Is a prior-period accounting adjustment that reduces a subsidiary's retained earnings (to correct a tax-expense booking error) a 'dividend paid' for the section 183 capital-stock tax?

Plain-English summary

Price Waterhouse LLP asked, for a client, whether a prior-period accounting adjustment that reduces a subsidiary's retained earnings is treated as a "dividend paid" under section 183 of the Tax Law. Section 183 imposes a capital-stock franchise tax on transportation and transmission corporations; the tax is the highest of three computations, one of which applies a higher rate to capital stock "on which dividends are paid" at 6% or more.

In the facts, a parent and its subsidiary used a cashless accounting system: the parent collected the subsidiary's cash and paid its expenses (including the subsidiary's income taxes), with an intercompany receivable as the offset. By oversight, the parent's payment of the subsidiary's income taxes was not booked, so the subsidiary's earnings, net worth, and intercompany receivable were overstated. To fix the error, the subsidiary proposed a prior-period adjustment: debit retained earnings, credit the intercompany receivable.

The Department explained that "a dividend on corporate stock implies a division or distribution of corporate profits" (Adams Electric). The proposed reduction to retained earnings is not a distribution of current or accumulated earnings and profits -- it is an accounting entry that properly restates retained earnings to reflect the income taxes the parent paid for the subsidiary in prior years. Therefore the prior-period adjustment does not constitute a dividend for purposes of the section 183 capital-stock tax.

What this means for you

A correcting entry is not a dividend

Restating retained earnings to fix a booking error does not distribute profits to shareholders, so it is not a "dividend paid."

The capital-stock rate test looks for real distributions

The higher section 183 rate applies to stock on which dividends are actually paid -- a division or distribution of corporate profits -- not to bookkeeping adjustments.

Substance over the ledger entry

The Department looked to what the entry does (correct an intercompany tax-expense error), not merely that retained earnings decreased.

Common questions

Q: Why isn't reducing retained earnings a dividend?
A: Because nothing is distributed to shareholders; it is an accounting restatement, not a division of profits.

Q: What defines a dividend here?
A: A division or distribution of corporate profits, under Adams Electric and the Business Corporation Law surplus rules.

Q: Does this affect the capital-stock tax base?
A: The adjustment is not a "dividend paid," so it does not trigger the higher dividend-rate computation under section 183.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 183 (capital-stock franchise tax on transportation and transmission corporations)
- People ex rel Adams Electric Light Co v Graves, 272 NY 77
- Business Corporation Law section 510(b) (dividends paid out of surplus)
- Business Corporation Law section 102(a)(13) (definition of surplus)
- Op. Counsel, Dept of T&F, Aug. 12, 1966 (earned surplus distribution is a dividend)
- Price Waterhouse LLP, TSB-A-98(5)C (March 24, 1998)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1998.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a98_5c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-98(5)C
Corporation Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C971231C

On December 31, 1997, a Petition for Advisory Opinion was received from
Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York 10036-2798.
The issue raised by Petitioner, Price Waterhouse LLP, is whether a
reduction to retained earnings due to a prior period adjustment is treated as a
dividend paid for capital stock purposes under section 183 of Article 9 of the
Tax Law.
Petitioner submits the following facts as the basis for this Advisory
Opinion.
Subsidiary, a wholly-owned subsidiary of Parent, is subject to the
franchise tax based on capital stock imposed under section 183 of the Tax Law.
For the tax years 1994 through 1996, the earnings of Subsidiary were overstated
due to the incorrect booking of a specific expense paid by Parent on behalf of
Subsidiary.
Parent and Subsidiary utilize a cashless system of accounting whereby
Parent retains all cash from Subsidiary's sales and pays all of its cash
expenses.
An "intercompany receivable/payable" is set up to be the offset
account for these revenues and expenses.
As Subsidiary is profitable, the
natural balance of this account is an intercompany receivable on Subsidiary's
books.
Parent's payment of Subsidiary's income tax expense is part of this
cashless system of accounting. However, due to an internal oversight, these tax
payments were not properly reflected on the books of Subsidiary. (Tax payments
made on behalf of Subsidiary were not deducted by the Parent in its computation
of Subsidiary's net income.) Therefore, Subsidiary's net after-tax earnings and
net worth have been overstated by the amount of this expense.
Subsidiary paid dividends from its current earnings to Parent, but the
increase in earnings due to the non-booking of tax did not compose part of these
dividends.
As the tax expense was not properly booked, the resultant "intercompany
receivable" was also overstated. To correct this error, Subsidiary is proposing
to make the following prior period adjustment: debit - retained earnings and
credit - intercompany receivable.
Section 183 of the Tax Law provides for a franchise tax on transportation
and transmission corporations based on the net value of issued capital stock
employed in New York State. The franchise tax required to be paid under section
183 is the highest tax computed by the following three methods:

-2­
TSB-A-98(5)C
Corporation Tax

1. Allocated value of issued capital stock multiplied by the tax
   rate of 1.5 mills.
2. Allocated value of issued capital stock on which dividends are
   paid at a rate of 6 percent or more multiplied by the tax rate of
   .375 mills for each 1 percent of dividends paid. The rate of 1.5
   mills is applied to capital stock on which dividends are not paid or
   are paid at a rate of less than 6 percent.
3. Minimum tax of $75.
   The phrase "dividends paid" is not defined in section 183. Therefore, in
   an Opinion of Counsel, Dept of T&F, August 12, 1966, Op. Counsel 1966 NYTB-V.3,
   p. 17, holding that an earned surplus distribution was a dividend, Counsel looked
   to the Court of Appeals in construing the term "dividends" under the franchise
   tax imposed by section 186 of the Tax Law.
   The Court of Appeals stated as
   follows: "a dividend on corporate stock implies a division or distribution of
   corporate profits." (People Ex Rel Adams Electric Light Co v Graves, 272 NY
   77,79) The Opinion of Counsel also looked to section 510(b) of the Business
   Corporation Law governing the definition of dividends. Such section states that
   "[d]ividends may be declared or paid and other distributions may be made out of
   surplus only, so that the net assets of the corporation remaining after such
   declaration, payment or distribution shall at least equal the amount of its
   stated capital...." Section 102(a)(13) of the Business Corporation Law defines
   surplus as "the excess of net assets over stated capital." In the Opinion of
   Counsel, a wholly owned subsidiary which had an earned surplus in excess of $45
   million, received $39 million from the parent as a contribution to capital
   surplus, and as part of the same transaction paid the parent a dividend of $41
   million. The subsidiary had to pay the dividend tax on the full amount of $41
   million, the tax was not limited to the portion which was in excess of the amount
   received from the parent corporation.
   In this case, the proposed reduction to Subsidiary's retained earnings is
   not a distribution from current or accumulated earnings and profits. It is an
   accounting entry that properly restates Subsidiary retained earnings to reflect
   the reimbursement of income taxes paid by Parent on behalf of Subsidiary in prior
   years. This prior period adjustment does not constitute a dividend for purposes
   of computing the franchise tax on capital stock imposed under section 183 of the
   Tax Law.

DATED: March 24, 1998

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.