Montgomery Ward & Co. v. Franchise Tax Bd.

• Citation: 85 Cal.Rptr. 890,6 Cal.App.3d 149
• Court: California Court of Appeals Court of Appeals
• Decision Date: 31 March 1970
• Parties: MONTGOMERY WARD & COMPANY, Incorporated, Plaintiff and Appellant, v. FRANCHISE TAX BOARD of the State of California, Defendant and Respondent. Civ. 26105.

Page 890

85 Cal.Rptr. 890

6 Cal.App.3d 149

MONTGOMERY WARD & COMPANY, Incorporated, Plaintiff and Appellant, v. FRANCHISE TAX BOARD of the State of California, Defendant and Respondent.

Civ. 26105.

Court of Appeal, First District, Division 1, California.

March 31, 1970.

Hearing Denied May 28, 1970.

Valentine Brookes, Charles S. Franklin, San Francisco, for plaintiff and appellant; Irwin J. Shapiro, Regional Counsel, Montgomery Ward & Co., Inc., Oakland, of counsel.

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

SIMS, Associate Justice.

Plaintiff taxpayer has appealed from a judgment which denied it recovery of a portion of its corporate franchise taxes (REV. & TAX.CODE, S 23151 )¹ assessed and paid for the taxpayer's fiscal income years ending on January 31st in the years 1955 through 1960. The income upon which the tax for each year was based was that portion of the taxpayer's total net income which the taxing authorities found to be derived from, or attributable to, sources within this state. ² The taxpayer contends that respondent Franchise Tax Board erred in allocating its income in each of the years in question because it included property in transit to California in the numerator of the property factor used in the income allocation formula. It also asserts that some of the assessments were barred because the board's notices of assessment were not issued within the time provided by law.

It is concluded for the reasons set forth below that the taxpayer's attack on the allocation formula must fail, and that the notices of additional taxes proposed to be assessed were timely made. Nevertheless the case must be remanded because the judgment failed to include a refund to which it was stipulated the taxpayer was entitled. The stipulated facts relating to the issues involved are incorporated in the discussion.

I Statement of Facts

The taxpayer is a corporation organized under the laws of Illinois with its principal office and place of business in Chicago, Illinois. It conducts a nationwide retail sales business, and is qualified to do business in California and in other states. It sells its merchandise both by mail order and by direct sale from retail stores which it owns and manages in many different cities throughout California and other states.

For purposes of this action, the parties stipulated that the taxpayer's operations constitute a unitary business, and that it is appropriate to compute the amount of its income attributable to California sources by use of the three-factor apportionment formula of property, payroll and sales. The parties do not dispute the computation of unitary net income (a term meaning the taxpayer's net income from all its business operations, part of which is apportionable to California by formula), the computation of the payroll factor in the formula and the computation of the sales factor in the formula, except as these amounts may not have been timely determined by the Franchise Tax Board.

In accordance with the rules of the Franchise Tax Board, for purposes of computing the property factor of the apportionment formula, the taxpayer used the average of the property, including inventory, on the first day of the year and the last day of the year. Upon any one day the taxpayer owns property, usually merchandise and store supplies, which is physically moving from one location to another. In some cases the property is moving from one of Montgomery Ward's retail stores, mail order stores, warehouses or distribution centers to another of Montgomery Ward's retail stores, mail order stores, warehouses or distribution centers. In other cases the property is moving from an independent vendor or from a company factory to one of the retail stores, mail order stores, warehouses or distribution centers. The transportation is sometimes wholly intrastate and sometimes interstate.

In computing the property factor for use in its California franchise tax returns for the years here involved, the taxpayer included all its property, including its property-in-transit, in the denominator of the fraction. It included no property-in-transit in the numerator of the fraction. The taxpayer included in the numerator of the fraction only the property physically at rest at a California store or warehouse. In its returns, the taxpayer did not treat as California property that property which was moving from one California location to another California location. Likewise not treated by the taxpayer as California property was that property which, coming to California from out-of-state or going from California to an out-of-state destination, was actually within California at midnight of January 31, the date used for averaging purposes.

The board determined that the numerator of the property factor fraction should have contained those amounts of the taxpayer's property-in-transit which were en route to a California destination. As thus recomputed by the board, the numerator of the fraction included that portion of the property-in-transit which was determined to be in transit to a California destination, regardless of its actual location on midnight of January 31. Likewise, the board excluded from the numerator of the fraction that portion of the property-in-transit that was determined to be in transit from a California point of origin to a destination outside California, regardless of whether the property was actually within the territorial boundaries of California on midnight of January 31. The board then issued notices of proposed assessments accordingly.

The taxpayer paid the additional assessments and filed claims for refund for the full amount of the payments. After those claims were denied, it brought this suit for refund, still praying for the full amount of the payments.

On appeal the taxpayer refers to stipulated figures which represent the value of the property in transit to, but not within the State of California, and confines its argument to the exclusion of these values from the numerator. It contends (1) that the statutory provisions (fn. 2 above) direct that all property which does not have a taxable situs within the state must be excluded from the numerator, (2) that the board cannot substitute its discretion for the mandate of the Legislature, (3) that if the statute is construed to give the board discretion to initiate its own formula it would be invalid as an unconstitutional delegation of legislative power, and (4) that the due process and commerce clauses of the United States Constitution prohibit the board from measuring the taxpayer's liability by extra-territorial property. An examination of these contentions reveals that they are not controlling in view of the expressed and constitutionally authorized legislative intent to measure the tax by the net income derived from or attributable to sources within this state, and the reasonableness of the formula applied to obtain this end.

'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 * * *' (El Dorado Oil Works v. McColgan (1950) 34 Cal.2d 731, 741, 215 P.2d 4, 10.)

Following the judgment of the lower court in this case, the foregoing principles were reaffirmed in McDonnell Douglas Corp. v. Franchise Tax Board (1968) 69 Cal.2d 506 at page 511, 72 Cal.Rptr. 465, 446 P.2d 313. There the court added, '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. (Citations.)

'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 * * *.)' (69 Cal.2d at pp. 551--512, 72 Cal.Rptr. at p. 468, 446 P.2d at p. 316, fn. omitted.)

The taxpayer emphasizes the clause of the statute (see fn. 2 above) which reads 'value and situs of tangible property,' and interprets it as a mandate that the allocation formula cannot use the value of property as a measure of the net income derived from or attributable to sources within the state, unless that property has a situs for taxation within the state.

It is axiomatic that tangible personal property which is situated outside of the taxing jurisdiction generally cannot be subjected to a property tax. (Frick v. Pennsylvania (1925) 268 U.S. 473, 489, 45 S.Ct. 603, 69 L.Ed. 1058; Union Refrigerator Transit Co. v. Kentucky (1905) 199 U.S. 194, 204, 26 S.Ct. 36, 50 L.Ed....