Response
April 30, 1992
April
30, 1992
XXXXX,
CPA
Re:
Whether a Utah corporation can make an equitable adjustment in excluding income
from forgiveness of debt under the tax benefit rule.
Dear
XXXXX:
This
letter is in response to your recent request for a Tax Commission ruling on
whether an equitable adjustment can be made by a Utah corporation to exclude
income from forgiveness of debt under the tax benefit rule. In the scenario
presented, the fact that Utah law allows a taxpayer to carry its losses forward
for no more than five years means that the losses expired before they can be
used to offset income from the forgiveness of debt. For federal purposes, the
fifteen year loss carryforward provisions enables the corporation to offset the
losses against the forgiveness of debt income.
The
Tax Commission policy is to refer such requests to the division most qualified
to analyze the request and make recommendations concerning it. As such, your
request was referred to the Tax Commission's Auditing Division for their
analysis and recommendation. The division's recommendation is as follows:
There
are several sections of the Utah Code that must be reviewed in considering this
matter:
DEFINITION
OF GROSS INCOME
U.C.A.
59-7-106(1) defines "Gross income" for Utah corporation franchise tax
purposes to include, "...gains, profits, and income derived from services
of whatever kind in whatever form paid, or from trades, businesses, commerce,
or sales, or dealings in property, whether real or personal, growing out of the
ownership or use of or interest in such property; also from interest, rent,
dividends, or securities, or the transaction of any business carried on for
gain or profit, or gains or profits and income derived from any source whatever."
The
above section does not tie into the federal code but stands on its own as to
the income that is to be included in the Utah corporation franchise tax return.
The gain on "forgiveness of debt" would be includable in Utah gross
income under the above definition.
EXCLUSIONS
FROM GROSS INCOME
U.C.A.
59-7-106(2) outlines a number of exclusions of certain types of gross income.
These exclusions are: 1) life insurance, 2) annuities or endowments, 3) gifts
bequests and devises, and 4) certain dividends in the case of a corporation
filing a combined report. This section of the Utah law does not tie into the
federal code but stands on its own as to the exclusions available under the
Utah law. None of the above exclusions would exempt gain on forgiveness of debt.
DEDUCTIONS
FROM GROSS INCOME
U.C.A.
59-7-108 provides for the allowance of certain deductions. These deductions
include: 1) ordinary and necessary expenses except certain unallowable expenses
delineated in U.C.A. 59-7-111, 2) interest on indebtedness, 3) certain taxes.
4) uninsured losses sustained within the taxable year, 5) bad debts in
accordance with IRC provisions, 6) depreciation, 7) depletion, 8) a reasonable
allowance for future expense liabilities relating to the disposition of real
property, 9) certain amounts in connection with withdrawable shares by building
and loan associations, 10) certain pension costs, 11) certain contributions
and, 12) certain losses incurred with limitations as to carryback/carryforward
provisions. The above deductions do not tie into the federal code provisions
except in those instances where the Utah statute specifically indicates that
the federal amounts will be used on the Utah return such as the deductions for
depreciation, depletion and bad debts. None of the above deductions include a
deduction for gain on the forgiveness of debt.
ACCOUNTING
PERIODS/METHODS OF ACCOUNTING
U.C.A.
59-7-118 provides that net income shall be computed on the basis of "the
same taxable period used for federal income tax purposes" and "Net
income shall be computed under the method of accounting on the basis of which
the corporation computes its income for federal income tax purposes." This
section basically provides that the "forgiveness of debt income"
should be included in the Utah corporation franchise tax return for the same
year in which it was included in the federal corporation income tax return.
There is nothing in this section which would allow the exclusion of
"forgiveness of debt" income.
AUDITING
DIVISION RECOMMENDATION
IRC
111 provides for a specific exclusion from gross income for "income
attributable to the recovery during the taxable year of any amount deducted in
any prior taxable year to the extent such amount did not reduce the amount of
tax imposed by this chapter." However, the Utah statute as reviewed above
neither contains a similar provision in its exclusions from gross income nor
references IRC 111. The Utah legislature could have adopted a fifteen year loss
carryforward provision as congress did for federal purposes which would have
resolved the taxpayer's concern in this case. However, the Utah legislature
chose to limit the Utah loss carryforward to five years. The federal "loss
benefit rule" under IRC 111 is not applicable for Utah corporation franchise
tax purposes as presently constituted and there is no provision in the Utah law
for an equitable adjustment to exclude income from forgiveness of debt.
