Opinion ID: 2600495
Heading Depth: 2
Heading Rank: 1

Heading: Gross Receipts

Text: Here, as in the companion case Microsoft Corporation, supra, ___ Cal.4th ___, 47 Cal.Rptr.3d 216, 139 P.3d 1169, General Motors held some marketable securities until maturity. In Microsoft Corporation, we held the entire redemption price of a marketable security is includible as gross receipts in the sales factor. That conclusion applies equally to the marketable securities held to maturity by General Motors. Thus, we conclude the Court of Appeal erred to the extent it excluded the full price of these securities from General Motors' gross receipts.

Repurchase agreements, commonly known as `repos,' sound esoteric and can be quite complicated. They are, however, in essence nothing more than financing arrangements by which one party provides funds to another for a short period of time. There are two parties to a repurchase agreement: one has money to lend, the other needs cash and has securities. The repurchase agreement itself consists of two transactions that are agreed to simultaneously, but are performed at different times: (1) the seller-borrower agrees to transfer securities to the buyer-lender in exchange for cash; and (2) the seller-borrower agrees to repurchase the securities from the buyer-lender at the original price plus `interest' on a specified future date or upon demand. ( Bewley v. Franchise Tax Bd., supra, 9 Cal.4th at p. 529, 37 Cal.Rptr.2d 298, 886 P.2d 1292.) The seller-borrower who transfers the securities and agrees to buy them back is said to be engaged in a repo; the buyer-lender who provides the cash and agrees to sell the securities back is said to be engaged in a reverse repo. ( Resolution Trust Corp. v. Aetna Casualty & Sur. Co. (7th Cir.1994) 25 F.3d 570, 572; In re Bevill, Bresler & Schulman Asset Management Corp. (D.N.J.1986) 67 B.R. 557, 567; but see Gov.Code, § 53601, subd. (i)(5)(A), (C) [reversing terms].) It appears General Motors principally engaged in reverse repos, but the distinction between the two transactions is unimportant in this case; thus, we will occasionally refer to both repos and reverse repos generically as repos. Repos serve at least four critical functions. First, the Federal Reserve uses repos to make short-term adjustments in the money supply and carry out the government's monetary policy. To restrict the money supply, it enters repos, selling securities and withdrawing cash from the economy; conversely, to expand the money supply, it enters reverse repos, buying securities and injecting cash into the economy. (Note, Lifting the Cloud of Uncertainty over the Repo Market: Characterization of Repos as Separate Purchases and Sales of Securities (1984) 37 Vand. L.Rev. 401, 403-404.) Second, repos are used by securities dealers to finance their underwriting of new government debt issues. A liquid, well-functioning repo market allows dealers to sell current securities holdings for cash (as part of the front end of a repo) and use the cash to acquire new government securities, thereby reducing the federal government's financing costs. ( Bevill, Bresler & Schulman Asset Management Corp. v. Spencer Sav. & Loan Assn. (3d Cir.1989) 878 F.2d 742, 746; Granite Partners, L.P. v. Bear Stearns & Co. (S.D.N.Y. 1998) 17 F.Supp.2d 275, 299 ( Granite Partners ).) Third, repos contribute to the domestic housing market. Mortgage-backed securities guaranteed by government agencies such as the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) become more attractive to investors when they can be repackaged and resold in an active repo market. These agencies can thus raise funds more cheaply, which in turn means residential home buyers can obtain lower rate mortgages. ( Granite Partners, supra, 17 F.Supp.2d at p. 299; In re Bevill, Bresler & Schulman Asset Management Corp., supra, 67 B.R. at p. 568.) Fourth, repos are a valuable investment tool for the public, institutional investors, large corporations, and state and local governments. Because repos can be structured with a maturity date tailored to the needs of the individual investor, they provide a high degree of liquidity and flexibility. ( Securities & Exchange Com. v. Miller (S.D.N.Y.1980) 495 F.Supp. 465, 471.) This liquidity and flexibility, combined with high yields, makes them an attractive financial management tool for entities (such as General Motors here) with large amounts of idle cash seeking secure short-term investments. (See Granite Partners, supra, 17 F.Supp.2d at pp. 299, 302; Securities & Exchange Com. v. Miller, at p. 471; Comment, The Need for a Uniform Classification of Repurchase Agreements: Reconciling Investor Protection with Economic Reality (1987) 36 Am. U. L.Rev. 669, 670-671.)
