Could a new Virginia corporate group choose either predecessor group's filing method after a near-equal merger of previously unrelated affiliated groups?

Subject

Department modifed its filing status policy with regard to mergers and acquisitions

Plain-English summary

Virginia allowed the post-merger affiliated group to choose either consolidated filing, following the target group's prior method, or separate returns, following the technical acquirer's method. The Department announced a special near-equal-merger policy pending regulations.

The policy applied when two affiliated groups merged or were acquired, neither held a substantial interest in the other beforehand, and the target group's assets or net value were almost equal to or greater than the acquirer's. Virginia defined "almost equal" as the target exceeding 45% of the two groups' combined value immediately before the transaction.

Although the acquirer was technically designated and its shareholders received just over half of the new company, management was split equally between officers and directors from both predecessor groups. Those facts differed from ordinary acquisitions addressed by the Department's prior policy.

Choosing the target's filing status started a new 20-year period under the cited Virginia provision. Federal carryover restrictions still applied; the ruling specifically noted SRLY limits on target-group net operating losses.

What this means for you

• Near-equal mergers received special treatment under this 2007 policy, unlike ordinary acquisitions.
• Measure the target's assets or net value immediately before the transaction against combined value.
• Preserve both predecessor groups' Virginia filing histories and ownership records.
• A filing-method choice does not remove federal limitations on inherited tax attributes.
• Because the ruling anticipated regulations, confirm the current rule before making an election.

Common questions

What was the relative-size threshold? The target had to exceed 45% of the combined assets or net value.

Could this group file consolidated? Yes. It could choose consolidated filing or continue with separate returns.

Did consolidated filing free the target's NOLs from federal limits? No. The ruling preserved federal carryover restrictions, including SRLY rules.

Citations and references

• Va. Code § 58.1-442.
• 23 VAC 10-120-320.
• Treas. Reg. § 1.1502-21(c).
• P.D. 94-170 (June 8, 1994).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-155

Original ruling text

October 4, 2007

Re: Corporate Income Tax: Return Filing Status

Dear *:

This will respond to your letter submitted on behalf of your client, * (the "Taxpayer"), in which you request that it be allowed to file a consolidated Virginia corporate income tax return effective for the taxable year ended December 31, 2006.

FACTS

* (A) and *** (B) merged effective in 2005. Under the merger agreement, A was designated as the acquiring entity and its shareholders received just over 50% of the stock of the Taxpayer.

For the taxable years prior to the merger, A filed separate Virginia income tax returns, and B filed consolidated Virginia income tax returns. Based on the structure of the merger transaction, Virginia regulations require that the Taxpayer conform to the filing status election made by A. As such, the Taxpayer and its Virginia affiliates are required to file separate Virginia income tax returns.

The Taxpayer requests permission to change its filing status and file consolidated Virginia returns as a result of the extraordinary circumstances surrounding the merger between A and B.

RULING

Virginia Code § 58.1-442 allows corporations to elect to file returns as separate, combined, or consolidated entities regardless of how the corporations file their federal income tax returns. Title 23 of the Virginia Administrative Code (VAC) 10-120-320 provides that in the first year, two or more members of an affiliated group of corporations are required to file Virginia returns, the group may elect to file separate returns, a combined return, or a consolidated return. All returns for subsequent years must be filed on the same basis unless permission to change is granted by the Department. The Department will generally not grant permission to change to a consolidated filing status absent extraordinary circumstances.

The Department has found that mergers and acquisitions are normal business transactions generally within a taxpayer's control. Therefore, the consequences of a merger and acquisition do not constitute extraordinary circumstances for purposes of requesting a change in filing status. See Public Document (P.D.) 94-170 (6/8/1994).

In the instant case, the Department finds it appropriate to modify its filing status policy with regard to mergers and acquisitions. While A was technically the acquiring corporation, the management of the Taxpayer is equally split between the officers and directors of A and B. The Department finds that this fact pattern is significantly different from the cases that prompted prior rulings.

Therefore, pending the promulgation of regulations in this area, when a merger or acquisition occurs between two affiliated groups of corporations (1) neither of which owned any substantial interest in the other prior to the merger and (2) where the total assets or net value of the target group is almost equal to or greater than that of the acquiring group on the date of the transaction, the resulting new affiliated group may choose to file Virginia income tax returns using the filing method previously elected by the acquiring group or the target group.

For purposes of the test in number 2 above, the affiliated groups involved in the merger or acquisition would be considered to be almost equal if the target group's assets or net value immediately prior to the merger or acquisition transaction is greater than 45% of the combined value of the acquiring group and target group.

No matter what Virginia filing status is selected, the new Virginia affiliated group would still be subject to federal carryover limitations from the target group when computing federal taxable income for Virginia purposes. For example, if the target group is carrying forward net operating loss deductions (NOLDs), the use of such NOLDs would be subject to the separate return limitation year (SRLY) rules under Treas. Reg. § 1.1502-21(c).

With regard to Va. Code § 58.1-442 C, the choice to use the target's filing status under the policy articulated above will constitute the start of a new 20-year period.

Accordingly, under the conditions set forth above, the Taxpayer may choose to file a consolidated return with its affiliated entities or file separate returns for each affiliate subject to Virginia income tax.

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 and regulation sections cited, along with other reference documents, 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 Appeals and Rulings Unit at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1736374627.o