ATTORNEYS FOR PETITIONER:
LARRY J. STROBLE
JENNIFER A. DUNFEE
BARNES & THORNBURG
ATTORNEYS FOR RESPONDENT:
ATTORNEY GENERAL OF INDIANA
DEPUTY ATTORNEY GENERAL
INDIANA TAX COURT
SUBARU-ISUZU AUTOMOTIVE, INC., )
COMPANY, Successor in Merger with
v. ) Cause No. 49T10-0010-TA-108
INDIANA DEPARTMENT OF )
STATE REVENUE, )
ON APPEAL FROM TWO FINAL DETERMINATIONS
OF THE INDIANA DEPARTMENT OF STATE REVENUE
January 31, 2003
Subaru-Isuzu Automotive, Inc. (Subaru) appeals two final determinations of the Indiana Department of
State Revenue (Department) assessing it with approximately $1.5 million in Indiana adjusted gross
income (AGI) tax and supplemental net income tax for 1997 and 1998.
The issues are:
I. Whether Subaru must add back to its 19971998 Indiana adjusted gross income computation
the property taxes that it had capitalized as inventory costs for federal tax
II. Whether Indiana Code Section 6-3-2-2.6 requires Subaru to adjust its net operating loss
by the amount of its adjusted gross income modifications each year it used
its net operating loss.
FACTS AND PROCEDURAL HISTORY
For the reasons stated below, the Court REVERSES the Departments final determinations.
Subaru is an Indiana corporation that manufactures motor vehicles. In 1999 and
early 2000, the department completed two separate audits of Subaru covering the tax
years 1994 through 1998. As a result of these audits, the Department
determined that Subaru had incorrectly determined its Indiana AGI and supplemental net income
tax liabilities for the 1997 and 1998 tax years. Specifically, the Department
determined that when Subaru calculated its Indiana tax liabilities, it failed to add
back the property taxes it had capitalized as inventory costs for federal tax
purposes (the add-back issue). The Department also maintained that Subaru had erroneously
calculated its net operating loss (NOL) deductions (the NOL issue).
Subaru timely filed two protests contesting the Departments proposed assessments. The Department
subsequently denied both protests. Subaru now appeals to this Court. On
January 14, 2002, the Court conducted one trial on both appeals. Oral
argument was heard on November 1, 2002. Additional facts will be supplied
ANALYSIS AND OPINION
Standard of Review
This Court hears an appeal from a final determination of the Department de
novo. Ind. Code § 6-8.1-5-1(h); Snyder v. Indiana Dept of State Revenue,
723 N.E.2d 487, 488 (Ind. Tax Ct. 2000), review denied. The Court therefore
is not bound by the evidence or the issues raised at the administrative
level. Snyder, 723 N.E.2d at 488.
Both issues in this case ultimately turn on whether Subaru erroneously calculated its
AGI. Consequently, the Court finds that it would be useful first to
explain how AGI is computed.
To calculate Indiana AGI, a taxpayer must first determine its gross income, which,
for Indiana tax purposes, means gross income as defined by section 61(a) of
the Internal Revenue Code. Ind. Code § 6-3-1-8 (1998). I.R.C. § 61(a)
generally provides that gross income is all income from whatever source derived[.]
I.R.C. § 61(a) (emphasis added). However, Congress has determined that that certain
types of income, although within the purview of I.R.C. § 61, should not
be included in a taxpayers gross income. These items are exclusions from
gross income, and are embodied at I.R.C. § 101 et seq. See
generally I.R.C. § 101 et seq. Thus, once a taxpayer identifies all
items that are exclusions from gross income, its remaining income equals its gross
income. See generally I.R.C. § 61. The taxpayer then subtracts certain
deductions from its gross income to arrive at its AGI, then takes certain
other deductions from its AGI
See footnote to arrive at taxable income.
I.R.C. § 63.
Under federal law, an exclusion from gross income is legally distinguishable from a
deduction. See, e.g., Max Sobel Wholesale Liquors v. Commr of Internal Revenue, 630
F.2d 670, 671 (9th Cir. 1980); Molson v. Commr, 85 T.C. 485, 502
(1985). An exclusion from gross income means that an item is not
included in gross income at all; it is an item that will forever
escape the income tax. Gwendolyn Griffith, Basic Federal Income Tax 80 (1997).
