LENNANE v. FRANCHISE TAX BOARD

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Court of Appeal, First District, Division 2, California.

James P. LENNANE et al., Plaintiffs and Respondents, v. FRANCHISE TAX BOARD, Defendant and Appellant.

No. A057655.

Decided: June 29, 1993

John R. Shuman, Jr., Aimee E. Jorgensen, Rebecca P. Falco, Ware & Freidenrich, Palo Alto, for plaintiffs and respondents. Richard F. Finn, San Francisco, for defendant and appellant.

In this case of first impression, we interpret Revenue and Taxation Code section 17063.11 1 to exempt from the preference income tax (§ 17062), only that small business stock which was purchased after September 16, 1981.   Accordingly, we reverse the summary judgment and direct the superior court to enter judgment in favor of defendant Franchise Tax Board (FTB).

I

FACTS

The undisputed facts establish that during the period between 1974 and 1976 plaintiffs James and Susan Lennane purchased stock in System Integrators, Inc. (SII).  In 1986, plaintiffs sold a portion of the stock realizing capital gains.   The SII stock qualified as “small business stock” under section 18162.5, subdivision (e).   In their 1986 California personal income tax return, plaintiffs properly excluded from their taxable income, 50 percent of the capital gains realized from the sale of the stock.  (§ 18162.5, subd. (a)(3).)   Plaintiffs believed that this unrecognized portion of the capital gain was excludable from the tax preference income tax under section 17063.11.   On March 9, 1991, the FTB issued plaintiffs a notice of proposed additional preference income tax in the amount of $386,911.65 for calendar year 1986, plus interest in the amount of $197,459.82 for a total unpaid balance of $584,371.47.   On May 10, 1991, plaintiffs paid the full amount of the additional tax plus interest and filed a claim for a refund.   Subsequently, plaintiffs paid an additional $8,345.54 in interest.   The FTB denied plaintiff's refund claim on July 24, 1991, and plaintiffs brought this action for a refund under section 19082 and for attorney fees under section 19420.

Plaintiffs filed a motion for summary judgment arguing that section 17063.11 excludes capital gains from the sale of small business stock, whenever purchased, from preference income taxation.   At the time of the sale, that section stated:  “For the purpose of Section 17063, that portion of capital gains attributable to the sale of small business stock, as defined in Section 18162.5, is not an item of tax preference.”

The FTB defended, arguing that section 17063.11 applies only to the sale of small business stock acquired after September 16, 1981, the effective date of the statute.   The trial court granted plaintiffs' motion for summary judgment, holding the statute was unambiguous on its face and it contained no limitation to stock acquired after September, 16, 1981.   This timely appeal followed.

II

DISCUSSION

 The interpretation of this statute is purely a question of law for which we exercise our independent judgment, unrestricted by the trial court's decision.  (Public Utilities Com. v. Energy Resources Conservation & Dev. Com. (1984) 150 Cal.App.3d 437, 443, 197 Cal.Rptr. 866;  Consolidated Accessories Corp. v. Franchise Tax Board (1984) 161 Cal.App.3d 1036, 1039, 208 Cal.Rptr. 74.)   As we explain in detail below, the statute is ambiguous, and it is susceptible to more than one reasonable interpretation.  (See generally, People v. Woodhead (1987) 43 Cal.3d 1002, 1008–1009, 239 Cal.Rptr. 656, 741 P.2d 154.)   After considering the legislative history, the ostensible objects to be achieved, and the entire statutory scheme of which it is a part, we conclude that the exemption from preference income taxation granted by section 17063.11 applies only to stock acquired after the effective date of the statute, i.e., September 16, 1981.

A

Legislative History1. 1971 Act—The Preference Income Tax

In 1971, the Legislature enacted section 17062 which imposed an additional 2.5 percent tax on preference income as defined in section 17063 (e.g., capital gains), which is not otherwise subject to personal income tax.   (Added Stats. (First Ex.Sess.1971) ch. 1, § 16, pp. 4900–4901, Summary Dig., p. 759.) 2  Section 17063 identified the items subject to tax preference as follows:  “For purposes of this chapter, the items of tax preference are:  ․ [¶] (f) An amount equal to one-half of the amount by which net long-term capital gain exceeds the net short-term capital loss for the taxable year.”

