_.~ 

SeCr8tam Of Stat8 

Capitol Station 

Austin,~ Texas '. 

Dear Slr:~ 

. 

Re: The inclusion of unkealized prdf'it from'lnstallment sales as sur@lus for 

franchise tax purposes. 

,Your request .for reconslderation.of Opinl6n 

RO. 0-5680 addressed to Ron:Sldney Latham, Secretary 

of State, approved January 8,. 1944, by Hon. Grover 

Sellers as Attorneg General is.as follows:. 

"During recbnt months the St&Auditor has been engeged in’ exsmlnlag’ cotiporations' books to determine if th6 ptiop@r " 

amount of~~taxable capital for franchise' ). 

tax purposes .has been reported in th8 si+' 

nuai reports:filed in fihis ofriC8. In not 

a few oases he has r8conDWnd8d assessment 

of franchise tsx upon unrealized gross 

profi-t from installment sales of merahan-~ 

dlse. Several such cases Involve corporations dealing in real estate, selling also 

on the Installment basis. The accounts and 

notes XWc8iVabl8 are spread over. a period 

Of S8V8rd mOnthS.and 8V8tl 88V8Fd y8aZ’S. 

As collections sxe made the net profit is 

transf8Pr8d surplus and'uadlvided profits. 

Taking intb earning6 the net profit only 

as, If and when accounts and notes:are collected results in inaome tax liability on 

only the net gross income involved in any 

one ye* and not upon the gross smount'at 

date-of the contract.. sale'.~.Tbls has long 

been reconnleed bs th~mmlssioner'6f Internal Re~ehue. - 

"Your attention iS directed to Attorney G8n8ral'S opinion dated April 30, 1934. 

For the sake of brevity we shall not qUOt8 

from the opinion, but it Is noted that a 

sound and reasonable construction of the 

meaning of 'surplus aed undivided profits' 

la presented, both from the standpoint of 
78 

HOtI. Ben Ramsey - PSg8 2 (v-774) 

accounting terminology and the recognition 

under th8 F8d8rti Income Tax Law Of the 

equity of th8 treatment of Unr8aliZ8d profits. It being held in the opinion that such 

profits should not be Included as tSxabl8 

capital for franchise tax purposes, this 

Office has cOnSiSt8ntlg fOllOW8d the rUlirg 

and D8V8F attempted t0 .5tdj,UASt the P8pOl’tS SO 

as to include unrealized profits from installment sales as surplus for franchise tax purpOS8S. 

"DUXlrilIg 1943, hOWeVer, the question Was 

again raised and in opinion No. 0-5680, dated 

January 8, 1944, it was held'that unrealized 

profits should b8 taxed but only to the extent Of the cash ValU8 of the &count. A 

Settlement WaS &88d UpOn in the CaS8 involved which prompted the request for the 

OpiniOn, but upon th8 basis of th8 corporation's appraisal: You can readily 888 that 

an attempt to plsc.8 a cash value upon an account of this nature would Involve expensive 

InvestIgatIona which would be time-aodsuming. 

Indeed, such a prOCedUr8 would b fraught with 

many UlIknOWn and UnfOr8S88lI faCtOr's. .Them 

would be COlleCtiOn expenses, estimated in-' 

come tax -tO be paid Upon net future CO118CtionS and fOr8clos~8s~ : 

"III alillOSt eVel’7 CaS8 without 8XC8ptiOn 

th8 taxpayer ha?sVvigOrOualy protested th8 

proposed additional aSS8SSm8nts as r8cOID8nd8d by the State Auditor-and in two or three 

instances the SCCOUntS were referred back ,to 

th8 Auditor. These W8r8 finally adjusted On 

a basis of abou$ 25% or 30# of the gross 

amount in the unrealized profit account. 

Even this inVOlv8d the expense of re-examinatlon and re-investlg@ion. To say the least, 

the recommendations for additional assessments 

based on lOO$ of the &~count Is CSUSiUg UO 

little confusion in this office In attempting 

to arrive at some equitable basis of aSS8SSing 

additional tax, if any Is actually dU8- 
Hon. Ben Ramsey - P-8 3 (v-774) 

"Since the Issuance of opinion No. 0-5680 

th8 SUpr8IIE COUrt Of the United States; in 

South T8XaS Lumber Company vs. Commissioner 

of Internal Revenue, 333 cr. s. 496, 68 s. ct. 

695, 92 I,. Ed. 631, held that Unr8aliZed lncome attributable to the unpaid Installment 

obligations could not be considered a part 

Of invested Capital. Rmphasls was placed upon 

'the difficult and time-consuming effort of 

appraising the uncertain market value of Installment obllgatlons' which 'may never be paid 

or may be paid only in pa&.' 

nIn the light of th8 d8clSion of the Supreme COUrt in the.abOV8 mentioned baS8 and 

the Conflicting OpiniOnS, alSO referred to, 

W8 r8SpWtfUlly l’8qU8St that YOU r8Vi8W the 

qU8StiOn before US and inform thiS Offi& 

whether or not we should COnSid8r Unti8SliZ8d 

profit from Installment sales as surplus for 

franchise tsx purposes." 

