Verisign, Inc. v. Dir. of Revenue

• Decision Date: 17 December 2020
• Docket Number: C.A. No. N19C-08-093 JRJ
• Parties: VERISIGN, INC., Plaintiff, v. DIRECTOR OF REVENUE, Defendant.
• Court: Delaware Superior Court

VERISIGN, INC., Plaintiff, v. DIRECTOR OF REVENUE, Defendant.

C.A. No. N19C-08-093 JRJ

SUPERIOR COURT OF THE STATE OF DELAWARE

Date Submitted: December 7, 2020

December 17, 2020

OPINION

Upon Plaintiff's Motion for Summary Judgment: GRANTED.

Upon Defendant's Motion for Summary Judgment: DENIED.

Benjamin P. Chapple, Esquire, Reed Smith LLP, 1201 Market Street, Suite 1500, Wilmington, DE 19801; Frank J. Gallo, Esquire (pro hac vice), Kyle O. Sollie, Esquire (pro hac vice), Sebastian C. Watt, Esquire (pro hac vice), Reed Smith LLP, Three Logan Square, Suite 3100, 1717 Arch Street, Philadelphia, PA 19103; Attorneys for Plaintiff.

Matthew Warren, Esquire, Department of Justice, 820 N. French Street, 8th Floor, Wilmington, DE 19801; Steven S. Rosenthal, Esquire (pro hac vice), Tiffany R. Moseley, Esquire (pro hac vice), Loeb & Loeb LLP, 901 New York Avenue NW, Suite 300 East, Washington, D.C. 20001; Attorneys for Defendant.

Jurden, P.J.

I. INTRODUCTION

Corporations can join with groups of affiliated corporations to file consolidated income tax returns with the Internal Revenue Service. On these consolidated returns, groups can claim consolidated net operating loss ("NOL") deductions. In Delaware, group members must file separate-company income tax returns with the Delaware Division of Revenue (the "Division"). If a member claims a separate-company NOL deduction, the Division limits it to the amount of the consolidated NOL deduction that the member's group claimed on its consolidated income tax return.

Applying that policy, the Division limited the amount of the NOL deduction that Verisign, Inc. could claim in two tax years. The limitation exposed positive taxable income for those years, and the Division taxed it. The Division assessed almost $1.67 million in income tax (plus interest and penalties) against Verisign. Verisign has challenged the validity of the Division's limitation policy and seeks to have its tax assessment stricken. Verisign and the Director of Revenue have now filed cross-Motions for Summary Judgment. The parties have stipulated that no material facts are in dispute.¹ For the reasons explained below, Verisign's Motion is GRANTED, and the Director's Motion is DENIED.

II. BACKGROUND

A. Statutory and Regulatory Framework

Each non-exempt corporation must pay Delaware an income tax on the "taxable income" that it earns by conducting business in Delaware.² For the purpose of Delaware income tax, "taxable income" is the portion of a corporation's "entire net income" that is apportioned to Delaware.³ A corporation's "entire net income" is the corporation's "federal taxable income . . . as computed for purposes of the federal income tax."⁴ The "federal income tax" is "the tax imposed on corporations by the federal Internal Revenue Code [("IRC")]."⁵ Accordingly, the parties agree that the starting point for calculating Delaware corporate income tax is a corporation's federal taxable income.⁶

Pursuant to the IRC, a corporation's federal "taxable income" is calculated by taking the corporation's gross income and subtracting all applicable deductions that the IRC allows.⁷ One of these deductions lies at the core of this case: the NOL deduction.⁸ An NOL is the "flip side" of taxable income; if a corporation's allowabledeductions exceed the corporation's gross income, an NOL results.⁹ Suppose that in Year 1, Corporation X were to receive $1 million in gross income and could claim deductions of $5 million. In that case, Corporation X would have produced an NOL of $4 million in Year 1.

The IRC allows a corporation to "carry over" an NOL into each of the next 20 tax years to reduce its federal taxable income.¹⁰ Corporation X could take its $4 million NOL from Year 1 and reduce its federal taxable income in any tax year until Year 21.¹¹ If Corporation X were to use its Year 1 NOL to reduce its Year 2 federal taxable income to zero, it could carry over the remainder into Year 3. And if Corporation X were to produce another NOL in Year 3, it could carry over both NOLs into Year 4.

