McDonnell Douglas Corp. v. Franchise Tax Bd.

• Decision Date: 04 November 1968
• Citation: 72 Cal.Rptr. 465,446 P.2d 313,69 Cal.2d 506
• Court: California Supreme Court
• Parties: , 446 P.2d 313 McDONNELL DOUGLAS CORPORATION, Plaintiff and Appellant, v. FRANCHISE TAX BOARD, Defendant and Respondent. L.A. 29184.

Page 465

72 Cal.Rptr. 465

69 Cal.2d 506, 446 P.2d 313

McDONNELL DOUGLAS CORPORATION, Plaintiff and Appellant, v. FRANCHISE TAX BOARD, Defendant and Respondent.

L.A. 29184.

Supreme Court of California,

In Bank.

Nov. 4, 1968.

Forster, Gemmill & Farmer, James H. Knecht, Jr., Los Angeles, Louis Lieber, Jr., Santa Monica, and M. B. Hunt, for plaintiff and appellant.

Thomas C. Lynch, Atty. Gen., Ernest P. Goodman, Asst. Atty. Gen., and John J. Klee, Jr., San Francisco, for defendant and respondent.

BURKE, Justice.

In this corporate franchise tax controversy, a hearing was granted by this court, after decision by the Court of Appeal, Second Appellate District, Division Three, for the purpose of giving further study to the problems presented. After such study we have concluded that the opinion of the Court of Appeal, prepared by Presiding Justice Ford, correctly treats and disposes of the issues involved, and with certain further comments pertinent to contentions urged, it is adopted as and for the opinion of this court. Such opinion (with appropriate deletions and additions as indicated) is as follows: ¹

The plaintiff, formerly named Douglas Aircraft Company, has appealed from a judgment for the defendant Franchise Tax Board in an action for a refund of a portion of the corporation franchise taxes paid by the plaintiff for the taxable fiscal income years 1942 to 1945. ² The principal amount of the refund sought is approximately one million dollars. The primary question to be resolved is whether the plaintiff, in determining its income from California sources by means of a three-factor formula of sales, property and payroll, properly included government-owned property as well as property owned by the plaintiff in calculating the property factor. Alternatively, the plaintiff raises the question of whether the property factor should be disregarded entirely and only a two-factor (payroll and sales) formula used to determine the allocation of the plaintiff's income to California.

The parties stipulated in writing as to the pertinent facts, to some of which reference will now be made. The plaintiff was a corporation incorporated in the State of Delaware and qualified to do business in the State of California. Its principal office for the transaction of its business was in the City of Santa Monica, California, and its commercial domicile was in the State of California. During the fiscal income years beginning December 1, 1941, and ending November 30, 1945, the plaintiff was principally engaged in the business of constructing aircraft for the United States government, doing business both interstate and intrastate. Construction of aircraft was performed pursuant to both fixed-price and cost-plus-fixed-fee ('C.P.F.F.') contracts with the United States government. Under fixed-price contracts, the plaintiff was paid an agreed price for a particular model of aircraft. Under C.P.F.F. contracts, the plaintiff was directly reimbursed for costs incurred in the performance of the contract ³ and was paid a fixed fee which was negotiated between the parties. Virtually all the fixed-price contracts were performed in California.

With respect to its aircraft manufacturing business, Douglas operated three manufacturing plants and one modification plant in California, two manufacturing plants in Oklahoma and one manufacturing plant in Illinois. With the exception of two plants, the Santa Monica and El Segundo plants in California, the facilities were owned entirely by the United States government. In addition, the United States government owned facilities in and adjacent to the Santa Monica and El Segundo plants which were operated by the plaintiff as part of those plants. The plaintiff did not pay rent or other compensation to the United States government for the use of the government-owned property and facilities. The fixed fee, as a percentage of estimated cost, which was negotiated between the plaintiff and the United States government on C.P.F.F. contracts, did not differ between contracts performed in the plaintiff's facilities and contracts performed in government-owned facilities. The place of performance was limited by the United States government's previous direction as to which models of airplanes were to be manufactured in a particular plant and by specification in the contract of the plant of delivery.