A deduction, on the other hand, shelters income by ensuring that income
in an amount equal to the deduction will not be taxed.
When Congress passed the Tax Reform Act of 1986, it enacted uniform capitalization
See footnote which provide in relevant part that all or a portion of
an inventorys allocable share of indirect costs (including taxes) must be capitalized.See footnote
I.R.C. § 263A(a). Congress enacted the UNICAP rules, in part, out of
concern that certain taxpayers were deducting inventory costs from their gross income as
they were incurred but before their goods were sold.
See Griffith at
30910. Thus, costs were being deducted before income actually was earned, which
inaccurately reflected the taxpayers income. Id. Accordingly, Congress intended that four
categories of indirect costs be allocable to inventory: (1) off-site storage and warehousing
costs (including rent or depreciation attributable to a warehouse, property taxes, insurance premiums,
security costs, and other costs directly identifiable with the storage facility); (2) purchasing
costs; (3) handling, processing, assembly, repackaging, and labor costs; and (4) general and
administrative costs allocable to these functions. 1986 U.S.C.C.A.N. 4394.
The capitalization of property taxes as inventory costs is significant because U.S. Treasury
Regulations define gross income for manufacturing businesses as total sales, less the cost
of goods sold[.] Treas. Reg. § 1.61-3(a). Furthermore, Federal case law
states that subtracting the cost of goods sold from total sales constitutes an
exclusion from gross income. See, e.g., Max Sobel, 630 F.2d at 671;
Molson, 85 T.C. at 502. Thus, under federal law, inventory costs are
not included in gross income and so are not included in taxable income.
See Treas. Reg. § 1.61-3(a); Max Sobel, 630 F.2d at 671; Molson,
85 T.C. at 502.
I. Add-back issue
This brings us to the first issue in this case, which is whether
Subaru must add back its capitalized property taxes under Indiana Code Section 6-3-1-3.5(b)(3).
When computing its taxable income for state purposes, a corporations AGI is
the same as taxable income (as defined in Section 63 of the Internal
Revenue Code)[.] Ind. Code § 6-3-1-3.5(b) (1998). Therefore, a corporations Indiana
AGI depends in part on whether a particular item of income was included
in [federal] taxable income pursuant to I.R.C. § 63. Cooper Indus., Inc.
v. Indiana Dept of State Revenue, 673 N.E.2d 1209, 1213 (Ind. Tax Ct.
1996) (emphasis added). While a corporation may deduct state and local taxes
from its federal gross income, Consolidation Coal Co. v. Indiana Dept of State
Revenue, 538 N.E.2d 309, 310 (Ind. Tax Ct. 1989), affd, 583 N.E.2d 1199
(Ind. 1991), Indiana law mandates that the corporation must add back to its
AGI an amount equal to any deduction or deductions allowed or allowable pursuant
to Section 63 of the Internal Revenue Code . . . for taxes
on property levied by any subdivision of any state of the United States.
Ind. Code § 6-3-1-3.5(b)(3) (1998) (emphasis added).
Subaru argues that because federal law provides that inventory costs are exclusions from
gross income, any property taxes capitalized as inventory costs are also exclusions from
gross income. Accordingly, Subaru contends that its capitalized property taxes are not
deductions from gross income and therefore are not subject to the federal deduction
add-back provision of Indiana Code Section 6-3-1-3.5(b)(3). While the Department does not
deny that a portion of Subarus property taxes had to be capitalized as
inventory costs for federal tax purposes, it argues that because exclusions and deductions
have the same effect (i.e., they reduce tax liability), the word deduction in
Indiana Code Section 6-3-1-3.5(b)(3) encompasses both exclusions and deductions taken for federal tax
purposes. The Department is incorrect.
Article 3 of Indianas tax code incorporates by reference provisions of the Internal
Revenue Code, therefore, federal law interpreting those provisions is persuasive in ascertaining the
meaning of Indianas law. See F.A. Wilhelm Constr. Co. v. Indiana Dept
of State Revenue, 586 N.E.2d 953, 955 (Ind. Tax Ct. 1992) (holding that
the legislature intended Indianas Adjusted Gross Income Tax Act to be interpreted in
harmony with the Internal Revenue Code); Consolidation Coal, 538 N.E.2d at 311.
