Opinion ID: 1856252
Heading Depth: 1
Heading Rank: 3

Heading: Whether it was arbitrary or capricious for the Mississippi State Tax Commission, hereinafter referred to as MSTC. to calculate Lady Forest Farms, Inc.'s, hereinafter referred to as LFF's, franchise tax by the inclusion in the tax base of the amounts listed in the Liabilities and Stockholders' Equity portion of LFF's Financial Statement as Deferred Income Taxes and Deferred Section 481 Income and the balance sheets of LFF's tax returns as deferred income and deferred taxes?

Text: ¶ 3. The present case presents a juxtaposition of the federal income taxation and state franchise taxation schemes. The United States Congress issued a mandate for farms to convert from the cash to accrual method of accounting for federal income tax purposes, but, recognizing the disruptive nature of this change, Congress dictated that family farms maintain special suspense accounts [1] for accounts receivables and inventory under the cash method of accounting pursuant to § 447(i) of the Internal Revenue Code (IRC). This provision was designed to grant said family farms a break by permitting them to continue to maintain the then-existing inventory and accounts receivable under the cash method of accounting in a suspense account. ¶ 4. While accounts receivable and inventory are booked under the accrual method of accounting, they are not booked at all under the cash method, and a scheme whereby accounts and inventory are booked under the cash method is thus something of a contradiction in terms. Such was the dictate of IRC § 447(i), however, and the accountants for LFF duly complied with said federal mandate. The dictates of IRC § 447 were made even more complicated by a provision in IRC § 447(i) that the amount in the suspense account would remain constant unless the business of the family farm in question contracted (or declined) or until the farm ceased to be operated as a family farm. Thus, the benefits granted to family farms by Congress by permitting them to maintain § 447(i) suspense accounts were to be retracted to the extent that the family farms' business declined or, in the event that the family farms ceased to operate as such, the benefits would cease altogether and the accounts receivable and inventory would become taxable. ¶ 5. The primary issue in the present appeal is whether the § 447 suspense account is properly considered to constitute capital employed in this state for purposes of the Mississippi Franchise Tax. Section 27-13-9 of the Mississippi Code Annotated (1991), Basis of Valuation provides that: The tax imposed, levied, and assessed, under the provisions of this chapter, shall be calculated on the basis of the value of the capital employed in this state for the year preceding the date of filing the return, whether a calender year, or fiscal year, except where otherwise provided in this chapter, measured by the combined issued and outstanding capital stock, paid-in capital, surplus and retained earnings; provided, that in computing capital, paid-in capital, surplus, and retained earnings, there shall be included deferred taxes, deferred gains, deferred income, contingent liabilities and all true reserves, including all reserves other than for definite known fixed liabilities which do not enhance the value of assets and amounts designated for the payment of dividends shall not be excluded from such calculations until such amounts are definitely and irrevocably placed to the credit of stockholders, subject to withdrawal on demand... . (emphasis added). The MSTC ruled that the § 447 suspense account established by LFF constituted capital employed in this state and accordingly included said account in LFF's franchise tax base. ¶ 6. The scope of judicial review of the actions of an administrative agency is limited by the arbitrary and capricious standard. However, this Court will not defer to the MSTC's interpretation of a taxation statute when that interpretation is repugnant to the plain meaning thereof. See Mississippi State Tax Comm'n v. Dyer Inv. Co., 507 So.2d 1287 (Miss. 1987); State Tax Comm'n v. Reliance Mfg. Co., 236 Miss. 462, 111 So.2d 225, 228 (1959). ¶ 7. In the present case, this Court concludes that the § 447(i) suspense account does not fall under any of the classifications of capital employed in this state as set forth in § 27-13-9, and that the Chancellor was correct in finding the actions of the MSTC in ruling to the contrary to be arbitrary and capricious. This Court arrives at this conclusion based in part upon our decision in Dyer, wherein this Court held that the MSTC had failed to establish that a note fell within the specifically provided categories of capital employed in this state set forth in § 27-13-9. Thus, this Court has expressed an intent in the past to interpret said statute somewhat narrowly. This Court held in Dyer that: The Commission argues that the notes held by taxpayer Dyer are in fact capital enhancing assets, the value of which is employed in this state, and therefore, the amount thereof ought to be a part of the franchise tax base. It cannot be denied as a matter of economic reality that the Commission is correct. These notes do have value. And if Section 27-13-9 defined the franchise tax base as the value of all capital employed in this state, and stopped there, the Commission's argument would be powerful indeed. The problem with the argument is that the statute goes on, arguably inartfully, to define and modify and limit the phrase capital employed in this state to the four categories of capital stock, surplus, undivided profits and reserves. Id. at 1291. Thus, this Court has expressed a hesitance to expand the definition of capital employed in this state beyond the categories set forth in § 27-13-9. In the present case, this Court is faced with a much more anomalous and complicated entity than the installment note which this Court held to not constitute capital employed in this state in Dyer, and the suspense account in the present case is