Rev. Rul. 68-305

Advice has been requested with respect to the proper taxable year of deduction under section 461(a) of the Internal Revenue Code of 1954 of amounts paid by a corporation on its estimated California Bank and Corporation Franchise Tax.

The California Bank and Corporation Franchise Tax is an annual tax imposed on certain types of corporations for the privilege of exercising the corporate franchise in the State. The amount of the tax is not based upon the net income of the corporation received during the `taxable year' (the year for which the tax is paid) but upon the income of the next preceding or `income year,' special provisions being made for the first two years after the corporation commences business in the State. Returns for the tax are due within 2 months and 15 days after the close of the `income year.' In the event the corporation dissolves or withdraws from the State during a `taxable year,' it is required to pay a tax only for those months during the `taxable year' that preceded its dissolution or withdrawal.

Prior to January 1, 1965, the franchise tax accrued, under California law, on the first day of the `taxable year.' The tax was payable in two equal installments on or before the 15th day of the third and ninth months following the close of the `income year,' that is, the third and ninth months of the `taxable year.'

California legislative action taken in 1963 (Cal. Stats. 1963, 1st Ex. Sess., c. 2) amended the California Revenue and Taxation Code with respect to the franchise tax measured by the net income of years beginning on or after January 1, 1965. The accrual date of the tax was repealed, and the authority to pay the tax in two equal installments during the `taxable year' was eliminated.

New section 25441 was added to the California Revenue and Taxation Code and became operative January 1, 1965. It requires a corporation to file `within 5 months and 15 days after the beginning of its income year, * * * a declaration of estimated tax * * * to be computed on the basis of the estimated net income of the income year.'

Also operative January 1, 1965, new section 25563 of the California Revenue and Taxation Code provides that a percentage of the estimated tax shown on the declaration (but not less than a specified minimum) is payable on or before the 15th day of the 6th month of the `income year.'

The 1963 legislation also amended the California Revenue and Taxation Code to provide that the balance, if any, of the franchise tax is payable not later than the time for filing the return, that is, 2 months and 15 days after the close of the `income year.'

For example, a calendar year corporation is required to file its franchise tax return for the `taxable year' 1965 by March 15, 1965; the tax to be measured by its net income for 1964, the `income year.' The tax for 1965 is payable in two equal installments on or before March 15, 1965, and September 15, 1965. Further, on June 15, 1965, the corporation is required to file a declaration of estimated tax for its `taxable year' 1966 computed on the basis of its estimated net income for 1965, the `income year.' The corporation is required to pay all or a portion of its estimated tax for `taxable year' 1966 on June 15, 1965. The balance, if any, of its tax for `taxable year' 1966 (measured by the corporation's net income for 1965, the `income year') is payable on or before March 15, 1966 when the corporation is required to file its return for its `taxable year' 1966.

In the event the corporation dissolves or withdraws from the State during a `taxable year,' it is required to pay a tax only for those months during the `taxable year' that preceded its dissolution or withdrawal. Therefore, if the estimated tax paid is in excess of the tax due for the `taxable year,' any overpayment shall be refunded. Section 26071 of the California Revenue and Taxation Code.

Section 461(a) of the Internal Revenue Code provides, in part, that the amount of any deduction allowed shall be taken for the taxable year that is the proper taxable year under the method of accounting used in computing taxable income.

Section 1.461-1(a) of the Income Tax Regulations provides, in part, that under the cash receipts and disbursements method of accounting, amounts representing allowable deductions shall, as a general rule, be taken into account for the taxable year in which paid. Under an accrual method of accounting, an expense is deductible for the taxable year in which all the events have occurred that determine the fact of the liability and the amount thereof can be determined with reasonable accuracy. No accrual shall be made in any case in which all of the events have not occurred that fix the liability.

With respect to a corporation using an accrual method of accounting, its liability to pay the franchise tax is not determined until the first day of the `taxable year.' Such liability cannot be determined before the first day of the `taxable year' during which the corporate franchise is exercised, for the reason that it is the exercise of such franchise that fixes the tax liability of the corporation. Therefore, since all of the events that fix the amount of the tax and determine the corporation's liability to pay it have not occurred until the first day of the `taxable year,' the tax does not accrue until that time.

Accordingly, for purposes of section 461(a) of the Code, a corporation using an accrual method of accounting may not deduct until the `taxable year' amounts paid during the `income year' on its estimated California Bank and Corporation Franchise Tax as all the events that determine the fact of liability do not occur until the first day of the `taxable year.' A corporation using the cash receipts and disbursements method of accounting may deduct in the year in which actually paid amounts that it is required to pay on its estimated California Bank and Corporation Franchise Tax.