STATE OF FLORIDA
DIVISION OF ADMINISTRATIVE HEARINGS
PEN HAVEN SANITATION COMPANY, )
)
Petitioner, )
)
vs. ) CASE NO. 81-1220
) STATE OF FLORIDA, DEPARTMENT ) OF REVENUE and COMPTROLLER OF ) THE STATE OF FLORIDA, )
)
Respondents. )
) WEST FLORIDA UTILITIES, INC., )
)
Petitioner, )
)
vs. ) CASE NO. 81-1525
) STATE OF FLORIDA, DEPARTMENT ) OF REVENUE and COMPTROLLER OF ) THE STATE OF FLORIDA, )
)
Respondents. )
)
RECOMMENDED ORDER
Pursuant to notice, an administrative hearing was held before P. Michael Ruff, duly designated Hearing Officer of the Division of Administrative Hearings in Pensacola, Florida, on June 19, 1981.
APPEARANCES
For Petitioner: Thurston A. Shell, Esquire
Post Office Box 1831 Pensacola, Florida 32598
For Respondent: E. Wilson Crump, II, Esquire
Department of Legal Affairs The Capitol, Room LL04 Tallahassee, Florida 32301
The Pen Haven Sanitation Company and West Florida Utilities, Inc., were sold in 1977 to the Board of County Commissioners of Escambia County. The Board of County Commissioners elected to dissolve these corporations and distribute their assets to itself. Thereafter the corporations were required to file final corporate income tax returns reflecting capital gains on the sales of the assets of the corporations. A gain was reported on these assets equal to the fair market value or salvage value, less the cost basis of the assets. This gain was reported on the taxpayer's federal tax return and on the Florida corporate income tax return which was filed for the 1977 tax year. Subsequently, however,
the Petitioner filed an application for a Florida corporate income tax refund asserting that it should not have paid taxes on the amount of gains which represented a recapture of depreciation which had been taken prior to the termination of the Sub-chapter "S" status in the case of Pen Haven Sanitation and, alternatively, on the recaptured depreciation which had been taken by both corporations prior to the effective date of the Florida corporate income tax code, January 1, 1972.
Inasmuch as the facts underlying both disputes are substantially identical the parties stipulated that the cases be consolidated and heard on a consolidated basis, which has been done.
The Department of Revenue and the Comptroller of the State of Florida both denied the refund claims and thereafter the Petitioner Corporations timely petitioned for an administrative hearing pursuant to Chapter 120, Florida Statutes.
The Petitioner presented one witness. The Respondent presented no witnesses, but presented two Recommended Orders in cases number 78-1227 and 79-
167 entered by Hearing Officers of the Division of Administrative Hearings, which were officially noticed, in support of its case, as well as other legal authority and argument. There is in essence no factual dispute, but the parties previously agreed that the cause should be conducted as a formal proceeding.
Most definitely stated, the issue, in essence, is whether depreciation which was claimed for federal tax purposes prior to the effective date of the Florida corporate income tax code in January, 1972, and in the case of Pen Haven, prior to the termination of its Sub-chapter "S" status, and which was required to be recaptured by the Internal Revenue Service and declared as income for the 1977 tax year in which the corporations were sold, constitutes "realization" of income in that 1977 tax year and therefore is taxable by Florid as well. If not, is it "realization" of income during the years in which it was claimed prior to the enactment of the Florida Code, in that the charging-off of the subject depreciation resulted in a lowered federal tax liability and a consequent economic benefit to the taxpayer?
FINDINGS OF FACT
The facts in this cause are essentially undisputed. The Pen Haven Company was a Subchapter "S" corporation for federal income tax purposes and therefore incurred no State income tax liability. It was formed in 1960 and retained its Subchapter "S" status thorough 1976 for federal income tax purposes. In December of 1977, the capital stock of Pen Haven Sanitation Company was sold to the Board of County Commissioners of Escambia County. Inasmuch as the sole corporate stock holder then was no longer an individual, but rather a governmental entity, the corporation Subchapter "S" election for federal income tax purposes was terminated. Escambia County did not wish to own stock in a private corporation so it accordingly liquidated Pen Haven and its assets were distributed to the County's direct ownership. Thereafter the Corporation filed a final corporate income tax return for 1977 which reflected capital gains on the assets of the corporation which had been distributed. Some of those assets had tax bases which had been reduced to zero through reduction by depreciation, most of which had been charged off prior to January 1, 1972, the effective date of the Florida corporate income tax code. All of the depreciation deductions had been taken prior to the termination of the Subchapter "S" status of the Pen Haven Company. On disposition of the Pen Haven assets however, a gain was reported equal to the fair market value or salvage
value, less the basis. This gain was accordingly reported on Pen Haven's federal income tax return, and on the 1977 Florida corporate income tax return, albeit under the protest as to the Florida tax return.
Inasmuch as Pen Haven had previously deducted depreciation since its inception, and had the benefit thereof for federal tax purposes, it was required by the Internal Revenue Service to recapture the depreciation for federal tax purposes upon its sale and the filing of its tax return in 1977. The same recapture of depreciation treatment was required of West Florida Utilities. Thereafter an application was made by the Petitioner corporations for Florida Corporate Income Tax Refunds asserting that they should have not paid taxes on the amount of gains which represented a recapture of depreciation which had been taken as a deduction prior to the effective date of the Florida corporate income tax on January 1, 1972. In effect the Petitioner is contending that the so- called "income" which is the subject of the tax in question was not realized in 1977, but rather merely "recognized" in that year by the federal tax law and that it represented income actually "realized" during the years when the depreciation was taken as a deduction prior to January 1, 1972. The Petitioners contend that "realization" for federal income tax purposes occurs when the taxpayer actually receives an economic gain. "Recognition" on the other hand refers only to that time when the tax itself becomes actually due and payable. The Petitioners maintain that when the tax became due and payable in 1977 that was merely the point of "recognition" of the subject taxable gain and not "realization" in that the gain was actually realized prior to the Florida Jurisdictional date of January 1, 1972, in the form of the economic benefit derived from those depreciation deductions applied to federal tax liability prior to that date. The Petitioners cite SRG Corporation vs. Department of Revenue, 365 So2d 687 (Fla. 1st DCA 1978), for the proposition that Florida could not tax those gains accruing to the taxpayer prior to Florida's having the constitutional and statutory power to impose a corporate income tax.
The Respondent in essence agrees that the question of when the economic benefit to the Petitioners was received by them or was "realized" is the key question in this cause. The Respondent contends, however, that "realization" of a taxable gain occurred when the assets were disposed of by the Petitioners in 1977, well after the date when Florida's power to tax such a gain was enacted.
The underlying facts in the case of West Florida Utilities are substantially similar. This corporation, however, was organized in 1962 and has never been clothed with Subchapter "S" corporate status. The only grounds upon which it can therefore claim a refund is its assertion that Florida does not have authority to tax that portion of the capital gains attributable to recapture of depreciation which was originally charged off as a deduction prior to January 1, 1972. The Department of Revenue and the Comptroller of the State of Florida both denied the refund claim made on behalf of the Petitioners, and thereafter they seasonably petitioned for a formal administrative hearing pursuant to Chapter 120.57(1), Florida Statutes.
CONCLUSIONS OF LAW
The Division of Administrative Hearings has jurisdiction of the parties to and the subject matter of this proceeding. Section 120.57(1), Florida Statutes.
It is undisputed that Florida's corporate income tax law is governed and guided by federal income tax law insofar as practicable and that the Florida corporate income tax base uses as its starting point taxable income depicted on such a corporation's federal income tax return for the corresponding tax year. Section 220.11(1), Florida Statutes, supports this principle in that it imposes a tax "measured by net income" which term is defined in Section 220.12(1), Florida Statutes, as apportioned adjusted federal income, less the five thousand dollar statutory exemption allowed by Section 220.14, Florida Statutes. Section 220.13(1), Florida Statutes, defines "adjusted federal income" as an amount equal to the taxpayer's taxable income, less the adjustments made elsewhere in that Section or in Section 220.131, Florida Statutes. Subsection (2) of that section then defines "taxable income" in terms of the taxable income for that taxpayer as defined under the Internal Revenue Code for that same tax year. The Respondent maintains that some of these or other subsections of Chapter 220, Florida Statutes, would allow the alterations which the Petitioners would have to make to their tax bases in order to establish the refund claims herein. The case of Roger Dean Enterprises vs. Department of Revenue, 371 So2d 101 (Fla. 4th DCA 1978), affirmed at 387 So2d 358 (Fla. 1980), is authority for the mandatory nature of this concept wherein the Court held:
A taxpayer's adjust federal income forms the tax base upon which the
Florida Corporate Income Tax operates. . .
* * *
. . .[T]he exclusion of that gain would require the Department to violate the statute which requires that the gain (if includable for federal income tax
purposes) be included in the petitioner's tax base for determination of the Florida Corporate Income Tax. 371 So2d at 103-104.
The case law, however, has recognized one exception to the rule that the tax base cannot be varied absent specific statutory authority. Thus, if the tax base includes income which is recognized for federal income tax purposes in the tax year at issue, but which was realized, in part, for federal tax purposes in a tax year ending prior to November 2, 1971 (the date on which Article VII, Section V, of the Florida Constitution, was amended so as to permit the imposition of a corporate income tax), then the amount of income realized during that earlier, non-jurisdictional period continues to be protected from Florida taxation by virtue of lack of constitutional authority for Florida to impose such a tax. (Emphasis supplied.) SRG Corporation vs. Department of Revenue,
365 So2d 687 (Fla. 1978); Clearwater Federal Savings and Loan Association vs. Department of Revenue, 350 So2d 1134 (Fla. 2nd DCA 1977), affirmed at 366 So2d 1164 (Fla. 1979). This brings us then to the essential issue at bar which concerns the meaning of the term "realized" and whether the subject income was realized in the tax year 1977 or, instead, prior to the effective date of the Florida Revenue Code which was January 1, 1972.
In this regard, Department of Revue vs. Leadership Housing, Inc., 343 So2d 611 (Fla. 1977), held that all income realized for federal tax purposes from the disposition of an asset which took place in a tax year ending after the effective date of the Florida Code would be subject to Florida corporate income taxation, notwithstanding that substantial amounts of the gain had accrued through appreciation in value prior to the constitutional amendment authorizing the income tax code and the effective date of the code. Thus, the Respondent maintains that the Leadership Housing case is controlling the present situation
rather than the SRG and Clearwater Federal cases, because the only realization of income in the present situation occurred in the years prior to the date of Florida's jurisdiction to impose the corporate income tax.
In Florida Power Corporation vs Lewis, 381 So2d 1193 (Fla. 2nd DCA 1980), a hearing officer rendered a Recommended Order which was ultimately affirmed by the District Court of Appeal and which is germane to the issue herein, wherein it stated:
Depreciation is neither income nor the reciprocal of income. While the tax laws allow depreciation
to be deducted from earnings in determining taxable income, this deduction is available only until the cost of the asset has been recovered. No income was realized by the taxpayer as a result of accelerated depreciation taken before January 1, 1972. While the higher expenses allowed Petitioner which resulted from the accelerated depreciation served to reduce its federal income tax before January 1, 1972, still no income was realized. See Florida Power Corporation vs.
Gerald A. Lewis, et al., DOAH Case No. 78-1227. (Emphasis supplied.)
In affirming the Hearing Officer's Recommended Order the District Court of Appeal for the Second District opined:
We think the hearing officer had ample basis to reject petitioner's claims based upon its accelerated depreciation and capital outlay expense practices. Neither determines nor affects the date
on which income is earned or received, which we believe to be the primary consideration for determining whether or not the
income was taxable. See 381 So2d 1193.
The taxpayer in the Florida Power case had claimed depreciation by the double declining balance, accelerated method, and in the instant case the depreciation involved was claimed on a straight line basis. This is a distinction without a difference, however. In both cases, the depreciation methods employed prior to the constitutional amendment and the above effective date of the Florida Code resulted in the assets having a basis for federal tax purposes which was below the fair market value of those assets. This decision precludes any adjustment being made for Florida Tax purposes to compensate for such a result.
The issue at bar has been addressed in another jurisdiction in Shangri La vs. State, 113 N.H. 440, 309 A. 2nd 285 (1973). In that case the New Hampshire Supreme Court rejected the contention that the State could not
constitutionally tax a gain which represents the recapture of depreciation taken for federal tax deduction purposes prior to the effective date of that State's income tax code. The Court in that case held:
the taxpayer argues alternatively that the Legislature could not have intended RSA Ch. 77-A to apply the federal laws downward adjustments for pre-enactment depreciation. The Legislature's specific adoption of the federal income tax term of "'taxable Income'" belies this view.
By adopting this term, the Legislature levies a tax on income as federally defined and thereby incorporates federal adjustments to the basis used to arrive at this definition. Furthermore, federal basis rules apply an adjust basis existent before the effective date of a federal statue creating a tax on gain,
if the taxpayer realizes his gain after the statute's effective date. See MacLaughlin vs. Alliance Ins. Co., 286 U.S. 244, 52 S.Ct. 538, 76 L.Ed. 1083
(9132); See Coyne, State Taxation of Capital Gains: Is Use of the Federal Basis Constitutional, 24 National Tax J. 521 (1971). 309 A. 2d at 287.
The Shangri La case was noted with approval, and as embodying a similar result, by the Florida Supreme Court in its decision in Department of Revenue vs. Leadership Housing, supra, at 343 So2d 615, N.4.
Thus, as noted by the Hearing Officer in the Florida Power case, no realization of income results from the claiming of depreciation. The realization test employed by the Florida Supreme Court in the SRG case, supra, requires this results:
'realization' for federal income tax purposes occurs when the tax- payer received actual economic gain from the disposition of property. See Helvering vs. Horst, 311 U.S. 112, 115, 61 S.Ct. 144,
85 L.Ed. 75 (1940). It is when the taxable event occurs which gain 365 So2d at 689. (Emphasis supplied.)
The persuasive language in the Helvering vs. Horst decision upon which the SRG majority opinion was based is stated thusly:
from the beginning the revenue laws have been interpreted as defining 'realization' of income as the taxable event rather than the right to receive it. 311 U.S. at 115. (Emphasis supplied.)
In the Leadership Housing case the Supreme Court also cited with approval Eisner vs. Macomber, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521 (1920), which announced essentially the same test. If this test for realization of income from these federal decisions and the Leadership Housing case is applied to the facts of the instant case it is obvious that the taking of depreciation in earlier tax years is not a taxable event which would give rise to realization of income in those earlier tax years.
The Leadership Housing decision would also appear to preclude the apparent effort by the refund Petitioners herein to readjust the basis of their assets in the Florida properties to either the fair market value as of January 1, 1972, or, in the case of Pen Haven Sanitation Company, the fair market value of those assets as of the date of the termination of its Subchapter "S" status. See also Heftler Construction Company and Subsidiaries vs. Department of Revenue, 334 So2d 129, 133 (Fla. 3rd DCA 1976). Thus, the federal basis rules can only be departed from if their application would unconstitutionally subject to taxation income which was realized prior to November 2, 1971. The application of the federal basis rules to the instant situation however, does not subject to taxation any income which was realized prior to the constitutional amendment or the effective date of the Florida Corporate Income Tax Code, January 1, 1972. Thus, the Petitioners are not entitled to the use of a Florida basis which would differ from the federal basis for the tax years at issue.
The Petitioners place substantial reliance on the opinion of the Second District Court of Appeals in Clearwater Federal Savings and Loan Association vs. Department of Revenue, 357 So2d 1134 (Fla. 2nd DCA 1977). In advancing their position that the recapture of depreciation should not be taxed under the so-called "taxed benefit rule," the subject corporations maintain that they received no Florida tax benefit for the depreciation claimed prior to that enactment there was no Florida tax liability which the claiming of the depreciation could reduce and thereby render the Petitioners an economic benefit. (In the case of the Pen Haven Company the relevant date would be prior to the termination of its Subchapter "S" corporate status.) This tax benefit rule, however, is provided for in a specific statute, and regulation promulgated thereunder, to wit, Section 111 of the Internal Revenue Code and Section 1.111- 1(a) of the Internal Revenue Service Regulations to which the Second District Court referred in the Clearwater Federal case. It is thus not a rule of decisional law which a court or quasi-judicial officer has a fairly wide ranging discretion in applying. As such the rule should be strictly applied only in those circumstances to which the statute and its supporting regulation are directed. Section 1.111-1(a) of the Internal Revenue Service Regulations reads as follows:
the rule of exclusion so prescribed by statute applies equally with respect to all other losses, expenditures and accruals made the basis of deductions from gross income for prior taxable years, including war losses referred to in Section 127 of the Internal Revenue Code 127 of the Internal
Revenue Code of 1939, but not including deductions with respect to depreciation, depletion, amortization or amortizable bond premiums. (Emphasis supplied.)
