If the IRS limited our net operating loss carryovers after an ownership change on our consolidated federal return, does Virginia apply the same limitation to our separate Virginia corporate return?

Plain-English summary

A corporation appealed Virginia corporate income tax assessments for the tax years ended May 31, 2014 and 2015. The dispute centered on how the Department calculated the taxpayer's net operating loss deduction (NOLD) carryforwards.

The taxpayer filed a consolidated federal return but separate Virginia returns. It had carried forward pre-2013 net operating losses (NOLs) to offset its federal taxable income. When the Department audited, it adjusted the NOLDs to reflect the IRC § 382 loss limitation that applied after an ownership change, but it applied that limitation using the numbers reported on the consolidated federal return. The taxpayer argued that, on a separate-company basis, it actually had enough NOLs to fully offset its income for the years at issue, and it raised two more issues: (1) the Department left out NOL carryovers from several affiliated companies that had merged into the taxpayer before the years at issue, and (2) the Department wrongly denied a subtraction for Subpart F income for the 2014 tax year.

The Tax Commissioner ruled partly for the taxpayer and partly against it, and sent the case back to the auditor:

• NOLD/IRC § 382 limitation: The Commissioner agreed with the taxpayer. Because affiliated corporations that file a consolidated federal return but separate Virginia returns must compute federal taxable income and the NOLD as if each corporation had filed its own separate federal return, the IRC § 382 limitation reported on the consolidated federal return is not necessarily the right number for Virginia. The NOL carryovers must be recalculated on a separate-company basis.
• Subsidiary NOL carryovers: The Commissioner agreed in principle that NOLs from companies merged into the taxpayer before the years at issue should be included, to the extent allowed under the Internal Revenue Code. But the taxpayer had not given the auditor the documentation needed to verify those amounts, so this part was not simply granted — it was sent back for further review.
• Subpart F subtraction: The Department admitted this was an oversight and should have been allowed for the 2014 tax year.

Because the taxpayer still owed the Department supporting documentation, the Commissioner remanded the case to the auditor to recompute the NOLD carryovers on a separate-company basis, review the taxpayer's records for the subsidiaries' NOLs, and include the Subpart F subtraction. The taxpayer had 60 days to provide the requested documentation, or the assessments would be adjusted using whatever information was already available.

What this means for you

Corporations with consolidated federal returns but separate Virginia returns

If your corporate group files a consolidated federal return but files separate returns in Virginia, don't assume the IRC § 382 loss limitation (or other consolidated-return figures) carries over unchanged to your Virginia return. Under 23 VAC 10-120-100 B 5, you must recompute federal taxable income and the NOLD as if each member of the group had filed its own separate federal return — a consolidated-basis limitation can overstate the restriction on your Virginia NOL carryforward.

Corporations that have absorbed other companies through mergers

If companies with their own NOL carryovers were merged into your corporation before the years you're now reporting, those losses can carry over to you to the extent permitted under the IRC (citing IRC § 381(a) and (c) and the Department's own P.D. 96-38). But the Department will not simply take your word for it — be ready to produce the documentation (returns, schedules, and the required Virginia modifications under 23 VAC 10-120-100 B 5) proving the amount and eligibility of those carryovers. Without it, the Department can adjust your NOLDs based only on the records it has, under its authority in Virginia Code § 58.1-111.

Companies with Subpart F income

If you subtracted (or should have subtracted) Subpart F income under Virginia Code § 58.1-402 C 7 and IRC § 951 and the Department's assessment doesn't reflect it, check your notice carefully — this ruling shows the Department itself can make (and later correct) this kind of oversight.

Accountants and tax professionals handling a Virginia corporate appeal

This ruling illustrates that a § 58.1-1821 appeal can produce a mixed, remanded outcome rather than a clean win or loss: the Commissioner can agree with your legal theory (separate-company computation of the § 382 limitation, inclusion of merged subsidiaries' NOLs) while still sending the case back to the auditor because supporting documentation wasn't in the record. Be prepared to supply complete records promptly — here the taxpayer was given a 60-day window, after which the Department would proceed on the information already available.

Common questions

Q: Did the taxpayer win its appeal?
A: Not outright. The Tax Commissioner agreed with the taxpayer's legal position on two points — that the IRC § 382 loss limitation must be computed on a separate-company basis, and that the Subpart F subtraction was wrongly denied for 2014 — but remanded the case to the auditor rather than simply abating the assessments, because the taxpayer hadn't yet documented the subsidiaries' NOL carryovers.

