Utah Rules that Taxpayer Lost Net Operating Loss Carryover Following Merger

February 27, 2017

A recent Utah case stated that if an acquired company is merged out of existence, its NOLs cannot be deducted by the surviving entity.

By Jess Johannesen, SALT manager

When corporations engage in restructurings or acquisitions, one important tax consequence that must be addressed is the treatment of any tax attributes, particularly net operating losses (NOLs). Specifically, two issues must be analyzed: first, does the NOL carry over to the acquiring corporation following the transaction, and second, are there any limitations on the acquiring corporation’s ability to utilize the NOL in future tax years?

Internal Revenue Code (“IRC”) §381 generally provides for the carryover of the acquired corporation’s NOLs to the acquiring corporation. The acquiring corporation’s utilization of those NOLs may be subject to certain limitations. For example, upon certain changes in ownership, IRC §382 can limit the value of a corporation’s net operating loss that is allowed to be utilized by the acquiring corporation. For state income tax purposes, many states conform to or follow the federal rules; however, a minority of states do not permit the carryover of NOLs to an acquiring corporation, particularly when the entity that generated those NOLs is merged out of existence. This was the case in a recent Utah State Tax Commission’s appeals decision in which the Administrative Law Judge (“ALJ”) disallowed an acquired company’s entire net operating loss carryover following an acquisition. [1]

The issue in the case was whether an acquiring corporation could utilize on its Utah return the pre-acquisition Utah NOLs of an acquired corporation if the acquired corporation was merged out of existence. During the period at issue, the taxpayer acquired a corporation which was merged into the taxpayer’s wholly-owned subsidiary. After the merger, the acquired corporation’s business operated as a division of the taxpayer’s subsidiary. The subsidiary maintained the same plant and same operations in Utah of the acquired corporation that created the Utah losses before the acquisition. However, the acquired corporation was no longer a separate corporate entity since it merged out of existence and became a division of the taxpayer’s wholly-owned subsidiary.

Utah’s statutes provide that, “an acquired corporation may deduct [its] net losses incurred before the date of acquisition against [its] separate income . . . if [it] has continued to carry on a trade or business substantially the same as that conducted before the acquisition.” [2] The taxpayer asserted that it could use the acquired corporation’s existing Utah NOL to offset separately calculated post-acquisition income of that division (i.e., the acquired corporation’s business operating within the subsidiary) because the acquired corporation’s business was carried on in substantially the same manner as before the acquisition. However, Utah cited two prior appeals decisions which interpret the Utah statute to entirely disallow the losses incurred prior to the acquisition because the acquired corporation is merged out of existence. [3]

Utah’s position based upon these prior appeals decisions was, in essence, that there no longer was an acquired corporation that could deduct its own pre-acquisition NOLs against its own post-acquisition income. After being merged out of existence, the acquired corporation “no longer existed as a corporation,” and, therefore, also could not continue to carry on a trade or business substantially the same as that conducted before the acquisition (as required by Utah statutes). Instead, the operations of the acquired corporation were now integrated into a new and distinct corporate entity. Accordingly, it was ultimately held that none of the NOLs incurred prior to the acquisition were available for carry forward since the acquired corporation was merged out of existence.

As illustrated by this case, when entering into acquisition transactions, it is imperative to evaluate the relevant state statutes and regulations regarding the rules surrounding NOL carryovers. State NOLs can be a significant tax attribute for a purchaser, and a purchaser that expects to utilize them (and pays the seller for them) and assumes it will be able to do so because the federal rules permit it will be very disappointed (and angry) to find out that those NOLs are lost forever. The same analysis must be performed for internal restructurings as well. Otherwise, a company that simplifies its entity structure may inadvertently cause the state NOLs to disappear.

Aprio’s SALT team is very experienced with state tax issues associated with corporate transactions and restructurings and will make sure that your internal and external transactions are structured to maximize the preservation of state NOLs. We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jess Johannesen at jess.johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the February 2017 SALT Newsletter. To view the entire newsletter, click here.

[1] Utah State Tax Commission Appeal No. 14-2016, 11/01/2016.

[2] Utah Code Ann. §59-7-110(5)(b).

[3] Utah State Tax Commission Findings of Fact, Conclusions of Law, and Final Decision in Appeal No. 97-1296 (01/05/2000) and Appeal No. 89-2305 (05/12/1992).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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