Federal law clearly draws a legal distinction between an exclusion from gross income
and a deduction from gross income. See Max Sobel, 630 F.2d at
671; Molson, 85 T.C. at 502. Accordingly, the Court holds that a
deduction under Indiana Code Section 6-3-2-3.5(b)(3) means the same as a deduction under
federal lawno more, no less. See Wilhelm Constr., 586 N.E.2d at 955;
see also Indiana Dept of State Revenue v. Endress & Hauser, Inc., 404
N.E.2d 1173, 1178 (Ind. Ct. App. 1980) (holding that a court should not
extend the meaning of a statute beyond the language of the statute).
Because federal law treats Subarus capitalized property taxes as exclusions, not deductions, then
those taxes are not subject to the federal deduction add-back provision of Indiana
Code Section 6-3-1-3.5(b)(3).
Consequently, the Court REVERSES the Departments final determination on
this issue. The Court REMANDS this issue to the Department for further
proceedings consistent with this opinion.
II. The NOL issue
The next issue is whether Indiana Code Section 6-3-2-2.6 requires Subaru to adjust
its NOL by the amount of its AGI modifications (i.e., those property taxes
that Subaru was required to add back under Indiana Code Section 6-3-1-3.5(b)(3)) for
each year it used its NOL. Subaru argues that Indiana Code Section
6-3-2-2.6(b) unambiguously requires it to adjust its NOL by its AGI modifications only
for those years in which it actually incurred an NOL.
See footnote The Department,
on the other hand, contends that Subaru must adjust its NOL by its
AGI modifications every year it
uses its NOL.
See footnote The Department is incorrect.
For federal income tax purposes, an NOL is defined as the excess of
business deductions (computed with certain modifications) over gross income in a particular tax
Federal Tax Handbook 316 (2003). See also I.R.C. §
172(c). An NOL deduction is allowed to corporations,
See footnote and [a]n NOL sustained
in one year may be used to reduce the taxable income for another
Federal Tax Handbook at 316. It may be carried back
to earlier years and yield tax refunds. Id. If not exhausted
in earlier years (or if the taxpayer elects not to use the carryback)[,]
it may be carried forward to later years and reduce the tax for
those years. Id. NOLs for tax years beginning before August 6,
1997, could be carried back three years and forward fifteen years. Id.
When calculating NOL for Indiana tax purposes, Indiana Code Section 6-3-2-2.6(b) provides that
an NOL is calculated, in part, by applying those [AGI] modifications required under
See footnote for the
same taxable year during which each net operating loss
Ind. Code § 6-3-2-2.6(b) (1998) (emphasis and footnote added).
The Department contends that the first step for calculating NOL under Indiana Code
Section 6-3-2-2.6(a) requires a different outcome. That step provides: Determine, in
the manner prescribed in section 2 of this chapter, the taxpayers adjusted gross
income, for the taxable year, derived from sources within Indiana[.] Ind. Code
§ 6-3-2-2.6(a) (emphasis added). The Departments argument can be summarized as follows:
Indiana Code Section 6-3-2-2.6(a) requires Subaru to pay as much tax as
possible on its income derived from sources within Indiana, thus, Subaru must adjust
its NOL by its Indiana AGI modifications each year it uses its NOL.
(See Oral Argument Tr. at 3844.)
The Legislature has provided no statutory basis for the Departments position; this Court
applies the tax laws as the Legislature writes them. See Endress &
Hauser, 404 N.E.2d at 1178. It is a fundamental rule of statutory
construction that a statute which is clear and unambiguous on its face needs
no interpretation, Endress & Hauser, 404 N.E.2d at 1175, and in this case,
the clear and unambiguous meaning of Indiana Code Section 6-3-2-2.6(b) instructs corporations
to apply the AGI modifications required under Indiana Code Section 6-3-1-3.5 for the
year in which each NOL was incurred, not the year each NOL was
used. See I.C. 6-3-2-2.6(b). For these reasons, the Court REVERSES the
Departments final determination.
