Tax Type
Corporation Income Tax
Description
Reorganizations: issues related to mergers and acquisitions; Net operating loss deduction permitted
Topic
Computation of Income
Date Issued
08-28-1997
August 28, 1997
Re: § 58.1-1821 Application: Corporation Income Taxes
Dear**********
This will reply to your letter in which you contest an assessment of corporation income tax against your client,***** (the "Taxpayer"), for the taxable years ended December 31, 1994. I apologize for the delay in responding to your letter.
FACTS
The department audited the Taxpayer for the taxable year ended December 31, 1992 through 1994. The auditor eliminated the portion of the net operating loss deduction (NOLD) limited by Internal Revenue Code (IRC) § 382. The adjustment was made because the auditor determined the Taxpayer failed to meet the continuity of business requirements of IRC § 382(c)(1). You contest this adjustment claiming the Taxpayer has satisfied the continuity of business requirements.
DETERMINATION
Virginia income tax laws do not specifically address NOLDs. Virginia allows NOLDs to the extent that they are allowable in computing federal taxable income.
When federal and Virginia income tax returns are prepared on a different basis, federal taxable income must be computed for Virginia tax purposes as if the federal income tax return was filed on the same basis as the Virginia income tax return (including NOLDs). In the instant case, the Taxpayer has been filing as part of a consolidated group for federal purposes but filing separate Virginia income tax returns. Accordingly, in auditing any given taxable year, the department must determine the proper federal taxable income on a separate company basis. Because a net operating loss can affect taxable income in prior and subsequent years, it is proper to examine the amount of this deduction, and if appropriate, make positive or negative adjustments to this amount.
Under IRC § 382, loss carry overs that can be used annually to offset taxable income are subject to limitations when certain types of corporation ownership changes occur. In addition, if a corporation fails to meet the continuity of business requirements, no loss carry overs are allowed. According to Conference Report H.R. Rep. No. 841, 99th Cong., 2d Sess.11-189, the continuity of business requirements applicable to IRC § 382(c)(1) is the same as those for reorganizations under IRC § 368. Treasury Regulation § 1.368(d) provides that a corporation can satisfy the continuity of business requirements by (1) continuing the historic business of the corporation prior to the ownership change, or (2) continuing to use a significant portion of the assets owned by the corporation prior to the ownership change.
In January 1989, the employees purchased the Taxpayer through an employee stock ownership plan (ESOP). Then in March 1991, the ESOP sold a significant portion of their shares to an unrelated third party. The auditor concluded that the Taxpayer violated the continuity of business requirements because its ownership changed twice in three years. Our review of federal tax code and regulations does not support this conclusion.
Based on a review of the facts in this case, the Taxpayer has met the continuity of business requirements pursuant to Treasury Regulation § 1.368(d). Accordingly, the assessment has been abated in full. If you have any questions, do not hesitate to contact***** at ******** .
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/12087O
Rulings of the Tax Commissioner