On Nov. 29, 2021, the Delaware Supreme Court unanimously upheld a judgment from the Superior Court sustaining a corporation’s tax protest, but on statutory grounds rather than the state constitutional ones decided below in Director of Revenue v. Verisign, No. 18, 2021, — A.3d —-, 2021 WL 5563437 (Del. Nov. 29, 2021), affirming in part and reversing in part No. N19C-08-093-JRJ, 2020 WL 7640107 (Del. Super. Dec. 17, 2020). Because the state Legislature has acted in the intervening time, the decision calls into doubt the validity of certain provisions of Delaware’s corporate tax laws.
At issue is the interplay between two commonly used features of tax law: the carrying forward of net operating losses (NOLs) and the filing of consolidated federal returns by affiliated corporations. Both the federal and Delaware income tax authorities permit entities to “carry forward” NOLs. That carrying forward means that if a corporation’s net income in one tax year is negative, then in addition to there being no profits to tax, the corporation in a future year can use that loss to offset profits and reduce its taxable obligation. Unlike Delaware law, however, for federal income taxes, a group of affiliated corporations can file a single “consolidated” return, treating their combined financial flows as a unitary whole. Delaware, in keeping with its well-known respect for the corporate form and separate corporate identity, requires each corporation to file a separate tax return. Because income as reported to the federal government is the starting point for income as reported to the Delaware government for income tax purposes, Delaware requires that corporations who filed consolidated returns at the federal level file an individualized pro forma return, separating themselves from the consolidated group.
Under the facts as stipulated by the parties, the Delaware Division of Revenue (division) had a longstanding policy (policy) limiting the ability of corporations who filed consolidated federal returns to declare and carry forward net operating losses. Under the policy, if a corporation had filed its federal taxes as part of a consolidated return, its net operating loss was capped for Delaware income tax purposes at the consolidated group’s net operating loss, i.e., at the lesser of its own net operating losses and the operating losses of the group as a whole. The policy has an exception for not applying if the group consisted entirely of Delaware taxpayers.
Verisign, Inc. declared on its Delaware income taxes an NOL offset corresponding to its own net operating losses. The division, capping Verisign’s permissible NOL in accordance with the policy, did not permit the level of offset Verisign had taken and assessed an obligation of $1.7 million in taxes and fees. Verisign issued a protest, which the division denied, and the case was removed to the Delaware Superior Court in front of President Judge Jan Jurden. Verisign and the division made cross-motions for summary judgement over the undisputed facts. Verisign’s argument was fourfold, arguing that the policy derogated Delaware statute, the Delaware Constitution and the dormant and foreign commerce clauses of the U.S. Constitution.
The Superior Court rejected their statutory challenge, reasoning that a 1985 Superior Court case had already found the policy to be in harmony with the statute. That case was Cluett, Peabody, & Co. v. Director of Revenue, 1985 Del. Super. LEXIS 1089 (Del. Super. Jan. 22, 1985). Delaware trial courts treat one another’s rulings, whether reported or not, as stare decisis, a deference which attorneys not accustomed to Delaware practice may find surprising. Nor was the Superior Court persuaded that the policy was a form of protectionism violating the dormant commerce clause by penalizing networks of affiliated corporations unless all members did taxable business in Delaware. Instead, the Superior Court found that the policy, by applying different tax rules based on whether a corporation had filed an individual or consolidated federal return, violated the state constitutional requirement in Article VIII Section 1 that taxes “be uniform upon the same class of subjects.” Those different rules amounted to a “classification,” made by an administrative agency without legislative authorization, and were in the Superior Court’s view invalid. Though it had requested supplementary briefing on Verisign’s Foreign commerce clause challenge, the Superior Court did not reach that issue.
Because the Delaware Supreme Court, as a higher tribunal, was not bound by the 1985 Superior Court decision finding the policy consonant with the statute, the Supreme Court examined the issue de novo and found the policy invalid. As it explained, the clear legislative language provided for corporations to have their taxes assessed and paid as separate entities, individual and distinct. Because the policy varied an individual corporation’s taxes based on other entities’ income, it was contrary to the statute and so impermissible. The court therefore expressly declined to opine on the state and federal constitutional questions, though it described the lower court’s analysis of the Delaware constitutional provision as “thoughtful and well-reasoned.”
The court’s forbearance is noteworthy because, as it recounted in its opinion, the state Legislature codified the policy into statute—minus the carveout for groups consisting exclusively of Delaware taxpayers—while the appeal was pending. By leaving the constitutional questions unanswered, the Delaware Supreme Court appears to have intentionally left a serious question of corporate tax policy for future litigation.
Michael B. Gonen is an attorney in Duane Morris’ Wilmington office, practicing in the area of litigation. Prior to entering private practice, Gonen served as judicial clerk to Justice Karen Valihura of the Delaware Supreme Court; Judge Paul Wallace of the Delaware Superior Court; and Judge Jeffrey Trauger of the Bucks County Court of Common Pleas.
