Kms Financial Services, Inc. v. City of Seattle

• Decision Date: 18 September 2006
• Docket Number: No. 56808-6-I.,56808-6-I.
• Parties: KMS FINANCIAL SERVICES, INC., Respondent, v. CITY OF SEATTLE, Appellant.
• Court: Washington Court of Appeals

146 P.3d 1195

135 Wn. App. 489

KMS FINANCIAL SERVICES, INC., Respondent, v. CITY OF SEATTLE, Appellant.

No. 56808-6-I.

Court of Appeals of Washington, Division 1.

September 18, 2006.

Publication Ordered October 16, 2006.

COPYRIGHT MATERIAL OMITTED

Kent Charles Meyer, City of Seattle Attorneys Office, Seattle, WA, for Appellant.

Scott M. Edwards, Perkins Coie LLP, Seattle, WA, for Respondent.

APPELWICK, C.J.

¶ 1 This is a taxation case. The City of Seattle imposed a business and occupation (B & O) tax on the entire gross income of KMS Financial Services, Inc., a brokerage house based in Seattle. KMS argued that the City taxed earnings beyond its constitutional power, and sought a refund of the tax. Both parties filed motions for summary judgment. The trial court granted KMS's motion and denied the City's motion. The City appeals. We reject KMS's argument that the City's tax violates equal protection. We agree with KMS that by seeking to tax income generated by extraterritorial activities, the City's B & O tax as applied to KMS exceeds federal and state constitutional limits. KMS is entitled to apportionment. We conclude that neither party has correctly identified the measure of the tax. We vacate the trial court's order granting KMS's motion and denying the City's motion, and remand for further proceedings consistent with this opinion.

FACTS

¶ 2 KMS, a Washington corporation, is a broker-dealer under the Securities Exchange Act of 1934. KMS is registered with the Securities & Exchange Commission, the National Association of Securities Dealers (NASD), as well as the state securities regulators of all 50 states. KMS's home office is in Seattle, where KMS has approximately 24 employees. KMS did not own or lease any other real property in the period at issue in this case.

¶ 3 KMS has nearly 300 registered representatives who work from approximately 210 business locations in nine western states including Washington. Registered representatives arrange for the purchase and sale of securities under a broker-dealer's account. NASD has extensive rules governing its members and their registered representatives. As a broker-dealer, KMS must supervise its registered representatives, oversee their licensing status, and require them to comply with standards of conduct and procedures set out in a policy manual. KMS reviews and monitors the processing of each transaction arranged by its registered representatives. KMS's Seattle employees fulfill these supervisory tasks by using various remote monitoring methods and by inspecting the registered representatives' offices on a regular basis.

¶ 4 KMS has an independently negotiated contract with each registered representative that sets out the commission amounts. The record includes a sample of such a contract. This contract states that the registered representative is an independent contractor and not an employee. The registered representatives provide their own work spaces, pay their own rent and overhead, and hire their own employees. They retain exclusive control over their work, subject to KMS's policies and federal laws and regulations. They can conduct other business at their offices other than arranging for the sale of securities.

¶ 5 In a typical sale of securities, the client tells the registered representative to purchase or sell a security. The registered representative enters the client's order with KMS's primary clearing firm, Pershing LLC. Pershing executes the trade and records it in the client's account. The client writes a check to KMS or to Pershing (not to the registered representative) to pay for the transaction. The registered representative forwards the check to KMS, and a trade report is generated in KMS's office. After settlement of the trade (usually within three days), KMS receives a commission from Pershing and then pays the registered representative a commission based on its contract with the registered representative. KMS retains between 10 and 15 percent of the commission from Pershing, depending on its contract with the registered representative who generated the order.

¶ 6 The City issued a B & O tax assessment to KMS for additional taxes for January 1, 1999 through March 31, 2003. The City assessed the tax on all the commissions received into KMS's Seattle office no matter where the registered representative who generated the commission was based. The City asserts that because the Seattle office is KMS's sole office, KMS is not entitled to apportionment under the City's tax code. The City asserts that KMS may not deduct from its gross income the commissions it pays to its registered representatives. KMS does not contest paying taxes on its retained commissions or other miscellaneous income. However, KMS argues that the City's attempt to tax KMS's entire commission unconstitutionally reaches income earned from activities beyond the City's jurisdictional limits. KMS paid the assessed amounts under protest and filed a refund lawsuit against the City. On cross-motions for summary judgment, the trial court granted KMS's motion. The City appeals.

