Opinion ID: 1807052
Heading Depth: 1
Heading Rank: 1

Heading: consolidated reports and valuation of stock of wholly-owned subsidiaries

Text: As we have noted, National-Standard first filed consolidated balance sheets of it and its subsidiaries. The state determined that its annual reports were improperly filed and that, under the statute, the privilege fee had to be computed on the basis of unconsolidated balance sheets. The first question to be determined is whether a corporation may file annual reports based upon consolidated balance sheets of the corporation and its wholly-owned subsidiary corporations. PA 1921, No 85, as amended, prescribes the fees, taxes and charges to be paid to the State of Michigan by corporations, both foreign and domestic; sets forth the method and basis of computation; requires reporting; and schedules the amounts required to be paid. Section 4 of the act, cited supra, contains the following:    [E]very profit corporation organized or doing business under the laws of this state, or having the privilege to do business,    shall pay, at the time of filing the annual report with the Michigan corporation and securities commission, as required by sections 81 and 82 of Act No 327 of the Public Acts of 1931, as amended    an annual fee of 5 mills upon each dollar of its paid-up capital and surplus   .    It is the intent of this section to impose the tax herein provided for upon every corporation, foreign or domestic, having the privilege of exercising corporate franchises within this state, irrespective of whether any such corporation chooses to actually exercise such privilege during any taxable period,   . Section 81 of PA 1931, No 327, noted in the above quotation, refers to non-profit corporations and is inapplicable. Section 82, subd (m), PA 1931, No 327, as amended (MCLA 1970 Cum Supp § 450.82; Stat Ann 1970 Cum Supp § 21.82), provides that the report to be filed shall contain a    statement of the assets and outstanding liabilities of the corporation   . (Emphasis added.) In the provisions of the statute for the apportionment of the privilege fee base between Michigan and other states on the basis of the ratio of Michigan property and other criteria, the statute refers to the property, payroll and sales of the taxpayer (§ 5, PA 1921, No 85, as amended [MCLA § 450.305; Stat Ann 1970 Cum Supp § 21.208]). During all or a portion of the reporting years involved, National-Standard's wholly-owned subsidiaries which it sought to include in its consolidated balance sheets accompanying the annual reports filed with the state were: Wholly-Owned Subsidiaries of National-Standard Fiscal Year Company Ended September 30 Year Year Year Year National-Standard Co. of Canada, Ltd. (an Ontario, Canada corporation) 1961 1962 1963 1964 National-Standard Co., Ltd. (an English corporation) 1961 1962 1963 1964 National-Standard, (S.A.) (a French company) 1963 1964 Cheney Bigelow Wire Works, Inc. (a Delaware corporation with principal offices in Springfield, Massachusetts) 1962 1963 1964 Wholly-Owned Subsidiaries of National-Standard Fiscal Year Company Ended September 30 Year Year Year Year Multisonic Corp. (a New York corporation with principal offices in Westbury, New York) 1964 Reynolds Wire Co., (an Illinois corporation with principal offices in Dixon, Illinois) 1961 1962 1963 1964 None of these subsidiary companies had been admitted to do business in Michigan. As shown by the foregoing quotations from the statutes, the fees involved are assessed upon corporations having the privilege to do business in this state. That section alone would appear to exclude National-Standard from filing consolidated balance sheets for franchise privilege fee purposes. But additionally and of greater significance is the apparent legislative intent in drafting the statutes to embrace a single reporting corporation. Since all of the above provisions are in the singular, it must be concluded that a reporting corporation may not file a consolidated report with its wholly-owned subsidiaries but rather is required to file an unconsolidated financial statement. From time to time, National-Standard purchased the stock of subsidiary companies. It contends that its original cost is the correct figure to be used on its unconsolidated statements. These figures of original costs could only be obtained by National-Standard by reference to books and records as of the date the stock of each subsidiary was acquired because the investment shown on the books at the close of each balance sheet year was historical cost adjusted to show the amount of profit or loss the subsidiaries had experienced that year. This has resulted in a composite figure equal to the entire net worth of the subsidiaries at year end. The state contends the present equity ownership of National-Standard in its wholly-owned subsidiaries by virtue of National-Standard's ownership of their stock is the figure which reflects the current value (net worth) and which should be used on the unconsolidated statement. For example, as of September 30, 1964, over various