_.~

SeCr8tam Of Stat8 Capitol Station Austin,~Texas '.

Dear Slr:~ . 

### Re: The inclusion of unkealized prdf'itfrom'lnstallment sales as sur@lus for franchise tax purposes.

,Yourrequest.forreconslderation.of Opinl6n RO. 0-5680 addressed toRon:Sldney Latham, Secretary of State, approved January 8,. 1944, by Hon. Grover Sellers asAttorneg General is.as follows:.

"During recbnt months the St&Auditor has been engeged in’exsmlnlag’ cotiporations' books todetermine if th6 ptiop@r " amount of~~taxablecapital for franchise'). tax purposes .hasbeen reported in th8 si+' nuai reports:filed in fihis ofriC8. Innot afew oases he has r8conDWnd8d assessment offranchise tsx upon unrealized gross profi-tfrom installment sales ofmerahan-~ dlse. Several such cases Involve corporations dealing inreal 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 sxemade the net profit is transf8Pr8d surplus and'uadlvided profits. Taking intb earning6 the net profit only as, If andwhen accounts and notes:are collected results in inaome tax liability on only the net gross income involved in any oneye* and not upon the gross smount'at date-of the contract.. sale'.~.Tblshas long been reconnleed bs th~mmlssioner'6f Internal Re~ehue. -
"Your attention iS directed toAttorneyG8n8ral'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' lapresented, both from the standpoint of

## 78

HOtI.Ben Ramsey - PSg8 2 

### (v-774)

accounting terminology and the recognition under th8F8d8rti Income Tax Law Of the equity of th8 treatment of Unr8aliZ8d profits. It being held in the opinion that such profits should notbe Included as tSxabl8 capital for franchise tax purposes, this Officehas 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, itwas 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 th8basis of th8 corporation's appraisal: You can readily 888 that an attempt to plsc.8a cash value upon an account of this nature would Involve expensive InvestIgatIona which would be time-aodsuming. Indeed,

### suchaprOCedUr8 would 

### b fraughtwith
many UlIknOWn and UnfOr8S88lI faCtOr's. .Them would be COlleCtiOn expenses, estimated in-' come tax-tObe paid Upon net future CO118CtionS and fOr8clos~8s~ :


### "III alillOSt

eVel’7 CaS8 

### without8XC8ptiOn th8 taxpayer 

### ha?sVvigOrOualy protested th8 proposed additional aSS8SSm8nts as r8cOID8nd8dby the State Auditor-and in two or three instances the SCCOUntS were referred back ,to th8Auditor. These W8r8 finally adjusted On abasis 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 theUnited 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 apart Of invested Capital. Rmphasls was placed upon 'thedifficult and time-consuming effort of appraising the uncertain market value of Installment obllgatlons' which 'maynever bepaid ormay be paid only inpa&.'

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 notwe should COnSid8r Unti8SliZ8d profit from Installment sales as surplus for franchise tsx purposes."
Article 7084, R8ViS8d Civil Statutes, as anend- $d, prOVid8S .forthe 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. JamesV. Allred, Attorney General, &dr&ssed to Ron. W.X. Heath, Secretary of State, In answer to the question as toWhether or~not~~unr8aliz8dprofits from inStallm%nt .Sal8Sshould 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, .beoOnSid8r8d in measuring the tex due by a corporatiop." ‘1Y

..Thereasoning of this Well-CbnSid8r8d Opinion
was based upon cited authoritiesi and particular reference wasmad8 t0 s8ctiOn 44 Of the R8v8nU8 Act Of 1932, theFederal Income Tax Law.

On January 8, 1944, in opinion No. 0-5680by HOD. Grover s8118rS addressed t0Ron. Sidney Latham, Secretary of State,:ln answer to the question as to Whether or not items of "Un~'tiis8d profits" on installment saleswere tEUabl8 Under Article 8074, R. C. S.,as

## 80 HOII. ml3 RSlJlS8y - &3#38 4 (v-774)

amended, at-th6itiface value a& Shown on thefPanchiS8 tsXreports, itwas held that such'ltems were taxable &s part'of the "surpluS"'and the tSXbased~upon the actual Vdt.18 OS the UDr8aliZ8d profits rather than th8 faC8 VtiU8 thereof. No r8f8ti8DC8WaS mad8'tO th8 Opinion of Hon. Jsmes V. filr8d above referred to.

The Supreme Court of theUnited 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 shownby Itshistory, to r8li8V8 tSXpay8rS who adopted itfrom having to pay an income tax in theyear of salebased 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 4.4provides for th8 return as Income 'ifi any taXable year that proportion of the lnstallmant payments actually received in thatyear which the gross profit realized or tobe realized when payment IsCompleted, bears to the total contract price.'
. . .844 does not recognize as subject to income taX liability th8 'marketValU8' Of deferred Installment obligations. They may never be r8.cOgDiZ8dby a tSXpay8r on the installment basis for tax purposes under 844 or any other section, for theymay never be paid, ormay b8 paid only in part.

added)

The COUrt then held Under the facts of that C&S8 and theFed8r& statute inVOlV8d that unrealized .proSltsSromPnstallment sales could notbe considered as a part Of invested capita.Hon. Ben Ramsey -Page 5 (V-774)

After a careful reconsidetiationof each of the fOr8gOing OplnlOnS Of the former Attorneys General, in the light of the opinion of the Supreme Court of theUnited Stat80 cited, it lS the OplnioD of this office that the ruling Contained in the opinion byHon. James V. Allred, approved April 30, 1934, which held that unrealized profits from lnStS.llm8ntsties do not constitute either surplus or undivided prOfit for i&8 purpose Of COmpUtiDg 

### franchiS8 tsxes under the provisions ofArticle 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 itCOnfliCtS herewith.

SUMMARY

Items of unrealized profit from in Stdhtl8nt Sd8S do Dot COIlStitUt8 8ith8l’ "surplus" or "UnX'8tiiZ8dpPOfitSn for the purpose Of computing cOrpOrat8 fPaDchlS8 taxes under the provisions ofArticle’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 inpart. Opinion No. 0-5680 dated January 8, 1944, by Ron. Grover S8118r8, Attorney General, overruled inpart.

Yours very truly

ATTORNEY GRNERAL OF TEXAS

cKR:mul 

### BY C.K. Richards _Asalstant 

## 81