Delaware: NOL limitation policy not supported by statute (court decision)

Possible refund opportunities

Possible refund opportunities

The Delaware Supreme Court held that the Delaware Division of Revenue’s longstanding policy of limiting a corporate taxpayer’s separate Delaware net operating loss (NOL) to the amount of NOL claimed on the taxpayer’s federal consolidated return was not supported by statute. The high court agreed with the lower court that the policy was invalid, but reached its decision on alternate grounds.

The decision of the high court observes that legislation (House Bill 171) enacted earlier this year appears to have codified the NOL limitation previously found in the Division’s audit manual.

The case is: Director of Revenue v. Verisign, Inc. (November 29, 2021) Read the decision [PDF 193 KB]


Under Delaware law, corporations are required to file returns on a separate company basis and to compute pro forma federal taxable income as if the corporation had filed on a separate basis for federal purposes. 

Under a policy included in the Division’s audit manual, the allowable NOL deduction was capped at an amount equal to the NOL reported on the federal consolidated return. Thus, a Delaware corporate taxpayer was required to compute its Delaware NOL deduction using a two-step process.

  • First, the taxpayer was required to “compute its NOL on a separate company basis under the IRC.”
  • Second, the taxpayer was required to “limit that separate company NOL to the consolidated NOL deduction of the federal consolidated group of which the [corporation] is a member.” [Emphasis added.]

However, per the audit manual, the second step was not required if every member of the federal consolidated group filed a Delaware separate entity return. 

The taxpayer filed federal consolidated returns with its affiliates. For the 2005 to 2013 tax years, the taxpayer generated approximately $2.89 billion in NOLs on a separate company basis, and the NOLs were carried over to the 2014, 2015, and 2016 tax years to reduce the company’s pro forma federal taxable income to zero. 

On audit, the Division limited the amount of the NOL deductions in tax years 2015 and 2016 to the amount of the taxpayer group’s consolidated NOL deductions for those years. The allowable NOLs were significantly less than what the taxpayer would have had if the NOLs were computed on a separate company basis. The taxpayer subsequently challenged the limitation.

In a motion for summary judgment, the lower court first concluded that the policy was not inconsistent with Delaware’s statutes for determining taxable income and did not violate the dormant Commerce Clause. Nevertheless, the lower court held for the taxpayer, holding the Division’s policy violated the Delaware Constitution’s Uniformity Clause because it created two classes of corporate taxpayers—those that filed federal consolidated returns and those that filed single entity federal returns. Read TaxNewsFlash

Delaware Supreme Court decision

On appeal, the state’s high court affirmed the grant of summary judgment, but did so on statutory rather than constitutional grounds.

The Supreme Court concluded that the Division’s policy was inconsistent with the statutory requirement that each corporate taxpayer report income and deductions as a stand-alone entity, rather than on a consolidated basis. As the high court noted, while Title 30 (the tax code) was “hardly beach reading,” its provisions were unambiguous and obligated each eligible corporation to pay Delaware income tax as a singular entity. The law did not authorize the use of a consolidated deduction taking into account the income and deductions of multiple entities. Further, even if Title 30 were not clear, the Supreme Court noted that the corporate income tax form instructions for the year at issue required a taxpayer to report a separate company figure in all aspects—except for the NOL computation. The policy requiring that a taxpayer use an “aggregate” NOL deduction was found to be “flatly inconsistent” with the mandate that each eligible corporation “shall annually pay a tax . . . on its taxable income….” [Emphasis added.]

Having determined that the Division’s policy was not authorized by statute for the years at issue, the Supreme Court declined to address the taxpayer’s constitutional claims.

KPMG observation

Taxpayers that had their NOLs limited under the Division’s policy in prior tax years need to consider filing refund claims for open tax years, if they have not done so already. 

Although it appears the matter is settled for the tax years prior to the law change, there remains ambiguity concerning if and when the limitation is applicable going forward. Under House Bill 171, enacted earlier this year, Delaware Code § 1903(a)(2)(i) now requires a taxpayer to eliminate from federal taxable income

…any deduction for a net operating loss carryforward calculated in accordance with the provisions of the Internal Revenue Code, provided however that the deduction may not exceed the amount claimed on the federal return filed for the taxable year in which the taxpayer was included as a party.

This language falls directly under the subsection of § 1903 that requires taxpayers to eliminate any deduction for NOL carrybacks to the extent such deduction exceeds $30,000. Read literally, the amendment to § 1903 appears to require an addback of the federal NOL without also providing a subtraction for a separate company NOL limited to the consolidated NOL claimed on a taxpayer’s federal return. Although the recently enacted Delaware Code § 1903(a)(2)(i) is less than clear, based on the legislative synopsis, the intent of the law appears to be to codify the Division’s policy (except it does not include the exception for instances when all members file a Delaware return).

While the limitation is arguably now codified, there are outstanding questions that were not answered by the court. There may still be a state constitutional uniformity clause violation, despite the codification of the limitation. Furthermore, as revised, the law does not have a specific effective date, meaning the codification of the policy likely became effective when House Bill 171 was signed on July 30, 2021. However, it is unclear whether the Department will attempt to apply the NOL limitation to all returns filed after that date or to tax periods ending after the enactment of House Bill 171. 

For more information, contact a KPMG State and Local Tax professional:

Joshua Shantzer | +1 267 256-1707 | 


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