Central Inv. Corp. v. Commissioner

Central Investment Corporation (a Corporation), Petitioner, v. Commissioner of Internal Revenue, Respondent Central Inv. Corp. v. Commissioner Docket No. 7959 United States Tax Court 9 T.C. 128; 1947 U.S. Tax Ct. LEXIS 141; July 30, 1947, Promulgated *141 Decision will be entered for the respondent. California franchise tax imposed for the privilege of doing business during 1944, which tax is measured by income realized in 1943, held to accrue and be deductible for Federal tax purposes in 1944. Joseph D. Brady, Esq., and Thomas R. Dempsey, Esq., for the petitioner. H. A. Melville, Esq., for the respondent. Hill, Judge. HILL *128 Respondent determined a deficiency in petitioner's excess profits tax liability for the calendar year 1943 in the amount of $ 34,971.23. The deficiency results from the disallowance of a deduction in the amount of $ 43,174.36 on account of California franchise tax. The question is whether the California franchise tax is deductible in 1943, as petitioner *129 contends, or in 1944, as respondent contends. Petitioner's excess profits tax return for the calendar year 1943 was filed with the collector of internal revenue for the sixth district of California, on the accrual basis, which basis clearly reflects its income. The case was submitted on oral testimony and exhibits. FINDINGS OF FACT. Petitioner is a California corporation, organized October 6, 1921, with its principal offices located in Los Angeles, where it owns the Biltmore Hotel. At no time material hereto did petitioner have*143 any pending negotiations for the possible sale of its Biltmore Hotel property or contemplate dissolution or liquidation. In 1929 the California Legislature enacted the Bank and Corporation Franchise Tax Act, chapter 13, Laws of 1929, hereinafter referred to as the act. Petitioner is and has been subject to the act as a corporation as defined in such act. The act, as amended in 1943 in section 4 (3), provides that corporations doing business in California and not otherwise exempt "shall annually pay to the State, for the privilege of exercising its corporate franchises * * *, a tax according to or measured by its net income, to be computed, in the manner hereinafter provided at the rate of 4 per centum upon the basis of its net income for the next preceding fiscal or calendar year. In any event, each such corporation shall pay annually to the State, for the said privilege, a minimum tax of twenty-five dollars ($ 25)." Section 11 provides in part that: Sec. 11. Definitions. (a) The term "income year", as herein used, means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is computed herein. "Income year" includes, in*144 the case of a return made for a fractional part of the year, the period for which such return is made. (b) The term "taxable year", as herein used, means the calendar year, or the fiscal year ending during such calendar year, for which the tax is payable. A "taxable year" may constitute a perod of 12 months or of less duration. Section 4 (7) provides that: (7) Accrual date. Taxes under this section and under Sections 1 and 2 of this act shall accrue on the last day of the "income year" as defined in Section 11 hereof. Section 29 (a) provides in part that: The taxes imposed by this act and disclosed on the return shall constitute a lien upon the real property of the taxpayer, which lien shall have the same force, effect and priority as a judgment lien and shall attach on the last day of the "income year" * * *. Prior to the 1943 admendment of the act, it provided that the tax accrued and the lien therefor attached on the first day of the taxable year. *130 Section 13 of the act requires every corporation subject to the tax to file a return within two months and fifteen days after the close of its income year. Section 23 provides in part: Corporations. In the case of corporations*145 of the classes referred to in subdivision (3) of section 4 of this act, one-half the amount of tax disclosed by the return shall be due and payable as a first installment of the tax on such corporations on or before the fifteenth day of the third month following the close of the income year, as defined in section 11 hereof. The balance of the tax shall be due and payable as a second installment on or before the fifteenth day of the ninth month following the close of the income year. A tax imposed by this act or any installment thereof may be paid at the election of the taxpayer, prior to the date prescribed for its payment. Various subparagraphs of section 13 of the act deal with the computation of the franchise tax in situations wherein corporations are commencing business in their first taxable year or are withdrawn or dissolved within the taxable year. In the case of commencing corporations it is provided in general that the tax for the first taxable year shall be based on the income of such year and paid during the second year. With respect to