Butler Bros v. Colgan

Decision Date02 March 1942
Docket NumberNo. 283,283
PartiesBUTLER BROS. v. McCOLGAN, Franchise Tax Com'r of California
CourtU.S. Supreme Court

Mr. Leland K. Neeves, of Chicago, Ill., for appellant.

Mr. Valentine Brookes, of San Francisco, Cal., for appellee.

[Argument of Counsel from page 502 intentionally omitted] Mr. Justice DOUGLAS delivered the opinion of the Court.

This is an appeal (Judicial Code § 237(a), 28 U.S.C. § 344(a), 28 U.S.C.A. § 344(a) from a final judgment of the Supreme Court of California sustaining the validity of a statute of California against the claim that as construed and applied to appellant it violated the Fourteenth Amendment. 17 Cal.2d 664, 111 P.2d 334. The statute in question is the Bank and Corporation Franchise Tax Act. 2 Gen.Laws 1937, Act 8488, p. 3851; Stat.1929, p. 19, amended, Stat.1931, p. 2226, Stat.1935, p. 965, St.1937, p. 2324. Sec. 4(3) of that Act provides for an annual corporate franchise tax payable by a corporation doing business within the State. The tax is measured by the corporation's net income and is at the rate of four per cent 'upon the basis of its net income' for the preceding year. The minimum annual tax is $25. Sec. 10 prescribes the method for computing the net income on which the tax is laid. It provides in part:

'If the entire business of the bank or corporation is done within this State, the tax shall be according to or measured by its entire net income; and if the entire business of such bank or corporation is not done within this State, the tax shall be according to or measured by that portion thereof which is derived from business done within this State. The portion of net income derived from business done within this State, shall be 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.'

The tax in dispute is for the calendar year 1936. Appellant paid the minimum tax of $25, asserting that it operated in California during 1935 at a loss of $82,851. The tax commissioner made an additional assessment of $3,798.43 which appellant paid, together with interest, under protest. This suit was brought to recover back the amount so paid on the theory that the method of allocation employed by the tax commissioner attributed to California income derived wholly from business done without that State.

The facts are stipulated and show the following. Appellant is an Illinois corporation qualified to do business in California. Its home office is in Chicago, Illinois. It is engaged in the wholesale dry goods and general merchandise business, purchasing from manufacturers and others and selling to retailers only. It has wholesale distributing houses in seven states, including one at San Francisco, California. Each of its houses in the seven states maintains stocks of goods, serves a separate territory, has its own sales force, handles its own sales and all solicitation, credit and collection arrangements in connection therewith, and keeps its own books of account. For the period in question, all receipts from sales in California were credited to the San Francisco house. Appellant maintains a central buying division through which goods for resale are ordered, the goods being shipped by manufacturers to the houses for which they are ordered. All purchases made by appellant for sale at its various houses are made through that central buying division. The cost of the goods and the transportation charges are entered on the books of the house which receives the goods. No charges are made against any house for the benefit of appellant or any of its other houses by reason of the centralized purchasing. But the actual cost of operating the centralized buying division is allocated among the houses. The greater part of appellant's other operating expenses is incurred directly and exclusively at the respective houses. Certain items of expense are incurred and paid by appel- lant for the benefit of all the houses and allocated to them. No question exists as to the accuracy of the amounts of such expense or the method of allocation. The latter admittedly followed recognized accounting principles. For the year 1935 the amount of such allocated expense charged to the San Francisco house was $100,091. For purposes of this suit it was agreed that approximately 75% of that amount would have been incurred even though the San Francisco house was not operated. The accuracy and propriety of the basis of allocation of those common expenses for 1935 were admitted. Included in such expenses were executive salaries, certain accounting expenses, the cost of operating a central buying division, and a central advertising division. Except for such common expenses, each house is operated independently of each other house. Appellant computed its income from the San Francisco house for the period in question by deducting from the gross receipts from sales in California the cost of such merchandise, the direct expense of the San Francisco house, and the indirect expense allocated to it. By that computation a loss of $82,851 was determined. In the year 1935 the operations of all houses of appellant produced a profit of $1,149,677. The tax commissioner allocated to California 8.1372 per cent. of that amount. That percentage was determined by averaging the percentages which (a) value of real and tangible personal property, (b) wages, salaries, commissions, and other compensation of employees, and (c) gross sales, less returns and allowances, attributable to the San Francisco house bore to the corresponding items of all houses of appellant. No other factor or method of allocation was considered. The propriety of the use of that formula is not questioned if by reason of the stipulated facts a formula for allocation to California of a portion of appellant's income from all sources is proper.

The stipulation also states that in the year 1935 the total sales made by appellant at all its houses amounted to $66,326,000, of which $5,206,000 were made by the San Francisco house. The purchases made for the account of that house were substantially in the same proportion to total purchases. By reason of the volume of purchases made by appellant 'more favorable prices are obtained than would be obtainable in repect of purchases for the account of any individual house'. The addition of purchases 'in an amount equal to the purchases made for the account of the San Francisco house results in no more favorable prices than could be obtainable in respect of purchases in an amount equal to the purchases which would be made' by appellant for its other houses if the San Francisco house was not in existence; and 'a reduction in the volume of purchases in an amount equal to the purchases made for the San Francisco house would result in no less favorable prices being obtainable in respect of the purchases which would be made for the remaining houses' of appellant.

Hans Rees' Sons, Inc., v. North Carolina, 283 U.S. 123, 51 S.Ct. 385, 75 L.Ed. 879, constitutes appellant's chief support in its attack on the formula employed and the tax imposed by California. Appellant maintains...

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