Tax Type
Corporation Income Tax
Description
DISC adjustments; Excess cost recovery (ACRS)
Topic
ACRS Modifications
Computation of Income
Subtractions and Exclusions
Date Issued
11-07-1986
November 7, 1986
Re: §58.1-1821 Application; Corporation Income Tax
§58.1-446 DISC adjustment
§58.1-323 Excess Cost Recovery
Dear *****************
This is in response to your letter dated July 2, 1985, to the auditor in which you protest the assessment of additional taxes for 1982 and 1983. We have treated your letter as an application for correction of an erroneous assessment under §58.1-1821. Your letter raises three issues which will be discussed separately.
DISC Adjustments
You disagree with the adjustment under §58.1-446 for DISC income. As you know, the issue of DISC adjustments is presently in litigation before the Virginia Supreme Court in the case styled Commonwealth v. General Electric Company. Until there is a final decision in that case we require that the adjustment be made. You may wish to preserve your judicial remedies by paying the assessment and filing a protective claim for refund under §58.1-1824 within three years of the date of the assessment.
ACRS and Deferred Intercompany Transactions
The taxpayer files a consolidated federal and Virginia return. Under Treasury Regulation §1.1502-13, when one affiliate (hereafter S) sells property to another affiliate (hereafter P) gain or loss on the sale of property is deferred. P computes its separate federal taxable income using depreciation based on the purchase price. S computes its separate federal taxable income including a portion of the deferred gain or loss based on the depreciation claimed by P. The depreciation of P (to the extent the basis is more or less than it was in the hands of S) and the deferred gain or loss of S offset each other on the consolidated return. When the property is sold outside of the affiliated group S must include in its federal taxable income the balance of deferred gain or loss. Under federal rules the portion of the deferred gain or loss taken into taxable income retains its character as ordinary income or capital gain.
You state that "[t]he net effect on the consolidated group is to limit the basis upon which depreciation is taken, to the cost of the asset rather than the selling price." Based on this rationale the Virginia return reduced the ACRS addition by 30% of the deferred gain or loss taken into taxable income. The auditor removed this adjustment and based the addition on the full amount of the federal ACRS deduction.
Although the federal adjustment for deferred gain or loss on an intercompany transaction is sometimes affected by the federal ACRS deduction, it never changes the federal ACRS deduction. The purpose of the federal regulation is to treat inter-affiliate sales in the same manner as sales outside the affiliated group, except that the selling affiliate is allowed a deferral of gain or loss. This purpose may clearly be seen when various contingencies are examined. For example, sale of the property outside the group, changes in the ownership of the affiliates, and a subsequent election to file separate federal returns, may all cause immediate recognition of the deferred gain or loss. In no case is the depreciation affected.
Accordingly there is no authority for the reduction in the Virginia ACRS deduction claimed by the taxpayer. The ACRS addition is equal to 30% of the federal ACRS deduction and is not affected by the amount of deferred gain or loss that may be included in the consolidated federal return. The adjustment by the auditor is correct.
ACRS and Proceeds on Disposition
Under the Accelerated Cost Recovery System gain or loss must be recognized upon the sale or other disposition (including retirement) of recovery property. This involves accounting entries to the unadjusted basis and depreciation reserve. In lieu of making these accounting entries, I.R.C. §168(d)(2)(A) allows an election to include in income all proceeds realized on the disposition of property in a mass asset account.
The consequences of this election are that the ACRS deduction in the year of the disposition and in subsequent years will continue to reflect the unadjusted basis of the asset, but income will include the gross proceeds without any reduction for the remaining basis of the asset. In addition, the potential of capital gain treatment is foregone (assuming the gross proceeds exceed the unadjusted basis).
The taxpayer has elected to include in taxable income the proceeds from the disposition of assets in a mass asset account. In its Virginia return the taxpayer subtracted 30% of such proceeds on the grounds that "[s]ince Code of Virginia §58.1-402(b)(3) allows only 70% of the federal ACRS deduction, it should likewise include in Virginia taxable income 70% of the income required to be recognized for federal purposes." The auditor disallowed the subtraction.
Virginia law has no provision allowing such a subtraction. The subtraction claimed is roughly similar to a basis adjustment when the election is not made and gain or loss is recognized. The department has never permitted or required any adjustments to basis because of the ACRS modifications.
Determination
The assessment of additional tax is correct and is now due and payable. You will shortly receive an updated bill with accrued interest to date. The bill should be paid within thirty days to avoid accrual of additional interest.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner