Legal ruling 1995-4

1994 Water's-Edge Elections When Members of the Group Have Different Fiscal Years

Issue

When the taxpayer members of a water's-edge group have different fiscal years, for which income year must each elect in order to obtain a proper election for the entire group as of a certain date in 1994?

Holding

The answer varies according to whether an election is already in place and according to the start date desired. Several fact patterns are described for illustrative purposes.

Law and Analysis

Title 18, Cal. Code of Regs. §25111-1(g), effective for income years beginning on or after January 1, 1994, provides:

In the case of taxpayers which are on different fiscal years, each member of the water's-edge group shall make the election upon its initial return for the income year for which the election is being made. The election shall become effective as of the beginning of the income year of the last member of the water's-edge group to file its return and election. The 84-month election period for each member of the group will run from the date that the election becomes effective, i.e., the beginning of the income year of the last member of the group to elect.

The above quoted language is identical to 18 Cal. Code of Regs. §25111(g), effective for income years beginning prior to January 1, 1994, except that §25111(g) refers to a 60-month rather than an 84-month election period.

Revenue and Taxation Code (RTC) §25111.1 provides:

(a) For any income year beginning on or after January 1, 1994, consideration for water's-edge contracts in existence as of that date is no longer provided for by law. Contracts entered into for income years beginning prior to January 1, 1994, are rescinded for any periods remaining on those contracts commencing on the first day of the taxpayer's first income year that begins on or after January 1, 1994. Any fiscal year taxpayer whose contract is in effect as of December 31, 1993, shall continue to be bound by that contract until the close of its income year after January 1, 1994, and before December 31, 1994.

(b) Not withstanding subdivision (a), and except for the purposes of Section 25115, all taxpayers that are members of a water's-edge group consisting of taxpayers with different income years shall continue to be bound by the contract in effect as of December 31, 1993, until the income year beginning prior to January 1, 1994, and ending in 1994 for each of the taxpayer members of the water's-edge group has ended.

Further, RTC §25115(n) provides that RTC §25115 shall remain in effect until January 1, 1994, and as of that date is repealed. This was subsequently clarified by Stats. 1994, Chapter 22, Section 6, which provides that Section 25115 of the Revenue and Taxation Code, as that section read on December 31, 1993, applies to any income year beginning before January 1, 1994.

Analysis of Factural Situations

Situation 1. Corporations A and B are California taxpayers engaged in a unitary business. Corporation A's income year ends December 31, 1994, and Corporation B's income year ends March 31, 1994. Corporation A and B do not currently have a water's-edge election. To obtain a water's-edge election beginning on January 1, 1994, when must Corporations A and B elect water's-edge?

Answer: Corporation A must make two water's-edge elections with its return for income year ended December 31, 1994. The first covers the period from January 1, 1994, through March 31, 1994; the second covers the 84-month period beginning April 1, 1994. Corporation B must elect water's-edge with both its returns for income years ended March 31, 1994, and March 31, 1995.

Analysis: Title 18, Cal. Code of Regs. §25111 and §25111-1 each provides that in the case of taxpayers with different fiscal years, each must elect water's-edge with its original return and that the election becomes effective as of the beginning of the income year of the last member of the group to elect. To obtain an election beginning January 1, 1994, Corporation B must elect water's-edge with its return for the income year ended March 31, 1994. When Corporation A elects water's-edge with its return for the income year ended December 31, 1994, it becomes the last member of the group to file its return within B's income year. The election will become effective as of the beginning of A's income year, January 1, 1994, and will be rescinded as of the close of Corporation B's income year ending in 1994. (RTC §25111.1(b).) Prior to January 1, 1994, both A and B would compute their unitary taxable income on a worldwide basis.

Because contracts entered into for income years prior to January 1, 1994, are rescinded for any periods remaining on those contracts as of the first day of the taxpayer's first income year beginning on or after January 1, 1994, Corporation B's election is rescinded as of April 1, 1994. Corporation B will owe the election fee through the end of its income year ended in 1994 because RTC §25115 remains in effect for taxpayers whose income years begin prior to January 1, 1994. Corporation A will not owe an election fee because RTC §25115(n) repeals RTC §25115 for income years beginning on or after January 1, 1994. Corporation B must reelect, for the new statutory period of 84 months, with its return filed for its income year ended March 31, 1995. Corporation A's election commencing January 1, 1994, also is rescinded as of the last day of B's income year ended in 1994, therefore it also must file an additional contract covering the period beginning on April 1, 1994, and continuing for the next 84 months. (RTC §25111.1(b).) If Corporations A and B file a Notice of Nonrenewal, their election will run through March 31, 2001.

Situation 2. Assume the same facts as Situation 1 except that the taxpayers want the election to begin on April 1, 1994.

Answer: To obtain a water's-edge election beginning on April 1, 1994, Corporation A must elect water's-edge with its return for the year ended December 31, 1994. Corporation B must elect water's-edge with its return for the income year ended March 31, 1995.

Analysis: Title 18, Cal. Code of Regs. §25111-1(g) provides that in the case of taxpayers which are on different fiscal years, each member shall make its election upon its initial return for the income year for which the election is being made. The election becomes effective as of the beginning of the income year of the last member of the water's-edge group to file its return and election, in this fact situation, April 1, 1994. Prior to April 1, 1994, both A and B would compute their unitary taxable income on a worldwide basis.

Situation 3. Corporations A and B are California taxpayers engaged in a unitary business. Corporation A's income year ends December 31, 1994, and Corporation B's income year ends March 31, 1994. Corporations A and B had elected water's-edge effective for the period April 1, 1992, through March 31, 1997. Corporations A and B want to obtain a water's-edge election commencing April 1, 1994.

Answer: Corporation A must elect water's-edge with its return for the income year ended December 31, 1994. Corporation B must elect water's-edge with its return for income year ended March 31, 1995.

Analysis: Corporations A and B's water's-edge election beginning April 1, 1992, and ending March 31, 1997, would be rescinded as of the last day of the last income year ending in 1994. (RTC §25111.1.) Therefore, each member must make a new election for its income year beginning in 1994. Both Corporations A and B would apply the rules applicable to water's-edge elections for income years beginning before 1994 until their contract is rescinded on March 31, 1994. However, Corporation A would not owe the water's-edge election fee for the period from January 1, 1994, to March 31, 1994, while Corporation B would pay the election fee for the period prior to April 1, 1994. (RTC §25111.1.)

Drafting Information

The principal author of this ruling is Claudia Land of the Franchise Tax Board Legal Division. For further information regarding this ruling, contact Ms. Land at the Manhattan District Office, 1212 Avenue of the Americas, 4th Floor, New York, NY 10036-1601, (212) 704-9243, or Elaine Segarra of the Franchise Tax Board Compliance Division, P.O. Box 1779, Rancho Cordova, CA 95741-1779, (916) 845-3940.

NOTE: ((---)) = Indicates obsolete information.