Tax Type
Corporation Income Tax
Description
Merged corporations
Topic
Returns/Payments/Records
Date Issued
03-26-1993
March 26, 1993
Re: Va. Code § 58.1-1821 Application
Dear******************
This will reply to your letter dated September 4, 1991 in which you protest an assessment of corporation income tax made by this department, resulting from an audit of, ***** ("Taxpayer 1 ") and ***** ("Taxpayer 2").
FACTS
The taxpayers were separate, nonaffiliated corporations through 12/31/86, and filed separate Virginia returns and participated in different affiliated groups' consolidated federal returns for that taxable year.
Taxpayer 1 was owned by a foreign parent. On 2/28/87, the foreign parent purchased Taxpayer 2, and immediately merged Taxpayer 1 into Taxpayer 2. A single consolidated federal income tax return was filed for the 12/31/87 taxable year, which contained the two month short year of Taxpayer 1, and the ten month short year of Taxpayer 2 (after merger with Taxpayer 1). An additional short period federal return was filed, which reported the 1987 two month short year of Taxpayer 2.
Two Virginia income tax returns were filed to report the taxpayers' activities. A Virginia return on a separate basis was filed reporting the two months of activity of Taxpayer 1 previous to the merger. An additional Virginia return on a separate basis was filed which reported the activities of Taxpayer 2 for the entire 1987 year, including the periods both before and after the merger with Taxpayer 1.
An audit by the Department resulted in several adjustments to the Virginia income tax liability, four of which you are protesting. In a conversation with a member of my staff, you requested that a fifth issue, relating to intercompany profits in inventory should be excluded from your protest.
RULING
ACRS Subtraction
As of 2/27/87 Taxpayer 1 had an outstanding excess cost recovery balance. "Excess cost recovery" is the excess of ACRS additions reported on returns actually filed for 1982 through 1987, less all ACRS subtractions allowable for 1984 through 1987. You are protesting the Department's disallowance of Taxpayer 1's excess cost recovery balance in the return of Taxpayer 2 for taxable years 1987 through 1992.
Virginia Regulation (VR) 630-3-323 is in effect for taxable years ending on or before 12/31/87, and is the controlling authority for this issue. In general, a corporation surviving a merger may recover, through subtraction, the ACRS additions made by a corporation merged into it. This rule is only applicable to a surviving corporation that would be allowed under federal law to utilize the net operating loss deduction of the corporation merged into it. See VR 630-3-323.D.2.c.
Taxpayer 2 is allowed to subtract the excess cost recovery balance of Taxpayer 1 over the taxable years 1988 through 1997. See 1992 Acts of Assembly, Chapters 296 and 320. Taxpayer 2 would compute the subtraction for Taxpayer 1's previous ACRS additions as if Taxpayer 1 were a separate company. See VR 630-3-323.1, effective for taxable years beginning on and after 1/1/88. Please note that the regulation as written does not reflect amendments by the 1990, 1991 and 1992 sessions of the Virginia General Assembly, which extended the excess cost recovery period.
State and Local Taxes
You are protesting the inclusion of an additional amount of state income taxes as an addition to income for Taxpayer 2 for the 1987 taxable year.
A review of the pre-merger federal income tax return filed for Taxpayer 2 shows an amount of state and local taxes equal to the amount you contest. This adjustment reconciles the state and local taxes reported on the Virginia returns of taxpayers 1 and 2 to the amounts reported on their federal returns. Therefore, the auditor acted properly in adding the amount as shown on your short period federal income tax return. Accordingly, I am denying your request that this amount be excluded.
Net Operating Loss Deduction
Upon audit, it was determined that Taxpayer 2's Virginia income tax return was improperly filed for 1987. The auditor restated Taxpayer 2's results so that two 1987 Virginia short year income tax returns were deemed to be filed, to correspond with the two short period federal returns filed.
The first deemed return, which was for the short year ending 2/87, reflected pre-merger activity and reported a substantial federal net operating loss.
The second deemed return, which was for the remaining ten months in 1987, reflected post-merger activity and reported positive federal taxable income. The Virginia income tax return initially (and improperly) filed for Taxpayer 2 showed a negative federal taxable income, computed by offsetting post-merger activity income with pre-merger activity loss.
In the audit report, the auditor did not carry forward the federal net operating loss from the short period ending 2/87 to the ten month short period. Your letter stated that Taxpayer 2 should be allowed to carry forward the federal net operating loss for Virginia tax purposes, or in the alternative, should be allowed to carry back this loss.