For the aforementioned reasons, the Court REVERSES the Departments final determinations and REMANDS
this case to the Department for further proceedings consistent with this opinion and
pursuant to the parties stipulations.
Footnote: These deductions are not relevant to the issue here.
I.R.C. § 62.
Normally, exclusions are appropriate for items of income whereas deductions are appropriate
for items of expenditure.
Gwendolyn Griffith, Basic Federal Income Tax 116 (1997).
Although in terms of taxation exclusions and deductions have the same effect,
they arrive at these effects in distinctly different ways. Id.
In general, the UNICAP rules apply to all persons who (1) produce
real or tangible personal property or (2) acquire real or personal property for
resale if the average annual gross receipts of the taxpayer exceed $10 million.
I.R.C. § 263A(b).
Footnote: To capitalize a cost simply means to convert the cost into capital.
See Blacks Law Dictionary 202 (7th ed. 1999). In this case,
I.R.C. § 263A required Subaru to capitalize a portion of its property taxes,
i.e., it required Subaru to treat its property taxes the same as it
would treat any other indirect cost that could be allocated to its inventory.
Thus, under I.R.C. § 263A, a portion of Subarus property taxes was
recharacterized as an inventory cost.
As a result of an amendment effective January 1, 1999, Indiana taxpayers
are no longer required to add back property taxes in computing Indiana AGI.
See Pub. L. No. 273-1999 § 51 (cited in Ind. Code Ann.
§ 6-3-1-3.5 (West 2000)).
The Department argues that I.R.C. § 263A is unfair because it does
not apply to taxpayers with average annual gross receipts of $10 million or
less. That provision of I.R.C. § 263A, however, applies to persons who
acquire real or personal property for resale, which is not the issue in
this case. I.R.C. § 263A(b)(2). Thus, the Court will not address
the Departments argument.
Footnote: Thus, Subaru argues that because its NOLs were incurred in taxable years
19881992, only those AGI modifications required for 19881992 apply to its NOL.
Footnote: The Department relied on Indiana Administrative Code title 45 rule 3.1-1-9 in
its final determination on Subarus NOL. However, this rule was promulgated in
1979 in connection with the issue of how a taxpayer should apportion NOLs
suffered outside of Indiana.
See generally Ind. Admin. Code tit. 45, r.
3.1-1-9; Indiana Dept of State Revenue v. Endress & Hauser, Inc., 404 N.E.2d
1173 (Ind. Ct. App. 1980). In 1983, the Legislature enacted a two-sentence
provision that dealt with the apportionment issue. See 1983 Ind. Acts 82
§ 1 (codified at Ind. Code § 6-3-1-3.5(b)(4)). In 1987, the Legislature
repealed this provision. See 1987 Ind. Acts 91 § 2. In
its place, the Legislature enacted a lengthy, complex, four-step procedure for calculating NOL.
See id. at § 4 (codified at Ind. Code § 6-3-2-2.6).
The Department, however, never updated its rule to reflect the aforementioned legislative changes
codified in the newly enacted Indiana Code Section 6-3-2-2.6. (Trial Tr. at
4549.) An administrative rule is a nullity where the provision upon which
the rule is based has been repealed. Hutchison v. Indiana State Bd.
of Tax Commrs, 520 N.E.2d 1281, 1283 (Ind. Tax Ct. 1988). Accordingly,
the Departments reliance upon Indiana Administrative Code title 45 rule 3.1-1-9 to calculate
Subarus NOL under Indiana Code Section 6-3-2-2.6(b) is misplaced.
See generally I.R.C. § 172.
Indiana Code Section 6-3-1-3.5 provides the method for calculating AGI.
Ind. Code § 6-3-1-3.5.
Again, the relevant modifications here are the federal income tax deductions Subaru
took for the payment of its state property taxes, which, prior to 1999,
had to be added back to a taxpayers Indiana AGI under Indiana Code
See I.C. 6-3-1-3.5(b)(3) (1998).
The parties have stipulated to the amount due depending on the outcome
of this case. (Stipulation at 6.)