In preparing its California Bank and Corporation Franchise tax returns for the taxable fiscal years 1943 to 1946, inclusive (being the fiscal income years 1942 to 1945, inclusive), the plaintiff determined its income from California sources by means of a three-factor formula of sales, property and payroll. The property allocated by the plaintiff to California for the fiscal income year 1942 was 65.95 percent; for the year 1943 it was 45.04 percent; for the year 1944 it was 36.13 percent; and for the year 1945 it was 31.88 percent. The plaintiff computed the property factor by including the tangible properties owned and used by it in the production of aircraft and the tangible properties owned by the United States government and used by the plaintiff in the production of aircraft. The defendant recomputed the property factor for the years involved by including therein only tangible property owned and used by the plaintiff and excluding property owned by the United States government and used by the plaintiff. As thus computed by the defendant, the property factor for the fiscal income year of 1942 was determined to be 100 percent; for the year 1943, 99.94 percent; for the year 1944, 99.37 percent; and for the year 1945, 93.67 percent.

In each of its claims for refund of the additional taxes and interest paid, the ground specified by the plaintiff was as follows: 'The Franchise Tax Commissioner erroneously eliminated the value of Government-owned property from the tangible property factor in the formula for allocation of income within and without the State of California. The claimant contends that by such action the tangible property factor becomes valueless for use in any formula having for its purpose a fair allocation of income as between in and out of the State of California.' The Franchise Tax Commissioner denied the claims for refund. The State Board of Equalization, after a hearing, affirmed the denial of the refund and subsequently denied a petition for a rehearing. The present action was therefore timely commenced.

In El Dorado Oil Works v. McColgan, 34 Cal.2d 731, at page 741, 215 P.2d 4, at p. 10, ( ) (this) court stated: 'No method of allocation can precisely determine the exact amount of income attributable either to any given geographic area or to any given part of a series of business transactions culminating in the realization of a profit, and 'any effort' in that regard 'must be more or less arbitrary and fictitious' Gorham Mfg. Co. v. Travis, D.C., 274 F. 975, 978 as a matter of practical tax administration. In short, as was recently said by the Supreme Court of the United States in sustaining the validity of a franchise tax assessment, the 'practical impossibility of a state's achieving a perfect apportionment of expansive, complex business activities * * * (makes) 'rough approximation rather than precision' * * * sufficient' in the formula allocation of income from a unitary business. (International Harvester Co. v. Evatt, 329 U.S. 416, 422, 67 S.Ct. 444, 447, 91 L.Ed. 390.)'

The use of a formula consisting of the three factors of property, payroll, and sales often suffices to apportion to a state that part of a corporation's net income fairly attributable to business done within the state. (General Motors Corp. v. District of Columbia, 380 U.S. 553, 559, 85 S.Ct. 1156, 14 L.Ed.2d 68, 72; Butler Bros. v. McColgan, 315 U.S. 501, 509, 62 S.Ct. 701, 86 L.Ed. 991, 997; El Dorado Oil Works v. McColgan, supra, 34 Cal.2d 731, 744--745, 215 P.2d 4; Pacific Fruit Express Co. v. McColgan, 67 Cal.App.2d 93, 96, 153 P.2d 607.) ⁴

Discretion as to the factors to be used was placed in the commissioner and his successor, the Franchise Tax Board. As stated in RKO Teleradio Pictures, Inc. v. Franchise Tax Board, 246 Cal.App.2d 812, at page 819, 55 Cal.Rptr. 299, at page 304: 'The Franchise Tax Board is given discretion in the selection of (the) factors to be utilized in a tax formula (El Dorado Oil Works v. McColgan, (supra,) 34 Cal.2d 731, 736, 215 P.2d 4) and where, as here, the taxpayer contends that the formula is arbitrary and reaches an unreasonable result, the burden is on the taxpayer to establish such facts by clear and convincing evidence.' (See Butler Bros. v. McColgan, supra, 315 U.S. 501, 507, 62 S.Ct. 701, 86 L.Ed. 991, 996.)

In the determination of the question of whether the plaintiff has sustained the burden placed upon it, ( ) guidance is found in the reasoning of ( ) John Deere Plow Co. of Moline v. Franchise Tax Bd., 38 Cal.2d 214, at pages 224--225, 238 P.2d 569, at page 574: 'The only requirement is that the formula used be not intrinsically arbitrary or produce an unreasonable result. * * * In the apportionment of a unitary business the formula used must give adequate weight to the essential elements responsible for the earning of the income * * * but its propriety in a given case does not require that the factors appropriately employed be equally productive in the taxing state as they are for the business as a whole. Varying conditions in the different states wherein the integrated parts of the whole business function must be expected to cause individual deviation from the national average of the factors in the formula equation, and yet the mutual dependency of the interrelated activities in furtherance of the entire business sustains the apportionment process.'

The plaintiff directs attention to the fact that the plaintiff's income was earned almost entirely under C.P.F.F. contracts and was rigidly fixed irrespective of ownership of the property. ⁵ It is then argued that, by...