SIMPLICITY PATTERN COMPANY INC v. STATE BOARD OF EQUALIZATION (1980)

This is an action against the California State Board of Equalization (Board) to recover sales tax previously paid. In a nonjury trial conducted on a stipulated set of facts, the superior court denied recovery. The taxpayer appeals. We reverse.

The transaction which gave rise to the instant dispute involved wholly owned subsidiaries of two corporations Simplicity Pattern Company, Inc. (Simplicity) and Medcom, Inc. (Medcom). For purposes of convenience we will use the names of the parent corporations rather than those of the subsidiaries.

Prior to January of 1971, Simplicity was engaged, inter alia, in the business of producing and marketing audio-visual educational materials used in training nurses and nurses aides. The product, which Simplicity marketed, primarily to hospitals and schools, was a “package” comprised of a film strip, phonograph record and instructor's guide.

In that year, Simplicity transferred to Medcom all of the assets of that part of its operation devoted to the above described business. In return, Simplicity received a substantial but not a controlling amount of Medcom stock. This transaction qualified as a tax-free reorganization under both federal and state income tax laws. (Int.Rev.Code of 1954, ss 354, 368(a)(1) (C), and Rev. & Tax.Code, ss 17432, 17461.)

Among the assets transferred were completed master negatives¹ of the various “packages” from which copies were produced for retail sale and incomplete master negatives in various stages of completion. These items were carried on the books of Simplicity as inventory assets valued according to development and production costs incurred in the making of the master negatives.

The aggregate book value of the completed and incompleted master negatives amounted to a sum in excess of $600,000. The cost components were raw material, processing, research, technical consultation, salaries of production staff and pro rata allocation of basic overhead.

The Board determined that the transfer of these assets was a retail sale subject to sales tax. The assessment was approximately $35,000. Simplicity contends that the real value of the master negatives was in their intangible elements, i. e., the literary content, and thus not subject to sales tax.

California imposes a tax upon the “privilege of selling tangible personal property at retail.” (Rev. & Tax.Code, s 6051.) A retail sale has been defined as “a sale for any purpose other than resale in the regular course of business in the form of tangible personal property.” (Rev. & Tax.Code, s 6007.) “Tangible personal property is defined as ‘personal property which may be seen, weighed, measured, felt, or touched, or which is in any other manner perceptible to the senses.’ ” (Rev. & Tax.Code, s 6016.) The Legislature has delegated to the Board the duty of enforcing the sales tax and has authorized the Board to adopt regulations for effectively discharging its duty. (Rev. & Tax.Code, ss 7051, 7052.)

While the Board's interpretation of the legislative enactments is entitled to great weight (Culligan Water Conditioning v. State Bd. of Equalization, 17 Cal.3d 86, 130 Cal.Rptr. 321, 550 P.2d 593), it must be remembered that the ultimate taxing authority rests with the Legislature. The Board's interpretation of the legislative will must be reasonable and the Board must be faithful to its own pronounced regulations. The ultimate resolution of whether the Board has correctly interpreted the statutes and its own regulations rests with the courts. (Culligan, supra.) Tax statutes are to be construed in favor of the taxpayer. (Knudsen Dairy Products Co. v. State Bd. of Equalization, 12 Cal.App.3d 47, 90 Cal.Rptr. 533.)

The Legislature has specifically limited the sales tax to a transfer of “tangible property.” The term “tangible property” has a definite statutory as well as commonly understood meaning. Since every transfer of “property” includes both tangible and intangible components, the taxability of a particular transfer depends upon the “true object of the transaction.” (Albers v. State Board of Equalization, 237 Cal.App.2d 494, 47 Cal.Rptr. 69.)

This principle is embodied in the Board's regulation Title 18, California Administrative Code section 1501. That regulation by way of example and explanation states “an idea may be expressed in the form of tangible personal property and that property may be transferred for a consideration from one person to another; however the person transferring the property may still be regarded as the consumer of the property. Thus, the transfer to a publisher of an original manuscript by the author thereof for the purpose of publication is not subject to taxation. The author is the consumer of the paper on which he has recorded the text of his creation. However, the tax would apply to the sale of mere copies of an author's works or the sale of manuscripts written by other authors where the manuscript itself is of particular primary value as an item of tangible personal property and the purchaser's primary interest is in the physical property. Tax would also apply to the sale of artistic expressions in the form of paintings and sculptures even though the work of art may express an original idea since the purchaser desires the tangible object itself; that is, since the True object of the contract is the work of art in its physical form.” (Emphasis added.)

The concept is further reflected in the Board's regulation applicable to the taxing of motion pictures. (Title 18, Cal.Adm.Code, s 1529.) That regulation provides that “Producers of motion picture productions are consumers of all film and other tangible personal property used in production, and tax applies to sales to producers of such property. Tax does not apply to amounts received by the producer for the right to exhibit or reproduce motion picture productions.”

