El Dorado Oil Works v. McColgan

• Decision Date: 17 February 1950
• Citation: 34 Cal.2d 731,215 P.2d 4
• Parties: EL DORADO OIL WORKS v. McCOLGAN. S. F. 17862.
• Court: California Supreme Court

Page 4

215 P.2d 4

34 Cal.2d 731

EL DORADO OIL WORKS v. McCOLGAN.

S. F. 17862.

Supreme Court of California.

Feb. 17, 1950.

Rehearing Denied March 16, 1950.

Williamson & Wallace and W. F. Williamson, San Francisco, for appellant.

Swarts, Tannenbaum, Ziffren & Steinberg, Jacob Shearer and Shirley A. Siegel, Los Angeles, amici curiae, on behalf of appellant.

Fred N. Howser, Attorney General, and James E. Sabine, Deputy Attorney General, for respondent.

SPENCE, Justice.

Plaintiff brought this action to recover the amounts assessed against it as additional franchise taxes by defendant, under authority of the Bank and Corporation Franchise Tax Act, Stats.1929, p. 19, as amended, Deering's Gen.Laws, 1931, Act 8488, p. 4736, 1933 Supp., p. 2329, 1935 Supp., p. 1929, for the taxable years 1932 and 1936, which taxes were based respectively upon income for the years 1934 and 1935, and were paid under protest. The trial court found in defendant's favor, and from the judgment accordingly entered, plaintiff appeals.

The sole point in controversy is the propriety of the reallocation formula used by defendant in computing plaintiff's franchise taxes for the two years involved. An examination of the record in the light of applicable legal principles compels the conclusion that the method of apportionment applied by defendant in determining the net income earned by plaintiff's unitary business for purposes of the state franchise tax may not be successfully challenged, and accordingly the judgment must be affirmed.

During the years 1934 and 1935 plaintiff, a California corporation, was principally engaged in the processing and sale of cocoanut oil and meal. Its manufacturing plant and all related facilities were located in this state. It purchased the bulk of its raw material, copra, in the Philippine Islands, where it maintained offices for that purpose. In the first four months of 1934, a portion of its required copra supply was obtained in the Dutch East Indies through a buying agency in which plaintiff owned a 40 per cent interest, but such purchasing practice was discontinued in May of that year. The Dutch East Indies agency operated independently in making purchases on behalf of plaintiff as one of its stockholders, and plaintiff never had any of its own employees performing services outside of this state in connection therewith. Plaintiff's products were sold to purchasers throughout the United States, with the shipping terms 'f.o.b. cars at (its) plant in California.' It maintained no sales office or salesmen in any state other than California. Sales to customers out of the state were negotiated in the main through independent brokers not employees of plaintiff although occasionally such customers contacted plaintiff's local sales office directly by telephone or telegraph. Plaintiff's executive committee meeting in its local office passed upon all proposals relating to sales transactions. Plaintiff's only employees located out of the state were those engaged in its purchasing activities in the Philippine Islands. At the same time plaintiff also had certain employees within the state who performed limited buying services for it.

Plaintiff made and filed its tax returns for the two years mentioned and paid the taxes so reported, using as the basis for the returns, in computing the percentage of business done in California, the average which these five factors within the state property, payroll, sales, purchases, and manufacturing costs bore to the total of such factors within and without the state. On this basis plaintiff allocated to California for the respective two income years, 1934 and 1935, 63.6282 per cent and 59.0915 per cent of its total net income.

Defendant Tax Commissioner rejected the schedules and returns so filed by plaintiff and made a reallocation on the basis of a formula consisting only of these three factors property, payroll, and sales. In making such reapportionment, defendant accepted plaintiff's figures for two factors, property and payroll, but assigned 100 per cent of plaintiff's gross sales to business done within the state in lieu of the apportionment figures of 38.5029 per cent and 22.2821 per cent of total sales submitted by plaintiff for the respective income years, 1934 and 1935, upon the basis that sales to customers cut of the state were not allocable to California. Under such reallocation, plaintiff's net income from business done within the state was fixed at 89.8786 per cent for the income year 1934 and at 82.18 per cent for the income year 1935, and additional tax assessments were accordingly made by defendant. After taking an appeal to the State Board of Equalization, which sustained defendant in his reallocation formula, plaintiff paid under protest the additional assessments with interest and then brought this action to recover such amounts.

