Tax Type
Corporation Income Tax
Description
Statute of Limitations
Topic
Accounting Periods and Methods
Appropriateness of Audit Methodology
Corporate Distributions and Adjustments
Date Issued
05-11-1982
May 11, 1982
Re: § 58-1118 Application for 1974, 1975, 1976, and 1977
§ 58-411 Capital Not Otherwise Taxed
Intercompany Advances; Money on Deposit
Dear ********************
Taxpayers are a parent and one of its subsidiaries which were audited and assessed for CNOT taxes and interest due for 1974, 1975, 1976 and 1977. Both Taxpayers applied for correction of an erroneous assessment under § 58-1118.
FACTS
There are three general categories of taxable capital: inventory, excess of receivables over payables, and all-other taxable capital. Neither Taxpayer had any taxable inventory. The primary dispute involves extensive advances made by the parent to many of its subsidiaries. The parent contends that these advances were made in the usual course of business and should be in the second category where they may be offset by certain notes and bonds payable. The auditor determined that the intercompany advances were not in the usual course of business and classified them as other taxable capital. The auditor also determined that the notes and bonds payable were not made in the usual course of business and none of them were used to offset receivables in the second category.
The parent, the subsidiary involved in this proceeding and other subsidiaries are all engaged in similar businesses. All subsidiaries deposit their receipts into bank accounts controlled by the parent. Most bills of the subsidiaries are paid by the parent. Excess funds are invested and deficits are covered by the parent. The subsidiaries are charged a fee by the parent for centralized cash management. All receipts, bill payments and other items are debited or credited to the intercompany accounts.
The parent borrows frequently from various sources using various instruments. Occasionally assets of a subsidiary are pledged as collateral for debts of the parent whether or not the loan proceeds provide funds for the subsidiary.
DETERMINATION
Parent-Intercompany Advances
After extensive correspondence and conferences the parent has presented substantial and persuasive evidence that the intercompany advances were made in the usual course of business. Among the factors found to be persuasive are:
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- 1. The complete control of the parent over the subsidiaries finances,
2. The long and continuing course of conduct,
3. The fee charged by the parent for its services,
4. Assets of one subsidiary may be pledged to secure loans to the parent,
5. The arrangement includes all receipts and virtually all bills of the subsidiaries rather than occasional transactions.
- 1. The complete control of the parent over the subsidiaries finances,
Parent - Notes and Bonds Payable
At conference it was agreed that the auditor would return to Taxpayer's place of business and review the notes and bonds payable. The auditor reviewed each item and determined the percentage applied to: (1) loans to subsidiaries (via the intercompany account), (2) the parent's working capital and (3) capital outlays for the parent. It should be noted that § 58-422 requires all taxpayers to keep adequate records of items constituting taxable capital. In this case the parent was able to furnish sufficient information to trace the source and application of funds.
In line with the determination made above that intercompany advances were made in the usual course of business, it follows that payables incurred to make such advances are also in the usual course of business. Therefore, that portion of the notes, bonds and other payables incurred for the purpose of making loans to subsidiaries along with the portion used for the parent's working capital will be included in the second category, excess receivables over payables.
Parent - Notes Receivable
After reviewing evidence submitted by the taxpayer the following notes receivable have been determined to have been made in the usual course of business. They will be removed from the third category and added to the second category:
1974 - Sundry small items
1975 - Loans to employees
1976 & 1977 - Refund of insurance premium
1977 - Insurance proceeds for flood damage
Subsidiary - Intercompany Advances to Parent
The subsidiary's intercompany account showed substantial sums advanced to the parent. In other words, the normal deposits of receipts to bank accounts controlled by the parent greatly exceeded the bills and other amounts paid by the parent on behalf of the subsidiary. It has already been determined that these sums were advanced in the usual course of the parent's business and the same treatment will be accorded the subsidiary.
Accordingly, the intercompany advances will be removed from the third category of taxable capital and added to the second category.
Subsidiary - Money on Deposit
The subsidiary argued that the advances to its parent just discussed should be excluded from taxable capital on the grounds that they were money on deposit which is excluded from taxable capital. § 58-411(4).
The parent is not chartered as a banking corporation and does not carry on a banking business. However, the exclusion depends not on the nature of the parent's business but on the nature of the alleged "deposit" relationship between the subsidiary and its parent. In this case once the daily receipts have been deposited and transferred to accounts controlled by the parent, the subsidiary no longer has any control over the funds. The subsidiary cannot withdraw, draw checks upon or transfer the funds. It can only request the parent to use the funds to pay certain bills. The parent can delay or refuse payment. There is no contractual relationship requiring the parent to disburse funds on demand of the subsidiary.
While the intercompany account may superficially resemble a checking account, the crucial element of control is lacking. The parent controls disbursements. The funds are therefore not "on deposit" within the meaning of § 58-411(4). The funds will be taxed as intercompany advances made in the usual course of business as previously determined.
You will shortly receive revised assessments for both the parent and the subsidiary for all four years. It should be noted that the subsidiary's 1974 assessment was made on a jeopardy basis because the Statute of Limitations was about to expire. Upon completion of the audit the tax due was greater than the amount assessed, but since the limitation period had expired no additional tax could be assessed. The change to the subsidiary's audit for 1974 will change the computation of the tax due per audit but will not reduce the tax due below the amount assessed for 1974. Therefore the subsidiary's 1974 assessment remains unchanged.
Sincerely,
W. H. Forst
State Tax Commissioner
Rulings of the Tax Commissioner