United States: Court Holds Kentucky Consolidated Income Tax Returns Required

Applying fundamental rules of statutory construction, the Franklin Circuit Court reversed the final ruling of the Kentucky Department of Revenue (the "KDOR") and the Kentucky Board of Tax Appeals (the "KBTA") and held an out-of-state corporation and its Kentucky subsidiary were required to file consolidated income tax returns.  In World Acceptance Corporation, et al. v. Commonwealth of Kentucky, Finance & Administration Cabinet, Department of Revenue¹, World Acceptance Corporation ("WAC") and its wholly-owned subsidiary, World Finance Corporation of Kentucky ("WFCKY") (collectively "Taxpayers") amended the separate returns initially filed by WFCKY to reflect the consolidated filing of the Taxpayers for tax years 2007-2010.  The amended returns resulted in significant refund claims being owed to the Taxpayers, and the KDOR denied the refund claims (despite having previously issued a letter ruling advising WAC to file consolidated returns). 

The Taxpayers appealed the KDOR's denial of their refund claims to the KBTA.  The KBTA rejected the arguments of the Taxpayers and affirmed the KDOR's denial of the Taxpayers' refund claims.  The Taxpayers appealed the KBTA's decision to the Franklin Circuit Court.

Kentucky Revised Statute ("KRS") § 141.200(10)(b) requires taxpayers to file separate returns unless there is a "common parent corporation doing business in Kentucky" that has nexus with an affiliate.  Under KRS § 141.200(9)(c), a "common parent corporation" is defined as the member of an "affiliated group" that meets the ownership requirement of paragraph (a)1 or (b)1 of KRS § 141.200(9).   Because KRS § 141.200(9)(a)1 applies to taxable years prior to January 1, 2007, only KRS § 141.200(9)(b)1 applied in the instant case.  KRS § 141.200(9)(b)1 defines an "affiliated group" as "(1) or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation if [the common parent owns 80% or more of the stock and value in at least one other includible corporation and 80% of the stock in each of the includible corporations, excluding the common parent, is owned directly by one or more of the other corporations]."  An "includible corporation" is defined as any corporation doing business in Kentucky unless the corporation falls within one of the nine exceptions enumerated in KRS § 141.200(9)(e).  Of relevance here, KRS § 141.200(9)(e)7 provides that a corporation is not an includible corporation if the corporation realizes a net operating loss and the corporation's Kentucky property, payroll and sales factors pursuant to KRS § 141.120(8) are de minimis. 

The KDOR argued that under KRS § 141.200(9)(b)1, the parent, WAC, must, but does not, meet the definition of "includible corporation" because WAC was a corporation realizing a net operating loss whose property, payroll and sales factors were de minimis.  The Taxpayers argued the definition of "includible corporation" applicable to a "common parent corporation" is set forth at KRS § 141.200(9)(b), i.e., a common parent corporation is an includible corporation if the ownership requirements set forth in that section are satisfied. Furthermore, the Taxpayers argued that even if KDOR was correct that KRS § 141.200(9)(e)(7) is applicable, WAC's apportionment factors were not de minimis (per KDOR's own letter ruling), and therefore, this section does not prohibit WAC from meeting the definition of "includible corporation". 

The Franklin Circuit Court reversed the decision of the KBTA and found in favor of the Taxpayers.  The court agreed with the Taxpayers that KRS § 141.200(9)(b) sets forth the relevant definition of "includible corporation".  The court found the interpretation offered by the KDOR violated the rules of statutory construction by ignoring the plain meaning of the statute.  Specifically, the court noted that under the KDOR's interpretation, the phrase "which is an includible corporation if" in KRS § 141.200(9)(b)1 would have no meaning.

The KDOR has filed a motion to vacate the circuit court's judgment, which is currently under submission.

Footnote

1 Franklin Circuit Court, Civil Action No. 2014-CI-1193 (Aug. 14, 2015).

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