Delaware Supreme Court Rejects Division’s Longstanding but Unpublished Policy on NOLs

The BR State + Local Tax Spotlight

The Delaware Supreme Court has invalidated an audit policy that had been in place for at least 30 years as being inconsistent with the Delaware Code, demonstrating that just because a taxing agency’s policy is longstanding, does not mean that it is correct. Dir. of Revenue v. Verisign Inc., No. 18, 2021, 2021 WL 5563437 (Del. Nov. 29, 2021).

Facts: Verisign filed a federal consolidated return along with its affiliated corporations. As required by Delaware law, it filed a separate company Delaware corporate income tax return. In calculating its Delaware tax liability, Verisign computed its net operating losses for the two years at issue on a separate-company basis and reported no tax due. On audit, the Division of Revenue (“Division”) asserted that the net operating loss (“NOL”) computation violated its longstanding policy of limiting a taxpayer’s NOL to the consolidated NOL deduction reported by its federal filing group (the “Policy”).

The Policy, however, only appeared in the Division’s internal manual for auditors. Moreover, the Division could not explain why it was placed there or why it was enacted. All the Division stated was that the Policy “has been in place for at least 30 years and in any event longer than any current employee of the Division can remember.” (It is noted that the Policy’s limitation did not apply to federal consolidated groups that consisted of only Delaware taxpayers.)

The Decision: The Court looked to the Delaware Code and, after noting that it “is hardly beach reading,” found that in all instances a corporate taxpayer is required to report items of income and deductions on a separate-entity basis. It also noted that the Division’s return instructions explicitly provided that a corporation filing as part of a federal consolidated group is required to “calculate its stand‑alone federal taxable income, including all deductions, in accordance with the IRC” (emphasis in original).

The Court concluded that the Policy violated the Delaware Code and therefore invalidated the Policy.

Interestingly, on July 30, 2021, the General Assembly enacted legislation which codifies much of the Policy and explicitly limits a taxpayer’s NOL to the value of the consolidated NOL deduction claimed by the federal consolidated group. The legislation does not, however, have a carve-out for taxpayers that file a consolidated federal return exclusively with other Delaware taxpayers. While the Court discussed the legislation, it did not form part of its analysis.

Delaware taxpayers that have paid tax because of the Division’s now-invalidated Policy should consider whether refund opportunities exist. This decision is also a good reminder that just because a taxing agency says it has a longstanding position, does not mean that the position cannot be successfully challenged.

This article is one in a series of articles written for the December 2021 edition of The BR State + Local Tax Spotlight.