New York ALJ Determines Article 32 Taxpayer Not Required To Utilize NOL In Computing Tax Under Alternative Base

On January 22, an administrative law judge (ALJ) in the State of New York Division of Tax Appeals determined that a taxpayer subject to Article 32 (banking corporation franchise tax) was not required to apply a net operating loss (NOL) deduction to decrease its entire net income (ENI) in a tax year in which its ENI base was not the highest of the alternative bases for computing the tax.1 At this point, it is not known whether the New York State Department of Taxation and Finance is going to appeal this decision to the New York State Tax Tribunal.2

Background

The taxpayer, TD Holdings II, Inc., was a Delaware corporation with a principal place of business in New York City during the fiscal years ending October 31, 2005, October 31, 2006 and October 31, 2007. TD Holdings, which was subject to the banking corporation franchise tax3 for the years at issue, timely filed consolidated franchise tax reports with certain subsidiaries. The consolidated group was part of a larger consolidated group for purposes of its federal income tax returns during the relevant periods.

To determine the liability due on the consolidated reports, the smaller consolidated group prepared pro forma federal income tax returns to reflect the income and deductions on its federal consolidated returns as if it had filed as a consolidated group for federal income tax purposes. The pro forma returns resulted in (1) an NOL of nearly $12 million for the 2005 tax year; (2) income of nearly $4 million for the 2006 tax year; and (3) income of over $33 million for the 2007 tax year. Based on these amounts, the pro forma returns showed a federal NOL deduction of nearly $4 million for the 2006 tax year and a federal NOL deduction of nearly $8 million for the 2007 tax year.

In calculating ENI, the consolidated reports showed a New York State loss of over $9 million for the 2005 tax year; income of nearly $7 million for the 2006 tax year; and income of nearly $35 million for the 2007 tax years. The taxpayer computed its franchise tax liability based on its taxable assets allocated to New York, rather than on its ENI, for the 2005 and 2006 tax years. For the 2007 tax year, the taxpayer computed its franchise tax liability based on its ENI. In computing its tax liability, the taxpayer did not apply its 2005 state NOL to its ENI to the 2006 tax year. Instead, the taxpayer applied the 2005 state NOL entirely to its ENI to the 2007 tax year.

The Department initiated an audit of the consolidated reports and...