RIVER GARDEN Ret. HOME v. FRANCHISE TAX Bd.

• Decision Date: 10 November 2010
• Docket Number: No. A123316.,A123316.
• Court: California Court of Appeals Court of Appeals
• Parties: RIVER GARDEN RETIREMENT HOME, Plaintiff and Appellant, v. FRANCHISE TAX BOARD, Defendant and Respondent.

186 Cal.App.4th 922

113 Cal.Rptr.3d 62

RIVER GARDEN RETIREMENT HOME, Plaintiff and Appellant,

v.FRANCHISE TAX BOARD, Defendant and Respondent.

No. A123316.

Court of Appeal, First District, Division 4, California.

July 15, 2010.

Review Denied Nov. 10, 2010.

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Silverstein & Pomerantz, Amy L. Silverstein, Edwin P. Antolin, San Francisco, for Appellant.

Edmund G. Brown, Jr., Attorney General, Joyce H. Hee, Supervising Attorney General, David Lew, Deputy Attorney General, for Respondent.

REARDON, J.

For years Revenue and Taxation Code ¹ section 24402 allowed California corporate taxpayers to deduct a portion of the dividends they received from another corporation when those dividends were included in the payer's measure of California franchise, income or alternative minimum tax. The court in Farmer Bros. Co. v. Franchise Tax Board (2003) 108 Cal.App.4th 976, 980, 986–987, 134 Cal.Rptr.2d 390 ( Farmer Bros.) held that section 24402 violates the commerce clause of the United States Constitution by allowing the dividends received deduction where the dividend-paying corporation was subject to California tax, but disallowing it where such corporation was not subject to California tax.

Appellant River Garden Retirement Home (River Garden or the company) claimed the dividends received deduction for tax years 1999 and 2000, but, in the wake of Farmer Bros., respondent Franchise Tax Board (FTB) disallowed the deductions for tax years ending on or after December 1, 1999, and issued notices of proposed assessment for additional tax for the two years at issue in this case. As well, the FTB imposed an amnesty penalty under California's tax amnesty program ² because River Garden did not pay the tax deficiencies announced in those notices until two years after the close of the amnesty period. Section 19777.5, subdivision (a)(2) subjects eligible taxpayers, such as River Garden, who did not participate in the amnesty program to a penalty on amnesty-eligible deficiency assessments that remain “due and payable” after the close of the amnesty period. After unsuccessfully pursuing administrative remedies, River Garden sued for the refund of California tax and tax penalties, losing below.

Contrary to River Garden's assertions on appeal, we conclude, among related points, that section 24402 cannot be saved by severance of the offending language or by reformation. Moreover, the FTB proceeded with proper authority to remedy the commerce clause violation infecting section 24402, and the remedy of disallowing the dividends received deductions for the years at issue did not defy the due process prohibition against excessively retroactive tax increases. As well, the FTB's decision to recoup the deductions for those years did not run afoul of article XIII A, section 3 of the California Constitution requiring a two-thirds vote of the Legislature to enact revenue increasing tax laws.

On the amnesty front, we hold that the deficiency assessments for tax years 1999 and 2000 were “due and payable” within the meaning of section 19777.5, thereby empowering the FTB to assess amnesty penalties for those years. Additionally, section 19777.5 does not operate retroactively, and therefore imposition of the amnesty penalty does not raise due process concerns. Finally, there is no statute of limitations bar to imposing the amnesty penalty for the 1999 tax year. Accordingly, we affirm the judgment in its entirety.

I. FACT SUMMARY

River Garden, a California corporation, operates a retirement home in Lodi. The company received dividends in 1999 and 2000 in the respective amounts of $46,271 and $55,025. River Garden deducted 80 percent of the dividends it received in those years on its California tax returns, pursuant to section 24402.

On audit, FTB disallowed 100 percent of the dividends received deduction which River Garden claimed for those years on grounds that Farmer Bros. declared section 24402 unconstitutional and invalid. Implementing that decision, the FTB announced that it would allow section 24402 deductions for tax years ending prior to December 1, 1999, but disallow them for tax years ending on or after December 1, 1999. In keeping with this policy, in April 2004 the FTB issued to River Garden notices of proposed assessment in the amount of $2,666.08 (1999) and $2,704.18 (2000). River Garden protested the notices, the FTB published notices of action affirming them, and thereafter in December 2004, River Garden appealed to the State Board of Equalization.

