The taxpayer, Graybar Electric Company, Inc., received over $400 million of dividends in 2007 and 2008, claiming a DRD in that amount for federal income tax purposes. Graybar’s North Carolina returns for 2007 and 2008 reflected federal taxable income after application of the DRD. Graybar had substantial NELs available to be carried forward from years dating back to 2001. Graybar used those NELs to reduce its North Carolina taxable income remaining after state modifications in 2007 and subsequent taxable years.
For the years at issue in the case, North Carolina’s NEL regime differed from the federal NOL regime. Specifically, under North Carolina’s NEL regime, an NEL carryforward was required to be offset by any “income not taxable” before it could be deducted from taxable income.3
“Income not taxable” was defined as any income item deductible as an adjustment to federal taxable income under North Carolina statute and any nonapportionable income not allocable to North Carolina.4 The North Carolina Supreme Court in Dayco Corp. v. Clayton5 previously determined that dividend income allocable to states other than North Carolina constitutes “income not taxable,” finding the determinative issue for purposes of “income not taxable” to be whether North Carolina actually levies a tax on the item of income.6 The North Carolina Supreme Court did not consider dividends deducted at the federal level in Dayco.
In Graybar, the North Carolina Department of Revenue (the “Department”) determined on audit that the dividends deducted at the federal level constituted “income not taxable,” and Graybar’s NELs should have been reduced by the amount of North Carolina-apportioned dividends received each year. After the Department reduced Graybar’s NEL carryforward, Graybar no longer had sufficient NELs available to offset its taxable income in 2008, 2012, and 2013, so the Department assessed additional tax for those years.
On appeal, the Office of Administrative Hearings (“OAH”) ruled in favor of Graybar, concluding that the dividends were “taxable as a matter of law” and therefore were not “income not taxable” that reduced Graybar’s NEL. The Department appealed to the Business Court.
The Business Court reversed the OAH decision. Relying heavily on the Dayco precedent, the Business Court disagreed with the OAH’s interpretation. The court found it determinative that North Carolina had not actually levied a tax on the dividends. Thus, the court determined that “income not taxable” under the statute means any item of income that is not subject to North Carolina tax, regardless of whether it is deducted at the federal level or the state level.7
On 7 February, Graybar appealed the Business Court’s decision directly to the North Carolina Supreme Court.8
Reed Smith takeaway
Although North Carolina replaced its NEL regime with a more traditional NOL regime for tax years beginning on or after January 1, 2015, Graybar reminds us that the Department – and taxpayers – can go back into closed years to correct the computation of NELs available for carryforward to subsequent years. Taxpayers should evaluate their treatment of dividends in tracking their NEL carryforward. Taxpayers that received dividends (even in otherwise closed tax years) and did not reduce their NEL carryforward per the Graybar interpretation could have a potential exposure. Alternatively, taxpayers that reduced their NELs on account of dividends received (or any other adjustments reducing the NEL) may have an opportunity to increase their NEL carryforward if Graybar prevails on appeal.
If you have questions about how the Graybar case could impact your company or would like details about Reed Smith’s upcoming North Carolina Tax Luncheon, please contact one of the authors or the Reed Smith State Tax attorney with whom you typically work.
Client Alert 2019-040
- N.C. Dep’t of Rev. v. Graybar Electric Co., Inc., 2019 NCBC 2 (Wake Cnty. Sup. Ct.).
- Gloria Thompson is a non-attorney consultant at Reed Smith and a former Senior Vice President and State and Local Tax Director at Wells Fargo and Wachovia.
- N.C. Gen. Stat. § 105-130.8 (repealed effective Jan. 1, 2015).
- Id. at (a)(6).
- Dayco Corp. v. Clayton, 153 S.E.2d 28 (N.C. 1967).
- See id. at 33
- We note that as to the taxpayer’s assertion that the Department’s position violated the United States and North Carolina Constitutions, the court stated that “nothing in either the United States Constitution or the North Carolina Constitution prevents the State from imposing double taxation, provided the tax is imposed without arbitrary distinctions.” See Graybar at 24. With such standard in mind, the court concluded that Graybar failed to show that the tax burden resulting from the Department’s assessment, despite the potential for double taxation, was the product of discriminatory or arbitrary taxation. Id.
- Graybar appealed directly to the Supreme Court of North Carolina pursuant to N.C. Gen. Stat. § 7A-27(a).