The Supreme Court of Ohio (Court) in New York Frozen Foods, Inc. v. Bedford Hts. Income Tax Bd. of Rev.,¹ held that the applicable city ordinance barred an entity from changing its separate return to a consolidated return when filing an amended return. The Court reached concluded that such a change constituted a change in accounting methods which is generally prohibited by the local ordinance.

Facts

New York Frozen Foods, Inc. (NYFF) timely its municipal net profits tax returns on a separate entity basis for the tax years 2005-07. For federal income tax purposes, it had filed on a consolidated basis in those years. On 9 March 2010, NYFF filed amended municipal net profits tax returns on a consolidated basis resulting in a refund request of almost $700,000. The Regional Income Tax Agency (RITA), Bedford Heights' tax administrator, rejected NYFF's amended returns and refund claims.

NYFF appealed to the local review board which affirmed RITA's action. The local review board relied, in part, on Bedford Heights Ord. 173.15(a), 173.32, which precludes a taxpayer from making a change to "the method of accounting or the apportionment of net profits … ." after the due date for filing the original return. The local review board also relied on Section 5:06(A) of the RITA Rules and Regulations, which contained similar language with the additional prohibition against "changing the method of filing after the due date for filing the original return." This additional prohibition was adopted by RITA in 2009, after the tax years at issue. The local review board stated that these provisions, taken together, were "identical in effect" and applied to the tax years under review.

The Ohio Board of Tax Appeals (BTA) affirmed the local review board's decision.² The BTA agreed with NYFF that filing an amended consolidated return did not involve a prohibited change in the method of accounting or apportionment. However, the BTA concluded that the 2009 amendments to the RITA Rules and Regulations applied notwithstanding Section 5:00 of the RITA Rules and Regulations, which provided that "in the event of a conflict with this Chapter of the Rules and Regulations and any provision(s) of the Ordinance of Bedford Heights, the Ordinance will supersede." The BTA also concluded that it did not have the authority to address NYFF's state constitutional objections³ to applying the RITA rule.

Ohio Supreme Court's analysis

In ruling in favor of the city, the Court determined that the Bedford Heights Ordinance supported a restrictive view of the circumstances that justify amended returns. Bedford Heights Ordinance 173.15(a) provides that amended returns are permitted "[w]here necessary … in order to report additional income and pay additional tax due, or claim a refund of tax overpaid." The Court reasoned that NYFF's original separate company filing was both "legally proper and factually correct" as to the amount of tax owed. The amended returns did not claim a missed deduction or credit. Moreover, the payment of tax made on the original return was not an "illegal exaction" by the municipality. Since NYFF "itself chose which method to use in originally reporting its income" its attempt to amend its returns on a consolidated basis seeks to "reduce or minimize a tax assessment legally made." The Court concluded that this was a remedy not intended by the Ordinance.

The Court further held that the amended consolidated return was an impermissible change in accounting method. The Court observed the federal treasury regulations do not state that an accounting method change would only encompass cash versus accrual accounting. Instead, the federal treasury regulations support a more expansive view of what constitutes an accounting method change including any changes in the overall accounting for gross income. The Court also tied accounting for gross income to the computation of taxable income by noting that changing from a separate to a consolidated return affects the computation of taxable income by aggregating the transactions of the members of the group and eliminating intercompany transactions. In support of this conclusion, the Court cited Internal Revenue Manual 4.11.6.1(1) (May 13, 2005), which precludes a consolidated federal return from being filed once a separate return is filed. The Court also concluded that the 2009 amendments to the RITA Rules and Regulations were to be construed as a "clarification rather than a substantive change" to the existing authorities so they applied to the tax years at issue.

The Court rejected NYFF's arguments that Ohio Revised Code Section 718.06, which authorizes consolidated filings for municipal net profits tax purposes, preempted the local ordinance's restrictions to the amended returns discussed above. The Court cited Ohio constitutional principles granting municipalities home rule authority. The Court acknowledged that the Ohio legislature, via Ohio Revised Code Chapter 718, may impose limits on the power to tax, but such law may not be construed to impose local taxes by overriding provisions of local law. In the absence of an explicit statement in Ohio Rev. Code Section 718.06 allowing a consolidated election to be made on an amended return such a return is not permissible. To prohibit the municipality from refusing the amended return would constitute an additional limit on municipal taxing authority not explicitly stated in Ohio Rev. Code Section 718.06.

Finally, the Court noted Bedford Heights' "strong policy reason" to limit refund claims, that is, the municipality's fiscal stability depended on the finality of the filing election. The Court distinguished correcting errors or omissions on an original return from electing a substantially different method of reporting and computing income. The Court concluded that a municipality is required to provide relief in the former instances but not in the latter.

Implications

The Court's decision seems to close the door on the opportunity to make a consolidated election on an amended municipal net profits tax return, at least for tax years prior to 2016. Am. Sub. H.B. 5 made a number of changes to Ohio municipal tax provisions effective for tax years 2016 and after.⁴ One of the changes was to Ohio Rev. Code Section 718.41(A), which provides that if a taxpayer intends to file an amended consolidated municipal income tax return, or to amend its type of return from a separate return to a consolidated return, based on the taxpayer's consolidated federal income tax return, the taxpayer shall notify the tax administrator before filing the amended return. This seems to grant municipalities some discretion to allow such a filing under current law, but how and when, and under what standard, that discretion will be applied remains to be seen.

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ENDNOTES

¹ New York Frozen Foods, Inc. v. Bedford Hts. Income Tax Bd. of Rev., Slip Opinion No. 2016-Ohio-7582 (Ohio S. C. Nov. 3, 2016).

² See Tax Alert 2015-535.

³ Ohio courts have held that a statute unconstitutionally delegates legislative power, rather than authorizing administrative action, when it permits the agency to enact a law rather than execute an existing law. See Peachtree Development Co. v. Paul, 67 Ohio St. 2d, 345, 350 (1981).

⁴ See Tax Alert 2014-2226.