Lennane v. Franchise Tax Bd.

• Decision Date: 28 December 1994
• Docket Number: No. S034345,S034345
• Citation: 36 Cal.Rptr.2d 563,9 Cal.4th 263,885 P.2d 976
• Parties: , 885 P.2d 976 James P. LENNANE et al., Plaintiffs and Respondents, v. FRANCHISE TAX BOARD, Defendant and Appellant.
• Court: California Supreme Court

Page 563

36 Cal.Rptr.2d 563

9 Cal.4th 263, 885 P.2d 976

James P. LENNANE et al., Plaintiffs and Respondents, v. FRANCHISE TAX BOARD, Defendant and Appellant.

No. S034345.

Supreme Court of California,

In Bank.

Dec. 28, 1994.

Daniel E. Lungren, Atty. Gen., Timothy G. Laddish, Asst. Atty. Gen., and Richard F. Finn, Deputy Atty. Gen., San Francisco, for defendant and appellant.

Ware & Freidenrich, Gray, Cary, Ware & Freidenrich, John R. Shuman, Jr., Aimee E. Jorgensen and Rebecca P. Falco, Palo Alto, for plaintiffs and respondents.

Jerold A. Reiton, Berliner Cohen, San Jose, Briskin & Glushon, Robert A. Briskin, Douglas K. Schreiber, Irell & Manella, Gregory R. Smith, Joel Rabinovitz and David J. Richter, Los Angeles, amici curiae on behalf of plaintiffs and respondents.

KENNARD, Justice.

We granted review in this case to construe tax statutes--Revenue and Taxation Code sections 17063.11 and 18162.5--that have been repealed yet continue to govern the disposition of outstanding tax claims in excess of $300 million. ¹ At issue is the extent of California income tax liability for capital gain on the sale of "small business stock" that plaintiffs and other California taxpayers acquired on or before September 16, 1981, and sold between 1981 and 1987.

For the tax year 1986 (the tax year at issue here), capital gain from the sale of assets that had been held for more than one year was subject to two kinds of income tax. One portion of the gain (varying according to the type of asset and how long the taxpayer had held the asset) was taxed as ordinary income. The remainder of the gain in most cases did not escape taxation entirely but was treated as an "item of tax preference" and separately taxed as "preference income" at rates different from the rates at which ordinary income was taxed. If, however, the capital asset qualified as "small business stock," then the portion of capital gain not counted as ordinary income was also not considered to be "preference income" and did escape taxation entirely. Whether the portion of plaintiffs' capital gain in this case that was not counted as ordinary income was subject to taxation as preference income turns on whether the stock plaintiffs sold, and on which they realized the capital gain, qualified as "small business stock."

As applicable to the tax year at issue here, Revenue and Taxation Code section 17063.11 ² provides that none of the gain from a sale of "small business stock, as defined in Section 18162.5" is subject to tax as preference income. (Stats.1984, ch. 938, § 8, pp. 3199-3200.) When we turn to section 18162.5 (Stats.1985, ch. 106, § 133, pp. 322-324), we find in subdivisions (e) and (f) an express definition of the term "small business stock," with neither subdivision making any reference to the date on which the taxpayer acquired the stock. The only reference to acquisition date in section 18162.5 appears in subdivision (d), which in turn refers to subdivision (b). Read together, subdivisions (b) and (d) provide that gain from the sale of small business stock is excluded from taxation as ordinary income only if the taxpayer acquired the stock after September 16, 1981, and held the stock for more than three years.

The question in this case is whether section 17063.11's exemption from preference income tax applies to all small business stock within the definitional language of subdivisions (e) and (f) of section 18162.5, or instead only to small business stock acquired after September 16, 1981. Otherwise stated, the question is whether the acquisition date qualification that by its terms limits only the ordinary income tax exemption for small business stock also implicitly limits the express definition of "small business stock" found in subdivisions (e) and (f) of section 18162.5, which is the definition that section 17063.11 incorporates by reference.

We agree with plaintiff taxpayers that under sections 17063.11 and 18162.5, gains from the sale of small business stock are exempt from preference income taxation regardless of the stock's acquisition date. We draw this conclusion from both the unambiguous words of these provisions and the history of their legislative enactment.

I

From 1974 to 1976, plaintiffs James and Susan Lennane acquired stock in Systems Integrators, Inc. (the SII stock). In 1986, plaintiffs sold the SII stock, realizing a substantial capital gain. On their 1986 income tax return, plaintiffs reported 50 percent of this gain as ordinary income, but because they believed that section 17063.11 exempted the gain from preference income taxation, plaintiffs did not report the remaining 50 percent of the gain as preference income.

