Opinion
Apple, Inc. (Apple), is one of the world’s largest multinational corporations.
At issue in this tax refund action is the California tax treatment of repatriated dividends paid to Apple from certain of its subsidiaries in its 1989 tax year. More specifically, the issue is the appropriate method to account for the source from which repatriated dividends are paid, and which of two competing methods is more consistent with the provisions of our tax code that seek to ensure that foreign subsidiary income is appropriately taxed—but
Apple argued that FTB improperly subjected it to double taxation when it applied a last-in-first-out (LIFO) proration of its income, treating the dividends as paid first from the current year’s earnings, and only then from the most recent prior years’ earnings on a year-by-year basis. Apple contends that Revenue and Taxation Code section 25106,
Following a nonjury trial, presented largely on stipulated facts, the trial court ruled against Apple on the dividend ordering issue, but in Apple’s favor on the disputed interest deduction. As a result, it ordered that a refund be paid to Apple in the amount of $920,482.80 plus interest—the full amount sought by Apple in its complaint. Apple subsequently moved for an award of its attorney fees under section 19717, subdivision (a)
Apple appeals the court’s adverse ruling on the application of section 25106. FTB cross-appeals, challenging the determination on the interest deduction and the refund order. We have also consolidated Apple’s separate appeal from the court’s denial of its motion for attorney fees. We affirm in all respects.
As our Supreme Court has observed, “Ours is a global economy. In contrast, government and the taxing authority used to fund it are national and local. This geographic disparity generates difficulties when each jurisdiction seeks its piece of the economic pie, a pie generated by economic activity that knows no borders.” (Microsoft Corp. v. Franchise Tax Bd. (2006)
At the federal level, a United States corporation is taxed on all of its income whether it is earned inside or outside of the United States. To deter United States taxpayers from using related foreign companies to accumulate earnings offshore, the federal Internal Revenue Code (26 U.S.C.; hereafter IRC) requires that a United States entity include in current taxable income, as a constructive dividend, a portion of the United States entity’s share of the controlled foreign company’s current income.
California Taxation of Unitary Business Enterprises
California imposes a franchise tax on corporations doing business within the state on the corporation’s net income derived from or attributable to sources within California. (§ 25101.) When a corporation, and its affiliated corporations, conduct business both within and outside the state as part of a larger unitary business enterprise, it becomes necessary to determine how much of the income of the unitary business is attributable to sources within California.
California has adopted the unitary business principle to determine the portion of a corporate taxpayer’s total income that is attributable to this state for California franchise and income tax purposes. (Container Corp. v. Franchise Tax Bd. (1983)
Under the unitary business principle, an affiliated group of corporations under common control or ownership is viewed as a whole or a single unit. A taxpayer that is engaged in a unitary business generally determines its tax based upon a worldwide combined report, which includes the income of all domestic and foreign members (e.g., corporate affiliates and subsidiaries) of the unitary business. A formula is applied “ ‘apportioning the total income of that “unitary business” between the taxing jurisdiction and the rest of the world[,] . . . taking into account objective measures of the corporation’s activities within and without the jurisdiction.’ [Citation.]” (Microsoft, supra, 39 Cal.4th at p. 756.) “[T]axes are apportioned based on property, payroll, and sales to allocate to California for taxation ‘its fair share of the taxable values of the taxpayer . . . .’ [Citation.]” (Fujitsu, supra,
Effective January 1, 1988, taxpayers that constituted a unitary business were allowed to choose a “water’ s-edge election” combined report that includes the income of domestic entities and only a portion of the income of certain controlled foreign subsidiaries (controlled foreign corporations; CFC’s).
Apple’s California Tax Filings
Through the taxable year ending September 30, 1988, Apple filed its California franchise tax returns on the basis of a worldwide combined report, which included Apple and all of its domestic and foreign subsidiaries that were engaged in a single unitary business. During 1989 and prior tax years, Apple owned 100 percent of the stock of Apple Computer Inc. Limited, incorporated in Ireland (ACL), which, in turn, owned 100 percent of the stock of two subsidiary corporations, Apple Computer International Limited, a United Kingdom company (ACIL), and AC Limited, incorporated in Ireland (AC Ltd.). During the 1989 tax year in question, ACIL owned 100 percent of the stock of Apple Computer Cayman Finance Limited (AC Cayman), a Cayman Islands company. Apple calculated its inclusion ratios under section 25110 for ACL at 9.6490 percent; for ACIL at 73.7722 percent; and for AC Ltd. at 1.4578 percent. Also included in Apple’s worldwide combined report were Apple Computer Holding BY, Apple Australia, Apple Canada and Apple Computer A.B.
