Brown Group Retail, Inc. v. Franchise Tax Board

Opinion

The Franchise Tax Board of the State of California (FTB) appeals from a judgment entered against it and in favor of Brown Group Retail, Inc., successor by merger to Wetherby-Kayser Shoe Company, a Missouri corporation (Brown), awarding Brown a refund of franchise taxes paid for tax years ending in 1976 through 1981.

We conclude that the trial court did err in finding that Brown was immune from franchise tax payments by reason of section 381. Therefore, we need not address the FTB’s second argument.

Statement of the Case

Through a series of mergers, respondent Brown, a Missouri corporation, is the successor to the assets, liabilities and business of Wetherby-Kayser Shoe Company, a California corporation (Wetherby-Kayser). Brown is also a wholly owned subsidiary of Brown Group, Inc. (BGI), also a Missouri corporation. Brown is primarily engaged in the manufacture and sale of shoes.

Wetherby-Kayser filed California franchise tax returns with the FTB for the income years ending October 31, 1976, through October 31, 1981. In February 1985, FTB issued notices of assessment to Wetherby-Kayser, claiming a deficiency in the amount of franchise taxes paid for the above-mentioned income years. Under protest, Wetherby-Kayser paid the claimed deficiencies, which totaled over $300,000. After unsuccessfully pursuing its administrative remedies, Brown filed a complaint in the superior court in April 1993 for refund of the payment.

A court trial was conducted in October 1993, based upon undisputed facts. These facts primarily concerned the activities of BGI and its employees within the State of California. The trial court held that the evidence established that the activities of BGI’s employees within California consisted of mere solicitation of orders, and thus BGI was immune from the imposition of California franchise taxes pursuant to section 381. The court then rejected the FTB’s claim that the payroll attributed to California employees and the sales made in California by Brown should have been included in calculating the amount of taxes owned by the unitary group of BGI.

When an IRD employee was advised that an established retailer wanted to open a new California store, or a prospective retailer wanted to open a store in California, the IRD employee either performed, or assisted the retailer in performing, the following functions: financial analysis to determine the feasibility and potential for the new business; site selection; lease negotiations; store design; training office personnel; and assisting with sales seminars.

An IRD employee assisted established retailers in the daily operation of their stores by helping with the following activities: layout of advertising programs; merchandising displays; store remodeling; bookkeeping—they would provide the retailer with a bookkeeping system for laymen and instruct them on how to use it; and inventory and merchandise planning and control.

In addition to the above services, IRD would facilitate applications for loans from Brown to help retailers expand or open new stores. Retailers who sold only Brown products were eligible for loans from Brown equal to 60 percent of the needed capital, while dealers who sold Brown products as well as other products were eligible for loans equal to 30 percent. The loans would be approved by corporate headquarters in Missouri. In addition, IRD assisted retailers in expanding or relocating stores to suburban malls. The IRD employee would photograph potential new stores, take measurements, and draw up rough floor plans. The drawings and measurements would then be sent to Brown designers in Missouri. When the plans were finalized by the Brown employees in Missouri, they would be sent back to the IRD employee in California, who would review them with the retailer.

Certain activities were not allowed to be performed by IRD personnel: accepting orders from retailers; taking possession of Brown products which were to be returned; maintaining or possessing any Brown products for their own inventory; collecting delinquent accounts; counseling retailers with regard to insurance programs; or charging dealers for their services.

In other words, the business of the IRD employees was not to solicit sales for Brown. Instead, IRD helped develop new business opportunities for retailers and aided existing retailers in expanding their businesses, with the hope that Brown would benefit by means of increased sales.

Standard of review

The parties agree that resolution of the first issue turns on whether or not, under the facts presented, Brown falls within the immunity for taxation provided by section 381. As previously noted, the evidence before the court was undisputed. This is conceded by both parties to the appeal. However, the parties disagree upon the standard of review to be utilized by this court. FTB argues that because the facts were undisputed we review the case de novo and draw our own independent conclusion whether the facts fall within section 381 immunity or not. Brown urges that we must review the case based upon the substantial evidence standard.

This issue was addressed in Anaconda Co. v. Franchise Tax Board (1982) 130 Cal.App.3d 15 [ 181 Cal.Rptr. 640 ]: “Extensive testimony and voluminous documentary exhibits were received in evidence, but the essential facts of the case are undisputed. Since the issues here involve the application of taxing statutes to uncontradicted facts, this court is confronted purely with a question of law and is not bound by the findings of the trial court. (Container Corp. of America v. Franchise Tax Bd. (1981) 117 Cal.App.3d 988 , 993 [ 173 Cal.Rptr. 121 ]; Automatic Canteen Co. v. State Board of Equalization (1965) 238 Cal.App.2d 372 , 381 [ 47 Cal.Rptr. 848 ].)” (Id. at p. 23; see also Standard Register Co. v. Franchise Tax Board (1968) 259 Cal.App.2d 125 , 129-130 [ 66 Cal.Rptr. 803 ].)