Based
upon the facts presented in your letter, we are in agreement with the Auditing
Division's recommendations. Obviously, if there are deviations from these
facts, this opinion may be negated.
If
you do not agree with this determination, you may appeal to the Tax Commission
for a formal hearing. The results of that hearing would constitute a
declaratory judgement and be appealable to the Utah State Supreme Court. A
Notice of Appeal rights and a copy of the Utah Taxpayer Bill of Rights are
attached.
For
the Commission,
Joe
B. Pacheco
Commissioner
March
17, 1992
Joe
Pacheco
Utah
State Tax Commission
Heber
M. Wells Building
160
East 300 South
Salt
Lake City, Utah 84134
Dear
Joe,
In
reference to our telephone conversation on March 6, 1992, I am providing to you
the following information and request your advice on whether a Utah corporation
can make an equitable adjustment in excluding income from forgiveness of debt
under the tax benefit rule.
During
the early XXXXX's the corporation incurred consecutive net operating losses and
accumulated large liabilities from the operation of their business. (See schedule
of net operating losses enclosed). These liabilities were consolidated in 1986
when the corporation mortgaged all its land and equipment. In XXXXX the land
and equipment were foreclosed upon, resulting in income from forgiveness of
debt to the corporation. The corporation has since paid off the remaining debts
at less than face value, and has additional income from forgiveness of debts
for the XXXXX fiscal year ending September 30, 1991.
Business
operations have been limited since the foreclosure in XXXXX, with minimal
expenses in the current period. All debt forgiven is for expenses incurred in
prior years.
The
federal net operating loss carryforward prior to the inclusion of the
forgiveness of debt for XXXXX and XXXXX was $$$$$. The carryover to XXXXX will
be $$$$$. The corporation has negative equity of $$$$$as of September 30, 1991.
Due to the five year limitation on state carryforward of prior year losses,
$$$$$of prior year losses have been eliminated.
Under
Utah Code Sec. 59-7-106 the statute does not specifically require that
corporations determine state income by reference to federal income, but the
Utah return uses federal taxable income as a starting point in computing Utah
net income. In computing state taxable income, the forgiveness of debt should
be excluded from income because the expenses creating the debt have exceeded
the amount of Utah income subject to tax. The corporation will never be allowed
a tax benefit from the expenses incurred. In addition, due to the five year
limitation on state carryforward of net operating losses, the corporation will
never be allowed a tax benefit.
For
fiscal year ending September 30, 1990, the corporation reported income from
forgiveness of debt in the amount of $$$$$. They were allowed a state net
operating loss of $$$$$ resulting in state taxable income of $$$$$. The
corporation has additional income from forgiveness of debt of $$$$$for fiscal
year ending September 30, 1991.
As
the corporation was never allowed a state tax benefit from the expenses
associated with this debt, we believe the forgiveness of debt of $$$$$for XXXXX
should be excluded from state income under the tax benefit rule.
We
would appreciate being notified of the state tax commissions position on the
above matter prior to the June 15, 1992 extended due date. If you should have
any further questions, or need any additional information, please contact me.
Sincerely
yours,
XXXXX,
C.P.A.
Mr.
R. H. Hansen
Utah
State Tax Commission
Heber
M. Wells Office Building
160
East Third South, 5th Floor
Salt
Lake City, Utah 84134
Request
for Immunity
RE:
POSSIBLE STATE TAXATION OF FAILED THRIFTS
Dear
Commissioner:
XXXXX
represents XXXXX, XXXXX, XXXXX and XXXXX as Court-appointed
Receiver/Liquidator. We also represent XXXXX as advisor on taxation matters.
These five institutions are collectively referred to herein as the "Failed
Thrifts."
