Untitled Texas Attorney General Opinion

353

Hon. John Ben Shepperd
secretary of state
Austin, Texas

Attention: Hon. Louis Scott Wilkerson
Assistnnt Secretary

Opi.nion No. V-1037.

Re: The inclusion of intangible
drilling costs in an oil corn-
pany’s assets to determine
its surplus fol, the purpose
Deal- Mr. Shepperd: of franchise taxation.

You request the opinion of this office upon the follow-
Ing question:

“Must the full amount ot intangtble drilling costs
be included in a colporation’s assets for purpose of de-
termining its surpla (which is paat of the measure of
i~ts franchise tar under Article 7084, VACS)? As used
in this question, ‘intangible drilling costs’ are, as de-
fined in U. 5. Treasuy Regulations 103, Sec. 29.23 (III)-
16, “All expenditures for wages, fuel, repairs, hauling,
supplies, etc. incident to and necessary for the drilling
of wells and the preparation of wells for the production
of oil or gas, . . . ’ ”

The two statutory provisions with which we are here
pl,imarily concerned ar’e Articles 7084 and 7089, V.C.S.,, the first
dealing with the basis upon which the franchise tax is required to
be paid and the second the report required to be submitted by the
corpoxatlon flom which the amount of the tax is cal.culated,. These
two statutes provide in part as follows:

Article 7084. “( 1) Except as herein provided, ev-
ery domestic and foreign cwpora,tion heretofore or here-
after char tcred or authorized to do business in Texas,
oz doing business 1x1 Texas, shall, on or be:fwe May first
of each year, pay in advance to the Sec.~etary of State n
franchise tax for the year following, based upon that pro-
portion of the outstanding capit.al stock, surplus and un-
Hon. John 13en Shepperd, ,FQ,.~;<:L (V-10~7)

divided profits, plus the amount of outstanding bonds,
fiotrs and debentures . as Ihe. grosi r~xeipts from
its business done in Texas bears to the total gross re-
ceipts of the iox [‘oration from its enf,i~,e business, which
tax shall be computed on the basis of . . I ”

Article 7089. “Except as herein provided all cor-
poxations required to pay an annual franchise tax shall,
between Jan~uaxy first and March fifteenth of each year,
make a sworn report in duplicate to the Secr,etary of
State, on forms fwnished by that officer, showing the
condition of such cox,poration on the last day of the pre-
ceding fiscal year. The Secretary of State may for good
cause shown by any corporation extend such time to any
date up to May first. Said report shall give the cash
value of all gross assets of the corporation, the amount
of its authorized capital stock, the capital stock actual-
ly subscribed and the amount paid in, the surplu and
undivided profits or deficit, if any, the amount of mort-
gage. bonded and current indebtedness, the amount and
date of payment of the last annual, semi-annual, quar-
terly. or monthly dividend, the assessed value, for State
ad valorem purposes of all, property of the corporation,
real, personal, or mixed, owned by the corporation in
this State and the county in which assessed for such pur-
poses, the amount of all taxes paid, or due and payable
to the State of Texas, or to any county, city or town,
school district, road district, or other taxing subdivi-
sion of Texas, for the preceding tax year, the total gross
receipts of such corporation from al.1 sources and tb.e
gross receipts from its business done in Texas for the
fiscal year preceding, with a detailed balance sheet and
income and profit and loss statement in such form as
the Secretary of State may prescribe. . .”

Thus it is app~~rcnt from an examination of the forego-
ing Article 7084 that COUI Items constlt,ute the basis upon which the
tax IS computed., They are: (I) outstanding capit.al st.ock; (2) sur-
plus; (3) undi,vided profits; and (4) outst.anding bonds, notes, and
debentures, other than those mal~uring in less than a year from date
of issuance. The total of these factors is modified, however, by the
proportion the gloss receipts from business done in Texas bears
to the gross receipts of the corporation from its entire business
done III Texas and outside of Texas. The resulting total, after the
application of this proportion, constitutes the basis upon which the
tax owing by the corporation is determined.

The question resolves Itself into whether or not “‘intan-
gible driillng costs” may be considered as outstanding capital stock,
 355
Hon. John Ben Shepperd, Page 3 (V-1037)

surplus, and undivided profits, or outstanding bonds, notes, and
debentures other than those maturing in less than a year from the
date of issuance.

We think it quite true that the Lxgislature had in per-
spective the entire capital structure of the corporation in fixing a
basis for the calculation of the franchise tax, but broke it down in-
to four component parts, as we have heretofore pointed out, the
first of which is the outstanding capital stock. Certainly by no proc-
ess of reasoning could intangible drilling costs be considered as an
element of or addition to this item, or either of the three remain-
ing items, that is, surplus, undivided profits, or outstanding bonds,
notes, and debentures, unless it fall under the classification of “sur-
plus:. *’

Outstanding capital stock, as used in this statute, is
capital stock which has been issued, and this regardless of wheth-
er it is in the hands of the stockholders or the corporation. A.B.
Frank Co. v. Latham, 145 Tex. 30, 193 S.W.Zd 671 (1946). S-s
and undivided profits are variable and hence of greater 01~ less val-
ue, dependent upon the success or failure of the operation of the
business. These variable items are added to the outstanding cap-
ital stock as disclosed by the report required to be submitted to the
Secretary of State under the provisions of Ar,ticle 7089, and thus,
together with the outstanding bonds, notes and debentwes, is re-
flected the entire capital structure of the corporation upon which
the tax is computed.

