UNION OIL ASSOCIATES v. JOHNSON (1934)

This action brought by the plaintiff to recover from the defendant the franchise tax paid by the plaintiff in the year 1931, based upon its income for the year 1930. The demurrer of the defendant being overruled, and he declining to answer, his default was entered and judgment followed. This appeal is from the judgment.

By the complaint it is made to appear that the respondent was organized for the purpose of consolidating and maintaining in one holding or pool shares of the capital stock of the Union Oil Company of California. In return for shares of stock of the Union Oil Company, it issued an equal or like number of its own shares. Its stockholders received all of the dividends paid on Union Oil Company shares minus such sums as were necessary to deduct in order to pay the corporate expenses of the respondent. Further, it is alleged that the only assets possessed by respondent, other than capital stock of the Union Oil Company, was its office furniture and equipment and from time to time small amounts of cash for the defraying of current corporate expenses. Its only income is from shares of stock of the Union Oil Company, none of which stock, it is alleged, has ever been sold, mortgaged, or hypothecated.

Further allegations disclose that, by action of the franchise tax commissioner, approved by the state board of equalization, respondent was obliged to pay the sum of $44,552.63, plus interest in the sum of $4,522.09, the amount of which tax was arrived at by estimating that of the sum of $4,872,864 paid to the respondent as dividends by the Union Oil Company 29.643976 per cent. thereof arose out of and was paid from income earned by the Union Oil Company in business transactions outside the state of California.

In 1928, section 16 of article 13 was added to the state Constitution and in its material parts provides as follows:

‘2. (a) All financial, mercantile, manufacturing and business corporations doing business within the limits of this state, subject to be taxed pursuant to subdivision (d) of section 14 of this article * * * shall annually pay to the state for the privilege of exercising their corporate franchises within this state a tax according to or measured by their net income. * * *

‘5. The legislature shall define ‘corporations' and ‘doing business'; shall define ‘net income,’ and may define it to be the entire net income received from all sources. * * *'

In 1929 there was passed the ‘Bank and Corporation Franchise Tax Act’ (St. 1929, pp. 19, 20), the pertinent provisions of which are as follows: ‘Sec. 4. Every financial, mercantile, manufacturing and business corporation doing business within the limits of this state, of the classes referred to in subdivision 2(a) of section 16 of article thirteen of the constitution of this state, shall annually pay to the state, for the privilege of exercising its corporate franchises within this state, a tax according to or measured by its net income, to be computed, in the manner hereinafter provided, at the rate of four per centum upon the basis of its not income for the next preceding fiscal or calendar year. * * *

‘Sec. 5. The term ‘corporation,’ as herein used, shall include every financial corporation, other than a bank or banking association, and every mercantile, manufacturing and business corporation of the classes referred to in subdivision one (c) of section 5219 of the Revised Statutes of the United States.

‘The term ‘bank,’ as hereinafter used, shall include national banking associations.

‘The term ‘doing business,’ as herein used, means any transaction or transactions in the course of its business by a corporation created under the laws of this state, or by a foreign corporation qualified to do or doing intrastate business in this state.

‘Sec. 6. The term ‘gross income,’ as herein used, includes gains, profits and income derived from the business, of whatever kind and in whatever form paid; gains, profits or income from dealings in real or personal property; gains, profits or income received as compensation for services, as interest, rents, commissions, brokerage or other fees, or otherwise received in carrying on such business; all interest received from federal, state, municipal or other bonds, and, except as hereinafter otherwise provided, all dividends received on stocks.

‘Sec. 7. The term ‘net income,’ as herein used, means the gross income less the deductions allowed.'

In providing what deductions from the gross income shall be permissible, section 8 (h) reads:

‘Dividends received during the taxable year from income arising out of business done in this state; but if the income out of which the dividends are declared is derived from business done within and without this state, then so much of the dividends shall be allowed as a deduction as the amount of the income from business done within this state bears to the total business done.

‘The burden shall be on the taxpayer to show that the amount of dividends claimed as a deduction has been received from income arising out of business done in this state.’

That portion of section 5219, Revised Statutes of the United States (as amended by Act March 25, 1926 [12 USCA § 548]), referred to in section 5 of the Bank and Corporation Franchise Act which is material to the present case, permits the states to tax national banking associations ‘according to or measured by their net income, provided the following conditions are complied with: * * * (c) In case of a tax on or according to or measured by the net income of an association, the taxing State may, except in case of a tax on net income, include the entire net income received from all sources, but the rate shall not be higher than the rate assessed upon other financial corporations nor higher than the highest of the rates assessed by the taxing State upon mercantile, manufacturing, and business corporations doing business within its limits: Provided, however, That a State which imposes a tax on or according to or measured by the net income of, or a franchise or excise tax on, financial, mercantile, manufacturing, and business corporations organized under its own laws or laws of other States and laso imposes a tax upon the income of individuals, may include in such individual income dividends from national banking associations located within the State on condition that it also includes dividends from domestic corporations and may likewise include dividends from national banking associations located without the State on condition that it also includes dividends from foreign corporations, but at no higher rate than is imposed on dividends from such other corporations.’

