Richard's Auto City, Inc. v. Director, Div. of Taxation

Decision Date01 February 1994
Citation270 N.J.Super. 92,636 A.2d 572
PartiesRICHARD'S AUTO CITY, INC., Plaintiff-Appellant, v. DIRECTOR, DIVISION OF TAXATION, Defendant-Respondent.
CourtNew Jersey Superior Court — Appellate Division

Robert J. Kipnees, Woodbridge, argued the cause for appellant (Greenbaum, Rowe, Smith, Ravin & Davis, attorneys; Mr. Kipnees, of counsel; Thomas C. Senter and Chrysa A. Lawson, on the brief).

Margaret A. Holland, Deputy Attorney General, argued the cause for respondent (Fred DeVesa, Acting Attorney General; Joseph L. Yannotti, Assistant General, of counsel; Ms. Holland, on the brief).

McCarter & English, Newark, submitted a brief on behalf of amici curiae, Ernst & Young; Coopers & Lybrand, and Deliotte & Touche. (Michael A. Guariglia, of counsel; Gary A. Kruse and John K. Bradley, on the brief).

Before Judges SHEBELL, LONG and LANDAU.

The opinion of the court was delivered by


Since 1973, appellant, Richard's Auto City, Inc. (Auto City), an automobile dealership located on Route 9 in Freehold Township, has been a New Jersey corporation. The stock of Auto City is solely owned by Richard Catena.

Richard Catena, Inc. (Catena, Inc.) was the leasing company serving the interests of Auto City by providing financing for retail automobile customers through a leasing program offered to the public by Auto City. It was incorporated and began its business operations in 1983. The stock of Catena, Inc. was also owned exclusively by Richard Catena.

On January 1, 1984, Richard Catena transferred his stock in Catena, Inc. to Auto City, making Catena, Inc. a wholly-owned subsidiary of Auto City. Catena, Inc. incurred net operating losses of $421,837 for the tax year ending December 31, 1984, $607,745 for the tax year ending December 31, 1985, and $544,712 for the tax year ending October 31, 1986.

On October 31, 1986, Catena, Inc. merged into Auto City, leaving Auto City as the surviving corporation. A certificate of merger was filed with the Secretary of State's office on December 19, 1986. The functions of Catena, Inc., were assumed by the leasing department of Auto City.

Auto City claimed as a deduction on its 1986 corporate business tax return the net operating losses incurred by Catena, Inc. during the tax years prior to the merger. These losses were incurred as a result of an accelerated depreciation method that was available at that time for leased automobiles. The parties explained the following in their stipulation of facts:

Richard Catena, Inc., as the leasing entity, experienced net operating losses prior to the merger largely due to the accelerated depreciation method then applicable to leased automobiles. Specifically, a leased automobile was subject to an accelerated depreciation schedule which resulted in the cost of the automobile being deducted in the earlier years of a lease-term prior to Richard Catena, Inc.'s receipt of all of the corresponding lease income. A substantial portion of the income from a particular lease transaction would then not be recognized until the later years of the lease-term, and/or upon sale of the automobile. Therefore, if subsequent to the merger, the pre-existing net operating losses are not able to be utilized, income from particular lease transactions would have to be realized without a corresponding offset for all of the deductions created by such transactions.

By notice of assessment, dated April 17, 1989, the Director of the Division of Taxation (Director) assessed Auto City $88,517 for taxes due. Because the losses were incurred by Catena, Inc., the Director did not allow Auto City the carryover of the net operating losses under N.J.A.C. 18:7-5.13(b). The Director assessed a penalty and interest charges, but apparently waived the penalty and abated the interest to the statutory minimum.

On November 16, 1989, after review, the Director issued a final determination confirming the assessment. Auto City filed a complaint with the Tax Court contesting the Director's final determination. The parties agreed to stipulations of facts. On November 25, 1992, the Tax Court judge issued a written opinion granting the Director's cross-motion for summary judgment, denying Auto City's motion for summary judgment, and dismissing the complaint. 12 N.J.Tax 619, Auto City appeals, and we reverse and remand.

In his opinion, the judge framed the issue as "whether the net operating losses generated by one corporation for one tax year may be claimed as a legitimate corporation business tax deduction in a subsequent tax year by a second corporation after the loss-generating or first corporation has merged into the second or surviving corporation." He noted that Auto City asserted that the New Jersey Corporation Business Tax Act (CBT Act) ( N.J.S.A. 54:10A-1 to -40, specifically N.J.S.A. 54:10A-4(k)(6)) allows the loss carryover deduction, but he adopted the Director's position that under N.J.A.C. 18:7-5.13(b), the deduction is not allowable.

N.J.S.A. 54:10A-4(k)(6) provides the following:

(A) Net operating loss deduction. There shall be allowed as a deduction for the taxable year the net operating loss carryover to that year.

