United States: Missouri Administrative Hearing Commission Holds Group Filing

The Missouri Administrative Hearing Commission (AHC) has held that an affiliated group of corporations was not entitled to deduct, on its consolidated Missouri corporate income tax return, its members' net operating losses (NOLs) reported on separate Missouri returns in prior years.1 A federal regulation expressly allows the separate company losses to be deducted on subsequent consolidated returns, but Missouri does not have a comparable statute or regulation.

Background

Prior to 2001, a taxpayer consisting of an affiliated group of corporations filed Missouri and federal consolidated corporate income tax returns. Starting in 2001 and for all subsequent relevant tax years, the taxpayer filed consolidated federal income tax returns. The members of the taxpayer with Missouri nexus were permitted by the Missouri Director of Revenue to file separate Missouri income tax returns for the 2001 through 2003 tax years. The taxpayer attempted to file a Missouri consolidated return for the 2004 and 2005 tax years, but the Director denied permission. Accordingly, the members of the taxpayer with Missouri nexus continued to file separate Missouri income tax returns in 2004 and 2005. The taxpayer filed a consolidated Missouri income tax return for the 2006 tax year, which was audited by the Director, ultimately resulting in a notice of adjustment.

At audit, the Director examined the taxpayer's treatment of NOLs on the Missouri consolidated return. On its federal consolidated return, the taxpayer reported taxable income of over $481 million. On its Missouri return, the taxpayer deducted NOLs of its members who had incurred those losses in years when they had filed separate Missouri returns but joined in the taxpayer's consolidated federal returns. After deducting these losses, the taxpayer reported less than $19 million as federal taxable income on its 2006 Missouri return. In April 2013, the Director issued a final decision denying the taxpayer's NOL deduction.

NOLs and Consolidated Returns

Federal law creates an NOL deduction that equals the aggregate of the NOL carryovers and carrybacks for the taxable year.2 Missouri does not have a counterpart to the federal NOL deduction provisions. Instead, a Missouri taxpayer must deduct the NOLs from the taxpayer's gross income on the taxpayer's federal return.3 This amount is both the taxable income shown on the taxpayer's federal return and the federal taxable income shown on the Missouri return.

Under federal law, an affiliated group of corporations is allowed to file a consolidated return.4 By electing to file a consolidated return, the members agree to be included in the group for federal tax purposes and to abide by the related regulations promulgated by the Secretary of the Treasury. Missouri law requires that an affiliated group seeking to file a Missouri consolidated return also file a federal consolidated return for the taxable year.5 After the affiliated group has elected to file Missouri consolidated returns, it may withdraw or revoke that election only if there is a substantial change in the law or regulations adversely changing the group's income tax liability, or with permission of the Director upon a showing of good cause.6 If a withdrawal or election is made, the group may not file a Missouri consolidated return for five years unless it receives the Director's approval.7

A Treasury regulation provides a federal income tax deduction to an affiliated group of corporations for an NOL.8 Under this federal regulation, the NOL carryovers and carrybacks include any NOLs of the members arising in separate return years, subject to certain limitations.9 Missouri does not have a counterpart to this federal regulation.

Stipulation on Tax Scenarios

The taxpayer and the Director stipulated the calculations that would be applicable to determine the taxpayer's 2006 Missouri corporation income tax under three separate scenarios: (i) the taxpayer could use NOLs from all of its subsidiaries; (ii) the taxpayer could only use the NOLs from subsidiaries with Missouri nexus; and (iii) the taxpayer could not use any of the subsidiaries' NOLs. The taxpayer would not have had any Missouri income tax liability under scenarios (i) and (ii), but would have an approximately $1 million Missouri income tax liability under scenario (iii).

Taxpayer Could Not Deduct Prior Separate Company Losses

The taxpayer, with respect to its NOL deduction claim for 2006, sought to apply the federal income tax losses of its members that arose in the separate return years of 2001- 2005, as allowed for federal income taxes.10 Even though Missouri does not have a comparable provision, the taxpayer presented several arguments why it should be able to deduct its members' losses generated in prior separate company tax years. The AHC rejected all of the taxpayer's arguments.

