CullIGAn Water Conditioning v. State Bd. of Equalization

• Decision Date: 04 June 1976
• Citation: 550 P.2d 593,17 Cal.3d 86,130 Cal.Rptr. 321
• Court: California Supreme Court
• Parties: , 550 P.2d 593 CULLIGAN WATER CONDITIONING OF BELLFLOWER, INC., Plaintiff and Respondent, v. STATE BOARD OF EQUALIZATION, Defendant and Appellant. L.A. 30464.

Page 321

130 Cal.Rptr. 321

17 Cal.3d 86, 550 P.2d 593

CULLIGAN WATER CONDITIONING OF BELLFLOWER, INC., Plaintiff and Respondent, v. STATE BOARD OF EQUALIZATION, Defendant and Appellant.

L.A. 30464.

Supreme Court of California In Bank.

June 4, 1976.

Evelle J. Younger, Atty. Gen., Ernest P. Goodman, Asst. Atty. Gen., and Philip C. Griffin, Deputy Atty. Gen., for defendant and appellant.

J. Kimball Walker, Norwalk, for plaintiff and respondent.

Brookes, Brookes & Vogl, Valentine Brookes and Lawrence V. Brookes, San Francisco, as amici curiae on behalf of plaintiff and respondent.

SULLIVAN, Justice.

Defendant State Board of Equalization (Board) appeals from a judgment granting plaintiff Culligan Water Conditioning of Bellflower, Inc. recovery of certain use taxes paid under protest.

The case was tried by the court, sitting without a jury, upon an agreed statement of facts. In substance the pertinent facts are as follows: Plaintiff is in the business of conditioning water at the point of use. Hard water contains calcium and magnesium, and these 'hardness' ions cause it to be unsuitable in the home for doing the laundry or for washing and bathing. Plaintiff 'softens' the water by removing 'hardness' ions. This is accomplished at the point of use, in the home, by passing the water supply through a conditioning unit containing an ion-exchange material which exchanges its more soluble sodium ions for the calcium and magnesium ions. After the ion-exchanger is spent, the unit is regenerated.

Plaintiff's residential business consists of two separate categories: (1) The sale or lease of 'home-owned' automatic units; and (2) the furnishing of 'exchange units' under a water conditioning contract. The 'home-owned unit' is a softener complete within itself which continuously regenerates the ion-exchange material within the unit and regularly provides soft water once inserted in the customer's plumbing system. In connection with the sale or lease of this unit, plaintiff pays a sales tax and secures sales tax reimbursement from its customers. Such taxes are not in issue in the instant case.

It is the furnishing of the 'exchange unit' under the water conditioning contract which is at the heart of the present controversy. This unit, once inserted in the customer's plumbing, also regularly provides soft water but unlike the 'home-owned unit' cannot itself regenerate the ion-exchange material. Consequently this unit must be replaced periodically by plaintiff in order to provide soft water continuously. The householder contracts with plaintiff for water conditioning and does not purchase the installed equipment. Under its arrangement with the customer, plaintiff agrees to provide the exchange unit, to connect it to the customer's water system and to periodically replace the ion-exchange material in the unit in order to maintain a continuous flow of softened water. The customer pays an initial charge for the necessary alterations to the plumbing system and a monthly or bimonthly charge for the water conditioning depending upon the quantity of water and the degree of the hardness of the water. Plaintiff regularly removes the exchange material when exhausted, replaces it with new or regenerated material and regenerates the exhausted material at its plant. At all times, plaintiff retains ownership of, and full control over, the unit. ¹

Prior to 1966 plaintiff operated in a prescribed franchise area in and about the City of Bellflower, California. About May 1, 1966, plaintiff acquired the assets of a Culligan franchise business known as Culligan of South Gate, Inc. Among the assets purchased were 2,000 portable exchange units. Since plaintiff paid no sales tax reimbursement upon the acquisition of these units, the tax auditor for the Board determined that the 2,000 units were acquired by plaintiff 'ex-tax.' Accordingly, the tax auditor determined that the service income from the equivalent number of service customers should be included in the measure of taxable sales as 'taxable rentals.' The Board therefore assessed a tax delinquency of $12,816.17, with accrued interest of $2,347.86, or a total assessment of $15,164.03, for the audit period from April 1, 1966, to December 31, 1968. Plaintiff paid this assessment under protest and filed a timely claim for refund on the ground that the income derived from the lease of these 2,000 units was income from a service business rather than from the rental of property and thus not subject to sales and use tax liability. The Board rejected the claim for refund and plaintiff filed the instant action.

