Honolulu Oil Corp. v. Franchise Tax Bd.

• Decision Date: 29 October 1963
• Citation: 34 Cal.Rptr. 552,386 P.2d 40,60 Cal.2d 417
• Parties: , 386 P.2d 40 HONOLULU OIL CORPORATION, Plaintiff and Appellant, v. FRANCHISE TAX BOARD of the State of California, Defendant and Respondent. S. F. 21210.
• Court: California Supreme Court

Page 552

34 Cal.Rptr. 552

60 Cal.2d 417, 386 P.2d 40

HONOLULU OIL CORPORATION, Plaintiff and Appellant, v. FRANCHISE TAX BOARD of the State of California, Defendant and Respondent.

S. F. 21210.

Supreme Court of California, In Bank.

Oct. 29, 1963.

Rehearing Denied Nov. 27, 1963.

Herbert W. Clark, Franklin C. Latcham, Morrison, Foerster, Holloway, Clinton & Clark and Roger W. Findley, San Francisco, for plaintiff and appellant.

Forrest N. Shumway and Loren P. Oakes, Los Angeles, as amici curiae on behalf of plaintiff and appellant.

Stanley Mosk, Atty. Gen., James E. Sabine and Dan Kaufmann, Asst. Attys. Gen., and Frank M. Keesling, Los Angeles, for defendant and respondent.

PEEK, Justice.

Plaintiff Honolulu Oil Corporation appeals from a judgment in favor of the defendant Franchise Tax Board of the State of California in an action by the company to recover alleged overpayments of the corporate franchise tax in each of the taxable years 1951, 1952, 1953, and 1954.

Honolulu Oil Corporation is a Delaware corporation with its principal offices located in San Francisco. During the years in question it engaged in exploration for, and extraction and sale of oil and gas in fifteen states and the Dominion of Canada. In each of those years it originally computed its net income derived from sources in California by a separate accounting method. That is, it aggregated all of its receipts from the sale of petroleum products extracted from California wells, and subtracted therefrom all direct expenses incurred in its California operations together with a share of certain overhead expenses which were common to its operations both within and without California. The income so determined was used as a measure of the franchise tax. (REV. & TAX.CODE, S 23151. )¹

Subsequently Honolulu concluded that its returns based on separate accounting in California were in error and, within the statutory time limits, sought to amend those returns. The amended returns are based on an allocation formula which requires the apportioning to California of a share of the company's total net income according to the distribution within California of the proportionate share of its property, payroll and sales. The amendments are claimed to be authorized by and consistent with section 24301 of the Revenue and Taxation Code, which provided for the allocation of total net income of an interstate business '(w)hen the income of a taxpayer subject to the tax imposed under this part is derived from or attributable to sources both within and without the State * * *.'

Honolulu's claims for refund, based on the amended returns, were denied by the Franchise Tax Board, and this suit was instituted for the recovery of the alleged overpayments. The sole issue here presented goes only to the question of which of the two methods, separate accounting or an allocation formula, can be properly applied in the instant case to determine the measure of the California tax. The parties concede that if Honolulu is entitled to employ an allocation formula, the one so utilized in preparing the amended returns is proper. Based thereon, the overpayments are stipulated as follows: 1951, $101,941; 1952, $75,952; 1953, $66,560; 1954,.$148,661.

The use of a formula by Honolulu for purposes of determining its taxable income in California reduces that income substantially, largely because of the character of operations which are carried on in California, as distinguished from those out-of-state. While the California operation may generally be described as primarily production, with relatively high income, the out-of-state operations are best described as exploration and development with comparatively smaller current incomes and, in fact, on a net, over-all basis, were conducted at a loss for the period involved. For the four years in question Honolulu realized a total net income from all operations of $16,744,397.70. The share allocable to California by the formula method employed in the amended returns is $8,868,039.00. By the separate accounting method used in the original returns by Honolulu, there was a total net income in California of $18,581,825.60.

There is no dispute as to Honolulu's activities during the years in question. An agreed and lengthy statement of facts was stipulated to by the parties, and the trial court found the matters stated therein to be true. It appears therefrom that Honolulu is not a true 'integrated' oil company. Except for a relatively small amount of gasoline which it extracted from 'wet' or 'casinghead' gas it engaged in no refining operations. All of the oil and gas which it produced was sold to other companies, and no petroleum which it produced within or without California was moved by it across California borders. Originally its operations were confined entirely to California, but in recent years it has expanded its explorations to other areas, due to a claimed lack of virgin fields in California.

Honolulu's operations, whether within or without California, were controlled to a very considerable extent from its California offices. In addition, services such as accounting, purchasing of equipment, supplies and insurance and legal services were also centrally administered from California throughout the entire operation.

Honolulu's operations were divided into five geographical divisions, they being the California (California, Nevada and Utah, with the principal division office in San Francisco), Mid-Continent (Texas, New Mexico, Colorado, Nebraska and Oklahoma, with principal offices at Midland, Texas), Canadian (conducted as a joint venture with other oil companies, with main offices at Calgary, alberta, Canada), Rocky Mountain (Montana and Wyoming, with offices at Billings, Montana), and Southeastern (Mississippi, Louisiana, Alabama, Florida and Tennessee, with offices at Jackson, Mississippi) Divisions. The California Division functioned as any other division, and although there is an identity of principal offices with the company itself, the California Division as such exercised no superior control over the other divisions. Each division manager worked closely with the company's executives. Albert C. Mattei, President of Honolulu, exercised a great amount of supervision over each division, and considerable travel and other communications took place between Mr. Mattei and his staff, on the one hand and the division managers and their staffs on the other.

The company itself, and generally the divisions also, functioned through departments, the basic departments being the Land, Engineering, Exploration, Gasoline, Legal and Accounting Departments. The Land Department, with main offices in San Francisco, has steadily grown as land acquisitions in states other than California have increased. During the period here involved Honolulu had substantially more land under its control in Texas and Canada than in California, while the holdings in New Mexico were substantially equal to those in California. Each division maintained its own offices, except the Canadian Division which operated through the joint venture offices. The division offices did certain field work, maintained certain records, prepared documents and rental checks for approval and execution at the San Francisco Office, and supplied data which permitted the central office to maintain and keep land records current.

The Engineering Department was primarily concerned with drilling and production of wells, and maintained staffs both in California and Texas. The actual drilling was done by independent contractors, with Honolulu's engineers acting in an advisory capacity. There was a considerable exchange of technology between the various division during the years in the various divisions during the years in

An Exploration Department was headquartered in San Francisco, where approximately 40% of the technically trained men in that department were employed. A large portion of the funds expended for exploration were so expended pursuant to a master contract negotiated in California with the United Geophysical Company for seismographic surveys. While that company actually performed its exploratory work in the field, it developed its findings in its laboratories within California. Honolulu obtained many advantages under its contract with United and, although only a minor part of field exploration work was carried on in California, the California Division was able to benefit materially from technical reports obtained from United's California laboratories. Substantially larger payments were made to United in behalf of operations in New Mexico, Texas and Mississippi than in California. United also maintained officees in Texas for the purpose of assisting Honolulu.

A Gasoline Department, which...