830 CMR 63.00: TAXATION OF CORPORATIONS
830 CMR 63.00 is amended by adding the following section:
830 CMR 63.30.1: Liabilities in Determining the Net Worth of Intangible Property Corporations
(1) Introduction. M.G.L. c. 63, § 30 sets forth in paragraphs (8) and (9) the methods used in determining the Massachusetts net worth of domestic and foreign intangible property corporations, respectively. Under M.G.L. c. 63, § 30, intangible property corporations must subtract their "liabilities" from the book value of their total assets. This regulation identifies the items that constitute liabilities in determining net worth for purposes of M.G.L. c. 63, § 30.
(2) General. "Liabilities" includes accounts payable, notes and bonds payable, accrued and unpaid taxes, and other similar accrued liabilities. Except as otherwise provided herein, it does not include surplus reserve accounts or appropriations from retained earnings, such as reserves for contingencies.
At a minimum, amounts must be regarded as liabilities according to generally accepted accounting principles to constitute liabilities under M.G.L. c. 63, § 30, but amounts so regarded are not necessarily liabilities under M.G.L. c. 63, § 30.
(3) Special Rules.
(a) Contingent liabilities. When it is clear that a liability has been incurred on or before the last day of the taxable year, and the amount of the liability can be reasonably estimated at the time for filing the corporation's return, the reasonably estimated amount will be treated as a liability in determining net worth.
Example: Intangibles, Inc. is a calendar year taxpayer. In 1980, it sets aside reserves on its balance sheet for (1) approved public utility price increases to take effect in 1981; (2) projected 1982 office expansion; and (3) a fuel adjustment surcharge applicable to Intangibles' 1980 rent, but not payable until January 31, 1981; Intangibles has not yet been informed of the amount of the surcharge, but reasonably estimates it at $2,000.
Since the reserves for public utility increases and projected office expansion do not represent liabilities incurred on or before the last day of 1980, they may not be treated as liabilities on Intangibles' 1980 return. The reasonably-estimated amount of the fuel adjustment surcharge ($2,000) may be treated as a liability on Intangibles' 1980 return.
(b) Advance payments. When an intangible property corporation receives revenues that in whole or in part are not yet earned, because the corporation has not yet delivered all the goods or services to be provided in return for the revenues received, the unearned portion of the advance payments constitutes a liability.
Example 1: Fly-by-Night Travel Corporation, a calendar year taxpayer, is organizing a charter flight to the Bahamas in March of 1981. Fly-by-Night requires passengers to pay the full fare for the flight on or before November 15, 1980. In 1980, Fly-by-Night receives fares for the flight totaling $90,000.
Fly-by-Night's 1980 accounting entries for the fares are debits totaling $90,000 to cash and credits totaling $90,000 to deferred charter income.
On its 1980 tax return, Fly-by-Night may treat the $90,000 in credits to deferred charter income as a liability in determining net worth.
Example 2: World Publishing Co., Inc. is a calendar year taxpayer that sells magazines by subscription. On December 31, 1980, it has outstanding 10,000 one-year, 12-issue subscriptions that run from July, 1980 through June, 1981. The subscriptions each cost $25 and each was paid for in full prior to July, 1980.
As of December 31, 1980, World has delivered six of the 12 issues to be provided under each subscription.
On July 1, 1980, World's accounting entries for the subscriptions are debits totaling $250,000 to cash and credits totaling $250,000 to deferred subscription income, a liability account. By December 31, 1980, $125,000 has been transferred from the deferred subscription income account to a revenue account.
On its 1980 tax return, World may treat the $125,000 remaining in its deferred subscription income account as a liability in determining net worth.
In the case of an uncompleted "long-term contract" as defined in U.S. Treasury Regulation Section 1.451-3(b)(1), the excess of
1. the contractual payments received by a corporation at the close of the taxable year; over
2. the portion of the gross contract price corresponding to the percentage of the entire contract which has been completed at the close of the taxable year constitutes a liability in determining net worth.
(c) Subject to the Commissioner's right to disallow amounts not reasonable and proper ( see 830 CMR 63.30.1(4)(a)), a reserve or allowance for bad debts will reduce net worth, whether it is treated as an offset against assets or as a liability.
(d) Reasonable reserves established for the payment of employee annuities, pensions, or other retirement funds, or for the payment of deferred compensation, constitute liabilities in determining net worth.
(e) Reserves for deferred taxes. Reserves for deferred taxes constitute liabilities in determining net worth in the following circumstances.
