Anaheim Union Water Co. v. Franchise Tax Bd.

• Decision Date: 16 June 1972
• Court: California Court of Appeals Court of Appeals
• Parties: ANAHEIM UNION WATER COMPANY, a California corporation, Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant. Civ. 13178.

Page 692

102 Cal.Rptr. 692

26 Cal.App.3d 95

ANAHEIM UNION WATER COMPANY, a California corporation, Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant.

Civ. 13178.

Court of Appeal, Third District, California.

June 16, 1972.

Rehearing Denied July 12, 1972.

Hearing Denied Aug. 30, 1972.

Wright, Finley & Behrens, Santa Ana, for plaintiff-respondent.

Evelle J. Younger, Atty. Gen., by Ernest P. Goodman, Asst. Atty. Gen., John J. Klee, Jr., Deputy Asst. Atty. Gen., San Francisco, for defendant-appellant.

MORONY, ^* Justice.

This case involves the taxation of a mutual water company under the provisions of the California franchise tax law relating to cooperative associations. Such an association is allowed certain special deductions in computing its taxable income. All income from its business activities for or with the association's members or on a nonprofit basis with nonmembers is excludable from its gross income. However, the expenses incurred in producing such excludable gross income are not deductible in computing its taxable net income. (Rev. & Tax.Code, §§ 24401, 24405, 24421 and 24425.)

For a number of years plaintiff Anaheim Union Water Company elected to include in its gross income all the income it received which otherwise was deductible as being derived from its business activities for or with the association's members or on a profit basis with nonmembers. Hence, since it did not claim a special deduction for such income, it claimed as deductions all expenses incident to the production of such income. Such expenses were disallowed by the Franchise Tax Board (after excluding the appropriate income). Thereupon, the plaintiff paid the taxes and brought this suit to obtain refund of certain taxes (and interest thereon) previously paid for the years 1952--1965.

The trial court granted plaintiff's motion for summary judgment. The defendant appeals, contending (1) that the income and expenses of a mutual or cooperative association from its member and nonprofit nonmember business must be excluded ¹ from the computation of the franchise tax on such association, and (2) that the amount of interest awarded by the judgment is erroneous.

FACTS

On July 19, 1968, plaintiff filed its complaint for refund of taxes and interest paid. The affidavit in support of the motion for summary judgment, given by L. A. Peterson, secretary-treasurer of plaintiff, established that on January 23, 1967, plaintiff paid to defendant, under protest, the sum of $77,133.73, and, on January 4, 1968, claimed a refund in the amount of $76,182.89, representing a deficiency of $53,880.31, plus interest of $22,302.58. During the years in question, namely income years 1952 through 1965, plaintiff was engaged in the business of leasing real properties for various purposes, and, in addition, was engaged in the business of selling irrigation water to its shareholders and to nonshareholders. Plaintiff's retained earnings and profits for each of the years show that plaintiff suffered an accumulated reduction in its retained earnings and profits from $72,014.19 at January 1, 1952, to $32,268.92 at December 31, 1965. Operating losses are the reason for this reduction.

In computing its taxable income, plaintiff did not elect to take a deduction as provided in article 2, chapter 7, part 11, of division 2 (i.e., § 24401 et seq.) of the Revenue and Taxation Code, ² but instead included its income received from the sale of water in its gross taxable income. It is clear from the arguments presented below and on appeal that since plaintiff suffered high losses in its water business, it was attempting to deduct its expenses that had been incurred in producing its water business income, said income being considered by defendant as resulting from or arising out of plaintiff's business activities for or with plaintiff's members or on a nonprofit basis with nonmembers and therefore excludable from gross income under sections 24401 and 24405. Plaintiff conceded, for the purpose of summary judgment, that it is a mutual or cooperative association within the meaning of section 24405. In disallowing plaintiff's request for a refund, defendant claimed that business conducted with nonmembers on a profit basis was taxable as such regardless of any loss on member and nonprofit nonmember business.

