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IRVINE CO. v. MCCOLGAN.
This is an appeal from a judgment in two consolidated actions brought by the plaintiff to recover a portion of the franchise tax paid on its statutory net income for its fiscal year ending April 30, 1935, pursuant to the provisions of the Bank and Corporation Franchise Tax Act, Deering's Gen. Laws, Act 8488.
There is no dispute as to the facts. The plaintiff is a foreign corporation organized under the laws of West Virginia. Its only office and place of business is in Orange County, California. It owns a large tract of land there and is engaged in the business of raising horticultural and agricultural products and in harvesting, preparing for market, and selling the same. Most of its products were sold outside the state of California. The larger part of these were sold through non–profit cooperative marketing associations of this state under marketing agreements whereby said associations cleaned, graded and packed the fruit and shipped it to markets outside of this state where it was sold through the facilities of the California Fruit Growers Exchange, or similar exchanges. The agents or representatives of these exchanges collected the proceeds of the sales and, after deducting freight, storage, insurance, taxes and other expenses, transmitted the balance to the respective exchanges which paid the plaintiff its pro rata share of the proceeds less its pro rata share of the expenses. In some instances at points where the exchange did not have representatives these sales were made through brokerage concerns on a commission basis. Avocados were handled in a slightly different manner in that when they arrived at their destination they were stored in warehouses and later withdrawn and sold at private sales. Beans were also handled in a different manner, being shipped directly by the plaintiff to points in other states where they were sold through brokers. During the year in question the plaintiff had a gross income of $2,246,803.94, of which $2,071,113.53 or 92.18% came from the sale of products and the balance of $175,690.41 or 7.82% came from other sources. Of the gross income from products sold, $1,697,272.08 or 81.95% came from sales outside the state and the balance of $373,841.44 or 18.05% came from sales within the state. Of plaintiff's selling expense amounting to $776,807.42, 96.69% or $751,058.63 was incurred out of this state and the balance of $25,748.79 or 3.31% was incurred in California. Of plaintiff's total costs in the production of its income, 49.82% was expended in connection with out of state transactions and 50.18% was expended in production and sales activities within this state.
The plaintiff had a net income for that year of $715,463.62, of which $104,000.26 was admittedly intrastate net income. The remaining $611,463.36, which was derived from products produced in this state and sold in other states, was claimed to be subject to allocation under the provisions of section 10 of the Franchise Tax Act. The court found in all respects in favor of the plaintiff and held that this amount, $611,463.36, was subject to allocation. It adopted and applied an allocation formula under which it allocated 56.08% thereof to this state and the balance to business done outside of this state. By adding this amount to the portion of the income which was admittedly taxable and not subject to allocation, 62.48% of the plaintiff's total net income was held to be taxable under the Franchise Tax Act. The total tax thus due was found to be $17,836.35. The plaintiff had paid, under protest, $25,761.28. The court accordingly entered judgment for the plaintiff for $7,884.93, from which the defendant has appealed.
The first question presented is whether the respondent, during the year in question, was engaged in the transaction of business both within and without this state within the meaning and intent of section 10 of the Franchise Tax Act, so as to be entitled to have some part of its income allocated as having been produced by and being reasonably attributable to business done without this state. Section 10 reads, in part, as follows: “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.”
The appellant argues, in general, that it is thoroughly established in cases which are cited that there is no constitutional provision which would prevent the state from including in this tax base all of the net income, as distinguished from gross income, from sales made in interstate commerce and that it must be presumed that in adopting section 10 of this act the legislature intended to follow “the basic principle followed by all legislatures that the tax base should be as broad as the constitution of the United States and the constitution of the State permit.” Without further comment, and although there may be a tendency in that direction in some quarters, we hold that such a presumption does not necessarily exist and that the intention of the legislature must be determined from an examination of the language it used.
While the appellant admits that under section 10 of the act the entire net income is not the measure of the tax unless that income is entirely attributable to business done in this state, it contends that the court erred in concluding that because some of respondent's income was a result of interstate sales it was transacting some of its business elsewhere than in this state. It is argued that the respondent has no property or employees out of this state; that it pays no salaries or wages outside of this state; that all of its corporate activities are carried on within this state; that it employs no labor and uses none of its capital outside of this state; that through its agreements with the nonprofit cooperative marketing associations it either sold its products to these associations or made the associations independent contractors for the purpose of selling its goods; and that it follows that the entire net income of the respondent was derived from business done within this state.
