Computation of NY Net Operating Loss Deduction
In TD Holdings II, Inc., DTA No. 825329 (Div. of Tax App, January 22, 2015), an Administrative Law Judge (“ALJ”) held that a banking corporation was not required to utilize a net operating loss deduction (“NOLD”) to decrease its entire net income in a year in which its tax liability was measured by the capital base. While ALJ decisions are not precedential, the decision is important since it contests the Division of Taxation’s (“Division”) longstanding position that a NOLD must be utilized to reduce a taxpayer’s income to zero, even when the taxpayer is not subject to tax on income.
While the case addresses the Article 32 banking corporation tax (“Bank Tax”), it presumably has application to the Article 9-A corporate income tax (“Article 9-A Tax”), since the net operating loss rules in both tax regimes are virtually the same. The Division has extended its time to appeal the decision.
For 2005 through 2007, TD Holdings II, Inc. (“TD”) filed a federal consolidated return and a separate New York State Bank Tax return. During the years at issue, the New York Bank Tax (as well as the Article 9-A Tax) required taxpayers to pay tax on the highest of four alternative tax bases; (i) the entire income base; (ii) the capital (or asset) base; (ii) the alternative net income base; or (iv) the minimum tax base. In computing the entire net income base under the Bank Tax, taxpayers were permitted to claim a New York NOLD. The law provided that such deduction was “presumably the same as the federal net operating loss deduction determined under IRC Sec. 172,” with certain modifications.
In order to determine the Bank Tax for 2005 through 2007, TD prepared pro forma federal income tax returns reflecting the income and deductions of TD as if it filed separately for federal tax purposes. TD reported losses in 2005 on its pro forma federal income tax return as well as its Bank Tax return. In 2006 TD reported taxable income on its pro forma federal income tax return as well as its Bank Tax return. TD claimed an NOLD on its 2006 federal pro forma income tax return related to the 2005 NOL but failed to claim an NOLD on its 2006 Bank Tax Return. TD recognized that in 2006, its entire net income tax liability, even without the benefit of a NOLD, was less that the tax liability based on capital; therefore the company was subject to the tax based on capital (and not on net income). The company reasoned that claiming an NOLD in a year in which it was not subject to the entire net income tax would result in the deprivation of the economic benefit of the loss. Instead, the company utilized the 2005 loss to offset income reported on its 2007 New York Bank Tax return.
The Division re-determined TD’s Bank Tax by applying a portion of the 2005 net operating loss to 2006, thereby reducing the NOLD available in 2007. The Division argued that TD was required to utilize the loss in 2006, notwithstanding that it did not pay tax on income for such year. The Division argued that “presumably the same” means that the federal and New York NOLD are required to be the same, except when certain NY modifications increase or decrease NY entire net income. In addition, the Division believed that the federal net operating loss ordering rules required the use of the 2005 New York net operating loss in 2006, the same year in which it was used for federal purposes.
The ALJ held that, under New York’s Bank Tax, taxpayers are not required to utilize a net operating loss deduction in a year when, without such deduction, the taxpayer is subject to tax on the capital base. The ALJ based its decision in part on the Tax Appeals Tribunal Decision in Matter of Brooke-Bond Group (U.S.), Inc. (December 28, 1995). At issue in that case was whether the taxpayer was required to utilize the same NOLD used for federal purposes when New York entire net income was less than federal taxable income. The Tribunal held that while the tax law provides that a New York NOLD may never exceed the federal NOLD, there is nothing in the law preventing a taxpayer from utilizing less than that used for federal purposes.
Based on this decision, and the legislative history behind the implementation of the net operating loss rules, the ALJ determined that the applicability of an NOLD should be tied to a taxpayer’s income. In this case, it was unnecessary for TD to apply an NOLD to lower its income in 2006 when that income was already below the level triggering the application of the alternative tax base. The ALJ determined that in cases where the taxpayer does not pay tax on income, it is unnecessary, even under the federal ordering rules, to utilize a net operating loss.
GMG Observation: Although the corporate tax reform enacted in 2014 has eliminated the effect of this ruling for net operating losses generated in years beginning on or after January 1, 2015, this decision may have application in the computation of the net operating loss conversion subtraction (“NOLCS”). Beginning in 2015, taxpayers are permitted to claim a NOLCS based on their net operating losses available on the last day of 2014 (for calendar year taxpayers). This subtraction provides taxpayers with a mechanism to recover the benefit of prior year net operating losses which were computed and deducted prior to apportionment. Taxpayers should review the computation of their available net operating losses in light of this decision to determine whether additional losses may be included in the computation of the NOLCS.