City of Modesto v. National Med, Inc., F044492.

• Decision Date: 18 March 2005
• Docket Number: No. F044492.,F044492.
• Citation: 128 Cal.App.4th 518,27 Cal.Rptr.3d 215
• Court: California Court of Appeals Court of Appeals
• Parties: CITY OF MODESTO, Plaintiff and Appellant, v. NATIONAL MED, INC., et al., Defendants and Respondents.

27 Cal.Rptr.3d 215

128 Cal.App.4th 518

CITY OF MODESTO, Plaintiff and Appellant, v. NATIONAL MED, INC., et al., Defendants and Respondents.

No. F044492.

Court of Appeal, Fifth District.

March 18, 2005.

Michael D. Milich, City Attorney, Roland R. Stevens, Assistant City Attorney, Howard Rice Nemerovski Canady Falk & Rabkin, Steven L. Mayer and Ethan P. Schulman, San Francisco, for Plaintiff and Appellant.

Morrison & Foerster, Charles J. Moll III, Arturo J. Gonzalez and Pilar M. Sansone, San Francisco, for Defendants and Respondents.

OPINION

LEVY, J.

Appellant, City of Modesto (City), is requesting this court to reverse a judgment denying the City relief on its complaint to recover an alleged business license tax deficiency from respondent, National Med, Inc. (NMI). The trial court ruled that the business license tax ordinance that was operative for the tax years at issue was unconstitutional as applied to NMI because it imposed a tax on business activities occurring outside of the City.

The City has not appealed from the finding that its ordinance was unconstitutional. Rather, the City has amended its business license tax ordinance to provide for apportionment and has adopted apportionment guidelines. The City is requesting this court to remand the matter to the City's finance director (Finance Director) for a recalculation of NMI's alleged tax deficiency using the City's recently adopted apportionment guidelines.

However, in the context of this litigation, the City is not entitled to the remedy it seeks. The underlying complaint was filed to enforce an alleged business tax deficiency that was based on the former unconstitutional ordinance. The City concedes that the Finance Director's decision finding this additional tax liability is no longer enforceable.

Further, when the City amended its ordinance to include an apportionment provision it made a substantive change to this law. Under the former law, taxpayers were not entitled to apportion their gross receipts to reflect out-of-city activities. The ordinance itself specifies that procedural changes be applied retroactively.

Moreover, it would not be appropriate for this court to reform the prior law. The tax years at issue are 1996 to 2000, not a modest period of retroactivity. Also, it would be overly burdensome to force NMI to produce up to nine-year-old documentation that it was not previously required to maintain in order to prove "with clarity" its right to apportion gross receipts. Accordingly, the judgment will be affirmed.

BACKGROUND

Pursuant to a 1958 ordinance, entities that conduct business within the City are required to pay a tax for that privilege. This tax is based on the entity's gross receipts, less certain specified exclusions. During the period in question, January 1996 through June 2000, the exclusions included the amount of gross receipts that had been subject to a license tax paid to any other city. However, the ordinance did not distinguish between in-city and out-of-city business activities, i.e., there was no apportionment provision.

NMI was a health maintenance organization. While the underlying proceedings were pending, NMI was headquartered in the City. However, NMI maintained branch offices in other cities throughout California. Additionally, NMI had several employees who worked from their homes and whose job responsibilities included travel around the state.

In 2000, the City hired an outside contingency fee auditor to audit NMI's tax returns for January 1996 through June 2000. Based on this audit, the City Finance Director concluded that NMI had understated the tax it owed due to making improper adjustments to the gross receipts.

An administrative "show cause" hearing was held on January 18, 2001. NMI presented evidence of its numerous business activities outside of the City and argued that the ordinance was unconstitutional because it lacked an apportionment provision to account for these outside activities.

The Finance Director issued a written decision that disallowed the adjustments NMI had made with respect to the funds that it received and then paid out to its contract health care providers. The Finance Director further concluded that the gross receipts tax was constitutional despite the absence of an express apportionment clause because it excluded receipts that were subject to other cities' taxes. Further, there was no evidence that NMI's gross receipts had been double taxed. Based on these findings, the Finance Director concluded that NMI owed the City over $1 million in unpaid taxes, delinquency penalties and fraud penalties. For the tax period at issue, NMI had already paid the City more than $465,000 in business license taxes.