even more clearly not properly considered to be capital employed in this state than the note in Dyer. ¶ 8. This Court's conclusion that the § 447 account does not constitute capital employed in this State is strengthened by the MSTC's contradictory arguments in the present case, as well as the contradictory testimony of the MSTC's experts regarding under which category of capital set forth in § 27-13-9 the account properly falls. The MSTC's confusion as to under which category the § 447 account falls is evidenced by the testimony of MSTC's experts, including Randy Ladner, Director of the MSTC's Sales Tax Division, who testified that in my opinion it's deferred income; but if it's not deferred income then it's got to be a reserve. ¶ 9. The MSTC's primary argument before this Court is in fact that the § 447 account constitutes deferred income. Eddie Beck, Administrative Assistant to the Chairman of the MSTC, however, appeared in his testimony to be less than convinced that the § 447 account did in fact constitute deferred income, testifying that my solution would have been to call it retained earnings from conversion from cash to accrual method of accounting. That's the way I would have set it up. The MSTC argues alternatively that the § 447 account should fit under the classification of reserve. However, Mr. Beck testified on behalf of the MSTC that I suppose you could set it up as a reserve, but, usually, a reserve implies you're reserving it for a specific item. This, apparently, was just part of their working capital, was not reserved for any particular item. ¶ 10. It is difficult for this Court to conclude that the § 447 suspense account does in fact constitute deferred income or a reserve within the statutory definition of said terms when the MSTC's own experts are unable to agree that the account is properly classified as such. The § 447(i) suspense account is a highly idiosyncratic creation of Congress which is difficult to grasp even in comparison to other provisions of the Internal Revenue Code. Mr. Chance, accountant for LFF, testified that he had never seen any animal like it. Contrary to the MSTC's argument, it appears that the account represents neither deferred income nor deferred taxes, given that the suspense account will continue indefinitely under the provisions of § 447 until such time as LFF's business declines (at which point the account will shrink in proportion to the business) or until LFF ceases to operate as a family farm. LFF may continue indefinitely as a successful family farm, and it is thus very possible that the amounts in the account will never be recognized by LFF for federal income tax purposes and that the account thus represents an exclusion rather than a deferral. ¶ 11. LFF was merely complying with the dictates of Congress by switching to the accrual method of accounting but maintaining the suspense account on the cash basis. This Court is thus not faced with a case in which a taxpayer has deliberately constructed a suspense account in order to shelter franchise tax liability. The Chancellor found in his ruling that: MSTC employee witnesses concede that LFF never attempted to defraud the State of Mississippi by the filing of the tax returns in question, and acknowledge that the issue before the Court is arguable, the applicable statutes, the franchise tax return published by the MSTC and the books of LFF all being subject to differing interpretations. Indeed, LFF was given no franchise tax break relative to the prior years in which it filed franchise taxes at all by complying with the § 447 mandate. To the contrary, the view as set forth by the MSTC would result in a large increase in franchise tax liability for LFF relative to prior years, and LFF argues that it should not have its franchise taxes increased as a result of a federally mandated change in its accounting practices. ¶ 12. The Commission argues that, in an economic sense, many of the assets represented in the suspense account do constitute capital employed in the state. This Court made clear in Dyer, however, that we are not faced with a question of economic definitions, but rather of statutory definitions. Dyer, 507 So.2d at 1291. This Court in Dyer noted the limitations placed upon the scope of capital used in this state by the specific provisions of § 27-13-11, and the Legislature has full authority to change said provisions if it is of the view that said provisions serve to define capital used in this state too narrowly. ¶ 13. The MSTC notes that § 27-13-9 provides no exemption for cash method taxpayers, but it cites no statute or regulation which provides that cash method taxpayers are required to include accounts receivable and inventory in their franchise tax base. Further, the MSTC's argument that the statutes provide no exemption for inventory and accounts receivable held by cash method taxpayers loses its force when the MSTC itself acknowledges that it does not attempt to include said inventory and accounts in the franchise tax base of cash method taxpayers. The testimony of Mr. Chance and other witnesses indicates that the cash method of accounting is, at least as a matter of practice, advantageous for franchise tax purposes, and the MSTC does not dispute this fact. There is thus, arguably, an element of arbitrariness in the MSTC's taxing the § 447 cash method accounts of inventory and accounts receivable while permitting other cash method taxpayers to not include accounts receivables and inventory in their franchise tax base. ¶ 14. Disregarding the arguable arbitrariness of this particular practice, however, the central point of this appeal remains: the unique, federally mandated creation of law that is the 447(i) suspense account does not properly fall under any of the categories of capital employed in this state as set forth by the Legislature, regardless of the accounting methods or issues involved. The Chancellor correctly found that the MSTC acted arbitrarily and capriciously in ruling to the contrary and his ruling is affirmed.