Navistar, Inc. v. Testa, 2014–0140.

• Decision Date: 18 August 2015
• Docket Number: No. 2014–0140.,2014–0140.
• Parties: NAVISTAR, Inc., Appellant, v. TESTA, Tax Commr., Appellee.
• Court: Ohio Supreme Court

143 Ohio St.3d 460

39 N.E.3d 509

2015 Ohio 3283

NAVISTAR, Inc., Appellant,

v.TESTA, Tax Commr., Appellee.

No. 2014–0140.

Supreme Court of Ohio.

Submitted May 6, 2015.

Decided Aug. 18, 2015.

Maryann B. Gall ; Vorys, Sater, Seymour & Pease, L.L.P., Laura A. Kulwicki, and Steven L. Smiseck, Columbus, for appellant.

Michael DeWine, Attorney General, and Barton A. Hubbard, Assistant Attorney General, for appellee.

Bricker & Eckler, L.L.P., Mark A. Engel, and Anne Marie Sferra, urging reversal for amici curiae, Ohio Manufacturers' Association and Ohio Chamber of Commerce.

FRENCH, J.

{¶ 1} Under Ohio's 2005 tax-reform legislation, the new commercial-activity tax ("CAT") was enacted "to replace the existing corporate-franchise and personal-property taxes," which were phased out under that legislation for industrial corporations like Navistar, Inc. Beaver Excavating Co. v. Testa, 134 Ohio St.3d 565, 2012-Ohio-5776, 983 N.E.2d 1317, ¶ 23, citing Am.Sub.H.B. No. 66, 151 Ohio Laws, Part II, 2868; R.C. 5733.01(G)(2). In this appeal, appellant, Navistar, Inc., claims that it is due a credit against the CAT.

{¶ 2} According to the testimony of employees of the Department of Taxation, the tax break at issue here, referred to simply as the "CAT credit," was intended to restore a portion of the value of a corporate asset, known as a "deferred-tax asset," the value of which would otherwise be substantially reduced by the transition from the franchise tax to the CAT. Specifically, the CAT credit would preserve part of the value of net operating losses ("NOLs") that taxpayers like Navistar had accumulated and were entitled to carry forward to later years and use as a deduction against income. But with the phase out of the franchise tax for most taxpayers (including industrial corporations like Navistar) and its replacement by the CAT, those NOLs would have lost their value under state tax law unless a special tax break was created. That tax break was the CAT credit, R.C. 5751.53.

{¶ 3} In this appeal, Navistar complains that as a result of Navistar's 2007 restatement of its 2004 financial statement, the tax commissioner erroneously reduced the amount of its potential CAT credit from over $27 million to zero. The tax commissioner based his determination on the restatement's increase in the "valuation allowance," an accounting entry that reflects the company's estimation of its future ability to realize the tax benefit of its NOLs. The 2007 restatement increased Navistar's valuation allowance from 62.4 percent to 100 percent; that increase led to a 100 percent offset of the NOLs for purposes of computing Navistar's potential CAT credit.

{¶ 4} Navistar contends that the tax commissioner had no statutory authority to adjust the amount of potential CAT credit based on accounting changes that were made after the deadline for applying for the CAT credit in June 2006. The tax commissioner, on the other hand, argues that his statutory audit authority under R.C. 5751.53(D) allowed him to change the amount of potential CAT credit based on a subsequent restatement of the relevant accounting entries.

{¶ 5} In addition, the parties disagree on a legal and factual issue concerning the importance of generally accepted accounting principles ("GAAP"). Navistar argues that the CAT-credit statute took a "snapshot" of the company's books and records as of the time the credit application was filed in June 2006 and that no subsequent changes to the accounting entries can be taken into account, even if those changes are necessary to bring the company's financial reporting into compliance with GAAP. But Navistar also argues that even if GAAP compliance is required to qualify for the credit, it has proved through expert testimony that the restatement's increase in the valuation allowance to 100 percent did not involve a correction required by GAAP, but instead constituted a different estimation of probabilities made by different management at a different point in time. The original valuation allowance for 2004, under this view, was reasonable because it was within the range permitted under GAAP.

{¶ 6} We read R.C. 5751.53(D) as authorizing the tax commissioner to issue a final determination changing the amount of potential CAT credit, but limiting that authority to making changes that reflect a correction of an inaccuracy or error in the original reported amount. As a result, we conclude that the tax commissioner's use of Navistar's restated valuation allowance as the basis for the final determination was justified only if the restated valuation allowance was a correction of error, which in this context can be the case only if Navistar's original valuation allowance was not in compliance with GAAP.

