Farmer Bros. Co. v. Franchise Tax Bd., B160061.

• Decision Date: 21 May 2003
• Docket Number: No. B160061.,B160061.
• Court: California Court of Appeals Court of Appeals
• Parties: FARMER BROS. CO., Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant.

134 Cal.Rptr.2d 390

108 Cal.App.4th 976

FARMER BROS. CO., Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant.

No. B160061.

Court of Appeal, Second District, Division 1.

May 21, 2003.

Review Denied Aug. 27, 2003.^*

Certiorari Denied Feb. 23, 2004. See 124 S.Ct. 1411.

Bill Lockyer, Attorney General, W. Dean Freeman, Lead Supervising Deputy Attorney General, and Gregory S. Price, Deputy Attorney General, for Defendant and Appellant.

Anglin, Flewelling, Rasmussen, Campbell & Trytten, Robin C. Campbell, Los Angeles; Morrison & Foerster, Thomas Hugh Steele and Amy L. Silverstein, San Francisco, for Plaintiff and Respondent.

MALLANO, J.

In this case of first impression, we hold that California Revenue and Taxation Code section 24402 (section 24402), known as the "dividends received deduction," violates the commerce clause of the United States Constitution (commerce clause) by discriminating against corporations engaged in interstate commerce.¹ Section 24402 affords to a corporate taxpayer an income tax deduction for a portion of the dividends it receives from another corporation when the dividends are declared from income which was included in the payer corporation's measure of California franchise tax, alternative minimum tax, or corporation income tax.² In holding that section 24402 violates the commerce clause, we follow Ceridian Corp. v. Franchise Tax Bd. (2000) 85 Cal.App.4th 875, 102 Cal.Rptr.2d 611 (Ceridian), in which the First District held that Revenue and Taxation Code section 24410, which governs taxation of insurance company dividends paid to major corporate stockholders, was unconstitutional under the commerce clause.

The Franchise Tax Board (FTB) appeals from a judgment awarding plaintiff Farmer Bros. Co. (Taxpayer) state tax refunds totaling $811,000 for the tax years 1992 through 1998, plus interest and costs, as a remedy for overpaying taxes under the provisions of section 24402, which the trial court determined to be unconstitutional under the commerce clause. We agree with the trial court's conclusion and affirm the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

This case was submitted for determination by the trial court on a joint stipulation of facts and written trial briefs, which provide the undisputed factual background.

Taxpayer is a California corporation primarily engaged in the business of manufacturing and selling coffee and coffee-related products. For the years 1992 through 1998, Taxpayer timely filed California corporate income or franchise tax returns with the FTB. Each return reported a "dividends received deduction" under section 24402, representing a portion of the dividends Taxpayer had received during the income year. Taxpayer owned less than 20 percent of the stock in each of the payer corporations which had issued dividends to Taxpayer during the years at issue. Thus, for those dividends which qualify for the deduction under the terms of section 24402, subdivision (a), the statute affords Taxpayer a maximum deduction of 70 percent of the amount of the dividend. (§ 24402, subd. (b); see fn. 2, ante.)

FTB had promulgated a schedule listing the corporations and the percentage of their dividends that were deductible under section 24402. The schedule was based on a formula which allowed for a sliding scale deduction so that the taxpayer was entitled to a greater deduction the more the income of the payer corporation was subject to specified California corporate taxes. (See Cal.Code Regs., tit. 18, § 24402 (rule 24402).)

As explained in rule 24402, "Taxpayers are permitted a deduction under Section 24402, for dividends received which were declared from income included in the measure of tax of the declaring corporation under this part." Rule 24402 also provides three examples to illustrate the operation of the dividends received deduction. Example (1) states: "The A Corporation receives dividends from B Corporation, whose entire income is also subject to tax under this part and has no other earnings not taxable under this part. A is allowed a deduction for all such dividends received from B." (Rule 24402.) Example (2) states: "The A Corporation received dividends from B Corporation, which is not subject to tax in California. None of the dividends received from B are deductible." (Ibid.) Example (3) states: "The A Corporation receives dividends from B Corporation, whose income is subject to allocation because its activities are carried on within and without the State. B's allocation percentage is 50 percent. The percentage of the dividends received by A which are deductible is determined by formula. The variance from 50 percent will be affected by the extent of nonunitary and nontaxable income." (Ibid.)