(B) Net operating loss carryover. A net operating loss for any taxable year ending after June 30, 1984 shall be a net operating loss carryover to each of the seven years following the year of the loss....

(C) Net operating loss. For purposes of this paragraph the term "net operating loss" means the excess of the deductions over the gross income used in computing entire net income without the net operating loss deduction provided for in subparagraph (A) of this paragraph and the exclusions in paragraphs (4) and (5) of this subsection.

(D) Change in ownership. Where there is a change in 50% or more of the ownership of a corporation because of redemption or sale of stock and the corporation changes the trade or business giving rise to the loss, no net operating loss sustained before the changes may be carried over to be deducted from income earned after such changes. In addition where the facts support the premise that the corporation was acquired under any circumstances for the primary purpose of the use of its net operating loss carryover, the director may disallow the carryover.

N.J.A.C. 18:7-5.13(b) provides The net operating loss may only be carried over by the actual corporation that sustained the loss. The net operating loss may, however, be carried over by the corporation that sustained the loss and which is the surviving corporation of a statutory merger.... Section 4(k) of the Act defines entire net income in terms of a specific corporate franchise.

[Emphasis added.]

The judge, in applying the regulation, upheld the Director's assessment, stating:

As can readily be seen, the regulation does not permit plaintiff, Richard's Auto City, Inc., the surviving corporation, to carryover and deduct the net operating losses of Richard Catena, Inc., the merged corporation. Had the merger been effected the other way around, with Richard Catena, Inc. as the surviving corporation of the statutory merger, the deduction would have been allowed.

He noted that there was nothing in the language of N.J.S.A. 54:10A-4(k)(6) that expressly allows a taxable entity to assume the tax attributes or benefits of another entity after a statutory merger.

Auto City urges that the regulation is invalid because it goes beyond the statute and expressly disallows what the statute allows. Auto City relies on N.J.S.A. 14A:10-6, which provides as part of the New Jersey Business Corporation Act (BCA) that in a merger, the surviving corporation shall "possess all the rights, privileges, powers, immunities, purposes and franchises ... of each of the merging or consolidating corporations." Auto City contends that these rights and privileges include loss carryovers, and that the regulation is irrational because it permits the loss carryover if the corporation sustaining the loss is the survivor of a merger, but denies it when the entity sustaining the loss is not the survivor of a merger.

N.J.A.C. 18:7-5.13(b), as an administrative regulation promulgated by the Director of the Division of Taxation, is subject to the following standards of judicial review:

(1) administrative rulemaking does not require specific findings of fact based on evidence adduced at public hearings; supporting factual bases are presumed until rebutted by the party attacking the administrative action;

(2) administrative regulations are accorded a presumption of reasonableness, with the burden on the attacking party to demonstrate that they are arbitrary, capricious, unduly onerous or otherwise unreasonable (3) administrative regulations must be within the fair contemplation of the delegation of the enabling statute;

(4) the grant of authority to an administrative agency is to be liberally construed in order to enable the agency to accomplish its statutory responsibilities; courts should readily imply such incidental powers as are necessary to effectuate fully the legislative intent;

(5) courts are not free to substitute their judgment as to the wisdom of a particular administrative action for that of the agency so long as that action is statutorily authorized and not otherwise defective because arbitrary or unreasonable.

[Sorensen v. Director, Div. of Taxation, 2 N.J.Tax 470, 474-475, 446 A.2d 213 (1981), 184 N.J.Super. 393, 397-398, 446 A.2d 213 (Tax 1981) (citing New Jersey Guild of Hearing Aid Dispensers v. Long, 75 N.J. 544, 384 A.2d 795 (1978)).]

The issue in this case is whether N.J.A.C. 18:7-5.13(b) is valid as consistent with N.J.S.A. 54:10A-4(k)(6). The regulation provides that "[t]he net operating loss may only be carried over by the actual corporation that sustained the loss," however, it may "be carried over by the corporation that sustained the loss and which is the surviving corporation of a statutory merger." N.J.A.C. 18:7-5.13(b).


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3 cases
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1 books & journal articles
  • State tax treatment of net operating loss carryovers in corporate acquisitions.
    • United States
    • Tax Executive Vol. 48 No. 4, July 1996
    • 1 Julio 1996
    ...App. at 343. (52) 19 Ariz. App. 442, 508 P.2d 107 (1973). (53) 140 N.J. 523, 659 A.2d 1360 (1995). (54) 12 N.J. Tax 619 (1992). (55) 270 N.J. Super. 92 (App. Div. 1994) (56) Regs. [sections] 18:7-5 13(b) (57) Conn. Gen. Stat. [sections] 12-217. (58) 203 Conn. 455, 525 A.2d 106 (1987). (59) ......

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