As in Microsoft Corporation, supra, ___ Cal.4th ___, 47 Cal.Rptr.3d 216, 139 P.3d 1169, the issue here is what portion of the money received by the taxpayer in the course of its securities transactions qualifies as gross receipts. Also as in Microsoft Corporation, we begin by considering how the plain language of the UDITPA applies to these transactions. The plain language offers little immediate assistance. The statute does not define gross receipts. (See § 25120.) While the term gross receipts generally refers to the whole amount received, without deduction ( Microsoft Corporation, supra, ___ Cal.4th at p. ___ & fn. 7, 47 Cal.Rptr.3d at pp. 221-22 & fn. 7, 139 P.3d at pp. 1173-74 & fn. 7), how this concept should apply to a transaction like a repo is not readily apparent. Agency interpretation similarly does not decide the question. General Motors relies on two agency decisions, Appeals of Pacific Telephone & Telegraph (May 4, 1978) [1978-1981 Transfer Binder] Cal.Tax Rptr. (CCH) ¶ 205-858, page 14,907-36, and Appeal of Merrill, Lynch, Pierce, Fenner & Smith, Inc. (June 2, 1989) [1986-1990 Transfer Binder] Cal.Tax Rptr. (CCH) ¶ 401-740, page 25,549, as supporting its position. However, these decisions offer no insight here; in neither case was the tax treatment of repos at issue. The regulations interpreting the UDITPA are likewise unhelpful concerning the proper treatment of repos. General Motors cites out of context to one regulation that defines the term loan to exclude repos (see Cal.Code Regs., tit. 18, § 25137-4.2, subd. (b)(7)), but this citation is unavailing for two reasons. First, the definition expressly applies only within the regulation ( id., § 25137-4.2, subd. (b)), and the regulation is a special one governing application of the UDITPA to banks and financial institutions; it has no application to General Motors. Second, the regulation goes on to address the treatment of repos under the gross receipts factor and provides that only the interest (net gain) from repo sales is to be includedprecisely the treatment the Board advocates, and contrary to General Motors' position. ( Id., § 25137-4.2, subd. (c)(2)(A).) Finding no dispositive answer in either the plain language of the statute or agency interpretations of that language, we turn to a closer examination of the economic reality of repo transactions. (See Frank Lyon Co. v. United States (1978) 435 U.S. 561, 573, 98 S.Ct. 1291, 55 L.Ed.2d 550 [in deciding transaction's tax treatment, court should look to transaction's economic reality]; Microsoft Corporation, supra, ___ Cal.4th at pp. ___-___, 47 Cal.Rptr.3d at pp. 223-24, 139 P.3d at p. 1175 [examining economic reality of redemptions to decide their tax treatment under the UDITPA]; Bewley v. Franchise Tax Bd., supra, 9 Cal.4th at pp. 531-532, 37 Cal.Rptr.2d 298, 886 P.2d 1292 [examining economic reality of repos to decide their treatment under federal tax law].) We begin with two baseline observations. First, as both parties agree, in a sale of marketable securities the entire sale price constitutes gross receipts, just as it would for the sale of any other commodity. Second, under the ordinary meaning of gross receipts, the repayment of a loan is never considered a receipt. ( Marshall v. Commissioner (10th Cir.1975) 510 F.2d 259, 262; see also 26 C.F.R. §§ 1.41-3(c)(2)(iii) (2006) [gross receipts exclude repayment of the principal amount of a loan], 1.263A-3(b)(2)(ii)(D) [same], 1.448-1T(f)(2)(iv)(A) [same].) Thus, in a secured loan transaction, where A loans money to B and B provides A a marketable security as collateral to secure the loan, the loan principal B repays A is not a gross receipt; only the loan interest constitutes such. Given these baselines, the Board analogizes a repo to a secured loan or, alternatively, to the simple repeated deposit and withdrawal of cash from a bank account. The Court of Appeal did likewise. To support its analogy, the Board points to prior decisions of the United States Supreme Court and this court that expressly characterized a repo as a secured loan. In Nebraska Department of Revenue v. Loewenstein (1994) 513 U.S. 123, 115 S.Ct. 557, 130 L.Ed.2d 470, the United States Supreme Court followed Frank Lyon Co. v. United States, supra, 435 U.S. 561, 98 S.Ct. 1291, 55 L.Ed.2d 550, and looked to the economic reality of a repo in deciding how it should be treated under federal tax law, concluding that in economic reality, the [repo Buyer-Lenders] receive interest on cash they have lent to the Seller-Borrower. ( Loewenstein, at p. 134, 115 S.Ct. 557.) Loewenstein thus concluded that in a repo, the income from the transaction was interest from a private commercial loan and