In 1986, section 17063 was amended to alter the method for calculating the amount of capital gains to be included as tax preference income.  “For purposes of this chapter, the items of tax preference are:  ․ [¶] (e) The amount of the tax preference income with respect to capital gains shall be an amount (but not below zero) equal to the difference between (1) the taxpayer's total net capital gains and losses (determined without regard to any capital loss carryover) for the taxable year, and (2) the taxpayer's net capital gains and losses recognized by virtue of Section 18162.5 for the same taxable year.”   (Stats.1986, ch. 54, § 1.5, pp. 140–141.)   The preference income tax was repealed in 1987.  (Stats.1987, ch. 1138, § 40, p. 3911.)

In the same 1971 legislation that introduced the preference tax, the Legislature added section 18162.5 which revised the percentages of capital gains or losses recognized as taxable income based on the length of time the capital asset is held.   The bill made no distinction for small business stock.   As enacted, it provided:  “(a) In the case of any taxpayer, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing taxable income:  [¶] (1) One hundred percent if the capital asset has been held for not more than one year;  [¶] (2) Sixty-five percent if the capital asset has been held for more than one year but not more than five years;  [¶] (3) Fifty percent if the capital asset has been held more than five years.”  (Stats. First Ex.Sess.1971, ch. 1, § 108.5, pp. 4988–4989.)

2. 1981 Act—The Small Business Stock Exemption

a.

In 1981, the Legislature adopted Senate Bill No. 690 adding section 17063.11, which exempted from preference income capital gains recognized from the sale of small business stock.   As originally enacted, section 17063.11 provided:  “For the purpose of Section 17063, that portion of capital gains attributable to the sale of small business stock, as defined in section 18161.5, is not an item of tax preference.”  (Stats.1981, ch. 534, § 2, p. 1903.)

At the time of the Lennane's sale of SII stock, section 17063.11 read:  “For the purpose of Section 17063, that portion of capital gains attributable to the sale of small business stock, as defined in Section 18162.5, is not an item of tax preference.”  (Amend.Stats.1984, ch. 938, § 8, pp. 3199–3200.)   This section was repealed in 1987.  (Stats.1987, ch. 1138, § 40, p. 3911.)   There is no dispute here that plaintiffs' stock qualified as a “small business stock” as defined in section 18162.5, subdivisions (e) and (f).3

b.

As part of the same bill, section 18162.5 was amended to provide for more favorable personal income tax treatment for capital gains realized from the sale of long-held small business stock.  (Stats.1981, ch. 534, § 4, p. 1905.)   Section 18162.5, subdivision (b) provided:  “In the case of any taxpayer, only the following percentages of the gain recognized upon the sale or exchange of small business stock shall be taken into account in computing taxable income:  [¶] (1) One hundred percent if the small business stock has been held for not more than one year.  [¶] (2) Sixty-five percent if the small business stock has been held for more than one year but not more than three years.  [¶] (3) Zero percent if the small business stock has been held for more than three years․”  (Stats.1981, ch. 534, § 4, p. 1905.)   At the same time, the bill increased the percentage of gain subject to tax from the sale of “nonproductive assets,” defined as precious metals, objects of art, antiques, coins, stamps and jewelry.  (Stats.1981, ch. 534, § 1, p. 1903.)

Of particular concern to this appeal is subdivision (d) of section 18162.5 which read:  “Subdivision (b) shall apply with respect to small business stock acquired after the operative date of the act which adds this subdivision to this section [i.e., September 16, 1981].”  (Stats.1981, ch. 534, § 4, p. 1905.)   Section 18162.5 was last amended in 1985 without any substantial impact on the issue before us.  (Stats.1985, ch. 106, § 133, pp. 322–324.) 4

c.