corporations withdrawing or dissolving during the taxable year it is provided in general that the tax for such taxable year be reduced*146 on account of the portion of such year during which the taxpayer does not do business in California. For the privilege of doing business within the state during the calendar year 1943 the petitioner duly filed on April 26, 1943, with the Franchise Tax Commissioner of the State of California the franchise tax return required by section 13 of the Franchise Tax Act. This franchise tax return disclosed petitioner's gross and net incomes for the calendar year 1942 and a franchise tax liability of $ 19,736.60, which was paid by two checks -- one dated April 16, 1943, for $ 9,868.30 and the other dated September 7, 1943, for $ 9,868.30. For the privilege of doing business within the state during the calendar year 1944 the petitioner on May 5, 1944, duly filed with the Franchise Tax Commissioner of the State of California the franchise tax return required by section 13 of the aforesaid Franchise Tax Act, as amended. This franchise tax return disclosed petitioner's gross and net incomes for the calendar year 1943 in the amounts of $ 1,957,323.27 and $ 1,206,923.17, respectively, and disclosed a franchise tax liability of $ 43,174.36. The tax was imposed by section 4 (3) of the Franchise*147 Tax Act and was determined, as provided in that section, "according to or measured by" the net income of petitioner for the calendar year 1943, to wit, $ 1,206,923.17, and was correctly computed at the effective statutory percentage rate applicable to the net income. The tax of $ 43,174.36 was set up on petitioner's books of account as a liability as of December 31, 1943, before the closing of such books for the calendar year 1943, and was duly paid by petitioner to the Franchise Tax *131 Commissioner as follows: $ 22,000 by check dated March 13, 1944, and $ 21,176.36 by three checks all dated September 1, 1944. The petitioner has never at any time disputed its liability for the whole or any part of such tax, has never filed any claim for refund or credit for the whole or any part thereof, and has never had, and does not now have, any intention of filing any such claim. In filing its Federal income and excess profits tax returns for the calendar year 1943, the petitioner claimed deductions not only for the California franchise tax imposed for the privilege of doing business in the state during 1943, in the amount of $ 19,736.60, but also for the California franchise tax imposed*148 for the privilege of doing business in the state during 1944, in the amount of $ 43,174.36. Respondent, in his statement accompanying the deficiency notice with respect to 1943, stated: California State franchise tax paid during the year 1944, amounting to $ 43,174.36, treated as a deduction on your return for the calendar year 1943 is disallowed, since it is held that such taxes are properly allowable and deductible during the calendar year 1944 under section 23 (c) of the Internal Revenue Code. OPINION. The problem for our determination is whether the California franchise tax imposed for the privilege of doing business during 1944 is deductible for Federal tax purposes in 1944, as respondent contends, or is deductible in 1943, the year giving rise to the income which furnishes the measure for the tax, as petitioner contends. California imposes a tax on corporations for the privilege of doing business in the state during a given year, which year of privilege is designated the "taxable year." The tax so imposed is, with certain exceptions not here material, a percentage of the income of the preceding year, which preceding year is designated the "income year." Prior to 1943 the tax, *149 by the terms of the act, accrued and a lien therefor attached on the first day of the "taxable year." By amendment in 1943 it was provided that the tax accrued and a lien therefor attached on the last day of the "income year." It is this amendment which gives rise to the present problem. Petitioner, being on an accrual and calendar year basis, contends that the franchise tax imposed for the privilege of doing business in 1944, the "taxable year," by its own terms accrued December 31, 1943, and a valid lien under local law attached at that time. Petitioner argues from this that such tax was properly accrued and deducted by it in 1943 for Federal tax purposes. Petitioner's argument relies heavily on the fact that a valid lien under local law attaches on the last day of the "income year." Petitioner then cites the following cases which petitioner interprets as *132 standing for the proposition that the proper date to accrue liability for taxes, for purposes of deduction under section 23 (c), Internal Revenue Code, is the date when the lien to secure the payment of such taxes attaches, even though the taxes have not yet been assessed and are not yet due and payable. Magruder v. Supplee, 316 U.S. 394;*150 California