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Home / Courts / Taxation – Corporate – Restructuring – New Subsidiary – ‘True Revenue’ – Consolidated Return – 25% Penalty

Taxation – Corporate – Restructuring – New Subsidiary – ‘True Revenue’ – Consolidated Return – 25% Penalty

Delhaize America, Inc. v. Lay (Lawyers Weekly No. 11-15-0091, 37 pp.) (Ben Tennille, J.) N.C. Bus. Ct. Click here to read the full text of the opinion.

Holding: The plaintiff-corporation restructured itself solely for the purpose of decreasing its state income tax obligation; the defendant Department of Revenue had the authority to require plaintiff to file a consolidated return.

However, N.C. law at the time required plaintiff to file separate returns, and the department had no guidelines – not even internal guidelines – for determining whether separate corporate tax returns were based on the company’s “true revenue.” Therefore, it was a violation of the state and federal constitutions for the department to impose an automatic 25 percent penalty on corporations found to have misstated their “true revenue” by more than 25 percent.

The parties’ summary judgment motions are granted in part and denied in part. The department’s motion to dismiss is denied.

Even though plaintiff has now come up with other rationales for its restructuring, contemporaneous documents show that the purpose of the restructuring was the reduction of the company’s state tax liability and that the restructuring was to have no impact on the company’s day-to-day operations.

Since 1964 the department has stated in its Technical Bulletins that “a taxpayer corporation which is a subsidiary or affiliate of another corporation or group of corporations is required to limit any deductions for payments to, or charges by, its parent or other affiliated corporation to amounts which are reasonable in relation to the goods or services received therefor.”

The department never announced to the taxpaying public that taxpayers would not be permitted to take as a deduction for an otherwise valid business expense a payment to an affiliated corporation that was reasonable in relation to the goods and services received.

Moreover, the department’s polices with respect to the determination of what constitutes “true earnings” have not been consistent.

Before 2000, the department rarely required consolidated returns. However, from 2000 to May 2010, the department required consolidation in approximately 100 cases. The increase in the number of consolidations resulted from a combination of forces: (1) the efforts of accounting firms like Coopers & Lybrand selling strategies for tax reduction by shifting assets and income among affiliated corporate entities; (2) the budget shortfall that developed in early 2001; and (3) the efforts initiated by then Secretary E. Norris Tolson and his deputies to increase revenue generation at the Department of Revenue. 

At the time of plaintiff’s audit, when corporate combinations were steadily increasing, the department never issued any information in response to taxpayers’, lawyers’, or accountants’ requests for guidance on when the department would require a combined return. In fact, the department could not issue any guidance to taxpayers on this issue because, as Gregory Radford, Director Corporate, Excise and Insurance Tax Division of the department stated, “There [are] no rules or criteria that we’ve established either to our auditors or to the public” that would apply to all taxpayers.

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