Cutler v. Franchise Tax Bd.
| Decision Date | 28 August 2012 |
| Docket Number | No. B233773.,B233773. |
| Citation | 146 Cal.Rptr.3d 244,208 Cal.App.4th 1247 |
| Court | California Court of Appeals Court of Appeals |
| Parties | Frank CUTLER, Plaintiff and Appellant, v. FRANCHISE TAX BOARD, Defendant and Respondent. |
OPINION TEXT STARTS HERE
See 8 Witkin, Summary of Cal. Law (10th ed. 2005) Constitutional Law, § 1300.
Held Unconstitutional
West's Ann.Cal.Rev. & T.Code § 18152.5
Reed Smith, Margaret M. Grignon, Mardiros H. Dakessian and Zareh A. Jaltorossian, Los Angeles, for Plaintiff and Appellant.
Kamala D. Harris, Attorney General, Paul D. Gifford, Senior Assistant Attorney General, W. Dean Freeman and Felix E. Leatherwood, Supervising Deputy Attorneys General, and Stephen Lew, Deputy Attorney General, for Plaintiff and Respondent.
The trial court upheld, against a commerce clause challenge (U.S. Const., art. I, § 8, cl.3), the constitutionality of Revenue and Taxation Code provisions allowing an individual California taxpayer to defer capital gains on the sale of stock in a qualified small business if the taxpayer used the gain to purchase stock in another qualified small business. The deferral was available, however, only if the stock sold and purchased was issued by corporations that used 80 percent of their assets in the conduct of business in California and that maintained 80 percent of their payrolls in California. (Rev. & Tax.Code, § 18152.5, subds. (c)(2)(A), (e)(1)(A) & (e)(9).)
Under the teaching of the high court in Fulton Corp. v. Faulkner (1996) 516 U.S. 325, 330, 116 S.Ct. 848, 133 L.Ed.2d 796( Fulton ), we are bound to and do conclude that, because the statute affords taxpayers a deferral for income received from the sale of stock in corporations maintaining assets and payroll in California, while no deferral is afforded for income from the sale of stock in corporations that maintain assets and payroll elsewhere, the deferral provision discriminates on its face on the basis of an interstate element in violation of the commerce clause. We therefore reverse the judgment.
Under federal law, an individual taxpayer's gain on the sale of qualified small business stock is not recognized if the taxpayer purchases stock in other qualified small businesses within 60 days. (26 U.S.C.S. § 1045.) California law specifies that this rollover provision does not apply to California's personal income tax (Rev. & Tax.Code, § 18038.4), but California has its own provisions for the deferral of gains on qualified small business stock.1 ( Id.,§§ 18038.5 & 18152.5.) (All further statutory references are to the Revenue and Taxation Code unless otherwise specified.) California's provisions mirror the federal provisions in many ways,2 but limit the incentive to gains on investments in small businesses based in California.3 ( § 18152.5, subds.(c)(2)(A), (e)(1)(A) & (e)(9).)
Specifically, classification as a qualified small business requires that “[a]t least 80 percent (by value) of the assets of the corporation [must be] used by the corporation in the active conduct of one or more qualified trades or businesses in California” (§ 18152.5, subd. (e)(1)(A)), and a corporation does not meet this requirement “for any period during which more than 20 percent of the corporation's total payroll expense is attributable to employment located outside of California.” ( Id., subd. (e)(9).)
In 1998, plaintiff Frank Cutler sold stock he had acquired in an internet start-up company (U.S. Web Corporation or U.S. WEB) for $2,296,000. He used some of the proceeds to purchase stock in several other small businesses. However, the U.S. WEB stock he sold did not meet the “active business requirements” of section 18152.5—that is, U.S. WEB did not maintain 80 percent of its assets and payroll in California. (§ 18152.5, subds. (c)(2)(A), (e)(1)(A) & (e)(9).) We will refer to this as the California property and payroll requirement.
On his 1998 California tax return, plaintiff deferred that part of the gain from the sale of his U.S. WEB stock that he invested in three other small businesses. In May 2004, the Franchise Tax Board (the Board) disallowed the gain deferral, stating in its notice of proposed assessment that U.S. WEB stock was not qualified small business stock (and also that plaintiff did not substantiate other requirements concerning the replacement stock, including that the replacement stock was purchased within 60 days of the sale, the purchase price, and other items). Plaintiff filed a protest, asserting the U.S. WEB stock met the requirements of section 18152.5 and, even if it did not, the statute was unconstitutional under the commerce clause because it unfairly discriminates against investors in companies which conduct a portion of their business outside the State of California. Plaintiff also asserted he had substantiated or could substantiate the statutory requirements for the replacement stock.
