OFFSET PRODUCED IN YEAR ITC WAS CARRIED BACK DOES NOT REDUCE ITC RECAPTURE AMOUNT.

Rev. Rul. 87-56

ISSUE

If a taxpayer carries back investment credit to an earlier credit year, if the carryback of the investment credit was offset, in part, by an increase in the minimum tax under section 56 of the Internal Revenue Code, and if the taxpayer effects an early disposition of "section 38 property" that gave rise to the investment credit, does section 47(a)(1) require a recapture of the full amount of the investment credit that was carried back?

FACTS

In 1984, the taxpayer purchased and placed in service section 38 property that cost 500x dollars and has an estimated useful life of 7 years. Because of the limitations of section 38(c) of the Code, the taxpayer was not able to utilize the 50x dollars investment credit in 1984 attributable to the acquired section 38 property. However, the taxpayer was able to carry back the investment credit to the credit year 1981, the earliest year that it could utilize the investment credit. Carrying back the credit in this fashion reduced its federal income tax liability under section 11 of the Code by 50x dollars.

The reduction in federal income tax under section 11 of the Code for credit year 1981 reduced the taxpayer's regular tax deduction under section 56(c) for purposes of calculating taxpayer's minimum tax under section 56(a). This reduction in the taxpayer's section 56(c) regular tax resulted in an increase of 3x dollars in the taxpayer's minimum tax liability under section 56(a).

In 1985, the taxpayer disposed of the section 38 property that it acquired in 1984. On its 1985 federal income tax return, the taxpayer claimed that only 47x dollars of the investment credit should be recaptured because the original carryback of 50x dollars investment credit was offset by an increase in the minimum tax under section 56(a) of the Code of 3x dollars, leaving a balance of 47x dollars to be recaptured. Upon examination, the taxpayer's tax liability was increased by 3x dollars due to the recomputation and the recapture of the investment credit.

LAW AND ANALYSIS

Section 38 of the Code allows as credit against federal income tax a general business credit that includes the investment credit for qualified investment in section 38 property. Property that qualifies as section 38 property is defined in section 48.

Section 47(a)(1) of the Code provides that if during any taxable year any property is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer before the close of the useful life that was taken into account in computing the credit under section 38, then the tax under chapter 1 for such taxable year is increased by an amount equal to the aggregate decrease in the credits allowed under section 38 for all prior taxable years that would have resulted solely from substituting, in determining the qualified investment, for such useful life the period beginning with the time such property was placed in service by the taxpayer and ending with the time such property ceased to be section 38 property.

Section 47(a)(6) of the Code provides that in the case of any cessation described in section 47(a)(1), (3), or (5) or any change in the use described in section 47(a)(2) or (4), the carrybacks and carryovers under section 39 shall be adjusted by reason of such cessation (or change in use).

Section 47(c) of the Code provides that any increase in tax under section 47(a) is not treated as tax imposed by chapter 1 for purposes of determining the amount of any credit allowable under subpart A, B, or D.

Section 1.47-1(a)(1)(i) of the Income Tax Regulations provides that under section 47(a)(1) of the Code the credit earned for the credit year is recomputed by substituting the actual useful life of the property for the useful life taken into account originally in computing the qualified investment. This regulation section further requires the recomputing of the credit allowed for the credit year and for any other taxable year affected by reason of the reduction in credit earned for the credit year, giving effect to such reduction in the computation of carryovers and carrybacks of unused credit. If the recomputation of carryovers and carrybacks of unused credit. If the recomputation results in an aggregate decrease in the credits allowed for the credit year and for any other taxable year affected by the reduction of the credit earned for the credit year, then the income tax for the recapture year is increased by the amount of such decrease in credits allowed.