Q: Why did Virginia use a different IRC § 382 limitation than the one on the federal consolidated return?
A: Because the taxpayer filed separate Virginia returns while filing a consolidated federal return. Under 23 VAC 10-120-100 B 5, members of an affiliated group in that situation must compute federal taxable income and the NOLD as though each corporation had filed its own separate federal return, so the consolidated-return IRC § 382 limitation doesn't automatically apply for Virginia purposes.

Q: What happened to the NOL carryovers from the companies that merged into the taxpayer?
A: The Commissioner agreed those NOLs should be included to the extent allowed under the IRC, but the taxpayer had not provided the auditor with the returns and schedules needed to verify them. The auditor was directed to contact the taxpayer and review that documentation, which also had to include the Virginia modifications required by 23 VAC 10-120-100 B 5.

Q: What if the taxpayer doesn't provide the requested records?
A: The ruling gave the taxpayer 60 days from the date of the auditor's request to provide the needed documentation. If it wasn't received within that time, the assessments would be adjusted based on whatever information the Department already had available.

Q: Does Virginia have its own separate net operating loss statute?
A: No. Virginia income tax law generally does not address the NOLD directly. Instead, because Virginia starts its computation of corporate income tax with federal taxable income, and because Virginia Code § 58.1-301 generally gives Title 58.1 terms the same meaning as under the Internal Revenue Code, the Department allows an NOLD to the extent it is allowable in computing federal taxable income as calculated for Virginia purposes (subject to Virginia's fixed date conformity adjustments and 23 VAC 10-120-325's carryback/carryforward methodology).

Citations and references

• § 58.1-1821, Code of Virginia (application for correction of assessment)
• § 58.1-301, Code of Virginia (conformity to Internal Revenue Code terminology; fixed date conformity adjustments)
• § 58.1-402 C 7, Code of Virginia (Subpart F income subtraction from Virginia taxable income)
• § 58.1-111, Code of Virginia (Department's authority to estimate/adjust based on available records)
• 23 VAC 10-120-325 (methodology for corporate NOL deduction carrybacks and carryforwards)
• 23 VAC 10-120-100 B 5 (computing federal taxable income and NOLD on a separate-company basis for affiliated groups)
• 23 VAC 10-120-102 G (Subpart F income subtraction)
• IRC § 172 (net operating loss carryback and carryforward rules)
• IRC § 172(b)(1)(H) (five-year NOL carryback, not allowed for Virginia purposes)
• IRC § 382 (limitation on NOL carryovers after an ownership change)
• IRC § 382(b)(2) (calculation of the IRC § 382 limitation)
• IRC § 381(a) and (c) (carryover of tax attributes to a successor corporation)
• IRC § 951 (Subpart F income inclusion)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-159

Original ruling text

September 8, 2020

Re: § 58.1-1821 Application: Corporate Income Tax

Dear *:

This will reply to your letter in which you seek correction of the corporate income tax assessments issued to * (the “Taxpayer”) for the taxable years ended May 31, 2014 and 2015. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer filed consolidated federal corporate income tax returns and separate returns for Virginia tax purposes during the taxable years at issue. It reported net operating losses (NOLs) for years prior to the 2013 taxable year. The Taxpayer carried the losses forward offsetting its federal taxable income (FTI). The Department adjusted the net operating loss deductions (NOLDs) to reflect limitations on loss carryovers after an ownership change as reported on its federal returns, resulting in the assessments.

The Taxpayer appealed, contending that the loss carryover limitations reflected consolidated amounts, and there were sufficient NOLs on a separate corporation basis to offset the FTI of the taxable years at issue. In addition, it asserts that the Department did not include the NOL carryovers of several affiliated companies that were absorbed into the Taxpayer prior to the taxable years at issue. Finally, the Taxpayer argues that a subtraction of Subpart F income for the taxable year ended May 31, 2013 was erroneously disallowed.

DETERMINATION

NOLD Carryforward Limitation

Generally, Virginia income tax law does not address the NOLD. Nonetheless, Virginia 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 (IRC) unless a different meaning is clearly required. Because Virginia starts its computation of corporate income tax with federal taxable income (FTI), the Department allows an NOLD to the extent it is allowable in computing FTI as calculated for Virginia income tax purposes.

Title 23 of the Virginia Administrative Code (VAC) 10-120 325 provides the methodology that a corporation must use to calculate the NOLD carrybacks and carryforwards for purposes of corporate income tax. Under this regulation, a Virginia NOLD modification must be determined for the taxable year in which an NOL occurred. This Virginia NOLD modification must be carried back and forward in the same manner as the NOLD.