NMI timely appealed the Finance Director's decision and requested a hearing before the city council (City Council). However, on August 14, 2001, before this appeal process was completed, the City filed the underlying complaint to enforce the Finance Director's decision and to recover penalties for violation of the California False Claims Act.

In August 2002, NMI moved for summary adjudication on two causes of action. NMI argued that the California False Claims Act did not apply to the filing of tax returns and that the City's business license tax was unconstitutional because it did not contain a provision for apportioning income generated outside the City.

In response to this motion, the City noted that in August 2002 it amended its business license tax ordinance to add an apportionment provision. This amendment provides that "When, by reason of the provisions of the Constitution of the United States or the Constitution of the State of California, the business license tax imposed by this chapter cannot be enforced without there being an apportionment according to the amount of business done in the City," apportionment rules shall be established by either general guidelines to be adopted by the City Council or by rules and regulations to be promulgated by the Finance Director. The amended code further states that "Any amendment to the procedural provisions of this chapter is intended by the City Council to retroactively affect pending matters to the fullest extent permitted by law. . . ." (Italics added.)

On October 21, 2002, the trial court granted summary adjudication in favor of NMI on the ground that the City's business license tax was unconstitutional. The court found that NMI was engaged in business outside of the City during the relevant time period. However, the ordinance did not contain an apportionment provision to exclude this outside-generated income. Although the City had recently added an apportionment clause, the court concluded that the new language did not satisfy constitutional mandates. In stating that apportionment rules would be adopted, the City did no more than "promise to adopt specific apportionment language at some unknown future date." The court further concluded that this apportionment provision was not sufficiently definite to enable taxpayers to comply with the tax and did not discourage arbitrary or discriminatory enforcement.

The court then considered the appropriate remedy. It first noted that where a tax is unconstitutional because it reaches activities beyond the government's taxing jurisdiction, a refund is proper. The court further concluded that it would be unfair to burden NMI with the responsibility of establishing the extent of its out-of-city activities "so that the City could enforce its unconstitutional tax, when the City has given its taxpayers no indication of what records they were required to maintain to establish this constitutional right." Accordingly, the court held that the City's gross receipts tax was void and unenforceable as applied to NMI.

In September 2003, a year after the City added the apportionment provision to the gross receipts tax ordinance, the City Council enacted a resolution adopting detailed apportionment guidelines. These guidelines provide that an apportioning taxpayer may reduce its total receipts from its operation in the City by a specified range of percentages to reflect various kinds of out-of-city activities.

Under the 2003 apportionment guidelines, the taxpayer may divide its business into as many of the eight listed "economic components" that apply. These "factors" include the location where the taxpayer negotiated or solicited each sale, the location of the sales office that served as the base of operations for each sale, and the location where each service was performed. However, in order to apportion its gross receipts, the taxpayer's business records must "support with clarity the place of such outside activity and the receipts connected therewith."

With respect to their application, the guidelines provide:

"These rules will apply to all future payments under the City's business license tax, as well as all claims for refund of taxes already paid, including claims that are pending on the date these rules are adopted, if one basis for the claim is the City's application of the tax to receipts arising from transactions that occur, in whole or in part, outside the City."

On August 10, 2004, after NMI's brief was filed in this appeal, the City Council amended the City's business license tax apportionment guidelines.¹ This amendment provides that the guidelines are applicable to pending claims by the City for underpayment of tax in addition to future payments and claims for refund.

The City is not appealing the superior court's determination that the business license tax was unconstitutional as applied to NMI. In fact, the City has made it clear that it has no intention of seeking to enforce the Finance Director's decision against NMI. Rather, the City asserts the issue on appeal is what remedy should be ordered for this constitutional violation. According to the City, this court should reverse the trial court's ruling and remand the matter to the City to determine NMI's tax de novo,...