Delaware State Court Strikes Down NOL Limitation, Presenting Refund Opportunity

Under Delaware law, a corporation that claims a consolidated NOL deduction on its federal consolidated return may claim an NOL deduction for Delaware corporate income tax purposes by computing its NOL on a separate-company basis. However, according to the Division’s now-invalid policy, the corporation’s separate-company NOL deduction was limited to the consolidated NOL claimed on the federal consolidated return. This limitation did not apply if every member of the consolidated group filed a Delaware income tax return.

Verisign, Inc. filed federal consolidated returns and generated NOLs on a separate-company basis. For the tax years 2015 and 2016, the company had NOL carryovers that reduced its federal taxable income to zero. For Delaware corporate income tax purposes, however, the Division limited Verisign’s NOL deduction each year to the consolidated NOL reported by Verisign’s group on its federal consolidated return, which caused Verisign to have taxable income. Verisign challenged the validity of the Division’s policy on multiple grounds, including that it violated the Delaware Constitution’s Uniformity Clause.

The Delaware Superior Court, New Castle County, concluded that the Division’s policy violated the Uniformity Clause of the state constitution because it divided a single group of corporate taxpayers into two different classes—those who filed federal consolidated returns and those who did not—and applied the NOL limitation only to the first class. The court rejected the argument that the Division’s policy should nevertheless be upheld because the classification it created was “reasonable.” Although the Delaware Supreme Court has articulated a “reasonableness test” for determining whether classifications violate the Uniformity Clause, the superior court observed that the test is grounded in the notion that deference should be given to tax classifications created by the legislature. Finding no basis for deferring to a classification created solely by an administrative agency, the court held that the Division’s NOL limitation policy violated the state constitution. One potential issue not addressed by the court is which standard of review applies when classifications created by administrative agencies are challenged under the Uniformity Clause. That issue may be addressed by an appellate court should either party appeal.

The Verisign case presents a potential refund opportunity for any Delaware corporate taxpayers who were members of a federal consolidated group and, based on the Division’s now-invalid policy, had their separate-company NOL deductions limited to the consolidated NOL. The Pillsbury SALT Team will continue to monitor developments in this case.