Detailed North Carolina Development
The North Carolina Supreme Court recently affirmed a decision holding that a taxpayer was required to reduce its Net Economic Losses (NELs) to account for non-taxable dividends. In doing so, the state’s highest court did not draft its own opinion; the decision of the superior court was affirmed per curiam. The taxpayer at issue filed a consolidated federal return and a separate North Carolina return. In computing its North Carolina taxable income, the taxpayer was required to file “as if” it had filed separately for federal purposes. During the tax years at issue, the taxpayer received dividends from a subsidiary. On its federal pro forma returns, the taxpayer included the dividends in its tax base, then claimed a dividends-received deduction under IRC section 243. For state purposes in those same tax years, the taxpayer’s starting point reflected its federal taxable income after the DRDs. Ultimately, the taxpayer’s North Carolina taxable income for the 2007 and 2008 tax years at issue was reported as zero after application of NEL carryforwards. Later, on audit, the Department adjusted the taxpayer’s income for certain other tax years on the basis that its NELs used in the 2007 and 2008 tax years should have been reduced by the dividends received. In the Department’s view, any carried forward NEL must be reduced by any current year nontaxable income. Reducing the NELs reported in 2007 and 2008 by an apportioned amount of the dividends received that had been deducted had the effect of eliminating the NELs the taxpayer had taken in subsequent years. As a result, the Department issued assessments for those later years. After the Office of Administrative Hearings (OAH) ruled in favor of the taxpayer, the Department appealed.
Under North Carolina law in effect for the tax years at issue (the net economic loss provisions have since been repealed), a taxpayer’s NEL carryforwards could be deducted only to the extent that the loss carried forward from the prior year exceeded any “income not taxable” under “this part” received in the same year in which the deduction was claimed. Thus, the key issue was whether the dividends, deducted for federal purposes, constituted income not taxable under North Carolina law at the time. The OAH had held that the dividends did not constitute “income not taxable” because the statute specifically listed two types of non-taxable income and dividends were not mentioned. The superior court, however, disagreed with the OAH, observing that the statute identifying the two types of “income not taxable” was not exclusive or exhaustive. In the court’s view, because the dividends were income on which the state did not levy a tax, the dividends were “income not taxable” under the relevant statute and must reduce the taxpayer’s NELs in the year to which they were carried forward. This conclusion, the court noted, was supported by the Department’s bulletins on the matter, which stated that “income not taxable” incudes “any other income not taxable under state law.” The superior court also rejected the taxpayer’s argument that the state’s treatment resulted in unconstitutional double taxation. Please contact Nikki Emanuel Jarrell at 704-335-5344 with questions on North Carolina Dep’t of Revenue v. Graybar.
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