It is obvious then that this regulation which is promulgated pursuant to Section 111 of the Internal Revenue Code is not designed to apply to depreciation and its recapture. These two items are provided for by specific statutes on the subject of depreciation, and in the case of its recovery, basis adjustments and capital gains treatments. However, it should be noted that the Florida Code adopts all of the federal provisions without any adjustments attributable to events which occurred prior to the effective date of the Florida Code or the date at which a particular corporation became subject to the provisions of the Code (i.e., when the Pen Haven Company lost its Subchapter "S" status).
Although the Petitioner alludes to a supposed difference in the case of the Pen Haven Sanitation Company caused by its status as a Subchapter "S" corporation up to the year 1976, in fact Pen Haven Sanitation Company is entitled to no different treatment regarding the taxation of the subject gain declared in 1977. The same argument regarding West Florida Utilities relates to the Pen Haven Company, even taking into consideration that Subchapter "S" status. After its Subchapter "S" status was terminated it became a regular corporation fully subject to all of the provisions of the Florida Income Tax Code. Where it realized a gain for federal income tax purposes in a year in which it was a regular corporation (1977), its federal tax base also formed its Florida tax base and this could be altered only where there was statutory authority in the code. Thus the question still becomes whether Florida can tax income realized as taxable gain from the disposition of an asset during a year in which the corporation was subject to the code where that gain resulting from disposition (sale) of the asset represented recapture of depreciation taken for federal tax purposes in years in which the corporation was not subject to provisions of the Florida Corporate Income Tax Code.
Pursuant to the above authority and discussion which establishes that realization of the subject gain occurred upon dispositions of the capital assets, in effect, when the sale of the assets to Escambia County occurred, it is obvious that the subject income was realized by the Petitioners after the effective date of Florida's jurisdiction to tax corporate income, rather than during those years in which the subject depreciation deductions were first claimed prior to January 1, 1972. Therefore the Petitioners are concluded to be liable for the additional disputed amount of corporate income tax.
Having considered the foregoing Findings of Fact and Conclusions of Law, the evidence in the record, the candor and demeanor of the witness and pleadings and arguments of counsel it is, therefore
RECOMMENDED this 3rd day of September, 1981, in Tallahassee, Leon County, Florida.
P. MICHAEL RUFF, Hearing Officer Division of Administrative Hearings The Oakland Building
2009 Apalachee Parkway
Tallahassee, Florida 32301 904/488-9675
Filed with the Clerk of the Division of Administrative Hearings this 3rd day of September, 1981.
COPIES FURNISHED:
Thurston A. Shell Post Office Box 1831
Pensacola, Florida 32578
Robert A. Pierce, Esquire General Counsel Department of Revenue
Tallahassee, Florida 32301
Michael Basile, Esquire Deputy General Counsel Office of Comptroller The Capitol, Suite 1302
Tallahassee, Florida 32301
Wilson Crump, II, Esquire Assistant Attorney General Department of Legal Affairs The Capitol
Tallahassee, Florida 32310
STATE OF FLORIDA
DIVISION OF ADMINISTRATIVE HEARINGS
PEN HAVEN SANITATION COMPANY, )
)
Petitioner, )
)
vs. ) CASE NO. 81-1220
) STATE OF FLORIDA, DEPARTMENT ) OF REVENUE and COMPTROLLER OF ) THE STATE OF FLORIDA, )
)
Respondents. )
) WEST FLORIDA UTILITIES, INC., )
)
Petitioner, )
)
vs. ) CASE NO. 81-1525
) STATE OF FLORIDA, DEPARTMENT ) OF REVENUE and COMPTROLLER OF ) THE STATE OF FLORIDA, )
)
Respondents. )
)
CORRECTIVE ORDER
This matter comes before the undersigned, sua sponte, for a correction of the Recommended Order entered September 3, 1981. Accordingly, it is
ORDERED:
That the Recommendation on page 14 of that Recommended Order be amended to read as follows:
RECOMMENDED that a Final Order be issued denying the petitioners of Pen Haven Sanitation Company and West Florida Utilities, Inc., for corporate tax refunds in the amounts of $3,484.99 and $10,654.53, respectively. The said Recommended Order is hereby reaffirmed in all other respects.
DONE AND ENTERED this 9th day of October, 1981, in Tallahassee, Florida.
P. MICHAEL RUFF, Hearing Officer Division of Administrative Hearings The Oakland Building
2009 Apalachee Parkway
Tallahassee, Florida 32301 904/488-9675
Filed with the Clerk of the Division of Administrative Hearings this 9th day of October, 1981.
================================================================= AGENCY FINAL ORDER (DEPARTMENT OF REVENUE)
=================================================================
STATE OF FLORIDA DEPARTMENT OF REVENUE
PEN HAVEN SANITATION COMPANY,
Petitioner,
vs. CASE NO. 81-1220
STATE OF FLORIDA, DEPARTMENT OF REVENUE AND COMPTROLLER OF THE STATE OF FLORIDA,
Respondent.
/ WEST FLORIDA UTILITIES, INC.,
Petitioner,
vs. CASE NO. 81-1525
STATE OF FLORIDA, DEPARTMENT OF REVENUE AND COMPTROLLER OF THE STATE OF FLORIDA,
Respondent.
/
FINAL ORDER OF THE DEPARTMENT OF REVENUE
THIS CAUSE came before Randy Miller as Executive Director of the Department of Revenue, pursuant to the authority delegated to him by Rules 12-3.02 - 3.05, Florida Administrative Code. Notice of the Hearing was given to the attorneys for the parties and oral argument was waived.
An in camera review of the Recommended Order entered September 3, 1981 (as corrected by Order of October 9, 1981) by the Hearing Officer, P. Michael Ruff of the Division of Administrative Hearings, the Exceptions to that Order filed by the attorneys for the parties and the transcript of the hearing held on June 19, 1981, was made by the Executive Director.
APPEARANCES
For Petitioner: Thurston A. Shell, Esquire
Post Office Box 1831 Pensacola, Florida 32598
For Respondent: E. Wilson Crump, II, Esquire
Department of Legal Affairs The Capitol, LL04 Tallahassee, Florida 32301
PRELIMINARY STATEMENT
Having Noted that attorneys for the parties filed Exceptions to the Recommended Order, the Executive Director has reviewed the transcript of the hearing with regard to the exceptions and finds specifically that the Hearing Officer erred in some of his statements in the preamble of the Order, the Findings of Fact and the Conclusions of Law as hereinafter set forth. The Hearing Officer made statements that the capital gains upon which the tax accrued were realized on the sale of the assets of the Corporate Petitioners. The transcript of the hearing at pages 12-14 clearly establishes that the disposition which gave rise to the capital gains was the distribution of the Corporations' assets upon the liquidation of the Corporations following a sale of the Corporations' stock; not a sale of corporate assets.
Based upon the foregoing factual finding the Executive Director enters the following order as final agency action in this case.
The Pen Haven Sanitation Company and West Florida Utilities, Inc., were sold in 1977 to the Board of County Commissioners of Escambia County. The Board of County Commissioners elected to dissolve these corporations and distribute their assets to itself. Thereafter the corporations were required to file final corporate income tax returns reflecting capital gains on the disposition of the assets of the corporations. A gains was reported on these assets equal to the fair market value or salvage value, less the adjusted basis of the assets. This gain was reported on the taxpayer's federal tax return and on the Florida corporate income tax return which was filed for the 1977 tax year.
Subsequently, however, the petitioner filed an application for a Florida corporate income tax refund, asserting that it should not have paid taxes on the amount of gains which represented a recapture of depreciation which had been taken prior to the termination of the Subchapter "S" status in the case of Pen Haven Sanitation and, alternatively, on the recaptured depreciation which had been taken by both corporations prior to the effective date of the Florida corporate income tax code, January 1, 1972,
Inasmuch as the facts underlying both disputes are substantially identical, the parties stipulated that the cases be consolidated and heard on a consolidated basis, which has been done.
The refund claims were denied and thereafter the Petitioner Corporations timely petitioned for an administrative hearing pursuant to Chapter 120, Florida Statutes.