ANALYSIS

I. Standard of Review

¶ 7 This court reviews summary judgment orders de novo, engaging in the same inquiry as the trial court and viewing the facts and inferences in the light most favorable to the non-moving party.¹ Trimble v. Wash. State Univ., 140 Wash.2d 88, 92-93, 993 P.2d 259 (2000). "Summary judgment is appropriate if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law." Trimble, 140 Wash.2d at 93, 993 P.2d 259 (citing Clements v. Travelers Indem. Co., 121 Wash.2d 243, 249, 850 P.2d 1298 (1993); CR 56(c)).

II. Seattle's B & O Tax Provisions and Rules

¶ 8 The cities of Washington state have authority to levy B & O taxes. Dravo Corp. v. City of Tacoma, 80 Wash.2d 590, 593, 496 P.2d 504 (1972). Seattle has enacted a B & O tax ordinance that reads in part:

[T]here is hereby levied upon and shall be collected from every person a tax for the act or privilege of engaging in business activities within the City, whether the person's office or place of business be within or without the City.

SMC 5.45.050; see also former SMC 5.44.400.² Seattle's B & O tax is calculated by applying a specified tax rate "against gross proceeds of sale, gross income of business, or value of products." SMC 5.45.050; see also former SMC 5.44.400. Stockbroker commission income, like all other commission income, fits under the broad "service and other" classification of SMC 5.45.050(G) to determine the applicable tax rate. See also former SMC 5.44.400(F).

¶ 9 A business's gross income includes commissions. SMC 5.30.035(D). No deductions are allowed from gross income prior to calculating the tax, including labor costs or "any other expense whatsoever paid or accrued." SMC 5.30.035(D). The City's current tax code contains an exemption for real estate agents. Real estate agents are not taxed on their commissions if the agents' brokerage office has already paid tax on the gross commission. SMC 5.45.090(AA). The tax code contains numerous other exemptions for various industries. See generally SMC 5.45.090. For example, insurers who pay a state gross receipts tax are exempt from paying a B & O tax to the city. SMC 5.45.090(N).

¶ 10 The City has delegated authority to the Director of Finance to enact rules to carry out the tax code:³

The Director of Finance shall have the power and it shall be his or her duty, from time to time, to adopt, publish and enforce rules and regulations not inconsistent with this chapter, SMC Chapters 5.30, 5.32, 5.40, 5.45, 5.48, 5.52 or with law for the purpose of carrying out the provisions of such chapters, and it shall be unlawful to violate or fail to comply with, any such rule or regulation.

SMC 5.55.165; former SMC 5.44.130. Consistent with the City's tax code, Seattle's tax rules treat real estate brokers and stockbrokers differently. Real estate brokers, unlike stockbrokers, are permitted to exclude the commissions they pay their associated brokers from the broker's measure of tax. Seattle Tax Rule 5-532; former rules 5-44-128; 5-44-162.

III. Seattle's Disparate Tax Treatment of Stockbrokers and Real Estate Agents Does Not Violate Equal Protection

¶ 11 The federal constitution provides that no state shall "deny to any person within its jurisdiction the equal protection of the laws." U.S. Const. amend. 14, § 1. The Washington State Constitution provides that "[n]o law shall be passed granting to any citizen, class of citizens, or corporation other than municipal, privileges or immunities which upon the same terms shall not equally belong to all citizens, or corporations." Const. art. 1, § 12. "Ordinarily inconsistency with our `privileges and immunities' clause implies inconsistency with the federal equal protection clause." City of Seattle v. Rogers Clothing for Men Inc., 114 Wash.2d 213, 233, 787 P.2d 39 (1990). See also Andersen v. King County, 158 Wash.2d 1, 138 P.3d 963, 2006 Wash. LEXIS 598, *18 (holding that the same analysis that applies under the federal equal protection clause applies under the state privileges and immunities clause "unless the challenged law is a grant of positive favoritism to a minority class").

¶ 12 "Legislative bodies have extensive authority to make classifications for purposes of legislation and even broader discretion in making classifications for taxation than it has for regulation." Rogers Clothing, 114 Wash.2d at 234, 787 P.2d 39 (citing Sonitrol N.W., Inc. v. City of Seattle, 84 Wash.2d 588, 590-91, 528 P.2d 474 (1974)). A city council has the same powers of classification as the Legislature. Sonitrol, 84 Wash.2d at 594, 528 P.2d 474. "In Washington, absent involvement of fundamental rights or suspect classifications, equal protection challenges to tax laws are reviewed with a minimum level of scrutiny." Rogers Clothing, 114 Wash.2d at 233, 787 P.2d 39. The plaintiff has a heavy...