Safeway Stores, Inc. v. Franchise Tax Board

• Decision Date: 28 December 1970
• Docket Number: S.F. 22757
• Citation: 478 P.2d 48,91 Cal.Rptr. 616,3 Cal.3d 745
• Parties: , 478 P.2d 48 SAFEWAY STORES, INCORPORATED, Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant.
• Court: California Supreme Court

Page 616

91 Cal.Rptr. 616

3 Cal.3d 745, 478 P.2d 48

SAFEWAY STORES, INCORPORATED, Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant.

S.F. 22757.

Supreme Court of California In Bank.

Dec. 28, 1970.

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

Orrick, Herrington, Rowley & Sutcliffe and William D. McKee, San Francisco, for plaintiff and respondent.

Pillsbury, Madison & Sutro, John A. Sutro, Francis N. Marshall, Noble K. Gregory, Frank H. Roberts and Toni Rembe, San Francisco as amici curiae on behalf of plaintiff and respondent.

BURKE, Justice.

Plaintiff Safeway Stores, Inc. (Safeway) recovered judgment for a refund of a portion of the franchise taxes paid to the State of California for the income years 1947 through 1950, and defendant Franchise Tax Board ¹ appeals. As will appear, we have concluded that the trial court erred in its view that certain dividends paid to Safeway by its subsidiaries were not taxable under the Bank and Corporation Franchise Tax Act. Accordingly, the judgment will be reversed.

The matter was tried upon stipulated facts, which in pertinent part may be summarized as follows: Safeway, a Maryland corporation, has its commercial domicile in California. During the years 1947 through 1950 Safeway operated, directly or through subsidiary corporations, a chain of more than 2,000 retail food markets and related meat, grocery, produce and egg warehouses in 23 states, the District of Columbia and the five western provinces of Canada. In connection with its food store business Safeway, either directly or through subsidiaries, also conducted purchasing, warehousing, manufacturing and processing operations throughout the United States and Canada. Additionally, Safeway, either directly or through subsidiaries, maintained some 35 organizations which provided the entire Safeway organization with services in such fields as accounting, financing, advertising and law.

It is agreed that Safeway and its subsidiaries were engaged in a single unitary business. Accordingly, pursuant to principles established in Edison California Stores v. McColgan (1947) 30 Cal.2d 472, 183 P.2d 16, the amount of operating income earned in California by those members of the group of corporations which did business in California was determined by applying a three-factor apportionment formula to the total operating income of the entire group. The appropriateness of that procedure is not disputed.

Safeway, in addition to its own operating income, received dividends from subsidiaries engaged with it in the unitary grocery business described above. Most of such dividends were received from Canadian subsidiaries, which did business only outside California, with the balance coming from one subsidiary which did business only in California and from others which did business both in California and outside this state. These dividends were wholly paid from income from unitary business operations of the declaring corporation or from dividends paid to the declaring corporation by a subsidiary corporation out of the latter's income from unitary business operations. All of the income from which the dividends were declared had at one time been included in the combined total of the operating income of Safeway and its subsidiaries to which the Franchise Tax Board (board) had applied an apportionment formula in arriving at income attributable to California sources and thus subject to this state's franchise tax.

The only issue presented by this appeal is how those intercorporate dividends are to be taxed under the franchise tax law.

It is not disputed that the total operating income of the group, to which the apportionment formula was applied, was determined on the basis of a consolidated or combined report in which the net income of all of the corporations is consolidated and intercompany interest, sales, rents, service charges, and like items incident to operating the unitary business, are eliminated. Additionally, the board agrees that if Safeway had operated its unitary business as one corporation only, instead of through subsidiary corporations, then transfers of funds to the head office in California from branches or divisions doing business outside this state, would not constitute taxable transfers. However, the board contends that dividends paid to Safeway by subsidiary corporations from that portion of the total operating income of the group which had not been taxed by California when the apportionment formula was applied, are, under applicable statutes and case law, subject to the franchise tax. Safeway disagrees, arguing that the fact that it carries on its unitary business as a multicorporate enterprise rather than as a single corporation should not render any of its intercompany transfers of funds taxable, whether or not the transfers are in the form of dividends. In our view, however, the law was otherwise at the times here involved.