We review the matter de novo, applying the law to the uncontradicted evidence.

Section 381 and the Wrigley decision

Section 381 provides in pertinent part: “No State, . . . shall have power to impose, for any taxable year . . . , a net income tax on the income derived within such State by any person from interstate commerce if the only business activities within such State by or on behalf of such person during such taxable year are either, or both, of the following: HD (1) the solicitation of orders ... in such State for sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State; and [^D (2) the solicitation of orders by such person, or his representative, in such State in the name of or for the benefit of a prospective customer of such person, if orders by such customer to such person to enable such customer to fill orders resulting from such solicitation are orders described in paragraph (1).” ( 15

Application of section 381 in connection with state sales activities was directly addressed by the United States Supreme Court in Wisconsin Dept, of Revenue v. William Wrigley, Jr., Co. (1992) 505 U.S. 214 [ 120 L.Ed.2d 174 , 112 S.Ct. 2447 ]. The issue was whether salesmen of the William Wrigley Company, the world’s largest manufacturer of chewing gum, were carrying out activities in Wisconsin beyond the scope of immune activities recognized in section 381. Because a review of the facts in Wrigley is important to our determination, we set them out at length.

The facts in Wrigley:

Wrigley’s home office was in Chicago and it divided the country into districts, regions and territories. The midwestem district included a Milwaukee region which covered most of Wisconsin and parts of other states. The district manager for the midwestem district had his residence and company office in Illinois and visited Wisconsin only six to nine days each year, usually for a sales meeting or to call on important accounts. (Wisconsin Dept, of Revenue v. William Wrigley, Jr., Co., supra, 505 U.S. at p. 217 [120 L.Ed.2d at pp. 181-182].)

The regional manager for Milwaukee resided in Wisconsin, but Wrigley did not provide him with a company office. He spent 80-95 percent of his time working with the sales representatives in the field or contacting key accounts. The remainder of his time was spent in administrative duties: writing and reviewing reports, recruiting new sales representatives, making recommendations about the hiring and firing of sales representatives, and evaluating their performances. He would also preside at full-day sales strategy meetings for all representatives once or twice a year. The manager from 1973-1976, John Kroyer, generally held these meetings in the basement of his home which he used as an office, unreimbursed by Wrigley. The succeeding sales manager, Gary Hecht, would hold the meetings at a hotel or motel. Kroyer also intervened two or three times a year to help arrange a solution to credit disputes between the Chicago office and important local accounts. Hecht never engaged in such activities. (505 U.S. at p. 217 [120 L.Ed.2d at pp. 181-182].)

The sales, or field representatives, in the Milwaukee region resided in Wisconsin and were provided with company cars but not offices. They were also furnished with a supply of gum (with an average wholesale value of $1,000), a supply of display racks, and promotional literature. They kept

Wrigley did not own or lease any real property in Wisconsin; nor did it operate a manufacturing, training or warehousing facility. It had no telephone listing or bank account in Wisconsin. All Wisconsin orders were sent to Chicago for acceptance and were filled by shipment through common carrier from outside the state. Credit and collection activities were all handled through Chicago, except the few noted by Kroyer two to three times a year. While Wrigley engaged in print, radio and television advertising in Wisconsin, the purchase and placement of the advertising was handled by an independent Chicago agency. (505 U.S. at p. 218 [120 L.Ed.2d at pp. 182- 183].)

The history of section 381:

Prior to 1958, the case of Norton Co. v. Illinois Dept, of Revenue (1951) 340 U.S. 534 [ 95 L.Ed. 517 , 71 S.Ct. 377 ], was the standard to determine whether the sales activities of a corporation were sufficient to protect it from taxation by the state in which the sales were solicited: “ ‘Where a corporation chooses to stay at home in all respects except to send abroad advertising or drummers to solicit orders which are sent directly to the home office for acceptance, filling, and delivery back to the buyer, it is obvious that the State of the buyer has no local grip on the seller. Unless some local incident occurs sufficient to bring the transaction within its taking power, the vendor is not taxable.’ (Id. at p. 537.)” (Wisconsin Dept, of Revenue v. William Wrigley, Jr., Co., supra, 505 U.S. at pp. 238-239 [120 L.Ed.2d at p. 195].)