There is no express statutory authority in the Code of Virginia for a separate Virginia net operating loss. However, under Va. Code § 58.1-402 the starting point in computing Virginia taxable income is federal taxable income. The carryback or carryover of a federal net operating loss is reflected in federal taxable income. Therefore, Virginia taxable income is indirectly affected by federal net operating loss rules to the extent that such a loss is reflected in federal taxable income.
Assuming that Taxpayer 2 was a separate company for federal income tax purposes, Internal Revenue Code (I.R.C.) § 381 provides rules for the carryover and carryback of certain tax attributes (including net operating losses) by successor corporations in certain corporation acquisitions. Taxpayer 2 qualifies as an acquiring corporation for I. R.C. § 381 purposes by virtue of the fact that Taxpayer 1 was merged into it. See I.R.C. § 1.381(b)(1). The taxable year to which the net operating losses of Taxpayer 2 may be carried are prescribed in I.R.C. § 172(b)(1). See I.R.C. § 1.381(e)(2).
Taxpayer 2's federal net operating loss is required to be carried back three years and forward fifteen years, unless an election is made to forego the three year carryback period by filing the required statement with the federal return, or with the Virginia return if filed on a different basis than the federal return. See P.D. 88-106 (5/12/88, copy enclosed). See I.R.C. § 172(b)(3). The same treatment is required in order to determine federal taxable income for Virginia purposes. An examination of Taxpayer 2's short year federal return showed no such election. Therefore, the loss was required to be carried back three years. However, the statute of limitations on filing amended returns to claim the loss carryback expired before the audit assessment.
Since Virginia is a federal conformity state, the federal rules, and interpreting case law, are applicable in determining the treatment of a net operating loss carried to the incorrect years on the Virginia income tax return. There are court cases at several judicial levels supporting the concept that some or all of a net operating loss may be foregone if a return is originally filed which improperly carries a loss forward instead of backward, and an additional return to amend this improper treatment is filed after the statute of limitations for the loss year expires. See Ellery Willis Newton 57 T.C. 245 (11/17/71), Byron Weston Co. v U.S., 115 Ct.Cl. 232, and Philip G. Kuehn and Margery Kuehn v U.S., 202 CtCl 473.
The subject matter of the above cases is identical. A taxpayer incurred a federal net operating loss, failed to carryback the loss as required by I.R.C. § 172, and filed an amended return to carryback the loss after the statute of limitations had expired for the loss year. In each case, the taxpayer was denied a deduction for the amount of the loss that should have been carried back for the applicable three year period, and is allowed to use the remaining net operating loss carryforward.
Therefore, if you can provide documentation showing (1) an election to forego the three year carryback election for federal purposes, or (2) insufficient federal taxable income against which to carryback the federal net operating loss, I will allow the federal net operating loss to be carried forward for Virginia purposes, to the extent that a loss remains after removing the amount that should have been carried back.
Please provide such documentation, if available, to the Department's auditor within thirty days of the date of this letter.
Capital losses
As previously discussed, when taxpayers file on a consolidated and separate basis for federal and Virginia purposes, respectively, the federal taxable income of each taxpayer must be restated as if filing on a separate company basis. In this case, the capital losses incurred by the taxpayer were fully deductible on a consolidated basis, but were not deductible on a separate company basis. You request that Taxpayer 2 be allowed to carryforward the capital losses, or alternatively, to carry the losses back.
There is no express statutory authority in the Code of Virginia for a separate Virginia net operating loss. However, under Va. Code § 58.1-402 the starting point in determining Virginia taxable income is federal taxable income. Since capital losses and gains are reflected in federal taxable income, the federal rules for determining capital loss carryforwards and carrybacks are applicable for Virginia.
As with the federal net operating loss deduction, I.R.C. § 1212(a)(1)(A) is explicit in stating that capital losses must be carried back three years, and then forward for five years, subject to certain interactions with the federal net operating loss.
Given the similarity between the federal net operating loss deduction and the capital loss deduction, respectively, it is clear that the same logic should apply in determining the amounts available for carryforward for Virginia income tax purposes. Accordingly, I will allow the carryforward of capital losses (in determining federal income for Virginia purposes) equal to the amount of excess loss remaining after subtracting the amount of capital loss that should have been carried back three years on a separate company basis. Please submit a schedule to the auditor within thirty days of the date of this letter, on which is computed the amount of capital loss carryforward remaining on a separate company basis for Taxpayer 2.
Accordingly, the assessment with respect to the ACRS subtractions is abated. Also, I find that there may be additional information relevant to the audit that should be considered by the auditor. The assessment will be returned to the Interstate Audit Unit so that they may review your information and revise the assessment as appropriate.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/5608G
Rulings of the Tax Commissioner