2009 Metropoulos Family Trust v. Cal. Franchise Tax Bd.

• Decision Date: 27 May 2022
• Docket Number: D078790
• Parties: The 2009 METROPOULOS FAMILY TRUST et al., Plaintiffs and Appellants, v. CALIFORNIA FRANCHISE TAX BOARD, Defendant and Respondent.
• Court: California Court of Appeals Court of Appeals

79 Cal.App.5th 245

294 Cal.Rptr.3d 557

The 2009 METROPOULOS FAMILY TRUST et al., Plaintiffs and Appellants,

v.CALIFORNIA FRANCHISE TAX BOARD, Defendant and Respondent.

D078790

Court of Appeal, Fourth District, Division 1, California.

Filed May 27, 2022

Dakessian Law, Mardiros Hagop Dakessian, Los Angeles, and Donald Eugene Chomiak, Glendale, for Plaintiffs and Appellants.

Pillsbury Winthrop Shaw Pittman and Carley Ann Roberts, Sacramento, for California Taxpayers Association as Amicus Curiae on behalf of Plaintiffs and Appellants.

Rob Bonta, Attorney General, Tamar Pachter, Assistant Attorney General, Lisa W. Chao and Kara D. Siegel, Deputy Attorneys General, for Defendant and Respondent.

O'ROURKE, J.

Plaintiffs and appellants The 2009 Metropoulos Family Trust, The Evan D. Metropoulos 2009 Trust (the Family Trust and Evan Trust respectively or at times collectively the trusts), and the trusts' trustee, the J.P. Morgan Trust Company of Delaware (the trustee), appeal from a summary judgment entered in favor of the California Franchise Tax Board (FTB) on plaintiffs' complaint seeking a refund of 2014 income taxes. The parties filed cross-motions for summary judgment, with plaintiffs arguing their pro-rata share of income received from an S corporation's November 2014 sale of a wholly-owned subsidiary was not subject to California income tax. The plaintiff trusts, who were shareholders in the S corporation Pabst Corporate Holdings, Inc. (Pabst), argued the income was derived from the sale of intangible property, namely goodwill associated with the subsidiary's business, whose taxation was governed by Revenue & Taxation Code section 17952 and its corresponding regulation ( Cal. Code Regs., tit. 18, § 17952 ).¹ The trial court denied plaintiffs' motion and granted the FTB's, ruling (1) because the S corporation had characterized the income as business income on its return, the trusts were bound to treat their respective shares of that income the same way on their federal and California tax returns; and (2) even if section 17952 applied, the trusts' income would still be taxable since the S corporation's corporate headquarters were in California, the underlying businesses based marketing and sales departments in California, and the S corporation localized the goodwill in connection with its California business, giving the goodwill a "business situs" in this state.

Arguing the matter involves strictly a question of statutory interpretation, plaintiffs contend the trusts are not taxed on income earned from the sale of the intangible goodwill. They maintain the character of the goodwill income is determined under the Personal Income Tax Law (§ 17001 et seq.), not as business income under the Corporation Tax Law (§ 23001 et seq.), which are assertedly independent of one another and have different sourcing schemes. According to plaintiffs, a single item of income can have different characterizations under the two schemes, and here, it is business income under the Corporation Tax Law and income from intangible property that under section 17952 of the Personal Income Tax Law is not sourced to California. They further contend the goodwill does not have a business situs in California within the meaning of section 17952 so as to render the income taxable.

We hold that the nonresident trust shareholders of Pabst, a unitary multistate S corporation, are taxed on their pass-through pro rata share of the gain, which is business income sourced to California under the Uniform Division of Income for Tax Purposes Act (UDITPA or the Uniform Act; § 25120 et seq.). Our conclusion would not change even if the income could be characterized as from intangible goodwill within the meaning of section 17952, because we agree the goodwill acquired a business situs here, subjecting it to taxation in this state. We affirm the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

Many of the key background facts are undisputed. We state them from the parties' respective separate statements and the undisputed evidence in the record, viewing other facts in the light most favorable to plaintiffs. (See B.H. v. County of San Bernardino (2015) 62 Cal.4th 168, 178, 195 Cal.Rptr.3d 220, 361 P.3d 319 ; County of San Diego v. Superior Court (2015) 242 Cal.App.4th 460, 467, 195 Cal.Rptr.3d 374.)