Also noteworthy is the Legislature's written statement of purpose included in the 1981 bill establishing the small business stock preference income tax exemption.   It read:  “The Legislature finds that a key element of California's economic growth and prosperity over the past several decades has been the founding and expansion of new private businesses.   A majority of the increase in private employment in California has come as a result of the willingness of private entrepreneurs to take risks in starting and expanding small companies.   Similarly, the willingness of private investors to provide the start-up equity capital for entrepreneurs has been a critical element in the ability of new and small companies to transform ideas into jobs and income for California.  [¶] The Legislature finds, however, that state and national tax laws, in an inflationary era, provide insufficient incentive for many investors to risk their savings in new businesses, and excessive incentive to place their savings into nonproductive assets which add nothing to the strength of the economy.   The purely speculative returns on such investments as gold, silver, gems, paintings, stamps, and antiques represent the diversion of scarce capital from productive investment.”  (Stats.1981, ch. 534, § 1, p. 1903.)

We next turn our attention to the merits of this case.

B

 Plaintiffs contend that the language of section 17063.11 contains no restriction on the date by which the small business stock must be acquired to qualify for the preference income tax exclusion, that the language is clear and unambiguous and this court should not engage in any statutory construction.   We disagree.

The familiar rules of statutory construction require us to “look first to the words themselves.   When the language is clear and unambiguous, there is no need for construction.   When the language is susceptible of more than one reasonable interpretation, however, we look to a variety of extrinsic aids, including the ostensible objects to be achieved, the evils to be remedied, the legislative history, public policy, contemporaneous administrative construction, and the statutory scheme of which the statute is a part.”  (People v. Woodhead, supra, 43 Cal.3d at pp. 1007–1008, 239 Cal.Rptr. 656, 741 P.2d 154, internal citations omitted.)

While it is true section 17063.11 does not contain any threshold date for the acquisition of the stock, that section refers to section 18162.5 for a definition of small business stock.   By incorporating section 18162.5 into the statute, we may reasonably infer the Legislature intended the two statutes to be read in pari materia.   Moreover, since this section (§ 17063.11) was part of the same bill which reduced the capital gains tax on small business stock (§ 18162.5), we must attempt to harmonize the two laws keeping the single statutory purpose in mind.  “[T]he meaning of the enactment may not be determined from a single word or sentence;  the words must be construed in context, and provisions relating to the same subject matter must be harmonized to the extent possible.  [Citation.]”  (Title Ins. & Trust Co. v. County of Riverside (1989) 48 Cal.3d 84, 91, 255 Cal.Rptr. 670, 767 P.2d 1148.)   In light of the foregoing rules of statutory construction, we conclude the language is ambiguous, and we look to extrinsic sources to determine if the Legislature intended to limit the preference tax exemption to small company stocks purchased after September 16, 1981.

1.

As stated above, the legislative purpose behind the exemption and the favorable capital gains treatment, was to increase “the willingness of private investors to provide the start-up equity capital for entrepreneurs” and to reverse the “insufficient incentive for many investors to risk their savings in new businesses․”  (See ante, at p. 29.)   We believe this is a reasonable use of the government's taxing power to further desirable social goals, and plaintiffs do not contend otherwise.  (See, e.g., Kahn v. Shevin (1974) 416 U.S. 351, 355–356, 94 S.Ct. 1734, 1737, 40 L.Ed.2d 189 [Florida statute may grant widows, but not widowers, a property tax exemption since it is reasonably designed to further the social policy of mitigating the disparate financial impact on widows.];  Carmichael v. Southern Coal Co. (1937) 301 U.S. 495, 512, 57 S.Ct. 868, 873, 81 L.Ed. 1245 [“The Legislature may withhold the burden of the tax in order to foster what it conceives to be a beneficent enterprise.”];   accord Leslie's Pool Mart, Inc. v. Department of Food & Agriculture (1990) 223 Cal.App.3d 1524, 1544, 273 Cal.Rptr. 373.)

The manifest intent to encourage investors to risk their savings in start-up and small capitalization companies can only be realized if the investments are made after the effective date of the statute.   The tax breaks provided by the statute are not justified for those investors who purchased small business stocks 10, 20, and 30 years or more before the statute was enacted.   As perceived by the Legislature, those investors were not hindered with periods of high inflation and did not sacrifice a high rate of return compared to other investments.   In contrast, the investor who purchased small business stock after September 16, 1981, not only was taking the risk associated with every new business, but his or her dollar was losing value to high inflation.   It was because of this greater risk to an investors' total return that the Legislature created these tax benefits.   By enacting the 1981 bill, the Legislature sought to reverse the investment trend, which was to hedge against high inflation by investing in “nonproductive assets which add nothing to the strength of the economy.   The purely speculative returns on such investments as gold, silver, gems, paintings stamps, and antiques represent the diversion of scarce capital from productive investment.”  (Stats.1981, ch. 534, § 1, p. 1903.)

