For a bank's Texas franchise tax, are 'available-for-sale' securities treated as inventory, and how are proceeds from called or matured securities counted as gross receipts?

Plain-English summary

A banking corporation asked the Comptroller how to treat its securities for the pre-2008 franchise tax — specifically, which securities count as inventory (so their sales proceeds are counted gross) versus investments (counted net), and how to handle securities that are called or mature before the bank sells them.

Using the FAS 115 accounting categories, the Comptroller agreed:

• Held-to-maturity securities are generally treated as an investment (net, for the gross-vs-net determination).
• Trading securities are generally treated as inventory (gross).
• Available-for-sale securities are, as a general rule, also inventory — consistent with how the agency categorizes securities held for sale by banks and how other industries treat items held for sale in the regular course of business.
• Under Rule 3.547(d)(2), the classifications a bank makes on its published financial statements are presumed accurate unless the bank or the Comptroller shows otherwise.

For securities held as inventory that are called or mature before sale, the gross proceeds are included in the bank's gross receipts to the extent they are recognized as revenue under GAAP (for taxable capital) and are reportable as revenue on the bank's federal income tax return (for earned surplus), per Tex. Tax Code §§ 171.112(a) and 171.1121(a). (These are the same gross-receipts definitions the Comptroller applied in its earlier Ruling 9901261L, which this letter clarifies.)

Finally, the letter draws a line at principal: the principal of a loan repayment does not create a gross receipt for either component (Rules 3.549(e)(27), 3.557(e)(22)) — for example, when the U.S. government redeems its obligations, the returned principal generally is not revenue under GAAP or federal tax rules and is not a gross receipt.

Important currency note: This 1999 letter addresses the franchise tax before the 2008 overhaul into the current margin tax, which reworked the tax base. Use it for the gross-vs-net classification reasoning; confirm the current treatment of financial-institution receipts under the margin tax.

What this means for you

Banks and financial institutions

The classification of a security as inventory vs. investment drove whether you reported gross sale proceeds or only net gain — a large difference in your apportionment base. The Comptroller keyed this to your FAS 115 financial-statement categories and presumed those categories correct, so consistency between your books and your franchise reporting mattered. The margin tax changed the base, so treat the specific gross-vs-net outcomes as pre-2008.

The principal-vs-revenue line

A durable concept: returned principal (loan repayments, redeemed government obligations) is not a gross receipt, because it is not revenue. Only amounts recognized as revenue under GAAP or federal tax rules feed the receipts factor.

Accountants and tax professionals

Watch the two definitions of gross receipts (GAAP for taxable capital, federal-tax for earned surplus) and the Rule 3.547(d)(2) presumption that financial-statement classifications are accurate. All of this is pre-2008; re-verify under the current margin tax before relying on it.

Common questions

Q: Are 'available-for-sale' securities inventory for franchise tax?
A: As a general rule, yes — the Comptroller treated available-for-sale (and trading) securities as inventory, while held-to-maturity securities were treated as investments.

Q: How were proceeds from called or matured securities counted?
A: The gross proceeds were included in gross receipts to the extent recognized as revenue under GAAP (taxable capital) and reportable on the federal return (earned surplus), under §§ 171.112(a) and 171.1121(a).

Q: Is returned loan principal a gross receipt?
A: No. The principal of a loan repayment — or a redeemed government obligation — is generally not revenue and is not a gross receipt for either component (Rules 3.549(e)(27), 3.557(e)(22)).

Q: Can the Comptroller challenge how I classify securities?
A: Yes. Under Rule 3.547(d)(2), your financial-statement classifications are presumed accurate, but the bank or the Comptroller can show a classification is incorrect.

Citations and references

Statutes and rules:

• Tex. Tax Code §§ 171.112(a), 171.1121(a) (gross-receipts definitions — GAAP for taxable capital, federal income tax for earned surplus)
• Franchise Tax Rule 3.547(d)(2) (financial-statement classifications presumed accurate)
• Franchise Tax Rules 3.549(e)(27), 3.557(e)(22) (loan principal repayment is not a gross receipt)
• Prior guidance: STAR Ruling 9901261L (gross-vs-net treatment of securities held for sale), which this letter clarifies

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9906473L

Original ruling text

June 8, 1999

Dear **:

Thank you for the information contained in your letter of May 6, 1999
concerning the "sales of securities" issue as it relates to banking
corporations.

Your first question involves those securities classified as
"available-for-sale" and whether these securities would be treated as
inventory. You noted that under Financial Accounting Standard 115 (FAS 115),
debt and equity securities are classified as either (1) held-to-maturity, (2)
trading, or (3) available-for-sale.

We agree with your observation that those securities in the held-to-maturity
category would generally be treated as an investment (for purposes of the gross
vs. net determination) and those securities in the trading category would
generally be treated as inventory.

Under FAS 115, the available-for-sale category includes securities not
classified as held-to-maturity or trading. As a general rule, we would also
consider securities in the available- for-sale category as inventory. Such
treatment is consistent with the agency's practice of categorizing securities
held for sale by banks. It is also consistent with the treatment for other
industries in categorizing items held for sale in the regular course of
business.

Franchise Tax Rule 3.547(d)(2) holds that factual assertions made for published
financial statements will be presumed to be accurate unless the corporation or
the comptroller can show the assertions are incorrect. This rule would apply
to the manner in which the securities are classified on a bank's financial
statements - the classifications will be presumed to be accurate unless the
bank or comptroller can show that the classifications are incorrect.

The second question in the ruling request is directed at securities that are
deemed to be held as inventory but are called or matured before being sold by
the bank. This question is based on the situation described in Ruling 9901261L
(from the Comptroller's ) and you've asked for a clarification of
"those situations."

Ruling 9901261L contains two responses, dated December 16, 1998 and January 5,
1999. The December 16, 1998 response stated that the statutory definitions of
gross receipts for taxable capital and earned surplus look to the Generally
Accepted Accounting Principles (GAAP) and federal income tax (FIT) reporting
concepts of recognizing revenue, respectively. The statute further specifies
that gross receipts are computed without deduction for cost of property sold,
materials used, labor performed, or other costs incurred, unless otherwise
specifically provided for in the franchise tax law. Sections 171.112(a) and
171.1121(a), Texas Tax Code. Thus, in order for a gross receipt to be
recognized, the respective revenue recognition test must be established.

The response also provided guidelines of when gross or net amounts are
applicable for apportionment purposes. The response said that securities held
for sale would be treated as inventory with the receipts reported at the gross
sales price.

Applying the above guidelines to securities held as inventory that are called
or matured before being sold, the following treatment would result. The gross
proceeds from the calls or maturities would be included in the bank's gross
receipts to the extent those gross proceeds are recognized as revenue under
GAAP (for taxable capital) and are reportable as revenue on the bank's federal
income tax return (for earned surplus) in accordance with Sections 171.112(a)
and 171.1121(a) of the Tax Code.

As an added note in regard to debt securities, the principal of a loan
repayment does not result in a gross receipt for either taxable capital or
earned surplus. Franchise Tax Rules 3.549(e)(27) and 3.557(e)(22). For
example, if the United States government redeems its obligations, the principal
of the obligations presumably would not generate revenue under either GAAP or
FIT reporting and would not result in a gross receipt for either tax base
component.

This response is based on the facts presented. If there are different or
additional facts, the response may change.

If you have any questions, please call toll-free 1-800-531-5441, extension
3-4496 or (512)463-4496.

Sincerely,

Jerry Bobbitt
Tax Policy Division