Gray Horse, Inc. v. Limbach - Ohio Supreme Court Opinion - Ohio Supreme Court Decision

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OPINIONS OF THE SUPREME COURT OF OHIO
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Gray Horse, Inc., Appellant, v. Limbach, Tax Commr., Appellee.
[Cite as Gray Horse, Inc. v. Limbach (1993), Ohio
St.3d .]
Taxation -- Franchise tax -- Board of Tax Appeals decision
affirming Tax Commissioner's order that increases
corporation's value, under the net-worth basis of the
franchise tax, of the shares of stock the corporation held
in a subsidiary reversed, when.
(No. 92-1775 -- Submitted April 27, 1993 -- Decided July
14, 1993.)
Appeal from the Board of Tax Appeals, No. 89-M-33.
Gray Horse, Inc., appellant, challenges the Tax
Commissioner's, appellee's, order that increases the value,
under the net-worth basis of the franchise tax, of the shares
of stock Gray Horse held in a subsidiary. This action
increases its franchise tax.
Since 1976, when James M. Osborne and Alice Q. Osborne
incorporated Gray Horse, Gray Horse has recorded the value of
the shares contributed to it in Osborne Estates Company and
Panhandle Eastern Pipe Line Company, both formerly owned by the
Osbornes, at the cost or tax basis of the stock, $989,103.60.
Gray Horse obtained this valuation from source documents it
received from the Osbornes and, from its incorporation, has
recorded this same valuation on columnar work sheets. Gray
Horse reported the value of the shares under this method on its
1984 franchise tax return, with fiscal year ending June 30,
1983, and its 1985 franchise tax return, with fiscal year
ending on June 30, 1984.
However, for the corresponding federal tax years, 1982 and
1983, Gray Horse reported the value of the stock as $4,925,798
and $5,131,166.23, respectively. Gray Horse based this value
on one-half of the market value of the stock in Panhandle,
which had acquired the shares of Osborne Estates in a
reorganization. According to the accountant who prepared these
returns, Gray Horse valued the shares in this manner to
establish some substance for the corporation which would
justify the $100,000 salary paid Mr. Osborne, who managed the
underlying assets. Gray Horse reported these values only on

these federal returns, and these values did not affect Gray
Horse's federal income tax other than to support the salary
deduction.
The commissioner compared the federal returns with the
franchise tax returns and increased the value of the stock to
the amounts reported on the federal returns.
Gray Horse appealed, and the Board of Tax Appeals ("BTA")
affirmed. The BTA concluded:
"* * * Although the tax basis method of accounting is a
generally accepted and recognized method of accounting, the
taxpayer cannot use this method for its Ohio Franchise Tax
Returns since he [sic] did not use this method for its Federal
Income Tax Returns.
"Furthermore, to afford the taxpayer the luxury of
inflating the value of its stock for federal income tax
purposes to receive certain benefits and using the book value
of the stock for Ohio Franchise tax purposes to receive other
benefits would afford the taxpayer a windfall. Appellant's
witness admits he inflated the value of the stock for federal
income tax purposes so that the corporation would have the
substance to pay a shareholder a $100,000 salary for managing
corporate affairs. The corporation, in fact, did pay the
shareholder the salary, which appears to have been unchallenged
by the Internal Revenue Service. As the corporation procured a
benefit from its method of accounting, we find that it is not
unreasonable to require the corporation to consistently report
its asset valuation. See: National Tube Co. [v. Peck], supra
[(1953), 159 Ohio St. 98, 50 O.O. 74, 111 N.E. 2d 11]."
(Emphasis added.)
The cause is before this court upon an appeal as of right.

Jones, Day, Reavis & Pogue and John C. Duffy, Jr., for
appellant.
Lee I. Fisher, Attorney General, and Steven L. Zisser,
Assistant Attorney General, for appellee.

Per Curiam. R.C. 5733.06 calculates the franchise tax on
the net-worth and net-income bases and charges the corporation
the higher amount. R.C. 5733.05(A) sets forth the value of the
issued and outstanding shares of stock of a taxpayer under the
net-worth basis as:
"The total value, as shown by the books of the company, of
its capital, surplus, whether earned or unearned, undivided
profits, and reserves * * *." (Emphasis added.)
In Natl. Tube Co. v. Peck, supra, paragraphs three, four,
and five of the syllabus, we stated:
"3. The book value of an asset at any given time may be
more or less than its value. (Paragraph nine of the syllabus
in Opdyke v. Security Savings & Loan Co. [1952], 157 Ohio St.,
121 [47 O.O. 97, 105 N.E. 2d 9], approved and followed.)
"4. In the absence of statute, the books of account and
bookkeeping records of a business may legally be kept and
maintained in accordance with any sound and generally
recognized and approved accounting system.
"5. Under Sections 5497 [now R.C. 5733.03] and 5498 [now
R.C. 5733.05], General Code, 'book value' should be determined
from the books of a corporation which are generally regarded as

the accounting records of such corporation and are kept in the
ordinary course of the business of the corporation in
accordance with any sound and generally recognized and approved
accounting system, even though other records of the corporation
may disclose that the market value of some of the assets of the
corporation differs from the value thereof recorded in such
books. (Paragraphs one, two and three of the syllabus in
Wheeling Steel Corp. v. Evatt, Tax Commr. [1944], 143 Ohio St.,
71 [28 O.O. 21, 54 N.E. 2d 132], approved and followed.)"
Gray Horse argues that it reported the value of these
shares on the franchise tax returns according to generally
recognized and approved accounting methods. The commissioner
responds that Gray Horse did not establish that it had so
reported these values and that the BTA correctly affirmed her
order. We agree with Gray Horse and reverse the BTA's decision.
The BTA's factual finding undermines the commissioner's
argument. The BTA determined that the tax-basis method, on
which basis Gray Horse accounted for the transfer of the shares
to it in 1976, listed the shares in its records since then, and
reported the value of these shares in all its franchise tax
returns, is a generally accepted and recognized method of
accounting. This finding has record support. Two certified
public accountants testified that this was an acceptable method
to report the shares. We do not overrule findings of fact of
the BTA that are based upon sufficient, probative evidence.
Hawthorn Mellody, Inc. v. Lindley (1981), 65 Ohio St.2d 47, 19
O.O. 3d 234, 417 N.E. 2d 1257.
On the other hand, both accountants testified that the
hybrid valuation of the shares for the federal tax returns was
not a generally accepted accounting practice. The accountant
who prepared the returns testified that he created this value
to justify a salary expense; the other accountant, who
testified as an expert, stated that he had not seen the federal
valuation method before.
Moreover, we fail to detect the windfall for Gray Horse
that prompted the BTA's finding. Reporting an inflated value
to justify a $100,000 salary may have avoided the Internal
Revenue Service's questioning this expense and spared Gray
Horse the cost of withstanding an audit. However, the
justification for this salary expense stands or falls on the
effort Osborne expended to manage the assets, not the value of
Gray Horse's holdings.
As to inconsistency with the federal return, R.C.
5733.031(B), cited by the BTA in support of its decision,
requires a taxpayer's accounting method under R.C. 5733.05(B),
the net-income basis for the franchise tax, to be consistent
with its accounting method for the federal income tax. R.C.
5733.031(B) does not mention R.C. 5733.05(A), the net-worth
basis. R.C. 5733.031(B) does not require that the net-worth
accounting method be consistent with the federal return method.
Accordingly, under the above authority, we reverse the
decision of the BTA because the decision unlawfully increases
the value of shares held by Gray Horse above the value carried
on Gray Horse's books, which Gray Horse kept under a sound and
generally recognized and approved accounting system.

Decision reversed.