Director of Revenue v. Verisign, Inc.

• Citation: 267 A.3d 371
• Decision Date: 29 November 2021
• Docket Number: No. 18, 2021,18, 2021
• Parties: DIRECTOR OF REVENUE, Defendant-Below, Appellant/Cross-Appellee, v. VERISIGN, INC. Plaintiff-Below, Appellee/Cross-Appellant
• Court: United States State Supreme Court of Delaware

267 A.3d 371

DIRECTOR OF REVENUE, Defendant-Below, Appellant/Cross-Appellee,

v.VERISIGN, INC. Plaintiff-Below, Appellee/Cross-Appellant

No. 18, 2021

Supreme Court of Delaware.

Submitted: September 22, 2021

Decided: November 29, 2021

Anthony J. Testa, Jr., Esquire (argued), Matthew M. Warren, Esquire, Michael B. Cooksey, Esquire, DELAWARE DEPARTMENT OF JUSTICE, Wilmington, Delaware; Tiffany R. Moseley, Esquire (argued), Steven S. Rosenthal, Esquire, LOEB & LOEB, Washington, D.C., for Appellant/Cross-Appellee Director of Revenue.

Frank. J. Gallo, Esquire (argued), Kyle O. Sollie, Esquire, Sebastian C. Watt, Esquire, Benjamin P. Chapple, Esquire, REED SMITH LLP, Wilmington, Delaware, for Appellee/Cross-Appellant Verisign, Inc.

Before SEITZ, Chief Justice; VALIHURA, VAUGHN, TRAYNOR, and MONTGOMERY-REEVES, Justices, constituting the Court en banc.

Traynor, Justice:

Verisign, Inc. claimed large net operating loss deductions on its 2015 and 2016 Delaware income tax returns, which reduced its bill to zero in both years. The Division of Revenue reviewed the returns and found that Verisign's use of net operating losses violated a longstanding, but non-statutory, Division policy. Under the policy, a corporate taxpayer that filed its federal tax returns with a consolidated group was prohibited from claiming a net operating loss deduction in Delaware that exceeded the consolidated net operating loss deduction on the federal return in which it participated. The Division applied the policy, determined that Verisign had underreported its income, and assessed the company $1.7 million in unpaid taxes and fees.

After Verisign's administrative protest of the assessment was denied, it appealed to the Superior Court. The Superior Court held that the policy violated the Uniformity Clause of Article VIII, § 1 of the Delaware Constitution —the provision requiring that "[a]ll taxes shall be uniform upon the same class of subjects"—and invalidated it.¹ We agree with the Superior Court that the Division's policy was invalid, but we affirm on alternate grounds. We hold that the policy exceeded the authority granted to the Division by the General Assembly in 30 Del. C. §§ 1901 – 1903. As a result, we decline to reach Verisign's constitutional claims.

I

A

Each non-exempt corporation that does business in Delaware must "annually pay a tax of 8.7 percent on its taxable income" derived from in-state activities.² The starting point for this calculation is the corporation's federal taxable income determined by the Internal Revenue Code, 26 U.S.C. §§ 1 – 1564 (the "IRC"), which is then subject to Delaware-specific additions, subtractions, and apportionment.³ The IRC defines "federal taxable income" as "gross income minus the deductions allowed[.]"⁴ One such deduction is for a net operating loss (or, "NOL"), which occurs when a filer has more deductions than income during a tax year.⁵ A taxpayer may carry forward a net operating loss for 20 years after incurring it.⁶

Federal law allows affiliated corporations to file taxes together on a single consolidated return.⁷ Delaware law does not. Instead, 30 Del. C. § 1903(a) (" Section 1903(a)") requires each corporate taxpayer to report "its taxable income,"⁸ and the Division of Revenue (the "Division") asks each corporation that pays federal taxes on a consolidated basis "to calculate its stand-alone federal taxable income, including all deductions, in accordance with the IRC as if that corporation filed a separate company (non-consolidated) federal income tax return."⁹

Verisign, Inc. ("Verisign") is an internet infrastructure company incorporated in Delaware and headquartered in Virginia.¹⁰ During the tax years at issue in this case, Verisign operated a secure data center in New Castle, Delaware.¹¹ Along with its affiliate corporations, it participated in a single federal income tax return as the VeriSign, Inc. & Subsidiaries consolidated group (the "Verisign Group.")¹² Because Delaware does not accept consolidated returns, Verisign has filed standalone corporate income tax returns with the Division since 1995.¹³

In 2015 and 2016, Verisign reported zero federal taxable income on a standalone basis.¹⁴ It did so after deducting net operating losses of $114.9 million in 2015 and $156.7 million in 2016.¹⁵ Because federal taxable income is the "starting point" for Delaware taxable income and Verisign had no significant state additions, it paid no Delaware income tax in either year.¹⁶