Beginning with the 1989 tax year, Apple made a water’s-edge election and filed its California franchise tax return on the basis of a water’s-edge combined report, which included all the income of its unitary domestic subsidiaries and the partial income of certain CFC’s. In 1989, Apple had previously undistributed foreign subsidiary earnings of $698,778,366. It repatriated $86.6 million in dividends from its foreign operations. AC Cayman distributed a dividend of $11.4 million to ACIL, ACIL distributed a dividend of $45.1 million to ACL, AC Ltd. distributed a dividend of $2 million to ACL, and ACL distributed a dividend of $50 million to Apple. In addition, in the 1989 tax year, Apple received the following dividends from its other foreign subsidiaries: $10,440,309 from Apple Computer Holding BY; $8 million from Apple Australia; $18 million from Apple Canada; and $210,035 from Apple Computer A.B.
Apple deducted $10,691,430 in interest expenses for its 1989 tax year. FTB disallowed $1,893,886 of this amount on the basis that, to the extent that the dividends paid by Apple’s CFC’s were paid out of excluded income, they were deductible as “Qualifying Dividends” under section 24411.
FTB determined that Apple had underpaid its 1989 franchise tax liability and owed an additional $231,038 in tax for that tax year. With interest of $689,444.80, the total amount of FTB’s assessment was $920,482.80. Apple paid this amount prior to filing the suit for refund.
The Trial
On January 16, 2008, Apple filed its complaint against FTB in San Francisco Superior Court seeking a refund in the amount of $920,482.80, plus interest. A nonjury trial was held February 25 to 26, 2009 (before Judge Harold E. Kahn), presented largely on stipulated facts with limited live testimony. On January 26, 2010, the trial court issued its final statement of decision, ruling against Apple on the LIFO issue, and in favor of Apple on the section 24425 issue. An amended judgment was entered on February 22, 2010, granting Apple a tax refund in the amount of $920,482.80 plus interest. Apple filed its notice of appeal on March 29, 2010, and FTB filed its notice of cross-appeal on April 19, 2010.
The Attorney Fees Motion
On March 29, 2010, Apple filed its motion seeking an award of attorney fees. A hearing on the motion was held on April 26, 2010, and the trial court
II. Discussion
A. Appealability
FTB first contends that Apple is precluded from appealing the court’s adverse ruling on the distribution ordering issue because it succeeded in obtaining the full refund requested in its complaint.
Apple’s notice of appeal states that it is appealing from “the portion of the judgment . . . which incorporates the [trial court’s] ruling against [Apple] contained in the Final Statement of Decision (pp. 3-7) relating to the distribution ordering issue.” FTB correctly notes that an appeal can only be taken from a final judgment, not from a statement of decision, and that Apple cannot appeal a portion of the trial court’s statement of decision. (Bailey v. County of El Dorado (1984)
Apple insists that it is a “party aggrieved” because the distribution ordering issue was fully litigated before the trial court, was necessarily determined in the trial court’s decision in that the court reached the interest expense deduction issue at all only as a consequence of its ruling on this question, and
FTB contends that the two issues litigated before the trial court were merely “separate, alternative grounds” upon which the trial court could have relied in awarding the refund to Apple, and that the court’s determination of the distribution ordering issue was not “necessary” to the judgment. FTB’s reliance on Estate of Funkenstein is misplaced. There the court relied upon “well settled” law to find the judgment in favor of appellants to be nonappealable because “where a finding is contrary to a judgment or order rendered, or immaterial to it, and the judgment or order is based upon other findings that do support it, the findings contrary or immaterial are not adjudications against the party who prevails.” (Estate of Funkenstein, supra, 170 Cal. at pp. 595-596, italics added.)