Fixed date conformity additions (FDCA) and subtractions (FDCS) are not considered Virginia modifications. Rather, these exceptions identified in Virginia Code § 58.1-301 are added to or subtracted from FTI as computed under the IRC in order to determine a corporation’s FTI for Virginia income tax purposes. See Public Document (P.D.) 16-22 (3/8/2016). A corporation’s Virginia FTI is calculated by starting with FTI as reported on the federal income tax return, adding the FDCA, and then subtracting any FDCS. The formula for determining Virginia FTI would be as follows:

FTI + FDCA - FDCS = Virginia FTI

For Virginia income tax purposes, a corporation will have an NOL only if the formula results in a number that is less than zero. If FDCA exceeds the total of a loss reported on a federal return plus FDCS, the corporation will not have an NOL for Virginia income tax purposes. Conversely, if FDCS exceeds FTI plus FDCA, the taxpayer will have NOL for Virginia even if it does not report an NOL on its federal return. Such an NOL can be carried back and forward in accordance with the rules established under IRC § 172, except for the five year carryback allowed under IRC § 172(b)(1)(H). See Virginia Code § 58.1-301 B 2.

Under IRC § 382, loss carryovers that can be used annually to offset taxable income are subject to limitations when certain types of corporation ownership changes occur. If a corporation has a NOL or a NOL carryover in a taxable year in which there is an ownership change, it may offset the income in subsequent years by pre-change loss carryovers only to the extent of a IRC § 382 limitation. This limitation is equal to the value of the loss corporation immediately before the ownership change multiplied by the long-term tax exempt rate. See IRC § 382(b)(2).

In this case, a number of related entities reported an ownership change in 2011, triggering the IRC § 382 loss limitations reported on the federal returns. Title 23 VAC 10-120-100 B 5 v provides that “[m]embers of an affiliated group of corporations which file a consolidated federal return and separate or combined Virginia returns must compute federal taxable income and the NOLD as if each corporation had filed a separate federal return for all affected years.” Thus, IRC § 382 NOLD limitations reported on the consolidated federal returns may not be the same as the NOL carryovers that must be determined for Virginia income tax purposes on a separate company basis.

Subsidiary NOL Carryovers

The Taxpayer indicates several companies that had NOL carryovers were merged into it prior to the taxable year at issue, and the Department did not include those losses in its NOLD adjustments. In P.D. 96-38 (4/5/1996), the Department determined that any NOLs of merged corporations will be available to the surviving corporation if allowed under the IRC. Under IRC § 381(a) and (c), a successor corporation carries over certain tax attributes after certain corporate acquisitions, including carryover items. To the extent permitted under the IRC, the NOLs of companies merged into the Taxpayer in years prior to the taxable years at issue should be included in the Department’s adjustment to the Taxpayer’s NOLDs.

According to the auditor, returns and schedules requested during the examination to verify the amounts reported were not available or provided. Without verifying documentation, the auditor used available records to adjust the NOLDs and NOLD carryovers as permitted under Virginia Code § 58.1-111.

Subpart F Subtraction

The Taxpayer contends that the Department did not allow a subtraction for Subpart F income on its Virginia corporate income tax returns as a Virginia modification for the 2014 taxable year. Pursuant to Virginia Code § 58.1-402 C 7, income included in federal taxable income pursuant to IRC § 951, less attributable expenses, is subtracted in determining Virginia taxable income. Also see Title 23 VAC 10-120-102 G and P.D. 93-56 (3/5/1993). The Department acknowledges the denial of the subtraction was an oversight.

CONCLUSION

Thus, IRC § 382 NOLD limitations reported on the consolidated federal returns may not be the same as the NOL carryovers that must be determined for Virginia income tax purposes on a separate company basis. As such, the NOL carryovers must be adjusted to reflect that the NOLDs be computed on a separate company basis. Further, the Subpart F subtraction modification for the 2014 taxable year was erroneously omitted in the NOL carryover computation.

The Taxpayer, however, did not provide sufficient documentation to the auditor to support the inclusion of the former subsidiary corporations’ NOLs. In addition, the Taxpayer indicates that it did not incorporate Virginia modifications as required by Title 23 VAC 10-120-100 B 5 in its NOL carryback and carryover computations.

Accordingly, the case will be remanded to the Department’s auditor to adjust the NOLD carryovers to reflect the IRC § 382 loss limitations on a separate return basis. The auditor will contact the Taxpayer and arrange to review the documentation needed to include the subsidiary corporation’s NOLs in the Taxpayer’s NOL carryovers. Such documentation must include the Virginia modifications as required by Title 23 VAC 10-120-100 B 5. Any information that the auditor requires must be provided within 60 days of the date of the request. If the requested documentation is not received within the allotted time, the assessments will be adjusted based on the information available.

The Code of Virginia sections, regulations, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2088.B

Related Documents

93-56

96-38

16-22