The concept of a "unitary business" has been developed in cases addressing the problem of the local taxation of businesses operating in more than one jurisdiction. (See Container Corp. v. Franchise Tax Bd. (1983) 463 U.S. 159, 164-166, 103 S.Ct. 2933, 2939-2941, 77 L.Ed.2d 545.) "California, like many other States, uses what is called a `unitary business' income-calculation system for determining its taxable share of a multistate corporation's business income.... [¶] The income of which California taxes a percentage is constitutionally limited to a corporation's `unitary' income. Unitary income normally includes all income from a corporation's business activities, but excludes income that `derive[s] from unrelated business activity which constitutes a discrete business enterprise,' [citation]. As we have said, this latter `nonunitary' income normally is not taxable by any State except the corporation's State of domicile (and the States in which the `discrete enterprise' carries out its business)." (Hunt-Wesson, Inc. v. Franchise Tax Bd. (2000) 528 U.S. 458, 460-461, 120 S.Ct. 1022, 1024-1025, 145 L.Ed.2d 974.)

Pursuant to FTB's formula and schedule for dividends deductible under section 24402, some of the dividends received by Taxpayer from certain corporations in certain years were not deductible. For example, in 1998 Taxpayer received a dividend from Farmland Industries of about $11,000, but no part of the dividend was deductible, based on section 24402 and Farmland Industries's paying no California franchise tax in 1998. As to other corporations which paid dividends to Taxpayer, various portions of those dividends were subject to the section 24402 deduction. For example, in 1998, Taxpayer received a total dividend of about $4,800 from Merrill Lynch but only 1.839 percent of that dividend, or about $89, was deductible. As to a total dividend in 1992 of $17,550 from San Diego Gas & Electric, almost all of the dividend, or 99.546 percent, was deductible.

Taxpayer timely filed amended tax returns claiming a dividends received deduction for all dividends received for the years at issue and requested refunds totaling over $800,000, plus interest. Taxpayer asserted as the ground for the refunds that section 24402 violated the commerce clause of the United States Constitution. FTB denied Taxpayer's claims for refunds. Taxpayer appealed the denial to the State Board of Equalization (Board), which considered the appeal and sustained FTB's action on the ground that the Board "does not have the authority to deny the application of Revenue and Taxation Code section 24402 on constitutional grounds."

In September 2000, Taxpayer filed the instant action for refund of corporate franchise or income tax. In a first amended complaint, Taxpayer asserted that section 24402 is unconstitutional under the commerce clause of the United States Constitution because it discriminates on its face against interstate commerce by improperly taxing income that is not attributable to business transacted in California and the deduction cannot be justified as a lawful compensatory tax. FTB answered the first amended complaint in May 2001.

On the trial date, October 25, 2001, the parties filed opening trial briefs and a joint stipulation of facts and lodged interrogatories propounded by Taxpayer and FTB's responses. A witness list proffered by FTB indicated it intended to call as witnesses Professors Richard Pomp and Stephen Sheffrin regarding the issue of whether section 24402 violated the commerce clause. In response to FTB's witness list, Taxpayer filed a motion in limine to bar expert testimony on the constitutionality issue. The October 25, 2001 minute order indicates that the parties agreed to bifurcate the trial, with the court adjudicating first the issue of the constitutionality of section 24402 and then, if necessary, the issue of remedy. The court afforded the parties until November 8, 2001, to file responses to the opening briefs. With respect to the motion in limine, the minute order states that FTB would have until November 8, 2001, to file opposition and then "the cause will stand submitted. [¶] If the plaintiffs motion in-limine to bar expert testimony on the constitutionality issue is denied and expert testimony is to be taken, trial will be continued into early next year for that testimony."

In FTB's response to the motion in limine, FTB faulted Taxpayer for failing to obtain any discovery with respect to expert witnesses and instead, "on the day set for trial, Taxpayer file[d] a motion in which it presents to the Court Taxpayer's assumptions as to the nature of the testimony to be offered by the Board's witnesses and asks that they be barred from testifying because this assumed testimony is inadmissible. Taxpayer is not only tilting at windmills, it is doing so after constructing the very edifices at which it aims its lance." FTB then pointed out that expert opinion testimony properly could be offered as to factual issues arising under the compensatory tax doctrine defense but expressly refused to go into any greater detail as to any such testimony, thus refusing "to give Taxpayer the benefits ... which it would have received had it exercised the diligence...