John Deere Plow Co. v. Franchise Tax Board

Plaintiff brought this action to recover an additional franchise tax assessed against it for the taxable year 1938, based upon income for the year 1937, under authority of the Bank and Corporation Franchise Tax Act (Stats. 1929, p. 19, as amended; 2 Deering’s Gen. Laws 1937, Act 8488, p. 3851) and paid under protest. The trial court found in defendant’s favor, and from the judgment accordingly entered, plaintiff appeals.

The sole point in controversy is the propriety of the Franchise Tax Commissioner’s application of a three-factor formula in measure of plaintiff’s net. income from business done within this state for the year involved. Plaintiff maintains that such formula attributes to California income derived wholly from business done without this state, so that such allocation is not only contrary to the governing act but likewise is objectionable as violative of the due process and equal protection of the law clauses of the Fourteenth Amendment. But an examination of the record in the light of settled legal principles sustains the use of the challenged formula as a reasonable method of apportionment for determining plaintiff’s franchise tax liability in this state, and accordingly the judgment must be affirmed.

At all times herein mentioned plaintiff was an Illinois corporation, authorized to do business within this state, which business consisted of the sale of a full line of agricultural machinery, implements, and tractors at wholesale to dealers. It maintained a jobbing house in San Francisco to serve the states of California, Arizona and part of Nevada, and in addition, it did a certain amount of exporting to the Orient. It also owned and operated four other jobbing houses, each serving trade in the surrounding territory and respectively located at Moline, Illinois; Omaha, Nebraska; Portland, Oregon; and Salt Lake City, Utah.

All of plaintiff’s capital stock was owned by Deere and Company, an Illinois corporation, which was engaged in the business of manufacturing and selling farm equipment, with operations, extending from the purchase of raw materials to the distribution of the finished products. Deere and Company also owned the capital stock of some 83 other corporations—manufacturing plants, factories, jobbing houses, and retail outlets—integrated into the general flow of business of Deere and Company in its production, handling and marketing of a full line of farm equipment. The various acquired

In 1934 Deere and Company entered into a distribution arrangement with the Caterpillar Tractor Company to meet a competitive trade development. That year the International Harvester Company and AUis-Chalmers Manufacturing Company, both of which produced lines of farm machinery competitive with the Deere line, commenced to manufacture track-type tractors and so provided their distributors with a decided advantage in being able to offer customers a complete line of agricultural equipment—tractors plus the implements to be used with them. While Deere and Company manufactured wheel-type tractors along with its line of farm machinery, it did not manufacture track-type tractors. On the other hand, Caterpillar did manufacture track-type tractors but not the farm equipment to be used with them. In recognition of their mutual business interest, the Deere organization and Caterpillar arranged to have their respective products handled together by the same dealers, thus offering a full line of tractor and complementary farm equipment on a competitive basis with International Harvester and Allis-Chalmers. This connection with Caterpillar also enabled the Deere organization to develop its industrial as well as agricultural business so that it was not so completely dependent upon the farmer trade. Thus Caterpillar distributors throughout the country could handle the sale of Deere wheel-type tractors to industrial users so as to promote the use of such tractors with Caterpillar road machinery and other industrial equipment. The arrangement with Caterpillar was effected as a matter of policy by Deere and Company for general application to the entire organization.

The competitive situation was particularly acute on the West Coast in that differences in topographical, climatic and soil conditions as compared with other parts of the country caused trackdype tractors to be much more widely used in that area than the wheel-type machines. This situation caused plaintiff to make some basic changes in its method of doing business pursuant to the arrangement between Deere and Company and Caterpillar to use common dealers, who would sell the combined products of both organizations to all classes of customers. In plaintiff’s San Francisco trade territory the Caterpillar dealers were more strongly established,

The use of former Caterpillar dealers for the distribution of the Deere line of products in the trade territory of plaintiff’s San Francisco jobbing house necessitated plaintiff’s undertaking an extensive program of education with regard to the selling and servicing of such goods; and additional salesmen were employed to visit the new dealers and acquaint them with the Deere output. Plaintiff’s repair and service departments in the San Francisco territory were revised and expanded, staffed with additional trained employees, and equipped with facilities to provide equivalent maintenance and care for both lines of goods. Upon' the termination of its accounts with many of its former dealer customers, plaintiff’s San Francisco house had to arrange for the goods in their hands either to be transferred to the new Deere-Caterpillar distributor who took over that part of the San Francisco trade territory or returned to plaintiff’s San Francisco jobbing house. In some instances, after initial transfer to the new dealer, the old goods would subsequently be returned to plaintiff’s San Francisco jobbing house for credit. The handling of all this merchandise by plaintiff’s San Francisco jobbing house involved considerable checking and reconditioning of the goods, as well as the renting of additional storage space, with a resulting increase in warehouse and transfer expenses for plaintiff’s San Francisco house.

