UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
decided: March 10, 1976.
IN THE MATTER OF AVIEN, INC., DEBTOR. THE CITY OF NEW YORK, APPELLANT,
AVIEN, INC., APPELLEE
Appeal from an order of the United States District Court for the Eastern District of New York, Edward R. Neaher, Judge, disallowing the City's amended claim for unpaid corporate taxes against the debtor Avien, Inc.
Moore, Feinberg and Van Graafeiland, Circuit Judges.
MOORE, Circuit Judge:
The City of New York ("City") appeals from an order of the District Court, 390 F. Supp. 1335, affirming a decision of the bankruptcy judge expunging the City's claim against the bankrupt, Avien, Inc. ("Avien")*fn1 for allegedly unpaid corporation taxes in the amount of $17,789.32. The claim is predicated upon the following undisputed facts and the sole legal issue is the application of the loss carryback and carryover provisions of the City's General Corporation Tax, Administrative Code of the City of New York, § R46-2.0(8) (f),*fn2 which in turn, basically follow the federal income tax provisions on the subject.*fn3
Avien's fiscal year ended June 30th. From the year ending June 30, 1963 it had a checkered financial career, and sustained the following losses:
Fiscal year ending Taxable income (loss)
1966 (993,52 9.48)
The year 1968, in contrast, showed a profit reported respectively on its tax returns as $282,598.52 (U.S.) and $286,969.82 (City). As the result of a City audit in 1973 of Avien's books for the period January 1966 through December 24, 1970, the City claimed that a corporate income tax was due of $17,789.32 based on Avien's profitable 1968 year but without allowance for the large losses sustained in the surrounding years.
To avoid a result which at first glance would seem to be obvious, namely, that the losses sustained on either side of 1968 would more than wipe out a 1968 income or tax thereon,*fn4 the City resorts to an ingenious but untenable theory.
The City adopts as an unsupported hypothesis the assumption that under the federal law Avien must first apply its earliest (1963) loss to its 1968 income and argues that, until such loss is actually taken, no other yearly losses may be considered. Therefore, the City would ignore the carryovers of 1965 and 1966 and the carrybacks of 1969 and 1970.*fn5 But having theoretically applied the 1963 loss, it straightaway claims that Avien is disqualified from taking such a loss because it runs afoul of the City's Administrative Code which reads "such deductions shall not include any net operating loss sustained during any taxable year in which the taxpayer was not subject to the tax imposed by this part, * * *". § 2.0(8)(f). The City argues that its tax was not effective until January 1, 1966, ergo, no loss prior to this date can be considered.
The City's tax code provides that net income shall be "the same as" that which is reported on a taxpayer's federal return, and that net operating loss deductions shall also be "the same as" deductions allowed under § 172 of the Internal Revenue Code ("Code").*fn6 However, this does not mean, and the District Court so held,*fn7 that the reported figures on city and federal returns must be identical. Under the Code, it is not the identity of the loss deduction figures which is required, but rather the identity of permissible computation procedures used to calculate those figures.
Section 172 of the Code outlines the basic deduction allowed for net operating loss, and includes carryback and carryover provisions to ensure accurate and fair income averaging over a period of years. Under the Code the taxpayer is permitted to carry losses back three years, and forward five years. In that section it is expressly provided that carryovers and carrybacks shall be to "taxable" years within the permissible eight-year span.*fn8 Utilization of losses to or from the earliest year possible is thus subject to the qualification that all of the years in question be "taxable" years. This qualification is also explicitly incorporated into the Code's computation procedures: subsection (e) of § 172 specifies that "the necessary computations involving any other taxable year [than the one to which the loss is applied] shall be made under the law applicable to such other taxable year ". (emphasis supplied)
Applying this statutory scheme to Avien's deductions on its City return, it is readily apparent that Avien could not utilize losses from 1963 because that year was not a "taxable" year under the City tax laws. Similarly, computation of the permissible loss deductions under § 172(e) for the year 1963 would be impossible since there were no City tax laws applicable in that year.
The purpose of the City's adoption of loss carryovers and carrybacks is to give City taxpayers the benefit of income averaging, not to exclude them from it. This has been explicitly recognized in several recent New York decisions.*fn9 In the instant case, conformity of every figure reported on City and federal returns would not only do violence to the explicit language of § 172 of the Code, but would produce a result both entirely arbitrary and completely inimical to the equitable goals of income averaging.*fn10 We do not believe that the framers of § R46-2.0(8), which specifically adopts the federal system of loss carryovers and carrybacks, intended to completely undo the workings and purpose of that system by the disallowance of the calculations made by Avien on its 1968 City return. Accordingly, we hold that Avien's computation of its 1968 net operating loss deduction was proper under § R46-2.0(8).
As an additional argument the City has urged this Court to disallow Avien's substitution of loss figures on the grounds that the disparity between federal and City figures would necessitate special audits by the City, which conformity to federal figures would render unnecessary. While we are scarcely anxious to impose administrative burdens upon the City's tax department, nevertheless we believe that substantial justice compels the result which we reach here, and we will not refrain from reaching it on the grounds that the City will be inconvenienced thereby. As appellee pointed out in its brief (at p. 8), if the City chooses to impose a tax, it should bear the burden of collecting that tax.
The equitable purposes of income averaging are plainly served by the interpretation of § R46-2.0(8) adopted below, which accords with both the language and spirit of § 172. The decision of the District Court is accordingly affirmed.