Opinion ID: 2600524
Heading Depth: 2
Heading Rank: 1

Heading: Redemptions as Gross Receipts

Text: Microsoft asks us to apply a substantial evidence standard of review to the question whether the full amount or net price difference of its redemptions constitutes gross receipts for purposes of the UDITPA, arguing that both the nature of its investments and the extent of its activity here and out-of-state involve factual issues. We decline. The factual attributes of Microsoft's transactions are undisputed. Similarly, the parties have stipulated to the relevant facts concerning the scope of Microsoft's activities in California and elsewhere. While the parties dispute the proper legal characterization of Microsoft's transactions under the UDITPA, [t]he application of a taxing statute to uncontradicted facts is a question of law, and this court is accordingly not bound to accept the trial court's findings of fact made from the uncontradicted facts shown in the parties' stipulation and the documentary evidence. ( Communications Satellite Corp. v. Franchise Tax Bd. (1984) 156 Cal.App.3d 726, 746, 203 Cal.Rptr. 779.) As with any issue of statutory interpretation, we begin with the text of the relevant provisions. If the text is unambiguous and provides a clear answer, we need go no further. ( Hoechst, supra, 25 Cal.4th at p. 519, 106 Cal.Rptr.2d 548, 22 P.3d 324.) If the language supports multiple readings, we may consult extrinsic sources, including but not limited to the legislative history and administrative interpretations of the language. Where, as here, the Legislature has adopted a uniform act, the history behind the creation and adoption of that act is also relevant. ( Ibid. ) Under section 25120, subdivision (e), `Sales' means all gross receipts of the taxpayer not allocated [as nonbusiness income] under Sections 25123 through 25127 of this code. (Italics added.) The term gross receipts is undefined. Microsoft argues that gross receipts include the entire amount received upon redemption of a marketable security. The Board argues that gross receipts include only the net difference between the amount received and the original purchase price. We agree with Microsoft that the meaning of gross receipts in the UDITPA more naturally includes the entire redemption price of marketable securities. Gross implies the whole amount received, not just the amount received in excess of the purchase price. [7] To only consider the net price difference as gross receipts is an awkward fit with the statutory language, at best. To the extent the language is ambiguous, we generally will prefer the interpretation favoring the taxpayer. ( Edison California Stores, Inc. v. McColgan (1947) 30 Cal.2d 472, 476, 183 P.2d 16.) The Board, however, argues that only amounts received as consideration count as gross receipts, only the net price difference is consideration, and thus only the net difference should be treated as a receipt. We disagree. In the purchase of a 28-day Treasury bill at 99 and its redemption at 100, [8] for example, the investor exchanges money now for a larger sum of money in 28 days. The Federal Reserve's consideration is the entire amount it receives now; the investor's consideration is the entire larger, but deferred, amount it receives upon redemption. The transaction occurs because the Federal Reserve views the money it receives now as more valuable than the money it must pay later, while the investor views the money it will receive later as more valuable than the money it has now. The difference between the purchase and redemption price is a measure of either gross income or net receipts, not a measure of consideration. (Cf. Gray v. Franchise Tax Bd. (1991) 235 Cal.App.3d 36, 42, 286 Cal.Rptr. 453 [gross income is the excess of the sales price over the cost of goods sold]; MCA, Inc. v. Franchise Tax Bd. (1981) 115 Cal.App.3d 185, 197-198, 171 Cal.Rptr. 242 [gross receipts differs from gross income in that the latter subtracts the cost of goods sold].) While the language of section 25120 supports Microsoft's interpretation, it is not unambiguous and does not by itself preclude either side's proposed interpretation. Thus, we turn to extrinsic interpretive aids. The legislative history behind the UDITPA favors Microsoft's position. As in Hoechst, supra, 25 Cal.4th at pages 522-523, 106 Cal.Rptr.2d 548, 22 P.3d 324, because the Legislature adopted the UDITPA almost verbatim, we look to the drafting history of the UDITPA. An early version of the UDITPA defined sales as all income of the taxpayer not otherwise allocated, but this provision was amended to define sales instead as all gross receipts of the taxpayer not otherwise allocated. (Compare Proceedings of Com. of Whole for UDITPA, transcript of Aug. 22, 1956, p. 5 [income definition] with Proceedings of Com. of Whole for UDITPA, transcript of July 9, 1957, p. 28 [gross receipts definition].) This amendment suggests the choice of gross receipts was intentional and the drafters had in mind a definition of sales that encompassed more than just gross income. Agency interpretation of section 25120 likewise supports Microsoft, albeit in a more limited fashion. (See Hoechst, supra, 25 Cal.4th at pp. 523-525, 106 Cal.Rptr.2d 548, 22 P.3d 324 [relying on State Board of Equalization (SBE) decisions to interpret the UDITPA].) Consistent with Microsoft's interpretation of the statute, the SBE has interpreted gross