Article 7084, R8ViS8d Civil Statutes, as anend- 

$d, prOVid8S .for the payment of corporate franchise taxes 

. . . based upon that proportion of the outstanding capital stock, surnlus and undivided profits. . .* (Emphasis 

added) 

An opinion dated April 30, 1934, b$ the 

Ron. James V. Allred, Attorney General, &dr&ssed to 

Ron. W. X. Heath, Secretary of State, In answer to the 

question as to Whether or~not~~unr8aliz8d profits from 

inStallm%nt .Sal8S should be cOnSid8r8d either as surplus or undivided profits for the purpose of computing 

franchise taX88, held that such items "cannot b8 proper 

Carried as 8ith8r~ th8 'SurpluS' or 'undividGd"prOfit' 

account and should not, th8P8fOr6, .be oOnSid8r8d in 

measuring the tex due by a corporatiop." 

‘1Y 

..The reasoning of this Well-CbnSid8r8d Opinion 

was based upon cited authoritiesi and particular reference was mad8 t0 s8ctiOn 44 Of the R8v8nU8 Act Of 1932, 

the Federal Income Tax Law. 

On January 8, 1944, in opinion No. 0-5680 by 

HOD. Grover s8118rS addressed t0 Ron. Sidney Latham, 

Secretary of State,:ln answer to the question as to 

Whether or not items of "Un~'tiis8d profits" on installment sales were tEUabl8 Under Article 8074, R. C. S.,as 
80 HOII. ml3 RSlJlS8y - &3#38 4 (v-774) 

amended, at-th6iti face value a& Shown on the fPanchiS8 

tsXreports, it was held that such'ltems were taxable 

&s part'of the "surpluS"' and the tSX based~ upon the 

actual Vdt.18 OS the UDr8aliZ8d profits rather than th8 

faC8 VtiU8 thereof. No r8f8ti8DC8 WaS mad8'tO th8 

Opinion of Hon. Jsmes V. filr8d above referred to. 

The Supreme Court of the United Stat&S in 

the recent case of South T8XaS Lumber Compa 

cOUlJSiSSiOD8l'Of IlltW?tl& RBVenU8,$33 u. S. 

L. Ed. 631;68 S. ct. 695, reasoned that: 

"The installment basis of reporting 

was enacted, as shown by Its history, to 

r8li8V8 tSXpay8rS who adopted it from having to pay an income tax in the year of 

sale based on the full amount of anticipated profits when in fact they had reC8iV8d in cash Only a Small portion of 

the S&80 pl’iC8. Another reason was th8 

difficult and time-consuming effort of 

appraising the uncertain market value of 

installment obligations. . . . 

)I . . . SeCtiOn 4.4 provides for th8 

return as Income 'ifi any taXable year 

that proportion of the lnstallmant payments actually received in that year 

which the gross profit realized or to be 

realized when payment Is Completed, bears 

to the total contract price.' . . . 844 

does not recognize as subject to income 

taX liability th8 'market ValU8' Of deferred Installment obligations. They may 

never be r8.cOgDiZ8d by a tSXpay8r on the 

installment basis for tax purposes under 

844 or any other section, for they may 

never be paid, or may b8 paid only in part. 

added) 

The COUrt then held Under the facts of that C&S8 

and the Fed8r& statute inVOlV8d that unrealized 

.proSlts SromPnstallment sales could not be considered as a part Of invested capita. 
Hon. Ben Ramsey - Page 5 (V-774) 

After a careful reconsidetiation of each 

of the fOr8gOing OplnlOnS Of the former Attorneys 

General, in the light of the opinion of the Supreme 

Court of the United Stat80 cited, it lS the OplnioD 

of this office that the ruling Contained in the 

opinion by Hon. James V. Allred, approved April 30, 

1934, which held that unrealized profits from lnStS.llm8nt sties do not constitute either surplus or 

undivided prOfit for i&8 purpose Of COmpUtiDg franchiS8 tsxes under the provisions of Article 7084, 

R. C. S., as smended, Is correct, and this opinion 

Is therefore r84fflrm8d. Opinion No. O-5680 dated 

January 8, 1944, Is expr8881y OV8rrU18d Insofar as 

it COnfliCtS herewith. 

SUMMARY 

Items of unrealized profit from in 

Stdhtl8nt Sd8S do Dot COIlStitUt8 8ith8l’ 

"surplus" or "UnX'8tiiZ8d pPOfitSn for the 

purpose Of computing cOrpOrat8 fPaDchlS8 

taxes under the provisions of Article’708&, 

R. C. S., as amended. South T8XaS Lumber 

Company v. Commlssloner of Internal Revenue, 

333 0. S. 496, 92 L. Ed. 631, 68 S. Ct. 695; 

Opinion Hon. James V. Allred, Attorney G8neral, dated April 30, 1934, approved in part. 

Opinion No. 0-5680 dated January 8, 1944, by 

Ron. Grover S8118r8, Attorney General, overruled in part. 

Yours very truly 

ATTORNEY GRNERAL OF TEXAS 

cKR:mul 

BY 

C. K. Richards 

_Asalstant 

81