When Connecticut combined-group members that were allocated net operating losses merge into another member, do those NOLs survive so the surviving group can still use them?

Plain-English summary

A Connecticut combined unitary group of four related corporations (A, B, C, and D) generated net operating losses (NOLs) in 2016 and 2017 that were allocated to B, C, and D. In 2020, corporations B and C were merged into corporation D in tax-free reorganizations, leaving D as the survivor. Going forward, A and D would keep filing combined unitary returns together. The group asked: do the NOLs that had been allocated to B and C disappear when B and C merged away, or do they survive so D (or another remaining member) can still use them?

The Department of Revenue Services ruled that the NOLs survive the mergers and may be used by corporation D — or shared with any other member that was in the combined group in the year the loss arose — under Conn. Gen. Stat. § 12-217(a)(4)(A).

The reasoning turns on how combined unitary taxation works. Under Conn. Gen. Stat. § 12-218e(d), a combined group's NOLs are allocated to its taxable members, and members may share their NOLs with each other as long as they were all in the group in the loss year. After the mergers, surviving corporation D simply carries on the combined business activities of former B, C, and D, and A and D still file together — so the income the losses will offset is produced by "substantially the same businesses which incurred the losses." That is the classic test for whether a loss carryover survives a merger.

DRS was careful to distinguish an older Connecticut Supreme Court case, Golf Digest/Tennis, Inc. v. Commissioner (1987), where merged corporations had filed separate returns and the court disallowed the carryover. The difference: here the corporations were always taxed on a combined unitary basis, not separately, so the concern in Golf Digest (averaging one business's pre-merger losses against an unrelated business's post-merger income) simply isn't present.

What this means for you

Corporations and combined groups planning internal mergers

Good news for group restructurings: merging one Connecticut combined-group member into another does not by itself destroy the NOLs that had been allocated to the disappearing members. As long as the losses were generated while the entities were part of the same combined unitary group and the surviving business continues within that group, the allocated NOLs can still be used and shared. This gives groups flexibility to consolidate legal entities without forfeiting Connecticut loss carryforwards.

Tax directors and CPAs

The pivotal fact is combined unitary treatment. This ruling should not be read to bless carryovers where the merged entities filed separate Connecticut returns — that is exactly the Golf Digest situation the Department distinguished and where the carryover was denied. Track which members were in the combined group in each loss year, since sharing under § 12-218e(d) is limited to members that were in the group when the NOL was generated.

Tax attorneys

Note the interplay: the reorganizations were tax-free under IRC § 368, the NOL allocation/sharing mechanics live in Conn. Gen. Stat. § 12-218e(d)(2) and (3), and the carryforward authority is § 12-217(a)(4)(A). The Department applied the Lisbon Shops / Golf Digest "substantially the same business" standard, finding it satisfied because combined-basis taxation means the losses and the later income belong to the same taxed enterprise.

Common questions

Q: If a combined-group member with NOLs is merged away, are the losses lost?
A: Not under these facts. Connecticut ruled the allocated NOLs survive the merger and can be used by the surviving member or shared with other members that were in the combined group in the loss year.

Q: Why did this group keep its losses when the corporation in Golf Digest did not?
A: In Golf Digest the merged corporations filed separate Connecticut returns, so the surviving company's income came from a different, separately taxed business. Here the corporations were always taxed on a combined unitary basis, so the income is produced by substantially the same business that incurred the losses.

Q: Can any group member use the surviving NOLs?
A: They can be used by the surviving member and shared with any other member that was included in the combined group in the year the loss was generated — that "in the group in the loss year" condition is the key limit.

Q: Does this ruling apply to my group?
A: Not automatically. A Connecticut Ruling binds DRS only for the taxpayer and facts it addressed. If your entities filed separately, or the losses arose outside the combined group, the outcome could be different.

Citations and references

Statutes:

• Conn. Gen. Stat. § 12-217(a)(4)(A) (NOL carryforward)
• Conn. Gen. Stat. § 12-218e(d), (d)(2), (d)(3) (allocation and sharing of combined-group NOLs)
• Internal Revenue Code § 368 (tax-free reorganizations)

Administrative guidance and cases:

• Special Notice 2016(1), Combined Unitary Legislation – Corporation Business Tax
• Policy Statement 2008(2), Requests for the Issuance of a Ruling
• Golf Digest/Tennis, Inc. v. Commissioner of Revenue Services, 203 Conn. 455 (1987) (distinguished)
• Lisbon Shops, Inc. v. Koehler, 353 U.S. 382 (1957) ("substantially the same business" standard)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 2022-1

Original ruling text

Ruling 2022-1

CORPORATION BUSINESS TAX

COMBINED UNITARY GROUP

NET OPERATING LOSSES

FACTS:

A Connecticut combined unitary group consists of four taxable members: Corporation A, Corporation B, Corporation C, and Corporation D (the “Combined Group”). The Combined Group has filed a Connecticut unitary corporation business tax return since the income year ending December 31, 2016. Corporation D is a wholly owned subsidiary of Corporation C; Corporation C is a wholly owned subsidiary of Corporation B; and Corporation B is a wholly owned subsidiary of Corporation A.