The parties thus initially placed into contention the construction of the provisions of section 24401, which states that in addition to the deductions provided in article 1, 'there shall be allowed as deductions in computing taxable income the items specified in this article' (emphasis added), and section 24405 which provides for the deduction of All income of cooperative or mutual associations, which income results from or arises out of business activities with members, or with nonmembers when done on a nonprofit basis. The court phrased the question as whether, under section 24401, plaintiff was required to deduct and thus exclude its income from its business under section 24405, or whether plaintiff could choose to ignore section 24405, and include its cooperative or mutual association business income in its gross income for taxation purposes. ³

In a very carefully prepared and reasoned preliminary opinion, the trial court found that the words 'shall be allowed' of section 24401 is optional, and that plaintiff could choose not to take the deduction as provided in section 24405. However, the court felt the resolution of this question did not determine the issue on the motion for summary judgment, but instead raised the further question of whether, once plaintiff chose to ignore the deduction provided under section 24405, does it follow that plaintiff may deduct expenses allocable to such income in face of the prohibitions of sections 24421 and 24425. These sections provide that in computing net income, no deduction shall be allowed for any amount otherwise allowable as a deduction which is allocable to one or more classes of income 'not included in the measure of the tax imposed by this part . . ..' Following the parties' further briefing and argument, the court deemed that under section 24425, any income included in the gross income of a corporation 'measures the tax,' and felt that since plaintiff did not deduct its member and nonprofit income (§ 24405), but instead included such income in its gross income, such member and nonprofit income was included in the 'measure of the tax.' The court concluded that section 24425 did not apply to prohibit the deduction of expenses against such income. Summary judgment for plaintiff was granted accordingly.

Defendant contends that to compute 'net income' under section 24341, plaintiff is required under sections 24401 and 24405 to subtract from 'gross income' its income from its member business and from its nonprofit business with nonmembers; and that, therefore, it follows that under sections 24421 and 24425, plaintiff cannot deduct expenses incurred in producing its income from its member business and its nonprofit business with nonmembers. To maintain this position, defendant insists that plaintiff has no right to elect not to have section 24405 apply, and thus that the court erred in finding to the contrary.

The privilege of exercising a corporate franchise in this state is taxable. The tax is measured by the corporation's net income. (§ 23151.) However, certain types of corporations are given tax benefits not accorded to other corporate taxpayers. Hence, in determining net income there are certain deductions allowed. (§§ 24341 and 24401.) One of those special deductions applying to cooperative or mutual associations is found in section 24405 which provides, in pertinent part, that:

'In the case of other associations organized and operated in whole or in part on a co-operative or a mutual basis, all income resulting from or arising out of business activities for or with their members carried on by them or their agents; or when done on a nonprofit basis for or with nonmembers; provided, however, that the deduction allowable under this section shall not apply to such co-operative or mutual associations whose income is principally derived from the sale in the regular course of business of tangible personal property other than water, agricultural products, or food sold at wholesale.' (Emphasis added.)

On the other hand, certain specified items are nondeductible in computing taxable net income. (§ 24421.) One of these nondeductible items is set forth in section 24425, which provides that:

'Any amount otherwise allowable as a deduction which is allocable to one or more classes of income not included in the measure of the tax imposed by this part, regardless of whether such income was received or accrued during the income year.'

In Woodland Production Credit Assn. v. Franchise Tax Board (1964) 225 Cal.App.2d 293, 37 Cal.Rptr. 231, this court again had before it a case involving section 24405 in which there was no direct precedent. In Justice Friedman's opinion written for the court he discussed the 'pivotal concept' of section 24405 as follows (at pp. 298--299, 37 Cal.Rptr. at pp. 234--235):

'. . . Cooperative corporations are subject to the California Franchise Tax Law, but are permitted a special deduction of income arising out of business activity carried on with members or conducted on a nonprofit basis with nonmembers. (Rev. & Tax.Code, secs. 24404--24406; Security-First Nat. Bk. v. Franchise Tax Bd., 55 Cal.2d 407, 423--424, 11 Cal.Rptr. 289, 359 P.2d 625; McLaren and Butler, California Tax Laws of 1929, pp. 114--115; Traynor, National Bank Taxation in California, 17 Cal.L.Rev. 456, 493--494.) Income from profit-making activities with nonmembers is excluded from deductibility and thus forms part of the tax base. . . .

'The pivotal concept in section 24405 is that of income from business activities. The subsidiary notions of business done (a) for or with members, or (b) on a nonprofit...