N.J. Admin. Code § 18:7-5.14

Current through Register Vol. 56, No. 8, April 15, 2024

Section 18:7-5.14 - Limitations to the right of a net operating loss carryover

(a) The net operating loss carryover automatically becomes zero when the cumulative effect of all of the corporation's capital stock redemptions and sales after June 30, 1984, is a 50-percentage-point change in the ownership of its voting stock and the corporation changes from the business giving rise to the loss. For this purpose, the exchange of stock is a sale. Further, solely for this purpose and no other purpose in the Act, a business is defined in terms of the economic factors of production. The sequence in change of ownership and change in the business and the taxability of an exchange for Federal income tax purposes are irrelevant. The economic substance of the transaction is, however, paramount and may indicate forfeiture of a net operating loss carryover.

(b) The Director may disallow the carryover in those instances where the facts support the premise that a corporation was acquired for the primary purpose of the use of its net operating loss carryovers. In this context, to prevent the trafficking in loss corporations, the Director will consider the following facts:

1. Whether the physical location or other fixed assets of the loss corporation were used in a new business;

2. The extent of the termination of the existing work force of the loss corporation;

3. A price paid for the loss corporation in excess of the market value of the assets; and 4. Any other material factor deemed appropriate to the determination.

(c) No single factor shall be deemed on its own to be dispositive of the issue.

Example 1: B Corporation was wholly owned by a single stockholder. It operated a notably unsuccessful restaurant and built up significant net operating loss carryovers. The stockholder transferred 49 percent of his or her stock to an investor who has access to a recognized and uniformly profitable fast food franchise. B Corporation releases substantially all of its existing employees, disposes of its equipment and undertakes the fast food franchise business at a new location. Notwithstanding that B Corporation's sole stockholder sold less than 50 percent of his or her stock and the corporation still sells food in a heated state, the net operating loss carryovers to B Corporation become zero. The disposition of land, labor, and capital until nothing remains except an empty corporate shell whose principal attributes are the apparent existence of an unused net operating loss carryover and some liquid capital in quest of an entirely new business is deemed to support the premise that the corporation was acquired for the primary purpose of the use of its net operating loss carryover. The economic substance of the transaction would have been to transfer the loss carryovers to a new business which is precluded by the rule.

Example 2: C Corporation was a manufacturer of buggy whips and button hooks. Due to a declining demand for its products it has built up significant net operating loss carryovers. C Corporation has only one stockholder who sells 50 percent of his capital stock to a woman who has invented a cheap and well-styled perpetual motion machine for which there is a clamorous demand. C Corporation changes its name to D Corporation and hires additional employees. It expands its plants, closes out its old product lines and realizes huge profits in its rejuvenation. D Corporation's net operating loss carryovers from its buggy whip days are unaffected by any of the above circumstances and may be claimed as a net operating loss deduction. The economic substance of the transaction is a mere restructuring of its manufacturing product line. It did not change its business where it only reallocated its economic factors of production.

(d) Subsections (a), (b), and (c) above do not apply to combined returns and combined groups. See N.J.S.A. 54:10A-4.5 and N.J.A.C. 18:7-21 for more information on prior net operating loss conversion carryovers (PNOLS) and net operating losses (NOLs) in the context of combined reporting and combined groups.

(e) Subsections (a), (b), and (c) do not apply to statutory conversions where, under the business formation laws of the state the business entity was formed in, the business entity merely changes form while remaining the same entity taxed as a corporation for Federal and New Jersey corporation business tax purposes. For example: where a C corporation merely changes form to a limited liability company through a statutory conversion pursuant to the laws of this State or another state, and remains taxed as a C corporation, the PNOLS and NOLs will survive, since the business entity is the same business entity that originally generated the PNOLS and NOLS.

N.J. Admin. Code § 18:7-5.14

Amended by 49 N.J.R. 1694(a), effective 6/19/2017

Amended by 54 N.J.R. 1819(a), effective 9/19/2022