We do not agree that the trial court’s adjudication of the distribution ordering issue under section 25106 was “immaterial” to the judgment entered. The issue raised the legal question of whether the dividends that Apple received from its foreign subsidiaries in the 1989 tax year should be treated as paid first out of current and prior years’ earnings already taxed before consideration of any other earnings (preferential ordering), or subject to LIFO ordering under the approach applied by FTB. The parties stipulated that “[n]either ... § 24425 nor § 24344 applies to dividends that are eliminated under . . . § 25106.” If preferential ordering is applied, all of the dividends in question would be deemed paid from previously taxed earnings and thus eliminated from Apple’s income. (§ 25106.) If LIFO ordering is applied, some of the subject dividends would be eliminated and the remainder of the dividends would be deductible. (§ 24402.) The trial court’s determination of the distribution ordering issue decided whether Apple’s dividends should be eliminated in the first instance, or whether they should be deducted. Only the deductible dividends may result in disallowance of interest expense deductions (§ 24425)—the second issue that was then addressed and decided by the trial court.
For the reasons we have discussed above, we doubt our ability to decide the propriety of Apple’s interest expense deduction without necessarily addressing the issue of distribution ordering, and we do not agree that the distribution ordering issue was merely an alternative ground on which the trial court could have ruled in Apple’s favor. Even if it were possible for us to do so, we see little justification for avoiding the question. “The principal reason for an appellate court to decline to review alternative grounds for a trial court decision is judicial economy . . . .” (Zevnik, supra,
B. Standard of Review
In our review on the merits, “we apply the substantial evidence test to the trial court’s factual findings, but review legal determinations independently. [Citations.]” (Fujitsu, supra,
C. The Distribution Ordering Issue and Application of Section 25106
FTB characterizes this case as an attempt by Apple to avoid, or indefinitely defer, California taxes and to secure an improper “double benefit.” Apple argues that this is instead a case of “double taxation.” Apple complains that it previously paid $30 million in California franchise tax on the earnings of its CFC’s which it accumulated, and that section 25106 provides a “plain and broad mandate” that unitary members “be permitted to move previously taxed unitary earnings among themselves, in the form of dividends, without tax incident.” (Fn. omitted.) Apple asserts that Fujitsu is controlling here because Fujitsu addressed the same distribution ordering issue now before this court, and that FTB simply disagrees with the court’s holdings in Fujitsu and seeks to “avoid its application.” (Fn. omitted.) The trial court found that Fujitsu did not address the precise issue presented here, as do we.
Fujitsu did address application of section 25106, and the inclusion ratio to be applied to CFC income under section 25110, but in a different context. In Fujitsu, a multinational California-headquartered parent corporation filed water’s-edge combined income tax returns that included combined income of its unitary group members incorporated in the United States, and Subpart F income from its CFC’s. (Fujitsu, supra, 120 Cal.App.4th at pp. 468, 469.) The corporation characterized a United Kingdom tax refund it received, under the terms of a tax treaty, from the United Kingdom subsidiary as a dividend on its combined return, while FTB treated it as nondividend income. (Id. at pp. 471-472.) The corporation sued for a refund encompassing four tax years. FTB denied the refund, the trial court granted it, and the appellate court affirmed. (Id. at pp. 470-489.)
The Fujitsu court first held that, in determining the numerator (Subpart F income) of the inclusion ratio for taxable CFC income (§ 25110), “[i]t is clear
The Fujitsu court then considered the ordering to be applied to payment of dividends within a tax year “where part of the CFC’s income is Subpart F income and thus included in the unitary group’s tax return, and some is not.” (Fujitsu, supra,
The issue here, however, is characterizing the source of the dividend payments when the CFC’s also have an undistributed pool of accumulated earnings from prior tax years in addition to a surplus in the current year.
Fujitsu did not discuss at all how earnings accumulated over multiple tax years should be treated. Apple contends, however, that the rationale of Fujitsu dictates that retained earnings from prior years that have already been taxed as “included income” must be deemed to be the first source of a dividend until that retained surplus has been exhausted. Only in that way, Apple argues, can double taxation be avoided and the California tax policy reflected in section 25106, to ensure that amounts included in the combined income of a unitary group can be moved among members of the unitary group in the form of dividends without tax consequence, be respected.
