On Jan. 18, 2022, the Connecticut Department of Revenue Services released a letter ruling addressing the Connecticut Corporation Business Tax (CBT) treatment of the net operating loss (NOL) attribute derived by a combined unitary group that was transferred as a result of an internal reorganization.1
Derivation of combined group’s NOL
The taxpayer requesting the ruling consisted of four taxable members that qualified as a Connecticut combined unitary group, beginning in the 2016 tax year.2 The four taxable members formed a chain of tiered subsidiaries wholly owned by a corporate parent. The combined group generated NOLs for the 2016 and 2017 tax years, which were allocated to the three tiered subsidiaries.3 The NOLs were not utilized by the combined group.
During the 2020 tax year, two of the mid-tier subsidiaries were merged in a federally tax-free reorganization into the lowest-tier subsidiary, with the lowest-tier subsidiary surviving the merger. As a result, only the parent and the lowest-tier subsidiary remained in the Connecticut combined unitary group.
Ability to transfer NOL
The Rulings and Regulations unit of the Department’s litigation division was asked to consider whether the combined group’s NOLs that were allocated to the mid-tier subsidiaries in 2016 and 2017 survived the merger, so that either the parent or the remaining subsidiary potentially could utilize the NOLs for CBT purposes at a future date. In concluding that such NOLs could be so utilized, the Department noted that the business activities of the remaining combined group members were substantially the same as the activities engaged in by the historic members of the group when the NOLs were generated. Further, the parent and the surviving member of the reorganization would continue to file combined unitary CBT returns together. Therefore, the income against which the NOLs would ultimately be applied would be generated by substantially the same business that incurred the losses.
In arriving at this conclusion, the Department distinguished the taxpayer’s facts from historic Connecticut CBT case law governing the treatment of NOL transfers in separate reporting periods. In Golf Digest/Tennis, Inc. v. Commissioner of Revenue Services,4 a corporation with a Connecticut NOL merged into another corporation. Both entities historically had filed on a separate reporting basis. The surviving corporation tried to carry forward the NOL on its own CBT returns following the merger. The Connecticut Supreme Court rejected the taxpayer’s carryovers on the basis that in order to utilize the NOLs, such NOLs had to be produced by “substantially the same businesses which incurred the losses.”5
The issue of whether a material state-specific tax attribute created within a corporate structure may be at risk often arises when organizations consider the overall multistate corporation income tax effects of engaging in an internal reorganization. While it is understandable to think that the state corporate income tax treatment of a state NOL attribute should follow the federal income tax treatment of the federal NOL, differences often arise for a variety of reasons. The federal and state NOL attributes are distinct in many cases, often due to decoupling measures taken by the states, special restrictions imposed on state NOLs, or through the effect of state income tax modification on the tax base. In addition, the federal and state corporate income tax filing groups may substantially differ, leading to markedly different federal and state NOL attributes.
It is instructive to note that while the Department highlighted the Golf Digest case in its ruling, a more taxpayer-favorable line of Connecticut cases later developed in several “continuity of business enterprise” decisions involving the transfer of NOLs for purposes of the CBT when it was imposed on a separate reporting basis.6 The shift from separate to combined reporting under the CBT comes with the expanded ability of group members to share NOLs with other group members to the extent they were members during the time in which the NOLs were generated. However, the Department’s letter ruling serves to notify taxpayers that the transfer of historic NOLs will not always be effective, and that the continuity of business enterprise doctrine is still relevant. In determining whether an NOL is able to be transferred following a reorganization, while Golf Digest may live on, an analysis of the post-Golf Digest case law is also appropriate.
1 Ruling 2022-1, Connecticut Department of Revenue Services, Jan. 18, 2022.
2 Connecticut adopted mandatory unitary combined reporting for CBT purposes for the 2016 tax year and thereafter. CONN. GEN. STAT. § 12-218e et seq.
3 CONN. GEN. STAT. § 12-218e(d). Paragraph (2) of the statute specifically states that when a taxable member of a combined group has an NOL carryover from a loss incurred by the combined group in the 2016 tax year or later, such member can share the carryover with other taxable members of the combined group, but only if those members were also members in the year in which the loss was incurred.
4 525 A.2d 106 (Conn. 1987).
5 Libson Shops, Inc. v. Koehler, 353 U.S. 382 (1957).
6 See Thermatool Corp. v. Department of Revenue Services et al, 651 A.2d 763 (Conn. Sup. Ct. 1994); Grade A Market Inc. v. Commissioner of Revenue Services, 688 A.2d 1364 (Conn. Sup. Ct. 1996); Cunningham Group, Inc. v. Commissioner of Revenue Services, 709 A.2d 61 (Conn. Sup. Ct. 1997).
Robert C. Michaelis
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