Rosemary Properties, Inc. v. McColgan , 29 Cal. 2d 677 ( 1947 )

SPENCE, J.

Two actions were brought by plaintiff to recover additional franchise taxes assessed by defendant against plaintiff for the years 1938 and 1939, respectively. They were tried upon a stipulated set of facts, and they have been briefed together on appeal'in presenting a problem of statutory construction affecting the propriety of a dividend deduction for franchise tax purposes for the two years in question, under the terms of the Bank and Corporation Franchise Tax Act (Stats. 1929, ch. 13, p. 19, as amended; Peering’s Gen. Laws, 1937, Act 8488), hereinafter referred to as “the act.” The trial court entered a judgment in favor of plaintiff in each case and from said judgments, defendant has appealed.

Plaintiff, a California corporation, duly filed its franchise tax returns for the years 1938 and 1939, the former based on its 1937 income and the latter on its 1938 income. Plaintiff’s report of gross income for these successive years listed $76,195 and $83,545 as dividends paid to it respectively in 1937 and 1938 by the Ventura Land and Water Company, hereinafter referred to as “Ventura.” However, in computing its net income for franchise tax purposes for those years, plaintiff deducted the full amount of the respective Ventura dividends from its returns. As a result of that deduction and other deductions not here involved, plaintiff reported a net loss for each year and paid a minimum tax of $25 on each of its returns as required by section 4(3) of the act.

In due season defendant served notices on plaintiff of his intention to assess an additional franchise tax for each of the two years. Plaintiff protested the proposed assessments but paid them with interest, after which these actions followed to recover the additional assessments charged and collected by defendant by reason of his adjustment of the Ventura dividend deduction taken by plaintiff on each of its returns. This disputed item will determine whether or not plaintiff’s franchise tax obligation for each of the two years exceeds the minimum $25 assessment as originally reported. In order to appraise the factors in controversy, it is necessary to examine the franchise tax returns filed by Ventura for the corresponding years.

Ventura, a California corporation, conducted its entire business in this state. Its principal source of income was royalties from California oil and gas properties, which it owned and leased to operating oil producers. Ventura’s gross income for the year 1937—as reported on its 1938 return—was $1,203,-295.60 and for the year 1938—as reported on its 1939 return —was $1,417,090.48, of which sums $1,195,768.97 and $1,399,-534.92 were derived, respectively, from its oil royalties. Prior to 1937 Ventura had recovered in full its cost depletion for its oil-bearing lands. But in pursuance of section 8(g) of the act, which authorizes a deduction for depletion at the rate of 27% per cent of the gross income from oil and gas wells, Ventura listed, and was allowed, on its respective returns a deduction of $328,836.47 from its oil royalties for 1937 and a deduction of $384,872.10 from its oil royalties for 1938. These respective percentage depletions on its oil royalties and other allowable deductions reduced Ventura’s net income for franchise tax purposes for 1937 to $775,282.65 and for 1938 to $908,171.54. It was stipulated that Ventura’s earnings and profits for the year 1937 amounted to $963,338.63 and for the year 1938 amounted to $1,112,147.82, from which sums came the respective dividends of $76,195 and $83,545 paid plaintiff.

As the basis for the additional franchise tax assessments against plaintiff, defendant claims that only 80.478 per cent of the dividend paid in 1937 and 81.659 per cent of the dividend paid in 1938 were included in the measure of the tax imposed by the act on Ventura. Defendant obtains these percentages by dividing Ventura’s net income for the year in question by its earnings and profits for the same period. The two figures differ because of the factors taken into account: thus, the oil depletion allowance which entered into the computation of Ventura’s net income was a statutory percentage deduction but such item did not affect Ventura’s schedule of earnings and profits since depletion sustained on a cost basis had already been recovered in previous years; and disbursements such as those made for federal income tax and franchise tax charges, which reduced the amount of Ventura’s earnings and profits, did not affect the net income computation because not deductible under the act. (§8(c).) So— according to defendant—Ventura’s net income of $775,282.65 divided by its earnings and profits of $963,338.63 gives the percentage of 80.478, which multiplied by plaintiff’s dividend of $76,195 represents the proper dividend deduction to be allowed plaintiff for 1937; and Ventura’s net income of $908,171.54 divided by its earnings and profits of $1,112,147.82 gives the percentage of 81.659, which multiplied by plaintiff’s dividend of $83,545 represents the proper dividend deduction to he allowed plaintiff for 1938.