In March 1991, the Franchise Tax Board (the FTB), which administers California's income tax (§ 19501), sent plaintiffs a "notice of proposed additional tax." In the notice, the FTB observed that plaintiffs had acquired all the SII stock before September 16, 1981, and it proposed that the 50 percent of plaintiffs' gain that was not taxed as ordinary income be taxed as preference income. This resulted in a proposed assessment of $386,911.65, plus interest in the amount of $197,459.82, for a total of $584,371.47. Plaintiffs paid this amount and submitted a claim for refund. The FTB denied the claim.

In October 1991, plaintiffs commenced this lawsuit and soon thereafter moved for summary judgment. Because the material facts were undisputed, the sole issue before the trial court was a question of law: is the preference income tax exemption for gains on the sale of small business stock subject to the acquisition date limitation that applies to the ordinary income tax exemption for the same gains? Answering this question in the negative, the trial court granted summary judgment for plaintiffs requiring the FTB to refund the preference income tax plaintiffs had paid on the gains from the sale of the SII stock.

The Court of Appeal reversed. It determined that section 17063.11 was ambiguous. It then undertook an analysis of the statutory purpose and the relevant legislative history, from which it concluded that section 17063.11 was intended to apply only to small business stock acquired after September 16, 1981. ³

II

The question before us is whether section 17063.11's preference income tax exemption for capital gains on the sale of "small business stock, as defined in Section 18162.5," applies regardless of the date on which the taxpayer acquired the small business stock. To answer this question, we examine both the text and the enactment history of the relevant statutory provisions, sections 17063.11 and 18162.5.

A. Statutory Text

The applicable principles of statutory construction are well settled. "In construing statutes, we must determine and effectuate legislative intent." (Woods v. Young (1991) 53 Cal.3d 315, 323, 279 Cal.Rptr. 613, 807 P.2d 455.) "To ascertain intent, we look first to the words of the statutes" (ibid.), "giving them their usual and ordinary meaning" (DaFonte v. Up-Right, Inc. (1992) 2 Cal.4th 593, 601, 7 Cal.Rptr.2d 238, 828 P.2d 140). If there is no ambiguity in the language of the statute, "then the Legislature is presumed to have meant what it said, and the plain meaning of the language governs." (Kizer v. Hanna (1989) 48 Cal.3d 1, 8, 255 Cal.Rptr. 412, 767 P.2d 679.) "Where the statute is clear, courts will not 'interpret away clear language in favor of an ambiguity that does not exist.' [Citation.]" (Hartford Fire Ins. Co. v. Macri (1992) 4 Cal.4th 318, 326, 14 Cal.Rptr.2d 813, 842 P.2d 112.)

As it applies to the 1986 tax year, section 17063.11 provides that the "portion of capital gains attributable to the sale of small business stock, as defined in Section 18162.5, is not an item of tax preference" to be included in preference income. (Italics added.) Subdivisions (e) and (f) of section 18162.5, in turn, set forth an express and detailed definition of "small business stock." ⁴ Subdivision (e) begins as follows: "For purposes of this section, 'small business stock' is an equity security issued by a corporation which has the following characteristics...." Subdivision (f) begins: "For purposes of this section, 'small business stock' does not include an equity security issued by a corporation which has either of the following characteristics...." Neither subdivision makes any reference to the date on which the taxpayer acquired the stock.

The remaining subdivisions of section 18162.5 do not purport to define the term "small business stock." ⁵ Reading sections 17063.11 and 18162.5 together, therefore, we conclude that the term "small business stock," for purposes of preference income taxation, does not include an acquisition date limitation.

The FTB challenges this reading of the statutory text. According to the FTB, subdivisions (a), (b), and (d) of section 18162.5 (see fn. 5, ante, p. 566 of 36 Cal.Rptr.2d, p. 979 of 885 P.2d) impliedly modify the express definitional language of subdivisions (e) and (f) and restrict the definition of "small business stock" to stock acquired after September 16, 1981. The FTB reasons as follows: subdivision (a) sets forth general rules on recognition of capital gains as ordinary income, but it expressly excludes "small business stock" from these rules. Subdivision (b) sets forth particular rules on recognition as ordinary income of capital gains on the sale of "small business stock," but subdivision (d) states that these particular rules apply only to "small business stock acquired after September 16, 1981." Thus, stock acquired on or before that date may not be counted under subdivision (b), but neither can it be counted under subdivision (a) if it is "small business stock." Because the stock must be counted under either subdivision (a) or subdivision (b), and because it clearly cannot be counted under subdivision (b), the FTB insists that it must be counted under subdivision (a) as something other than "small business stock." This is...