We think this theory is contrary to the clear meaning of the act in question. By section 10 it is provided that the tax shall be measured by the entire net income only where the entire business of the corporation is done within this state. It is then provided that where the entire business is not done within this state the tax shall be measured by the portion of the income which is derived from business which is done within this state. The statute then goes on to provide for a segregation of these two elements and for a corresponding allocation of the income for the purposes of this tax. It is then provided that this allocation shall be determined upon the basis of sales, purchases, expenses, pay roll, value and situs of tangible property or by these or other factors, or by such other method as will fairly assign to this state the portion of net income which is reasonably attributable to the business done within this state. What is meant by “business done” is further clearly set forth in section 5 of the act, which defines doing business as used in the act as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”
As thus defined, it seems clear that a large part of respondent's business was “not done within this State” within the meaning of this section of the act. Under the statute a corporation is entitled to an allocation if some portion of its net income arises from business done outside this state and the same is not reasonably attributable to business done within this state. Matson Navigation Co. v. State Board, 3 Cal.2d 1, 43 P.2d 805; Id., 297 U.S. 441, 56 S.Ct. 553, 80 L.Ed. 791. The statute not only makes a distinction between the income from business done in this state and that done without the state, but the specific provisions for making an allocation based upon a consideration of sales, expenses, pay roll, property used and other factors where necessary, in order to determine what part of the income is fairly attributable to business done in this state, rather clearly indicate an intention to exclude, in arriving at the taxable amount, not only the income from business done entirely outside the state but also a portion of the income which is derived from business transactions which occur partly within and partly without the state when it cannot be fairly said that the entire business is transacted within this state. Under any other view, these specific provisions for allocation would be largely meaningless and useless in so far as transactions in interstate commerce is concerned, which is the precise field in which such questions are most likely to arise and the one which most calls for a consideration of and an apportionment of sales, expenses, pay roll, property and the like, in accordance with where the respective transactions have occurred.
Nor do we think, as appellant seems to argue, that it follows from the decision in Matson Navigation Co., Inc., v. State Board, supra [3 Cal.2d 1, 43 P.2d 810], that it must be held that in all cases business “originating in this state” is business “done within this state” within the meaning of section 10. While that factor was there used it neither appears from the decision in that case that the formula for allocation there employed was unfair or improper under the circumstances there appearing, nor that any attack was made upon the method of arriving at the allocation which was there approved. The court there considered and passed upon the contentions that the act in question should not be interpreted as imposing any tax measured in part by the income from interstate business, even though the state has power to impose such a tax, and that if it was so interpreted the act and the resulting tax were in violation of the commerce and other clauses of the federal constitution. The court held that the act contemplated the inclusion in the tax basis of such income from interstate or foreign business as is reasonably attributable to business done within this state. In holding against the contention of unconstitutionality there made the court pointed out, with appropriate citation of authority, that the state may require a foreign corporation engaged in both intrastate business and interstate business originating here to pay a tax measured by its net income attributable to business done in this state regardless of from which source it was derived, and that while this state has the power to tax the entire net income of a domestic corporation, including its income from interstate commerce, whether originating in this state or not, it has not done so, preferring to treat foreign and domestic corporations alike. While that case is authority for the proposition that the act in question permits, in the case of a foreign corporation doing business here, a proper allocation with respect to income derived from interstate commerce, in fixing the tax basis, it goes no further, so far as material here, and it does not hold that in all cases the income from business originating in this state is attributable to business done in this state. To so hold would be to render the allocation provisions of the statute largely meaningless, and would subject all such interstate commerce to the tax, for all interstate commerce originates in one state and is completed in another.
