CF 1991-03 - Credit for Investment in Qualified Subsidiaries
- July 16, 1991
For taxable years ending after April 9, 1991, Substitute
Senate Bill 223 (effective April 10, 1991) amends and
clarifies various provisions of the franchise tax credit for
investment in qualified subsidiaries (ORC section 5733.067).
Set forth below is a short summary of the new law. Following
the summary is a more detailed discussion and analysis.
Summary
The new law:
- amends the definition of a "subsidiary" for purposes of
determining the credit.
- eliminates the credit on "advances" (loans) to
subsidiaries.
- clarifies that the credit is computed only on direct
investments in subsidiaries.
- reduces the net worth liability of a subsidiary (for
purposes of computing its parent corporation's credit) by the
amount of any credit to which the subsidiary is entitled by
virtue of being a parent of a lower-tiered subsidiary.
- expands the conditions under which an amended franchise
tax report must be filed when adjustments to either federal
returns or franchise reports of the parent or the subsidiary
affect the credit.
Discussion
and Analysis
-
Definition of subsidiary - The new law
provides that a subsidiary must be more than 50% "owned or
controlled either directly or indirectly by the taxpayer or
by related interests that own or control either directly or
indirectly more than 50% of the . . . taxpayer." The
previous statute required ownership of more than
50% of the subsidiary's stock. The new statute, on the
other hand, requires either ownership or
control of more than 50% of the subsidiary's stock.
In addition, the previous statute required more than 50%
ownership of the subsidiary by another franchise taxpayer
corporation; the new statute provides for more than 50%
ownership or control of the subsidiary by a franchise
taxpayer corporation or by
related
interests that own or control the taxpayer
corporation. See ORC division (A) of section 5733.067.
Example
#1
Facts: Mr. and Ms. X and their immediate
family directly own 80% of franchise taxpayer Y Inc. Mr.
and Ms. X and their immediate family also own 40% of
franchise taxpayer Z Inc. In addition, Y Inc. owns 20% of
Z Inc. (see illustration on next page).
Analysis: Z Inc. is a subsidiary because
more than 50% of Z's stock-is owned directly or
indirectly by the X family which owns more than 50% of
taxpayer Y Inc. The X family directly or indirectly owns
56% of Z's stock. The X family directly owns 40% of Z
Inc. stock and indirectly owns another 16% (.80 X .20
=.16).
|
X's ownership of Z:
|
|
Direct
|
40%
|
|
Indirect (80% x 20%)
|
16%
|
|
TOTAL
|
56%
====
|
X's direct and indirect ownership of Z exceeds 50%.
Therefore, Z is a subsidiary of Y.
Since more than 50% of Z is directly and indirectly owned or
controlled by X and since X directly or indirectly owns or
controls more than 50% of Y, Y can claim the credit with
respect to Y's direct investment in
subsidiary Z.
-
No credit on advances (loans) to
subsidiaries - Under the new law the taxpayer
will compute the credit only on its investments in
subsidiaries. Under the old law the taxpayer computed the
credit under the first limitation on both its
investments
in and
its advances to
subsidiaries. The old law gave the taxpayer an unintended
benefit because while the credit is intended to eliminate
double taxation of the same net worth included on both
the taxpayer's books and on its subsidiary's books, the
credit extended to loans from a taxpayer to its
subsidiary. However, because a loan to a subsidiary is
not included in the subsidiary's net worth? such amounts
can not be "double net worth taxed" and should not
generate a credit. The new law corrects this error. See
division (B)(1) ORC section 5733.067.
-
Credit limited to direct investments in
subsidiaries - The new law specifically states
that the credit under the first limitation is computed on
the taxpayer's direct (as opposed
to both direct and indirect)
investments in subsidiaries. The old law provided for a
credit on the taxpayer's investments in subsidiaries.
This change negates the Board of Tax Appeals' adoption of
the "look through" approach to situsing investments in
Cliffs
International Inc. et al, v. Limbach (March 24,
1989), BTA Case No. 87-H-51. See division (B)(1)(a) of
ORC section 5733.067.
