TECHNICAL ASSISTANCE ADVISORY 88-015Re: Corporation Net Income Tax -- Credit Against Tax for B&O Taxes -- Disallowance of Interest Expense Shown on Line 18 of Federal Form 1120 as Offset to Interest Income Not Subject to B&O Tax. For some time we have had under consideration the question whether interest income not subject to business and occupation tax may be offset by the amount of interest expense reported by a corporation on line 18 of its federal income tax return, when determining the credit allowable against West Virginia corporate net income taxes for business and occupation taxes payable. As you may recall, on November 2, 1976, the Taxation Committee wrote to then State Tax Commissioner Richard L. Daily requesting a memorandum ruling concluding that: "(1) Items which are in fact a reduction of expenses rather than income should not be excluded from the numerator of the fraction used in computing the B&O credit for CNIT purposes. (2) Interest expense should first be offset against interest income before excluding interest income from the numerator in the B&O credit computation for CNIT purposes, for all taxpayers who receive interest income not subject to the B&O tax." A memorandum ruling was not issued in response to this request. Instead, Jon H. Snyder, then Director of Business Tax Division, responded in a letter to the Society concluding: "It is our position that a corporation having interest income not subject to business and occupation tax would be allowed to offset this income by the amount of any interest expense reported on line 18 of their Federal Form 1120. The allocation of any other expense should not be applied to reduce this amount of interest income before Schedule D modifications are made on line three (3) of the State return. Another issue arises when items of income are in fact a reduction of expenses, but were previously included as income on Federal Form 1120. The items of income reflected on page one (1) of Form 1120 (depreciation recapture, purchase discounts, bad debts, and patronage rebates) need not be deducted from line three (3) in the computation of Schedule D or business and occupation tax credit. When a corporation has a net capital gain reported for federal purposes, and in fact no business and occupation tax has been paid on this amount it is our position that the net gain must be removed from line three (3) of Schedule D in the computation of the credit. A corporation may have capital treatment of royalty income on which they would pay business and occupation tax and would therefore be allowed the business and occupation tax credit in this type of income. These are general guidelines but we will provide a specific response to a particular set of facts if needed. If you have additional questions, please let me know." While considering this matter, I became aware that the Corporate Net Income Tax Section of Business Tax Division had been instructed to follow the positions outlined in the Director's correspondence with the Taxation Committee; and that the Section sent letters, conducted audits and issued assessments in accordance with these positions, for about ten years, until the practice was stopped during the second half of 1986. You may also recall that beginning with the 1987 corporate net income package, the Department included a new worksheet for determining the portion of the West Virginia taxable income that was subject to both the business and occupation tax and the corporate net income tax. Prior to the issuance of Jon H. Snyder's letter, the policy of the Tax Commissioner's Office was that expenses or cost were to be allocated between income subject to business and occupation tax and income not subject to business and occupation tax by: (1) Tracing actual direct expenses to income not subject to B&O tax; and (2) Any other method which can be explained and justified s to its reasonableness. The obvious flaw in permitting interest expense to offset interest income not subject to business and occupation tax is its potential to shield corporate net income the tax on income which is not subject to offset by the credit allowed by W. Va. Code § 11­24­9. What is allowable as a deduction from interest income not subject to business and occupation tax is the amount of expenses incurred to generate that interest income. Having concluded that the policy of offsetting interest income not subject to business and occupation tax by interest expense shown on Line 18 of Federal Form 1120 is contrary to law and not in conformity with the policy of the Tax Commissioner, the question becomes whether to reverse that erroneous policy back to the date of its inception. A well accepted part of West Virginia law is that collateral estoppel does not run against the State. Thus, as a purely technical matter, this Office is not required to follow erroneous conclusions of law reached by others, including former commissioners. Against this point of law must be weighed, however, the extent to which Business Tax Division sought to enforce the interest offset policy and the extent to which taxpayers relied on that policy. Because both the Department and taxpayers relied upon this erroneous policy I conclude that the interest offset policy should not be changed retroactively. By the middle of calendar year 1986, Accounting Division had stopped allowing the interest offset. It is therefore determined that the interest offset policy should be followed for taxable years ending before January 1, 1987, but not thereafter. Additionally, I point out that since July 1, 1986, a statutory procedure has been available pursuant to which a taxpayer can obtain a binding ruling from the Tax Commissioner that can only be prospectively changed. See W. Va. Code § 11-10-5r. The obvious implication is that for a policy letter to be binding after July 1, 1986, it must be in the form of a Technical Assistance Advisory. For that reason, this letter will be issued as a Technical Assistance Advisory. Michael E. Caryl State Tax Commissioner Issued: December 9, 1988