Since plaintiff contends that the entire Ventura dividend received in 1937 and 1938 was deductible for franchise tax purposes in its respective returns as having been declared by Ventura from income “included in the measure of the tax” imposed by the act on Ventura, it is necessary to construe the language of the act to determine plaintiff’s liability for the additional taxes assessed and collected by defendant under the above formula.

Section 4(3) requires that every corporation doing business within this state and not expressly exempted from taxation by the Constitution shall annually pay, for the privilege of exercising its corporate franchise, “a tax according to or measured by its net income, to be computed ... at the rate of four per centum upon the basis of its net income for the next preceding fiscal or calendar year.”

Section 7 defines “net income” as “gross income less the deductions allowed.” Section 8 enumerates the allowable deductions. Among the items so listed is the dividend deduction under subdivision (h), the premise of the parties” dispute. Applicable to plaintiff’s 1938 return is the provision for the deduction in the subdivision as amended in 1937 (Stats. 1937, p. 2328) : “Dividends received during the income year from a bank or corporation doing business in this state declared from income which has been included in the measure of the tax imposed by this act upon the bank or corporation declaring the dividends.” (Italics ours.) Applicable to plaintiff’s 1939 return is the provision for the deduction in the subdivision as amended in 1939 (Stats. 1939, p. 2942) : “Dividends received during the income year declared from income which has been included in the measure of the tax imposed by this act upon the bank or corporation declaring the dividends, or from income which has been taxed under the provisions of the Corporation Income Tax Act of 1937 to the corporation declaring the dividends.” (Italics ours.)

The import of the above italicized language carried into the respective amendments of section 8(h) here applicable is the pivotal point in controversy. Defendant’s arguments rest on these steps: (1) That under fundamental principles of tax law as well as by statutory provision in the act itself since 1939, dividends are defined to be “ any distribution made by a corporation to its shareholders . . . out of its earnings or profits” (Stats. 1939, p. 2936, §6(c) (1); 33 C.J. 303, §78; Title 26, U.S.C.A., Internal Rev. Code, §115); (2) that the “earnings or profits” of a corporation are generally not the same figure as its taxable net income because affected by different considerations—the former by the corporation’s actual expenditures, the latter by the allowable statutory deductions; (3) that since the source of dividends is “earnings or profits,” the word “income” as used in the allowable deduction of “dividends . . . declared from income which has been included in the measure of the tax” means “earnings or profits”; and so (4) where “earnings or profits” exceed “net income,” then “it follows as a mathematical certainty that dividends declared from such earnings or profits are declared from earnings or profits which in part have not been included in the measure of the tax and the dividends are not fully deductible.” Plaintiff does not dispute steps (1) and (2) of defendant’s argument, but it does challenge their relevancy to the problem at hand and the logic of the concluding steps (3) and (4) in limiting the phrase “income which has been included in the measure of the tax” to mean no more than statutory net income. Rather, so plaintiff contends, the quoted phrase refers to “gross income subject to taxation by the state”; and since that item would include “earnings and profits” attributable to California sources, dividends paid therefrom would be “declared from income which has been included in the measure of the tax.” A reasonable construction of the disputed language in relation to the basic concept of the act sustains plaintiff’s position.

The tax in question is not one on income as such but one which the corporation must pay “for the privilege of exercising its corporate franchises within this state” (Matson Navigation Co. v. State Board of Equalization, 3 Cal.2d 1, 11 [43 P.2d 805]) and “according to or measured by its net income. ” (§4(3).) As the nature of the tax is distinguished, so is its basis, of calculation. Thus, the act uses the term “net income” to specify the sum which, when multiplied by the prescribed percentage rate, determines the amount of the franchise tax. In this sense “net income,” as defined by the act, is the final measure by which the tax is computed. (San Joaquin Ginning Co. v. McColgan, 20 Cal.2d 254, 256 [125 P.2d 36].) Since “net income” means “gross income less the deductions allowed” (§7), these factors necessarily enter into the computation and are included in the measure of the tax. The income involved is all income, including earnings and profits, attributable to California sources; the deductions, including the prescribed depletion rate of 27% per cent of gross income from oil and gas properties, are additional considerations. Following these principles, any dividend paid from “earnings and profits”—an item of gross income entering, like the authorized deductions, into the determination of net income—would be a dividend paid out of income included in the measure of the tax. As such the dividend is exempt from franchise tax in the hands of the recipient corporation.

