Opinion
No. 11-98-17429 MA
September 4, 2001
ORDER GRANTING UNITED STATES INTERNAL REVENUE SERVICE RELIEF FROM AUTOMATIC STAY
THIS MATTER is before the Court on the United States Internal Revenue Services (IRS) Motion To Lift Automatic Stay To Permit Set Off of Tax Overpayments filed on December 22, 2000 (the Stay Motion). One Objection was filed on January 10, 2001 by Frank Ciotti (Ciotti), creditor of Neelchine Industries, Inc. (NII), a related entity of Neelchine Engineering, Inc. (the Debtor).
NII is under Chapter 7 bankruptcy protection, No. 7-00-16963 MA. A hearing on the Stay Motion was held on March 5, 2001 at which the Court took the matter under advisement.
The Court FINDS:
1. The Debtor filed a bankruptcy petition under Chapter 11 of the Bankruptcy Code on December 9, 1998.
2. On December 8, 1999, the IRS timely filed a proof of claim for federal employment taxes in the amount of $120,948.00 as a secured claim subject to a right of offset under the Bankruptcy Code. The remainder of the claim sets forth an unsecured priority claim of $22, 891.95, and a general unsecured claim of $47,252.27.
3. For the fiscal year ending February 28, 1996, the Debtor as parent corporation, filed a consolidated income tax return with its three subsidiaries; 1) Clean Systems Technologies, Inc., 2) Maintenance Technical Services, Inc. and 3) Santa Fe Machinery Sales (collectively, the NEI group). The NEI group reported a taxable income of $770,119.00 which resulted in a tax liability of $261,840.00.
4. For the fiscal year ending February 28, 1997, the Debtor incurred a net operating loss (NOL) of $1,024,314.00 (the 1997 NOL).
In its Stay Motion the IRS stated that the Debtor filed a corporate income tax return showing this loss, and an unsigned copy of NEIs corporate tax return was attached to Exhibit 2 offered at the hearing.
5. NII and its subsidiaries, including the Debtor (collectively, the NII group) filed an amended corporate income tax return for 1996 on behalf of the Debtor (First Amended Return) in which a portion of the 1997 NOL was carried back thereby reducing the NEI groups taxable income to $455,576.00 and its tax liability to $154,930.00. The difference between the tax liability initially reported and paid and the amount actually due after the application of the 1997 NOL yielded a refund to NEI of $106,910.00.
6. For the fiscal year ending February 28, 1998, the Debtor and the NEI group filed a consolidated income tax return with the NII group. In that year the NII group had an aggregate loss of $1,244,838.00 that when netted against taxable income, resulted in a NOL of $545,218.00 (the 1998 NOL). The NII group filed another amended corporate income tax return for 1996 on behalf of the Debtor seeking to carry back $455,676.00 of its 1998 NOL to the NEI groups 1996 tax year and thereby eliminate all of the NEI groups 1996 taxable income (the Second Amended Return). Thereafter, NII filed an Application for Tentative Refund seeking a refund of the remaining $154,930.00 in taxes paid by the NEI group for that year.
The members of the NII group participated in the NOL as follows:
Entity Name Taxable Income (Loss) in dollars
Neelchine Engineering, Inc. 150,089.00 Neelchine Industries, Inc. (311,552.00) Clean Systems Technology (875,448.00) Superior Structural Tech. 397,142.00 Maintenance Tech. Services, Inc. 152,389.00 Santa Fe Machinery Sales .00 Santa Fe Bolt (57,218.00)
Consolidated Taxable Income (NOL) (545,218.00)
See, 26 U.S.C. § 1502.
Submitted into evidence was an copy of the Amended Return dated June 29, 1999 filed by Neelchine Industries, Inc. Subsidiaries
The treasury regulations require the common parent corporation to act as the sole agent for a consolidated group. 26 C.F.R. § 1.1502-77(a). Any refund will be made directly to and in the name of the common parent. Id. However, NII was not the common parent for the NEI group in 1996, therefore the treasury regulation does not require that a refund, if any, be issued to NII. It was improper for NII to apply for the refund; NEI should have made the application for refund. However, since the IRS seeks to offset NEI tax liability with the 1998 NOL, it will receive the benefit of the tax overpayment, just not in the form of a refund. The fact that the application for refund was filed by the wrong entity does not affect the proper placement of the refund as belonging to NEI.
7. In its investigation of the Debtors tax returns, the IRS determined that the wrong amount of the 1997 NOL was carried back in the First Amended Return. As a result, the Debtors taxable income for 1996 was adjusted to $513,513.00. In researching this error, the IRS also determined that the NII group should have carried back a smaller amount of the 1998 NOL in its Second Amended Return. The IRS and the Debtor agreed that the Debtor should have carried back only $383,431.00 of the 1998 NOL under the separate return year limitations set forth in the treasury regulations. See, 26 C.F.R. § 1-1502-21. These regulations limit the amount of the NII groups NOL that can be carried back to the Debtors separate return year (1996, a year in which the Debtor, was a member of the NEI group and was not a member of the NII group for tax purposes). 26 C.F.R. § 1.1502-21(c) (allowing a carry back of a consolidated groups loss to a taxpayers separate return year only in the amount that taxpayer (and/ or its affiliates) contributed to the loss). Once the Debtors share of the 1998 NOL, equaling $383,431.00, was offset against the NEI groups adjusted 1996 taxable income of $513,513.00, the taxable income for the NEI group for 1996 was reduced to $130,083.00. The income tax liability on the adjusted taxable income equaled $33,982.00. Subtracting that amount from the adjusted tax liability of $154,930.00 results in an overpayment of tax in 1996 of $120,948.00.
