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Court of Appeal, Third District, California.

Scott BEAMER et al., Plaintiffs and Respondents, v. The FRANCHISE TAX BOARD, Defendant and Appellant.

Civ. 15882.

Decided: November 23, 1976

Aiken, Kramer & Cummings, Oakland, for plaintiffs-respondents. Evelle Younger, Atty. Gen., by Charles Kobayashi, Depusty Atty. Gen., Sacramento, for defendant-appellant.

Plaintiffs sought refund of personal income taxes paid pursuant to the provisions of section 19082 of the Revenue and Taxation Code. The trial court granted the plaintiffs' motion for summary judgment. The defendant Franchise Tax Board appeals.

Plaintiffs, residents of the State of California, are interest owners in a certain oil and gas field situated in the State of Texas, and over the years have received ‘royalty’ income from the oil and gas produced in that field. The State of Texas has enacted a tax on the business of producing natural gas and crude petroleum; it is termed an ‘occupation tax’ and is levied upon all producers and purchasers of oil and gas in Texas. It is computed as a specified percentage of the ‘market value’ of the oil and gas as and when produced.

For the years 1970 through 1972 the plaintiffs reported their ‘royalty’ income on their California income tax returns but claimed deductions under section 172041 for the payments made to the State of Texas pursuant to the Texas occupation tax.2 The Franchise Tax Board disallowed the deductions and claimed deficiencies on the basis that the Texas oil and gas production tax is a ‘taxes on or according to or measured by income or profits.’

Plaintiffs paid the deficiencies, made refund claims and finally filed this action.

Plaintiffs' motion for summary judgment was generally based on the following two alternative grounds:

(1) Paragraph (a) of section 17204, by the plain and literal meaning of the second sentence, permits plaintiffs to deduct their payments of the Texas oil and gas production tax even if that tax does constitute (which plaintiffs deny) a state tax ‘on or according to or measured by income or profits . . ..’ (§ 17204, subd. (c)(2).)

(2) If section 17204 is interpreted as denying a deduction for any taxes categorized as ‘taxes on or according to or measured by income or profits' the claimed deduction is still allowable because the Texas oil and gas production tax is not, in fact or in effect insofar as plaintiffs are concerned, a tax ‘on or according to or measured by income or profits . . ..’3

The trial court granted plaintiffs' motion for summary judgment and held that the Texas tax is deductible under section 17204, subdivision (a), as a tax paid or accrued in carrying on a trade or business and does not constitute a tax ‘on or according to or measured by income or profits' under section 17204, subdivision (c)(2). The board appeals.4

1. Section 17204: Construction and Legislative History.

The board first argues that the Texas tax is not deductible in California (pursuant to the provisions of section 17204) as a tax paid in carrying on an activity for the production or collection of income and that the literal language of the section precludes plaintiffs from deducting the Texas Tax.

In order to perceive the board's argument, it is first necessary to examine the position of the plaintiffs as to their construction of section 17204. It is their view that the literal language of the portion of subdivision (a) (which begins ‘In addition’ and which concerns the deductibility of state ‘taxes not described in the preceding sentence’) permits the deduction because (1) the Texas tax is a state tax which is not described in the first sentence of subdivisions (a)5 and (2) the Texas tax has been paid by plaintiffs in the course of carrying on an activity which is described in section 17252 (relating to expenses for the production of income).

The board, however, argues that the prefatory phrase, ‘Except as otherwise provided in this section’, modifies both the first and second sentences of subdivision (a), and thus, plaintiffs have overlooked the balance of section 17204, namely subdivision (c), which provides generally that no deduction shall be allowed for state taxes on or according to or measured by income or profits paid or accrued within the taxable year. (§ 17204, subd. (c)(2)(B).)

The board maintains that the prefatory language cannot be construed so as to apply to the first sentence only. The rule of construction has been stated thusly: ‘Generally, when the words ‘this section’ are used, they mean the entire section, and unless the contrary clearly appears, they must be so construed.' (Kansas City v. Travelers Insurance Company (Mo.App.1955) 284 S.W.2d 874, 877.) The board concludes that if only a portion of the section were intended to be modified by the prefatory phrase, the Legislature could easily have done so. (See Du Pont v. Commissioner of Internal Revenue (3d Cir. 1938) 98 F.2d 459, 461; cf. County of Los Angeles v. Frisbie (1942) 19 Cal.2d 634, 642, 122 P.2d 526 [words in a statute to be given their ordinary meaning and receive a sensible construction].)6

As a concomitant argument, the board urges that the legislative history of section 17204 refutes plaintiffs' contentions. This argument, although somewhat difficult to grasp, appears to proceed as follows:

Prior to its amendment in 1964, section 17204 forbade the deduction of state taxes measured by profits or income. The Bank and Corporation Tax Law contained a similar provision. (§ 24345(a)(2).)