This same conclusion was reached in the case of Burton E. Green Investment Co. v. McColgan, 60 Cal.App.2d 224 [140 P.2d 451], with regard to a practically identical factual situation involving the application of section 8 (h) in its 1937 form. There the plaintiff taxpayer owned stock in Belridge Oil Company, a California corporation which during the year in question, 1937, derived all but a small portion of its income from the production and sale of oil and gas in this state. In its franchise tax return covering that year, Belridge Oil Company reported all its income and claimed the oil depletion allowance under section 8(g), which percentage depletion exceeded its actual cost depletion by a substantial amount. During 1937 Belridge Oil Company had paid to plaintiff certain dividends which plaintiff, in its appropriate, franchise tax return, included in its gross income and then deducted under authority of section 8(h). In asserting an additional assessment against plaintiff, defendant tax commissioner took the position that “because the 27% per cent of the gross income from the oil wells operated by Belridge exceeded the depletion deduction based upon actual cost, the excess of the deduction allowed over actual cost depletion is not a part of income which had been included in the measure of the tax imposed, within the meaning of section 8(h).” (60 Cal.App.2d 230-231.) In rejecting this theory, the court said at pages 231-232: “If the total Belridge income for 1937 was included in its gross income for franchise tax purposes and if out of its earnings of 1937 that corporation paid the dividend in question to plaintiff out of profits earned in that year, it must follow that the entire dividend so paid to plaintiff was declared from income which had been included in the measure of the tax. If it was, then it was deductible in full. The very purpose of section 8 subdivision (h) is to avoid double taxation and thereby prevent the destruction of capital assets. While it aims to tax all income received as dividends (except those exempted by law) which have not been taxed while in the treasury of the dividend payor, at the same time it purposes to avoid the inclusion of the same income in the measure of the tax to be paid by two or more different taxpayers. If the same dividend is included in the measure of the tax paid by two taxpayers successively under the Franchise Tax Act, the result is multiple taxation.”

Defendant attacks the pertinency of the Green Investment Company case because “it failed to take into consideration whether the earnings or profits of the declaring corporation out of which the dividends were declared were greater than the net income by which the tax on the declaring corporation had been measured.” But such claim mistakenly assumes the relationship between “earnings and profits” and “statutory net income” to be a distinctive and controlling factor. In fact, this ratio involves no different considerations than were before the court in the Green Investment Company case. It simply rests on the theory that to the extent Ventura’s dividends were declared from “earnings and profits” which exceeded in amount its “net income”—a difference wholly attributable to Ventura’s taking of the oil and gas statutory depletion allowance—such dividends were paid from an untaxed source, and so from income not “included in the measure of the tax.” In the Green Investment Company case the same point was considered as presented with relation to the extent the statutory percentage depletion exceeded the cost depletion and the consequent argument that “a portion of the Belridge dividend was paid from an untaxed source.” In declaring this argument to be based upon a fallacious concept, the court aptly said at page 235: “Whether the amount of net income for the purpose of computing the franchise tax is increased or decreased by any adjustment which does not at the same time proportionately enlarge or diminish profits, it will not affect either the declaration of a dividend or the amount thereof. . . . Since ... all of the Belridge income [including earnings and profits] was reported as gross income, all of its dividends were from a fund which had been flailed by the tax master,” and therefore from “income which has been included in the measure of the tax.”

The design of the act clearly contemplates the oil and gas percentage depletion (§ 8(g)) and the dividend deduction (§ 8(h)) as independent allowances to be taken by two separate corporations in the computation of their respective net incomes. Defendant attacks the propriety of a “percentage depletion [which] can go on and on after cost . . . has been completely recovered” by the oil operating company, but that is not a matter to be considered here. The procedure which defendant challenges is authorized by the act. Upon such premise it would appear that if the percentage depletion is properly deducted from gross income by the dividend declaring company in computing its net income for franchise tax purposes, it should not thereafter be assessed to the recipient corporation in the latter’s computation. Rather, as the court succinctly stated in the Green Investment Company case at page 234, “the recipient is authorized to deduct the dividend which has passed through the tax mill before its distribution by the declaring corporation.”