Note: For purposes of determining whether or not a
corporation is a "subsidiary" both direct and
indirect investments are considered. However, the
taxpayer computes its credit only on its direct
investments in subsidiaries. Thus, in the example above,
Z Inc. is a subsidiary by virtue of the combined direct
and indirect investments. However, Y Inc. will compute
the credit only on its 20% direct investment in Z Inc.
-
Reduction of credit for multiple tiers of
taxpayers claiming the credit - The credit is
available to a parent corporation on its direct
investment in subsidiaries if both the parent and the
subsidiary pay the tax on the net worth method. The
credit is also available to a subsidiary
corporation by virtue of being a parent of a lower-tiered
subsidiary. The new law provides that in computing the
investor's credit under limitation #3, the tax charged
each subsidiary must be reduced by the amount of any
credit to which the subsidiary is entitled by virtue of
its investments in lower-tiered subsidiaries. The old law
provided for no such reduction. See division (B)(3) of
ORC section 5733.067.
Example
#2
Facts: A Corp., B Corp., and C Corp., are
Ohio franchise taxpayers each of which have paid their
franchise tax on the net worth basis. A Corp. is the parent
of its 100% owned subsidiary, B Corp.; and B Corp. is the
parent of its 100% owned subsidiary, C Corp. The tax before
credits for each corporation is listed below.
Assume that B Corp. is entitled to a $200 credit by virtue
of its investment in C Corp. (for purposes of this example
assume that the allowable percent of the credit is 100%).
Also, assume that A Corp. is entitled to a credit by virtue
of its investment in B Corp. and that pursuant to division
(B)(3) of ORC section 5733.067 the difference between B's
tax on net worth and its tax on net income determines A's
credit.
Analysis: Under the old law A's credit is
$1,000, the difference between B's tax on net worth and B's
tax on net income ($4,000 - $3,000). However, B's tax was
reduced $200 by virtue of the credit for its investment in
C. In computing A's credit under division (B)(3) of ORC
section 5733.067, B Corp's tax on net worth should be
reduced by the amount of B's credit for its investment in
C. Thus, for purposes of computing A's credit, B's tax on
net worth should be $3,800 ($4,000 - $200) and A's credit
should be limited to $800 ($3,800 - $3,000) rather than
$1,000. The new law corrects this error.
-
Expanded conditions under which an amended
franchise tax report must be filed - The new law
clarifies that the taxpayer must file an amended franchise
tax report if its credit is affected by adjustment to
either the
federal income tax return or the franchise tax
report of the taxpayer or a subsidiary. The
statute prior to amendment by this legislation required
that the taxpayer file an amended franchise tax report if
the taxpayer's credit was affected by an adjustment to the
franchise tax report of a subsidiary, whether
such adjustment was initiated by the subsidiary or by the
Tax Commissioner. However, a taxpayer's credit may be
affected not only by adjustments to the subsidiary's
franchise tax report but may be affected as well by
adjustments to its own franchise tax report. See division
(D) of ORC section 5733.067.
Example
#3
Facts: D Corp. claims a credit on its
investment in C Corp., a qualifying subsidiary. Upon audit
the IRS increased D Corp's federal taxable income. However,
the franchise tax effects of the IRS audit adjustments did
not increase D's tax on net income above that already paid
on the net worth basis. D Corp's credit is determined under
limitation 2 (the amount by which D's tax on the net worth
basis exceeds D's tax on the net income basis).
Analysis: Although the IRS audit
adjustments have no effect on D's franchise tax before the
credit, the IRS audit adjustment reduces the credit (under
the second limitation) by the amount of increased tax
computed on net income. ORC section 5733.067, as amended,
clarifies that the taxpayer must file an amended franchise
tax report if the credit is affected by adjustment to
either the
federal income tax return or the franchise tax
report of the taxpayer or a subsidiary.
* * * * *
Franchise Tax Information Releases are not "Opinions of the
Tax Commissioner" within the meaning of ORC section 5703.53.
Accordingly, the Tax Commissioner is not bound by this
release. Nevertheless, the above discussion does reflect the
Income Tax Audit Division's interpretation of the law.
For further assistance please call 614-433-7617.