Technical Advice Memorandum TAM-CF 96-1

Subject: Deferred Liabilities/Deferred Tax Assets
Schedule: Corporate Franchise Tax - Article 3, Schedule C
Statute: N.C.G.S. § 105-122
Issued By: Corporate, Excise, and Insurance Tax Division
Date: August 1, 1996
Reference: TAM-CF 96-1

I. CHANGE IN ADMINISTRATIVE PRACTICE

For tax years ending on or after July 31, 1996, those liability accounts commonly labeled "deferred liabilities" which are required under the referenced statute to be included in the capital stock, surplus and undivided profits base on which the tax liability may be measured, may be reduced by the deferred asset amount that resulted when the deferred liability was required under the financial accounting standards to be determined and recognized for financial reporting purposes. Provided, when a separate deferred tax asset account is selected or required, the amount(s) must clearly be identified with a specific deferred liability and the reduction permitted for the specific deferred tax asset may not decrease the related deferred liability below zero (0).

II. PRESENT ADMINISTRATIVE PRACTICE

Under N.C.G.S. § 105-122, the capital stock, surplus and undivided profits base (net worth) permits only those liabilities that are definite and accrued legal liabilities to be excluded in the determination of the taxable amount of this base. Deferred liabilities that do not meet the explicit requirements of "definite and accrued" increase the taxable amount of this net worth base on the franchise tax return filed annually and a reduction of this base is not permitted for a deferred tax asset that may have resulted from a deferred liability or other credit accounts includible in the franchise tax base.

III. EXPLANATION OF CHANGE

Corporations complying with the requirements of the Financial Accounting Standards Board ("FASB") contend that the department's position of including a deferred liability in the computation of the net worth base should permit an offset or adjustment for the deferred tax asset required to be computed under the accounting standards without regard to how the deferred tax asset is reflected on the financial statement. Under the subject provision, the determination of net worth subject to tax does not seem to permit a reduction for a deferred tax asset account and there have been legal opinions and decisions rendered to that effect.

A further review of the concept for determining the taxable franchise base for those corporations doing business in this state using the valuation and/or capital employed in the state as the primary basis indicates a more equitable and consistent position is to recognize that such value (net worth) is incorrectly stated when the total amount of a deferred liability is included without a contra or netting adjustment for the deferred tax benefit resulting directly from such liability.

However, it is well established that net worth for franchise tax purposes is not required to be fully reconciled with the term as used for financial reporting purposes. The notable exception relates to those accounts labeled deferred liabilities which cannot meet the definite and accrued criteria and therefore are includible in the computation of net worth for franchise tax purposes. In the past, the most common "liability" causing controversy was the deferred tax liability that may arise from installment sales, accelerated deductions for tax purposes, etc. Also present for some time and becoming an issue more often are the employee post retirement liabilities required by various FASB statements that do not meet the definition of a liability under the subject statute and are required to be added to financial net worth in computing the franchise taxable base. The same Board requiring the financial standards for estimating/ computing the liability further requires a deferred tax asset be determined and either posted to an asset account or posted as a debit to the related deferred liability account.

There would not he an issue on this matter if the deferred liability was permitted in computing the franchise tax base. However, since it is clearly not allowed in computing net worth for franchise tax purposes, the effect of also not allowing the amount to be netted by the deferred tax asset is to include in the net worth base an amount in excess of the gross liability i.e., the amount of deferred tax asset attributed to the deferred liability.