Superior Oil Co. v. Franchise Tax Bd.

• Decision Date: 29 October 1963
• Citation: 386 P.2d 33,34 Cal.Rptr. 545,60 Cal.2d 406
• Parties: , 386 P.2d 33 SUPERIOR OIL COMPANY, Plaintiff and Respondent, v. FRANCHISE TAX BOARD of the State of California, Defendant and Appellant. L. A. 26672.
• Court: California Supreme Court

Page 545

34 Cal.Rptr. 545

60 Cal.2d 406, 386 P.2d 33

SUPERIOR OIL COMPANY, Plaintiff and Respondent, v. FRANCHISE TAX BOARD of the State of California, Defendant and Appellant.

L. A. 26672.

Supreme Court of California, In Bank.

Oct. 29, 1963.

Rehearing Denied Nov. 27, 1963.

Stanley Mosk, Atty. Gen., James E. Sabine and Dan Kaufmann, Asst. Attys. Gen., and Frank M. Keesling, Los Angeles, for defendant and appellant.

Latham & Watkins, Henry C. Diehl, Ira M. Price II, C. Robert Wilmsen, John H. Hall and Ralph E. Smith, Los Angeles, for plaintiff and respondent.

Forrest N. Shumway and Loren P. Oakes, Los Angeles, as amici curiae on behalf of plaintiff and respondent.

PEEK, Justice.

The defendant Franchise Tax Board appeals from a judgment awarding to the plaintiff Superior Oil Company a tax refund of $502,645.48 including interest, claimed to constitute an excess levy of the corporate franchise tax for the company's fiscal year ending August 31, 1952.

The franchise tax is impressed annually on corporations for the privilege of exercising the corporate franchise within California. (Rev. & Tax.Code, § 23151.) ¹

The measure of the tax is limited to income reasonably attributable to sources in California. Section 24301 of the Revenue and Taxation Code * as it read in part during the taxable year in question, provided as follows: 'When the income of a taxpayer subject to the tax imposed under this part is derived from or attributable to sources both within and without the State, the tax shall be measured by the net income derived from or attributable to sources within this State. Such income shall be determined by an allocation upon the basis of sales, purchases, expenses of manufacture, payroll, value and situs of tangible property or by reference to any of these or other factors or by such other method of allocation as is fairly calculated to determine the net income derived from or attributable to sources within this State. * * *'

The issue presented both to the trial court and on this appeal is whether the plaintiff's operations in several jurisdictions, including California, re unitary in nature and thus subject to local taxation on a basis which allocates a portion of the over-all net income to this state (Rev. & Tax.Code, § 24301) or whether, on the other hand, the local operations are sufficiently separate to justify local taxation on the net income derived from such separate, local operations.

Plaintiff takes the position that its operations are unitary with the result that the local allocated net income and taxes thereon are lesser amounts than the corresponding amounts which the Board contends properly result from the claimed separate, local operations. It is conceded that if Superior is entitled to use an allocation formula on the basis that its over-all operations are unitary, then the particular allocation of income which it urges, and determination of tax due therefrom, are correct.

The essential facts have been stipulated and are not in dispute.

Plaintiff is a California corporation with its principal place of business in Los Angeles. The franchise tax here involved is that for the tax year ending August 31, 1952 based on plaintiff's earnings for its tax year ending August 31, 1951. During that period plaintiff's principal income was derived from the production and sale of petroleum and petroleum products in more than a score of states, including California, and in foreign countries. Other income was produced from a realty subdivision in California, from gains made on the sale of capital assets both within and without this state, and from dividends on stock investments.

In a true sense plaintiff is not an integrated oil company. That is, it refined and processed only a minor portion of its production. Generally, its raw petroleum was sold at the well site to other companies. All production in California was sold in California, and all out of state production was sold outside of California.

Plaintiff's income producing activities were centrally controlled from its executive offices in Los Angeles, as well as were many administrative functions such as accounting, purchasing of equipment, supplies and insurance.

Personnel were moved frequently throughout the several states where plaintiff operated. At any given time only twenty per cent, more or less, of plaintiff's employees were employed primarily in California.