was not subject to the tax shield applicable to income received from the government pursuant to the purchase of government securities. ( Id. at pp. 130-133, 115 S.Ct. 557; see 31 U.S.C. § 3124.) The Supreme Court dismissed as irrelevant the taxpayer's argument that repos were viewed as sales and repurchases of government securities for purposes of securities, bankruptcy, and banking law. ( Loewenstein, at p. 134, 115 S.Ct. 557.) Several months later, in Bewley v. Franchise Tax Bd., supra, 9 Cal.4th 526, 37 Cal.Rptr.2d 298, 886 P.2d 1292, we reached the same conclusion when addressing the identical tax question. Like the United States Supreme Court, we considered the essential economic reality of the repos at issue. We concluded that they established a lender-borrower relationship, that the securities involved served as the functional equivalent of collateral, and thus that the income from the repos was essentially interest from private commercial loans. ( Id. at pp. 531-532, 37 Cal.Rptr.2d 298, 886 P.2d 1292.) Thus, in that tax context, we characterized repos as secured loans. In contrast, General Motors characterizes its repo transactions as sales: in a repo, like any other sale of a commodity, title passes, and thus, General Motors argues, its sale of a security in the course of a repo is no different than its sale of an automobile or its sale of any other security. To support this characterization, General Motors points to numerous decisions that have indeed characterized a repo as a purchase and sale of a security. [6] In truth, neither side's proffered analogies are precisely accurate, and neither side's cases are precisely on point. A repo is a true hybrid; it blends characteristics of both a sale of securities and a secured loan. ( In re Bevill, Bresler & Schulman Asset Management Corp., supra, 67 B.R. at pp. 596-597; KeyCorp v. Tracy (1999) 87 Ohio St.3d 238, 719 N.E.2d 529, 532.) In some circumstances, it is properly characterized as a secured loan; in other circumstances, it is properly characterized as a purchase and sale of a security. Which characterization fits depends heavily on context; those features of a repo salient in its characterization for bankruptcy purposes, or securities law purposes, or UCC purposes, or even federal tax purposes, are not necessarily the features that will be most salient in characterizing it under the UDITPA. (See In re County of Orange, supra, 31 F.Supp.2d at p. 779 [Different statutes have distinct purposes which warrant corresponding levels of examination. Different levels of examination result in different conclusions about the correct legal characterization of repos].) Thus, we cannot rely on superficial analogies, nor on the United States Supreme Court's or our own prior decisions that have characterized a repo for other purposes, to decide on which side of the sale/loan line a repo falls for purposes of section 25120, subdivision (e). Nor can we simply accept the repo parties' formal characterizations. Though General Motors' master repurchase agreement provides [T]he parties intend that all Transactions hereunder be sales and purchases and not loans, for tax purposes the economic reality of a transaction, not the form the parties employ, is dispositive. ( Frank Lyon Co. v. United States, supra, 435 U.S. at p. 573, 98 S.Ct. 1291.) Thus, Granite Partners, supra, 17 F.Supp.2d at pages 302-304, relied on by General Motors, which found this expression of intent dispositive for UCC purposes, is not instructive. To identify the portion of a repo that constitutes gross receipts, we consider how and why a sale or redemption of a security, on the one hand, and a secured loan, on the other, are treated differently for gross receipts purposes. Gross receipts are [t]he total amount of money or other consideration received by a business taxpayer for goods sold or services performed in a year, before deductions. (Black's Law Dict. (8th ed.2004) pp. 722-723, citing 26 U.S.C. § 448; see Microsoft Corporation, supra, ___ Cal.4th at p. ___, fn. 7, 47 Cal.Rptr.3d at p. 222, 139 P.3d at p. 1174.) In both the sale and redemption of a security, the entire amount is received for the relinquishment of a commodity. In contrast, in a secured loan, some of the amount is received for a service, the use of money (interest), while the remainder is simply a return of the money used (principal). The return of principal does not fit within the definition of gross receipts. To better understand this basic distinction and how it applies even in the case of debt instruments like bonds and Treasury bills, consider the case of a security (a $10,000 Treasury bill, say) bought on the market from a securities