periods of time from June 23, 1919 to that date, National-Standard had invested $3,580,770.59 in its subsidiaries. This is the figure it would use. The stock investment, plus equity increase (earnings) in the subsidiaries on that date, is $4,642,483.36. This is the figure the state would use. From discussion earlier in this opinion, it will be recalled that the problem in these cases is not to determine what is proper accounting, but rather to determine the net value of the corporation's property. Original cost is most unlikely to give this result unless a situation has remained completely static. With the passing of time, the value of stock may depreciate or it may increase. The difference in the figures in this case illustrates this very point. In In re Appeal of Hoskins Manufacturing Co., supra , the question before this Court was the proper valuation for privilege fee purposes of the corporation's marketable investments. Its balance sheet showed `marketable investments  at cost less reserve, $671,447.38,' with a notation thereunder `(Approx. market value $378,200).' (P 593.) In the annual privilege fee report, the investments were reflected at market value. The Court pointed out that on its books the corporation carried ledger accounts showing both cost and market value. The Court adopted the lower market value as the appropriate figure. The Court said (p 598): Undiscriminating adherence to some of the figures on a balance sheet cannot reasonably be made the measure of the tax. Because of the various reports and taxes required from corporations and the development of accounting and auditing along mysterious lines, the books and the balance sheet may have strange items and need interpreting. Following the principle laid down in Hoskins, we agree with the state that the value of the stock of its subsidiaries owned by National-Standard is most accurately reflected by taking the value of those subsidiaries as shown to exist on the consolidated balance sheets of National-Standard. Since the stock of the subsidiaries is wholly-owned and not on any stock exchange which would provide a market value, the net worth at which it was carried on the books of National-Standard for the tax years reflects current value and should be used rather than original cost. Finally, appellant argues that if it is required to include the entire net worth of the stock of each of its subsidiaries in the determination of its own net worth for franchise privilege fee purposes the result, in reality, amounts to consolidated reporting, if original cost for valuation purposes is rejected. Based on this premise, appellant charges the state with inconsistency since the state disapproved initial reports which the appellant had prepared on a consolidated basis. Appellant further complains that if its tax base is to include the value of the stock of its subsidiaries at the larger amount of net worth, rather than historical cost, the state in apportioning that base to Michigan by use of the three-factor formula of property, compensation and receipts (appearing in § 5, PA 1921, No 85, as amended [CLS 1961, § 450.305; Stat Ann 1963 Rev § 21.208]), should apply the formula to the consolidated property, compensation and receipts of the appellant and its subsidiaries. The Corporation Tax Appeal Board disposed of this issue in its decision in these words: The Appellant contends that if the investment in subsidiaries is part of the net worth and reflected as equity rather than cost, the 3-factor formula of property, payroll and receipts should be applied because practically all of the business of the subsidiaries is done outside Michigan. The principal offices of the Appellant are in Michigan; all of the correspondence exchanged between the company and the state regarding this appeal originated in Niles, Michigan, where its principal office is located; all of its officers, as indicated in its annual reports, reside in Niles, Michigan; and the Appellant employs the stock of the wholly-owned subsidiaries at its office in Niles, Michigan. Because the intangibles (subsidiary stock) is Michigan located property, the 3-factor formula should not be applied in computing the Appellant's privilege fee. A further answer is to be found in the following provision of § 5, supra: In the case of computing the annual franchise fee prescribed by section 4 of this act, both as to domestic and foreign corporations, such computations shall be made    upon the entire paid-up capital and surplus of any corporation which does not maintain a regular place of business outside this state other than a statutory office. If, as we have held, the subsidiary companies are not included in consolidation and, instead, appellant is required to report as a single corporation, on the record before us the above-quoted provision would become applicable. We find no merit in these contentions of appellant. V. RESERVE FOR FEDERAL INCOME TAXES The creation by National-Standard of a reserve for deferred federal income taxes presents a different question than was decided by this Court in