A consideration of the legislative history of section 8(h) lends additional force to plaintiff’s position. As first enacted in 1929 (Stats. 1929, p. 23), section 8(h) provided for the deductibility of dividends “received during the taxable year from income arising out of business done in this state. ’ ’ This was construed to mean that it did not require dividends to arise out of business done in this state by the corporation which declared the dividends. Consequently, the deduction could be taken where the corporation paying the dividend was a foreign corporation and did no business in the state but merely owned stock in corporations operating in California from which it received income. (Corporation of America v. Johnson, 7 Cal.2d 295, 299-300 [60 P.2d 417].) To correct this situation, section 8(h) was amended in 1933 (Stats. 1933, pp. 688-689) by adding the requirement that the declaring corporation must have done business in this state. At the same time there was inserted the further requirement that the declaring corporation must have been constitutionally taxable in this state. But the base of the deduction was still whether the dividend was declared from income “arising out of business done in this state.” Under such statutory test, it is apparent that the propriety of plaintiff’s claim to the full Ventura dividend deduction taken on its respective franchise tax returns could not be questioned.

Then in 1937 section 8(h) was amended to include the language in question. In making the change the words “arising out of business done in this state” were deleted and the deduction of dividends was allowed when declared from income “which has been included in the measure of the tax imposed by this act.” This new wording is significant in that coincident with its adoption the following provisions were eliminated from subdivision (h) as it read in 1933: (1) The allocation allowance applicable where dividends were declared from income ‘1 derived from business done within and without this state”; and (2) the reference to the inapplicability of the deduction to dividends paid by constitutionally tax exempt corporations. With its attention so focused on the eliminated provisions, the Legislature in the 1937 amendment apparently considered them unnecessary in view of the new wording, briefer in form, as expressive of the purpose of the deduction to avoid double taxation. Thus the language “income which has been included in the measure of the tax” appears to have a definite connection with the problem of allocating income within and without the state; and appears to refer to income attributable to California sources. Such view of the 1937 amendment coincides with the original purpose of the dividend deduction and with the natural import of the words. (Cf. Burton E. Green Investment Co. v. McColgan, supra, 60 Cal.App.2d 232-233.) The substituted language furnishes no basis for assuming that it was intended thereby to establish a new scheme of tax deduction dependent upon a ratio between “earnings or profits” and “net income”—a view which would require, as defendant concedes, the interpretation of the word “income” in the disputed phrase to mean “earnings or profits.” Such interpretation not only creates a redundancy in that the word “dividend” itself implies a distribution from “earnings or profits,” but it also does violence to a cardinal principle of statutory construction in assigning a forced and strained meaning to a word contrary to its common understanding. (Corbett v. Chambers, 109 Cal. 178, 180 [41 P. 873]; In re Alpine, 203 Cal. 731, 737 [265 P. 947, 58 A.L.R. 1500]; County of Los Angeles v. Frisbie, 19 Cal.2d 634, 642 [122 P.2d 526] ; 23 Cal.Jur. 749, § 124.) Under such circumstances it is but reasonable to conclude that had the Legislature intended to restrict the dividend deduction solely to taxable net income, rather than to correlate it simply with income attributable to California sources, language expressive of such material change of purpose would have been adopted.

Additional proof of the legislative intention is found in section 9(d) which was also enacted in 1937 (Stats. 1937, pp. 2329-2330) when the phrase “included in the Measure of the tax” first appeared in section 8(h). Thus, in computing net income, section 9(d) allowed no deduction for “any amount otherwise allowable as a deduction which is allocable to one or more classes of income not included in the measure of the tax imposed by this act.” In so referring to income which is excluded from the computation of the franchise tax, the Legislature must have intended it in the sense of “gross income,” since deductions are not allocable to “net income,” which can only result after the appropriate deductions have been, taken. Speaking to this point, the court in the Green Investment Company ease, supra, said at page 233: “In view of the use of the word income in section 9 subdivision (d) in the sense of gross income we are convinced that it has the same significance in section 8 subdivision (h). The Legislature could not have intended to use a significant word in two different senses in the same statute (Ransome-Crummey Company v. Woodhams, 29 Cal.App. 356 [156 P. 62]; Coleman v. Oakland, 110 Cal.App. 715 [295 P. 59].)”

