Section 25106.5-3 - Accounting Methods and Elections(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.(c) This regulation shall apply to income years open to adjustment under applicable statutes of limitation.Cal. Code Regs. Tit. 18, § 25106.5-3
1. Change without regulatory effect renumbering former section 25137-6 to section 25106.5-3 and amending subsection (e)(1) and NOTE filed 2-14-95 pursuant to section 100, title 1, California Code of Regulations; operative 3-13-95 (Register 95, No. 7).
2. Renumbering of former section 25106.5-3 to new section 25106.5-10 and new section filed 7-13-99; operative 8-12-99 (Register 99, No. 29). Note: Authority cited: Section 19503, Revenue and Taxation Code. Reference: Section 25106.5, Revenue and Taxation Code.
1. Change without regulatory effect renumbering former section 25137-6 to section 25106.5-3 and amending subsection (e)(1) and Note filed 2-14-95 pursuant to section 100, title 1, California Code of Regulations; operative 3-13-95 (Register 95, No. 7).
2. Renumbering of former section 25106.5-3 to new section 25106.5-10 and new section filed 7-13-99; operative 8-12-99 (Register 99, No. 29).