The Combined Group generated net operating losses (“NOLs”) for combined unitary tax purposes in income years ending December 31, 2016, and December 31, 2017, which were allocated to Corporation B, Corporation C, and Corporation D in both years. 1   These NOLs were reported on the Combined Group’s Connecticut unitary corporation business tax returns for the above years, and have not yet been utilized by any member of the Combined Group. 2

Corporation B and Corporation C were merged into Corporation D during the income year ending December 31, 2020. Corporation D is the surviving entity. Both mergers were treated as tax-free reorganizations for federal tax purposes under Internal Revenue Code section 368.

Subsequent to the mergers, Corporation A and Corporation D will file combined unitary corporation business tax returns together.

ISSUE:

Do the Combined Group’s NOLs that were allocated to Corporation B and Corporation C survive the mergers so that they may be utilized by Corporation D or any other member that was included in the Combined Group in the year of the loss, pursuant to Conn. Gen. Stat. § 12-217(a)(4)(A)?

RULING:

Yes. The NOLs allocated to Corporation B and Corporation C survive the mergers and may be utilized by Corporation D or any other member that was included in the Combined Group in the year of the loss, pursuant to Conn. Gen. Stat. § 12-217(a)(4)(A).

DISCUSSION:

Prior to the mergers, Corporation A, Corporation B, Corporation C, and Corporation D were taxed on a combined unitary basis. 3   Pursuant to Conn. Gen. Stat. § 12-218e(d), Corporations B, C and D were allocated a portion of the NOLs generated by the Combined Group. As they were each a part of the Combined Group that generated the NOLs, Corporations B, C and D were permitted to share their NOLs with each other and with Corporation A on subsequent combined unitary tax returns. 4   As such, any of the four Corporations could utilize the NOLs against their allocated share of the Combined Group’s income.

Following the mergers, Corporation B and Corporation C became a single corporation with Corporation D. As one entity, the business activities of surviving Corporation D are comprised of the collective business activities of former Corporations B, C, and D. Moreover, Corporation A and Corporation D will continue to file combined unitary tax returns together. Thus, the business activities subject to combined unitary tax remain the same both before and after the mergers. By allowing Corporation D to utilize the NOLs allocated to Corporation B and Corporation C or to share such NOLs with Corporation A, the income against which the NOLs will be applied will be generated by substantially the same businesses which incurred the losses. 5

Therefore, where taxable members are allocated a portion of a combined unitary group’s NOLs, and one or more of the taxable members merge with another taxable member of the combined unitary group, those NOLs may continue to be shared and utilized by the surviving taxable members as permitted by Conn. Gen. Stat. § 12-218e(d)(2) and (3). Accordingly, the NOLs allocated to Corporation B and Corporation C survive the mergers and may be utilized by Corporation D or any other member that was included in the Combined Group in the year of the loss, pursuant to Conn. Gen. Stat. § 12-217(a)(4)(A).

RULINGS AND REGULATIONS UNIT

LITIGATION DIVISION

January 18, 2022

1  NOLs incurred by a combined group are allocated to and carried forward by the taxable members. See Conn. Gen. Stat. § 12-218e(d). See also Special Notice 2016(1), Combined Unitary Legislation – Corporation Business Tax, p. 11.

2  Consistent with Policy Statement 2008(2), Requests for the Issuance of a Ruling, the Department has not verified and is not confirming the accuracy of the statement of facts.

3   See Special Notice 2016(1), Combined Unitary Legislation – Corporation Business Tax.

4  Pursuant to Conn. Gen. Stat. § 12-218e(d), a taxable member is permitted to share an NOL with another taxable member so long as they were both members of the combined group in the income year the NOL was generated.

5  The facts in this Ruling are distinguishable from those in Golf Digest/Tennis, Inc. v. Commissioner of Revenue Services, 203 Conn. 455 (1987). In Golf Digest, two corporations filing separate Connecticut corporation business tax returns were merged into the plaintiff corporation. One of the two merged corporations had generated a Connecticut NOL in the income year ending December 31, 1979. The surviving corporation sought to carry this loss forward and claimed operating loss carryovers in income years ending December 31, 1980, and December 31, 1981. The Connecticut Supreme Court denied these carryovers, following the reasoning in Lisbon Shops, Inc. v. Koehler, 353 U.S. 382 (1957), that the income against which a carryover is claimed must have been produced “by substantially the same businesses which incurred the losses.” Id. at 390. Examining the federal treatment of NOLs following a merger, the Court in Lisbon Shops found that there was no indication that the federal provisions “were designed to permit the averaging of the pre-merger losses of one business with the post-merger income of some other business which had been operated and taxed separately before the merger.” Id. at 386-87 (emphasis added). Unlike Golf Digest, Corporations B, C and D were taxed on a combined unitary basis and, therefore, were not taxed separately before the mergers when the NOLs were generated.