Nor does a contrary purpose appear from the 1939 amendment of section 8 (h) by the addition of language allowing the deduction where the dividends were declared “from income which has been taxed under the provisions of the Corporation Income Tax Act of 1937 to the corporation declaring the dividends.” The Corporation Income Tax Act (Stats. 1937, p. 2184, as amended; Peering’s Gen. Laws, 1937, Act 8494a) supplements the Franchise Tax Act and is complementary thereto. (West Publishing Co. v. McColgan, 27 Cal.2d 705, 708 [166 P.2d 861].) Manifestly, the purpose of the 1939 amendment in the application of the dividend deduction was to place corporate stockholders of corporations taxable under the Corporation Income Tax Act on an equal basis with corporate stockholders of corporations taxable under the Franchise Tax Act. Accordingly, the phrase “income which has been included in the measure of the tax” for franchise tax purposes and “income which has been taxed under the provisions of the Corporation Income Tax Act” should be given consistent interpretation. Defendant argues that this is not possible unless the phrase in each case refers to “net income.” The subject of the tax under the Corporation Income Tax Act is net income; under the Franchise Tax Act, as previously noted, the subject of the tax is the privilege of exercising corporate franchises within this state, and the final measure thereof is “net income.” The rate of tax is the same in both cases, 4 per cent of net income. But notwithstanding this distinction in the nature of the tax, once the taxpayer reports his gross income from California sources, whether for purposes of computation under the Franchise Tax Act or the Corporation Income Tax Act, all of that income “has passed through the tax mill”—has, so to speak, been taxed. Under such circumstances the 1939 amendment does not deflect from the propriety of construing the word “income” as used in the correlated references to mean “gross income. ’ ’

Moreover, in considering these successive amendments the force of the decision in the Green Investment Company case cannot be overlooked. The court there said: “Since the gross income and specified deductions are the factors included in arriving at the net income, the conclusion is unavoidable that it is gross income that is included in the measure of the tax.” (60 Cal.App.2d 233.) That case was decided in August, 1943. Since that time the Legislature has met on three occasions: at special sessions in 1944 and 1946, and at its regular biennial session in 1945, yet it has not amended section 8(h) of the act to avoid the result of that decision. Notable at the 1945 session is its readoption of section 8(h) without the slightest change in the language construed in the Green Investment Company case. (Stats. 1945, p. 1791.) Such re-adoption of a statutory provision amounts to ratification of the court’s construction thereof. Speaking to this point, the court said in Union Oil Associates v. Johnson, 2 Cal.2d 727, at pages 734-735 [43 P.2d 291, 98 A.L.R. 1499] : “It is a cardinal principle of statutory construction that where legislation is framed in the language of an earlier enactment on the same or an analogous subject, which has been judicially construed, there is a very strong presumption of intent to adopt the construction as well as the language of the prior enactment.” (See, also, Guardianship of Reynolds, 60 Cal.App.2d 669, 675 [141 P.2d 498]; Hecht v. Malley, 265 U.S. 144, 153 [44 S.Ct. 462, 68 L.Ed. 949]; Carroll Electric Co. v. Snelling, 62 F.2d 413, 416.)

But of even greater significance in this connection is the Legislature’s direct refusal at the 1945 session to adopt an amendment to section 8(h) designed to overcome the effect of the decision in the Green Investment Company ease. Assembly Bill No. 912, introduced at that session for the purpose of amending various sections of the act in question, referred, among others, to section 8(h). After restating in subdivision (1) of that subsection the language of section 8(h) as amended in 1939, supra, said Assembly Bill 912 significantly proposed the following addition: “ (2) The portion of the dividend deductible under subdivision (1) of Section 8 (h) shall be determined by ascertaining the ratio which the net inpome of the corporation declaring the dividend bears to the earnings and profits of such corporation for the same income year.” Assembly Bill No. 913, introduced at the same session for the purpose of amending various sections of the Corporation Income Tax Act, contained the same proposal with reference to .section 7 (h) of that act, so that the correlation in operation between that Act and the Franchise Tax Act would continue. It is obvious that the proposed addition in the pertinent sections of the two acts provided for the dividend deduction to be determined exactly in the manner in which defendant seeks to have it computed here in the absence of such provision. However, the Senate, upon recommendation of its Committee on Revenue and Taxation, amended both Assembly bills and the proposed addition was stricken in each case. (Senate Journal, Fifty-Sixth Session, p. 2635.) In such form both bills were ultimately passed: Assembly Bill No. 912 became chapter 946 of the 1945 laws (Stats. 1945, p. 1779) and Assembly Bill No. 913 became chapter 859 of the 1945 laws (Stats. 1945, p. 1572). Such action of the Legislature forcefully demonstrates that it appreciated that a substantial change in the wording of section 8(h) would be required to effect a different basis for allowance of the dividend deduction as previously provided and construed; and that it decided to adhere to the premise of the Green Investment Company case in the construction of said section.

For these reasons we conclude that plaintiff was entitled to deduct the Ventura dividend in full on its respective franchise tax returns covering its 1937 and 1938 income.

The judgments are, and each of them is, affirmed.

Shenk, J., Edmonds, J., and Schauer, J., concurred.