FTB first disputes Apple’s contention that the CFC accumulated earnings necessarily represent amounts which were “included in the combined income of the unitary group” since only a fraction of this income (based on Subpart F income or “included income”) is taxed, and the balance is excluded and
1. Application of IRC Section 316 and Revenue and Taxation Code Former Section 24495
FTB relies upon IRC section 316 and Revenue and Taxation Code former section 24495 as establishing a definitive LIFO ordering rule for dividends paid. IRC section 316(a)(2) defines a dividend as “any distribution of property made by a corporation to its shareholders . . . out of its earnings and profits of the taxable year . . . .” (Italics added.) It further provides that “[e]xcept as otherwise provided in this subtitle . . . , every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits. . . .” (Italics added.) Its purpose was to preclude a corporation from declaring which year’s profits were being distributed. (Edwards v. Douglas (1925)
2. IRC Section 959(c)
Apple contends that IRC section 316 is only a rule of general applicability and nevertheless expressly allows for alternative ordering in that it governs “[e]xcept as otherwise provided ....” In Apple’s view, IRC section 959(c) otherwise provides and “trumps” IRC section 316. We disagree. Apple is correct that IRC section 959(c) provides that distributions received from a foreign subsidiary are deemed to have been paid first from earnings and profits attributable to amounts previously included in taxable gross income and then to other earnings and profits. But as FTB points out, IRC section 959(c), unlike IRC section 316, is not expressly incorporated in the Revenue and Taxation Code, and the federal tax scheme differs with respect to tax treatment of income from CFC’s, deeming it to be a constructive dividend paid in the year earned (and thereby taxable income to the parent company), whether or not any of the amounts are repatriated in that year. Fujitsu did not hold otherwise, since it expressly addressed only current year earnings. Fujitsu's sole discussion of IRC section 959, and application of the double
Nor are we persuaded by Apple’s insistence that section 25106 implicitly adopts an equivalent preferential ordering mle in its temporal references to tax of a corporation which “is or has been determined under this chapter with reference to the income and apportionment factors of one or more corporations with which it is doing or has done a unitary business.” (§ 25106, subd. (a)(1), italics added.) Section 25106 says nothing about ordering of dividends, or the tax year in which they are recognized. Section 25106 expresses a clear legislative policy against imposition of double taxation on income, but we are not convinced that the double taxation specter Apple invokes necessarily arises simply by virtue of LIFO ordering of dividend distributions. Certainly it does not appear that it did so with respect to the tax year at issue here.
In Apple’s administrative appeal in this matter, the SBE’s opinion included a detailed analysis of the dividend ordering issue. (Appeal of Apple Computer, Inc., supra, Cal.Tax Rptr. (CCH) ¶ 404-085, pp. 34,110-34,115 [2006 Cal. Tax Lexis 431 at pp. *6-*32].) The Legislature has delegated to the SBE the duty of hearing and determining appeals from actions of the FTB. (§§ 19045-19048.) In rejecting Apple’s proposed preferential ordering, the SBE found that the plain language of IRC section 316 and Regulation 24411 required LIFO ordering as between tax years (and pro rata allocation between included and excluded income within the tax year). (Appeal of Apple Computer, Inc., at pp. 34,111, 34,114 [2006 Cal. Tax Lexis 431 at pp. *11-*16, *21-*28].) Further, it found that the ordering suggested by Apple would “render meaningless the statutory and regulatory references to ‘current’ and ‘most recent’ earnings.” (Id. at p. 34,111 [2006 Cal. Tax Lexis 431 at p. *2].) The SBE concluded that CFC dividends paid from accumulated earnings must be “deemed paid from the current year’s earnings until those earnings are exhausted, and thereafter from the most recent years’ earnings, exhausting each year’s earnings in turn.”
We agree with the SBE’s conclusion that LIFO ordering as between tax years is consistent with clear statutory and regulatory authority, and that it deters abuse by preventing a corporation from declaring what year’s earnings are being distributed. To allow preferential ordering of dividends between tax years would allow potentially indefinite tax avoidance by ignoring consideration of earnings attributable to untaxed excluded income until all included income had been exhausted. We believe that the policy of section 25106 to prevent double taxation is still honored in allowing total exclusion for dividends received within a tax year to the extent of included income for that tax year.