dealer, then redeemed with the issuer, the United States government. The price the purchaser/taxpayer receives on redemption, $10,000, is dependent on the value of the commodity it holds and independent of the price it paid to the broker. The taxpayer is not being repaid for money it lent; it had, in fact, paid nothing and lent nothing to the United States government. The entire amount received is properly treated as gross receipts. There are in fact four scenarios for acquisition and disposition of this hypothetical Treasury bill: (1) purchase from a third party/redemption with the issuer; (2) purchase from the issuer/redemption with the issuer; (3) purchase from the issuer/sale to a third party; and (4) purchase from a third party/sale to a third party. The dispositions in the first two scenarios are labeled redemptions and in the last two are labeled sales, but in each case the two halves of the transaction are independent, which illustrates a fundamental point: in the dispositional half of the transaction, the transaction we are analyzing for tax purposes, money is received for surrendering title to a marketable security and not for a service (i.e., the use of moneyinterest), because the amount received is dependent on the value of the security and independent of the amount one originally provided the buyer/issuer. In contrast, with a secured loan the opposite is true. The amount received is dependent on the amount originally paid (loaned) and is independent of the particular value of the securities held as collateral, whose value may rise or fall during the term of the loan without affecting the amount received. Neither General Motors nor the Board contends here that the return of money loaned is money received in payment for goods or services and is includible in gross receipts. Viewed this way, it becomes apparent that, for gross receipts purposes, a repo has the characteristics of a loan, not the sale of a commodity. In a repo, the amount paid depends not on the value of the surrendered security, but on the amount of money the repo buyer paid the repo seller in the front end of the transaction. This can be seen from two key features of a standard repo transaction, each of which is present in General Motors' repos. [7] First, under a provision generally referred to in the securities trade as a mark-to-market provision, [8] if the value of the securities drops, the buyer may require the seller to provide additional securities to ensure the value of the securities held exceeds 102 percent of the agreed-upon repurchase price. Conversely, if the value of the securities rises, the seller may require the buyer to return securities sufficient to maintain the value of the amount held at no more than 102 percent. Thus, as with a secured loan, market fluctuations in value create a right to increase or reduce the amount of securities (collateral) held; the buyer is protected from fluctuations in the value of the securities it has acquired. (See In re County of Orange, supra, 31 F.Supp.2d at p. 777.) Second, the repurchase price is set exclusively by reference to the purchase price and is independent of any increase or decrease in value the sold securities may undergo. [9] Instead, the repurchase price is the purchase price increased by an annual percentage rate, adjusted for the number of days between sale and repurchase. Thus, the repurchase price is dependent on the money initially paid and independent of the value of the securities surrendered. Consequently, the repurchase price is payment for the interim use of the repo buyer's money, not payment for the securities the repo buyer is returning. This means, in a repo, the seller is buying cash (i.e., receiving a loan), while in a sale or redemption, the buyer/issuer is paying for a commodity. Thus, a repo is properly characterized as a secured loan for gross receipts purposes. To summarize: For tax purposes, we care why money is being received. If it is received in exchange for a commodity, we treat the full price as gross receipts. If it is received in exchange for the use of money, only the interest, not the principal, is a gross receipt. In a securities sale or redemption, the price paid the seller is a function of the securities held and is independent of the initial cost. In a secured loan, the price paid is tied to the initial cost (the amount loaned) and is independent of fluctuations in the value of the securities held. In a repo, the price paid is also tied to the initial cost and is independent of fluctuations in the type or value of the securities held. Thus, a repo has the characteristics of a loan, and only the interest received is a gross receipt for purposes