To support its argument that the separate company NOLs could be deducted, the taxpayer claimed that the Director was directed by the legislature to promulgate a regulation enabling an affiliated group filing a consolidated return to deduct the NOLs of its members that arose in separate return years. Specifically, the taxpayer argued that provisions in the Missouri taxable income statute11 and the statute authorizing the Director to make rules and regulations12 read together required the Director to promulgate a regulation treating Missouri taxpayers filing consolidated returns in the same manner as they are treated for federal income tax purposes. However, the taxable income statute provides that "the director of revenue may prescribe such regulations ...." The AHC held that the use of the word "may" did not make the language a mandate and found no direction from the legislature to the Director to promulgate the regulation the taxpayer sought.

The statute authorizing the promulgation of rules provides that "[t]he rules and regulations prescribed by the director of revenue shall follow as nearly as practicable the rules and regulations of the Secretary of the Treasury."13 The AHC held again that this did not actually mandate the Director to promulgate regulations. Furthermore, the Director was not required to follow a federal regulation if the impact of following the regulation would change the substantive rules of Missouri law.

The taxpayer also argued that a Missouri regulation provided for the utilization of NOLs of members incurred in prior separate company years based upon like treatment under federal law.14 The taxpayer contended that the Missouri regulation had the same impact as the federal regulation15 and would create the deduction for prior-year separate company NOL deductions.

In rejecting this argument, the AHC found that a plain reading of the language in the Missouri regulation did not apply to the taxpayer's situation. The language read:

When the filing status or combination for the Missouri return for any taxable year is different from the federal filing status or combination for that taxable year the taxpayer must follow the federal Internal Revenue Code and regulations as they would apply to the facts and circumstances for the Missouri return.

The AHC found that the language "must follow" was nothing like the federal regulation that contained a specific definition of "consolidated net operating loss." Even if the AHC read the regulation as the taxpayer proposed, the regulation would still be inapplicable to the taxpayer's situation for the 2006 tax year.

The taxpayer turned to the AHC's decisions in Kerr-McGee Refining Corp. v. Director of Revenue16 and Cooper Industries, Inc. v. Director of Revenue17 for its third argument, in that such cases provided for the utilization of NOLs in the manner sought by the taxpayer. The AHC distinguished both of those cases from the instant case because the taxpayers in Kerr- McGee and Cooper Industries claimed deductions for NOLs they obtained from subsidiaries that had merged into them, thus triggering the claim to the subsidiaries' NOLs under a federal provision allowing the carryover of tax attributes in certain corporate acquisitions.18 In addition, in both cases the taxpayers had filed separate company rather than consolidated returns.

The taxpayer's fourth argument related to a provision in the taxable income statute allowing the Director to promulgate regulations concerning consolidated returns.19 The taxpayer claimed such provision constituted a modification to federal taxable income and did not take into account the entirety of the taxable income statute.20 The AHC agreed that the provision allowing the Director to issue consolidated return regulations must be read with the rest of the taxable income statute, but the AHC found that such a reading did not support the taxpayer's argument. The AHC found it more appropriate to read the provision allowing the promulgation of consolidated return regulations in conjunction with the other consolidated return provisions contained in the taxable income statute. Following this approach, the provision allowing the consolidated return regulations did not modify federal taxable income in the manner suggested by the taxpayer, but instead was an authorization for the Director to promulgate regulations.

The taxpayer's fifth and sixth arguments concerned Missouri's unexpected decision21 and change in policy22 statutes. Under the unexpected decision statute, the AHC would need to find "a reasonable person would not have expected the decision or order based on prior law, previous policy or regulation of the department of revenue."23 Under the change in policy statute, there would need to be a final decision by the Department which would be the result of a change in policy or interpretation by the Department affecting a particular class of person subject to such decision.24 As with the unexpected decision, if a change of policy is determined, then the change would only be applied prospectively.