1. Where, under federal or state law, the tax on income is deferred to a year subsequent to the year of receipt, and the receipts are reflected in the book value of the corporation's assets in determining its net worth, reserves for deferred federal and state income taxes arising therefrom constitute liabilities in determining net worth. For example, where, under Internal Revenue Code Section 453, an intangible property corporation reports income on an installment sale in a year or years subsequent to the year of the sale, but the gross receipts from the sale are reflected in the book value of the assets of the corporation in the year of the sale, deferred federal and state taxes arising therefrom may be treated as liabilities in determining net worth.
2. Where, under federal or state law, an intangible property corporation deducts an item from taxable income before the year in which the expense or loss giving rise to the deduction is reflected in the book value of the corporation's assets, deferred federal and state taxes arising therefrom may be treated as liabilities in determining net worth. For example, an intangible property corporation which, in accordance with Internal Revenue Code section 167, uses accelerated depreciation in computing net income for tax purposes, but uses the straight-line method in computing the book value of its assets, may treat deferred taxes arising therefrom as liabilities in determining its net worth.
(a) General. The amount that a corporation identifies as a liability on its return must be reasonable and proper in light of the circumstances existing at the time the return is filed, and must be set in good faith. The Commissioner may disallow, in whole or in part, any such amount judged not reasonable and proper.
(b) Deferred taxes.
1. Rates. Deferred taxes constituting liabilities generally must be calculated at federal and state tax rates applicable when the corporation's return is filed, but if at such time other rates have been established by law for the period during which the deferred income will be recognized for tax purposes, such other rates must be applied.
The applicable federal tax rate for purposes of calculating deferred taxes is the highest rate that applies to the corporation's taxable income. For example, a corporation with $80,000 of taxable income in 1980 must calculate deferred federal taxes by applying a rate of 40 per cent to the amount of income deferred (with such further adjustments as may be required herein).
2. Estimating amount of deferred income that will be taxed. Generally, a taxpayer must calculate the amount of deferred taxes by applying the appropriate tax rate to the amount of income deferred, multiplied by a fraction the numerator of which is the corporation's estimated taxable income for the year during which the income will be recognized, and the denominator of which is the corporation's estimated gross income for that year. For this purpose, "gross income" means gross receipts from all sources less only returns and allowances. The corporation's estimates of taxable and gross income must be reasonable and proper under all the circumstances. This usual method of calculation is illustrated by the following example.
Example: In 1980, Intangibles, Inc. makes installment sales the total receipts from which are $500,000. The entire $500,000 is reflected in the book value of Intangibles' assets in 1980. However, of this amount, $400,000 will be reported as income for federal tax purposes in years subsequent to 1980.
Intangibles' federal taxable income for 1980 is $1,000,000.
The average ratio of taxable to gross income in Intangibles' taxable years 1975-1979 is .735. There is no reason to believe that its ratio of taxable to gross income will be substantially less than .735 in the years in which the $400,000 will be reported as income.
In 1980, Intangibles may treat $135,240 as a liability for deferred federal taxes in determining its net worth. This amount is obtained by applying the 46 per cent federal tax rate for corporate income over $100,000 to the $400,000 of deferred income, multiplied by .735, the corporation's average ratio of taxable to gross income for the previous five years.
There are two instances in which the usual method of calculation need not be used.
First, where a taxpayer reasonably believes that his taxable income for the year in which deferred income will be recognized will be at least 90% of his gross income, the taxpayer may treat the entire amount of deferred income as subject to tax in calculating deferred taxes constituting liabilities.
Second, where a taxpayer demonstrates to the Commissioner that use of the usual method of calculation results in an understatement of the amount of deferred income that will in fact be taxed, it may use an alternative method that more accurately estimates the amount that will be taxed. The taxpayer bears the burden of proving that the usual method of calculation results in an understatement of deferred taxes and that his alternative method is more accurate. The Commissioner will calculate the reserve in accordance with the usual method and assess the tax accordingly if the taxpayer fails to meet this burden of proof.
(5) Record Retention. Every intangible property corporation must maintain records sufficient to establish that amounts identified as liabilities on its return are reasonable and proper, in accordance with the requirements of State Tax Administration Regulation 830 CMR 62C.25.1 (Record Retention).
830 CMR 63.30.1: M.G.L. c. 14, § 6(1); M.G.L. c. 62C, § 3
Date of Promulgation: 9/3/81