On appeal from the Tax Court of New Jersey.
Shebell, Long and Landau. The opinion of the court was delivered by Shebell, P.J.A.D.
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 lossgenerating 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.
The Judge, in applying the regulation, upheld the Director's ...