In 1972 the Supreme Court reviewed the history of section 381 in Heublein, Inc. v. South Carolina Tax Comm’n (1972) 409 U.S. 275 [ 34 L.Ed.2d 472 , 93 S.Ct. 483 ], and concluded that section 381 was “ ‘designed to define clearly a lower limit’ for the exercise of state taxing power, and that ‘Congress’ primary goal’ was to provide ‘[c]larity that would remove [the] uncertainty’ created by Northwestern States. . . .” (Wisconsin Dept, of Revenue v. William Wrigley, Jr., Co., supra, 505 U.S. at p. 223 [120 L.Ed.2d at p. 185].)

In Wrigley the court recognized that adoption of section 381 and review of the standard in Heublein had not cleared up confusion. The court noted: “experience has proved [section] 381’s ‘minimum standard’ to be somewhat less than entirely clear. The primary sources of confusion, in this case as in others, have been two questions: (1) what is the scope of the crucial term ‘solicitation of orders’; and (2) whether there is a de minimis exception to the activity (beyond ‘solicitation of orders’) that forfeits [section] 381 immunity.” (505 U.S. at p. 223 [120 L.Ed.2d at p. 185].)

The standard adopted in Wrigley:

The court first addressed the term solicitation: “ ‘Solicitation,’ commonly understood, means ‘[a]sking’ for, or ‘enticing’ to, something, see

Turning to what is encompassed within the term “solicitation,” the court noted: “That the statutory phrase uses the term ‘solicitation’ in a more general sense that includes not merely the ultimate act of inviting an order but the entire process associated with the invitation is suggested by the fact that [section] 381 describes ‘the solicitation of orders’ as a subcategory, not of in-state acts, but rather of in-state ‘business activities’—a term that more naturally connotes courses of conduct. [Citation.] Moreover, limiting ‘solicitation of orders’ to actual requests for purchases would reduce [section] 381(a)(1) to a nullity. . . . And limiting it to acts ‘essential’ for making requests would engender endless uncertainty, contrary to the whole purpose of the statute. ... It seems to us evident that ‘solicitation of orders’ embraces request-related activity that is not even, strictly speaking, essential, or else it would not cover salesmen’s driving on the State’s roads, spending the night in the State’s hotels, or displaying within the State samples of their product. We hardly think the statute had in mind only day-trips into the taxing jurisdiction by empty-handed drummers on foot. [Citation.]” (Wisconsin Dept, of Revenue v. William Wrigley, Jr., Co., supra, 505 U.S. at pp. 225-226 [120 L.Ed.2d at pp. 187-188], italics added and deleted.)

The majority rejected three suggested standards: “We reject this ‘routinely-associated-with-solicitation’ or ‘ customarily-performed-by-salesmen ’ approach, since it converts a standard embracing only a particular activity (‘solicitation’) into a standard embracing all activities routinely conducted by those who engage in that particular activity (‘salesmen’). If, moreover, the approach were to be applied ... on an industry-by-industry basis, it would render the limitations of [section] 381(a) toothless, permitting ‘solicitation of orders’ to be whatever a particular industry wants its salesmen to do.” (505 U.S. at p. 227 [120 L.Ed.2d at p. 188].)

The court then turned to adoption of a proper standard: “We proceed, therefore, to describe what we think the proper standard to be. Once it is

The court then applied this enunciated standard to the facts of the case.

“We conclude that the replacement of stale gum, the supplying of gum through ‘agency stock checks,’ and the storage of gum were not ancillary. As to the first: Wrigley would wish to attend to the replacement of spoiled product whether or not it employed a sales force. Because that activity serves [as] an independent business function quite separate from requesting orders, it does not qualify for [section] 381 immunity. [Citation.] Although Wrigley argues that gum replacement was a ‘promotional necessity’ designed to ensure continued sales, ... it is not enough that the activity facilitate sales; it must facilitate the requesting of sales, which this did not. [^Q The provision of gum through ‘agency stock checks’ presents a somewhat more complicated question. It appears from the record that this activity occurred only in connection with the furnishing of display racks to retailers, so that it was arguably ancillary to a form of consumer solicitation. Section 381 [, subdivision] (a)(2) shields a manufacturer’s ‘missionary’ request that an indirect customer (such as a consumer) place an order, if a successful request would ultimately result in an order’s being filled by a [section] 381 ‘customer’ of the manufacturer, i.e., by the wholesaler who fills the orders of the retailer with goods shipped to the wholesaler from out of state. [Citation.] (‘Advice to retailers on the art of displaying goods to the public can hardly be more thoroughly solicitation. . . .’) It might seem, therefore, that setting up gum-filled display racks, like Wrigley’s general advertising in Wisconsin, would be immunized by [section] 381[, subdivision] (a)(2). What destroys this analysis, however, is the fact that Wrigley made the retailers

“By contrast, Wrigley’s in-state recruitment, training, and evaluation of sales representatives and its use of hotel and homes for sales-related meetings served no purpose apart from their role in facilitating solicitation. The same must be said of the instances in which Wrigley’s regional sales manager contacted the Chicago office about ‘rather nasty’ credit disputes involving important accounts in order to ‘get the account and [Wrigley’s] credit department communicating.’ [Citation.] It hardly appears likely that this mediating function between the customer and the central office would have been performed by some other employee—some company ombudsman, so to speak—if the on-location sales staff did not exist. The purpose of the activity, in other words, was to ingratiate the salesman with the customer, thereby facilitating requests for purchases.” (505 U.S. at pp. 233-235 [120 L.Ed.2d at pp. 192-193].), fns. omitted, italics added and deleted.)

