Indiana Tax Court Decides Foreign Source Dividends Are Deductible in Calculating Indiana NOLs

On March 28, 2013, the Indiana Tax Court issued its decision in Caterpillar, Inc. v. Indiana Dept. of State Revenue, holding that dividend income from foreign subsidiaries is deductible when calculating Indiana net operating losses. The decision presents an opportunity for Indiana taxpayers with income from foreign source dividends to file for refunds of overpaid taxes.

The Facts of Caterpillar

During the tax years, Caterpillar received dividends from both domestic subsidiaries and foreign subsidiaries that operated exclusively outside the United States. When it calculated its Indiana adjusted gross income tax, Caterpillar started with its federal taxable income, which included foreign source dividends (FSDs) but not U.S. source dividends. Caterpillar took a deduction for the FSDs and reported net operating losses (NOLs). Because it had reported taxable adjusted gross income on its earlier returns, Caterpillar filed amended returns for those years to carryback the unused Indiana NOLs and requested a refund for overpaid taxes.

The Department denied the refund, determining that Caterpillar could not deduct the FSD income. In the Department's view, taxpayers cannot deduct FSDs in calculating Indiana NOLs because the statute establishing NOLs neither specifically references an FSD deduction nor expressly incorporates the statute that does.

The Court's Analysis

A taxpayer's Indiana Adjusted Gross Income is the taxpayer's federal taxable income derived from Indiana sources, subject to a variety of statutory modifications. The Court found that the plain language of Ind. Code § 6-3-2-2.6 (the "Indiana NOL Statute") requires that a taxpayer modify its federal NOL using the same statutory modifications that it uses to convert federal taxable income derived from Indiana sources into Indiana adjusted gross income.

Indiana's list of statutory modifications does not require the subtraction of FSD income, but a separate statute provides that a "corporation that includes any foreign source dividend in its adjusted gross income for a taxable year is entitled to a deduction from that adjusted gross income." The Court concluded that this provision is separate from the list of modifications because the legislature intended it to apply whenever FSD income is included in adjusted gross income.

Federal taxable income is gross income minus deductions. Gross income includes FSD income, and Indiana's list of statutory modifications does not require the subtraction of FSD income. Therefore, Caterpillar's FSDs were included in its federal taxable income, its federal NOL and its adjusted gross income within the Indiana NOL Statute. As a result, Caterpillar was entitled to deduct its FSD income in calculating its Indiana NOLs.

A Refund Opportunity

The Court's decision in Caterpillar presents an opportunity for certain Indiana taxpayers to seek refunds for overpaid taxes. Since the tax years at issue in Caterpillar, the Indiana legislature has amended the Indiana NOL Statute so that NOLs may only be carried forward to future tax years. NOLs can no longer be carried back to prior returns, as Caterpillar did.

Indiana taxpayers may still see some benefit from the Tax Court's decision, however. Imagine a taxpayer that had NOLs in 2010 which it carried forward to its 2011 return. The taxpayer had income from foreign source dividends, but it did not deduct that income in calculating its 2010 NOLs. Under those circumstances, the taxpayer could amend its returns to reflect the higher NOL carryforward and file a claim for refund of the excess taxes paid in 2011.

Indiana taxpayers with income from foreign source dividends should consider amending Indiana corporate income tax returns filed in prior years and requesting refunds for overpaid taxes where NOLs have been or could be carried forward. Refund claims must be filed within three years of the latter of the due date of the return or payment of the tax, so taxpayers should act quickly to file refund claims with the Indiana Department of Revenue.

If you have questions about the impact of the Caterpillar decision on your business, please contact a Faegre Baker Daniels tax attorney.