the consolidated NOL reported by Verisign’s group on its federal consolidated return, which caused Verisign to have taxable income. Verisign challenged the validity of the Division’s policy on multiple grounds, including that it violated the Delaware Constitution’s Uniformity Clause.

The Delaware Superior Court, New Castle County, concluded that the Division’s policy violated the Uniformity Clause of the state constitution because it divided a single group of corporate taxpayers into two different classes—those who filed federal consolidated returns and those who did not—and applied the NOL limitation only to the first class. The court rejected the argument that the Division’s policy should nevertheless be upheld because the classification it created was “reasonable.” Although the Delaware Supreme Court has articulated a “reasonableness test” for determining whether classifications violate the Uniformity Clause, the superior court observed that the test is grounded in the notion that deference should be given to tax classifications created by the legislature. Finding no basis for deferring to a classification created solely by an administrative agency, the court held that the Division’s NOL limitation policy violated the state constitution. One potential issue not addressed by the court is which standard of review applies when classifications created by administrative agencies are challenged under the Uniformity Clause. That issue may be addressed by an appellate court should either party appeal.

The Verisign case presents a potential refund opportunity for any Delaware corporate taxpayers who were members of a federal consolidated group and, based on the Division’s now-invalid policy, had their separate-company NOL deductions limited to the consolidated NOL. The Pillsbury SALT Team will continue to monitor developments in this case.

[View source.]

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.

© Pillsbury Winthrop Shaw Pittman LLP | Attorney Advertising

Written by:

Pillsbury Winthrop Shaw Pittman LLP
Contact
more
less

Pillsbury Winthrop Shaw Pittman LLP on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.