Under section 6 of the Bank and Corporation Franchise Tax Act (act) ² dividends received on stocks are includable in gross income. ³ However, section 8 provides in subdivision (h)(1) that in computing net income a deduction shall be allowed for 'Dividends received during the income year declared from income which has been included in the measure of the tax imposed by this act upon the * * * corporation declaring the dividends * * *.'

The purpose of the section 8, subdivision [h], dividend deduction is to avoid double taxation At the corporate level of income which has already been subjected to California taxation in the hands of the dividend- declaring corporation. (See Burton E. Green Inv. Co. v. McColgan (1943) 60 Cal.App.2d 224, 232--233, 140 P.2d 451; Rosemary Properties, Inc. v. McColgan (1947) 29 Cal.2d 677, 683, 689, 177 P.2d 757 (dissent).) When such income is eventually paid as a dividend to the ultimate stock-owning individual who is a California taxpayer, it is again includable in his gross income for California personal income tax purposes, and is of course subjected to double taxation at that point. (See Rev. & Tax. Code, § 17071.) But if in the meantime it had been paid as dividends to one or more corporations standing between the original dividend-declaring corporation and the ultimate stock-owning individual and had been subjected to California taxation in the hands of each such corporation, then absent the section 8, subdivision (h), deduction the same income could well have been taxed several times by California before what might remain of it eventually reached the hands of the ultimate individual owner.

Safeway urges that because the California apportionment formula was applied to the total operating income of the Safeway group of corporations, determined on the basis of a consolidated or combined report, it then follows that All of such operating income was at one time 'included in the measure of the tax imposed by' the act within the meaning of the section 8, subdivision (h), dividend deduction, and that therefore all of the dividends paid to Safeway by its subsidiary corporations were entitled to the section 8, subdivision (h), deduction. This contention is fallacious. Clearly income attributed to sources outside California when the apportionment formula was applied has never been included in the measure of the tax imposed by the California act upon either the 'corporation declaring the dividends' (in the language of section 8, subdivision (h)), or upon any other corporation, and it is only dividends received by Safeway from such income not previously taxed by California that the board now proposes to tax. The fact that the combined or consolidated report of the group of corporations reflected total gross income and total deductions of all of the corporations, in order to arrive at the group's total net operating income to which the apportionment formula was applied, does not mean that the total gross income was included in the measure of the tax within the holding of Rosemary Properties, Inc. v. McColgan, Supra, 29 Cal.2d 677, 177 P.2d 757. ⁴ This case dealt with income 'attributable to California sources' (p. 682 of 29 Cal.2d, 177 P.2d 757), and nothing found therein supports the view that income attributed to non-California sources, and thus not subject to taxation under the act, has nevertheless been included in the measure of the California tax.

Safeway's suggestion that the consolidated or combined report authorized by section 14 of the act, ⁵ to which the apportionment formula was applied, somehow constituted a 'consolidated return' which had in some fashion subjected all of the income reflected in the report to the measure of the franchise tax, is equally without merit. Section 14 authorizes the board to permit or require the filing of a combined or consolidated report showing the combined net income in the case of two or more corporations owned or controlled by the same interests, and in the case of a parent corporation and subsidiary corporations. Section 10 authorizes application of the formula allocation whenever activities are partially within and partially without California. ⁶ (See Edison California Stores v. McColgan, Supra, 30 Cal.2d 472, 476--477, 480, 183 P.2d 16.) In the present case, the combined or consolidated report was filed as provided by section 14, and the allocation formula was applied under section 10, thereby attributing a portion of the group's total combined operating income to California sources and the remainder to sources outside this state. Only that portion attributed to California sources from (in the words of § 14, see fn. 5, Ante) 'business done in this State' was included in the measure of the tax imposed by the California act. And it is only such dividends as were paid from income attributed to sources outside California that the board now proposes to tax. ⁷ Plainly dividend income from those...