Tax Type
Bank Franchise Tax
Description
Bank Franchise deduction for retained earnings and surplus of certain subsidiaries
Topic
Computation of Tax
Taxpayers' Remedies
Date Issued
08-18-2006
August 18, 2006
Re: § 58.1-1824 Application: Bank Franchise Tax
Dear *****:
This will reply to your letter in which you submit a ruling request and protective claim for refund concerning the bank franchise tax deduction for retained earnings and surplus of certain subsidiaries. I apologize for the delay in responding to your letter.
FACTS
***** (the "Taxpayer") is a bank subject to the bank franchise tax. The Taxpayer has investments in numerous subsidiaries that are reported in the Taxpayer's official report of condition (the "Call Report").
The computation of the bank franchise tax permits a deduction for retained earnings and surplus of subsidiaries to the extent included in the gross capital of the bank. The Taxpayer requests that it be allowed a pro rata deduction from the gross capital for the surplus of subsidiaries.
DETERMINATION
The bank franchise tax is imposed on the net capital of a bank. Virginia Code
§ 58.1-1205 provides the computation for determining a bank's net capital. There is no provision under Virginia statute that requires or permits banks to combine capital among affiliated banks for purposes of determining its bank franchise tax liability. Instead, each bank must make a separate determination of its capital.
The computation of net capital begins with the Call Report. See Title 23 of the Virginia Administrative Code ("VAC") 10-330-20 B 7. Banks are required to include majority-owned subsidiaries in a consolidated Call Report under United States Generally Accepted Accounting Principles ("GAAP"). Accordingly, a Call Report filed by a bank may include the bank and its subsidiaries.
In addition, certain unconsolidated subsidiaries must be reported under the equity method of accounting. Under this method, the carrying value of the bank's investment is originally recorded at cost but is adjusted periodically to reflect a proportionate share of the investee's earnings, losses and dividends.
While a bank's investment in its subsidiaries is an asset of the bank and is included in the computation of a bank's capital, the General Assembly recognized that these reporting requirements could create a situation under which capital or income could be taxed both to the bank and to the subsidiary. Virginia Code § 58.1-1206 A 4 permits a deduction equal to the "amount of retained earnings and surplus of subsidiaries to the extent included in the gross capital of the bank."
Title 23 VAC 10-330-30 E explains that the intent of the deduction is to remove the amount of increase in the bank's recorded investment in its subsidiaries resulting from undistributed earnings of such subsidiaries from the gross capital of a bank. Under this regulation, the deduction is limited to the amount included in gross capital that represents the undistributed earnings of its subsidiaries during the period of the bank's investment in such subsidiaries.
For reporting purposes, the regulatory requirements applicable to the Call Report conform to GAAP. Under Accounting Research Bulletin No. 51, issued in 1959, retained earnings of a purchased subsidiary at the date of acquisition are not included in consolidated financial statements. Consequently, the only undistributed earnings of a subsidiary that should be included in a bank's consolidated financial statement would be the subsidiary's retained earnings during the period of the bank's investment.
Such increases are generally reflected in a subsidiary's undivided profits or retained earnings. In some instances, however, the increase may be reflected in the subsidiary's surplus. As such, the deduction is permitted for the subsidiary's retained earnings and surplus.
The Taxpayer's request involves the computation of the deduction as it relates to a subsidiary's surplus. The Taxpayer believes that the Department's approach is not consistent with basic accounting principles wherein each asset of a bank (if not directly traceable) is attributable in part to its liabilities and in part to its gross capital (i.e., Assets = Liabilities + Equity). Thus, the Taxpayer believes that the true measure of the deduction is not achieved because some portion of a subsidiary's surplus is represented in a parent bank's gross capital.
The Taxpayer's issue, therefore, is not with identifying the amounts set forth in the regulation. Instead, the Taxpayer believes an additional pro rata deduction should be permitted for the surplus of subsidiaries to the extent not directly traceable to an increase in the bank's gross capital. According to the Taxpayer, this additional deduction for surplus of subsidiaries should equal the percentage of the gross capital of the bank as the non-directly traceable surplus of subsidiaries bears to the total assets of the bank. The Taxpayer contends this is the same rationale underlying the deduction for obligations of the United States under Title 23 VAC 10-330-30 D. Essentially, the Taxpayer believes it is entitled to a deduction for the directly traceable increases in its subsidiaries' investment accounts plus a pro rata deduction for the amount of the investment included in the Taxpayer's surplus.
Pursuant to Title 23 VAC 10-330-20 B, "surplus" is defined as the amount shown on the Call Report including "reserves for contingencies and other capital account reserves." For purposes of the Call Report, the surplus account includes capital contributions, adjustments arising from treasury stock transactions, and any amount received for common stock in excess of its par value.
Unlike retained earnings, a subsidiary's surplus at the date of acquisition is not eliminated in consolidated financial statements under GAAP. Consequently, the clear language of the statute permits a deduction for any amount of a subsidiary's surplus included in the Call Report of a bank. Such surplus, including reserves, treasury stock, and amounts paid in excess of par, should be readily identifiable on the subsidiary's year end financial statements. Accordingly, there is no need to grant a pro rata deduction.
Further, the rationale underlying the deduction for United States obligations addresses a prohibition against state taxation of such instruments. There is no such prohibition for a bank's investment in a subsidiary.
Accordingly, I find the Department's regulation correctly interprets the statutory deduction for the retained earnings and surplus of subsidiaries. A pro rata deduction from the gross capital of the bank for the surplus of subsidiaries to the extent not directly traceable to an increase in the bank's gross capital is not permitted by statute.
The Taxpayer may be entitled to a refund claim to the extent that it did not compute its deduction for retained earnings and surplus in accordance with this determination. A revised refund claim, if applicable, must be filed within 30 days of the date of this letter. The claim should be mailed to: Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, Post Office Box 27203,
Richmond, Virginia 23261-7203, Attention: *****. If the revised refund claim is not received within the time allotted, the Department will consider the matter closed.
The Code of Virginia and regulation sections cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions about this ruling, you may contact ***** at *****.
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- Sincerely,
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- Janie E. Bowen
Tax Commissioner
- Janie E. Bowen
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AR/538990
Rulings of the Tax Commissioner