Meanwhile, California's tax amnesty program went into effect in February 2005 while River Garden's administrative appeal was pending. The amnesty program afforded taxpayers a two-month window (Feb. 1, 2005 through Mar. 31, 2005), to apply for amnesty and thereafter pay in full all outstanding tax liabilities and interest for tax years prior to January 1, 2003, thereby avoiding tax penalties, fees and possible criminal action. (§§ 19731–19733.) River Garden was aware of the tax amnesty program, but did not remit payment to the FTB during the two-month window of any portion of the tax deficiencies assessed against it for the years in question.

The State Board of Equalization affirmed the FTB's notices of action in September 2006. There followed a series of notices from the FTB to River Garden: (1) January 18, 2007 notice of balance due for tax, interest and penalty totaling $8,844.53; (2) March 23, 2007 corporation past due notice for tax, interest and penalty totaling $8,969.46; and (3) April 27, 2007 corporation formal demand for tax, interest and penalty in the amount of $9,038.51. On May 9, 2007, River Garden remitted the full amount, which included an amnesty penalty pursuant to section 19777.5 for failure to participate in the tax amnesty program and clear the unpaid tax and interest. Thereafter the company filed a claim for refund, the FTB denied the claim, and River Garden sued for a refund of the tax assessments as well as the amnesty penalties. The trial court sustained the FTB's demurrer to River Garden's challenge to the tax assessment, and subsequently granted summary judgment in the FTB's favor on the challenge to the amnesty penalty. This appeal followed.

II. DISCUSSION

A. Section 24402 Deduction

[1] In its opening brief, River Garden argues that we should preserve section 24402 by severing the portion of the statute that unconstitutionally limits the dividend deduction to those dividends paid from California sources. After the brief was filed, the Court of Appeal in Abbott Laboratories v. Franchise Tax Bd. (2009) 175 Cal.App.4th 1346, 96 Cal.Rptr.3d 864 ( Abbott ) persuasively rejected this proposition. River Garden contends in its reply brief that the Abbott court got it wrong. Now conceding that section 24402 has been “conclusively determined to be unconstitutional, and that question is no longer in issue,” River Garden frames the question presented on appeal this way: “[W]hat is the proper remedy for River Garden for the years at issue?” Its attempt to recycle severance as the remedy for curing section 24402 of its unconstitutionality is not persuasive because the substance of the argument is the same. Nevertheless, River Garden is correct that the ultimate issue is articulating the proper remedy. Before reaching that issue, some background on the statute's constitutional infirmity and its insusceptibility to salvation by separability is in order.

1. Background

We start with Farmer Bros. There, the taxpayer filed state tax returns claiming a dividends received deduction for all dividends it received for the years at issue, regardless of whether the dividend-paying corporation paid California taxes or not. The taxpayer sought refunds totaling more than $800,000 plus interest, asserting that section 24402 contravened the “dormant” commerce clause ³ because on its face the statute discriminates against interstate commerce by improperly taxing income that is not attributable to business taking place in this state, and the deduction could not be justified as a lawful compensatory tax. The trial court agreed, declaring that section 24402 facially and unconstitutionally burdens interstate commerce. It awarded refunds of $811,000 plus interest and costs. On appeal the FTB challenged the substantive ruling that section 24402 is unconstitutional, but did not attack the remedy. ( Farmer Bros., supra, 108 Cal.App.4th at pp. 983–985, 134 Cal.Rptr.2d 390.)

Affirming, the Farmer Bros. court first pointed out that the dormant commerce clause “prohibits economic protectionism—that is, regulatory measures designed to benefit in-state economic interests by burdening out-of-state competitors.” ( Farmer Bros., supra, 108 Cal.App.4th at pp. 985–986, 134 Cal.Rptr.2d 390.) Section 24402 favors dividend-paying companies that do business in California and pay California taxes over dividend-paying companies that do not do business in California and pay no taxes here. Thus, the deduction discriminates between transactions based on an interstate element, branding it facially discriminatory under the commerce clause. ( Farmer Bros., supra, at pp. 986–987, 134 Cal.Rptr.2d 390.) Specifically, the discriminatory impact of this scheme operates to favor domestic corporations over their foreign competitors in raising capital among California residents, and by the same token tends to discourage domestic corporations from plying their business in interstate commerce. ( Id. at pp. 987–988, 134 Cal.Rptr.2d 390; accord, Ceridian Corp. v. Franchise Tax Bd. (2000) 85 Cal.App.4th 875, 883–887, 102 Cal.Rptr.2d 611 ( Ceridian ) [concluding that § 24401, which allows deduction for insurance subsidiary dividends only to corporations domiciled in California, and limits amount...