United States: You Can’t Take it With you: Net Loss Carryovers of a Merged Corporation Don’t Carry Over to the Successor Corporation

The Court of Appeals of Tennessee in AT&T Corp. v. Johnson, 2004 Tenn. App. LEXIS 214 (April 8, 2004) reaffirmed the Department of Revenue’s position that a successor corporation cannot take advantage of net operating losses of a predecessor corporation following a merger or consolidation for purposes of the state’s excise tax.

The decision only applies to tax years 1991 through 1996. The legislature repealed the excise tax provisions and replaced them with the new Excise Tax Law of 1999.¹

Previously, in Little Six Corp. v. Johnson, the Tennessee Court of Appeals had already held that a parent corporation could not use the net operating losses of a subsidiary following a merger of the subsidiary into the parent.² In that case, the Court of Appeals had stated that the legislature had intended the entity that suffered the loss to enjoy the tax benefit and not another entity.

The taxpayer, AT&T Corp., unsuccessfully tried to distinguish its situation from Little Six Corp. AT&T argued that its circumstances differed from those of Little Six Corp. because AT&T was required by the Federal Communications Commission to keep its tariffed services in a separate corporation from its tariffed services. When the FCC changed its position in 1986, AT&T merged the corporation providing non-tariffed services, AT&T Information Systems ("Information Systems"), into AT&T. AT&T, the surviving corporation in the merger, tried to deduct the net operating losses of Information Systems from before the merger, but the Tax Commissioner disallowed the deductions.

The court refused to distinguish AT&T’s circumstances from those in Little Six Corp. The Court of Appeals stated the facts in Little Six Corp. were "surprisingly similar" to AT&T’s case, even though Little Six Corp. was not required by law to maintain operations in a separate subsidiary.

AT&T also argued that it was the taxpayer for purposes of the statute that granted the deduction of net operating losses.³ The court rejected this argument because Information Systems, which generated the losses, was a separate corporation from AT&T.

AT&T also presented the same arguments presented in Little Six Corp. and argued that that the Court of Appeals’ prior holding should be reconsidered. AT&T argued the Department of Revenue had exceeded its rule-making authority and placed unreasonable and arbitrary restrictions on the use of net operating losses.

Tennessee Department of Revenue Rule 1320- 6-1-.21(2)(d) provides: "Each corporation is considered a separate entity; therefore, in the case of mergers, consolidations, etc., no loss carryovers incurred by the predecessor corporation will be allowed as a deduction from net earnings on the tax return of the successor corporation." The Court of Appeals upheld its earlier finding that the Department of Revenue had acted within its authority.

the court stated.

The current excise tax statutes explicitly provide that a successor corporation cannot use the net operating loss carryforwards of a merged predecessor: "[c](2) Except for unitary groups of financial institutions, each taxpayer is considered a separate entity; therefore, in the case of mergers, consolidations, and like transactions; no loss carryovers incurred by the predecessor taxpayer shall be allowed as a deduction from net earnings on the excise tax return filed by the successor taxpayer. With the exception set forth in subdivision (c)(3), a loss carryforward may be taken only by the taxpayer that generated it. [c](3) Notwithstanding the provisions contained in subdivision (c)(2), when a taxpayer merges out of existence and into a successor taxpayer that has no income, expenses, assets, liabilities, equity or net worth, any qualified Tennessee loss carryover of the predecessor that merged out of existence shall be available for carryover and deduction from the net earnings of the surviving successor in accordance with the provisions of this subsection."⁵

AT&T also claimed an industrial machine credit for tax years 1993 through 1996. The statute was amended in 1999 to condition the credits for businesses using computers and computer equipment upon qualification for the job tax credit. AT&T argued that the amendment suggested that prior to 1999, the legislature had not intended to place the job tax credit qualifications as a condition on the credits. The Appellate Court disagreed, holding that the expansion of the definition of industrial machinery to include computers, networks and software, and their peripheral devices had always contemplated that the taxpayer would qualify by making the "required capital investment" required by statute for the job tax credit.⁶

1 Tenn. Code Ann. § 67-4-2001, et. seq. (2004).

2 Little Six Corp. v. Johnson, 1999 Tenn. App. LEXIS 334, 1999 WL 336308 (Tenn. Ct. App.).

3 Tenn. Code Ann. § 67-4-805 (1996)(this section of the statute has since been reorganized and repealed by a 1999 public act, 1999 Tenn. Pub. Acts chapter 406).

4 AT&T Corp. v. Johnson, 2004 Tenn. App. LEXIS 214 (April 8, 2004) (quoting Little Six Corp. v. Johnson, 1999 Tenn. App. LEXIS 334, 1999 WL 336308 (Tenn. Ct. App.)).

5 Tenn. Code Ann. § 67-4-2006(c)(2) and (3) (2004).

6 AT&T Corp. v. Johnson, 2004 Tenn. App. LEXIS 214, at *14 (April 8, 2004).

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