Do a surviving corporation's pre-merger Connecticut net operating loss carryovers survive an ownership-change merger, free of the federal Section 382 limit?

Plain-English summary

A purchaser acquired a holding company (which, with its subsidiaries, files a combined Connecticut corporation business tax return) through a reverse triangular merger: the purchaser formed a new subsidiary ("Newco"), then merged Newco into the holding company, so the holding company survived and became the purchaser's subsidiary. For federal purposes this was treated as a taxable purchase of the holding company's stock. The holding company and its subsidiaries kept running the same businesses and carried pre-merger operating loss carryovers. The question: can those losses still be deducted after the ownership change — and does the federal § 382 loss-limitation apply?

DRS said the losses survive, and § 382 does not apply. Connecticut's corporation business tax (§ 12-217(a)) turns an excess of deductions into an operating loss carryover deductible in each of the five following income years, and § 12-223a lets an affiliated group file a combined return. Key points:

• Merger, not consolidation. In a merger, one company absorbs another and keeps its own identity; a consolidation creates a brand-new entity and terminates the old ones (§ 33-481). Here the holding company survived as the same entity, so it simply carries forward its own pre-merger losses. Nothing in § 12-217 prohibits that.
• The combined group's losses survive too. Because the merger didn't make the subsidiaries disappear, the combined group's pre-merger combined operating loss carryovers are unaffected and remain deductible (subject to § 12-223a and its regulations).
• § 382 is not incorporated. Federal law limits loss carryforwards after a substantial ownership change (26 U.S.C. § 382), but Connecticut's § 12-217 does not adopt § 382. So the ownership change doesn't cap the Connecticut losses.
• A name change doesn't matter. DRS declined to follow the federal notion (26 U.S.C. § 368(a)(1)(F)) that changing a corporation's name changes its "identity."
• Golf Digest distinguished. Golf Digest/Tennis v. Dubno barred a newly-created consolidated corporation from deducting a pre-consolidation loss of one of its members. That's a consolidation rule and is inapposite to a merger where the loss corporation itself survives.

This Ruling is later cited in Ruling 97-3.

What this means for you

Acquirers structuring deals with valuable NOLs

In Connecticut, a merger in which the loss corporation survives generally lets that corporation keep deducting its pre-merger net operating loss carryovers — and, unlike federal law, without a § 382 ownership-change haircut, because § 12-217 doesn't incorporate § 382. That can make a surviving-entity merger structure meaningfully more favorable for Connecticut losses than the federal treatment implies.

Merger vs. consolidation is decisive

The result hinges on survival of identity. A merger (one entity absorbs another and continues) preserves the survivor's losses; a consolidation (a new entity replaces the old ones) can lose the pre-consolidation carryovers under Golf Digest. Structure and document the transaction with that distinction in mind.

Combined filers

If the loss corporation is part of a combined group whose members don't disappear in the merger, the group's combined loss carryovers can survive too — subject to the § 12-223a combined-return rules. And don't worry about a mere name change of a subsidiary; Connecticut doesn't treat that as a change in identity.

Common questions

Q: Does an ownership-change merger wipe out Connecticut net operating loss carryovers?
A: No, when the loss corporation is the surviving entity in a merger. Its pre-merger carryovers survive and are deductible under § 12-217, and Connecticut doesn't apply the federal § 382 limitation.

Q: Why doesn't the federal Section 382 limit apply?
A: Because Connecticut's § 12-217 does not incorporate 26 U.S.C. § 382. The federal ownership-change loss limitation simply isn't part of the Connecticut operating-loss rules.

Q: What about the combined group's losses?
A: They survive too, because the merger didn't cause the subsidiaries to disappear. The combined pre-merger operating loss carryovers may be deducted subject to Conn. Gen. Stat. § 12-223a and its regulations.

Q: How is this different from Golf Digest/Tennis v. Dubno?
A: Golf Digest involved a consolidation that created a new corporation, which couldn't use a pre-consolidation loss of a member. This ruling involves a merger where the loss corporation itself survives — a different situation DRS said Golf Digest doesn't govern.

Citations and references

Statutes, regulations, and case law:

• Conn. Gen. Stat. § 12-217(a) (deductions; operating loss carryover over the five following income years)
• Conn. Gen. Stat. § 12-223a (combined returns); Conn. Agencies Regs. § 12-223a-2 (combined operating loss carryovers)
• Conn. Gen. Stat. § 33-481 (merger vs. consolidation)
• 26 U.S.C. § 382 (federal NOL ownership-change limitation, not incorporated by Connecticut); § 368(a)(1)(F) (federal "identity" change, not adopted)
• Golf Digest/Tennis, Inc. v. Dubno, 203 Conn. 455, 525 A.2d 106 (1987)

Related guidance (described in prose, not linked):

• Ruling No. 97-3 (cites this Ruling)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 93-23

Original ruling text

Ruling 93-23, Corporation Business Tax / Net Operating Losses

Cited in Ruling 97-3

FACTS:

A company (hereinafter "the Purchaser") acquired a corporation (hereinafter "the Holding Company") which, together with several of its subsidiaries, has filed in preceding income years and will file in the current income year a combined corporation business tax return. The Holding Company and its subsidiaries have combined operating loss carryovers, as the term is used in Conn. Agencies Regs. § 12-223a-2, available to be deducted in the current income year.