It is respondent's first contention that it is not doing business in this state within the meaning of the constitutional section, that the Legislature has not the right to create a liability by defining the words ‘doing business,’ and that by the adoption of the section of the Constitution we have adopted the construction placed upon the phrase ‘engaged in business' used in the federal acts referred to later in this opinion.

However, the mere recital of the constitutional provision, the sections of the legislative act, and the material provisions of the federal act provokes two preliminary observations: First, it is to be noted that the tax here in question is one upon the franchise of domestic corporations and foreign corporations ‘doing business' in this state, and not one upon the income of such corporations. Second, the enumeration of certain kinds of corporations in section 5219 of the Revised Statutes of the United States is in nowise restrictive of the corporate franchises which may be taxed by the state, but only that those enumerated must be taxed if a franchise tax measured by the net income is to be laid upon national banking associations. In other words, it was the congressional intention to prevent discrimination in favor of the designated corporations to the detriment of national banking associations. These observations suggest that the expression ‘doing business' was employed in the constitutional provision in order to include foreign corporations ‘doing business' of an intrastate character in the state. This thought is to a degree confirmed by decisions heretofore rendered to the effect that it is the exercise of the right by a foreign corporation to do intrastate business in the state which was the property to be taxed under article 13, section 14(d) of the Constitution providing that the franchises of all corporations except those otherwise mentioned in the section should be taxed at their actual cash value. See People v. Alasks S. S. Co., 182 Cal. 202, 187 P. 742, 745; People v. Ford Motor Co., 188 Cal. 8, 204 P. 217, 218. In the first cited case this court said: ‘The theory that the potential unexercised right of a foreign corporation to do business in this state, which exists by comity only, constitutes taxable property within this state, would lead to results ridiculous and absurd. Every corporation of any foreign state or country is privileged to enter this state and do business therein (herein). While it is doing such business it is exercising corporate powers within this state and the privilege of doing so becomes valuable, but before it exercises that power, or when it ceases to do so, it is no longer possessed in this state of anything of value.’ And in the second case cited we find the following persuasive language: ‘The right to be a corporation, or to do business as a corporation, is a franchise which ordinarily has its situs at the place where the home office of the corporation is situated, but, when a corporation engages in business in a state other than the state wherein it was chartered, the actual exercise of the power to engage in business creates valuable intangible property in the foreign state where the business is transacted. In other words, the actual exercise of the power to do business is also a franchise, and such a franchise has a substantial existence in every state where the business is transacted.’ $The respondent places great weight for its contention that the words ‘doing business' must be held to mean ‘the aggressive pursuit of gain’ and not merely the receipt of the ordinary fruits incident to the ownership of property, upon decisions of the federal courts construing and applying the Corporation Tax Law (Act of August 5, 1909, 36 U. S. Stat. c. 6, pp. 11, 112–117), and the Capital Stock Tax Law of 1918 (40 Stat. p. 1126, § 1000) and 1921 (42 Stat. p. 294, § 1000), which levied a tax upon corporations ‘engaged in business,’ but excluded those not so engaged. Having before it the contention that the tax imposed by the act of 1909 was a direct tax upon property, the United States Supreme Court, in the case of Flint v. Stone-Tracy Co., etc., 220 U. S. 107, at page 145, 31 St. Ct. 342, 346, 55 L. Ed. 389, Ann. Cas. 1912B, 1312, says: ‘While the mere declaration contained in a statute that it shall be regarded as a tax of a particular character does not make it such if it is apparent that it cannot be so designated consistently with the meaning and effect of the act, nevertheless the declaration of the lawmaking power is entitled to much weight, and in this statute the intention is expressly declared to impose a special excise tax with respect to the carrying on or doing business by such corporation, joint stock company or association, or company. It is therefore apparent, giving all the words of the statute effect, that the tax is imposed not upon the franchises of the corporation, irrespective of their use in business, nor upon the property of the corporation, but upon the doing of corporate or insurance business, and with respect to the carrying on thereof, in a sum equivalent to 1 per centum upon the entire net income over and above $5,000 received from all sources during the year; that is, when imposed in this manner it is a tax upon the doing of business, with the advantages which inhere in the peculiarities of corporate or joint stock organization of the character described. As the latter organizations share many benefits of corporate organization, it may be described generally as a tax upon the doing of business in a corporate capacity. In the case of the insurance companies, the tax is imposed upon the transaction of such business by companies organized under the laws of the United States or any state or territory, as heretofore stated.’ And in Rose v. Nunnally Inv. Co. (C. C. A.) 22 F.(2d) 102, 103, in applying the Capital Stock Tax Law the court uses similar language as follows: ‘Upon the authority of these cases it may safely be stated that the tax is based, not upon the charter powers of the corporation, but upon its activities, and that a corporation which merely receives the income earned by assets which it owns, and distributes that income among stockholders, is not engaged in business.’ Bearing in mind the restriction against the levy of direct taxes by the federal government except when apportioned according to population (for thorough discussion of the subject of direct taxes see Pollock v. Farmers' Loan & Trust Co., 157 U. S. 429, 15 S. Ct. 673, 39 L. Ed. 759), the consequent necessity of levying an excise tax upon the doing of business under a corporate form, if the corporation is to be taxed, and the difference between a tax so levied and that laid upon the franchises of domestic corporations and foreign corporations ‘doing business' in this state, it becomes apparent that the federal cases construing the statutes already mentioned cannot be considered as controlling. This conclusion disposes of the contention that we have adopted the construction of the words ‘engaged in business' placed thereupon by the federal courts, and also demonstrates that the Legislature did not transcend its power of definition when it placed a construction upon the words ‘doing business' which they would have borne even without legislative expression.