The Petitioner presented one witness, The Respondents presented no witnesses, but presented two Recommended Orders in cases numbered 78-1227 and 79-167 entered by Hearing Officers of the Division of Administrative Hearings, which were officially noticed, in support of its case, as well as other legal
authority and argument. There is in essence no factual dispute, but the parties previously agreed that the cause should be conducted as a formal proceeding.
Most definitively stated, the issue, in essence, is whether depreciation which was claimed for federal tax purposes prior to the effective date of the Florida corporate income tax code in January, 1972, and in the case of Pen Haven, prior to the termination of its Subchapter "S" status, and which was required to be recaptured by the Internal Revenue Service and declared as income for the 1977 tax year in which the corporations were sold constitutes "realization" of income in that 1977 tax year and therefore is taxable by Florida as well. If not, is it "realization" of income during the years in which it was claimed prior to the enactment of the Florida Code, in that the charging-off of the subject depreciation resulted in a lowered federal tax liability and a consequent economic benefit to the taxpayer?
FINDINGS OF FACT
The facts in this cause are essentially undisputed. The Pen Haven Company was a Subchapter "S" corporation for federal income tax purposes and therefore incurred no State income tax liability. It was formed in 1960 and retained its Subchapter "5" status through 1976 for federal income tax purposes. In December of 1977, the capital stock of Pen Haven Sanitation Company was sold to the Board of County Commissioners of Escambia County. Inasmuch as the sole corporate stock holder then was no longer an individual, but rather a governmental entity, the corporation Subchapter "S" election for federal income tax purposes was terminated. Escambia County did not wish to own stock in a private corporation so it accordingly liquidated Pen Haven and its assets were distributed to the County's direct ownership. Thereafter the Corporation filed a final corporate income tax return for 1977 which reflected capital gains on the assets of the corporation which had been distributed. Some of those assets had tax bases which had been reduced to zero through reduction by depreciation, most of which had been charged off prior to January 1, 1972, the effective date of the Florida corporate income tax code. All of the depreciation deductions had been taken prior to the termination of the Subchapter "S" status of the Pen Haven Company. On disposition of the Pen Haven assets however, a gain was reported equal to the fair market value or salvage value, less the basis. This gain was accordingly reported on Pen Haven's federal income tax return, and on the 1977 Florida corporate income tax return, albeit under protest as to the Florida tax return.
Inasmuch as Pen Haven had previously deducted depreciation since its inception, and had the benefit thereof for federal tax purposes, it was required by the Internal Revenue Service to recapture the depreciation for federal tax purposes upon its liquidation and the filing of its tax return in 1977. The same recapture of depreciation treatment was required of West Florida Utilities.
Thereafter an application was made by the Petitioner corporations for Florida Corporate Income Tax Refunds asserting that they should have not paid taxes on the amount of gains which represented a recapture of depreciation charged-off prior to the termination of the Subchapter "S" status, and, alternatively on the recapture of the depreciation which had been taken as a deduction prior to the effective date of the Florida corporate income tax on January 1, 1972. In effect the Petitioner is contending that the so-called "income" which is the subject of the tax in question was not realized in 1977, but rather merely "recognized" in that year by the federal tax law and that it represented income actually "realized" during the years when the depreciation was taken as a deduction prior to January 1, 1972. The Petitioners contend that "realization" for federal income tax purposes occurs when the taxpayer actually receives an economic gain. Recognition on the other hand refers only to that time when the tax itself becomes actually due and payable. The Petitioners maintain that when the tax became due and payable in 1977 that was merely the point of "recognition" of the subject taxable gain and not "realization" in that the gain was actually realized prior to the Florida jurisdictional date of January 1, 1972, in the form of the economic benefit derived from those depreciation deductions applied to federal tax liability prior to that date. The Petitioners cite SRG Corporation vs. Department of Revenue, 365 So.2d 687 (Fla. 1st DCA 1978), for the proposition that Florida could not tax those gains accruing to the taxpayer prior to Florida's having the constitutional and statutory power to impose a corporate income tax.
The Respondents in essence agree that the question of when the economic benefit to the Petitioners was received by them or was "realized" is the key question in this cause. The Respondents contend, however, that "realization" of a taxable gain occurred when the assets were disposed of by the Petitioners in 1977, well after the date when Florida's power to tax such a gain was enacted.
The underlying facts in the case of West Florida Utilities are substantially similar. This corporation, however, was organized in 1962 and has never been clothed with Subchapter "S" corporate status The only grounds upon which it can therefore claim a refund is its assertion that Florida does not have authority to tax that portion of the capital gains attributable to recapture of depreciation which was originally charged off ash a deduction prior to January 1, 1972. The refund claims made on behalf of the Petitioners were denied, and thereafter they seasonably petitioned for a formal administrative hearing pursuant to 120.57(1), Florida Statutes.
CONCLUSIONS OF LAW
The Division of Administrative Hearings has jurisdiction of the parties to and the subject matter of this proceeding. Section 120.57(1), Florida Statutes.
It is undisputed that Florida's corporate income tax law is governed and guided by federal income tax law insofar as practicable and that the Florida corporate income tax base uses as its starting point taxable income depicted on such a corporation's federal income tax return for the corresponding tax year. Section 220.11(1), Florida Statutes, supports this principle in that it imposes a tax "measured by net income" which term is defined in Section 220.12(1), Florida Statutes, as apportioned adjusted federal income, less the five thousand dollar statutory exemption allowed by Section 220.14, Florida Statutes. Section 220.13(1), Florida Statutes, defines "adjusted federal income" as an amount equal to the taxpayer's taxable income, less the adjustments made elsewhere in that section or in Section 220.131, Florida Statutes. Subsection (2) of that section then defines "taxable income" in terms of the taxable income for that
taxpayer as defined under the Internal Revenue Code for that same tax year. The Respondent maintains that none of these or other subsections of Chapter 220, Florida Statutes, would allow the alterations which the Petitioners would have to make to their tax bases in order to establish the refund claims herein. The case of Roger Dean Enterprises vs. Department of Revenue, 371 So.2d 101 (Fla.
4th DCA 1978), affirmed at 387 So.2d 358 (Fla. 1980), is authority for the mandatory nature of this concept wherein the Court held:
A taxpayer's adjusted federal income forms the tax base upon which the
Florida Corporate Income Tax operates. . .
* * *
[T]he exclusion of that gain would require the Department to violate the statute which requires that the gain (if includable for federal income tax
purposes) be included in the petitioner's tax base for determination of the Florida Corporate Income Tax. 371 So.2d at 103-104.
The case law, however, has recognized one exception to the rule that the tax base cannot be varied absent specific statutory authority. Thus, if the tax base includes income which is recognized for federal income tax purposes in the tax year at issue, but which was realized, in part, for federal tax purposes in a tax year ending prior to November 2, 1971 (the date on which Article VII, Section V, of the Florida Constitution, was amended so as to permit the imposition of a corporate income tax), then the amount of income realized during that earlier, nonjurisdictional period continues to be protected from Florida taxation by virtue of lack of constitutional authority for Florida to impose such a tax. (Emphasis supplied.) SRG Corporation vs. Department of Revenue, 365 So.2d 687 (Fla. 1978); Clearwater Federal Savings and Loan Association vs.
Department of Revenue, 350 So.2d 1134 (Fla. 2nd DCA 1977), affirmed at 366 So.2d 1164 (Fla. 1979). This brings us then to the essential issue at bar which concerns the meanings of the term "realized" and whether the subject income was realized in the tax year 1977 or, instead, prior to the effective date of the Florida Revenue Code which was January 1, 1972.
In this regard, Department of Revenue vs. Leadership Housing, Inc., 343 So.2d 611 (Fla. 1977), held that all income realized for federal tax purposes from the disposition of an asset which took place in a tax year ending after the effective date of the Florida Code would be subject to Florida corporate income taxation, notwithstanding that substantial amounts of the gain had accrued through appreciation in value prior to the constitutional amendment authorizing the income tax code and the effective date of the code. Thus, the Respondents maintain that the Leadership Housing case is controlling in the present situation rather than the SRG and Clearwater Federal cases, because the only realization of income in the present situation occurred in the years prior to the date of Florida's jurisdiction to impose the corporate income tax.