Plaintiffs' purchase of small business stock before the enactment of the statute did not help the state meet its perceived need to create and expand small businesses at the time of the statute.   In short, plaintiffs did not risk their capital entitling them to the tax benefits created by the Legislature.

In fact, plaintiffs' interpretation would undermine the very economic policy articulated in the enactment.   For example, if plaintiffs purchased their small business stock before September 16, 1981, but sold it on January 1, 1982, they would pay no preference tax on their capital gains.   But, this sale of the stock would remove scarce investment capital from targeted businesses at the most critical time, as perceived by the Legislature.   In essence, plaintiffs would reap the benefit of the exemption from the preference tax while, simultaneously, harming the very business interests the statute was created to protect.   Viewing section 17063.11 “ ‘in the context of the entire statutory system of which it is a part ․’ ”  (People v. Woodhead, supra, 43 Cal.3d at p. 1009, 239 Cal.Rptr. 656, 741 P.2d 154, internal citation omitted), we hold that the preference tax exemption in section 17063.11 applies to small business stock purchased after September 16, 1981.

This interpretation is consistent with the analysis of Senate Bill No. 690 by the Legislative Analyst.  (See Pacific Bell v. California State & Consumer Services Agency (1990) 225 Cal.App.3d 107, 115–116, 275 Cal.Rptr. 62 [legislative analysis is relevant to divine legislative intent].)   In referring to the bill as a whole, the Legislative Analyst expressly stated, “The provisions of this bill would become effective January 1, 1982, except with respect to small business stock, in which case the provisions would apply only to those stocks acquired after the operative date of the measure.”   (Legis. Analyst's Analysis, Sen. Bill No. 690 (1981–1982 Reg.Sess.) p. 3.)

This same conclusion was reached by the Assembly Revenue and Taxation Committee.  (See Assem. Revenue and Taxation Com., Analysis of Sen. Bill No. 690 (1981–1982 Reg.Sess.) as amended May 5, 1981.)

The anticipated fiscal effect also supports our interpretation that the bill applies to small business stocks purchased after September 16, 1981.   As stated in the analysis by the Department of Finance, “This bill would be effective with the 1982 tax year, and would apply only to small business stock acquired after the bill's operative date․  [¶] There would be no revenue loss from the ‘small business' provisions until the 1985 tax year․  Beginning with 1985, there would most likely be a net revenue loss of several million per year.”  (Cal. Dept. Finance Analysis, Sen. Bill No. 690 (1981–1982 Reg.Sess.) as amended Aug. 26, 1981, p. 2.)   This analysis presumes the stock was purchased after September 16, 1981, and was held for three years before sale in order to reap the maximum capital gains benefits.

When viewed as part of the entire statutory scheme, we conclude section 17063.11 must be interpreted to apply only to the sale of small business stock acquired after the effective date of the statute, September 16, 1981.   Any other interpretation would clash with the manifest purpose of the act, and we cannot permit that result.  (See generally, DaFonte v. Up–Right, Inc. (1992) 2 Cal.4th 593, 601, 7 Cal.Rptr.2d 238, 828 P.2d 140.)

2.

In support of their position that section 17063.11 contains no purchase date requirement, plaintiffs rely on the decision of the State Board of Equalization (SBE) in Appeal of Hagen (4 SBE 587, CCH Cal.Tax.Rptr. ¶ 401–312, filed April 9, 1986), which ruled in favor of the taxpayer on this very issue.   In that appeal, the SBE reversed the FTB's denial of a refund to the Hagens, concluding the plain language of section 17063.11 did not impose a date for the purchase of the stock.