The amount of the 1998 NOL attributable to the NEI group is calculated by using only the losses of those affiliates that were part of the NEI group in 1996 and multiplying the 1998 NOL by a fraction consisting of the NOL attributed to any member of the NEI group that realized a loss (Clean Systems Technologies, Inc. loss of $875,446.00 was the only one), divided by the NII groups 1998 aggregate loss of $1,244,838.00. 26 C.F.R. § 1.1502-79A. The result of this equation is $383,431.00, the amount of the 1998 NII group NOL allowed to be carried back to the NEI groups 1996 taxable income. In other words, this amount is the proportionate amount of the 1998 loss that NII as the taxpayer could use to offset previous taxable income of a different group, the NEI group. In theory, NII could use its proportionate share of the 1998 NOL as either a carry back to offset taxable income from earlier tax years or a carry forward to offset future taxable income.
7. It is this overpayment amount that the IRS seeks to setoff against the Debtors employment tax liability for the third quarter of 1997.
DISCUSSION
Ciottis objection focuses on mainly one issue: whether the Debtor improperly benefitted from the carry back of a portion of the NII groups 1998 NOL which was credited against previous taxable income generated by the NEI group in 1996. Ciotti argues that the 1998 NOL should be used to generate a $120,948.00 refund to NII. He reasons that as an asset of the NII bankruptcy estate, this refund should be used to the benefit of himself and the other NII creditors. In dealings with the IRS for a consolidated group, the common parent acts as agent for the consolidated group and any refund is paid to the common parent. 26 C.F.R. § 1.1502-77. NII acted as agent for the NEI group in requesting the refund. However, in 1996 the common parent for the NEI group was the Debtor. In 1998 the common parent for the NII group was NII, of which the members of the NEI group, including the Debtor, were a part. The Debtor, as the parent of the 1996 NEI group, was the proper agent to apply for a refund for that group. Although NII acted as agent on behalf of the Debtor in applying the 1998 NOL, NII cannot benefit from a tax overpayment incurred by a group of entities in which it was not a member. Ciotti fails to explain how NII, who was not a member of the NEI group in 1996, can claim as an asset the overpayment of tax on income generated by the NEI group.
The treasury regulations specifically account for these differences in group membership in the regulations governing NOL carry backs for taxpayers consisting of consolidated entities. See, 26 C.F.R. § 1.1502. Any perceived inequity to NII is addressed by application of the treasury regulations governing separate return year limitations, which provide for use of only a proportionate part of a consolidated groups NOL when applied to a different groups taxable income. 26 C.F.R. § 1.1502-21. In other words, only the NEI groups contribution to the 1998 NOL was carried back to offset its 1996 income. Under this regulatory scheme, NII cannot claim exclusive ownership of the 1998 NOL.
Ciotti argues that the transfer of an asset of NII, here the 1998 NOL, to offset NEI income was somehow fraudulent under the bankruptcy code. As shown above, the 1998 NOL, to the extent attributable to NEI group entities, is not an asset of NII. Therefore, there was no improper transfer of an NII asset. In sum, Ciotti presents no reason, either legal or equitable, for this Court to disallow the use of the 1998 NOL in a manner specifically allowed by the treasury regulations.
Once it is determined that the overpayment properly belongs to the Debtor, the Court must decide whether it is proper to allow the IRS to offset part of its claim in bankruptcy. The Tax Code allows the IRS to offset an overpayment of tax against any other liability that the taxpayer owes, and only after these credits have been applied, is the taxpayer eligible for a refund. 26 U.S.C. § 6402. A lift of stay, however, is required before the IRS can apply the offset. 11 U.S.C. § 362(a)(7) and (d)(1). The IRS correctly asserts that its right of setoff under 26 U.S.C. § 6402 is preserved by 11 U.S.C. § 553. Both the overpayment and the tax liability are attributable to pre-petition activities, are mutual debts and are not within the exceptions to setoff in § 553(a). The IRS has established its right of setoff, and thereby has made a prima facie showing of cause for relief from stay under 11 U.S.C. § 362(d)(1). Ciotti has failed to refute the IRSs right to setoff. Therefore, the Court finds that cause exists to lift the stay to allow the IRS to offset the overpayment amount ($ 120,948.00) against the Debtors outstanding employment tax liability for the last quarter of 1997. See, I. R. S. v. Orlinski (In re Orlinski), 140 B.R. 600, 602-03 (Bankr.S.D.Ga. 1991) (finding IRSs right of setoff constituted cause for lift of stay to credit against Debtors prepetition tax liability).
IT IS ORDERED that the IRSs Motion for Relief From Stay is granted, and the stay is lifted to allow the IRS to offset the Debtors tax overpayment against the Debtors employment tax liability for the last quarter of 1997.