Could a successor use an affiliate's net operating loss deductions after a qualifying liquidation or reorganization?

Subject

Generalized scenarios concerning the carryforward of NOLDs

Plain-English summary

A multistate corporation filing a consolidated Virginia return planned to eliminate affiliates through liquidations or reorganizations. Some affiliates had net operating loss deductions, and the taxpayer asked whether successor corporations could use them.

Virginia generally follows the federal treatment because Virginia taxable income starts with federal taxable income. NOLDs transferred through an I.R.C. § 332 liquidation or § 368(a) reorganization would be available for Virginia purposes to the extent they would be allowed federally, including federal limitations such as I.R.C. § 382. Prior Virginia nexus was not required, but Virginia additions and subtractions for the loss year still had to be computed correctly. NOLDs reduce federal taxable income before apportionment, so the loss-year apportionment method did not control the carryforward year.

What this means for you

• Start with whether the successor may use the loss under federal law; Virginia's allowance follows that federal result in this ruling.
• Reconstruct Virginia additions and subtractions for the loss year even if the corporation then had no Virginia-taxable income.
• When federal and Virginia returns use different filing bases, recompute federal taxable income as though the federal return used the Virginia filing basis.

Common questions

Did the loss corporation need prior Virginia business activity?

No. The ruling said Virginia law did not require prior Virginia business activity to use an otherwise allowable NOLD.

Did mixed apportionment methods change the NOLD carryforward?

No. The NOLD reduced federal taxable income before apportionment, so the apportionment method in the loss year did not affect the year to which the loss was carried.

Citations and references

• Va. Code § 58.1-301, Virginia conformity framework.
• I.R.C. §§ 332, 368(a), 381, and 382, cited federal restructuring and loss-carryover provisions.
• P.D. 96-38, Virginia policy for NOLDs carried through mergers.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-120

Original ruling text

July 31, 2007

Re: Request for Ruling: Corporate Income Tax

Dear *:

This will reply to your letter in which you request a ruling concerning the availability of net operating loss (NOL) carry forwards of corporations involved in liquidations and reorganizations. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer, a multi-state corporation headquartered outside of Virginia, files a consolidated Virginia corporate income tax return. The Taxpayer intends to eliminate a number of affiliates through either liquidation or reorganization. Several of the affiliates are carrying forward net operating loss deductions (NOLDs). The Taxpayer requests a ruling that the successor corporation is entitled to take into account the acquired entity's NOLD when computing taxable income.

RULING

In general, Virginia income tax laws do not address NOLDs. Nonetheless, Va. Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the Internal Revenue Code (I.R.C.), unless a different meaning is clearly required. Because the starting point in computing Virginia taxable income is federal taxable income, Virginia allows a NOLD to the extent that it is allowable in computing federal taxable income.

A NOLD is considered to be an adjustment to federal taxable income in the taxable year in which it is used. Accordingly, the availability of a NOLD is not affected by whether a corporation was subject of Virginia income tax or the apportionment method used for the taxable year the NOL occurred. Even if a corporation did not have income subject to Virginia tax for the taxable year the NOL occurred, Virginia additions and subtractions for such taxable year would have to be calculated in order to correctly compute the Virginia taxable income for the taxable year to which the NOLD is carried.

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 computing consolidated federal taxable income for Virginia purposes, NOLDs are allowable only if, and to the extent that, they would be allowable on a consolidated federal income tax return.

In Public Document (P.D.) 96-38 (4-5-96), the Department set forth Virginia's policy with regard to NOLDs carried over as a result of mergers under I.R.C. § 381 for corporations filing separate or combined Virginia income tax returns. Such carryovers may be limited by I.R.C. § 382. The same rationale would, generally, apply to corporations filing a Virginia consolidated income tax return.

While this policy is straightforward with regard to mergers of unrelated entities, the policy with regard to liquidations and reorganizations among related entities that are not affiliated under Va. Code § 58.1-302 is not so clear. For example, a liquidation can only be made pursuant to I.R.C. § 332 if the corporations are affiliated under I.R.C. § 1504(a)(2). However, Virginia does not conform to the federal definition of "affiliated." In order to be affiliated under Va. Code § 58.1-302, corporations must be subject to Virginia income tax.

The Taxpayer states that it will be liquidating entities that do not have nexus with Virginia and, therefore, are not affiliated for Virginia income tax purposes. This raises an issue as to the availability and amount of NOLDs carried over from a liquidated entity to which there is not clear guidance under federal tax law.

In many respects, the liquidation'of one entity into another or the merger of two entities is similar to affiliated corporations filing on a consolidated basis. In a consolidated filing, NOLDs of one affiliate will reduce the taxable income of another affiliate provided the limitations of I.R.C. § 382 do not apply.

Further, there is no requirement in the Code of Virginia or the Virginia Administrative Code that the corporation must have had business activity in Virginia in order to utilize a NOLD. See P.D. 89-136 (4/28/06).

Accordingly, to the extent that such NOLDs carried over as a result of a liquidation made pursuant to I.R.C. § 332 or through a corporate reorganization made through I.R.C. § 368(a) are allowable for federal income tax purposes if federal returns had been filed, they would be allowable for Virginia income tax purposes.

In the case of mixed apportionment factors, NOLDs reduce federal taxable income before apportionment. As such, the methods of apportionment used in the taxable year in which an NOL occurs has no affect on the year to which it is carried.

The Taxpayer has offered a number of generalized scenarios concerning the carryforward of NOLDs. The general rules set forth in this document should provide sufficient guidance to determine the appropriate treatment of the NOLDs.

This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia section, regulation and public document cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this ruling, please contact * in the Department's Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-343762212B