receipts to include the full amount of any redemptions. In Appeals of Pacific Telephone & Telegraph (May 4, 1978) [1978-1981 Transfer Binder] Cal.Tax Rptr. (CCH) ¶ 205-858, page 14,907-36 ( Pacific Telephone & Telegraph ), as here, the taxpayer's treasury department invested idle cash in short-term securities such as Treasury bills, government obligations, certificates of deposit, and commercial paper, selling some but holding most investments to maturity. The SBE concluded the gross receipts from these activities come within the literal definition of sales' that are includible in the sales factor. ( Id. at p. 14,907-42.) However, because the inclusion of sales and redemptions in gross receipts was not a major point of contention or analysis, we do not place great weight on this decision. [9] (See Yamaha Corp. of America v. State Bd. of Equalization (1998) 19 Cal.4th 1, 14-15, 78 Cal.Rptr.2d 1, 960 P.2d 1031.) In deciding how to apply section 25120, we look as well to the economic reality of the taxed transaction. For purposes of taxation, what matters is substance, not form. In applying this doctrine of substance over form, the [United States Supreme] Court has looked to the economic realities of a transaction rather than to the particular form the parties employed. ( Frank Lyon Co. v. United States (1978) 435 U.S. 561, 573, 98 S.Ct. 1291, 55 L.Ed.2d 550.) Thus, we focus on the actual rights and benefits acquired, not the labels used. When we consider the economic reality of a security redemption, it becomes clear Microsoft is correct: gross receipts include the entire redemption price. The key is the similarity between the sale and the redemption of a marketable security. The Board concedes that when an investor sells a marketable security to a third party, the entire sale price is includible as gross receipts, just as it would be for the sale of any other tangible or intangible property. But from the perspective of the taxpayer, economically a sale and a redemption are indistinguishable. In the sale of a security one day before maturity, the investor relinquishes the bundle of rights that go with the security in exchange for, let us say, a sale price of 99.98. In a redemption upon maturity, the investor relinquishes the identical bundle of rights on the maturity date for the full par value of 100. From the perspective of the investor's balance sheet, the transactions are identical (the minor price differential aside), notwithstanding that different labels apply. The difference between the transactions exists only with respect to the other side of the transaction, that of the recipient: in one case, a third party acquires the same bundle of rights the investor had, and in the other, because the recipient is the original issuer of the security, the security is retired. Because from a tax perspective we are concerned only with the economic activity of the taxpayer/investor, we can discern no reason to treat the two transactions differently. We conclude the full redemption price, like the full sale price, must be treated as gross receipts. This rule is consistent with the application of gross receipts to a wide range of other transactions that include a return of capital. Thus, for example, when a taxpayer enters into a cost plus fixed fee contract, pursuant to which the taxpayer is reimbursed for its outlay of costs and paid a fee in addition, the entire amount receivedboth the fee and the reimbursed costsis included in gross receipts. (See Cal.Code Regs., tit. 18, § 25134, subd. (a)(1)(B).) [10] When a taxpayer sells off equipment used in its businessa truck, for examplethe entire sale price, not just the sale price less cost of goods and adjustments for depreciation, constitutes gross receipts. ( Id., subd. (a)(1)(F).) We see no reason to treat redemptions on maturity differently for gross receipts purposes. The Board argues, and the Court of Appeal intimated, that differential treatment is justified because in one instance, the sale to a third party, there is a sale, while in the other there is no sale. This argument promotes form over substance. We care about the nature of the transaction, not the label attached. We use different labels to distinguish a third party sale from a redemption on maturity because, as noted above, for the security's recipient the transactions have different consequences. From the perspective of the taxpayer/investor, however, they are identical; hence, from the perspective of tax law, they should be treated identically. Moreover, we note that under Regulation section 25134, subdivision (a)(1), gross receipts include payments arising not just from sales but from transactions and activity in the regular course of the taxpayer's business as well. Thus, we place no great emphasis on the significance of the label sale. The Board further argues that a sale the day before redemption is different because it carries with it an additional risk of lossthe risk the security might be sold for less than the purchase price. The Board, however, fails to explain why this difference would justify treating a sale and redemption differently for gross receipts purposes, nor do we discern any reason it would. The Board argues that its position is supported by a different source of administrative interpretation than the agency decisions relied on by Microsoft, to wit, Regulation section 25134, subdivision (a)(1)(A), which includes in gross receipts