In Florida Power Corporation vs. Lewis, 381 So.2d 1193 (Fla. 2nd DCA 1980), a Hearing Officer rendered a Recommended Order which was ultimately affirmed by the District Court of Appeal and which is germane to the issue herein, wherein it stated:
Depreciation is neither income nor the reciprocal of income. While the tax laws allow depreciation
to be deducted from earnings in determining taxable income, this deduction is available only until the cost of the asset has been recovered. No income was realized by the taxpayer as a result of accelerated depreciation taken before January 1, 1972. While the higher expenses allowed Petitioner which resulted from the accelerated depreciation served to reduce its federal income tax before January 1, 1972, still no income was realized. See Florida Power Corporation vs.
Gerald A. Lewis, et al., DOAH Case No. 78-1227. (Emphasis supplied.)
In affirming the Hearing Officer's Recommended Order the District Court of Appeal for the Second District opined:
We think the hearing officer had ample basis to reject petitioner's claims based upon its accelerated depreciation and capital outlay expense practices. Neither determines nor affects the date
on which income is earned or received, which we believe to be the primary consideration for determining whether or not the
income was taxable. See 381 So.2d 1193.
The taxpayer in the Florida Power case had claimed depreciation by the double declining balance, accelerated method, and in the instant case the depreciation involved was claimed on a straight line basis. This is a distinction without a difference, however. In both cases, the depreciation methods employed prior to the constitutional amendment and the above effective date of the Florida Code resulted in the assets having a basis for federal tax purposes which was below the fair market value of those assets. This decision precludes any adjustment being made for Florida tax purposes to compensate for such a result.
The issue at bar has been addressed in another jurisdiction in Shangri La vs. State, 133 N.H. 440, 309 A. 2nd 285 (1973). In that case the New Hampshire Supreme court rejected the contention that the State could not constitutionally tax a gain which represents the recapture of depreciation taken for federal tax deduction purposes prior to the effective date of that State's income tax code. The Court in that case held:
The taxpayer argues alternatively that the Legislature could not have intended RSA Ch. 77-A to apply the federal laws downward adjustments for pre-enactment depreciation. The Legislature's specific adoption of the federal income tax term of 'taxable income' belies this view.
By adopting this term, the Legislature
levies a tax on income as federally defined and thereby incorporates federal adjustments to the basis used to arrive at this definition. Furthermore, federal basis rules apply an adjusted basis existent before the effective date of a federal statute creating a tax on gain, if the taxpayer realizes his gain after the statute's effective date. See MacLaughlin vs. Alliance Ins. Co., 286 U.S. 244, 52 S.Ct. 538, 76 L.Ed. 1083
(1932);. See Coyne, State Taxation of Capital Gains: Is Use of the Federal Basis Constitutional, 24 National Tax J. 521 (1971). 309 A.2d at 287.
The Shangri La case was noted with approval, and as embodying a similar result, by the Florida Supreme Court in its decision in Department of Revenue vs. Leadership Housing, supra, at 343 So.2d 615, n.4.
Thus, as noted by the Hearing Officer in the Florida Power case, no realization of income results from the claiming of depreciation. The realization test employed by the Florida Supreme Court in the SRG case, supra, requires this result:
'realization' for federal income
tax purposes occurs when the taxpayer received actual economic
gain from the disposition of property. See Helvering vs. Horse, 311 U.S. 112, 115, 61 S.Ct. 144, 85
L.Ed 75 (1940). It is when the taxable event occurs which gives rise to actual economic gain.
365 So.2d at 689. (e.s.)
The persuasive language in the Helvering vs. Horst decision upon which the SRG majority opinion was based is stated thusly:
from the beginning the revenue laws have been interpreted as defining 'realization' of income as the taxable event
rather than the right to receive it. 311 U.S. at 115. (e.s.)
In the Leadership Housing case the Supreme Court also cited with approval Eisner vs. Macomber, 253 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521 (1920), which announced essentially the same test. If this test for realization of income from these federal decisions and the Leadership Housing case is applied to the facts of the instant case it is obvious that the taking of depreciation in earlier tax years is not a taxable event which would give rise to realization of income in those earlier tax years.
The Leadership Housing decision would also appear to preclude the apparent effort by the refund Petitioners herein to readjust the basis of their assets in the Florida properties to either the fair market value as of January 1, 1972,
or, in the case of Pen Haven Sanitation Company, the fair market value of those assets as of the date of the termination of its Subchapter "S" status. See also Heftler Construction Company and Subsidiaries vs. Department of Revenue, 334 So.2d 129, 133 (Fla. 3rd DCA 1976). Thus, the federal basis rules can only be departed from if their application would unconstitutionally subject to taxation income which was realized prior to November 2, l971. The application of the federal basis rules to the instant situation however, does not subject to taxation any income which was realized prior to the constitutional amendment or the effective date of the Florida Corporate Income Tax Code, January 1, 1972.
Thus, the Petitioners are not entitled to the use of a Florida basis which would differ from the federal basis for the tax years at issue.
The Petitioners place substantial reliance on the opinion of the Second District Court of Appeals in Clearwater Federal Savings and Loan Association vs. Department of Revenue 350 So.2d 1134 (Fla. 2nd DCA 1977). In advancing their position that the recapture of depreciation should not be taxed under the so- called "taxed benefit rule," the subject corporations maintain that they received no Florida tax benefit for the depreciation claimed prior to Florida's enactment of the corporate income tax since prior to that enactment there was no Florida tax liability which the claiming of the depreciation could reduce and thereby rendered the Petitioners an economic benefit. (In the case of the Pen Haven Company the relevant date would be prior to the termination of its Subchapter "S" corporate status.) This tax benefit rule, however, is provided for in a specific statute, and regulation promulgated thereunder, to wit, Section 111 of the Internal Revenue Code and Section 1.111-1(a) of the Internal Revenue Service Regulations to which the Second District Court referred in the Clearwater Federal case. It is thus not a rule of decisional law which a court or quasi judicial officer has a fairly wideranging discretion in applying. As such the rule should be strictly applied only in those circumstances to which the statute and its supporting regulation are directed. Section 1.111-1(a) of the Internal Revenue Service Regulations reads as follows:
The rule of exclusion so prescribed by statute applies equally with respect to all other losses, expenditures and accruals made the basis of deductions from gross income for prior taxable years, including war losses referred to in Section 127 of the Internal
Revenue Code of 1939, but not including deductions with respect to depreciation, depletion, amortization or amortizable bond premiums. (Emphasis supplied)
It is obvious then that this regulation which is promulgated pursuant to Section 111 of the Internal Revenue Code is not designed to apply to depreciation and its recapture. These two items are provided for by specific statutes on the subject of depreciation, and in the case of its recovery, basis adjustments and capital gain treatments. However, it should be noted that the Florida Code adopts all of the federal provisions without any adjustments attributable to events which occurred prior to the effective date of the Florida Code or the date at which a particular corporation became subject to the provisions of the Code (i.e., when the Pen Haven Company lost its Subchapter "S" status).
Although the Petitioner alludes to a supposed difference in the case of the Pen Haven Sanitation Company caused by its status as a Subchapter "S"
corporation up to the year 1976, in fact Pen Haven Sanitation Company is entitled to no different treatment regarding the taxation of the subject gain declared in 1977. The same argument regarding West Florida Utilities relates to the Pen Haven Company, even taking into consideration that Subchapter "S" status. After its Subchapter "S" status was terminated it became a regular corporation fully subject to all of the provisions of the Florida Income Tax Code. Where it realized a gain for federal income tax purposes in a year in which it was a regular corporation (1977), its federal tax base also formed its Florida tax base and this could be altered only where there was statutory authority in the code. Thus the question still becomes whether Florida can tax income realized as taxable gain from the disposition of an asset during a year in which the corporation was subject to the code where that gain resulting from disposition of the asset represented recapture of depreciation taken for federal tax purposes in years in which the corporation was not subject to provisions of the Florida Corporate Income Tax Code.
Pursuant to the above authority and discussion which establishes that realization of the subject gain occurred upon disposition of the capital assets, in effect, when the sale of the assets to Escambia County occurred, it is obvious that the subject income was realized by the Petitioners after the effective date of Florida's jurisdiction to tax corporate income, rather than during those years in which the subject depreciation deductions were first claimed prior to January 1, 1972. Therefore, the Petitioners are concluded to be liable for the additional disputed amount of corporate income tax.