The Board denied plaintiff's protest and affirmed the proposed assessment in February 2007. Plaintiff appealed to the State Board of Equalization, and in July 2009, plaintiff paid $442,000 to the state, equivalent to the tax, penalties and interest assessed by the Board. The State Board of Equalization denied plaintiff's appeal and sustained the Board's action.
Plaintiff filed this action for a refund in September 2009, claiming that the California property and payroll requirement violates the commerce clause because it discriminates on its face against interstate commerce, and that the due process clause of the 14th Amendment requires a full refund. Plaintiff filed a motion for summary adjudication, seeking a ruling declaring the property and payroll requirement to be unconstitutional and awarding him a refund. The Board filed its own motion for summary judgment, contending both that the California property and payroll requirement was constitutional and that plaintiff failed to show his gain on the sales of the U.S. WEB stock could otherwise be deferred. The parties stipulated to basic facts about the sale and purchase of the small business stock, the amount of taxes plaintiff paid, and the Board's denial of a refund. The Board argued there remained material disputes as to whether plaintiff qualified for the tax deferral under provisions other than the California property and payroll requirement.
The trial court denied plaintiff's motion and granted the Board's motion, concluding the property and payroll requirement was not unconstitutional. Because plaintiff conceded he could not demonstrate the stock transactions at issue met that requirement, it was unnecessary for the trial court to decide the other issues presented in the parties' motions. Judgment was entered in favor of the Board and plaintiff appealed.
The issue of the constitutionality of the California property and payroll requirement is one of law and our review is de novo.
The United States Supreme Court has stated many times the principles applicable to a claim that state regulation—or state taxation—violates the commerce clause (U.S. Const., art. I, § 8, cl. 3). The commerce clause is phrased as a grant of regulatory power to Congress, but it “has long been seen as a limitation on state regulatory powers, as well as an affirmative grant of congressional authority.” ( Fulton, supra, 516 U.S. at p. 330, 116 S.Ct. 848.)Fulton tells us that in this negative aspect—also referred to as the dormant commerce clause—the clause “ ‘prohibits economic protectionism—that is, “regulatory measures designed to benefit instate economic interests by burdening out-of-state competitors.” ’ ” ( Ibid.) This construction furthers “the Framers' purpose to ‘prevent a State from retreating into economic isolation or jeopardizing the welfare of the Nation as a whole, as it would do if it were free to place burdens on the flow of commerce across its borders that commerce wholly within those borders would not bear.’ ” ( Id. at pp. 330–331, 116 S.Ct. 848.)
The first step in evaluating a state regulatory measure under the dormant commerce clause is “ ‘to determine whether it “regulates evenhandedly with only ‘incidental’ effects on interstate commerce, or discriminates against interstate commerce.” ' ” ( Fulton, supra, 516 U.S. at p. 331, 116 S.Ct. 848.) A law is discriminatory “if it ‘ “tax[es] a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State.” ’ ” (Ibid.;see also Boston Stock Exchange v. State Tax Comm'n (1977) 429 U.S. 318, 332, fn. 12, 97 S.Ct. 599, 50 L.Ed.2d 514( Boston Stock Exchange ) [].) “State laws discriminating against interstate commerce on their face are ‘virtually per se invalid.’ ” ( Fulton, at p. 331, 116 S.Ct. 848.)
“[T]he purpose of, or justification for, a law has no bearing on whether it is facially discriminatory.” ( Oregon Waste Systems, Inc. v. Department of Environmental Quality (1994) 511 U.S. 93, 100, 114 S.Ct. 1345, 128 L.Ed.2d 13( Oregon Waste ).) When a law discriminates against interstate commerce, “the virtually per se rule of invalidity provides the proper legal standard” and the law must be invalidated unless the state can “ ‘show that it advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.’ ” ( Id. at pp. 100–101, 114 S.Ct. 1345; see Maine v. Taylor (1986) 477 U.S. 131, 148, 106 S.Ct. 2440, 91 L.Ed.2d 110 [].) “ ‘[J]ustifications for discriminatory restrictions on commerce [must] pass the “strictest scrutiny.” ’ ” ( Fulton, supra, 516 U.S. at p. 345, 116 S.Ct. 848.) “The State's burden of justification is so heavy that ‘facial discrimination by itself may be a fatal defect.’ ” ( Oregon Waste, at p. 101, 114 S.Ct. 1345; see also New Energy Co. of Indiana v. Limbach (1988) 486 U.S. 269, 274, 108 S.Ct. 1803, 100...
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