Not all of the income of the respondent derived from the sale of its products in other states can be fairly said to be attributable to business done by it in this state. While the respondent engaged in certain transactions in this state in raising its products and in preparing them for market it also engaged in very considerable transactions in other states in marketing those products. Not only is the marketing of large quantities of food products a separate transaction, as distinguished from the raising of those products, but the selling of them in other states certainly constituted transactions in those states, and those transactions were engaged in for the purpose of financial gain or profit, which is “doing business” under the plain provision of the statute. In carrying on these transactions in other states the respondent was doing business both as defined by the statute and as that term is commonly accepted and used throughout the business world. The carrying on of those transactions required the assistance of others in many fields, all of which was obtained at the expense of the respondent and paid for by it. It cannot be said that none of respondent's capital was used in these transactions. Both the crops themselves and the income therefrom were a part of respondent's capital and they were not only used in these transactions but enabled them to take place. Not only was a part of respondent's income derived from these transactions, which were business actually done in other states, but a considerable part of its net income or profit is directly attributable to the fact that a part of its transactions, the marketing of these products, was thus carried on in the other states. If the products of such farming operations were all sold in this state there would be little, if any, profit. The reason such transactions in other states are engaged in is because greater profits can thus be realized. In fairness and common honesty it must be recognized that a part, and a considerable part, of the net income of respondent was derived from its transactions in other states and we think that the legislature had such things in mind, among others, in providing for an allocation in arriving at the basis for this tax. The reasoning set forth in United States Glue Co. v. Oak Creek, 161 Wis. 211, 153 N.W. 241, Ann.Cas.1918A, 421, especially relied upon by the appellant, is not applicable or controlling here in view of the language and clearly expressed intention of our statute.
There is no merit in appellant's argument to the effect that the respondent either sold its products to the cooperative marketing associations or made those associations independent contractors for the purpose of selling its goods and that, therefore, the respondent had no part in conducting the transactions in other states. A part of respondent's products were not shipped through these marketing associations but were shipped to eastern points by the respondent and there sold for its account by brokers employed by it and who were its agents, the goods being handled for the respondent and it paying the expenses. In the case of the products shipped through the cooperative marketing associations this was all done under contracts which obligated the association to market and sell the produce as agents of and for the account of the respondent, and to pay the respondent its pro rata share of the proceeds, less his pro rata share of the costs and expenses. It cannot be questioned that these agreements were contracts of agency. Poultry Producers of Southern California, Inc., v. Barlow, 189 Cal. 278, 208 P. 93; California Bean Growers' Association v. Rindge Land & Navigation Co., 199 Cal. 168, 248 P. 658, 47 A.L.R. 904; Poultry Producers of Central California, Inc., v. Murphy, 64 Cal.App. 450, 221 P. 962. While the respondent acted through agents it carried on these marketing transactions in the other states and thus did business in those states as that term is defined in the statute in question.
The only other point raised is that, in the event that some allocation was proper here, the formula adopted by the trial court was unfair to the state and deprived it of revenue to which it was justly entitled. The only arguments made are that the formula adopted by the court gave too much importance to the items of sales made in interstate commerce and that the court should have adopted a formula proposed by the appellant.
The formula adopted by the court was as follows:
The formula proposed by the appellant was as follows:
The appellant's proposed formula applied to the admitted figures would result in an overassessment and overpayment amounting to $2747.14, while the court's formula resulted in an overpayment of $7884.93, for which judgment was given.
In both formulas the first item, “Property”, is the same, all of respondent's property being in California and 100% being credited to this state. As the second item the court's formula used “Expenses”, setting forth the total expenses incurred and the amount incurred in this state, including respondent's pay roll in producing its crops, as a result of which 50.18% of the expenses were credited to this state. The appellant, however, in its proposed formula, used “Wages” instead of expenses as item 2, and credited 100% to this state. If a proper allocation is to be made it would seem obvious that both pay roll and other expenses should be considered. The statute expressly provides for this and, with respect to this item, the court's formula appears to us to be reasonable and to be more in accord with the intent of the statute than that suggested by the appellant. With respect to the third item, “Sales”, the court took the total sales made and credited to this state the amount of the sales actually made here, thus crediting 18.05% of the sales to this state. The appellant's proposed formula took the same figures but added to the part credited to this state the amounts realized from the sale of beans through eastern brokers, thus raising the percentage of sales credited to the state to 28.26%. The beans were sold outside of this state through the respondent's agents and no good reason appears why they should be in any way distinguished from the other sales made in interstate commerce. In each of the formulas the percentages credited to the state in the three items used were added together and divided by three to give the average percentum to be used in fixing the amount of net income allocable to business done in this state. Under the court's formula this resulted in 56.08% being allocated to this state while the appellant's proposed formula would allocate 76.08% to this state.
There is nothing in the record to indicate that the formula used and adopted by the trial court was unfair or unreasonable and no good reason for altering it has been pointed out. It appears to follow the provisions of the statute very closely and we can see no just criticism either of the method employed or of the result.
The judgment is affirmed.
BARNARD, Presiding Justice.
MARKS and GRIFFIN, JJ., concur.
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Docket No: Civ. 3098.
Decided: January 25, 1944
Court: District Court of Appeal, Fourth District, California.
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