_.~                                     .
SeCr8tam Of Stat8
Capitol Station          Re:   The inclusion of unkeal-
Austin,~ Texas '.              ized prdf'it from'lnstall-
                               ment sales as sur@lus for
                               franchise tax purposes.
Dear Slr:~

          ,Your request .for reconslderation.of Opinl6n
RO. 0-5680 addressed to Ron:Sldney    Latham, Secretary
of State, approved January 8,. 1944, by Hon. Grover
Sellers as Attorneg General is.as follows:.

          "During recbnt months the St&Audi-
     tor has been engeged in’ exsmlnlag’ cotipora-
     tions' books to determine if th6 ptiop@r "
     amount of~~taxable capital for franchise' ).
     tax purposes .has been reported in th8 si+'
     nuai reports:filed in fihis ofriC8.   In not
     a few oases he has r8conDWnd8d assessment
     of franchise tsx upon unrealized gross
     profi-t from installment sales of merahan-~
     dlse. Several such cases Involve corpora-
     tions dealing in real estate, selling also
     on the Installment basis. The accounts and
     notes XWc8iVabl8 are spread over. a period
     Of S8V8rd mOnthS.and 8V8tl  88V8Fd y8aZ’S.
     As collections sxe made the net profit is
     transf8Pr8d surplus and'uadlvided profits.
     Taking intb earning6 the net profit only
     as, If and when accounts and notes:are col-
     lected results in inaome tax liability on
     only the net gross income involved in any
     one ye* and not upon the gross smount'at
     date-of the contract..sale'.~.Tbls has long
     been reconnleed bs th~mmlssioner'6f        In-
     ternal Re~ehue. -

          "Your attention iS directed to Attor-
     ney G8n8ral'S opinion dated April 30, 1934.
     For the sake of brevity we shall not qUOt8
     from the opinion, but it Is noted that a
     sound and reasonable construction of the
     meaning of 'surplus aed undivided profits'
     la presented, both from the standpoint of
78
     HOtI. Ben Ramsey - PSg8 2 (v-774)



          accounting terminology and the recognition
          under th8 F8d8rti Income Tax Law Of the
          equity of th8 treatment of Unr8aliZ8d prof-
          its. It being held in the opinion that such
          profits should not be Included as tSxabl8
          capital for franchise tax purposes, this
          Office has cOnSiSt8ntlg fOllOW8d the rUlirg
          and D8V8F attempted t0 .5tdj,UASt the P8pOl’tS SO
          as to include unrealized profits from install-
          ment sales as surplus for franchise tax pur-
          pOS8S.


               "DUXlrilIg
                        1943, hOWeVer, the question Was
          again raised and in opinion No. 0-5680, dated
          January 8, 1944, it was held'that unrealized
          profits should b8 taxed but only to the ex-
          tent Of the cash ValU8 of the &count.            A
          Settlement WaS &88d       UpOn  in  the CaS8   in-
          volved which prompted the request for the
          OpiniOn, but upon th8 basis of th8 corpora-
          tion's appraisal: You can readily 888 that
          an attempt to plsc.8 a cash value upon an ac-
          count of this nature would Involve expensive
          InvestIgatIona which would be time-aodsuming.
          Indeed, such a prOCedUr8 would b fraught with
          many UlIknOWn and UnfOr8S88lI     faCtOr's. .Them
          would be COlleCtiOn expenses, estimated in-'
          come tax -tO be paid Upon net future       CO118C-
          tionS and fOr8clos~8s~        :

                    "IIIalillOSteVel’7 CaS8 without 8XC8ptiOn
          th8      taxpayer ha?sVvigOrOualy  protested th8
          proposed additional aSS8SSm8nts as r8cOID8nd-
          8d by the State Auditor-and in two or three
          instances the SCCOUntS  were referred back ,to
          th8 Auditor. These W8r8 finally adjusted On
          a basis of abou$ 25% or 30# of the gross
          amount in the unrealized profit account.
          Even this inVOlv8d the expense of re-examina-
          tlon and re-investlg@ion.    To say the least,
          the recommendations for additional assessments
          based on lOO$ of the &~count Is CSUSiUg  UO
          little confusion in this office In attempting
          to arrive at some equitable basis of aSS8SSing
          additional tax, if any Is actually dU8-
Hon. Ben Ramsey - P-8   3 (v-774)



          "Since the Issuance of opinion No. 0-5680
     th8 SUpr8IIE COUrt Of the United States; in
     South T8XaS Lumber Company vs. Commissioner
     of Internal Revenue, 333 cr. s. 496, 68 s. ct.
     695, 92 I,.Ed. 631, held that Unr8aliZed ln-
     come attributable to the unpaid Installment
     obligations could not be considered a part
     Of invested Capital. Rmphasls was placed upon
     'the difficult and time-consuming effort of
     appraising the uncertain market value of In-
     stallment obllgatlons' which 'may never be paid
     or may be paid only in pa&.'

           nIn the light of th8 d8clSion of the Su-
     preme COUrt in the.abOV8 mentioned baS8 and
     the Conflicting OpiniOnS, alSO referred to,
     W8 r8SpWtfUlly   l’8qU8St that YOU r8Vi8W the
     qU8StiOn before US and inform thiS Offi&
     whether or not we should COnSid8r Unti8SliZ8d
     profit from Installment sales as surplus for
     franchise tsx purposes."