Finally, the majority held that the nonsolicitation activities were not de minimis. (505 U.S. at p. 235 [120 L.Ed.2d at p. 193].)

The court reversed the Wisconsin Supreme Court by concluding: “Because Wrigley’s business activities within Wisconsin were not limited to those specified in [section] 381, the prohibition on net-income taxation contained in that provision was inapplicable.” (505 U.S. at p. 235 [120 L.Ed.2d at p. 193].)

The dissent.

Three dissenting justices offered a different standard.

First, they noted that normal acts of courtesy should be considered within the context of solicitation. “A salesperson cannot solicit orders with any degree of effectiveness if he is constrained from performing small acts of courtesy. [Citation.]” (Wisconsin Dept, of Revenue v. William Wrigley, Jr., Co., supra, 505 U.S. at p. 242 [120 L.Ed.2d at p. 197] (dis. opn. of Kennedy, J.).) “No responsible company would expect its sales force to decline giving minimal assistance to a retailer in replacing damaged or stale product. In enacting [section] 381 [, subdivision] (a), Congress recognized the importance of interstate solicitation to the strength of our national economy. The

The standard espoused in the dissent can reasonably be described as a “value added” test to be viewed from the perspective of the retailer: “The test I propose does not depend on the sellers’ intentions or motives whatsoever; rather it requires an objective assessment from the vantage point of the reasonable buyer. If a reasonable buyer would consider the replacement of stale gum to provide significant independent value, then this service would subject Wrigley to taxation.” (505 U.S. at p. 243 [120 L.Ed.2d at p. 198], italics added.) “The [majority] pursues a laudable effort to state a workable rule, but in the attempt condemns business activities that are bound to solicitation and do not possess independent value to the customer apart from what often accompanies a successful solicitation.” (Id. at p. 246 [120 L.Ed.2d at p. 200], italics added.)

Application of section 381 and the Wrigley decision to the facts of this case

Utilizing either standard propounded in Wrigley, we have no problem concluding that the activities of the IRD personnel on behalf of Brown do not fit within the immunity provided by section 381.

First, it is clear from the majority opinion in Wrigley that only request-related activity qualifies for immunity. That is not the situation presented here.

IRD employees are employed within a separate division of Brown. They are not used to solicit sales from customers; that is the job of the 14 sales employees. In fact, IRD employees are excluded from accepting orders from retailers, taking possession of Brown products to be returned, maintaining or possessing any Brown products for their own inventory, or dealing with delinquent accounts; all activities which may be considered ancillary to solicitation of sales.

The IRD activity is not undertaken in connection with sales activity. It is undertaken independent of sales activity with the intent that in the future new retailers will exist, existing retailers will have expanded their capacity,

While the IRD activities may ultimately result in increased sales for Brown, they are not request related activities and do not facilitate the requesting of sales. As the court stated in Wrigley. “Although Wrigley argues that gum replacement was a ‘promotional necessity’ designed to ensure continued sales, ... it is not enough that the activity facilitate sales; it must facilitate the requesting of sales, which this did not.” (Wisconsin Dept, of Revenue v. William Wrigley, Jr. Co., supra, 505 U.S. at p. 233 [120 L.Ed.2d at p. 192], fn. omitted, italics added and deleted.)

Many of the services offered are not at all related to sales and are the type which a small retailer would have to pay a marketing or management service to duplicate. For example: financial analysis to determine the feasibility and potential for the new business; site selection; lease negotiation; store design; training of office personnel; provision of a bookkeeping system; and inventory management and control. None of these services fits within the standard enunciated by the majority because they are not request related activities and do not facilitate the requesting of sales.

Utilizing the standard enunciated in the dissent, much of the IRD activity also falls outside the immunity. The services provided to the retailers clearly result in added value to the retailers, services the retailers would normally have to facilitate through their own employees or by hiring independent contractors.

Brown emphasizes the fact that the IRD services were provided without charge to retailers. The trial court also made reference to this fact: “We know that the IRD function was not directly compensated for by the retailers.” If Brown had charged for these services, the issue would have been much easier to decide. The following exchange took place while the Senate was considering enactment of section 381: “Senator Saltonstall: ‘There is some question as to whether the sale of services is left out of the