all interest income. This means, the Board argues, that by negative implication gross receipts exclude a return of principal. The surrounding text demonstrates the error in this interpretation: Gross receipts for this purpose means gross sales, less returns and allowances and includes all interest income, service charges, carrying charges, or time-price differential charges incidental to such sales. ( Ibid. ) This subdivision thus includes interest in addition to the principal price for any sale of goods or products. It does not support a reading of gross receipts that includes interest but excludes the principal sale price. The Board also points to two judicial decisions it contends support its interpretation of gross receipts. ( City of Los Angeles v. Clinton Merchandising Corp. (1962) 58 Cal.2d 675, 25 Cal.Rptr. 859, 375 P.2d 851 ( Clinton Merchandising ); County of Sacramento v. Pacific Gas & Electric Co., supra, 193 Cal.App.3d 300, 238 Cal.Rptr. 305.) In Clinton Merchandising, we addressed whether a municipal tax on gross receipts should apply to the principal of intracompany loans made within a family of affiliated corporations. We concluded it should not. ( Clinton Merchandising, at p. 681, 25 Cal.Rptr. 859, 375 P.2d 851.) That decision is of little help. We treated repayment of corporate loans between affiliates as the functional equivalent of a principal reimbursing its agent for monies advanced by the agent. Thus, we held that money collected or paid out by an agent on behalf of its principal did not constitute gross receipts. ( Id. at p. 682, 25 Cal.Rptr. 859, 375 P.2d 851.) Here, we are presented not with intracompany loans between Microsoft affiliates, but receipts from investments made with third parties. In County of Sacramento v. Pacific Gas & Electric Co., supra, 193 Cal.App.3d at pages 309-312, 238 Cal.Rptr. 305, the Court of Appeal addressed whether a franchise fee assessed against gross receipts should apply to the intracompany use of gas and electricity and concluded it should not because nothing was received. Like Clinton Merchandising, County of Sacramento involved intracompany transactions in which nothing was received from outside the taxed entity. It sheds no light on the proper understanding of gross receipts in the context of payments received from outside Microsoft. Finally, the Board asks us to follow out-of-state decisions concluding that gross receipts under the UDITPA apply only to the net difference between sale or redemption price on the one hand, and purchase price on the other. However, we find a split of authority. While many courts have adopted the Board's position, [11] others have adopted Microsoft's. [12] On balance, we find the latter cases better reasoned than the former. The progenitor of the former line of cases, AT & T, supra, 476 A.2d 800, rests its holding on the notion that interpreting New Jersey's receipts factor to include all receipts from short-term securities investments would produce absurd results. ( Id. at p. 802.) The cases following AT & T reason similarly. (See Walgreen Ariz. Drug Co. v. Ariz. Dept. of Revenue, supra, 97 P.3d at pp. 899-900; Sherwin-Williams Co. v. Ind. Dept. of State Revenue, supra, 673 N.E.2d at p. 852.) There are two problems with these absurd results cases. First, they do violence to the language of the statutes they interpret. In each case, the same language governs both sales of off-the-shelf products and sales of securities. AT & T and its progeny offer no explanation why in one instance that language should require inclusion of gross proceeds and in the other require inclusion of only net proceeds. Second, they overlook the fact no absurd result is required. As the Tennessee Court of Appeals has explained: With deference to sister jurisdictions, this court is reluctant to apply the same `absurd result standard.' An absurd result is not necessary for, in spite of the plain language of [the sales factor statute], the commissioner may opt for a different scheme of assessment whenever the resulting apportionment does not fairly represent the taxpayer's business in this state. ( Sherwin-Williams Co. v. Johnson, supra, 989 S.W.2d at p. 715.) The UDITPA contains an equitable relief provision so that, in cases where application of the statutory sales definition results in excessive distortion, an absurd result may be avoided. (See § 25137.) Nor do we find a legislative consensus over whether in a redemption of securities the full or net price constitutes gross receipts. Some states retain the same partially ambiguous language as California. [13] Other states expressly acknowledge that redemptions generate gross receipts, then exclude them by statute. [14] Still other states define gross receipts in a way that expressly includes only the net gain from redemptions or excludes them entirely. [15] The lack of consensus is even clearer when we consider that some of the foregoing statutes have been amended since 1991, the tax year at issue here. During that year, certainly no legislative consensus obtained as to the treatment of redemptions. This legislative and judicial division of opinion offers no persuasive reason to reject the interpretation of gross receipts most naturally suggested by the text of the statute, the economic reality of sales and redemptions, and agency interpretation. In any event, there is another way to achieve uniformity, as we discuss in part II, post.