Luckenbach S. S. Co. v. Franchise Tax Bd.

• Decision Date: 03 September 1963
• Citation: 33 Cal.Rptr. 544,219 Cal.App.2d 710
• Court: California Court of Appeals Court of Appeals
• Parties: LUCKENBACH STEAMSHIP COMPANY, Inc., a corporation, Plaintiff and Appellant, v. FRANCHISE TAX BOARD of the State of California, Defendant and Respondent. Civ. 10519.

Page 544

33 Cal.Rptr. 544

219 Cal.App.2d 710

LUCKENBACH STEAMSHIP COMPANY, Inc., a corporation, Plaintiff and Appellant, v. FRANCHISE TAX BOARD of the State of California, Defendant and Respondent.

Civ. 10519.

District Court of Appeal, Third District, California.

Sept. 3, 1963.

Hearing Denied Oct. 23, 1963.

John Hays, George L. Waddell, Dorr, Cooper & Hays, Hart H. Spiegel, Brobeck, Phleger & Harrison, San Francisco, for appellant.

Stanley Mosk, Atty. Gen., by Ernest P. Goodman, and John M. Traynor, Deputies, Atty. Gen., San Francisco, for respondent.

FRIEDMAN, Justice.

California levies a tax on the net income of corporations engaged exclusively in interstate commerce. ¹ Luckenbach Steamship Company, concedely subject to the tax, takes issue with the formula employed by the state Franchise Tax Board in allocating to California a portion of its net corporate income from interstate operations during the years 1942 through 1947.

Luckenbach is a Delaware corporation with its principal place of business in New York City. At the outbreak of World War II it was operating a fleet of merchant vessels as a common carrier, principally in intercoastal trade, with stops at California ports. In 1942 wartime exigencies caused the federal government to requisition the ships of Luckenbach and other carriers and to place them under a 'time charter' arrangement administered by the War Shipping Administration. Under this arrangement, which prevailed during most of 1942 and 1943, the government controlled the vessels' movements but Luckenbach continued as operator of the ships. Effective about the beginning of 1944 the government requisitioned the vessles on a 'bareboat charter' basis under which the War Shipping Administration became the actual operator. Luckenbach retained legal title and acted as general agent for these and other government-operated vessels. During 1946, the vessels (other than several which were lost) were returned to Luckenbach, which resumed intercoastal common carrier operations.

Luckenbach filed California income tax returns for the years 1942 through 1947, utilizing a so-called 'voyage-day' formula by which to compute that portion of its corporate income attributable, in its view, to California sources. Dissatisfied with the formula used by Luckenbach, the Franchise Tax Board levied an assessment for larger amounts, using the so-called 'port-day' formula in the computation of income attributable to California. Luckenbach paid the additional taxes under protest and sued to recover. The trial court denied recovery and Luckenbach appeals. Sole issue on appeal is lawfulness of the portday formula employed by the taxing agency as applied to income derived from operation of vessels during the years 1942 through 1947.

The problem is a perennial one in state taxation of multistate business concerns. Where a firm's business operations within and outside the taxing state are so closely integrated that each is dependent upon and contributes to the other, its income is treated as a unit, and it is regarded as a 'unitary business' for state tax purposes. (Butler Bros. v. McColgan, 315 U.S. 501, 62 S.Ct. 701, 86 L.Ed. 991, affirming 17 Cal.2d 664, 111 P.2d 334; Bass, Ratcliff & Gretton, Ltd. v. State Tax Com., 266 U.S. 271, 45 S.Ct. 82, 69 L.Ed. 283; Pacific Fruit Express Co. v. McColgan, 67 Cal.App.2d 93, 153 P.2d 607.) Separate accounting of in-state activities of a unitary business does not accomplish clear segregation of net income attributable to sources within the taxing state. (John Deere Plow Co. v. Franchise Tax Bd., 38 Cal.2d 214, 223, 238 P.2d 569.) In order to allocate a part of the net income subject to state income taxation, the taxing state may apply a formula fairly calculated to reflect the relative contribution of in-state activities to total net income. (El Dorado Oil Works v. McColgan, 34 Cal.2d 731, 738, 215 P.2d 4; Edison California Stores v. McColgan, 30 Cal.2d 472, 479-480, 183 P.2d 16; Keesling and Warren, The Unitary Concept in the Allocation of Income, 12 Hastings L. J. 42; Altman and Keesling, Allocation of Income in State Taxation (2d ed. 1950) p. 107.) Various states have adopted varying formulae. (Hartman, State Taxation of Corporate Income from a Multistate Business, 13 Vand.L.Rev. 21, 65.)