Having considered the foregoing Findings of Fact and Conclusions of Law, the evidence in the record and other relevant facts and matters, it is, therefore,
ORDERED.
That the refund requested by Pen Haven Sanitation Company in the amount of $4,484.97 be denied, and
That the refund requested by West Florida Utilities, Inc., in the amount of $10,654.23 be denied.
DONE AND ENTERED this 20th day of November, 1981.
RANDY MILLER EXECUTIVE DIRECTOR DEPARTMENT OF REVENUE STATE OF FLORIDA
I HEREBY CERTIFY that the foregoing Final Order has been filed in the official records of the Department of Revenue, this 20th day of November, 1981.
MARY FORD, SECRETARY TO GENERAL COUNSEL
Agency Clerk
================================================================= AGENCY FINAL ORDER (DEPARTMENT OF BANKING AND FINANCE)
=================================================================
STATE OF FLORIDA DEPARTMENT OF BANKING AND FINANCE
DIVISION OF ACCOUNTING AND AUDITING
PEN HAVEN SANITATION COMPANY,
Petitioner,
vs. CASE NO. 81-1220
STATE OF FLORIDA, DEPARTMENT OF REVENUE AND COMPTROLLER OF THE STATE OF FLORIDA,
Respondent.
/ WEST FLORIDA UTILITIES, INC.,
Petitioner,
vs. CASE NO. 81-1525
STATE OF FLORIDA, DEPARTMENT OF REVENUE AND COMPTROLLER OF THE STATE OF FLORIDA,
Respondent.
/
RECOMMENDED ORDER
This matter has come before.the Comptroller of the State of Florida, as Head of the Department of Banking and Finance (hereinafter referred to as DEPARTMENT) for Final Order upon the receipt of Hearing Officer P. Michael Ruff's Recommended Order and Corrective Order, Exceptions filed by both parties pursuant to Subsection 120.57(1)(b)8, Florida Statutes, and Respondents Proposed Substituted Order. After review and consideration of said Orders and Exceptions, together with the record, the following Order is hereby rendered.
FINDINGS OF FACT
In accordance with the provisions of Subsection 120.57(1)(b)9, Section 120.59, Florida Statutes, and Rule 28-5.405(3), Florida Administrative Code, the DEPARTMENT finds the following pertinent facts:
Pursuant to Rule 28-5.106, Florida Administrative Code, the above- styled cause was consolidated upon the motions of the Petitioners, which was granted at the administrative hearing held on June 19, 1981.
Subsequent to the June 19th hearing, the DEPARTMENT determined through examination of letters and other correspondence with the Attorney General' s Office, the Department of Revenue, and the Department of Administrative Hearings that it had in fact been inadvertently made a party to the present action. notwithstanding same, the DEPARTMENT does not object to the consolidation of said cause, nor does it sock the representation of other counsel as was alternatively provided for in the preliminary stages of the June 19, 1981hearing.
The DEPARTMENT finds that the Exceptions submitted by the attorneys for the parties were timely filed.
4 The exceptions filed by Respondents' are adopted in full and have been incorporated into the DEPARTMENT'S CONCLUSIONS OF LAW. A copy of said Exceptions are attached hereto as Exhibit 1.
On or about September 18, 1981, Respondents also filed a Proposed Substituted Order which essentially tracked the language of the Recommended Order, but modified the recommendation by increasing the amount to be denied Pen Haven Sanitation Company (hereinafter referred to as Pen Haven) from $3,484.99 to 4,484.97 and adding a denial for the $10,654.23 refund requested by West Florida Utilities, Inc. (hereinafter referred to as West Florida Utilities). A copy of said Proposed Substituted Order is attached hereto as Exhibit 2.
The hearing officer entered a Corrective Order on October 9, 1981 which amended the Recommendation in Recommended Order to read:
"RECOMMENDED that a Final Order be issued denying the petitions of Pen Haven Sanitation Company and West Florida Utilities, Inc., for corporate tax refunds in the amounts of
$3,484.99 and $10,654.53, respectively. The said Recommended Order is hereby reaffirmed in all other respects."
The DEPARTMENT concurs with the hearing officer's Recommendation, as amended in the Corrective Order, and further finds no basis in the record to support the amount suggested by Respondents in their Proposed Substituted Order to be denied Petitioner, Pen Haven Sanitation Company.
Exceptions numbers 1 and 2 submitted by Petitioners are directed toward the hearing officer's Findings of Fact. In Exception number 1, Petitioners contend that the hearing officer erroneously based his Recommended Order on the conclusion that there was a "sale of assets" which triggered the recapture provisions of Chapter 220, Income Tax Code, Florida Statutes. Petitioners list the statements appearing on the following pages and lines to support their position.
Page 2 Lines 2-8
Page 3 Lines 8 and 9, and the Last 2 Lines
Page 4 Line 17
Page 13 Line 19
Exception number 2, Page 5 Line 30
Initially, it should be noted that the statements contained on page 2 (lines 2-8) and page 3 (lines 8 and 9) appear in preamble of the hearing officer's Recommended Order, while the language on page 13 (line 9) appears in the hearing officer's Conclusions of Law. Neither of these statements have an effect on the hearing officer's Findings of Fact nor do they appear to have an impact on the hearing officer's ultimate Conclusions of Law. As such, said Exceptions are hereby rejected.
The last two lines on page 3, page A (line 17) and Exception number 2, page
5 (line 30) are contained in the hearing officer's Findings of Fact. Nevertheless, the DEPARTMENT has determined that those statements had no substantive effect on the ultimate decision to deny Petitioners' request for refund of Florida corporate income tax for the fiscal year ending January 31, 1978. The reason being that the nature of the income, i.e. capital gains versus ordinary taxable income, was never at issue. The real issue was and is at what point in time did the Petitioners receive ("realize") an economic gain. While portions of the Recommended Order incorrectly refer to the income in question as having resulted from the sale of the assets of the corporation, the record clearly indicates that Petitioners' taxable income was "realized" when Escambia County elected to distribute the assets in liquidation, upon acquisition of said corporations stock. Therefore, Petitioners' Exceptions number 1, the last two lines on page 3, page 4 (line 17) and Exception number 2, page 5 (line 30) are also hereby rejected. A copy of Petitioners' Exceptions are attached hereto as Exhibit 3.
Petitioners' Exceptions number 3 end number 4 deal with questions of law and are aimed at the hearing officer's Conclusions of Law. The DEPARTMENT, while considering said Exceptions, nevertheless, rejects their application to the case at hand.
The DEPARTMENT adopts, in part, Hearing Officer, P. Michael Ruff's, Findings of Fact and Conclusions of Law as set forth in his Recommended Order, but modifies said Findings of Fact and Conclusions of Law to the extent that they make any reference to the sale of assets as being the act which brought about Petitioners' taxable income. Rather, the act that generated the taxable income, to be recaptured for purposes of Florida's corporate income tax, was the liquidation of said corporations and distribution of their assets to the county's direct ownership.
The DEPARTMENT further finds that Pen Haven was a Subchapter "S" corporation for federal income tax purposes and therefore incurred no State income tax liability. It was formed in 1960 and retained its Subchapter "S" status through 1976 for income tax purposes. In December of 1977, the capital stock of Pen Haven was sold to the Board of County Commissioners of Escambia County. Inasmuch as the sole corporate stock holder then was no longer an individual, but rather a governmental entity, the corporation Subchapter "S" election for federal income tax purposes was terminated. Escambia County did not wish to own stock in a private corporation so it accordingly liquidated Pen Haven and its assets were distributed to the County's direct ownership. Thereafter the Corporation filed a final corporate income tax return for 1977 which reflected capital gains on the assets of the corporation which had been distributed. Some of those assets had tax bases which had been reduced to zero through reduction by depreciation, most of which had been charged off prior to January 1, 1972, tie effective date of the Florida Corporate Income Tax Code. All of the depreciation deductions had been taken prior to the termination of the Subchapter "S" status of Pei Haven. On disposition of the Pen Haven assets however, a gain was reported equal to the fair market value or salvage value,
less the basis. This gain was accordingly reported on Pen Haven's federal income tax return, and on the 1977 Florida corporate income tax return, albeit under protest as to the Florida tax return.