of the UDITPA. The only out-of-state case to consider the question, H.J. Heinz Co. v. Revenue Division (1992) 197 Mich.App. 210, 494 N.W.2d 850, reached the same result. There, as here, the court rejected the parties' characterizations of their transactions as purchases and sales and emphasized it must consider the real nature of the transactions without regard to the terms applied to them by the parties. ( Id. at p. 853.) The taxpayer was engaged in reverse repos; it purchased securities from various financial institutions with its excess cash and resold them the next day, although [t]he securities, themselves, never changed hands. ( Id. at p. 851.) Rather, the taxpayer received its cash back, plus one day's earnings at the quoted yield. ( Ibid. ) On these facts, the court concluded the repo transactions should be treated like secured loans. ( Id. at p. 853; see also 18-125 Me.Code Reg. 801.08, subd. (B)(2) [treating repos as loans for gross receipts purposes]; Va. Dept. of Tax. public doc. ruling 91-212 (Sept. 6, 1991) [same].) As we have previously noted, when interpreting the UDITPA, we will strive to achieve uniformity with sister states when possible. ( Microsoft Corporation, ___ Cal.4th at p. ___, 47 Cal.Rptr.3d at p. 228, 139 P.3d at p. 1179; Hoechst Celanese Corp. v. Franchise Tax Bd. (2001) 25 Cal.4th 508, 526, 106 Cal.Rptr.2d 548, 22 P.3d 324; see also § 25138 [the UDITPA shall be so construed as to effectuate its general purpose to make uniform the law of those states which enact it].) This interpretation does no harm to the aforementioned essential role repos play in the national economy. The key features that make repos valuable for short-term investments, short-term capital acquisition, and control of monetary policy are their liquidity, security, high yields, and efficient default remedies. [10] Treating them as secured loans solely for UDITPA purposes does nothing to impair these essential features. Thus, we hold that only the interest from repo transactions should be included as gross receipts.
General Motors argues that the Board's exclusion of some of its investment proceeds in this case constitutes a regulation subject to the requirements of California's Administrative Procedure Act. (See Gov.Code, § 11340 et seq.) An agency action is subject to that act, however, only if it adopts a rule applicable to a range of cases. ( Morning Star v. State Board of Equalization (2006) 38 Cal.4th 324, 333-334, 42 Cal.Rptr.3d 47, 132 P.3d 249; Tidewater Marine Western, Inc. v. Bradshaw (1996) 14 Cal.4th 557, 571, 59 Cal.Rptr.2d 186, 927 P.2d 296.) The Board's decision concerning how the tax laws should apply to General Motors' transactions is not such a rule. General Motors further argues that refusal to include the entire proceeds involved in repo transactions is unconstitutional, in violation of the due process and commerce clauses. [11] To establish this, it has the burden of showing `by clear and cogent evidence that the income attributed to [California] is in fact out of all appropriate proportions to the business transacted . . . in that State, [citation], or has led to a grossly distorted result, [citation].' ( Container Corp. v. Franchise Tax Bd. (1983) 463 U.S. 159, 170, 103 S.Ct. 2933, 77 L.Ed.2d 545.) It has not done so. General Motors' argument focuses instead on the effect exclusion of gross proceeds would have on the attribution of income to New York. As California's tax law is not being used to calculate tax on New York income, and as General Motors has failed to demonstrate any grossly disproportionate attribution of income to California, the argument fails.
As we discussed in depth in Microsoft Corporation, supra, ___ Cal.4th at pp. ___-___, 47 Cal.Rptr.3d at pp. 226-32, 139 P.3d at pp. 1178-82, the UDITPA contains a relief provision, section 25137, pursuant to which either the taxpayer or the Board may argue (1) the standard formula fails to fairly represent the extent of the taxpayer's California business activity, and (2) the taxpayer's or Board's proposed alternative method of calculation is reasonable. Here, in the parties' stipulation prior to entry of judgment, the Board expressly reserved the right to argue that any gross securities proceeds included in the sales factor produced distortion and should be excluded under section 25137. Neither the trial court nor the Court of Appeal had occasion to address application of this relief provision. Because the full proceeds from General Motors' redemptions should have been treated as gross receipts, we remand for further proceedings to allow the Board to make its section 25137 case in accordance with the principles set out in Microsoft Corporation.