Legal ruling 1999-2

Net Operating Losses - "Elegible Small Business" and "New Business"

Purpose

Legal Ruling 96-5 sets forth the department’s position as to the scope of the terms "eligible small business" and "new business" as used in Revenue and Taxation Code §§ 17276 and 24416, relating to net operating losses. The Franchise Tax Board has determined that the positions articulated in that ruling, relating to the application of the net operating loss rules to taxpayers who have made a water’s-edge election, are in conflict with statutory provisions and inconsistent with the general principles underlying California’s taxation of water’s-edge taxpayers. Therefore, those positions should properly be deleted from that ruling. This ruling is specifically intended to remove any inference that different net operating loss rules apply in a case where a water’s-edge election is in effect.

Description of Specific Modifications

In describing the computation of the denominator for purposes of applying the "asset test" set forth in Revenue and Taxation Code §§ 17276(f)(1) and 24416(g)(1), Legal Ruling 96-5 states that the computation shall be different if a taxpayer has a valid water's-edge election in effect. However, since Revenue and Taxation Code §§ 17276(f)(5) and 24416(g)(5) define the term "related person" by reference to Sections 267 or 318 of the Internal Revenue Code, related persons are not limited to members of a combined report. Therefore, a water's-edge election will have no effect on the assets that must be taken into account for purposes of applying the "asset test."

In describing the computation of the "gross receipts" of an "eligible small business" under Revenue and Taxation Code §§ 17276(e)(1) and 24416(f)(1), Legal Ruling 96-5 states that the computation shall be different if a taxpayer has a valid water's-edge election in effect. However, since Revenue and Taxation Code §§ 17276(f)(5) and 24416(g)(5) define the term "related person" by reference to Sections 267 or 318 of the Internal Revenue Code, related persons are not limited to members of a combined report. Therefore, a water's-edge election will have no effect on the computation of the gross receipts that must be taken into account for purposes of determining whether a taxpayer may be treated as an "eligible small business."

All references to water's-edge taxpayers and the special rules applicable thereto in Legal Ruling 96-5, including the references in the specific hypothetical examples and the analysis and holdings accompanying those examples, are hereby deleted.

Effect on Other Rulings

Legal Ruling 96-5 is modified as described herein.

Drafting Information

The principal author of this ruling is Douglas K. Powers of the Franchise Tax Board, Legal Branch. For further information regarding this ruling, contact Mr. Powers at the Franchise Tax Board, Legal Branch, P.O. Box 1720, Rancho Cordova, CA 95741-1720.