In 1964, the Congress amended Intermal Revenue Code section 164 (Title 26, U.S.C.A. § 164) to add the second part of paragraph (a) to provide that taxes other than those listed would be deductible if attributable to a trade or business or for the production of income.

In 1964, California, in conformity with the federal law, enacted a substantially identical statute into the Personal Income Tax Law by amendment of section 17204. (Stats.1964, 1st Ex.Sess., ch. 140, p. 464.) The board notes that the 1964 amendment, among other things, also deleted ‘State and local, and foreign, income, or profits, and excess profits taxes' from the federal list of deductible taxes, but retained the provisions pertaining to the disallowance of the deduction for taxes measured by income. At that time, no change was made in section 24345.

From the foregoing, the board ascertains a clear legislative purpose to eliminate a number of taxes as personal dedutions and, accordingly, the addition of the second sentence to subdivision (a) was not intended to add any new deductions for taxes to those previously allowed. To reinforce this conclusion, the board notes that section 24345 remain unchanged, so that state income taxes continue not to be deductible by corporations. The board states: ‘Since all ordinary expenses of corporations are deemed business expenses, and therefore are deductible unless expressly prohibited, it would be anomalous to disallow the deduction of state taxes measured by income to a corporation but, yet, allow the deduction to individuals . . ..’

After a careful analysis of section 17204 and the positions of the two parties, we are of the opinion that the Texas tax is a tax paid or accrued in carrying on a trade or business and is therefore deductible under subdivision (a) of section 17204. The arguments of the board to the contrary are simply not persuasive.

The board's analogy to the federal law is so thin as to be nonexistent.7 Although this state may have followed the federal government's lead in enacting the trade or business deduction, there is no indication that by doing so the Legislature intended no change in the state law. Further, the reference to section 24345 is rather mystifying. Surely the board is not contending that corporations may not be taxed differently than individuals. (See Lehnhausen v. Lake Shore Auto Parts Co. (1973) 410 U.S. 356, 93 S.Ct. 1001, 35 L.Ed.2d 351; see also, 5 Witkin, Summary of Cal.Law (8th ed. 1974), Constitutional Law, § 347, p. 3643.) Perhaps more importantly, the board fails to cite a single authority in support of its legislative history argument. We find nothing in the board's arguments which throws any light on the meaning and purpose of the legislation in question.

Turning to the statute itself, we believe the common and ordinary meaning of the words contained in the second sentence of subdivision (a) entitles plaintiffs to deduct from their income tax payments made on account of the Texas tax if the payment of that tax was made to carry on a trade, business or activity described in section 17252. In our opinion the ‘In addition’ clause of subdivision (a) creates an exemption which is not affected by subdivision (c). The second sentence begins by creating deductions ‘in addition’ to those described in the first or preceding sentence. Moreover, the opening caveat of the first sentence logically applies only to the ‘following [four categories of] taxes' described in the first sentence and not to the fifth category described in the second sentence, which is descriptive of the Texas tax.

2. The Texas Tax.

The trial court ruled the Texas oil and gas production tax was not a tax ‘on or according to or measured by income or profits . . ..’ (See, § 17204, subd. (c)(2).) The board contends this was error and therefore no deduction is allowable under California law. It argues that Texas tax may be called an occupation tax but that is of no significance for that tax is measured by income and thus within subdivision (c).

Our review of the law leads us to conclude the trial court correctly held that the Texas tax was not a tax ‘on or according to or measured by income or profits' pursuant to subdivision (c) of section 17204, and hence was deductible.8 Basically, there are several reasons for our decision.

First, the Texas Legislature itself has denominated the tax an ‘occupation tax’ on the particular business or occupation of producing oil and gas in the State. (See Vol. 20A, Vernon's Texas Statutes Annot., Title 122A, ch. 3, art. 3.01 et seq.; ch. 4, art. 4.01 et seq.; see also, Vol. 16B, Title 102, art. 6032.) Moreover, the Court of Civil Appeals of the State of Texas has declared that a predecessor statute was indeed an occupation tax (not a gross proceeds, sales, or transfer tax) on the business of producing oil and gas. (State v. Humphrey (Tex.Civ.App.1941) 159 S.W.2d 162, 164–165.) Thus, two coequal branches of the Texas state government have stated, in essence, that the subject tax is not a tax on, according to or measured by income or profits. Their interpretation should be accorded great weight.