The bulk of the goods sold by plaintiff’s San Francisco house was purchased from Deere and Company for a price determined by applying agreed discounts to the minimum resale price of the goods to the retail dealers. Deere and Company charged the same uniform price to all jobbing houses in the organization for the various lines of goods, adjusting, of course, for freight differentials. The prices and terms so fixed for plaintiff’s San Francisco house allowed it a gross profit margin from its sales comparable to that realized by the other jobbing houses operating in the Deere organization. However, in plaintiff’s San Francisco trade territory the change in the dealer outlets markedly affected

For the taxable year 1938 plaintiff filed an amended franchise tax return showing a California net income of $70,-446.79, according to its separate accounting system, and the tax computed thereon was paid. Thereafter plaintiff received notice of an additional tax assessment of $12,167.53, based upon the commissioner’s determination of plaintiff’s California net income in the total amount of $378,047.71, computed through use of a three-factor formula—property, payroll and sales—in allocating to plaintiff’s California business a percentage of net income out of the consolidated net income of all the affiliated companies in the Deere organization. After protest had been made and overruled by the Franchise Tax Commissioner, plaintiff paid the additional assessment plus interest, and then filed this action for recovery of such payment.

Section 10 of the Bank and Corporation Franchise Tax Act, as in effect during the period here involved, provided that “if the entire business ... is not done within this State, the tax shall be according to or measured by that portion thereof which is derived from business done within this State . . . determined by an allocation upon the basis of sales, purchases, expenses of manufacturer, pay roll, value and situs of tangible property, or by reference to these or other factors, or by such other method of calculation as is fairly calculated to assign to the State the portion of net income reasonably attributable to the business done within this State and to avoid subjecting the taxpayer to double taxation.” (2 Deering’s Gen. Laws 1937, Act 8488, pp. 3851, 3858; Stats. 1929, p. 19; amended by Stats. 1931, p. 2226; Stats. 1935, p. 965.)

Plaintiff does not question the Franchise Tax Commissioner’s determination that its California business was part of the unitary enterprise of Deere and Company as a multistate manufacturing and selling organization, and it concedes that

Plaintiff claims that the impropriety of the formula in question stems from its disregard of differences in both the expenses of operation and the productivity of income from the three factors of property, payroll, and sales in relation to its Californa business for the tax period involved. As shown by the accounting records, prepared at the home office of Deere and Company and covering the nine affiliated jobbing houses in the organization but treating them as separate entities, plaintiff submits that its San Francisco house was not conducted so profitably as other jobbing houses in the national system. In this connection it refers to these conditions of variation from the national average as found by the trial court: that in 1937 “the San Francisco ratio was $6.76 in wages and salaries for each $100 of sales, whereas the average ratio for all included United States houses was $4.46,”

But in so arguing plaintiff fails to take into account the underlying concept of formula apportionment in the allocation of income from a unitary business: that the unitary income is derived from the functioning of the business as a whole, to which the activities in the various states contribute; and that by reason of such interrelated activities in the integrated overall enterprise, the business done within the state is not truly separate and distinct from the business done without the state so as reasonably to permit of a segregation of income under the separate accounting method rather than use of the formula method in assigning to the taxing state its fair share of taxable values. (Butler Brothers v. McColgan, supra, 17 Cal.2d 664 , 667-668; Edison California Stores, Inc. v. McColgan, supra, 30 Cal.2d 472 , 477-479; El Dorado Oil Work v. McColgan, supra, 34 Cal.2d 731 , 735.) As above stated, here the overall organization of Deere and Company was a manufacturing and selling business having its operations extending into a number of different states and providing an example of a typical unitary business subject to formula allocation as a reasonable method of apportionment for franchise tax purposes. (Underwood Typewriter Co. v. Chamberlain, 254 U.S. 113 [ 41 S.Ct. 45 , 65 L.Ed. 165 ]; Bass,

In the apportionment of a unitary business the formula used must give adequate weight to the essential elements responsible for the earning of the income (Butler Brothers v. McColgan, supra, 315 U.S. 501 , 509 [ 62 S.Ct. 701 , 86 L.Ed. 991 ]; see Pacific Fruit Express Co. v. McColgan, 67 Cal.App.2d 93 , 100 [ 153 P.2d 607 ]) and must not include income unconnected with the unitary business (People ex rel. Alpha Portland Cement Co. v. Knapp, 230 N.Y. 48 [ 129 N.E. 202 , 204-205], cert. den. 256 U.S. 702 [ 41 S.Ct. 624 , 65 L.Ed. 1179 ]; also Fargo v. Hart, 193 U.S. 490 , 501-502 [ 24 S.Ct. 498 , 48 L.Ed. 761 ]; Union Tank Line Co. v. Wright, 249 U.S. 275 , 282-293 [ 39 S.Ct. 276 , 63 L.Ed. 602 ] ; Southern Pac. Co. v. McColgan, supra, 68 Cal.App.2d 48 , 82; see Altman and Keesling, Allocation of Income in State Taxation, 2d ed., 1950, p. 97), but its propriety in a given case does not require that the factors appropriately employed be equally productive in the taxing state as they are for the business as a whole. Varying conditions in the different states wherein the integrated parts of the whole business function must be expected to cause individual deviation from the national average of the factors in the formula equation, and yet the mutual

