Hon. Tom Reavley                              Opinion     No,     S-217
Secretary    of State
Capitol   Station                             Re:   Proper    treatment     in a fran-
Austin,   Texas                                     chise   tax return      of an amount
                                                    shown as “reserve         for ‘vaca-
                                                    tion   pay ” for    vacations    earned
                                                    during    the taxable       year but
                                                    to be taken during          the suc-
Dear      Mr.   Retivley:                           ceeding    year;

                 You have    requested.     an.,opinion      of    this   Office     as
follows

              “We have a fact     situation       involving     the proper
classif  ication    of a certain     reserire   ‘item.      Our   tentative’
decision    to classify     the reserve      as a part of the surplus                      or
net worth     for franchise    tax purposes        has been challenged                    by
the taxpayer.

            “The reserve     is identified      in the liability      section
of the balance     sheet  presented     in the corporationls       franchise
tax return    as qReserve    for Vacation     Payc.   Upon our request-
ing information     as to the exact      nature   of the use to be made
of the amount so set aside,         the corporation     subm~itt.ed t.he
following   facts:

                “‘This       amount represents         an estimate       of the
       liability         to employees        existing      December     31. for
       vacation        pay earned        on and prior       to such date but
       which will          not be paid until          th,e following       y!ear.
       Even though an employee                 completes      his vacation        for
       one year        in December;        he may start        his vacation
       for the following             year on January          1.    An employee’s
       right       to    a  vacation      beginning      on   January    1 is es-
       tablished         by virtue       of his having        performed      ser~vices
       during      the preceding          year.      Thus,    the Company has a
       definite        liability       for vacations        at the end of each
       year.       Since      it  is  the    general     accounting      policy
       . . . .       to    charge    against      income    “.he  expense
Hon.   Tom Reavley,        page    2          (Opinion      No.   s-217)



       attributable            thereto,       even though     the expense
       is not paid until              the suhsequent         year,     it was
       decided        that     this    liability      should    also     be accrued
       on the corporate              books.       It is not considered
       proper       accounting        to treat      such a liability         as a
       surplus       reserve.         As further       evidence      of this
       liability,          the Fed,eral        Government     has allowed       . .    .
       deductions          for    income      tax purposes,      on an accrual
       basis      for all       years     audited    ,after   1941.’

               “With the foregoing         facts   before    you, please
       advise    this    office    if an amount designated        in the
       balance     sheet     as ‘Reserve     for Vacation     Pay* should
       under the franchise           tax law, be classified       as a
       surplus     item for     franchise      tax purposes.”

               It is immaterial        what    the Federal      Government    does
concerning       deductions     for   income     tax purposes.       The Secre-
tary of State        is not bound by Federal          Income Tax Laws in the
administration         of the franchise        tax laws of this       State,
This position        is based     on an analogous       situation     concerning
decisions     of federal      courts     construina     the income tax
statutes.        In Houston,      Belt 8 Terminal      Ry. Co. v. Clark,         122
S.W.2d    356 (Tex.Civ.App.,          1938 sustained        in 135 Tex. 388,
143 S.W.2d      373, ‘1940)     the Couri      said:

                “Appellant      contends     that    the part     of said
       opinion      relied     upon by appellees         is pure obiter
       dictum;      and that       the decision      is out of harmony
       with    later     decisions      of Federal      Courts    constru-
       ing the income tax statutes.                 As to such alleged
       conflicts       we have made no search,             because    they
       are not material.              Such decisions       are not binding
       on this     Court.”

             The only   question      to be determined       is,  does                the
“Reserve   for Vacation     Pay” constitute        “surplus”     within                the
purview  of the franchise        taxing   statute?      A. B. Frank                   B Co.
v. Latham,     145 Tex.   30, 193 S.W.2d 671, 672 (1946).

            Article   7084, Vernon’s         Civii    Statbes,     levies     a
franchise   tax against     corporaticr.5       based    upon that proportion
of the outstanding      capital    stock,     r-urp? ;J.:. and undividedprofi                 ts,
plus   the amount of outstanding          bonds,    notes,     and deben.tures,
Hon.     Tom Reavley,             page   3          (Opinion    No.   S-217)



as     the   gross        receipts,from       the    business    done    in Texas    bear
to     the   total        gross    receipts    of    the  corporation.

              Article     7089,   V.C.S.,      provides    that    all corpora-
tions    required      to pay a franchise         tax shall     between      January
First   and March 15th of each year make a report’ to the
Secretary      of State,     on forms furnished          by that officer,         show-
ing the condition         of such corporation           on the last      day of the
fiscal    vear.      It further     requires,      among other       things,     that
“Said    report    shall    gi,ve the’cash      ~value of all      gross-assets       of
the corporation.”         (Emphasis     ours.)

              In United   North & South Development                       Co.   ‘v. Heath,
78   S.W.2d   650 (TexCi,v.App.     1935, error   ref. ),                 the   Court   said   in
defining    the surplus     account   of a corporation:
                 11
                      .   .   .  The surplus    account   represents         the net
         assets    of         a corporation     in excess    of all       liabilities
         including            its capital    stock.”

           Article  1.02,    Section    A (12),     of the Business,Corpora-
tion Act of Texas,    states    that “surplus”        means excess   of the
net assets  of a corporation       over  its    stated   capital.

             In our opinion,     a liability,       within     the terms of our
franchise    tax laws is not created          by the fact      that employees
may take their     paid vacations     in a.year        subsequent      to the year
in which thee paid vacations       were earned.          Employee     A begins
his employment     on the first     of the corporation’s           fiscal    year and
ea’rns a vacation     for that year but does not take same during
that year.      The following    year he also       earns     a paid vacation
and takes    only one vacationthat          year   in that his second         paid
vacation   is taken the following         year.      It is thus seen that          in
no one year does the employee         take more than one vacation--
the same amount of paid vacations             as he actually       earns   during
that particular     year.

                In our opinion      a “Reserve  for Vacation     Pay” set-up
on the books       of a corporation       in any one year,    to pay em-
ployees     for   th,at period    of time in th,e future     when the em-
ployees     take their     vacation,     should be treated    as’burplus”
for   franchise      tax purposes.
Hon.   Tom Reavley,      page   4     (Opinion     No.   S-217)




              A “Reserve    for Vacation    Pay” set up on the
       books   of a corporation       in any one year,    to pay the
       employees    for  that period     of time in the future
       when the employees       take their    vacation,   should   be
       treated   as “surplus    ” for franchise      tax purposes,
       under Article     7084,   V.C.S.

APPROVED:                                  Yours    Avery truly,

W. V. GEPPERT                              JOHN BEN SHEPPERD
   Taxation Di.vision                      Attorney General of      Texas

MERT STARNES
   Reviewer

ROBERT E. ANDERSON
   Reviewer

L.   W. GRAY
     Spec’ial Reviewer

DAVIS GRANT
   First Assistant

JOHN BEN SHEPPERD
   Attorney Genera.1