Secondly, Humble Oil & Refining Company v. Calvert (Tex.1972) 478 S.W.2d 926, relied upon by the board, is completely distinguishable. In that case the Texas court was concerned with a federal statute having a very limited application. It carefully noted that it was ‘dealing with a particular statutory definition of an ‘income tax’ in a particular context, and not with any sort of common understanding of an ‘income tax.” (Id. at p. 929.) The Calvert court did not hold that the Texas oil and gas production tax was an income tax for any purpose other than the specific federal statute involved in that case.

Thirdly, there is the calculation of the tax itself. As we have previously noted, the statutory measure of the Texas oil and gas production tax is the market value of the pertinent resource, when, as and if produced and severed. (Title 122A, arts. 3.01 and 4.02, supra.) As we view the situation, it is the act of production or severance which constitutes the taxable event. (See State v. Humphrey, supra, 159 S.W.2d at p. 165.) Mere production of oil and gas, without sale, disposition or any other transaction, derives neither gross nor net income or profits for California (or federal) income tax purposes. Since the Texas tax can be assessed prior to realization of income, it appears to us that the subject of the tax is the extraction or severance privilege; hence the tax is not measured by or according to income or profits under section 17204.

The judgment is affirmed.


1.  All section references are to the Revenue and Taxation Code unless otherwise noted. Section 17204, as relevant herein, provides as follows:‘(a) Except as otherwise provided in this section . . . the following taxes shall be allowed as a deduction for the taxable year within which paid or accrued:‘(1) State and local, and foreign, real property taxes, less any amounts received from the state pursuant to the authorization contained in Section 1d of Article XIII of the Constitution;‘(2) State and local personal property taxes;‘(3) State and local general sales taxes;‘(4) State and local taxes on the sale of gasoline, diesel fuel, and other motor fuels; andIn addition, there shall be allowed as a deduction state and local, and foreign, taxes not described in the preceding sentence which are paid or accrued within the taxable year in carrying on a trade or business or an activity described in Section 17252 (relating to expenses for production of income).‘. . .(c) No deduction shall be allowed for the following taxes:‘. . .‘(2) Taxes on or according to or measured by income or profits paid or accrued within the taxable year imposed by the authority of:‘. . .‘(B) Any state, territory, county, city and county, school district, municipality, or other taxing subdivision of any state or territory . . .’

2.  Plaintiffs state they claimed a deduction ‘by categorizing the Texas Tax as a privilege-severance-occupation tax which is measured by the market value of oil and gas production from their land (in effect, measured by their gross receipts) and which is incurred by them as an ordinary and necessary expense for the production and collection of income.’

3.  The board characterizes this alternative as ‘whether or not the Texas tax is a tax on gross receipts.’

4.  In their brief, plaintiffs state: ‘The central issue presented by this appeal is whether [the board] may properly refuse to permit [plaintiffs] both a credit and a deduction on account of their prior payment of sums to the State of Texas on account of the Texas Oil and Gas Production Tax.’ The board, in its closing brief, claims that plaintiffs have misstated the issue on appeal, introduced a new issue pertaining to the tax credit, and clouded the issues by ‘interjecting inflammatory language such as ‘confiscatory results' and ‘double taxation.”

5.  In other words, plaintiffs appear to be saying that the language ‘Except as otherwise provided in this section’ does not apply to the second sentence. They claim this restrictive language applies only to the first sentence.

6.  The board also argues that if the contentions of plaintiffs were upheld, then subdivision (c) of section 17204 would become totally meaningless and superfluous. The upshot of this whole argument is, of course, that the Texas tax is not deductible in this state since it is measured by income or profits. (§ 17204(c).)

7.  For example, section 164 of the Internal Revenue Code generally permits a deduction for state taxes measured by income. Section 17204, however, in many instances denies such a deduction on account of state taxes.

8.  In a letter to plaintiffs the board occasion to comment: ‘Texas has no personal income tax law. Therefore, the taxpayers paid no personal income taxes to Texas on the royalties in question [although they did pay production taxes to Texas].’ Although this remark was made in the context of tax credits, it is perhaps of some significance in view of the board's position herein.

REGAN, Associate Justice.

FRIEDMAN, Acting P. J., and PARAS, J., concur.

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