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                                           THE        ATTORNEY                   GENERAL
                                                            0F TEXAS
                                                        Amrn~.TscxAn            76711
                    JOHN    L     ElI.L
                A-aIN-          o-
                                                                 July 11, 1973



                           Honorable    Robert S. Calvcrt                        Opinion   No.   H-62
                           Comptroller     of Public Accountr
                           State  of Texas                                       Rc:       Whether reserve    for
                           Auetin.   Texrr                                                 relining furnace ir to
                                                                                           be included as part of
                                                                                           rurplur of corporate
                                                                                           taxpayer in computing
                           Dear      Mr.   Calvert:                                        franchire  tax.

                                    The quertion here prerented        ir whether a reserve       account  for relining
                           furnacer     ured in the steel production      procerr    ir to be included l e part of the
                           “aurplua”     of the corporate     taxpayer in computing the Texan Franchise            Tax
                           under Article 12.01, Title 122A, TaxationzGenerrl,               V. T. C. S. The firebrick
                           used to line the furnaces        progrernively    deteriorates    with uee necessitating     a
                           relining of the furnacea approximately           every five years     and the reserve
                           account ir ured to provide the fundr necessary              for thir purpose.     The cost
                           value    of thefirebrickliningof      the furnace is reflected      on the corporate    books
                           aa a fixed~aaaet which contribute6          to the ourplum of the corporation.

                                    Article 12.01 definer “taxable capital” upon which the franchire   tax
                           may be computed,       aa including the stated capital, surplus, and undivided
                           profite.

                                      “Surplur”   aa 80 ured is not defined.

                                                      “The Legislature    did~not undertake to define
                                             what is meant by the term ‘surplus. ’ In a generally
                                             accepted     commercial    sense, it usually     applies to
                                             funds remaining on hand after fixed charges or lia-
                                             bilitiee have been deducted.       As applied to corpora-
                                             tione, it has been held to be the value of all the cor-
                                             poration’s     assets after its liabilities,   including its
                                             capital stock, have been deducted.           Willcutr v. Milton




                                                                       p. 264
Honorable      Robert   S. Culvert,     page 2 (H-62)




                Dairy Co., 275 U.S. 215, 40 S. Ct. 71, 72 L. Ed.,
                247. Judge Brandeia.        diecunning the term aa used
                in the Federal Revenue Act, ured the following lan-
                gurge    in Edward6 v. Douglar,        269 U.S. 205, 46 S.
                Ct. 85, 88, 70 L. Ed. 235; ‘The word “rurplur”             ia
                a term commonly        employed in corporate     finance
                and accounting to designate an account on corporate
                bookr.     But thir is not true of the wordr “undivided
                profits. ‘I ’ The surplus      account repreeentr      the net
                areete of a corporation       in excese of all liabiiities
                including its capital stock.        This surplus may be
                 ‘paid in surplus, ’ as where the stock in irrued at
                a price above par; it may be ‘earned surplus,’ as
                where it was derived wholly from undistributed
                profits;   or it may, among other things, represent
                the increase     in valuation of land or other aareta
                made upon a revaluation         of the company’r    fixed
                property. ‘I. United North and South Development
                 Co. v. Heath, 78 S. W. 2d 650 (Tex. Civ.App.,
                Auetin, 1934, error ref.) (emphasis          added)

          Section (12) of Article     1.02,    Texas     Business   Corporation    Act,   V. T. C. S.,
defines     “Surplus” as:

                 ” . . . the excess of the net assets           of a corporation
                 over its state’d capital. ” (emphasis          added)

       The Comptroller   of Public Accounts     in Ruling No. 9 of 1961, amended
 June 1965, and filed with the Secretary    of State in June, 1965, states:

                 “Surplus,   ae defined in Article     1.02, Business
                 Corporation    Act, V. A. T. S., is ‘the excess of the
                 net assets of a corporation     over its stated capital. ’
                 Surplus,   therefore,  will include all surplus accounts
                 carried on the books,    such as earned surplus,         sur-
                 plur from appreciation     of assets,    contributed    surplus,
                 capital or paid in surplus and ‘reduction         surplus’




                                              p.   265
Honorable   Robert   S. Cdvert.   page 3 (H-621




             created by or arising out of a reduction of etated
             capital by any of the methoda authorized      by the
             above Act.   It will aleo include all rurplur   rererver
             no actual accrued liabilities.   . , . ” (emphrrir   added)

      Thie reprerentr    the administrative     conrtruction   of the term   “rurplur”
aa ured in Article  12.01.

