An Alabama administrative law judge (ALJ) has issued an opinion and preliminary order finding that a parent company's net operating losses (NOLs) incurred prior to 1999 could not be used to offset the current year income of one of its subsidiaries on a consolidated return.1 As Alabama did not allow taxpayers to file on a consolidated basis prior to 1999, separate return limitation year (SRLY) rules adopted by Alabama acted to restrict the availability of the NOL deduction. However, NOLs generated in years beginning after 1998 could be carried forward and used to offset the group's income.
Background
The taxpayer, Coca-Cola Enterprises, Inc., was the common parent of two subsidiaries, Vending Holding Company (VHC) and Roddy Coca-Cola Bottling Company (Roddy). The taxpayer and its subsidiaries filed separate entity Alabama income tax returns through 2006. The taxpayer had claimed NOLs on its 1992 through 2002 separate returns and on its 2004 separate return.
The entities, which constituted an Alabama affiliated group, elected to file a group consolidated return in 2007. Each entity was required to compute its taxable income or loss on the consolidated return on a separate basis. The taxpayer and VHC each reported small amounts of losses on the 2007 return, while Roddy reported taxable income of approximately $11 million. Netting the group members' individual taxable income and losses resulted in a group taxable income of over $10 million. The consolidated return deducted the separate return NOLs incurred by the taxpayer in 1992 through 2002 and in 2004. These NOL carryovers nearly eliminated the group's 2007 consolidated income.
The Alabama Department of Revenue disallowed the NOLs and partially denied the refund claim on the basis that the taxpayer's first consolidated return was filed for the 2007 tax year, and the taxpayer could not claim the NOL deduction generated in years in which the taxpayers filed separately. The taxpayer appealed to the Administrative Law Division. The issue before the ALJ was whether the group was permitted to deduct the taxpayer's prior NOLs on its consolidated 2007 return to offset Roddy's taxable income.
Alabama Consolidated Returns
Prior to 1999, all corporations subject to the Alabama corporation income tax were required to file separate entity returns. Alabama adopted legislation allowing an "Alabama affiliated group" that filed a consolidated federal return to elect to file an Alabama consolidated return for tax years beginning after 1998.2 In addition, pursuant to the 1998 legislation, a group that made this election was treated as a single taxpayer for purposes of computing the group's taxable income or loss.3 As such, the NOL carryovers attributable to one member of the group could be applied to offset the income of the other group members.
The 1998 legislation also adopted the federal SRLY rules, which limit an NOL carryover to the income of the entity that incurred the loss.4 The SRLY rules prohibit the application of an NOL incurred in a prior year by one member of the group to offset the current year income of another member or the other members of the group.
In 2001, the state legislature made additional substantive changes to the law. Effective for tax years beginning after 2001, "Alabama affiliated group" was redefined to include only those members of a federal affiliated group that have income tax nexus with Alabama.5 In addition, each member must compute its state income or loss on a separate return basis.6 Finally, the provision relating to the SRLY limitation was revised to spell out the general federal SRLY rule.7
NOLs Incurred before 1999 Subject to SRLY Limitation
In determining whether the group could use the taxpayer's prior NOLs on its 2007 consolidated return to offset the income of a consolidated subsidiary, the ALJ was required to consider two separate issues. First, the ALJ needed to determine whether Alabama's consolidated return statute, as amended in 2001, generally allows an Alabama affiliated group that files a consolidated return to deduct the NOLs incurred by one group member in a prior year to offset another group member's current year income. Second, provided that Alabama law generally allows consolidated group members to share NOLs on a consolidated return, the ALJ was required to decide whether the taxpayer's prior year NOLs claimed on the 2007 consolidated return were limited by Alabama's SRLY rule, as amended in 2001.
After analyzing the legislative history and intent of the consolidated return statute, the ALJ concluded that the statute allows Alabama affiliated group members to share NOL carryovers on a consolidated return, but only if the SRLY limitation does not apply. According to the ALJ, the SRLY limitation applies if an NOL was incurred by a group member in a year before becoming a member of the Alabama affiliated group. Because an Alabama affiliated group could not exist before 1999, all NOLs incurred before 1999 are subject to the SRLY limitation. In reaching this conclusion, the ALJ acknowledged that he had incorrectly decided a prior ruling, Weyerhaeuser USA Subsidiaries v. Alabama, which held that the SRLY limitation did not apply to losses incurred prior to 1999.8
The ALJ reached a different result for losses that occur after 1998. If the loss was incurred after 1998 by a corporation that was a group member in the loss year, the SRLY limitation does not apply, even if the Alabama affiliated group did not file an Alabama consolidated return in the loss year.
Based on this interpretation of the law, the ALJ held that the SRLY limitation applied to NOLs incurred by the taxpayer during the 1992 through 1998 tax years. Therefore, these losses could not be used on the group's 2007 Alabama consolidated return. In contrast, the taxpayer's 1999 through 2002 and 2004 NOLs could be allowed as group NOLs on the 2007 consolidated return because the taxpayer was a member of the Alabama affiliated group during the years that these losses were incurred. The group was allowed to use these losses even though it did not file an Alabama consolidated return before 2007.
Commentary
In reaching his decision, the ALJ emphasized that it was irrelevant that the taxpayer did not file consolidated returns prior to 2007. The question was whether the taxpayer was deemed a group member when its losses were incurred, regardless of whether the group had filed its first consolidated return at the time of the loss. Due to the fact that Alabama did not allow consolidated groups until 1999, NOLs incurred prior to 1999 are treated differently than NOLs incurred after this time.
Interestingly, the ALJ overruled his prior decision from 2005 based on an admission that he made an erroneous assumption with respect to the interplay between the federal consolidated return rules and the state's consolidated return rules. Thus, the ALJ has clarified that the SRLY limitation applies to losses incurred prior to 1999. Of course, this change in interpretation could have deleterious effects to corporate groups that decided to file on a consolidated basis in Alabama and calculated their NOL deductions based on Weyerhaeuser. Groups may have to revisit their NOL calculation and potentially file amended returns reporting additional tax liability for certain tax years. Further, as a result of making an Alabama consolidated election, the group is required to file on a consolidated basis for ten years, or upon the revocation or termination of the group's federal consolidated return election,9 so terminating the Alabama election in response to this decision (if finalized and upheld at appeal) is not a feasible option.
Footnotes
1 Coca-Cola Enterprises, Inc. v. Alabama Department of Revenue, Alabama Department of Revenue Administrative Law Division, No. CORP. 09-641, Aug. 15, 2012.
2 ALA. CODE § 40-18-39(c)(1).
3 ALA. CODE § 40-18-39(c)(3).
4 ALA. CODE § 40-18-39(h) as originally enacted in 1998.
5 ALA. CODE § 40-18-39(b)(1).
6 ALA. CODE § 40-18-39(c)(5).
7 ALA. CODE § 40-18-39(h).
8 Alabama Department of Revenue Administrative Law Division, No. 04-511, March 11, 2005. In Weyerhaeuser, the ALJ held that even though the group had not filed Alabama consolidated returns in the pre-1999 loss years, the SRLY limitation did not apply because the two subsidiaries that incurred the losses were members of the consolidated group in the loss years. The ALJ admitted that he erroneously assumed that because the two subsidiaries were members of the federal consolidated group in the pre-1999 loss years, they were also members of the Alabama affiliated group in these years. Because an Alabama affiliated group could not exist for tax years beginning prior to 1999, the SRLY limitation should have been applied in Weyerhaeuser. The subsidiaries had incurred the losses in tax years before they became members of the Alabama affiliated group.
9 ALA. CODE § 40-18-39(c)(7).
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