Is “intangible drilling cost ” “surplus” as that term is
used in this statute? We think not, unless the taxpayer elects to
treat it as such.

In the case of United North and South Development Co.
v. Heath. 78 S.W.2d 650 (Tex. Clv. AUD.
_. 1935~. error dlsm.1, the court
round it necessary to consider fully the meaning of the term “sux -
plus” as used in Article 7084. It is not necessary to consider all
of the various meanings of the term discussed in this opinion, as they
are all somewhat analogous. The court said:

“The Legislature did not undertake t.o define what
is meant by the term ‘surplus’. In a generally accepted
commercial sense, it usually applies to funds remain-
ing on hand after fixed charges or liabilities have been
deducted. As applied to corporations, it has been held
to be the value of all the ccwporation’s assets after its
liabilities, including its capital stock, have heen deduct-
ed.”
Hon. John Ben Shepperd, Page 4 (V-iO37)

You state that this definitioc has been consistently fol-
lowed and is now being followed by the Secretary of State in connec-
tion with the administration of the franchise tax law, Long accept-
ance of this definition by the Secretary of State, in the absence of
a statutory definition, should not now be changed without some com-
pelling reason. Moreover, the Legislatur’e has met many times since
the court z,endered the opinion in the case of United North and South
Development Co. v. Heath, supra, and It may6e presumed that&
deflnltlon of the term- surplus” given in that case did not meet the
approval of the L.egislature. it would have been changed,

Your opinmn request states that the term “intangible
drilling costs” is used as defined in United States Treasury Regu-
lations 103, Section 29.23 (m)-16. This term as there defined is
as follows:

“All expendi,tures for wages, fuel, repairs, haul-
ing, supplies, etc., incident to and necessary for the
drilling of wells and the preparation of wells for the
production of oil or gas. _) . .*

In the case of Commissioner of Inl:ernal Revenue v. Am-
brose, 127 F.2d 47, the Circuit Court of Appeals of this circuit in
n’iiiticome tax case in which intangible drilling costs had been de-
ducted as operating expense by the taxpayer approved this deduction
in the following language:

“Article 23(m)-16 of Treasury Regulations 86
relates to intangible dr,illing and development costs,
and gives the taxpayer an optlon either to deduct such
costs from gross income as an expense, or to charge
them to his capital account. . . .

“The lease operator who undertakes his own drill-
ing is granted t.he option because the intangible costs
are not capital in nature, as they have no salvage value;
they can be allocated; and the expenditures to defray the
intangible costs are made by the t.axpayer.”

The Federal statute and regulations thereunder give the
taxpayer the option to deduct “lntangibl,e drilling costs” as an op-
erating expense or to charge such costs to capital account, thus rec-
ognizing that it is acceptable accounting practice to treat such costs
as operating expense or as invested capital. Of cwxse, if a taxpay-
er should elect to capitalize “intangible dl,illing costs ” in the form
of a reserve for that pur’pose and allocate it from other, available
funds, amortizing it over a peI.iod of years not to exceed the life of
profltable development, there is nothing in the law that would pre-
clude this. The Secretary of State should accept It as was done in
‘. ,

Hon. John Ben Shepperd, page 5 (V-1037)

the case of United Nort,h dnd South Development Co. Y. -.---
Heath,, supra,
where rhe taxpayer by tts own sworn statement toCheSecxetary of
State fixed the value on what was called “app~ ec iatrd sur~plus ,”

If a taxpayer has been txtating Intangible drilling costs
as current operating expenses and making his repat to the Secre-
tar.y of State as required by Articl~e 7089 upon ihis basis and has
paid the taxes owing upon the basis of said report, this, in our opin-
ion, is in compliance with the statute. The Secretary of State would
tlerefore be without authority to require the taxpayer to revise and
pay additional taxes based upon the theory that intangible drilling
costs should have been capitalized and treated as taxable capital.
If, however, the t~axpayer has heretofore submitted his franchise tax
report by treating intangible drilling costs as a capital investment
to be amortized over an appropriate period of times this likewise
is acceptable.

It is our understanding that the Secretary of State has
so construed this statute over a long period of years during which
time the Legislature has met several times, and we must assume
that this construction has been with legislative approval or some
action would have been taken to chaage it. As was said by the Su-
preme Court in the case of Isbell v. Gulf Union Oil Co., 147 Tex. 6,
209 S.W.2d 762 (1948):

“If the Legislature did not approve the constrac-
tion which had been given the statute, it could have eas-
ily amended the law. This was not done.”

SUMMARY

Intangible drilling costs may be treated as cur-
rent annual operating expense under the franchise tax
statute, or set up as a reserve by allocation from other
available capital resources and amortized over an ap-
propriate period of yeal’s. Arts.. 7084 and 7089, V,C..S.;
A.B. Frank Co. v. Latham, 145 Tex. 30, 193 S.W.Zd 671
(1946) United North and South Development Co. v, Heath,
78 &.2 -935, error di.sm.): Com-
missioner of Internal Revenue v. Ambrose, 127 F.m;
Xsbetl v. Gulf Umon 011 C o., 4 I Tex. 6, 209 S.W .Ld 762
(1948).

YOUX~S ve:::*,y t2 uly,
APPROVED:
PRICE DANIEL
W 1 V. Geppert Attorney Gene:ral
Taxation Division

Charles D. h4athews
Executive Assistant Assistant

LPL/mwb