Could Virginia assess the bank's 2013 franchise tax late, include minority interests in 2014 capital, and deny subsidiary-surplus deductions and credit carryovers?

Plain-English summary

The bank won on the limitations, minority-interest, subsidiary-surplus, and credit-carryover issues, although its subsidiary deduction remained limited to amounts actually included in gross capital.

The bank amended its 2012-2014 Virginia bank franchise tax returns to claim larger deductions for subsidiaries and refunds. The Department allowed smaller deductions, increased the bank's 2014 taxable capital, denied the refunds, and assessed 2013 and 2014 tax.

The 2013 assessment was too late

Virginia Code § 58.1-104 generally allowed the Department three years from the due date of a timely return to assess tax. The determination concluded that the Department's February 2017 assessment for 2013 came after the limitations deadline and could not stand.

Minority interests were not part of statutory gross capital

The Department had adjusted 2014 total equity capital to equal the bank's consolidated Call Report. But Virginia's bank-tax statute and regulation started with specified accounts: preferred and common stock, surplus, undivided profits and related reserves, and half of the loan-loss reserve net of deferred tax.

Accounting rules had moved noncontrolling or minority interests in consolidated subsidiaries from liabilities into a separate equity line on the Call Report. That accounting presentation did not add the minority-interest line to Virginia's statutory gross-capital categories. The Commissioner therefore reversed the adjustment that included it.

Subsidiary retained earnings and surplus were deductible only if included in gross capital

Virginia Code § 58.1-1206(A)(4) allowed a deduction for retained earnings and surplus of subsidiaries to the extent included in the bank's gross capital. The Commissioner rejected the audit's narrower view that only undistributed earnings qualified: the statute separately named surplus, including identifiable subsidiary surplus accounts.

The bank still could not deduct amounts eliminated before they reached the consolidated Call Report. Its reconciliation showed that a significant part of the claimed retained earnings and surplus had been eliminated in consolidation, so the allowable amount had to be tied to what was actually included in gross capital.

Credit carryovers had to follow the corrected liability

The bank had historic rehabilitation credits from pass-through entities. When its amended deductions reduced bank-tax liability to zero, it did not claim credits on the amended returns. Once the Department disallowed part of the deductions and restored liability, it also had to adjust the credit carryovers. The audit had failed to reflect the full eligible amounts.

The Department also accepted documentation correcting minor transposition errors. It ordered the resulting state overpayments refunded with interest and notified affected localities to refund the local portion.

What this means for you

Banks preparing Virginia franchise-tax returns

Do not automatically equate every equity line on a consolidated Call Report with Virginia taxable gross capital. Reconcile the return to the specific statutory and regulatory accounts.

Banks claiming subsidiary deductions

Both retained earnings and surplus can qualify, but trace the amount through consolidation. A subsidiary balance eliminated before inclusion in gross capital cannot support the deduction.

Taxpayers amending deductions and credits together

Recompute credit usage and carryovers whenever an amended deduction changes liability. An audit that reverses the deduction must also consistently restore credits available against the resulting tax.

Common questions

Q: Was the 2013 assessment valid?
A: No. The Commissioner held it was issued after the three-year assessment period.

Q: Did all Call Report equity count as Virginia bank capital?
A: No. Noncontrolling minority interests were reported in equity under accounting rules but were not one of Virginia's specified gross-capital accounts.

Q: Could the bank deduct subsidiary surplus as well as retained earnings?
A: Yes, to the extent each amount was included in the bank's gross capital.

Q: Were amounts eliminated in consolidation deductible?
A: No. The statute limited the deduction to retained earnings and surplus actually included in gross capital.

Q: What happened to the historic rehabilitation credits?
A: The Department had to correct the carryovers to reflect the amounts eligible for 2012-2014 after the liability adjustments.

Citations and references

• Va. Code § 58.1-104 — assessment limitations period
• Va. Code §§ 58.1-1205 and 58.1-1206(A)(4) — bank capital and subsidiary deduction
• Va. Code § 58.1-1207 — bank franchise tax return due date
• Va. Code § 58.1-339.2 — historic rehabilitation tax credit and carryover
• 23 VAC 10-330-20 — gross-capital accounts
• 23 VAC 10-330-30(E) — subsidiary retained earnings and surplus
• FASB Statement No. 160 and ARB No. 51 — consolidated reporting discussed by the determination
• Segaloff v. Segaloff, 59 Va. Cir. 55 (2002) — retained and undistributed earnings terminology

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-113

Original ruling text

October 1, 2019

Re: § 58.1-1824 Application: Bank Franchise Tax

Dear *:

This is in response to your letter in which you seek correction of the bank franchise tax (BFT) assessments issued to * (the “Bank”) for the 2013 and 2014 tax years and protective claim for refund for the 2012 through 2014 tax years. I apologize for the delay in responding to your appeal.

FACTS

For the tax years at issue, the Bank had investments in numerous subsidiaries that were reported in the Bank’s official report of condition (the “Call Report”). The Bank timely filed amended BFT returns for the taxable years at issue, reporting a significant increase in its deduction for retained earnings and surplus of subsidiaries and requested refunds.