California, like a number of other states, employs a three-factor formula consisting of property, payroll and revenue. A simplified statement of the formula is that the average of the percentages of property, payroll and revenue located or occurring in California is applied to unitary net income, in order to establish that portion attributable to California. Validity of the three-factor formula as an abstract proposition has been judically confirmed and is not challenged here. (Butler Bros. v. McColgan, supra, 315 U.S. at p. 509, 62 S.Ct. at p. 705; El Dorado Oil Works v. McColgan, supra, 34 Cal.2d at p. 738, 215 P.2d at p. 9; Edison California Stores v. McColgan, supra, 30 Cal.2d at p. 479, 183 P.2d at p. 20.) What is challenged is the subordinate port-day formula used by the taxing agency as an adjunct of the property-payroll-revenue formula in computing Luckenbach's taxable income from ocean-going vessels. The ratio of the total days spent by a vessel in California ports during a given year to its total days spent in all ports was calculated. That ratio was applied to the vessel's value, payroll and revenue, as a preliminary to application of the standard three-factor formula. ² The port-day method is expressed fractionally as follows:

Number of days in California ports ³/Number of days in all ports

The voyage-day formula urged by Luckenbach apportions the vessel's income to California on the basis of ratio of the number of voyage days (including days in port) in California to the total number of voyage days during the period. Fractionally, this is expressed:

Number of days in California/Number of days in and out of California

Thus, in the case of a ship which occupied 10 per cent of its time in California ports, 30 per cent in other ports and 60 per cent on the high seas, the California allocation of property-payroll-revenue would be one-quarter under the port-day formula but only 10 per cent under the voyage-day method.

Luckenbach points out that vessels earn income not only in ports but while traveling the high seas, outside the territorial limits of California or any other taxing jurisdiction; that a fair apportionment formula would allocate some portion of vessel income to the location (high seas) where it is earned; that the port-day formula refuses recognition to vessel time on the high seas, results in extraterritorial taxation of income earned on the high seas and violates the due process and interstate commerce provisions of the federal Constitution, as well as the then current provisions of the taxing law itself. The argument emphasizes location of the income-producing activity as the dominant element in apportioning unitary income. (See Hartman, op. cit. supra, 13 Vand.L.Rev. at pp. 663-665.)

The courts have had numerous occasions to consider local ad valorem taxability of vessels plying the high seas in interstate and foreign commerce. (See cases cited in Scandinavian Airlines System, Inc. v. County of Los Angeles, 56 Cal.2d 11, 21-24, 45, 14 Cal.Rptr. 25, 363 P.2d 25.) So far as we are aware, this is the first case considering apportionment of unitary income derived exclusively from ocean-going vessels.

The due process phase of the taxpayer's attack rests on the general principle that states may not tax income of foreign corporations derived from extraterritorial sources. (Connecticut General Life Ins. Co. v. Johnson, 303 U.S. 77, 58 S.Ct. 436, 82 L.Ed. 673; James v. Dravo Contracting Co., 302 U.S. 134, 58 S.Ct. 208, 82 L.Ed. 155; Hans Rees' Sons, Inc. v. No. Carolina ex rel. Maxwell, 283 U.S. 123, 51 S.Ct. 385, 75 L.Ed. 879.) The limit of taxability has been described in various ways. In assessing taxes against interstate income, the state may not tax 'extraterritorial values.' (Butler Bros. v. McColgan, supra, 315 U.S. at p. 507, 62 S.Ct. at p. 704.) Its taxing power must bear 'fiscal relation to protection, opportunities and benefits given by the state'; a controlling question is 'whether the state has given anything for which it can ask return.' (Wisconsin v. J. C. Penney Co., 311 U.S. 435, 444, 61 S.Ct. 246, 85 L.Ed. 267.) A formula for apportionment of unitary income must be 'fairly calculated' to assign to the taxing state that portion of income 'reasonably attributable' to the business done there. (Butler Bros. v. McColgan, supra, 315 U.S. at p. 506, 62 S.Ct. at p. 704; Bass, Ratcliff & Gretton, Ltd. v. State Tax Com., supra, 266 U.S. at pp. 281-282, 45 S.Ct. at p. 84; Southern Pacific Co. v. McColgan, 68 Cal.App.2d 48, 60, 156 P.2d 81.) A formula valid in its general application must pass the test of fairness as applied to the individual taxpayer's situation. (Norfolk & Western Ry. Co. v. North Carolina, 297 U.S. 682, 685, 56 S.Ct. 625, 80 L.Ed. 977; Pacific Fruit Express Co. v. McColgan, supra, 67 Cal.App.2d at pp. 99-100, 153 P.2d at p. 610.) If the formula attributes to the taxing state income 'out of all appropriate proportion' to the business done there, the formula and the tax will fall. (Hans Rees' Sons v. North Carolina ex rel. Maxwell, supra, 283 U.S. at p. 135, 51 S.Ct. at p. 389.) One who attacks a formula of apportionment carries a 'distinct burden' of showing by 'clear and cogent evidence' that extraterritorial values are being taxed. (Butler Bros. v. McColgan, supra, 315 U.S. at p. 507, 62 S.Ct. at p. 704; Norfolk & Western Ry. Co. v. North Carolina, supra, 297 U.S. at p. 688, 56 S.Ct. at p. 628; El Dorado Oil Works v. McColgan, supra, 34 Cal.2d at p. 744, 215 P.2d at p. 12.)

It is impossible to divide the revenues and costs of a unitary business in accordance with state lines. (Norfolk & Western Ry. Co. v. North Carolina, supra, ...