There
is a State tax matter for the Failed Thrifts which we need to present to the
Commission. A very brief history is summarized below for your convenience.
BACKGROUND
On
July 31, 1986, the Commissioner of Financial Institutions placed the XXXXX into
receivership due to insolvency, and at the same time took possession of the
Failed Thrifts. These XXXXX were the remaining institutions which could not
qualify for XXXXX deposit insurance coverage, and were therefore closed.
Attempts by the State over the subsequent year to revive these institutions
through merger acquisition, etc. were not successful, and in mid-1987 the Court
appointed XXXXX as Receiver/Liquidator of four of the Failed Thrifts, and
appointed XXXXX as Receiver/Liquidator of Commerce Financial. Our
responsibility is to liquidate the assets in an orderly manner to maximize
recovery and return to the depositors.
In
XXXXX, the depositors of the Failed Thrifts filed a complaint against the State
of Utah in connection with the failure of the XXXXX, the resultant closing of
the Failed Thrifts, and the losses they anticipated after all recoveries from
the liquidation of assets. Shortly, thereafter, the State of Utah entered into
negotiations with the depositors to reach a settlement.
Negotiations
were conducted through the Governors office, and the Governor appointed a
Legislative Task Force to study the issue. After the Task Force conducted a
number of hearings and after further negotiations, settlement legislation was
prepared and a special session was called by the Governor in the Fall of XXXXX.
Senate
Bill 2, sponsored by State Senator XXXXX, was passed during the special
session. In brief summary, the legislation provided for funds to be paid to the
depositor group as follows:
Contribution
by the State of Utah $$$$$
Contribution
by the State's liability
insurance carrier: $$$$$
Advance
payment by the State of Utah in
exchange for a 50% interest in future
liquidation proceeds: $$$$$
Total
Settlement Paid to Depositors $$$$$
In
exchange for this payment, the depositors withdrew the complaint against the
State of Utah. The liquidation of assets continues, and the depositors and the
State of Utah will share 50/50 in future liquidation proceeds. The future
liquidation distributions were carefully considered by the depositors when they
estimated their losses and accepted the settlement amount outlined above.
TAX
PROBLEM
The
Failed Thrifts have varying amounts of Net Operating Losses to offset any taxes
from current operations. However, the $$$$$settlement amount awarded to the
depositors reduces the depositor account balances at the Failed Thrifts,
reduces the Failed Thrifts' debt to the depositors, and falls into a
"forgiveness of debt" category for tax purposes. Although full
recovery by depositors through the settlement and the liquidation is not
likely, the forgiveness of debt problem raises sizeable tax ramifications since
forgiveness of debt is treated as "income from discharge of
indebtedness" for tax purposes.
With
regard to the federal income taxes, we have prepared the federal income tax
returns for the Failed Thrifts, and have claimed immunity from any federal
income tax under Section 7507 of the Internal Revenue Code (IRC). (See copy of
Section 7507 IRC attached.)
Section
7507 IRC essentially provides for an exemption for any federal tax, except
employment taxes, that would operate to diminish the assets of a failed
financial institution, such as the failed thrifts, and injuring the depositors as
a result thereof. The immunity/exemption under Section 7507 IRC will end when,
and to the extent that, taxes may be assessed and collected without diminishing
the assets available and necessary for payment of depositors. To claim immunity
from tax under Section 7507 IRC, the institution must file a statement, under
oath or affirmation, showing:
1)
the total of depositors claims outstanding
2)
the amount of the following, and the amount of the depositors' claims properly
chargeable against:
a.
segregated or transferred assets
b.
unsegregated assets
c.
estimated future average annual earnings and profits
d.
amount collectible from shareholders
e.
other resources available for payment of depositors' claims.
Although
the Failed Thrifts can claim immunity from federal income taxes under Section
7507 IRC, we have been unable to find any specific provision in the State code
for a similar abatement or immunity from State taxes. Because of the settlement
funds already received and to be received by the depositors the Failed Thrifts
are at risk of exhausting their NOL tax offsets in the future, and will need
special consideration from the State Tax Commission to avoid State tax
liability. This special consideration is important for the following reasons:
1.