Plaintiff acquired the 2,000 portable exchange units from its transferor (Culligan of South Gate) under a contract of sale whereby such transferor agreed to pay any sales tax due. Plaintiff paid no sales tax reimbursement on this transfer of the 2,000 units, but Culligan of South Gate had paid sales tax reimbursement on them at the time that South Gate had originally acquired the units and prior to the sale to plaintiff by South Gate. Plaintiff had paid sales tax reimbursement on all Other portable exchange units at the time plaintiff originally acquired them and accordingly was not required to charge sales tax to its customers in connection with the units other than the 2,000.

The Board took the position that section 6006, subdivision (g), of the Revenue and Taxation Code ² applied to the transactions involving the above-mentioned 2,000 exchange units and therefore assessed the tax as being due on a 'lease of tangible personal property' in its audit for the period April 1, 1966, through December 31, 1968. ³ Attached to the agreed statement of facts and made a part thereof is a declaration of Thomas P. Putnam, assistant chief counsel of the Board, who, the parties agreed, if called as a witness would testify to the statements made in the declaration, it being further agreed, however, that the relevance and probative value of his testimony and the Board's position concerning the lease 'are issues in this case.'

Mr. Putnam stated that the Board and its staff considered the type of transaction here involved pertaining to the portable exchange units 'to be a 'lease' within the meaning of the Sales and Use Tax Law and, unless the property is leased in substantially the same form as acquired by the lessor and he has previously paid sales tax reimbursement or use tax measured by his purchase price, as a 'sale' and 'purchase' within the meaning of that law, subject to tax measured by the payments made by his customers . . ..' He explained that this type of transaction was considered to fall within the definition of 'hiring' in Civil Code section 1925 and that the periodic payments made by the customer were considered to be the measure of tax by reason of section 6011. He concluded as follows: 'By reason of the interworking of Sections 6009, 6201, 6203, 6390, and 6401, the basic tax on leases is considered to be a use tax on the lessee, which the lessor must collect. If the lessee is exempt, then the tax is considered imposed on the lessor as a sales tax and Sections 6051 and 6012 become applicable.

'Regulation 1660 (18 Cal.Admin.Code, § 1660), a copy of which is attached, describes the position of the Board with respect to leases of tangible personal property in general.'

The trial court adopted by reference as its findings of fact the agreed statement of facts and concluded that the income upon which the Board's assessment was made 'is service income and not a receipt from the lease of tangible personal property and as such is not taxable under the Sales Tax Law,' that the Board's position that the transaction in question constituted a lease of tangible personal property 'is, on the facts of this case, an arbitrary, unreasonable and unwarranted extension of the interpretation of the words 'lease,' 'rental,' 'sale,' or 'purchase," and that plaintiff was entitled to a refund of the tax paid. Judgment was entered accordingly. This appeal followed.

Initially, we must determine the appropriate standard of review applicable to the assessment against plaintiff of use tax liability based on the receipts derived from the lease of the exchange units. The Board contends that the assessment, grounded on what it denominates an administrative classification, may be overturned only if such classification was arbitrary, capricious or without rational basis. However, it is clear from the record that the basis of the assessment was not embodied in any formal regulation or even interpretative ruling covering the water conditioning industry as a whole and directed to the industry's use of exchange units (see § 7051 and Gov.Code, § 11420 et seq.), but rather that the basis of the assessment was nothing more than the Board auditor's interpretation of two existing regulations, that is, the regulation governing the lease of tangible personal property (Cal.Admin.Code, tit. 18, § 1660) and the regulation governing service businesses (Cal.Admin.Code, tit. 18, § 1501).

If the Board had promulgated a formal regulation determining the proper classification of receipts derived from the rental of exchange units to condition water and the regulation had been challenged in the action for refund of the tax paid (§ 6933), the proper scope of reviewing such regulation would be one of limited judicial review as urged by the Board. (Henry's Restaurants of Pomona, Inc. v. State Bd. of Equalization (1973) 30 Cal.App.3d 1009, 1020--1021, 106 Cal.Rptr. 867; Mission Pak Co. v. State Bd. of Equalization (1972) 23 Cal.App.3d 120, 124--125, 100 Cal.Rptr. 69; see Carmona v. Division of Industrial Safety (1975) 13 Cal.3d 303, 309--310, 118 Cal.Rptr. 473, 530 P.2d 161; Pitts v. Perluss (1962) 58 Cal.2d 824, 834--835, 27 Cal.Rptr. 19, 377 P.2d 83.) However, in the instant case the, board adopted no formal regulation of a general nature. Considering the particular facts of the transactions involved in the audit of plaintiff...