On Aug. 25, 2014, the Indiana Supreme Court overturned an Indiana Tax Court decision and held that a company’s deduction for foreign source dividends cannot increase its net operating loss (Indiana Department of State Revenue v. Caterpillar, Inc.). In general, the Indiana corporate income tax calculation begins with federal taxable income, provides for modifications, and then allows deductions. Corporations are allowed an Indiana net operating loss (NOL) deduction and a foreign dividend deduction in the computation of Indiana taxable income. At issue in the case was the proper computation of the Indiana NOL when the taxpayer also had a foreign dividend deduction.
The Indiana NOL statute begins with federal taxable loss, applies the allowed Indiana modifications, and then apportions the loss using the apportionment for the loss year. Because the foreign dividend deduction is not a modification, the Supreme Court ruled it should not be included in the calculation of the Indiana NOL.
For example, assume a corporation receives a $10 dividend from a subsidiary in a year in which its Indiana taxable loss prior to the dividends-received deduction was $90. If the dividend was paid from a domestic subsidiary, the corporation would be entitled to a deduction for the dividend received, resulting in an Indiana NOL of $100. However, under the court’s ruling in Caterpillar, a deduction would not be allowed in the calculation of the NOL if the taxpayer received the dividend from a foreign subsidiary. In that case the taxpayer would have only a $90 NOL carryforward. The U.S. Supreme Court previously held in Kraft v. Iowa that states may not discriminate against foreign commerce with respect to the dividends-received deduction. While the Caterpillar ruling seems contrary to that decision, the court did not analyze the merits of discrimination; rather, it dismissed the argument on the basis that Caterpillar did not carry its burden of proof.
Caterpillar may request a rehearing before the court in order to provide the required proof of discrimination against foreign commerce, or it may appeal the case to the U.S. Supreme Court.
There are currently similar cases pending on this issue before the Indiana Tax Court. However, as the law stands today, companies with foreign source dividend deductions on their Indiana returns should review their current structure and dividend transactions to account for the court’s determination in Caterpillar and evaluate options to minimize any adverse effects of this decision.
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