Consumers Power Company v. Michigan (1970), 383 Mich 579. In that case, it was held that since the primary jurisdiction and control of electric utilities lies with the Public Service Commission, the accounting methods required or permitted by it shall control for determination of surplus. See also, Corporation & Securities Commission v. Michigan Consolidated Gas Company (1968), 381 Mich 116, and Detroit Edison Company v. Corporation & Securities Commission (1962), 367 Mich 104. The validity of mandatory or permissible requirements of the Public Service Commission pertaining to electric utilities' corporate surplus was never tested by these cases since it was found that the Corporation Franchise Fee Division of the Department of Treasury could not challenge the authority of the Public Service Commission in this regard. [2] The reserve for deferred Federal income tax purposes has been described earlier in this opinion. Here, once again, we are confronted with a conflict between generally accepted accounting principles on the one hand  which may be good and prudent corporate practice by setting up of reserves to meet future contingencies  and, on the other hand, with the statutory test  surplus is to be determined by deducting from the net value of the corporation's property its outstanding indebtedness and paid-up capital. Future Federal income taxes are not an outstanding indebtedness  they are a mere contingency. The fact that a tax is certain to accrue in years to come does not make it a present debt. If it did, a corporation could remove from surplus any amount of its assets by the simple expedient of setting up reserves for the payment of property taxes or for meeting other eventualities certain to occur in future years in connection with its corporate existence. Reserves for future Federal income taxes present the same difficulty in determining the corporation's franchise privilege fee as did the use of original cost of stock in wholly-owned subsidiary companies. It cannot be too firmly stressed that the corporation franchise privilege fee is an annual tax. It is the tax exacted year by year for the privilege of doing business in the State of Michigan. It must be annually determined on the basis of the corporation's condition as it existed during the reporting period. If the corporation's financial condition in years past or in years to come is injected into the reporting period, the basis for the tax loses any possible rationality. The statute does not permit reserves for future contingent liabilities to be treated as outstanding debts. The disallowance by the state of the reserve for future income taxes was correct. As shown by our prior discussion of its bookkeeping entries, appellant would equate outstanding indebtedness with accounting liabilities. It recognizes that accelerated depreciation is no more than a device for deferring payment of Federal income taxes and does not effectuate any permanent reduction of ultimate tax liability. But appellant further argues that if we reject its claim that reserves for deferred Federal income taxes are properly excludable from surplus, nonetheless, such reserves should be approved as a proper deduction from surplus because, as a result of using the accelerated method of depreciation, there has been a loss in value of appellant's assets for future income tax deduction purposes. In effect, appellant alternatively seeks approval of these deductions from surplus as a form of valuation reserves. It argues that under the statutory definition, previously quoted, surplus means the net value of the corporation's property (less its outstanding indebtedness and paid-up capital) and that by using accelerated depreciation appellant will experience loss of value of its assets for future income tax deduction purposes which should be recognized by permitting charges to annual surplus  such deductions from surplus having the effect of a current reduction of net value. From the standpoint of annual franchise privilege fee determination, there is no real distinction between appellant's claim that reserves to meet deferred Federal income taxes are an allowable deduction from surplus and its alternative claim that reserves in the same amount are deductible from surplus if carried on the corporation's books as representative of a loss in value of assets for future income tax deduction purposes. In either instance, accruals to the reserve anticipate a future condition. As heretofore stated, the privilege fee is an annual calculation made from current values as they existed during the reporting period. For that reason, this type of bookkeeping entry is not binding on the state in its determination of corporate surplus in conformity with the statutory meaning. In the case of American Standard v. Michigan, the judgment of the Court of Claims is reversed and the judgment of no cause for action is entered. Costs to the State of Michigan. In the case of National-Standard v. Department of Treasury, the decision of the Corporation Tax Appeal Board is affirmed. Costs to the State of Michigan.