          Article 7084, R8ViS8d Civil Statutes, as anend-
$d, prOVid8S .for the payment of corporate franchise taxes
 . . . based upon that proportion of the outstanding cap-
ital stock, surnlus and undivided profits. . .* (Emphasis
added)

          An opinion dated April 30, 1934, b$ the
Ron. James V. Allred, Attorney General, &dr&ssed to
Ron. W. X. Heath, Secretary of State, In answer to the
question as to Whether or~not~~unr8aliz8d profits from
inStallm%nt .Sal8S should be cOnSid8r8d either as sur-
plus or undivided profits for the purpose of computing
franchise taX88, held that such items "cannot b8 proper‘1Y
Carried as 8ith8r~ th8 'SurpluS' or 'undividGd"prOfit'
account and should not, th8P8fOr6, .be oOnSid8r8d in
measuring the tex due by a corporatiop."

         ..The reasoning of this Well-CbnSid8r8d Opinion
was based upon cited authoritiesi and particular refer-
ence was mad8 t0 s8ctiOn 44 Of the R8v8nU8  Act Of 1932,
the Federal Income Tax Law.

          On January 8, 1944, in opinion No. 0-5680 by
HOD. Grover s8118rS addressed t0 Ron. Sidney Latham,
Secretary of State,:ln answer to the question as to
Whether or not items of "Un~'tiis8d profits" on install-
ment sales were tEUabl8 Under Article 8074, R. C. S.,as
80   HOII.   ml3   RSlJlS8y   -   &3#38   4   (v-774)



     amended, at-th6iti face value a& Shown on the fPanchiS8
     tsXreports,   it was held that such'ltems were taxable
     &s part'of the "surpluS"' and the tSX based~ upon the
     actual Vdt.18 OS the UDr8aliZ8d profits rather than th8
     faC8 VtiU8 thereof. No r8f8ti8DC8 WaS mad8'tO th8
     Opinion of Hon. Jsmes V. filr8d above referred to.

                The Supreme Court of the United Stat&S in
     the recent case of South T8XaS Lumber Compa
     cOUlJSiSSiOD8l'OfIlltW?tl& RBVenU8,$33 u. S.
     L. Ed. 631;68   S. ct. 695, reasoned that:

                      "The installment basis of reporting
             was enacted, as shown by Its history, to
             r8li8V8      tSXpay8rS who adopted it from hav-
             ing to pay an income tax in the year of
             sale based on the full amount      of antici-
             pated profits when in fact they had re-
             C8iV8d in cash Only a Small portion of
             the     S&80   pl’iC8. Another reason was th8
             difficult and time-consuming effort of
             appraising the uncertain market value of
             installment obligations. . . .
                  )I. . . SeCtiOn 4.4 provides for th8
             return as Income 'ifiany taXable year
             that proportion of the lnstallmant pay-
             ments actually received in that year
             which the gross profit realized or to be
             realized when payment Is Completed, bears
             to the total contract price.' . . . 844
             does not recognize as subject to income
             taX liability th8 'market ValU8' Of de-
             ferred Installment obligations. They may
             never be r8.cOgDiZ8d by a tSXpay8r on the
             installment basis for tax purposes under
             844 or any other section, for they may
             never be paid, or may b8 paid only in part.




             added)

      The COUrt then held Under the facts of that C&S8
      and the Fed8r&   statute inVOlV8d that unrealized
     .proSlts SromPnstallment   sales could not be con-
      sidered as a part Of invested capita.
                                                        81
Hon. Ben Ramsey - Page 5   (V-774)



          After a careful reconsidetiation of each
of the fOr8gOing OplnlOnS Of the former Attorneys
General, in the light of the opinion of the Supreme
Court of the United Stat80 cited, it lS the OplnioD
of this office that the ruling Contained in the
opinion by Hon. James V. Allred, approved April 30,
1934, which held that unrealized profits from ln-
StS.llm8nt sties do not constitute either surplus or
undivided prOfit for i&8 purpose Of COmpUtiDg   fran-
chiS8 tsxes under the provisions of Article 7084,
R. C. S., as smended, Is correct, and this opinion
Is therefore r84fflrm8d.    Opinion No. O-5680 dated
January 8, 1944, Is expr8881y OV8rrU18d Insofar as
it COnfliCtS herewith.


                        SUMMARY

          Items of unrealized profit from in
     Stdhtl8nt Sd8S  do Dot COIlStitUt8   8ith8l’
     "surplus" or "UnX'8tiiZ8d pPOfitSn for the
     purpose Of computing cOrpOrat8 fPaDchlS8
     taxes under the provisions of Article’708&,
     R. C. S., as amended. South T8XaS Lumber
     Company v. Commlssloner of Internal Revenue,
     333 0. S. 496, 92 L. Ed. 631, 68 S. Ct. 695;
     Opinion Hon. James V. Allred, Attorney G8n-
     eral, dated April 30, 1934, approved in part.
     Opinion No. 0-5680 dated January 8, 1944, by
     Ron. Grover S8118r8, Attorney General, over-
     ruled in part.

                        Yours very truly

                   ATTORNEY GRNERAL OF TEXAS



                   BY
                                 C. K. Richards
                                     _Asalstant
cKR:mul