Inasmuch as Pen Haven had previously deducted depreciation since its inception, and had the benefit thereof for federal tax purposes, it was required by the Internal Revenue Service to recapture the depreciation for federal tax purposes upon its liquidation and the filing of its tax return in 1977. The same recapture of depreciation treatment was required of West Florida Utilities. Thereafter an application was made by the Petitioners corporations for Florida Corporate Income Tax Refunds asserting that they should have not paid taxes on the amount of gains which represented a recapture of depreciation charged-off prior to the termination of the Subchapter "S" status, and, alternatively on the recapture of the depreciation which had been taken as a deduction prior to the effective date of the Florida corporate income tax on January 1, 1972. In effect the Petitioner is contending that the so-called "income" which is the subject of the tax in question was not realized in 1977, but rather merely "recognized" in that year by the federal tax law and that it represented income actually "realized" during the years when the depreciation was taken as a deduction prior to January 1, 1972. The Petitioners contend that "realization" for federal income tax purposes occurs when the taxpayer actually receives an economic gain. "Recognition" on the other hand refers only to that time when the tax itself became actually due and payable. The petitioners maintain that when the tax became due and payable in was merely the point of "recognition" of the subject taxable gain and not "realization" in that their gain was actually realized prior to the Florida jurisdictional date of January 1, 1972, in the form of the economic benefit derived from those depreciation deductions applied to federal tax liability prior to that date. The Petitioners cite SRG Corporation vs. Department of Revenue, 365 So.2d 087 (Fla. 1st DCA 1978), for the proposition that Florida could not tax those gains accruing to the taxpayer prior to Florida's having the constitutional and statutory power to impose a corporate tax.
The Respondents in essence agree that the question of when the economic benefit to the Petitioners was received by them or was "realized" is the key question in this cause. The Respondents contend, however, that "realization" of a taxable gain occurred when the assets were disposed of by the Petitioners in 1977, well after the date when Florida's power to tax such a gain was enacted.
The underlying facts in the case of West Florida Utilities are substantially similar. This corporation, however, was organized in 1962 and has never been clothed with Subchapter "S" corporate status. The only grounds upon which it can therefore claim a refund is its assertion that Florida does not have authority to tax that portion of the ordinary income attributable to recapture of depreciation which was originally charged off as a deduction prior to January 1, 1972. The 7 refund claims made on behalf of the Petitioners were denied, and thereafter they seasonably petitioned for a formal administrative hearing pursuant to 120.57(1), Florida Statutes.
CONCLUSIONS OF LAW
Under the provisions of Chapter 120, and Section 215.26, Florida Statutes, the DEPARTMENT has jurisdiction of the parties to and the subject matter of this proceeding.
It is undisputed that Florida' s corporate income tax law is governed and guided by federal income tax law insofar as practicable and that the Florida corporate income tax base uses as its starting point taxable income depicted on such a corporation's federal income tax return for the corresponding tax year. Subsection 220.11(1), Florida Statutes, supports this principle in that it imposes a tax "measured by net income" which term is defined in Subsection 220.12(1), Florida Statutes, as apportioned adjusted federal income, less the five thousand dollar statutory exemption allowed by Section 220.14, Florida Statutes. Subsection 220.13(1), Florida Statutes, defines "adjusted federal income" as an amount equal to the taxpayer's taxable income, less the adjustments made elsewhere in that section or in Section 220.131, Florida Statutes. Subsection (2) of that section then defines "taxable income" in terms of the taxable income for that taxpayer as defined under the Internal Revenue Code for that same tax year. The Respondents maintain that none of these or other subsections of Chapter 220, Income Tax Code, Florida Statutes (hereinafter referred to as FLORIDA TAX CODE) would allow the alterations which the Petitioners would have to make to their tax bases in order to establish the refund claims herein. The case of Roger Dean Enterprises vs. Department of Revenue, 371 So.2d 101 (Fla.4th DCA 1978), affirmed at 387,So.2d 358 (Fla.
1980), is authority for the mandatory nature of this concept wherein the Court held:
A taxpayer' s adjusted federal income forms the tax base upon which the
Florida Corporate Income Tax operates. . . .
* * *
[T]he exclusion of that gain would require the Department to violate the statute which requires that the gain (if includable for federal income tax
purposes) be included in the petitioner's tax base for determination of the Florida
Corporate Income Tax. Roger Dean Enterprises, supra, at 103-104.
The case law, however, has recognized one exception to the rule that the tax base cannot be varied assent specific statutory authority. Thus, if the tax base includes income which is recognized for federal income fax purposes in the tax year at issue, but which was realized, in part, for federal tax purposes in a tax year ending prior to November 2, 1971 (the date on which Article VII, Section V, of the Florida Constitution, was amended so as to permit the imposition of a corporate income tax), then the amount of income realized during that earlier, nonjurisdictional period continues to be protected from Florida taxation by virtue of lack of constitutional authority for Florida to impose such a tax. (Emphasis Supplied). SRG Corporation vs. Department of Revenue,
365 So.2d 687 (Fla. 1978); Clearwater Federal and Loan Association vs. Department of Revenue, 350 So.2d 1134 (Fla. 2nd DCA 1977), affirmed at 366 So.2d 1164 (Fla. 1979). This brings us then to the essential issue at bar which concerns the meaning of the term "realized" and whether the subject income was realized in the tax year 1977 or, instead, prior to the effective date of the Florida Revenue Code which was January 1, 1972.
In this regard, Department of Revenue vs. Leadership Housing, Inc., 343 So.2d 611 (Fla. 1977), held that all income realized for federal tax purposes from the disposition of an asset which took place in a tax year ending after the effective date of the FLORIDA TAX CODE would be subject to Florida corporate income taxation, notwithstanding that substantial amounts of the gain accrued
through appreciation in value prior to the constitutional amendment authorizing the FLORIDA TAX CODE and the effective date of said CODE. Thus, the Respondents maintain that the Leadership Housing case is controlling in the present situation rather than the SRG and Clearwater Federal cases, because the only realization of income in the present situation occurred in the years prior to the date of Florida's jurisdiction to impose the corporate income tax.
In Florida Power Corporation vs. Lewis, 301 So.2d 1193 (Fla. 2nd DCA 1980), the hearing Officer rendered a Recommended Order, which ultimately affirmed by the District Court of Appeal and which is germane to the issue herein, wherein he stated:
Depreciation is neither income nor the reciprocal of income. While the tax laws allow depreciation
to be deducted from earnings in determining taxable income, this deduction is available only until the cost, of the asset has been recovered. No income was realized by the taxpayer as a result of accelerated depreciation taken before January 1, 1972. While the higher expenses allowed Petitioner which resulted from the accelerated depreciation served to reduce its federal income tax before January 1, 1972, still no income was realized. Florida Power Corporation vs.
Gerald A. Lewis, et al., DOAH Case No. 78-1227. (EMPHASIS SUPPLIED)
In affirming the Hearing Officer's Recommended Order the District Court of Appeal for the Second District opined:
We think the hearing officer had ample basis to reject petitioner's claims based upon its accelerated depreciation and capital outlay expense practices. Neither determines nor affects the date
on which income is earned or received, which we believe to be the primary consideration for determining whether or not the income was taxable. Florida Power Corporation, supra, at 1193.
The taxpayer in the Florida Power, supra, had claimed depreciation by the double declining balance accelerated method, and in the instant case the depreciation involved was claimed on a straight line basis. This is a distinction without a difference, however. In both cases, the depreciation methods employed prior to the constitutional amendment and the above effective date of the FLORIDA TAX CODE resulted in the assets having a basis for federal tax purposes which was below the, fair market value of those assets. This decision precludes any adjustment being made for Florida tax purposes to compensate for such a result.
The issue at bar has been addressed in another jurisdiction in Shangri La vs. State, 133 N.H. 440, 309 A. 2nd 285 (1973). In that case the New Hampshire Supreme Court rejected the contention that the State could not constitutionally tax a gain which represents the recapture of depreciation taken for federal tax deduction purposes prior to the effective date of that State's income tax code. The Court in that case held:
The taxpayer argues alternatively that the Legislature could not have intended RSA Ch. 77-A to apply the federal laws downward adjustments for pre-enactment depreciation. The Legislature's specific adoption of the federal income tax term of 'taxable income' belies this view.
By adopting this term, the Legislature levies a tax on income as federally defined and thereby incorporates federal adjustments to the basis used to arrive at this definition. Furthermore, federal basis rules apply an adjusted basis existent before the effective date of a federal statute creating a tax on gain, if the taxpayer realizes his gain after
the statute's effective date. Shangri La, supra, at 287; see also, MacLaughlin vs.