{¶ 7} Whether Navistar's original valuation allowance was in compliance with GAAP is a question of fact that must be determined in light of evidence that militates both ways. The Board of Tax Appeals ("BTA") considered certain statements by Navistar as relevant to this point but ignored the testimony of Navistar's experts, an omission that makes the BTA's decision unreasonable and unlawful. We therefore vacate the BTA's decision and remand the cause for a determination whether the original valuation allowance was in compliance with GAAP based upon all the evidence in the record. Disposition of this case will depend upon that determination.

NET OPERATING LOSSES AND THE CAT CREDIT

{¶ 8} The franchise tax's net-income method used the corporation's federal "taxable income," with Ohio adjustments, as the base on which the tax was imposed. See R.C. 5733.04(I) and 5733.05(B). As a general matter, "[t]he taxable income of a taxpayer engaged in business or profit-oriented activities is generally net profits rather than gross receipts or gross income." 1 B. Bittker & L. Lokken, Federal Taxation of Income, Estates, and Gifts, ¶ 20.1.1 (3d Ed.1999). By contrast, Ohio's CAT is measured not by net income but by the gross receipts generated by income-producing activity. See R.C. 5751.01(F) (defining "gross receipts" as "the total amount realized by a person, without deduction for the cost of goods sold or other expenses incurred, that contributes to the production of gross income of the person, including the fair market value of any property and any services received, and any debt transferred or forgiven as consideration"); R.C. 5751.03 (imposing the tax on the "taxable gross receipts"). Compared with the franchise tax that it replaced, the CAT imposes a lower rate of taxation on a larger tax base: a tax base that consists of revenues that have not been offset by expenses.

{¶ 9} Under the franchise-tax law, which previously applied to Navistar, a corporation that experienced an NOL one year was allowed to use that loss to offset income in a different year by "carrying back" or "carrying forward" the NOL and using it as a deduction against income in a different year. See R.C. 5733.04(I)(1)(b).

{¶ 10} Because Ohio's franchise-tax law, along with other corporate-income-tax laws, allowed a carryforward of NOLs, accounting principles required that the future benefit be reflected as an asset on the corporation's books and records and accompanying financial statements. When the CAT was enacted in 2005, corporations feared that the substantial Ohio portion of the NOL asset on their books would lose its value. To soften that blow, the CAT credit was devised and was included in the original CAT legislation. Navistar refers to the promulgation of R.C. 5751.53 as a "grand bargain" between Ohio franchise-tax payers and the tax department, under which the taxpayers would support the tax reform while still retaining some of the value of their Ohio deferred-tax assets such as NOLs.

{¶ 11} Under R.C. 5751.53, taxpayers were able to compute a potential amount of CAT credit. That amount consists of a portion of the Ohio-apportioned NOLs on their books at the end of their 2004 fiscal year, which, when adjusted, furnished a total amount of credit that could be used to reduce CAT liabilities over a period of up to 20 years, stretching from 2010 (the year the CAT was fully phased in and the general franchise tax phased out for taxpayers such as Navistar) through 2029. R.C. 5733.01(G)(2)(a)(vi) (phase out of franchise tax); R.C. 5751.53(B)(1) through (10).

{¶ 12} The starting point for determining the potential CAT credit was the amount of Ohio-related NOLs on the corporation's books at the end of fiscal year 2004. R.C. 5751.53(A)(5), (6), and (9). That number would be reduced by the amount of "related valuation allowance." R.C. 5751.51(A)(6)(b). "Valuation allowance" is an adjustment dictated by accounting principles that is made on the books from year to year to reflect the likelihood that the company will realize the tax benefit of the NOLs. The less likely the corporation will be able to use the NOLs, the greater the valuation allowance. The lump sum that resulted from offsetting the Ohio NOLs with the valuation allowance would be "amortized" over a period of up to 20 years beginning with calendar year 2010; the lump sum is therefore referred to in the statute as the "amortizable amount." R.C. 5751.53(A)(9) and (B).

{¶ 13} To take the credit, a company was required to file an Amortizable Amount Report with the tax commissioner by June 30, 2006, that set forth the computation of the amortizable amount. R.C. 5751.53(D). The statute then gave the tax commissioner until June 30, 2010, to "audit the accuracy of the amortizable amount * * * and adjust the amortizable amount or, if appropriate, issue any assessment or final determination, as applicable, necessary to correct any errors found upon audit." Id .

FACTUAL BACKGROUND

{¶ 14} Navistar is in the business of manufacturing commercial trucks, buses, and military vehicles under the brand names International, Navistar Defense, and IC. Navistar has long operated a manufacturing plant in Springfield, Ohio, as well as facilities in other states. Before enactment...