Under review, the Department requested additional documentation concerning the deductions for the surplus of subsidiaries. Based on the additional documentation, the Department granted deductions that were less than originally claimed. The Department also increased taxable capital on the 2014 return. The refunds were denied and assessments were issued for the 2013 and 2014 tax years.

The Bank filed a protective claim for refund, contending it had correctly reported its capital on the 2014 return and the deductions on its amended returns. The Bank also asserts the Department assessed the 2013 tax year beyond the statute of limitations. Further, if relief is not granted on the issue of the deduction, the Bank claims the Department failed to allow a historic rehabilitation tax credit to which it was entitled.

DETERMINATION

Statute of Limitations

Pursuant to Virginia Code § 58.1-104, the Department generally has authority to issue an assessment within three years of the due date of a timely filed return. Under Virginia Code § 58.1-1207, the 2013 BFT return was due March 1, 2013. Thus, the Department had until March 1, 2016, to issue an assessment. The 2013 assessment was issued in February 2017, beyond the statute of limitations.

Total Equity Capital

The BFT is imposed on the net capital of a bank. Virginia Code § 58.1-1205 provides the computation for determining a bank’s net capital. There is no provision under Virginia statute that requires or permits banks to combine capital among affiliated banks for purposes of determining its BFT liability. Instead, each bank must make a separate determination of its capital.

For the 2014 tax year, the Department adjusted the Bank’s “total equity capital” to equal the amount reported on the Call Report. While Title 23 of the Virginia Administrative Code (VAC) 10-330-20 B 7 starts the BFT computation with total equity capital as reported on the Call Report, the Department has recognized that changes in United States Generally Accepted Accounting Principles (GAAP) and federal banking regulations have included items reported in a bank’s equity beyond those items identified in Virginia’s statute. See Public Document (P.D.) 05-165 (12/5/2005).

Under Virginia Code § 58.1-1205, the computation of net capital begins “by adding together its capital, surplus, undivided profits and one half of any reserve for loan losses net of applicable deferred tax . . . .” Title 23 VAC 10-330-20 defines “gross capital” to mean “the total of capital stock, surplus, and undivided profits and one half of any reserve for loan losses net of applicable deferred tax . . . .” Under the regulation, the gross capital of a bank is computed by adding the following accounts as reported on the Call Report: (1) preferred stock, (2) common stock, (3) surplus, (4) undivided profits and reserve for contingencies and other capital reserves, and (5) 50% of reserve for loan losses reduced by deferred tax. Under Virginia’s regulation, any amounts not included in these five categories are not included in a bank’s computation of total equity capital.

For the 2012 through 2014 tax years, the Bank included “noncontrolling (minority) interests in consolidated subsidiaries” in computing its total equity capital reported on its Call Reports. The Bank argues this line was created as a result of the reclassification of liabilities related to minority interests in relegated entities from the liability section of the balance sheet. According to the Bank, it was required to report a lower-tiered subsidiary as a noncontrolling interest because it was held outside the consolidated group included in the Call Report.

Financial Accounting Standards Board (FASB) Statement No. 160 made a number of amendments to Accounting Research Bulletin (ARB) 51 with regard to consolidating financial statements of related entities. Included in the amendments was a change in the way noncontrolling interests in other entities were reported in the financial statements. Instead of reporting the noncontrolling or minority interests in the liability section of the balance sheet, FASB Statement No. 160 began requiring entities to report noncontrolling interests in the consolidated statement of financial position with equity but separate from the parent’s equity. Under the provisions of FASB Statement No. 160, the total equity capital reported on the Call Report included a separate item in its equity section for “noncontrolling (minority) interests in consolidated subsidiaries.” The description of the equity accounts included in determining a bank’s capital subject to BFT does not include noncontrolling or minority holdings in a subsidiary.

Deduction for Surplus

Under GAAP, banks are required to include majority-owned subsidiaries in a consolidated Call Report. Accordingly, a Call Report filed by a bank may include the bank and its subsidiaries. Before consolidation, a parent bank will include the investment in its subsidiary as an asset. The subsidiary reports a corresponding equity owned by the parent bank in the equity section of its balance sheet. When the entities are consolidated, an elimination adjustment is made to offset the intercompany transaction. In the elimination, the parent bank’s asset will be offset by the subsidiary’s equity owned by the bank.

Virginia Code § 58.1-1206 A 4 permits a deduction equal to the “amount of retained earnings and surplus of subsidiaries to the extent included in the gross capital of the bank.” Title 23 VAC 10-330-30 E explains that the intent of the deduction is to remove the amount of increase in the bank’s recorded investment in its subsidiaries resulting from undistributed earnings of such subsidiaries from the gross capital of a bank. This reduces the possibility that the bank would be taxed on the activities of its subsidiaries. Under the regulation, the deduction is limited to the amount included in gross capital that represents the undistributed earnings of its subsidiaries during the period of the bank’s investment in such subsidiaries.