A corporation that produces an NOL can claim an NOL deduction on its own federal income tax return. But corporations need not file their federal income tax returns on a separate-company basis. In fact, the IRC allows a group of affiliated corporations "to file a single consolidated return, . . . [leaving] it to the Secretary ofthe Treasury to work out the details by promulgating regulations governing such returns."¹²

Pursuant to these U.S. Treasury regulations, groups can elect to report their "consolidated taxable income" on consolidated federal income tax returns.¹³ Consolidated taxable income is calculated by "combining the separate taxable income . . . of each member of the group and then incorporating certain adjustments calculated on a consolidated basis."¹⁴ Of course, this calculation may result in an NOL rather than positive taxable income. In that case, the regulations allow the group to claim a "consolidated NOL" deduction.¹⁵ Naturally, a group's consolidated NOL deduction could be better or worse for a particular group member than if the member had never joined the group and simply claimed its own NOL deduction.

Although the federal government allows groups to file consolidated returns based on their consolidated taxable income, Delaware does not.¹⁶ Delaware expresses this prohibition in its statutes¹⁷ and corporate income tax returninstructions.¹⁸ So when a member of a consolidated group files a Delaware income tax return, it must "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."¹⁹ In this way, the corporation must disaggregate its own federal taxable income and deductions from its group's consolidated amounts and present them to the Division. The corporation does this on a pro forma federal income tax return, which it files with its Delaware income tax return for the same year.²⁰

If a Delaware corporation claims a consolidated NOL deduction on its federal consolidated return, it can claim an NOL deduction on its Delaware return by taking the following two steps. First, as noted above, it must "compute its NOL on a separate-company basis under the IRC."²¹ Second, it must "limit that separate-company NOL to the consolidated NOL deduction of the federal consolidated groupof which the [corporation] is a member."²² The validity of the limitation in step two is the central issue in this case.²³

B. Stipulated Facts and Procedural History

Verisign, Inc. was incorporated in Delaware in 1995.²⁴ From 1995 to 2016, Verisign filed corporate income tax returns with the Division.²⁵ At the federal level, Verisign filed consolidated income tax returns with an affiliated group of corporations (the "Verisign Group").²⁶ Hence, Verisign accompanied each of its Delaware income tax returns with a pro forma federal Form 1120 calculating its separate-company federal taxable income and deductions pursuant to the IRC.²⁷

From tax years 2005 to 2013, Verisign generated about $2.89 billion in NOLs on a separate-company basis.²⁸ Verisign carried over those NOLs into the 2014 tax year and reduced its federal taxable income to zero.²⁹ Verisign carried over the remainder of its NOLs (about $2.76 billion) into the 2015 tax year and reduced itsfederal taxable income of about $115 million to zero.³⁰ Verisign again carried over the remainder of its NOLs (about $2.65 billion) into the 2016 tax year and reduced its federal taxable income of about $157 million to zero.³¹

The Division limited the amount of Verisign's NOL deductions in tax years 2015 and 2016 to the amount of the Verisign Group's consolidated NOL deductions for those years.³² The Verisign Group's consolidated NOL deductions amounted to about $39 million and $2 million in tax years 2015 and 2016, respectively.³³ So the Division's limitation meant that Verisign could not reduce its federal taxable income to zero in either year. That meant that Verisign had positive federal taxable income, which, in turn, meant that Verisign owed income tax to Delaware.³⁴

The Division assessed almost $1.67 million (plus interest and penalties) against Verisign; that amount represented the difference between Verisign's federal taxable income and the Verisign Group's consolidated NOLs for the two tax years.³⁵ Verisign protested the assessment, but the Division denied the protest.³⁶ After filinga petition with the Tax Appeal Board, Verisign removed the matter to this Court.³⁷ Verisign and the Director of Revenue, standing in for the Division, have each moved for summary judgment.³⁸

III. STANDARD OF REVIEW

In general, summary judgment is appropriate when "there is no genuine issue as to any material fact and . . . the moving party is entitled to a judgment as a matter of law."³⁹ When, as here, the parties file cross-motions for summary judgment and agree that there no genuine issues of material fact,⁴⁰ "the Court shall deem the motions to be the equivalent of a stipulation for decision on the merits based on the record submitted with the motions."⁴¹

IV. DISCUSSION

The Division's limitation policy has been explained in two ways throughout this litigation.⁴² For the purpose of resolving the instant Motions, however, the Court will use the parties' stipulated explanation: "First, consistent with Delaware statute, a taxpayer must compute its NOL on a separate-company basis under the IRC. Second, the taxpayer must limit that separate-company NOL to the consolidated NOL deduction of the federal consolidated group of which the taxpayer is a member."⁴³

A. Whether the Division's Policy Is Consistent with Delaware Statute

1. Parties' Contentions

Verisign argues that the Division's policy is "contrary to Delaware statute."⁴⁴ In Verisign's view, the policy poses a statutory issue because Delaware's corporate income tax statutes do not reference the U.S. Treasury regulations, so "Delaware statute...