Sanitary Co. Ltd., 32 B. T. A. 122; and Crown-Zellerbach Corporation, 43 B. T. A. 541. These cases are not considered applicable to the instant situation. They involved generally the question of who was liable for local property taxes as between transferor and transferee. In Magruder v. Supplee, supra, for instance, the taxpayer-vendee purchased real property on May 10, 1936. In January 1936 the local taxes became due and payable on the property for the taxable year 1936 and a lien attached therefor at that time. The vendor was the one against whom the taxes were assessed and he became personally liable therefor prior to the sale. It was held that the vendee-taxpayer could not deduct in 1936 any local taxes paid by him on account of the property, since he was not liable therefor. In California Sanitary Co. Ltd., supra, was involved the California property tax, which provided that property must be assessed for local tax purposes "to the persons by whom it was owned or claimed, or in whose possession or control it was, at twelve o'clock meridian*151 of the first Monday in March * * *." A lien attached for the taxes at that time. We held that the taxpayer who acquired property subsequent to the lien date was not entitled to deduct taxes paid by him for that year on the property because the transferor, owning the property on the crucial date, had become liable therefor. Crown-Zellerbach, supra, is essentially similar in principle to the California Sanitary case. None of those cases, in our opinion, is controlling of the question at hand, because they involve property taxes, the personal liability for which arises by virtue of ownership at a specified time. A transfer of the property subsequent to the existence of a personal liability for the taxes thereon has no effect on such liability. In those cases the personal liability for the taxes as of the specified day of ownership and the lien attaching therefor arose simultaneously, and no subsequent events could control or alter the liability therefor, despite the fact such taxes may be considered as covering a taxable period subsequent to the existence of the liability. In this connection the Supreme Court, in Magruder v. Supplee, supra,*152 said that real estate taxes "are not like rent, nor are they paid for the privilege of occupying property for any given period of time." The nature and character of the franchise tax here in question is essentially different from the property taxes involved in the above discussed cases. The franchise tax is imposed for the privilege of doing business during the "taxable year." It is true that such tax is measured by the preceding year's income, but it is not an income tax on such *133 income, but rather an excise tax for the privilege of doing business in the "taxable year" subsequent to the "income year." That the tax is essentially a tax on the privilege of doing business in the "taxable year" is clear from the terms of the act and further from the fact that withdrawal or dissolution relieves the taxpayer from taxation for the period of the "taxable year" during which the franchise privilege is not exercised. Therefore, on the last day of the "income year" we are unable to see how any liability can arise for a tax imposed on the privilege of doing business for a year not yet commenced. It is true that on the last day of the "income year" the facts are available which may*153 constitute one of the basic elements of the prospective tax computation and it may also be that then it may seem almost inevitable that some liability will arise by virtue of the next day being the first day of the "taxable year." But however inevitable its prospective existence may seem on the last day of the "income year," the tax being for the privilege of doing business in the taxable year, the liability therefor arises only with and from the exercise of such privilege. If no business operations were carried on in the taxable year the tax would not be imposed. In the instant case the franchise tax for the privilege of doing business in 1943 was properly taken and allowed as a deduction in petitioner's tax return for 1943, the year before us. The tax here in question was imposed on the privilege of doing business in 1944 and not in 1943. We think it not open to argument that the obligation to pay this tax was an expense of petitioner's business operations in 1944. It was, therefore, an expense which must necessarily be taken into account in the tax year 1944 in order properly to reflect petitioner's net income in that year. A business expense incurred which is attributable*154 to the business operations of a particular tax year or period is, for the purpose of the Federal income tax, accruable in such year. United States v. Anderson, 269 U.S. 422; Petaluma & Santa Rosa R. R. Co., 11 B. T. A. 541; H. H. Brown Co., 8 B. T. A. 112; Durst Productions Corporation, 8 T. C. 1326. In the Anderson case, referring to the right to keep books