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

Decision Date21 June 1995
Citation140 N.J. 523,659 A.2d 1360
PartiesRICHARD'S AUTO CITY, INC., Plaintiff-Respondent, v. DIRECTOR, DIVISION OF TAXATION, Defendant-Appellant.
CourtNew Jersey Supreme Court

Margaret A. Holland, Deputy Atty. Gen., for appellant (Deborah T. Poritz, Atty. Gen. of New Jersey, attorney; Joseph L. Yannotti, Asst. Atty. Gen., of counsel).

Robert J. Kipnees, Iselin, for respondent (Greenbaum, Rowe, Smith, Ravin & Davis, attorneys; Mr. Kipnees and Thomas C. Senter, of counsel and on the brief).

Michael A. Guariglia, Newark, submitted a letter brief on behalf of amici curiae Ernst & Young, Coopers & Lybrand and Deloitte & Touche (McCarter & English, attorneys).

The opinion of the Court was delivered by


This appeal involves a conflict over the interpretation of provisions of the Corporation Business Tax Act that permit certain net-operating losses to be carried over and deducted in successive tax years. Specifically, at issue is whether those provisions permit the net-operating losses incurred in past tax years by a corporation that has been merged into a successor corporation to be carried over and deducted by the surviving corporation in a subsequent tax year.

In this case, the Director of the Division of Taxation disallowed the deduction by the surviving corporation because the losses had not actually been incurred by its business operations, but rather the losses were sustained by the merged corporation, which was no longer in existence. The Director's determination was based on an administrative regulation that was adopted to implement the net-operating loss carryover provisions of the tax statute. The issue involving the proper interpretation of the statute, therefore, necessarily involves the validity of the administrative regulation.


Richard's Auto City, Inc. ("Auto City"), a New Jersey corporation formed in 1973, sells automobiles from its dealership in Freehold Township. Catena, Inc. ("Catena") was the leasing company affiliated with Auto City, providing lease financing for Auto City's customers. Catena was incorporated and began operations in 1983, working from the same location as Auto City. Richard Catena was the sole stockholder of each corporation. In January 1984, Richard Catena transferred 100% of his shares in Catena to Auto City, making Catena a wholly-owned subsidiary of Auto City.

During the next several years, Catena incurred substantial net-operating losses, totaling $1,574,294 for the tax years ending December 31, 1984, December 31, 1985, and, October 31, 1986. Those losses were attributable primarily to the accelerated depreciation method then applicable to leased automobiles. Under the applicable depreciation schedule, in the earlier years of the lease terms, Catena deducted the cost of the leased automobiles prior to the receipt of all the corresponding lease income. Catena did not realize a substantial portion of the income from lease packages until the later years of the lease terms and/or the eventual sale of the automobiles. As a result, Catena sustained large net-operating losses during 1984, 1985, and 1986.

Pursuant to a plan of merger adopted on October 31, 1986, Catena merged into Auto City. A Certificate of Merger filed with the Secretary of State on December 19, 1986 identified Auto City as the survivor corporation. Following the merger, the leasing programs that Catena previously offered continued in the same manner under Auto City's leasing department.

On its 1986 Corporate Business Tax Return, Auto City claimed as a deduction the net-operating losses Catena had incurred as a result of depreciation during the tax years prior to the merger. By notice of assessment dated April 17, 1989, the Director of the Division of Taxation disallowed the deduction and assessed Auto City $88,517 in additional taxes. Further, the Director imposed a $4,426 late payment penalty and $43,643 in interest charges through November 30, 1989. That decision was reaffirmed by a final determination letter dated November 16, 1989, which reduced the penalty and interest to the statutory minimum.

Auto City filed a complaint with the Tax Court contesting the Director's final determination. Both parties stipulated to the foregoing facts. The Tax Court granted the Director's cross-motion for summary judgment, and dismissed Auto City's complaint. 12 N.J.Tax 619 (1992). The Appellate Division reversed the Tax Court's determination and remanded the matter to the Tax Court for entry of judgment in favor of Auto City. 270 N.J.Super. 92, 636 A.2d 572 (1994). The Director filed a petition for certification, which this Court granted. 137 N.J. 167, 644 A.2d 614 (1994).


This case focuses on the proper interpretation and application of provisions in the Corporation Business Tax Act ("CBT") for the carryover and deduction of net-operating losses ("NOLs"). Those provisions, N.J.S.A. 54:10A-4(k), state:

(6)(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. The entire amount of the net operating loss for any taxable year (the "loss year") shall be carried to the earliest of the taxable years to which the loss may be carried. The portion of the loss which shall be carried to each of the other taxable years shall be the excess, if any, of the amount of the loss over the sum of the entire net income, computed without the exclusions permitted in paragraphs (4) and (5) of this subsection or the net operating loss deduction provided by subparagraph (A) of this paragraph, for each of the prior taxable years to which the loss may be carried.

(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.

Following the Legislature's enactment of those provisions in 1985, the Director adopted N.J.A.C. 18:7-5.13(b), effective February 3, 1986, to implement N.J.S.A. 54:10A-4(k)(6). The regulation provides:

(b) 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. The net operating loss may not be carried over by a taxpayer that changes its state of incorporation or is a part of a statutory consolidation. Section 4(k) of the [CBT] Act defines entire net income in terms of a specific corporate franchise.

The dispute between the parties centers on the Director's regulation and its restriction of the net-operating loss deduction to the corporation that actually sustained that loss and whether that regulation expresses the authority intended to be conferred by the enabling statute. Because the issue of statutory interpretation implicates the validity of the Director's regulation, our resolution properly commences with the standards governing judicial review of administrative regulations.

This Court has stated,

Agency regulations are presumptively valid and should not be invalidated unless they violate the enabling act or its express or implied legislative policies. Generally, courts accord substantial deference to the interpretation an agency gives to a statute that the agency is charged with enforcing.

[GE Solid State, Inc. v. Director, Div. of Taxation, 132 N.J. 298, 306 (1993) (citations omitted).]

The standard of judicial review of regulations acknowledges the very broad grant of authority to administrative agencies for the purpose of adopting regulations. New Jersey Guild of Hearing Aid Dispensers v. Long, 75 N.J. 544, 560-63, 384 A.2d 795 (1978). That standard is fully applicable to administrative regulations governing taxation. See Sorensen v. Director, Div. of Taxation, 184 N.J.Super. 393, 2 N.J.Tax 470, 446 A.2d 213 (1981). We thus accept the strong presumption in favor of the validity of the Director's regulation, but recognize, nonetheless, that

an administrative agency may not, under the guise of interpretation, extend a statute to give it a greater effect than its language permits. Accordingly, we have invalidated regulations that flout the statutory language and undermine the intent of the Legislature.

[GE Solid State, supra, 132 N.J. at 306-07 (citations omitted).]

The Appellate Division determined that the Director's regulation, N.J.A.C. 18:7-5.13(b), was invalid because it was inconsistent with the enabling statute; it "goes beyond the legislative scheme and imposes a restriction that is neither intended nor authorized." 270 N.J.Super. at 103, 636 A.2d 572. The Tax Court reached the opposite conclusion. 12 N.J.Tax at 640-42.

In the enterprise of statutory construction, the first step is the examination of the provisions of the legislative enactment to ascertain whether they are expressed in plain language that, in accordance with ordinary meaning, clearly and unambiguously yields only one interpretation. GE Solid State, supra, 132 N.J. at 307, ...

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