The Division reviewed Verisign's returns and determined that the company's use of net operating loss deductions violated a longstanding Division policy (the "Policy"). The Policy operated in two steps.¹⁷ First, it required each corporate taxpayer to report its net operating loss calculated under IRC § 172.¹⁸ Second, the Policy capped the taxpayer's net operating loss at the size of the consolidated NOL deduction reported by its federal filing group and calculated under Treasury Regulation § 1.1502–21.¹⁹ The Policy exempted filers who completed a federal consolidated return exclusively with other Delaware taxpayers.²⁰ Verisign did not qualify for this exception.²¹

During the tax years at issue here, the Policy was located in the Division's internal manual for auditors,²² but the Division cannot explain how it got there or why it was enacted.²³ All the Division has offered on this point is 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."²⁴ When asked about the authority for the Policy, the Division's Rule 30(b)(6) witness testified that "[i]t's not in the statute."²⁵

The Division applied the Policy to Verisign and found that the company was not permitted to deduct net operating losses larger than $38.7 million in 2015 and $2.1 million in 2016, which were the consolidated net operating losses used by the Verisign Group in those years.²⁶ Because Verisign exceeded the Policy's deduction limit by more than $230 million, the Division found that the company had underreported its income and assessed it $1.7 million in tax and penalties.²⁷

Verisign filed a protest, and the Director denied it on April 9, 2019.²⁸ Verisign then petitioned the Tax Appeal Board and subsequently removed the petition to the Superior Court.²⁹

B

In the Superior Court, the parties filed cross-motions for summary judgment based on stipulated facts.³⁰ Verisign argued that the Division's net operating loss Policy was not consistent with 30 Del. C. §§ 1901 – 1903.³¹ It also claimed that the Policy—even if valid under the Delaware Code—violated the Uniformity Clause of the Delaware Constitution and the Dormant and Foreign Commerce Clauses of the United States Constitution.³² The Division argued that the Policy was authorized by statute and denied any constitutional violations.³³

The Superior Court held that the Policy was invalid, struck the Division's $1.7 million assessment of Verisign, and determined that Verisign could continue to deduct the full value of its net operating losses calculated under IRC § 172.³⁴ Although the court found that the Policy complied with the Delaware Code's corporate income tax statutes and did not violate the Dormant Commerce Clause, the court concluded that the Policy violated the Uniformity Clause of the Delaware Constitution.³⁵ As mentioned, the relevant text of the Delaware Constitution is found in Section 1 of Article VIII and, in pertinent part, provides that "[a]ll taxes shall be uniform upon the same class of subjects[.]"³⁶ The court held that the Policy was invalid because it treated a single class of taxpayers—Delaware corporate income tax filers—differently based on whether they filed federal taxes as a member of a consolidated group or individually.³⁷ The court explained that this classification was not entitled to deference because it was made by an agency—the Division—and not the legislature.³⁸

C

On July 30, 2021, the General Assembly enacted House Bill. No. 171. Section Five of the legislation amends 30 Del. C. § 1903(a) to codify much of the Policy.³⁹ Although Section 1903(a) still taxes each corporation based on "its federal taxable income," § 1903(a)(2) i now includes an explicit textual warrant for capping a filer's net operating loss at the value of the consolidated NOL deduction claimed by its federal filing group.⁴⁰ As amended, the statute allows for "[a] deduction for a net operating loss carryforward calculated in accordance with the [IRC], provided however that the deduction may not exceed that amount claimed on the federal return filed for the taxable year in which the taxpayer was included as a party."⁴¹ Unlike the Policy, the amended statute does not have a carve-out for taxpayers who file a consolidated federal return exclusively with other Delaware taxpayers.

II

We review agency action "to determine whether [the agency] acted within its statutory authority[.]"⁴² We review questions of statutory interpretation de novo and do not defer to an agency's interpretation of a statute.⁴³

III

To withstand judicial review, a challenged agency action must comply with the Delaware Code.⁴⁴ Thus, although Verisign attacks the Policy with three constitutional claims, the threshold question is whether the Policy was consistent with 30 Del. C. §§ 1901 – 1903 before the 2021 amendment. We agree with Verisign's lead argument below that the Policy contravened the plain language of Title 30 and was therefore invalid.⁴⁵ We do not reach Verisign's constitutional claims because "[i]t is the settled policy of this Court that a constitutional question will not be decided unless its determination is essential to the disposition of the case."⁴⁶

A

In its Complaint, Verisign alleged that the Division "has erroneously determined that Verisign must compute its net operating losses ... on a basis that consolidates Verisign with Verisign's affiliates" in violation of Sections 1901 – 1903.⁴⁷ The Superior Court found that the Policy complied with the Delaware...