A like situation prevails here in that plaintiff argues that unusual conditions affecting the conduct of its San Francisco jobbing house preclude reasonable application of the three-factor formula. Thus it refers to the effect of the above-mentioned Caterpillar transaction on its California business as involving an increase of operating expenses—through expanded payrolls, added repair and service facilities, extended warehouse handling and transfer charges—and a decrease in productive financial return—through the greater demand for cash and volume discount allowances on sales to the new strongly financed dealers. While plaintiff admits that the sales of its San Francisco jobbing house were slightly more productive of gross income than were the sales of the other

Likewise the property investments and payroll expenses of plaintiff’s San Francisco jobbing house are not segregable solely to California business and in disregard of the unitary business of which it is an integrated part. In the balance of the three factors of the formula—property, payroll, and sales—the operation of the portion of the unitary business within one state is dependent upon or contributes to the operation of the unitary business without the state, and the California business of plaintiff’s San Francisco jobbing house may not fairly be considered as a unit separate not only from other jobbing houses in the entire system but also from the manufacturing activities in the national enterprise. (Underwood Typewriter Co. v. Chamberlain, supra, 254 U.S. 113 , 120-121; Bass, Ratcliff & Gretton, Ltd. v. State Tax Com., 266 U.S. 271 , 282 [ 45 S.Ct. 82 , 69 L.Ed. 282 ].) With regard to a unitary business, the place where expenses affecting the entire business are incurred has little or no bearing on the

Nor does the fact that the trial court found that the accounting records of plaintiff’s San Francisco jobbing house accurately set forth its California sales and operating expenses preclude the further finding that such “records . . . during the period involved did not accurately reflect the income of the plaintiff attributable to its operations and property within the State of California for said period.” There is “no necessary inconsistency between the accuracy and fairness of the taxpayer’s accounting and the different result obtained by the formula method of allocating income” (Edison California Stores, Inc. v. McColgan, supra, 30 Cal.2d 472 , 483) since a “particular accounting system, though useful or necessary as a business aid, may not fit the different requirements when a State seeks to tax values created by business within its borders” (Butler Brothers v. McColgan, supra, 315 U.S. 501 , 507 [ 62 S.Ct. 701 , 86 L.Ed. 991 ]), so that for “taxation purposes the one does not impeach the other.” (Edison California Stores, Inc. v. McColgan, supra, p. 483.)

Plaintiff argues that contrary to the situation in Butler

Plaintiff does not suggest that another formula embracing different factors would produce a more accurate apportionment of the unitary business of the Deere organization done within and without the state (cf. Pacific Fruit Express Co. v. McColgan, supra, 67 Cal.App.2d 93 , 95; El Dorado Oil Works v. McColgan, supra, 34 Cal.2d 731 , 735-736), but it

A state in attempting to place upon a business extending into several states “its fair share of the burden of taxation” is “faced with the impossibility of allocating specifically the profits earned by the processes conducted within its borders” (Underwood Typewriter Co. v. Chamberlain, supra, 254 U.S. 113 , 121), and as a matter of practical tax adminis^ tration it has been “declared that ‘rough approximation rather than precision’ is sufficient.” (International Harvester Co. v. Evatt, supra, 329 U.S. 416 , 422.) As the record has been here analyzed, and particularly in the light of the decision in Edison California Stores, Inc. v. McColgan, supra, 30 Cal.2d 472 , plaintiff’s San Francisco jobbing house operated as an integrated unit in the Deere organization, a manufacturing-selling enterprise, providing the advantages of a unitary business through “unity of ownership, unity of operation by centralized purchasing, management, advertising and accounting, and unity of use in the centralized executive force and general system of operation. ” (Pp. 479-480.) Consistent with these observations, the three-factor formula in its application to plaintiff’s San Francisco jobbing house appears to have “fairly calculated” the portion of the unitary income of the Deere organization “attributable to the business done within this state,” and as so computed it is not open to constitutional objection as operating to tax extraterritorial values. (Edison California Stores, Inc. v. McColgan, supra, 30 Cal.2d 472 , 483; Butler Brothers v. McColgan, supra, 315 U.S. 501 , 507-509;

The judgment is affirmed.

Gibson, C. J., Shenk, J., Carter, J., Traynor, J., and Schauer, J., concurred.