Any taxes would reduce the amounts we would be able to distribute to depositors
from future liquidation proceeds. As stated above, these future liquidation
proceeds were carefully considered by the depositors when they accepted the
settlement.
2.
The legislative intent was to award the depositors an amount acceptable to both
parties to avoid litigation. Although this State tax issue was not anticipated
and was not addressed in the settlement legislation the legislative intent was
clearly to award substantial settlement funds to the depositors and then reduce
their liquidation recoveries by taxes which resulted from that same settlement.
3.
The federal provision under which we have sought abatement of taxes to avoid the
circular of payment of federal funds to offset depositor losses followed by
federal taxes as a result of those payments. The circumstances of the Failed
Thrifts make a similar provision at the State level a necessity.
SPECIAL
RELIEF REQUESTED
In
light of the above stated facts we respectfully request the State Tax
Commission render an administrative ruling providing the Failed Thrifts with
immunity from State taxes similar to the immunity granted under Section 7507 of
the Internal Revenue Code. In connection therewith, we would be happy to
provide you with any additional information and/or tax research that you feel
is necessary to carefully consider this request.
Since
the tax consequences of this issue will materialize in XXXXX and/or XXXXX, your
immediate consideration of this special relief requested would be appreciated.
Very
truly yours,
XXXXX,
CPA
Partner
EXEMPTION OF INSOLVENT BANKS FROM TAX
Sec.
7507 [1986 Code]. (a) ASSETS IN GENERAL.--Whenever and after any bank or trust company,
a substantial portion of the business of which consists of receiving deposits
and making loans and discounts, has ceased to do business by reason of
insolvency or bankruptcy, no tax shall be assessed or collected, or paid into
the Treasury of the United States, on account of such bank or trust company,
which shall diminish the assets thereof necessary for the full payment of all
its depositors; and such tax shall be abated from such national banks as are
found by the Comptroller of the Currency to be insolvent; and the Secretary,
when the facts shall appear to him, is authorized to remit so much of the said
tax against any such insolvent banks and trust companies organized under State
law as shall be found to affect the claims of their depositors.
(b)
SEGREGATED ASSETS; EARNINGS.--Whenever any bank or trust company, a substantial
portion of the business of which consists of receiving deposits and making
loans and discounts, has been released or discharged from its liability to its
depositors for any part of their claims against it and such depositors have
accepted, in lieu thereof, a lien upon subsequent earnings of such bank or
trust company, or claims against assets segregated by such bank or trust
company or against assets transferred from it to an individual or corporate
trustee or agent, no tax shall be assessed or collected, or paid into the
Treasury of the United States, on account of such bank or trust company, such
individual or corporate trustee, or such agent, which shall diminish the assets
thereof which are available for the payment of such depositor claims and which
are necessary for the full payment thereof. The term "agent", as used
in this subsection, shall be deemed to include a corporation acting as a
liquidating agent.
(C)
REFUND; REASSESSMENT; STATUTES OF LIMITATION.--
(1)
Any such tax collected shall be deemed to be erroneously collected, and shall
be refunded subject to all provisions and limitations of law, so far as
applicable, relating to the refunding of taxes.
(2)
Any tax, the assessment, collection, or payment of which is barred under
subsection (a), or any such tax which has been abated or remitted shall be
assessed or reassessed whenever it shall appear that payment of the tax will
not diminish the assets as aforesaid.
(3)
Any tax, the assessment, collection, or payment of which is barred under
subsection (b), or any such tax which has been refunded, shall be assessed or
reassessed after full payment of such claims of depositors to the extent of the
remaining assets segregated or transferred as described in subsection (b).
(4)
The running of the statute of limitations on the making of assessment and
collection shall be suspended during, and for 90 days beyond, the period for
which, pursuant to this section, assessment or collection may not be made, and
a tax may be reassessed as provided in paragraphs (2) and (3) of this
subsection and collected, during the time within which, had there been no
abatement, collection might have been made.
(d)
EXCEPTION OF EMPLOYMENT TAXES.--This section shall not apply to any tax imposed
by chapter 21 or chapter 23.