Ohio Department of Taxation Information Release

CF 1991-03 - Credit for Investment in Qualified Subsidiaries - July 16, 1991

For taxable years ending after April 9, 1991, Substitute Senate Bill 223 (effective April 10, 1991) amends and clarifies various provisions of the franchise tax credit for investment in qualified subsidiaries (ORC section 5733.067). Set forth below is a short summary of the new law. Following the summary is a more detailed discussion and analysis.

Summary

The new law:

• amends the definition of a "subsidiary" for purposes of determining the credit.
• eliminates the credit on "advances" (loans) to subsidiaries.
• clarifies that the credit is computed only on direct investments in subsidiaries.
• reduces the net worth liability of a subsidiary (for purposes of computing its parent corporation's credit) by the amount of any credit to which the subsidiary is entitled by virtue of being a parent of a lower-tiered subsidiary.
• expands the conditions under which an amended franchise tax report must be filed when adjustments to either federal returns or franchise reports of the parent or the subsidiary affect the credit.

Discussion and Analysis

• Definition of subsidiary - The new law provides that a subsidiary must be more than 50% "owned or controlled either directly or indirectly by the taxpayer or by related interests that own or control either directly or indirectly more than 50% of the . . . taxpayer."  The previous statute required ownership of more than 50% of the subsidiary's stock. The new statute, on the other hand, requires either ownership or control of more than 50% of the subsidiary's stock. In addition, the previous statute required more than 50% ownership of the subsidiary by another franchise taxpayer corporation; the new statute provides for more than 50% ownership or control of the subsidiary by a franchise taxpayer corporation or by related interests that own or control the taxpayer corporation. See ORC division (A) of section 5733.067.

Example #1

Facts: Mr. and Ms. X and their immediate family directly own 80% of franchise taxpayer Y Inc. Mr. and Ms. X and their immediate family also own 40% of franchise taxpayer Z Inc. In addition, Y Inc. owns 20% of Z Inc. (see illustration on next page).

Analysis: Z Inc. is a subsidiary because more than 50% of Z's stock-is owned directly or indirectly by the X family which owns more than 50% of taxpayer Y Inc. The X family directly or indirectly owns 56% of Z's stock. The X family directly owns 40% of Z Inc. stock and indirectly owns another 16% (.80 X .20 =.16).

X's ownership of Z:
Direct	40%
Indirect (80% x 20%)	16%
TOTAL	56% ====

X's direct and indirect ownership of Z exceeds 50%. Therefore, Z is a subsidiary of Y.

Since more than 50% of Z is directly and indirectly owned or controlled by X and since X directly or indirectly owns or controls more than 50% of Y, Y can claim the credit with respect to Y's direct investment in subsidiary Z.

• No credit on advances (loans) to subsidiaries - Under the new law the taxpayer will compute the credit only on its investments in subsidiaries. Under the old law the taxpayer computed the credit under the first limitation on both its investments in and its advances to subsidiaries. The old law gave the taxpayer an unintended benefit because while the credit is intended to eliminate double taxation of the same net worth included on both the taxpayer's books and on its subsidiary's books, the credit extended to loans from a taxpayer to its subsidiary. However, because a loan to a subsidiary is not included in the subsidiary's net worth? such amounts can not be "double net worth taxed" and should not generate a credit. The new law corrects this error. See division (B)(1) ORC section 5733.067.

• Credit limited to direct investments in subsidiaries - The new law specifically states that the credit under the first limitation is computed on the taxpayer's direct (as opposed to both direct and indirect) investments in subsidiaries. The old law provided for a credit on the taxpayer's investments in subsidiaries. This change negates the Board of Tax Appeals' adoption of the "look through" approach to situsing investments in Cliffs International Inc. et al, v. Limbach (March 24, 1989), BTA Case No. 87-H-51. See division (B)(1)(a) of ORC section 5733.067.
  