 Plaintiffs refer us to the rule of statutory construction which permits the courts to accord “great respect” to the interpretation of the statute by the administrative agency charged with enforcing that statute.   (See San Lorenzo Education Assn. v. Wilson (1982) 32 Cal.3d 841, 850, 187 Cal.Rptr. 432, 654 P.2d 202.)   But that rule has little relevance to situations such as this, where the agency is not interpreting its own regulations, and instead, it is trying to discern the legislative intent based upon a reading of the statutory language and the relevant legislative history.  (See People v. Woodhead, supra, 43 Cal.3d at p. 1013, 239 Cal.Rptr. 656, 741 P.2d 154 [“Although contemporaneous administrative opinion or practice is entitled to ‘respect’ [citation], it is ‘not controlling as to the meaning of a constitutional provision or statute.’  [Citation.]”].)  The interpretation of the statute is a question of law which ultimately rests with the courts.  (Culligan Water Conditioning v. State Bd. of Equalization (1976) 17 Cal.3d 86, 93, 130 Cal.Rptr. 321, 550 P.2d 593;  accord Robinson v. Fair Employment & Housing Com. (1992) 2 Cal.4th 226, 235, fn. 6, 5 Cal.Rptr.2d 782, 825 P.2d 767.)   Our review is based on the same legislative record to which the SBE had access.   In our view, the SBE in Appeal of Hagen clearly erred when it refused to consider the entire legislative enactment of which section 17063.11 was a part.

3.

Plaintiffs also contend that the Legislature's failure to enact later legislation which sought to specifically include September 16, 1981, as the acquisition date, is evidence that section 17063.11 never restricted the date for the purchase of the stock.   As amended, Assembly Bill No. 3424 (Hannigan) and Senate Bill No. 249 (Presley) 5 would have modified section 17063.11 to expressly apply to stock acquired after September 16, 1981.  (Assem.Amend. to Sen. Bill No. 249 (1985–1986 Reg.Sess.) Aug. 18, 1986;  Assem.Amend. Bill No. 3424 (1985–1986 Reg.Sess.) May 29, 1986.6

 The Legislature's failure to adopt these amendments cannot be used to support the view that the original statute did not impose the acquisition date requirement.   As stated by our Supreme Court in Ingersoll v. Palmer (1987) 43 Cal.3d 1321, 1349, 241 Cal.Rptr. 42, 743 P.2d 1299, “Legislative silence is an unreliable indicator of legislative intent in the absence of other indicia.   We can rarely determine from the failure of the Legislature to pass a particular bill what the intent of the Legislature is with respect to existing law.  [Fn. omitted.]  ‘As evidence of legislative intent they [unpassed bills] have little value.  [Citations.]’ ”

Other reasons may exist for not passing these bills, unrelated to the question before us.  “The Legislature may have objected to other portions of the bills, for example, and not felt any further clarification ․ was necessary.   Although it may be true that ‘[t]he rejection by the Legislature of a specified provision contained in an act as originally introduced is most persuasive to the conclusion that the act should not be construed to include the omitted provision,’ [citations] for the reasons stated above, there is relatively little value in examining an existing statute in light of proposed amendments which have not been approved.”  (Sav–On Drugs, Inc. v. County of Orange (1987) 190 Cal.App.3d 1611, 1623, 236 Cal.Rptr. 100.)

 The failure of the Legislature to pass “clarifying legislation” may indicate that no clarification was needed and its rejection of the proposed amendments does not undercut our analysis.

4.

Lastly, plaintiffs argue that the FTB unfairly caused them to rely on the Hagen decision to their detriment, and the FTB should be estopped to assert that only stock purchased after September 16, 1981 is exempt.   Plaintiffs have cited no case law to support their position that an administrative ruling in which they are not interested parties, can have an estoppel effect as to them.   Additionally, the evidence does not support the claim of detrimental reliance.

 As a general rule, “an estoppel will not arise against the government in tax matters where the taxpayer relies on an erroneous construction of a statute by an official.  [Citations.]”  (U.S. Fid. & Guar. Co. v. State Bd. of Equal. (1956) 47 Cal.2d 384, 390–391, 303 P.2d 1034;  La Societe Francaise v. Cal. Emp. Com. (1943) 56 Cal.App.2d 534, 553–554, 133 P.2d 47.)   However, the government may be estopped in tax matters only in the most limited circumstances—i.e., where the injustice is clear and great.  (U.S. Fid. & Guar. Co., supra, 47 Cal.2d at p. 389, 303 P.2d 1034.)