For reporting purposes, the regulatory requirements applicable to the Call Report conform to GAAP. Under ARB No. 51, retained earnings of a purchased subsidiary at the date of acquisition are not included in consolidated financial statements. Consequently, the only undistributed earnings of a subsidiary that should be included in a bank’s consolidated financial statement would be the subsidiary’s retained earnings during the period of the bank’s investment.

Such increases are generally reflected in a subsidiary’s undivided profits or retained earnings. In some instances, however, the increase may be reflected in the subsidiary’s surplus. As such, the deduction is permitted for the subsidiary’s retained earnings and surplus.

Pursuant to Title 23 VAC 10-330-20 B, “surplus” is defined as the amount shown on the Call Report including “reserves for contingencies and other capital account reserves.” For purposes of the Call Report, the surplus account includes capital contributions, adjustments arising from treasury stock transactions, and any amount received for common stock in excess of its par value.

Unlike retained earnings, a subsidiary’s surplus at the date of acquisition is not eliminated in consolidated financial statements under GAAP. Consequently, the clear language of the statute permits a deduction for any amount of a subsidiary’s surplus included in the Call Report of a bank. Such surplus, including reserves, treasury stock, and amounts paid in excess of par, should be readily identifiable on the subsidiary’s year end financial statements. See P.D. 06-69 (8/18/2006).

The Department denied the deductions for surplus because Title 23 VAC 10-330-30 E restricts the deduction to undistributed earnings. In addition, the deduction reported on the 2014 return far exceeded the amount reported on the Call Report.

The term “undistributed earnings” is not defined for BFT purposes. Generally, the term “undistributed earnings” is used along with a number of terms to describe retained earnings, which are earnings or profits that are not paid as distributions to the entity’s owners. The Virginia Supreme Court has used the terms “undistributed earnings” and “retained earnings” interchangeably. See Segaloff v. Segaloff , 59 Va. Cir. 55, 2002 Va. Cir. LEXIS 131 (2002). Virginia Code § 58.1-1206, however, permits a deduction for surplus in addition to retained or undistributed earnings. See also P.D. 06-69 (8/18/2006).

As to the amount of the deduction claimed by the Bank, Virginia Code § 58.1-1206 A 4 limits the deduction to the extent retained earnings and surplus are included in the gross capital of the bank. In conjunction with its review, the Department requested the Bank to provide a reconciliation of its deduction to amounts reported on the Call Report. The reconciliation provided by the Bank indicated that a significant amount of the deduction for retained earnings and surplus claimed on its amended returns had been eliminated before being reported on the Call Reports. In accordance with the statute, the Bank would not be permitted to deduct retained earnings and surplus not included in gross capital.

Historic Rehabilitation Tax Credit

In 2009, the Bank received a Historic Rehabilitation Tax Credit (the “Credit”) from a pass-through entity. In subsequent years, the Bank became eligible to claim additional Credits received through various pass-through entities.

Under Virginia Code § 58.1-339.2, any individual, trust, estate, or corporation is entitled to the Credit equal to 25% of eligible expenses. Credits granted to partnerships are allocated to the partners either in proportion to their ownership interest or as agreed. The credit may be carried over for up to 10 tax years.

As permitted under the statute, the portion of the Credit that was not used on the 2010 BFT return was carried forward to 2011 and 2012. Credits earned in subsequent taxable years were likewise carried forward to 2012, 2013 and 2014 and claimed on the Bank’s original BFT returns. When the Bank filed amended returns, the state BFT tax liability was reduced to $0. As a result, the Bank had no BFT liability on which to apply the Credits that had been carried forward. Thus, the Bank did not report any Credit on the amended returns.

The Bank asserts the Department has not reflected available Credits against the assessments made for the 2013 and 2014 tax years. A review of the audit reports confirms the Department failed to adjust Credit carryovers to reflect the full amounts that were eligible to be claimed in its audit findings and resulting assessments.

When the Bank amended its deduction of retained earnings, it also amended its claims for the Credit in accordance with the resulting state BFT liability. Because the Credit carryovers were amended, the Department was obligated to adjust the Credit carryovers when it disallowed the deduction.

Mathematical Errors

During the course of considering the Bank’s appeal, a number of minor transposition errors were discovered on the amended returns. The Bank has provided documentation to verify the correct amounts.

CONCLUSION

In accordance with this determination, the adjustment to increase equity capital for the 2014 tax year by including noncontrolling (minority) interests in consolidated subsidiaries is reversed. In addition, the Department will allow a deduction for both retained earnings and surplus of the Bank’s subsidiaries to the extent included in gross capital. Finally, the Credit carryovers must be corrected to show the amounts that should have been claimed for the 2012 through 2014 tax years. The enclosed schedules display the adjustments (including mathematical errors) to be made as a result of this determination. The overpayments of state BFT, including applicable interest, will be refunded shortly. The Department will notify the affected localities and refunds of the local portion of the BFT will be issued by those localities.

The Code of Virginia sections, regulations, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1289.o

Related Documents

05-165

06-69