HOLLY SUGAR CORPORATION v. McCOLGAN (1940)

Plaintiff brought this action to recover from the state a portion of its franchise tax in the amount of $6,100.58, paid under protest. From a judgment entered upon the sustaining of a demurrer to the complaint plaintiff prosecutes this appeal.

The plaintiff is a New York corporation with its principal place of business in Colorado. It is qualified to do business in California and other states. Its principal business consists of growing sugar beets and marketing and refining the sugar therefrom. The action involves the computation of the corporation franchise tax properly due from plaintiff for the taxable year ending March 31, 1935. Under the terms of the act the tax is measured by the income of the preceding taxable year. The problem involved is whether the corporation may properly deduct certain losses arising out of a stock transaction. The complaint alleges that prior to January 1, 1928, plaintiff acquired 4173.4 shares of the capital stock of the Santa Ana Sugar Company, a California corporation, at a cost of $1,808,253. The number of shares so purchased constituted 70 per cent of the total outstanding capital stock of the Santa Ana Sugar Company. After the purchase of this stock the plaintiff “controlled the policies and operations of the said Santa Ana Sugar Company”. On May 1, 1928, the Santa Ana Sugar Company paid a dividend of $111,188.24, and thereby reduced, for franchise tax purposes, the cost of the shares of that company to $1,697,064.76. During the fiscal year here under consideration the Santa Ana Sugar Company was completely liquidated and plaintiff received as a liquidating dividend $530,191.17. Thus, the plaintiff suffered a net loss of $1,166,873.59. The franchise tax commissioner refused to consider this loss in computing the tax. It is the contention of appellant that this loss, under the terms of the franchise tax act, should have been deducted from the net profit of its entire business.

So far as pertinent here, the Bank and Corporation Franchise Tax Act, Stats.1929, p. 19, as it read at the times here pertinent, provided in section 4, Stats.1933, p. 870, that every financial corporation of the class to which appellant belongs doing business in this state, must pay to the state for the privilege of exercising its corporate franchises in this state “a tax according to or measured by its net income”, computed as provided in the act. Section 6, Stats.1933, p. 694, provided that the term “gross income” as used in the act “includes gains, profits and income derived from the business, of whatever kind and in whatever form paid”. Subdivision (c) of this section excludes from gross income that income derived from stock dividends or subscription rights, but provides “but gain may be derived or loss sustained by the shareholders from the sale of such stock or the sale of such rights”. Section 7 as originally enacted, and as it read at the times involved herein, provided that the term “net income”, as used in the act, “means the gross income less the deductions allowed”. Section 8, Stats.1933, p. 687, sets forth the allowable deductions. Subdivision (d) of this section provides for the deduction of “uncompensated losses”. So far as pertinent here, it provides that the taxpayer may deduct “Losses sustained during the taxable year and not compensated for by insurance or otherwise, *.” The balance of the section provides for so-called “wash sales”. Section 10, Stats.1931, p. 2226, provided for the “Computation of tax on intrastate business”, and then read:

“If the entire business of the bank or corporation is done within this state, the tax shall be according to or measured by its entire net income; and if the entire business of such bank or corporation is not done within this state, the tax shall be according to or measured by that portion thereof which is derived from business done within this state. The portion of net income derived from business done within this state, shall be determined by an allocation upon the basis of sales, purchases, expenses of manufacturer, pay roll, value and situs of tangible property, or by reference to these or other factors, or by such other method of allocation as is fairly calculated to assign to the state the portion of net income reasonably attributable to the business done within this state and to avoid subjecting the taxpayer to double taxation. Income from intangible personal property which is not deductible under the provisions of subsection (h) of section 8 hereof shall be subject to allocation.

“If the commissioner reallocates net income upon his examination of any return, he shall, upon the written request of the taxpayer, disclose to him the basis upon which his reallocation has been made.”