 There is no proof, here, that plaintiffs relied on the Hagen decision either in selling their stock or in preparing their 1986 state tax return.   The Hagen case was decided on April 9, 1986.   Plaintiffs sold their stock on March 20, 1986, and on April 23, 1986.   Plaintiffs filed their 1986 tax return on August 15, 1987.   We have reviewed the plaintiffs' moving papers and find no evidence or allegation that they relied on the Hagen decision at any time.   In their claim for a refund, plaintiffs relied only on their reading section 17063.11 to support the claim that they were not subject to the preference income tax.   While they cited to the Hagen decision as support for their interpretation, they never alleged that they acted in reliance on the Hagen ruling.

In the subject complaint for a refund, plaintiffs alleged that section 17063.11 excludes capital gains as an item of preference income, but do not allege that they also relied on the Hagen decision in reaching this conclusion.

Plaintiffs' motion for summary judgment likewise asserted that the plain language of section 17063.11 should be read to exclude small business stock purchased before September 16, 1981.   Plaintiffs again cite to Hagen to support their argument, but they never asserted that they relied on the Hagen decision either in deciding to sell their stock or in computing their personal income tax liability.   In their reply memorandum in support of summary judgment, plaintiffs do not allege facts indicating they relied on the Hagen decision.

Finally, in their respondents' brief, plaintiffs, for the first time, claim that they relied both on section 17063.11 and “on the Hagen decision in excluding the unrecognized capital gain on their sale of the SII Stock [sic ] from preference income.”   Significantly, plaintiffs have not referred us to any place in the record which might contain evidence of such reliance.

On this record, the undisputed evidence demonstrates that plaintiffs could not have relied on the FTB's conduct following the Hagen decision, since there is no evidence that plaintiffs acted with knowledge of that decision in selling the stock or in filing their 1986 personal income tax return.  (See, e.g., People ex rel. Franchise Tax Bd. v. Superior Court (1985) 164 Cal.App.3d 526, 552, 210 Cal.Rptr. 695 [no evidence of detrimental reliance to estop the FTB from retroactively changing its policy regarding taxation of investment annuities].)   The estoppel argument must fail.

The FTB's denial of the refund was entirely proper and the trial court erred in granting summary judgment for the plaintiffs.

The summary judgment is reversed and the superior court is directed to enter judgment for the FTB.   Each side is to pay its own costs on appeal.

FOOTNOTES

1.   All further statutory references are to the Revenue and Taxation Code.

2.   In 1971, section 17062 stated:  “In addition to the other taxes imposed by this part, there is hereby imposed for each taxable year, with respect to the income of every taxpayer under this part, a tax equal to 2.5 percent of the amount (if any) by which the sum of the items of tax preference in excess of thirty thousand dollars ($30,000) is greater than the amount of net business loss for the taxable year.”

3.   Former section 18161.5 was repealed in 1983 and much of it was incorporated in the 1985 amendment to section 18162.5.  (Stats.1983, ch. 488, § 64, p. 1929 [repealed], as amended by Stats.1985, ch. 106, § 133, pp. 322–324.)

4.   This section was repealed in 1987, and was renumbered as section 18161.   The new section 18161 provided for more generous deductions of capital gains from the sale of small business stock.  (Stats.1987, ch. 1138, §§ 130–131, pp. 3932–3934.)

5.   Both Senate Bill No. 249 and Assembly Bill No. 3424 would amend section 17063.11 to read:  “For the purpose of Section 17063, that portion of capital gains attributable to the sale of small business stock, as defined in Section 18162.5, and acquired after September 16, 1981, is not an item of tax preference.”

6.   Assembly Bill No. 3424 failed to pass the Ways and Means Committee, and Senate Bill No. 249 passed the Senate, but died in the Assembly.  (See 2 Assem.Final Hist. (1985–1986 Reg.Sess.) p. 2179;  Sen. Final Hist. (1985–1986 Reg.Sess.) p. 199.)

PHELAN, Associate Justice.

KLINE, P.J., and BENSON, J., concur.