As we have already indicated, the intention sought to be expressed in the constitutional provision, followed by the legislative enactment by the use of the words ‘doing business,’ was to subject those corporations to a tax which are doing some substantial part of their ordinary business, or exercising some of the functions for which they were created (Estate of Wellings, 192 Cal. 506, 221) P. 628), because they are then doing business within the state. See Estate of Wellings, supra; Bullfrog Goldfield R. R. Co. v. Jordan, 174 Cal. 342, 163 P. 40; 7 Cal. Jur., p. 222, §§ 704–706.

Respondent also contends that it is not within the act because it is neither a financial, a mercantile, a manufacturing, or a business corporation. We may assent to the proposition that it is neither mercantile nor manufacturing in character. But we cannot agree that it is neither a business nor a financial organization. The expression ‘business corporation’ signifies a corporation the purpose of which is that of personal material gain to its members. National Bank Taxation in California, 17 Calif. Law Review, 456, at 493, and cases cited. The respondent's articles of incorporation, by reference made a part of its complaint, disclose that it was formed for the purpose of buying or otherwise acquiring shares of stock of the Union Oil Company and of exercising all of the rights, powers, and privileges of the ownership of such shares and to avail itself ‘of all benefits at any time offered to or conferred upon, or made available to, stockholders of said Union Oil Company of California,’ and to vote the stock at meetings of the stockholders of the Union Oil Company. We cannot say to what degree the respondent controls the management of the Union Oil Company through its stockholdings, but it is apparent that its purpose is the mutual protection and material, pecuniary gain of its members.

Respondent asserts that the act is unconstitutional because article 13, § 16, subd. 2 (a), already quoted, provides that corporations ‘shall annually pay * * * a tax according to or measured by their net income’ wherever the act says that the tax shall be ‘upon the basis of its net income for the next preceding year.’ It is claimed that the act is at variance with the Constitution. We need spend but little time on this statement. The tax is measured by the nearest ascertained income, and we know of no more logical or reasonable way of carrying out the intention of the people. Instead of being at variance, the two provisions are in complete harmony.

It is also claimed that the tax exacted from respondent constitutes a burden upon interstate business. The only argument advanced in support of this statement is that the tax ‘is based entirely upon income derived from the interstate business of the Union Oil Company—a tax with relation to interstate commerce alone.’ A complete answer to this suggestion is found in Pacific Co. v. Johnson, 212 Cal. 148, 298 P. 489, wherein it was held that, the tax being upon the franchise of the corporation without reference to the character of the property in which its funds are invested, income from nontaxable securities might be used for the purpose of measuring the tax.

Finally, it is said that the act is discriminatory, in that personal corporate stockholders of the Union Oil Company are not taxed. A complete refutation of this assertion may be framed as follows: Every corporation of like class pays a similar tax upon its franchise; hence there is no discrimination. Individuals are not involved.

From what has been said it is evident that appellant's demurrer should have been sustained without leave to amend and judgment entered for the defendant. Accordingly, the judgment is reversed, with instructions to the trial court to proceed in accordance with the views expressed herein.

IRA F. THOMPSON, Justice.

We concur: WASTE, C. J.; LANGDON, J.; CURTIS, J.; SHENK, J.