and make income tax returns on the accrual basis, the Supreme Court said: * * * It was to enable taxpayers to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during that period; and indeed, to require the tax return to be made on that basis, if the taxpayer failed or was unable to make the return on a strict receipts and disbursements basis. (2) The appellee's true income for the year 1916 could not have been determined without deducting from its gross income for the year the total cost and expenses attributable to *155 the production of that income during the year. The Petaluma & Santa Rosa R. R. Co. case involved accrual date of the California franchise tax on public utilities measured by a certain *134 percentage of the gross receipts on account of business done during the last preceding tax year. Sections of the California Code applicable were 3664a, 3665a, 3668, 3668b, and 3668c, as they existed in the years there involved. Petitioner contended that the franchise taxes which were assessed and became due and payable in 1921 were deductible in 1920, on the theory that they were based on the earnings of the prior year. The tax year there involved was 1921. We held that "a consideration of the statute leads us to the conclusion that there was no liability for the 1921 tax created by any events which occurred in 1920. If the corporation did not own the franchise and other property in 1921 there was no liability for the tax for that year, although the measure existed by which it could have been determined, if there was any liability. The 1921 tax was an expense of the business for that year and not for the prior year and it can not be deducted in the prior year as an accrued liability." *156 The California statute provided that the franchise tax there in question became a lien on the property involved on the first Monday of March of the tax year. In the H. H. Brown Co. case we said: The basic idea under the accrual system of accounting is that the books shall immediately reflect obligations and expenses definitely incurred and income definitely earned without regard to whether payment has been made or whether payment is due. Expenses incurred in the operations for a particular year are properly accrued in the accounts for that year, although payment may not be due until the following year. Article 9A of New York Consolidated Laws, involved in the case of Durst Productions Corporation, imposes a corporation franchise tax each year for the privilege of doing business in that state. The tax is measured by a stated percentage of the "entire net income" of the year for which the tax is imposed, but it is payable and a lien therefor attaches in a subsequent taxable year. In the Durst case we said: "The tax being calculated on the amount of earnings for the year in issue, its charge against those earnings seems to accord with the theory of accrual." Nor do we *157 think that the wording of the act to the effect that the tax accrues and the lien therefor attaches on the last day of the "income year" alters the situation. This provision of the act, in our opinion, has significance only in terms of priority of liens and does not affect the question of accrual for Federal tax purposes. Since the provision of the act specifying the last day of the "income year" as the time of accrual and as the lien date is for a special and limited purpose only, i. e., priority of liens, and has reality in this connection only as it relates back from a delinquency occurring in the "taxable year," we do not think such provision can be considered determinative of the question before us. Respondent has ruled that the California franchise tax before us is deductible for Federal tax purposes in the "taxable year." I. T. 3446, *135 C. B. 1944, p. 104. This ruling to us seems proper and is consistent with the treatment accorded other state franchise taxes. 1 For the reasons above indicated, we hold that the California franchise tax for 1944 accrued for Federal tax purposes in 1944 and was deductible in that year rather than 1943. *158 Decision will be entered for the respondent. Footnotes 1. Illinois, I. T. 3186, C. B. 1938-1, p. 140; Kentucky, I. T. 3232, C. B. 1938-2, p. 70; Maryland, I. T. 3192, C. B. 1938-1, p. 144; Massachusetts, G. C. M. 22525, C. B. 1941-1, p. 350; Michigan, I. T. 3047, C. B. 1937-1, p. 66; Oklahoma, I. T. 3136, C. B. 1937-2, p. 100; Pennsylvania, I. T. 3189, C. B. 1938-1, p. 141; Tennessee, I. T. 3150 and 3151, C. B. 1938-1, pp. 125, 126. The Connecticut tax has been ruled to accrue on the last day of the "income year," I. T. 2935, C. B. XIV-2, p. 91, but it is difficult to determine from reading the state statute (ch. 66 b, Cumulative Supplement to Connecticut General Statutes, January Sessions, 1931, 1933, 1935) whether the tax is imposed for the privilege of doing business during the "income year" or the "taxable year." See in this connection "Deductions for Accrued Taxes," 14 Taxes 197↩.