Section 56(a) of the Code, prior to its amendment by section 701(a) of the Tax Reform Act of 1986, provided that in addition to the other taxes imposed by chapter 1, there is imposed for each taxable year, with respect to the income of every corporation, a tax equal to 15 percent of the amount by which the sum of the items of tax preference exceeds the greater of $10,000, or the regular tax deduction for the taxable year (as determined under subsection 56(c)). Section 56(c) defines the term "regular tax deduction" as an amount equal to the taxes imposed by chapter 1 for the taxable year (computed without regard to the taxes imposed by sections 531 and 541), reduced by the sum of the credits allowable under subparts A, B, and D of part IV. For purposes of the preceding sentence, the amount of the credit determined under section 38 for any taxable year shall be determined without regard to the employee stock ownership credit determined under section 41, prior to its repeal by section 1171(a) of the Tax Reform Act of 1986.

In Rev. Rul. 72-221, 1972-1 C.B. 15, a taxpayer placed in service various items of section 38 property in the taxable years 1963, 1964, and 1966. Because the section 38 property placed in service in 1963 was disposed of in 1966, a determination of the increase in tax resulting from the disposition was required under section 47 of the Code. Prior to the recomputation of the taxpayer's additional tax (recapture tax), taxpayer had an unused investment credit carryback of $300 in 1966. The issue in Rev. Rul. 72-221 was whether section 47(c) precludes the carryback to 1963 of the $300 unused investment credit, in recomputing the tax liabilities for all prior taxable years to determine the amount of recapture tax liability under section 47(a).

Rev. Rul. 72-221 concludes that in computing the recapture tax under section 47(a) of the Code on the early disposition of section 38 property, unused investment credit earned during the tax year of disposition must be carried back to open tax years before the aggregate decrease in credits allowed under section 38 for all prior taxable years can be computed. That ruling thus holds that section 47(c) does not preclude the carryback of the $300 investment credit from 1966 to 1963 for purposes of recomputing the tax liabilities for all prior years. The carryback was not precluded because section 47(c) applies only after the recapture tax liability has been computed and thus the section precludes only offsets against carryovers or carrybacks available at that time.

More specifically, Rev. Rul. 72-221 indicates that if no investment credit had been claimed in 1963, the $300 investment credit earned but unused in 1966 would have been added to the investment credit allowable in 1963 in accordance with the provisions of section 46(b) of the Code. Since there would have been an income tax liability in that year against which the 1966 investment credit could have been applied, the investment credit would have been treated as an investment credit allowed in 1963 and a claim for refund would have been allowable. Thus the $300 unused investment credit earned in 1966 must be treated as an increase in credits allowed under section 38 for prior taxable years that results solely from substituting the actual useful life of the section 38 property acquired in 1963 and disposed of in 1966 in place of the useful life claimed initially, and this increase must be taken into account in computing the aggregate decrease in credits under section 47(a).

There is no authority in section 47(a)(1) of the Code and the regulations thereunder for the computation of the aggregate decrease in the credits allowed by section 38 to take into account not only decreases and increases in such credits but also a resulting increase in minimum tax under section 56(a). The legislative history of section 47 explicitly stated that the recapture mechanism in that section would not require any actual recomputation of the taxes of prior years. See H.R. Rep. No. 1447, 87th Cong., 2d Sess. 13, 14 (1962), 1962-3 C.B. 405, 417-18; S. Rep. No. 1881, 87th Cong., 2d Sess. 18 (1962), 1962-3 C.B. 707, 724. By its terms, section 47 involves a recomputation only of the investment credit and not of other taxes that may be affected. Thus, Rev. Rul. 72-221 is distinguishable from the present situation.

This result is not unjust. Since no interest is imposed on the investment credit recapture, the taxpayer enjoyed for a period of time interest-free use of the recaptured investment credit less the minimum tax. One of the tax benefits at which the minimum tax was targeted was deferral. See S. Rep. No. 938, 94th Cong., 2d Sess. 114 (1976), 1976-3 (Vol. 3) C.B. 57, 152. Because a taxpayer subject to recapture has nevertheless enjoyed deferral, it is appropriate for the recapture to be unreduced by the minimum tax previously imposed.

HOLDING

Section 47(a)(1) of the Code requires a recapture of the full amount of 50x dollars unused investment credit that was carried back in 1981.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 72-221 is distinguished.