California: bank and financial corporation v. general corporation taxation.by Newcomb, S. M.
The State of California taxes banks and "financial" corporations under rules that differ substantially from those imposed on other types of corporations ("general" corporations).
What Is a Financial
The "financial" classification was created by the California legislature to comply with the federal statute (12 U.S.C.A. 548) prohibiting the imposition of state taxes which discriminate against national banks. It was created to avoid giving preferential treatment to corporations which compete with national banks. The term "financial" is not defined in any California statute but has been determined in State Board of Equalization decisions to be a corporation which deals with moneyed capital in substantial competition with national banks. The "financial" classification can be assigned despite a low level of financial activity, as long as the activities that are performed place the corporation in such competition. Examples of "financial" corporations include savings and loan associations, loan brokers, a corporation that issues credit cards, various types of corporations that deal in and discount commercial paper, and corporations that make loans to affiliated entities only.
One major difference between the two types of corporations is that "financial" corporations and banks are taxed at a higher rate than are "general" corporations. Banks and financials pay a franchise tax at a rate determined annually by the Franchise Tax Board. The rate has fluctuated between 10% and 12% over the past several years. The bank and financial tax rate is higher than the general corporation franchise tax rate because the state takes into account the exemption of banks from personal property taxes and business license fees. The question of whether "financial" corporations are subject to local business licensee taxes is currently under adjudication in California. If a final court decision upholds the imposition of these taxes, a "financial offset" (credit) against the tax liability will be permitted in order to prevent banks from having an unfair advantage over "financial" corporations.
Bad Debt Deduction
Another difference between a bank and a "financial" corporation, and a general corporation, involves the treatment of the bad debt deduction. A general corporation may only take a deduction for debts which actually become wholly or partially worthless within the income year. On the other hand, banks and "financial" corporations may still use a bad debt reserve, computed under California Reg. Sec. 24348(b), which is similar to, but not exactly the same as, the federal bad debt reserve method in effect prior to TRA 86. Also, note that the federal "large bank" bad debt exception has not been adopted in California.
Apportionment of Income
Perhaps the most important distinction between financial and general corporations is the method of calculating the apportionment factors. The Franchise Tax Board has issued Reg. 25137-4 for banks and financial corporations.
Property Factor. For all corporations, the property factor is based on the average value of the real and personal tangible property owned, rented, or used by the taxpayer in the state and everwhere else during the taxpayer's income year. Property is generally valued at its original cost (without allowance for depreciation). Rented property is valued at eight times its annual rent. For banks and financial corporations, the property factor additionally includes all intangible assets valued at their tax basis (less goodwill). These intangible assets, which for general corporations are not a part of the property factor, are the most important element of the property factor for banks and financial corporations. The reason for this is because these intangibles (mainly loans to individuals and corporations and investments in securities) are the main income-producing assets for banks and "financial" corporations. Thus, the property factor could include items such as coin and currency, and intangible items, such as loan receivables, investments and credit card receivables.
Receipts Factor. Banks and "financial" corporations differ significantly in the development of the numerator of the receipts factor. In general, the numerator of the receipts factor includes gross receipts attributable to California and derived by the taxpayer from transactions and activities in the regular course of its trade or business. However, the following special rules are applicable to banks and "financials:"
1. Interest and other receipts from assets in the nature of loans is attributable to the state in which the customer applies for the loan, unless the loan is recognized by an appropriate banking regulatory authority as being made from and as an asset of an office located in another state (the booking rule presumption).
2. Interest and service charges from credit card receipts and credit card holders' fees are attributed, in the case of a corporate customer, to the state of the corporation's commercial domicile, and in the case of an individual, to his residence, provided in both cases that the taxpayer is taxable in such state. If the taxpayer is not taxable in such state, then the income is attributable to the taxpayer's commercial domicile.
3. In general, receipts from investments of a bank in securities are attributed to the bank's commercial domicile. For "financial" corporations they are also attributable to the commercial domicile unless the securities have acquired "business situs" elsewhere.
4. Receipts from the lease or rental of tangible personal property are attributed to the taxpayer's commercial domicile unless such property is located in another state for the entire year and the taxpayer is taxable in that state.
In contrast, for a general corporation, receipts other than receipts from the sale of tangible personal property, are attributed to California only if the related income-producing activity occurs there. If the activity occurs in more than one state, it is attributable to the state in which the greater portion of income producing activity occurs. Thus, income from the rental of tangible personal property is sourced to the location of the property, and investment income from securities, is sourced to where the services involved in generating the income are performed.
Interest income would also be included in the apportionment factor, but only if there is an income-producing activity related to its generation. Passively earned income, such as bank account interest, is generally excluded from the factor.
The apportionment of intangible property in the property factor follows the rules enunciated under the sales factor.
The payroll factor is treated the same for both financial institutions and general corporations.
Stockbrokers are taxed as general corporations. However, the Franchise Tax Board has taken an audit position in two areas that is not based on the law or regulation.
* First, historically it has taken the position that only the net gain from the sale of investments is included in the receipts factor. However, in a recent State Board of Equalization decision, the Appeal of Merrill Lynch, Pierce, Fenner, Smith, Inc., California SBE, 6/2/89, the State Board of Equalization said that the apportionment factor should properly include gross receipts.
* Second, in apportioning commission income from buying and selling securities, the FTB takes the position that on the sale of stock, a corporation should attribute 60% of the commission to the state of the originating office and 40% to the state in which the exchange is located, and, in the case of bonds, 50% of the receipts should be attributed to the state of the originating office and 50% to the state of the underwriter. This is purely an internal FTB position. Under the law, the commissions should be sourced to where the income producing services are performed.
Combining General and
In June 1989, the Franchise Tax Board issued Prop. Reg. 25137-10 addressing the computation of income on combined returns including banks and financial corporations with predominantly general corporations. If this regulation is approved in its current form, it would have a significant impact on the brokerage industry, investment bankers, and retailers with credit card operations. There are important planning opportunities that all affected taxpayers should become familiar with if the regulation passes. Table 1 encapsulates the matters discussed in this article.
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