This is a recognition of the fact that while the film itself is of course tangible, the real object of the transaction between producer and distributor is the intangible literary effort captured on the film. To that extent then the producer is comparable to the author of a manuscript and the distributor compares to the book publisher.

The Legislature has embraced this principle in enacting Revenue and Taxation Code section 6362.5. That section provides an exemption from sales tax for the sale of master tapes or master records embodying sound. It does provide that the sale by a recording studio to the producer of the “tangible elements” of a master record or tape Is taxable. “Tangible elements” obviously refers to the equipment and materials used in the fabrication of the record as distinguished from the artistic talent which is recorded thereon. While this particular exemption is not specifically applicable to the facts of this case,² it is a clear indication of the legislative thinking in regard to the intangibility of literary property regardless of the form to which that type of property is reduced.

The “object” of the transaction with which we are here dealing was the master negatives in film and record form and the originals of written instruction guides. Simplicity contends, however, that the “True object” was the literary or intangible content and the right to retail copies of that material. The Board's position is one of equating the master negatives with tools and dies which are in turn used to produce other tangible items. In short, the Board argues that the “true object” of the transaction was to obtain the master negatives for their own sake and denies that their major value is in their intangible ingredients.

It seems evident to us that the master negatives and the original of the instructor's guides were products of the expertise of the collective mind of the Simplicity production staff and that their primary value was in the intangible content rather than the tangible items of the film, plastic discs and paper on which that content was recorded. The marketable value of copies of these master negatives lies in their content.

Under the Board's own regulation, a writer of a “How to” manuscript on any One of the subjects of Simplicity's “packages” who sold that manuscript to a publisher would be as free from sales tax as would Peter Benchley in selling “Jaws” to the publisher of that best seller.

The intangibility and ergo the non-taxability of the transfer of such a literary property cannot turn on its appeal to particular literary tastes. Nor can there be any distinction between material which is instructional and material which is simply entertaining.

For example, in terms of Revenue and Taxation Code section 6362.5, a master recording of Arnold Palmer giving tips on golf would qualify for exemption on an equal footing with the Beatles' master recording of “Yellow Submarine.”

Simplicity's master negatives contained “How to” ideas on certain medical subjects. The fact that they were recorded partly on film, partly on record and partly in writing does not make them any more tangible than if they had been reduced entirely to writing for copying into book form.

Simplicity was a consumer of the raw film, blank records and paper on which the instructional material was recorded and presumptively paid sales tax upon acquisition of that material. That material is now nothing more than a tangible form of preconceived ideas. (Italiani v. Metro-Goldwyn-Mayer Corp., 45 Cal.App.2d 464, 114 P.2d 370.)

Contrary to the Board's contention, the issue here is not an “exemption” from tax but rather whether the material fits the definition of the basic taxing statute. Thus we reject as arbitrary and unreasonable the Board's corollary position that in order to qualify for an “exemption” the material must be complete unto itself.

The fact that under modern technology the sound motion picture contains both the picture and the sound on one film strip, is no basis for arguing that a literary property is “tangible” simply because it is contained in two separate, but coordinated, components.

We deal here with a pure question of law, i. e., whether the true object of the transfer was the tangible or intangible quality of the property involved. The facts are not in dispute. In this context the Board's bald pronouncement that the property was tangible is of no particular weight since it does not rest on reasonable interpretation of the relevant statute or regulation. On the contrary, the statutory and case law definitions of “tangible,” coupled with the Board's own guidelines as set forth in their self-promulgated regulation, unerringly point to the conclusion we have reached, i. e., the transfer was not a sale of “tangible personal property.”

Our conclusion on this issue makes it unnecessary to discuss Simplicity's other contentions.

The judgment is reversed and the matter is remanded to the trial court with directions to enter a judgment in favor of Simplicity.

I concur in the reversal on the ground that no sale of “tangible personal property at retail” (Rev. & Tax.Code, s 6051) took place. What occurred was a sale of inventory of intangible personal property at wholesale, which the purchaser would thereafter sell at retail “in the regular course of business (as) tangible personal property” (Rev. & Tax.Code, s 6007; cf. sales tax exemption on the transfer of motion picture negatives, 18 Cal.Admin.Code, s 1529). These latter sales would be subject to sales tax; the first sale was not.

FOOTNOTES

1.  We use the term “master negative” to refer to both the film negative and the master phonograph record which accompanied the film.

2.  Revenue and Taxation Code section 6362.5 was enacted after the transaction in this case.

COMPTON, Associate Justice.

BEACH, J., concurs.