       Net arretr are defined as the amount by which the total assets of a
corporation    exceed the .total debts of the corporation. Art. 1.02 (10).
Burineie    Corporation  Act.

       In Huey & Philp Hardware Co. v. Sheppcrd,          251 S. W. 2d 515 (Tcx.
1952), a reserve     for bad debts wae allowed as a deduction to reflect the
decrease    in net rraet value.     On the other hand, the Court of Civil Appeals
in United North and South Development          Co. v. Heath, auprr, held that a
revaluetion.of    oil properties   upward to reflect their true value war a proper
part of the corporation’s      surplus.   A,nd see Fulghrm v. Gulf, C. &S. F. Ry.Co.,
288 S. W. 2d 811 (Ter. Civ,App.,        Austin, 1956, error ref.,  n. r. e.).

       In order to arrive at this net asset value, depreciation         accounts have
long been rllowed by the Comptroller        of Public Accounts ae a deduction.
Such accounts theoretically      are used to replace    depreciable   assets at the
end of their useful service life.      Thir also is the purpose of the Reserve
Acount for Relining Furnaces here involved.           The firebrick   lining of the
furnacer   deteriorate0    through its use over a five year period and must then
be replaced.      The reserve   account performr     the same function as a depre-
ciation account and, in our opinion, it likewine should be allowed as a deduc-
tion from “8urpIur. ” Such a deduction r.eflectr the lore in value of the fire-
brick lining shown otherwise       on the corporate    books at its coot value.

       Of course,    if any other depreciation   ~&count exists regarding the value
of this same rreet,     a double deduction would result which is not allowed.
Huey & Philp Hardware        Co. v. Shepperd,    supra.   It is our understanding
that no such other account exists,      but that the reserve    account   performs
this function.    We 81~0 s.ssume that the amount in the reserve         account is a
true  reflection  of the depreciated   value of the firebrick    lining.




                                     p.   266
Honorable   Robert   S. Culvert,    page 4 (H-62)




        In City of Columbur v. Public Utilitier Commirrion,     93 N. E. 2d
693   (Ohio ISSO), a “depreciation reserve”   was described as:

              81. . . an accounting technique whereby a fund ir
              built up from annual contributionr,        a~ an item of
              expeme    of operation,    over a period of time repre-
              oenting the service life of.      . . [an rrset] . , . to
              offset and to equal in value the ultimate lose through
              use of the . . . [asset]    . . . so that at the end of
              such service    life the depreciation    renerve fund will
              replace the property      so worn out by the various
              factorr  of depreciation.     . . .” (at p. 701)

     Here the reserve   account for relining of the furnaces  performs     the
same function and should be treated as a depreciation   type account that
may be deducted from “rurplua” as that term is ueed in Article      12.01; eupra.

                                        SUMMARY

                      A reserve     account for firebrick    relining of
              furnaces    used in steel production that must be per-
              formed approximately         every five years,     and which
              reflects   the reduced value of the firebrick        lining is
              a~depreciation      account that may be deducted from
              “surplus,    ‘I as that term is used in Article 12.01,
              Title 122A, Taxation-General,          V. T. C. S., in com-
              puting the Texas Franchise         Tax.   This conclurion
              aaaumea     this reserve    account is the only deprecia-
              tion deduction taken on the capitalized         coot value of
              the firebrick     lining and that it correctly    reflecte    the
              depreciated      value of such property lost through and
              by virtue of its use in the steel production         process.

                                                  -Very   truly yourn,




                                              u     Attorney   General    of Texas




                                         p. 267
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b               Honorable     Robert    S.   Calvert,   page    5   (H-62)



                APPROVED:




                Opinion     Committee




                                                               p. 268
