(a) Except as otherwise provided by this
regulation or other regulations under Section
25106.5
of the Revenue and Taxation Code,
the taxpayer members of a combined reporting
group may elect to determine the total separate net income of each member of
the group under accounting methods and other elections as authorized by
Division 2, Part 11 of the Revenue and Taxation Code, independently of the
total separate net income of other members of the combined reporting group.
(1) Once an accounting method or other
election is made for each member, that member's net income must be consistently
treated in all combined reports which characterize that income as combined
report
business income. In the event that
the taxpayer members do not file in a
consistent manner, the Franchise Tax Board may, in its discretion, resolve the
inconsistency as it deems necessary or appropriate, taking into account the
totality of
facts and circumstances relating to the applicable accounting
methods or elections.
Example: Corporations A, B, and C are members of a
combined reporting group. Corporations A and B are taxpayer members of the
group. Corporations A and B do not elect to file a group return. In the
combined report which Corporation A attaches to its return, Corporation A
computes Corporation C's income by electing to expense research and development
expenditures. However, in the combined report which Corporation B attaches to
its return, Corporation B computes Corporation C's income by electing to
capitalize research and development expenditures. Because Corporations A and B
did not determine Corporation C's income consistently, in an audit examination,
the Franchise Tax Board may resolve the consistency in any manner which it
deems appropriate, taking into account the totality of facts and circumstances
of the election.
(2) Once an
accounting method or election is applied to income included in a combined
report, the election is irrevocable (unless expressly revocable under the
applicable provisions of Division 2, Part 11 of the Revenue and Taxation Code).
If, under the provisions of Division 2, Part 11, an accounting method or
election must continue to be applied in a subsequent tax period, the accounting
method or election made in the tax period of the election shall apply to the
net income of that member in such subsequent period. This subsection shall also
apply with respect to that member if it joins another combined reporting group
or later becomes a taxpayer which is not a member of a combined reporting
group.
(b) In the event
of an audit examination (represented by a notice of additional tax proposed to
be assessed, a notice of proposed overpayment, notice of action on a claim for
refund, or a letter from the tax auditor regarding a computational effect which
does not
result in a current year adjustment (e.g., a computation of net
operating loss carryover)) which determines that a corporation, which is not
itself a California taxpayer, was erroneously excluded from the combined
reporting group,
the taxpayer members of the combined reporting group may elect
to determine the net income of that corporation under accounting methods and
other elections as authorized by Division 2, Part 11 of the Revenue and
Taxation Code, whether or not such accounting methods or other elections are
otherwise required to be made on a timely filed return. For an election under
this subsection to be effective, all taxpayer members must agree to the same
accounting method or other election for the erroneously excluded entity.
(1) The election described in subsection (b)
of this regulation cannot be made if the erroneously excluded entity was
obligated to file a U.S. income tax return, and made an election on its U.S.
return with respect to the available election or accounting method. In such
case, the federal election or accounting method shall apply.
(2) Time for making a subsection (b)
election. An election or a selection of an accounting method under subsection
(b) of this regulation should ordinarily be made during the course of the audit
examination, so that the results of that election can be reflected in the
applicable notice relating to the examination. However, except for claims for
refund, the election or accounting method authorized under this subsection must
be made no later than 60 days after the date of the applicable notice, and such
election or accounting method must be clearly specified. The Franchise Tax
Board may extend such 60-day period for good cause, not to exceed 180 days. In
the case of a claim for refund which includes an erroneously excluded entity in
the combined reporting group, a request for a subsection (b) election must be
included in the claim itself or presented before issuance of the notice of
action on the claim. Information to substantiate the effect of the election or
accounting method shall be provided within a reasonable time after the election
under this subsection is made.
(3)
Elections made under subsection (b) of this regulation may be made on a
protective basis, contingent upon a final determination that the excluded
member was properly included in the combined reporting group, and do not
operate as a concession that the inclusion of the corporation in the combined
reporting group was correct. In the event of a protective election,
substantiation of the effect of the election may be deferred until the final
determination is made whether the excluded member was properly included in the
combined reporting group. However, the members of the combined reporting group
(as determined) must retain all records to substantiate the effect of the
election, under Section
19141.6
of the Revenue and Taxation Code and the regulations thereunder, and assumes
the effects described therein associated with failure to retain the appropriate
records.
(4) An election under
subsection (b) of this regulation shall only be invoked for the first set of
income years under examination, in the first year for which the erroneously
excluded member's accounting method or election is applicable.
Example: Taxpayer was under a single audit examination
for income years 1992, 1993, and 1994. In the course of the examination, the
auditor proposed to include Corporation A, a nontaxpayer, in the combined
reporting group. Had Corporation A been originally included in the combined
reporting group, the taxpayer would have been able to make an election to
expense research and development costs on behalf of Corporation A. The first
year in which such eligible costs were incurred was 1993. The taxpayer did not
contest the inclusion of Corporation A in the combined reporting group, and did
not invoke this subsection to elect to expense such costs. The taxpayer was
reexamined for income years 1995, 1996, and 1997, and the auditor again
proposed to include Corporation A in the combined reporting group. The taxpayer
cannot invoke this section to expense research and development costs for
1995-1997, and may only apply for permission to change that method on a timely
basis for a current income year.
(5) In the event that an audit examination
determines that a California taxpayer, which had previously filed a California
return, was erroneously excluded from the combined reporting group, the
accounting methods and elections reflected in the return of that taxpayer shall
continue to apply.