For the income year here involved plaintiff was required to file returns reporting its net income in eight other states, in addition to California. With respect to the returns filed in seven of such other states and pursuant to the local requirements thereof, it computed its income by the use of the separate accounting method, deducting from the gross receipts derived from the production and sale of petroleum products in each state the expenses attributable thereto including a fixed share of the common overhead expenses. Losses from such operations ranged from $9,397.69 in Arkansas to $3,410,381.90 in Louisiana and only in one state, mississippi, was a profit ($942,395.68) reported. In the eighth state, Kentucky, plaintiff employed a formula method which allocated a nominal portion of the integrated over-all net income to that state. The method of computation in each of the several states was dependent only on local requirements, and was in no way affected by that employed in any other state.

In reporting its income during the year ending on August 31, 1951, petitioner employed the separate accounting method for those purely intrastate activities the real estate subdivision project, sale of capital assets in California, and income from dividends. The allocation formula which it utilized as to its petroleum operations required that it total all receipts from those operations in all the states and countries involved, deducting therefrom the aggreate expenses in all the states and countries, and apportioning the remaining net income based upon the pro rata distribution within California of property, payroll and sales factors. This resulted in a net income attributable to the production and sale of petroleum products in California of $756,533.16, and a total net income from all sources attributable to California of $1,135,060.68.

By its separate accounting method the board determined that the net income from California sources was $10,637,633.46, subject to some minor statutory adjustments not in issue. Accordingly, it imposed an additional tax assessment of $381,250.99, representing the differential in the tax calculated pursuant to the disputed accounting methods. Eventually the additional assessment was paid, under protest, and the instant action was instituted to recover the same.

It might be noted that the circumstances surrounding Superior's particular income record vividly point up the effect of the accounting method to be utilized, not only as to the California tax, but also as to the gross tax payable in all of the various taxing states involved. For the tax year in question Superior had over-all net earnings of, roughly, $3,200,000. If an allocation arrangement were employed in each taxing state involved, Superior would pay taxes to each of the various states based on such state's pro rata share of that amount, which shares could not exceed 100% of the amount. On the other hand, if the separate accounting method were used in each state involved, then in six of the nine taxing states no tax would be paid (other than some nominal minimum), as losses were sustained in such states. In the other three states, including California, profits of $11,500,000 were realized and taxes in each such state would be payable on individual bases, the total of which bases would equal that amount. The unitary accounting method employing an allocation formula then, if applied uniformly, would result in a substantially smaller over-all tax liability, as the total taxable basis would be substantially less, neglecting for the moment the differing rates and exemptions in the several states.

It would be of still greater benefit to Superior if it could employ a separate accounting method in the states wherein it suffered losses, which method it apparently has employed in six of the seven states wherein there were losses, and an allocation method in the taxing state or states where it has realized large profits, as in California. Superior's over-all tax liability would be greatest if it were required to employ an allocation method in the states where losses were sustained, and a separate accounting method in the profit-making states. In any event it is Superior's contention that the board seeks to impose a tax on claimed separate earnings in California which are more than three times greater than its actual over-all earnings, and that such imposition is inequitable and improper under the California law. Of course, we are not concerned in this proceeding with the propriety of the methods used to determine taxable income in the other states.

The narrow issue herein, in terms of the statute, is whether Superior's income is 'derived from or attributable to sources both within and without the State.' (Rev. & Tax.Code, § 24301.) If such income can be so categorized then an allocation of total net income would naturally follow from the mandatory language of section 24301, and a separate accounting, as sought by the board, could not be approved.

Previously this court has had occasion to determine when separate accounting was proper. In Butler Brothers v. McColgan, 17 Cal.2d 644, 111 P.2d 334, the Franchise Tax Board assessed an additional tax based, in that case, on an allocation formula following a return by Butler Brothers on a separate accounting basis. The taxpayer paid and sought to recover. Judgment was for the board on a finding that the business was unitary in nature.

Butler Brothers was a corporation engaged in a wholesale merchandising business with outlets in several states,...