As above indicated, the protested taxes were levied under authority of the Bank and Corporation Franchise Tax Act, Stats.1929, p. 19, as amended, Deering's Gen.Laws, Act 8488, hereinafter referred to as the act. Section 4 provided that a corporation doing business within the limits of the state, and not expressly exempted from taxation, shall annually pay, for the privilege of exercising its corporate franchise in the state, a tax measured by 4 per cent of its net income earned during the preceding fiscal or calendar year, the minimum tax being $25. As in effect during the period here involved, section 10 provided that if the entire business of the corporation is not done within the state, the 'tax shall be according to or measured by that portion thereof which is derived from business done within this State. * * * determined by an allocation upon the basis of sales, purchases, expenses of manufacturer, pay roll, value and situs of tangible property, or by reference to these or other factors, or by such other method of allocation as is fairly calculated to assign to the State the portion of net income reasonably attributable to the business done within this State and to avoid subjecting the taxpayer to double taxation.'

Plaintiff concedes that income from business done within the state may properly include income from interstate and foreign commerce to the extent that such is done within the state, as well as income from purely intrastate business, Matson Nav. Co. v. State Board of Equalization, 3 Cal.2d 1, 43 P.2d 805, affirmed 297 U.S. 441, 56 S.Ct. 553, 80 L.Ed. 791; United States Glue Co. v. Oak Creek, 247 U.S. 321, 38 S.Ct. 499, 62 L.Ed. 1135, Ann.Cas.1918E, 748; Underwood Typewriter Co. v. Chamberlain, 254 U.S. 113, 41 S.Ct. 45, 65 L.Ed. 165; Southern Pacific Co. v. McColgan, 68 Cal.App.2d 48, 61, 156 P.2d 81, and that during the period here involved it was engaged in a unitary business within and without the state so as to to be subject to an allocation method of taxation in the assessment of the franchise tax, Butler Brothers v. McColgan, 17 Cal.2d 664, 111 P.2d 334, affirmed 315 U.S. 501, 62 S.Ct. 701, 86 L.Ed. 991. The only question is whether defendant may be sustained in his reallocation of plaintiff's net income for franchise tax purposes.

As the disputed issue is so narrowed, plaintiff and amicus curiae argue that the legislature designated in the terms of the act five factors for use in the allocation formula as a standard yardstick for determining that portion of a unitary business taxable within the state; that the statutory authority to use an alternative formula contemplates only a situation where the five factor formula would not truly reflect the income-producing elements of the unitary business, and to that limited extent the Franchise Tax Commissioner may exercise his discretion in the choice of a formula; and that since the five designated factors were all applicable to plaintiff's business, it was improper to substitute another formula for the computation of its franchise tax and in particular, excluding as a separate factor plaintiff's purchase transactions in the consideration of its business activities, an omission which allegedly threw the entire reallocation formula off balance in reflecting plaintiff's overall business operations. Plaintiff also objects to defendant's 'arbitrary' assignment of 100 per cent of its gross sales to within-the-state business, claiming that such treatment did not take into account its undisputed method of transacting sales without the state. Accordingly, plaintiff and amicus curiae contend that defendant's reallocation formula, in its application to plaintiff's unitary business, attributed to California a percentage of income out of proportion to the business done within the state and so violated the due process and equal protection of the law clauses of the Fourteenth Amendment of the Federal Constitution.

On the other hand, defendant urges that the three factor formula he adopted in reallocating plaintiff's net income earned in its unitary business is recognized as a reasonable method of apportionment, Butler Brothers v. McColgan, supra, 17 Cal.2d 664, 677, 111 P.2d 334, affirmed 315 U.S. 501, 509, 62 S.Ct. 701, 86 L.Ed. 991; Edison California Stores, Inc. v. McColgan, 30 Cal.2d 472, 479, 183 P.2d 16, and is most frequently used throughout the states in working out allocation problems, Silverstein, Problems of Apportionment in Taxation of Multistate Business, 4 Tax Law Review (1949), 207, 258; Altman and Keesling, Allocation of Income in State Taxation (1946), pp. 37, 107-108; that the act authorizes the exercise of discretion in the adoption of an allocation formula deemed appropriate to the tax problem at hand in determining the income derived from business done within the state; and that his reallocation formula based upon three rather than five factors, omitting as an independent item plaintiff's purchase transactions and reassigning the sales' values attributable to California activities, fairly apportioned plaintiff's income within and without the state...