The Purchaser acquired the Holding Company through a triangular merger that was accomplished in the following manner. First, the Purchaser formed a new, wholly-owned subsidiary (hereinafter "Newco"). Then, under an agreement providing for the Holding Company shareholders to receive stock of the Purchaser and other consideration in exchange for their Holding Company stock, Newco was merged into the Holding Company. At the conclusion of the transaction, shareholders who had tendered their Holding Company stock held stock of the Purchaser and the Holding Company continued in existence as the surviving corporation in the merger and as a subsidiary of the Purchaser. For federal income tax purposes the merger was treated as a taxable purchase of Holding Company stock by Newco.

The Holding Company and its subsidiaries continue to engage in the same respective businesses in which they were engaged prior to the merger. The Purchaser intends to amend the certificate of incorporation of the Holding Company's Connecticut-based subsidiary to change its name.

ISSUE:

Whether the net operating loss deduction of the surviving corporation in a merger may be carried forward to, and deducted under Conn. Gen. Stat. § 12-217(a), an income year following the merger, without regard to the net operating loss limitation provisions of 26 U.S.C. § 382.

DISCUSSION:

The Corporation Business Tax Act, Conn. Gen. Stat. § 12-213 et seq. , allows certain deductions from gross income. In particular, Conn. Gen. Stat. § 12-217(a) provides that:

. . . there shall be deducted from gross income, (A) all items deductible under the federal corporation net income tax law effective and in force on the last day of the income year . . . except no deduction shall be allowed for . . . losses of other calendar or fiscal years . . . notwithstanding anything in this section to the contrary, (1) . . . any excess of the deductions provided in this section for any income year commencing on or after January 1, 1973, over the gross income for such year or the amount of such excess apportioned to this state under the provisions of section 12-218, shall be an operating loss of such income year and shall be deductible as an operating loss carry-over in each of the five income years following such loss year . . .

Conn. Gen. Stat. § 12-217(a).

The Corporation Business Tax Act also permits the filing of combined corporation business tax returns. Conn. Gen. Stat. § 12-223a provides that:

[a]ny taxpayer included in a consolidated return with one or more other corporations for federal income tax purposes may elect to file a combined return under this chapter together with such other companies subject to the tax imposed thereunder as are included in the federal consolidated corporation income tax return . . . (3) In the case of a combined return, the tax shall be measured by the sum of the separate net income or loss of each corporation included or the additional tax base of the included corporations but only to the extent that said income, loss, or additional tax base of any included corporation is separately apportioned to Connecticut in accordance with the provisions of section 12-218, 12-219a or 12-44, whichever is applicable . . .

Conn. Gen. Stat. § 12-223a.

Corporate law defines a merger as the absorption of one company by another, the latter retaining its own name and identity and acquiring the assets, liabilities, franchises, and powers of the former, with the absorbed company ceasing to exist as a separate business entity. A merger differs from a consolidation, wherein all the corporations terminate their existence and become parties to a new one. Conn. Gen. Stat. § 33-481; 19 Am Jur 2d, Corporations § § 2509-11.

As the surviving corporation in the merger, the Holding Company seeks only to deduct its pre-merger net operating loss carryovers (assuming they exist) from income earned by the entity produced by the merger of Newco into the Holding Company. Nothing in Conn. Gen. Stat. § 12-217 prohibits this. A fortiori, because the merger did not cause the Holding Company's subsidiaries to disappear, the merger had no effect on the operating loss carryovers of the combined group. Similarly, nothing in Conn. Gen. Stat. § 12-217 prohibits the combined group from deducting its pre-merger combined operating loss carryovers from its post-merger income.

Although the Connecticut Supreme Court addressed an issue related to this one in Golf Digest/Tennis, Inc. v. Dubno , 203 Conn. 455, 525 A.2d 106 (1987), the holding in that case is inapposite to the facts of this Ruling. The issue in Golf Digest was whether Conn. Gen. Stat. § 12-217 authorizes a newly-created consolidated corporation to deduct from its income the pre-consolidation operating loss carryover of one of the consolidated corporations. Id . , 456. On those facts the Court held that Conn. Gen. Stat. § 12-217 did not authorize such a deduction. Id. , 466. This rule does not apply to the present situation, in which the entity produced by a merger seeks to deduct from its income the pre-merger net operating loss carryovers of the corporation that survived the merger.

It is of no consequence to the combined operating loss carryovers that the name of one of the Holding Company's subsidiaries will be changed. The Department does not adopt the position taken in federal law that considers a change of the name of a corporation to be a change in "identity" as that term is used in 26 U.S.C. § 368(a)(1)(F).

Finally, under federal law the use of a corporation's net operating loss carryforwards is limited if, inter alia, there is a substantial change in ownership of the loss corporation. 26 U.S.C. § 382. However, that portion of Conn. Gen. Stat. § 12-217 relevant to net operating losses does not incorporate the loss limitation provisions of 26 U.S.C. § 382. Therefore, 26 U.S.C. § 382 is not a factor in analyzing whether Conn. Gen. Stat. § 12-217 allows pre-merger net operating loss carryovers to be deducted from post-merger income.

RULING:

Where the surviving corporation in a merger has pre-merger net operating loss carryovers apportioned to Connecticut, such losses are not diminished by reason of the merger and, in accordance with Conn. Gen. Stat. § 12-223a and the regulations thereunder, if applicable, may be deducted under Conn. Gen. Stat. § 12-217 without regard to the net operating loss limitation provisions of 26 U.S.C. § 382. Accordingly, the pre-merger combined operating losses of the Holding Company combined group survive the merger and, subject to the provisions of Conn. Gen. Stat. § 12-223a and the regulations thereunder, may be deducted under Conn. Gen. Stat. § 12-217.

LEGAL DIVISION

November 23, 1993