North Carolina Court Of Appeals Upholds Forced Combination Of Returns Under Prior Law

The North Carolina Court of Appeals has affirmed a trial court's decision that upheld the Secretary of the North Carolina Department of Revenue's ability to order a combined return under prior law.1 However, the Court of Appeals reversed the trial court's decision that the taxpayer was entitled to a refund of the 25 percent gross understatement penalty that it had paid to the Department.

Background

Delhaize America, Inc. (DZA) was a corporation that had its principal place of business in North Carolina. For the 2000 tax year, DZA filed a separate North Carolina income tax return which included a deduction for expenses arising from a royalty agreement with FL Food Lion, Inc. (FLFL), a Florida corporation and affiliate of DZA. FLFL also filed a 2000 North Carolina corporation income tax return reflecting the income arising from the royalty agreement. The royalty deduction and income arose from a transaction in which DZA transferred assets to FLFL; DZA paid fees and royalties to FLFL for use of the assets, creating a tax deduction in North Carolina for DZA; and FLFL distributed tax-free dividends to DZA.

In 2004, following an audit, the Department concluded that DZA's income should be combined with FLFL's income to reflect DZA's true net earnings in North Carolina. The Department issued a Notice of Corporate Income Assessment of additional tax, interest and negligence penalty against DZA for the 2000 tax year.

In 2006, DZA paid the additional income taxes, interest and negligence penalty to the Department and requested a refund. After the Department denied the refund, DZA filed a complaint against the Secretary of the North Carolina Department of Revenue alleging violations of the statutes allowing the Secretary to require combined returns, the Commerce Clause and the Due Process Clause. In 2011, the trial court granted partial summary judgment for both parties. The trial court found in favor of the Department on the issue of combining the returns and the resulting additional taxes and interest. However, the trial court granted DZA's motion for a refund of the penalties. Both DZA and the Department filed appeals.

Forced Combination Did Not Violate Procedural Due Process

The Court of Appeals denied DZA's argument that the Department's decision to require the combined returns violated procedural due process. Under the law that was in effect prior to 2012, the Department could adjust a corporation's net income by eliminating intercompany payments...