The taxpayer claimed the assessment should be abated based on the unexpected decision and change in policy even if Missouri law does not provide for the taxpayer's utilization of the NOLs in the manner sought. The AHC held that this decision was not unexpected based on the fact that the Kerr-McGee and Cooper Industries decisions were distinguishable on their facts and neither the law, policy, nor regulations had changed.

Finally, the AHC considered the taxpayer's indirect argument that it was entitled to deduct the prior separate NOLs and that it would be inequitable not to allow deductions for them. In rejecting this argument, the AHC explained that the taxpayer did not cite authority for its claim of right for the state NOL deduction and that deductions only are allowed to the extent authorized by statute. Furthermore, the promulgation of a regulation that would specifically allow affiliated groups to deduct separate company NOLs from prior years was not authorized by the legislature and would violate Missouri's statutory emphasis on the concept of a "taxable year." Also, the Missouri Supreme Court consistently has rejected taxpayers' attempts to adjust the federal income tax amount on their Missouri returns to fit their theories of taxation.

Commentary

In a comprehensive decision, the AHC found that an affiliated group filing a consolidated return was not entitled to deduct NOLs of its members that arose in prior years when the corporations had filed separate returns. However, because the AHC only distinguished Kerr-McGee and Cooper Industries and did not overturn these cases, taxpayers still can claim deductions for NOLs they obtained from subsidiaries that had merged into them, thus triggering the claim to the subsidiaries' NOLs under the federal provision allowing the carryover of tax attributes in certain corporate acquisitions.25 It is important to note that in Kerr-McGee and Cooper Industries, the taxpayers had filed separate company returns rather than consolidated returns. Based on the instant case, unused NOLs generated on a separate Missouri income tax return appear to become unusable once the separate taxpayer files on a consolidated basis in Missouri. This could give pause to taxpayers considering whether to switch filing methods for Missouri corporation income tax purposes.

The AHC is not a court of law and its decisions do not have precedential authority, but the AHC decisions are indicative of the Missouri Department of Revenue's position and how the AHC interprets this position. However, the AHC decisions do not bind other taxpayers. Based on this decision, the Department likely will continue to apply its current policy unless it is overturned by the Missouri Supreme Court. The taxpayer appealed this case directly to the Missouri Supreme Court on September 5, 2014, with a decision possible in the spring of 2015.

Footnotes

1 Express Scripts, Inc. v. Director of Revenue, Missouri Administrative Hearing Commission, No. 13-0865 RI, Aug. 5, 2014.

2 IRC § 172.

3 Eilian v. Director of Revenue, 402 S.W. 3d 566 (Mo. Banc 2013).

4 IRC § 1501.

5 MO. REV. STAT. § 143.431.3(1).

6 MO. REV. STAT. § 143.431.3(2).

7 Id.

8 Treas. Reg. § 1.1502-21(a).

9 See Treas. Reg. § 1.1502-21(c), which states the general rule on separate return loss year limitations: the aggregated NOL carryovers and carrybacks of a member actually or treated as arising in separate return loss years that are included in the consolidated NOL deductions for consolidated return years of the group cannot exceed aggregate consolidated taxable income for such consolidated return years of the group determined by reference to only the member's items of income, gain, deduction and loss.

10 Treas. Reg. § 1.1502-21(a)(2).

11 MO. REV. STAT. § 143.431.3(5).

12 MO. REV. STAT. § 143.961.2.

13 Id.

14 MO. CODE REGS. ANN. tit. 12, § 10-2.165(6).

15 Treas. Reg. §1.1502-21(a)(2).

16 Missouri Administrative Hearing Commission, No. 93-000717 RI, March 29, 1994.

17 Missouri Administrative Hearing Commission, No. 98-2920 RI, Aug. 9, 2000.

18 IRC § 381.

19 MO. REV. STAT. § 143.431.3(5).

20 Id. Note that this argument was raised for the first time in the taxpayer's reply brief.

21 MO. REV. STAT. § 143.903.

22 MO. REV. STAT. § 32.053.

23 MO. REV. STAT. § 143.903.

24 MO. REV. STAT. § 32.053.

25 IRC § 381.

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