  Note: For purposes of determining whether or not a corporation is a "subsidiary" both direct and indirect investments are considered. However, the taxpayer computes its credit only on its direct investments in subsidiaries. Thus, in the example above, Z Inc. is a subsidiary by virtue of the combined direct and indirect investments. However, Y Inc. will compute the credit only on its 20% direct investment in Z Inc.

• Reduction of credit for multiple tiers of taxpayers claiming the credit - The credit is available to a parent corporation on its direct investment in subsidiaries if both the parent and the subsidiary pay the tax on the net worth method. The credit is also available to a subsidiary corporation by virtue of being a parent of a lower-tiered subsidiary. The new law provides that in computing the investor's credit under limitation #3, the tax charged each subsidiary must be reduced by the amount of any credit to which the subsidiary is entitled by virtue of its investments in lower-tiered subsidiaries. The old law provided for no such reduction. See division (B)(3) of ORC section 5733.067.

Example #2

Facts: A Corp., B Corp., and C Corp., are Ohio franchise taxpayers each of which have paid their franchise tax on the net worth basis. A Corp. is the parent of its 100% owned subsidiary, B Corp.; and B Corp. is the parent of its 100% owned subsidiary, C Corp. The tax before credits for each corporation is listed below.

Assume that B Corp. is entitled to a $200 credit by virtue of its investment in C Corp. (for purposes of this example assume that the allowable percent of the credit is 100%). Also, assume that A Corp. is entitled to a credit by virtue of its investment in B Corp. and that pursuant to division (B)(3) of ORC section 5733.067 the difference between B's tax on net worth and its tax on net income determines A's credit.

Analysis: Under the old law A's credit is $1,000, the difference between B's tax on net worth and B's tax on net income ($4,000 - $3,000). However, B's tax was reduced $200 by virtue of the credit for its investment in C. In computing A's credit under division (B)(3) of ORC section 5733.067, B Corp's tax on net worth should be reduced by the amount of B's credit for its investment in C. Thus, for purposes of computing A's credit, B's tax on net worth should be $3,800 ($4,000 - $200) and A's credit should be limited to $800 ($3,800 - $3,000) rather than $1,000. The new law corrects this error.

• Expanded conditions under which an amended franchise tax report must be filed - The new law clarifies that the taxpayer must file an amended franchise tax report if its credit is affected by adjustment to either the federal income tax return or the franchise tax report of the taxpayer or a subsidiary. The statute prior to amendment by this legislation required that the taxpayer file an amended franchise tax report if the taxpayer's credit was affected by an adjustment to the franchise tax report of a subsidiary, whether such adjustment was initiated by the subsidiary or by the Tax Commissioner. However, a taxpayer's credit may be affected not only by adjustments to the subsidiary's franchise tax report but may be affected as well by adjustments to its own franchise tax report. See division (D) of ORC section 5733.067.

Example #3

Facts: D Corp. claims a credit on its investment in C Corp., a qualifying subsidiary. Upon audit the IRS increased D Corp's federal taxable income. However, the franchise tax effects of the IRS audit adjustments did not increase D's tax on net income above that already paid on the net worth basis. D Corp's credit is determined under limitation 2 (the amount by which D's tax on the net worth basis exceeds D's tax on the net income basis).

Analysis: Although the IRS audit adjustments have no effect on D's franchise tax before the credit, the IRS audit adjustment reduces the credit (under the second limitation) by the amount of increased tax computed on net income. ORC section 5733.067, as amended, clarifies that the taxpayer must file an amended franchise tax report if the credit is affected by adjustment to either the federal income tax return or the franchise tax report of the taxpayer or a subsidiary.

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Franchise Tax Information Releases are not "Opinions of the Tax Commissioner" within the meaning of ORC section 5703.53. Accordingly, the Tax Commissioner is not bound by this release. Nevertheless, the above discussion does reflect the Income Tax Audit Division's interpretation of the law.

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