96-2051,96-2052,96-2053

INCOME

SIGNED NOVEMBER 14, 1997

BEFORE THE UTAH STATE TAX COMMISSION

____________________________________

PETITIONER, )

, ) ORDER

Petitioners, ) Appeal Nos. 96-2051

: 96-2052

v. ) 96-2053

AUDITING DIVISION OF THE )

UTAH STATE TAX COMMISSION, :

STATE OF UTAH, )

Respondent. ) Tax Type: Income Tax

_____________________________________

STATEMENT OF CASE

This matter came before the Utah State Tax Commission for a Status Conference, G. Blaine Davis, Administrative Law Judge, presiding. Present and representing Petitioners was Mr. Gail Anger, CPA. Present and representing Respondent were Mr. Frank Hales and Mr. Dan Engh, of the Auditing Division.

At the Status Conference, the parties agreed to consolidate all of the above-entitled cases, to file briefs and reply briefs thereto, and to then submit the matter to the Commission for its decision based upon the briefs. There were no substantial issues of fact. The parties agreed to waive the Initial Hearing, and to have the Order from the Commission be deemed to be the Order from the Formal Hearing.

These matters involve the income tax for 1993 for each of the Petitioners.

In 1993, COMPANY C was an electing small business corporation, so its income and credits were passed through to the shareholders who included such items on their individual returns. In 1993, COMPANY C elected to claim a research and development credit under Section 41 of the Internal Revenue Code. Those portions of the Internal Revenue Code provide that when a research and development credit is claimed, the amount of research and development expense on which the credit is claimed cannot also be used as a deduction as an expense by the corporation. Accordingly, on the federal income tax return of the corporation, the corporation claimed a research and development credit in accordance with Section 41, but it did not deduct the development expenses on which the credit was claimed. The research and development credit was passed through to the individual shareholders, the Petitioners herein, who deducted the credit on their federal individual income tax returns from the amount of tax due. However, the income passed through to the individual shareholders was higher than it would have been if the research and development expenses had been deducted as an expense instead of claiming the credit on those expenses. The decision of whether to claim a credit or to deduct the expenses on the federal return is a choice given to the shareholders, so Petitioners herein are the persons who made the decision whether to claim the credit or to deduct the expenses.

For the Utah individual income tax returns of the Petitioners, the proportionate share of income from COMPANY C was placed on the returns, but an additional adjustment was made to deduct the research and development expenses which had not been deducted in arriving at the net income shown on the federal return of Ultradent. The statutes of the State of Utah do not provide for a state research and development credit.

Respondent disallowed the adjustment made on the individual returns of Petitioners, and Petitioners timely filed a Petition for Redetermination.

The position of Petitioners is that they should be entitled to deduct the research and development expenses on their State of Utah individual income tax returns because they were legitimate business expenses and they were not deducted on the federal return in arriving at the net income which was brought forward to the individual returns, nor was their any research and development credit allowed on the State of Utah return.

The position of Respondent is that state law requires individuals to place on their state return the amount of income from their federal return, and there is no adjustment provided by state statute to allow for research and development expenses to be deducted when individuals did not deduct those expenses on their federal return.

The specific position of Petitioners is set forth in their brief as follows:

AState taxable income is defined by reference to

federal taxable income, Section 59-10-112 of the

Utah Code. Section 59-10-111 of the Utah Code

states >federal taxable income means taxable in-

come as currently defined in Section 63 of the

Internal Revenue Code of 1986.= Under Section 63

of the Internal Revenue Code, adjusted gross in-

come is determined by reference to Section 62 of

the Internal Revenue Code. Section 62 of the Code

allows as a trade or business expense, research

and development expense under Section 174 of the

Code unless a credit under Section 41 of the

Code is elected. Since '59-10-110 of the Utah

Code allows no federal credit, the research and

development expenses under Section 174 would be

allowed as a deduction for adjusted gross income

under section 62 of the code and taxable income

under Section 63 of the code. This adjustment

complies with the intent of the statute and the

requirements of the Utah Code.@

The Respondent rejects the arguments of Petitioner, and the substance of the argument of Respondent is that federal taxable income is required to be used as the state taxable income, except for certain additions and subtractions which are provided by Utah Code Ann. '59-10-114, and that said section does not allow a subtraction for federal research and development credits. In fact, they refer to Utah Code Ann. '59-10-110, as amended, which provides:

ANo credit applied directly to the income tax

calculated for federal income tax purposes

pursuant to the Internal Revenue Code shall be

applied in calculating the tax due under this

chapter.@

The Commission finds that the income which is taxable by the State of Utah is that which is included on the federal return as filed by Petitioners, and there is no statutory provision which permits the deduction of research and development expenses which were not deducted on the federal return. Petitioners had an election whether to deduct those expenses or to claim the credit. In claiming the credit, they forfeited any right to claim the deductions. The inability to deduct those expenses on the State of Utah return is one of the factors which must be considered by taxpayers in determining whether or not to elect to take the research and development credit, or to deduct the research and development expenses.

Petitioners have also argued they are entitled to an equitable adjustment pursuant to Utah Code Ann. '59-10-115, which provides an equitable adjustment for situations where the taxpayer would otherwise receive or have received a double tax benefit or suffer or have suffered a double tax detriment. A reading of the statute makes it clear that it is not intended for this type of situation. Petitioners have not suffered a double tax detriment, as the income has been taxed by only one state on one occasion. Section 59-10-115 does not mention any federal credits being an equitable adjustment, which makes it consistent with '59-10-110, supra.

Petitioners are likewise not entitled to an equitable adjustment under the provisions of Administrative Rule R865-9I-4, because the income has only been required to be included on the Utah return a single time.

One final argument of Petitioners is that Afor many years it has been the practice of the Utah State Tax Commission to allow corporations deductions for expenses reduced on federal returns to account for credits claimed on federal returns.@ The basis for that argument has been codified in Utah Code Ann. '59-7-106(4), which allows federal credit deductions for corporate income tax. However, Chapter 7 of Title 59 is applicable to corporation taxes, but is not applicable to individual income taxes. If the legislature wanted such a provision to be applicable to income taxes, it would have adopted a specific statute to do that.

One final issue is that of a penalty which was apparently imposed upon the audit assessment at the time the returns of Petitioners were corrected. Petitioners returns were apparently timely filed, and the penalty is presumably a negligence penalty. Based upon the facts presented to the Commission, there is no factual basis upon which a negligence penalty should be imposed on these Petitioners.

DECISION AND ORDER

Based upon the foregoing, the Commission determines that the Petitioners were not entitled to make an adjustment to their state taxable income for the research and development expenses, and the adjustment made by Respondent to those returns should be sustained. The Petition for Redetermination is hereby denied, except to the extent it requested the penalty be removed, and any penalty imposed on the returns of Petitioners for negligence is hereby waived and removed.

DATED this 14 day of NOVEMBER, 1997.

BY ORDER OF THE UTAH STATE TAX COMMISSION.

_______________________________

G. BLAINE DAVIS

Administrative Law Judge

The agency has reviewed this case and the undersigned concur in this decision.

DATED this 14 day of NOVEMBER, 1997.

BY ORDER OF THE UTAH STATE TAX COMMISSION.

W. Val Oveson Richard B. McKeown

Chairman Commissioner

Joe B. Pacheco Pam Hendrickson

Commissioner Commissioner