Alliance Ins. Co., 286 U.S. 244, 52 S.Ct.
538, 76 L.Ed. 1083 (1932); See Coyne, State Taxation of Capital Gains: Is Use of the Federal Basis Constitutional, 24 National Tax J. 521 (1971). 309 A.2d at 287.
The Shangri La, supra, was noted with approval, and as embodying a similar result, by the Florida Supreme Court in its decision in Department of Revenue vs. Leadership Housing, supra, at 615, N.4.
Thus, as noted by the Hearing Officer in Florida Power, supra no realization of income results from the claiming of depreciation. The realization test employed by the Florida Supreme Court in the SRG, supra requires this result:
'realization' for federal income tax purposes occurs when the tax- payer received actual economic gain from the disposition of property. See Helvering vs. Horse,
- 311 U.S. 112, 115, 61 S.Ct. 144, 85
L.Ed 75 (1940). It is when the taxable event occurs which gives rise to actual economic gain.
SRG Corporation, supra, at 689. (EMPHASIS SUPPLIED)
The persuasive language in the Helvering vs. Horst decision, upon which the SRG majority opinion was based, is stated thusly:
from the beginning the revenue laws have been interpreted as defining 'realization' of income as the taxable event rather than the right to receive It. Helvering, supra, at 115. (EMPHASIS SUPPLIED)
In Leadership Housing, supra, the Supreme Court also 189, 64 L.Ed. 521 (1920), which announced essentially the same test. If this test for realization of income from these federal decisions and the Leadership Housing case is applied to the facts of the instant case it is obvious that the taking of depreciation in earlier tax years is not a taxable event which would give rise to realization of income in those earlier tax years.
The Leadership Housing decision would also appear to preclude the apparent effort by the refund Petitioners herein to readjust the basis of their assets in the Florida properties to either the fair market value as of January 1, 1972, or, in the case of Pen Haven the fair market value of those assets as of the date of the termination of its Subchapter "S" status. See also Heftler Construction Company and Subsidiaries vs. Department of Revenue, 334 So.2d 129,
133 (Fla. 3rd DCA 1976). Thus, the federal basis rules can only be departed from if their application would unconstitutionally subject to taxation income which was realized prior to November 2, 1971. The application of the federal basis rules to the instant situation however, does not subject to taxation any income which was realized prior to the constitutional amendment or the effective date of the Florida Tax Code, January 1, 1972. Thus, the petitioners are not entitled to the use of a Florida basis which would differ from the federal basis for the tax years at issue.
The Petitioners place substantial reliance on the opinion of the Second District Court of Appeals in Clearwater Federal Savings and Loan Association vs. Department of Revenue, 350 So.2d 1134 (Fla. 2nd DCA 1977). In advancing their position that the recapture of depreciation should not be taxed under the so- called "taxed benefit rule", the subject corporations maintain that they received no Florida tax benefit for the depreciation claimed prior to Florida's enactment of the corporate income tax, since prior to that enactment there was no Florida tax liability which the claiming of the depreciation could reduce and thereby render the Petitioners an economic benefit. (In the case of Pen Haven the relevant date would be prior to the termination of its Subchapter "S" corporate status). This tax benefit rule, however, is provided for in a specific statute, and regulation promulgated thereunder, to wit, Section 111 of the Internal Revenue Code and Section 1.111-1(a) of the Internal Revenue Service Regulations to which the Second District Court referred in the Clearwater Federal, supra. It is thus not a rule of decisional law which a court or quasi judicial officer had a fairly wideranging discretion in applying. As such the rule should be strictly applied only in those circumstances to which the statute and its supporting regulation are directed. Section 1.111-1(a) of the Internal Revenue Service Regulations specifically provides:
The rule of exclusion so prescribed by statute applies equally with respect to all other losses, expenditures and accruals made the basis of deductions from gross income for prior taxable years, including war losses referred
to in Section 127 of the Internal Revenue Code of 1939, but not including deductions with respect to depreciation, depletion, amortization or amortizable bond premiums. (EMPHASIS SUPPLIED)
It is obvious then that this regulation which is promulgated pursuant to Section 111 of the Internal Revenue Code is not designed to apply to depreciation and its recapture. These two items are provided for by specific statutes on the subject of depreciation, aid in the case of its recovery, basis adjustments add capital gain treatments. However, it should be noted that the FLORIDA TAX CODE adopts all of the federal provisions without any adjustments attributable to events which occurred prior to the effective date of the FLORIDA TAX CODE or the date at which a particular corporation became subject to the provisions of said CODE (i.e., Pen Haven, lost its Subchapter "S" status)
Although the Petitioner alludes to a supposed difference in the case of Pen Haven caused by its status as a Subchapter "S" corporation up to the year 1976, in fact Pen Haven is entitled to no different treatment regarding the taxation of Use subject gain declared in 1977. The same argument regarding West Florida Utilities relates to Pen Haven, even taking into consideration that Subchapter "S" status. After its Subchapter "S" status was terminated it became a regular corporation fully subject to all of the provisions of the FLORIDA TAX CODE. Where it realized a gain for federal income tax purposes in a year in which it was a regular corporation (1977), its federal tax base also formed its Florida tax base and this could be altered only where there was statutory authority in Chapter 220, Florida Statutes (1979). Thus, the question still becomes whether Florida can tax income realized as taxable gain from the disposition of an asset during a year in which the corporation was subject to the CODE where that gain resulting from disposition of the asset represented recapture of depreciation taken for federal tax purposes in years in which the corporation was not subject to provisions of the FLORIDA TAX CODE.
Based on the foregoing authority and discussion which establishes that realization of the taxable income occurred upon disposition of the capital assets, (i.e. when Escambia County chose to liquidate the corporations and distribute the assets), it is obvious that the subject income was realized by the Petitioners after the effective date of Florida's jurisdiction to tax corporate income, rather than during those years in which the subject depreciation deductions were first claimed prior to January 1, 1972. Therefore, the Petitioners are concluded to be liable for the additional disputed amount of corporate income tax.
HAVING considered the foregoing FINDINGS OF FACT AND CONCLUSIONS OF LAW, the evidence in the record and other relevant facts and matters, it is, hereby,
ORDERED:
That the refund requested by Pen Haven Sanitation Company in the amount of $3,484.99 be denied, and
That the refund requested by West Florida Utilities, Inc., in the amount of $10,654.23 be denied.
DONE AND ORDERED this 22nd day of December, 1981.
GERALD LEWIS
Comptroller, State of Florida The Capitol
Tallahassee, Florida 32301
(904) 488-0370
COPIES FURNISHED:
P. Michael Ruff, Hearing Officer Division of Administrative Hearings The Oakland Building
2009 Apalachee Parkway
Tallahassee, Fla 32301
E. Wilson Crump, III Assistant Attorney General Department of Legal Affairs The Capitol
Tallahassee, Florida 32301
Robert A. Pierce, Esquire Legal Services
Florida Department of Revenue Carlton Building
Tallahassee, Florida 32301
Thurston A. Shell, Esquire SHELL, FLEMING, DAVIS & MENGE
Seville Tower, Seventh Floor
P. O. Box 1831 Pensacola, Florida 32598
| Issue Date | Proceedings |
|---|---|
| Dec. 01, 1981 | Final Order filed. |
| Sep. 03, 1981 | Recommended Order sent out. CASE CLOSED. |
| Issue Date | Document | Summary |
|---|---|---|
| Nov. 20, 1981 | Agency Final Order | |
| Sep. 03, 1981 | Recommended Order | A Final Order should be issued denying the Petitioners corporate tax refunds where subject income was realized by Petitioners after the effective date of Florida's jurisdiction to tax corporate income. |
PEACHES OF FLORIDA, INC. vs. DEPARTMENT OF REVENUE, 81-001220 (1981)
SCHINE ENTERPRISES, INC. vs. DEPARTMENT OF REVENUE, 81-001220 (1981)
MURRAY KRAMER CORPORATION vs. DEPARTMENT OF REVENUE, 81-001220 (1981)
DEPARTMENT OF REVENUE vs. FLORIDA WELDING SERVICES CORPORATION, 81-001220 (1981)
CLEARWATER FEDERAL SAVINGS AND LOAN ASSOCIATION vs. DEPARTMENT OF REVENUE, 81-001220 (1981)