The question thus presented is whether, under this act, the plaintiff being a foreign corporation with its principal place of business in Colorado, but qualified to do business in this state, engaged in the business of growing sugar beets and refining and marketing the sugar therefrom, is entitled to deduct a loss sustained in the purchase and sale of stock of a California corporation, in the absence of an allegation that the stock had acquired a situs here, or in the absence of an allegation that the purchase or sale of the stock was attributable to, or in any way connected with, the portion of the business carried on in California? This is primarily a question of statutory construction. But, in construing the statute we must give it that construction which will uphold it, if possible. In the absence of compelling language to the contrary, we must assume that the legislature only intended to tax that portion of a foreign corporation's business that it constitutionally could tax. When these rules are applied to the problem here presented, the conclusion necessarily follows that the claimed deduction was properly disallowed. Section 10, supra, expressly limits the tax, when the entire business of the corporation is not done in this state, to the income from that portion of its business “derived from business done within this state”. In computing the tax due from a foreign corporation with its principal place of business elsewhere, if the income due solely from its California business can be readily ascertained, that is the end of the state's power. But the section recognizes that it may not always be possible to segregate the portion of the income of the business of a foreign corporation with its principal place of business elsewhere, earned in any one state, and provides in such a case for the application of a formula in order to ascertain “the portion of net income reasonably attributable to the business done within this state”. Obviously, what the legislature was trying to do, and did do, was to tax that portion of the income of the business of foreign corporations fairly attributable to business done in this state. That, clearly, is the ultimate aim of the statute. Thus, if a foreign corporation, with its principal place of business outside of this state, ran one business in this state and an entirely different business in another state, the determination of the portion of its income attributable to business done in this state would be a simple matter. No formula would have to be applied. No portion of the foreign income would have to be included to ascertain the ultimate fact—the portion of its income derived from business done in this state. But, if the business were a unitary business, such as where a foreign corporation with its principal place of business elsewhere grows sugar beets in one state and refines and markets the sugar in this state, it is impossible to tell accurately how much of its net profit is due to the activities in the foreign state, and how much to its activities here. In that event the commissioner is authorized to take the entire net income and apply thereto a formula “fairly calculated” to assign to this state “the portion of net income reasonably attributable to the business done within this state”. That is exactly what was done in this case to that portion of income of this appellant that could not be segregated. But, where a foreign corporation, with its principal place of business elsewhere, engages in a transaction outside of this state, a transaction independent and separate from its ordinary business, and a transaction that has no connection with its business done in this state and which can readily be segregated therefrom, the profit from such transaction cannot be taxed under section 10, supra, nor can losses be deducted from the income earned in the unitary business. That is exactly the situation here presented. The complaint alleges that plaintiff is a New York corporation with its principal place of business in Colorado, and that the business of this corporation consists of the growing of sugar beets and the marketing and refining of sugar. That, obviously, is a unitary business and the formula principle necessarily would have to be applied to ascertain the portion of net income fairly attributable to business done in California. Then the complaint alleges that the corporation engaged in an entirely separate transaction—it bought the stock of a California corporation, and suffered a loss on this transaction in the taxable year. There is no allegation that the sale of this stock was integrally connected with the ordinary business of the company, or that it was tied up with any portion of its business done in California. Nor is there an allegation that the stock had acquired a business situs in California. So far as the complaint discloses, this was a separate and distinct transaction from its California business. Without such allegations the profits from it could not be taxed, nor can losses sustained be deducted.

This construction of section 10, supra, is reasonable and sensible. Moreover, to construe the section in any other fashion would violate fundamental principles of taxation, and would probably render the statute unconstitutional. It is elementary that a state has no power to tax income of a nonresident or income of a foreign corporation with its principal place of business elsewhere, when such income is properly attributable to business or property located in another state. Hans Rees' Sons v. North Carolina, 283 U.S. 123, 51 S.Ct. 385, 75 L.Ed. 879. It is also well-settled that when a foreign corporation is engaged in business both inside and outside the taxing state, and is engaged in a unitary indivisible business, then the taxing state may treat the entire income as a unit, and may apply thereto a formula fairly designed to allocate to the taxing state the portion of the income fairly attributable to business done in that state. Underwood Typewriter Co. v. Chamberlain, 254 U.S. 113, 41 S.Ct. 45, 65 L.Ed. 165; Bass, Ratcliff & Gretton, Ltd., v. Tax Comm., 266 U.S. 271, 45 S.Ct. 82, 69 L.Ed. 282. But, the converse is equally true. If a foreign corporation, with its principal place of business not in the taxing state, earns income or suffers a loss from other than its unitary business—i.e., from a transaction not integrally connected with, or attributable to, the business done in the taxing state—then such income or loss cannot be included in the tax base, nor may any portion thereof be allocated to the taxing state, nor may a formula be applied that includes it within such formula. Such income must be allocated to that state that has jurisdiction to tax under the Fourteenth Amendment. The taxing state, in such example, has no such jurisdiction. Fargo v. Hart, 193 U.S. 490, 24 S.Ct. 498, 48 L.Ed. 761; Meyer, Auditor of Oklahoma v. Wells, Fargo & Co., 223 U.S. 298, 32 S.Ct. 218, 56 L.Ed. 445; People v. Knapp, 230 N.Y. 48, 129 N.E. 202; California Packing Corporation v. State Tax Comm., 97 Utah 367, 93 P.2d 463.

From what has been said it is clear that the complaint fails to state a cause of action.

The judgment appealed from is affirmed.

PETERS, Presiding Justice.

We concur: KNIGHT, J.; WARD, J.