Indiana Supreme Court Holds Foreign Source Dividends Not Deductible In Calculating Net Operating Loss

The Indiana Supreme Court has held that foreign source dividends (FSDs) deductible from adjusted gross income (AGI) are not deductible when calculating a taxpayer's Indiana net operating loss (NOL) deduction.1 Also, the Court rejected the taxpayer's argument that the Indiana tax statutes facially violated the Foreign Commerce Clause of the U.S. Constitution by disallowing the FSD deduction in the Indiana NOL calculation, but incorporating the federal domestic source dividend deduction in the same calculation.

Background

Caterpillar, a multinational corporation headquartered in Illinois, deducted FSDs when calculating its Indiana NOLs for its 2000-2003 tax years.2 In 2004 and 2005, Caterpillar timely filed amended returns for its 1996-1999 tax years and sought refunds by using the NOLs calculated in Caterpillar's 2000-2003 tax years to offset Indiana taxable income. Following the Indiana Department of Revenue's determination that the FSD deductions were improper, Caterpillar timely protested the Department's recalculation of its Indiana NOL deductions. After the Department denied Caterpillar's protest, Caterpillar filed an appeal with the Indiana Tax Court. In its petition, Caterpillar appealed the Department's reduction of its Indiana NOLs available to be carried forward and used in future tax years. The Indiana Tax Court granted Caterpillar summary judgment and held that Caterpillar was allowed to deduct FSDs in the calculation of its Indiana NOLs. The Department appealed the Tax Court's decision to the Indiana Supreme Court.

Calculation of Indiana AGI and NOLs

Indiana AGI is calculated by beginning with federal taxable income.3 One of the allowable deductions in arriving at Indiana AGI is FSD income.4 After a taxpayer has made the necessary additions and subtractions in accordance with Indiana law, the taxpayer arrives at Indiana AGI by apportioning its income, which does not take into account the Indiana NOL deduction.5

Indiana has a separate statute that provides for the calculation of the Indiana NOL.6 This is a three-step process which entails (1) calculation of the federal NOL; (2) modification of the federal NOL required by Indiana law;7 and (3) determining the portion of the NOL derived from sources within Indiana.8 The calculation of the NOL does not expressly include a modification for FSDs.

FSD Deduction Not Applicable to NOL Computation

In reversing the Indiana Tax Court,9 the Indiana Supreme Court held that Indiana's tax...