In 2014, the Family Trust and the Evan Trust were respectively 20 percent and 39.5 percent shareholders of Pabst, a Delaware subchapter S corporation based in Connecticut. Pabst Holdings, Inc. is a wholly owned subsidiary of Pabst, and Pabst Brewing, as well as Falstaff Brewing Corporation, are wholly owned by Pabst Holdings, Inc. Pabst did business in California as Pabst Brewing. Pabst and its subsidiaries are what is termed a "unitary" business.²

In November 2014, Pabst sold Pabst Holdings, Inc. in a transaction that Pabst treated for tax purposes as an asset sale under the Internal Revenue Code. The sale resulted in a long-term capital gain that Pabst reported as apportionable business income on its 2014 corporate tax return. Pabst allocated 6.6 percent of that income to the State of California. The return identified over 99 percent of the long-term capital gain as from the sale of "brand [and] intangibles." (Capitalization omitted.)

As Pabst shareholders, the Family Trust and Evan Trust each received a California Schedule K-1 form for tax year 2014, listing their respective distributive shares of income from Pabst for that year. The trustee reported the income as apportionable to California on the trusts' respective 2014 California Form 541 fiduciary income tax returns. The Family Trust and Evan Trust respectively paid $1,202,841 and $2,375,612 in taxes on the income received from the sale.

In June 2016, the trustee filed amended 2014 tax returns on behalf of the trusts, seeking refunds of the amounts paid. The FTB issued proposed denials of the requests in May 2017. The trusts then appealed the denials to the now Office of Tax Appeals.

Following a hearing on the matter, the Office of Tax Appeals issued a decision upholding the FTB's decision to deny the refunds. ( Appeals of Metropoulos Family Trust (Cal. OTA, Nov. 7, 2019, Nos. 18010012, 180100013), 2019 WL 7565283.) Two of the three administrative law judges reasoned that regulation 17951-4 contained "an explicit set of instructions" requiring business income be apportioned at the S corporation level, then geographically sourced to California under regulation 17951-4(d) for multistate unitary S corporations.

In March 2020, the trustee and trusts filed this action against the FTB for a refund of the over $3.6 million in taxes they paid.³ They alleged none of the income at issue was taxable under California law because the trusts were nonresidents: neither had a California resident fiduciary or California resident noncontingent beneficiaries at any relevant time. Alternatively, they alleged the income was not taxable even under the theory that the trusts' income was derived from California sources. In part, they alleged that Pabst realized capital gains from the sale of intangible personal property—goodwill—and under S corporation pass-through rules (the so-called "conduit rule"), the trusts' pro rata share of that income was likewise realized from goodwill. They alleged that under section 17952 and this court's decision in Valentino v. Franchise Tax Bd. (2001) 87 Cal.App.4th 1284, 105 Cal.Rptr.2d 304 ( Valentino ), that income was sourced for California income tax purposes to the nonresident trusts' out-of-state residence, and did not fall within the "business situs" exception to that rule so as to render it taxable here.

Plaintiffs and the FTB separately moved for summary judgment. Plaintiffs argued the nonresident trusts were only taxed on their California source income, and there was no dispute over 99 percent of the sale income was derived from intangible goodwill governed by section 17952, providing that income from intangible personal property is " ‘not income from sources within this state ....’ " Plaintiffs argued the goodwill did not acquire a business situs within the meaning of that statute because the trusts "did not possess or control the intangibles, or employ them in California in any localized manner."

The FTB did not dispute for purposes of its motion the nonresident status of the trusts. It argued that operation of the conduit rule meant that the trusts' income from the subsidiary's sale was business income because Pabst had characterized the income as apportionable business income on its tax return. That business income, the FTB argued, was taxed under section 17951 and corresponding regulation 17951-4. The FTB argued section 17952 did not apply to business income even if the business income was derived from intangible property, but if it did apply, the gain was taxable because the goodwill was used to do business in California. The FTB argued that the goodwill's business situs was determined with reference to the business—the operation of subsidiaries by the S corporation Pabst—not by the actions of the trusts. Because Pabst had allocated 6.6 percent of its 2014 income to California operations, at least that much of the subsidiary's goodwill was " ‘localized in connection with a business ... in this State so that its substantial use and value attach to and become an asset of the business ... in this State" within the meaning of regulation 17952(c).

The trial court denied plaintiffs' motion and granted the FTB's.⁴ It ruled that S corporation shareholders are bound by however an S corporation chooses to characterize and allocate its income for tax purposes, and noted that tax regulations provided that business income is apportioned at the S corporation level, not the shareholder level. According to the court, because Pabst characterized the income at issue as business income, the trusts were bound to treat their respective shares of that income in the same way on their federal and California tax returns. The...