Tax Type
Bank Franchise Tax
Description
Computation of net capital; Deferred income
Topic
Rate of Tax
Date Issued
12-06-1996
December 6, 1996
Re: Ruling Request: Bank Franchise Taxes
Dear*******
This will reply to your letter in which you request a ruling on behalf of********** (the "Taxpayer") as to the proper treatment of deferred income taxes in computing the reserve for loan losses (the "reserve") on the Bank Franchise Tax return ("Form 64"). 1 apologize for the delayed response.
FACTS
Form 64 contains a Reserve for Loan Losses schedule ("Schedule G") for the purpose of reconciling a bank's reserve as reported on the reports of condition and income ("report of condition"), as required by the Federal Deposit Insurance Corporation, with the reserve for income tax purposes under Internal Revenue Code ("IRC") § 585. Schedule G includes an adjustment for deferred income tax included in liabilities.
The Taxpayer requests a ruling on the treatment of such a deferred income tax asset on Form 64.
RULING
The computation of the Virginia bank franchise tax starts with gross book capital as reported on the report of condition. Under Code of Virginia §58.1-1205, the computation of net capital includes a deduction from gross capital for "any reserve for loan losses which is allowable by the Internal Revenue Service in computing federal taxable income.
Beginning in 1978, the department recognized banks may report their reserve divided among as many as three different accounts on the report of condition, including deferred income taxes and capital accounts (either "undivided profits" or "reserve for contingencies"). In addition, the department determined that adjusting the reserve to agree with the IRC without considering amounts of the reserves reported in capital accounts and deferred income taxes created tax benefits for the banks in the form of excess reserve deductions. In the case of deferred income tax, the benefit is created by the deferred income tax liability's reduction of retained surplus on the report of condition, which is included in the calculation of gross capital, and the deduction of the reserve allowed under the IRC.
By allowing a deduction from gross capital for the amount of the reserve allowed for federal income tax purposes, the Code of Virginia is in essence saying that for the purposes of loan losses, the bank franchise tax is computed on net capital per the federal income tax return. The following example will illustrate this point. Assume a bank has income statements and balance sheets as follows:
INCOME STATEMENT Book Federal Tax
Income before loan loss $100.00 $100.00
expense:
Loan loss expense: $50.00 $70.00
Income before tax $50.00 $30.00
Income tax (50%) $25.00 $15.00
Net Income: $25.00 $15.00
BALANCE SHEET PER BOOKS
Assets Liabilities &
Equity
Loans receivable: $100.00 Liabilities: $165.00
Reserve for loan ($50.00) Deferred income tax $10.00
loss: liability:
Other Assets: $200.00 Stock: $50.00
Total: $250.00 Surplus: $25.00
Total: $250.00
BALANCE SHEET PER FEDERAL
Assets
Loans receivable: $100.00
Reserve for loan ($70.00)
loss:
Other Assets: $200.00
Total: $230.00
Liabilities &
Equity
Liabilities: $165.00
Deferred income tax $0.00
liability:
Stock: $50.00
Surplus: $15.00
Total: $230.00
In this simple scenario, gross capital per books is $75.00 (Stock plus Surplus). If the department simply allowed a deduction from gross capital for the difference between federal and book reserve, the result is net capital of $55.00. Thus, the bank gets the benefit of the higher federal reserve and higher book income tax to reduce its net capital. On the other hand, the federal reserve is already used to determine federal gross capital. The federal net capital would be $65.00 since no income tax would be deferred. This difference is equal to the amount of deferred income tax liability attributable to the difference between book and federal reserve.
In response, Schedule G was created to reconcile book reserve to the reserve allowed under IRC §585. The department included an adjustment to Schedule G to reduce the amount of the reserve adjustment by the deferred income tax liability. It is clear that the department intended that the adjustment on Schedule G be limited to deferred tax directly attributed to differences between book reserve and the federal reserve allowance.
By contrast, a deferred asset for income tax would have the exact opposite effect as the deferred income tax liability. Accordingly, the state and localities receive a tax benefit from a deferred income tax asset. It is determined, therefore, that an adjustment for a deferred tax asset directly attributable to differences between book reserve and the federal reserve allowance is proper in order to reconcile these items. In reconciling these items, a deferred income tax asset will be subtracted from the book reserve. The bank should attach a schedule showing how the asset or liability was computed on its Form 64 to document the amount and character of the deferred income tax used to adjust the reserve on Schedule G.
If you have any additional questions regarding this ruling, please don't hesitate to call******* in the Office of Tax Policy at*********.
Sincerely,
Danny M. Payne
Tax Commissioner
Rulings of the Tax Commissioner