Rev. Rul. 56-623

Advice has been requested concerning the proper application of section 24.31(b)(4) of Regulations 129 in the circumstances described below.

X corporation is the common parent of an affiliated group of corporations including Y corporation. For the calendar year 1953, X filed a consolidated return claiming a consolidated net operating loss deduction of 500 x dollars, resulting from net operating losses sustained by Y corporation in the taxable years 1949 to 1951, inclusive, for which years Y had filed separate income tax returns. For the year 1953, X corporation received a large amount of dividends from domestic corporations. The net income of Y corporation computed with the exceptions specified in section 122(d) of the Internal Revenue Code of 1939 exceeded its normal-tax net income for 1953 by 2 x dollars, and effect was given to this adjustment in arriving at the amount of the consolidated net operating loss deduction. Y corporation received no dividends for the taxable year 1953.

Section 24.31(a)(2) of Regulations 129 provides that, in the case of a consolidated return, the consolidated net operating loss deduction shall be reduced by the excess of the consolidated net income, computed with the exceptions and limitations provided in section 122(d) of the Code, over the consolidated normal-tax net income computed without any net operating loss deduction and without certain credits (such credits inapplicable in the instant case). Section 122(d) of the Code does not provide for any adjustment to be made to the credit for domestic dividends received under section 26(b) of the Code.

Section 24.31(b)(4) of Regulations 129 provides, in part, as follows:

If a portion of the consolidated net operating loss deduction arises as a carryover pursuant to the provisions of (a)(3)(ii) of this section (relating to net operating losses sustained by a corporation in years for which separate returns were filed, or for which such corporation joined in a consolidated return by another affiliated group), * * * the consolidated net operating loss deduction shall not be less than the amount of such portion reduced by the amount, if any, by which the net income of such corporation (computed with the exceptions and limitations provided in section 122(d)(1), (2), (3), and (4)) exceeds the normaltax net income of such corporation (computed without any net operating loss deduction, but taking into account the additional capital loss deduction authorized by section 204(c)(5)), or, in the case of two or more such corporations, the sum of such portions so reduced.

In the instant case, even though X , the parent corporation, had a substantial dividends received credit, which under section 24.31(a)(2), supra , would have the effect of eliminating in a consolidated return the net operating loss carryover of Y , section 24.31(b)(4), supra , prevents such an elimination. The purpose of section 24.31(b)(4) is to provide a rule, in the case of the amount of a net operating loss deduction which has been limited under section 24.31(b)(3) coming into the group from a corporation which filed a separate return, whereby there shall be no reduction of the net operating loss carryover by the section 122(d) adjustments of the entire group for the taxable year of the deduction.

Accordingly, it is held that in determining a net operating loss deduction in a consolidated return for the taxable year 1953 arising from a net operating loss carryover of an affiliated corporation from years for which separate income tax returns were filed, the carryover shall be reduced by the section 122(d) adjustments applicable to the loss affiliate, as provided in section 24.31(b)(4) of Regulations 129, and not by such adjustments applicable to the entire affiliated group for the taxable year of the deduction.

There is no comparable provision in the consolidated return regulations under the Internal Revenue Code of 1954, since section 172 of the 1954 Code no longer requires that the net operating loss deduction be reduced by the dividends received deduction allowed by section 243 of the 1954 Code. Treasury Decision 6140, C.B. 1955-2, 317.