D. The Interest Deduction
“Deductions may be allowed or withheld by the Legislature as it sees fit [citations] and such deductions, like credits and exemptions, are to be narrowly construed against the taxpayer [citations].” (Great Western, supra, 4 Cal.3d at pp. 5-6.) “In a suit for refund of tax, the burden of proof is on the taxpayer. [Citation.] The taxpayer must not only prove that the tax assessment is incorrect, but also he must produce evidence to establish the proper amount of the tax. [Citations.]” (Honeywell, Inc. v. State Bd. of Equalization (1982)
The evidence with respect to this issue was largely undisputed. There was a dispute, however, as to the dominant purpose of Apple’s borrowings. The trial court made detailed findings of fact on this question. It found that, while FTB failed to offer evidentiary support for disallowance of the interest deduction, Apple presented substantial evidence showing that the dominant purpose of its borrowings in 1989 was to fund its domestic operations. The evidence established that Apple had no long-term debt in 1989, 1988 or 1987, and its short-term debt had an average date to maturity of 26 days in 1989; Apple incurred short-term debt to finance its domestic working capital needs; Apple’s seven CFC dividend payors held $601 million in cash reserves in 1989, and did not need to borrow funds from Apple to fund their operations; there were no intercompany loans from Apple to any of the seven dividend payors during the 1989 tax year; and there was no other flow of funds from Apple to the seven CFC dividend payors during the 1989 tax year. The court noted that FTB’s own witness on this issue (Jenice Twomey) testified that
FTB argues that, nevertheless, “it is reasonable to infer that, when Apple incurred indebtedness to fund its domestic operations, a portion of the proceeds from [that] indebtedness was also used to carry the assets of the subsidiaries that paid the dividends at issue in this case,” and that a portion of the interest expense must therefore be allocable to the dividend income deducted. The gist of this argument is that even when money is borrowed for a specific purpose, the borrowing will generally free other funds for discretionary purposes and that the expense thereby contributes to all aspects of the corporate operations. In this instance, FTB further contends that the evidence shows that Apple “admitted” that it borrowed to fund its domestic activities in order to avoid the tax consequences of repatriation of dividends from its cash-rich foreign subsidiaries (sometimes referred to as “ ‘tax arbitrage’ "; see Hunt-Wesson, Inc. v. Franchise Tax Bd. of Cal. (2000)
Both Apple and FTB cite the SBE determination in Zenith, supra, Cal.Tax Rptr. (CCH) ¶ 402-965 [1998 Cal. Tax Lexis 1], in support of their respective positions.
Premised on the “fungibility of money,” FTB took the position that interest, by its nature, is not susceptible to direct allocation, and could only be indirectly allocated by formula. (Zenith, supra, Cal.Tax Rptr. (CCH) ¶ 402-965, pp. 28,991-28,992 [1998 Cal. Tax Lexis 1 at p. *18].) The SBE said that the establishment of the proper allocation of interest expense would instead involve an inquiry into both the purpose of the borrower and an accounting as to the actuad use or uses the borrowed funds were put. (Id. at p. 28,992 [1998 Cal. Tax Lexis 1 at p. *14].) The SBE held that the burden was on the taxpayer to establish a direct allocation between the borrowing expense and the investment purpose, and that FTB’s allocation formula would otherwise apply: “In the absence of direct evidence linking indebtedness with a particular purchase, the IRS, and this Board, will determine whether the totality of the facts and circumstances establish a sufficiently direct relationship between the borrowing and the investment to allow for a direct allocation between those two items. [Citation.] Unless the taxpayer can establish its dominant purpose and a sufficiently direct relationship between the expense and the income, [FTB’s] allocation formula will provide the best means to allocate interest expense between taxable and nontaxable activities. Further, due to the factual nature of the inquiries presented by this analysis, it is also clear that the taxpayer must carry the general burden of proving its dominant purpose for incurring and/or continuing the subject obligations (and the related interest expense), as well as the burden of demonstrating the actual use of the subject funds, by tracing or some other method.” (Ibid., italics added.) The SBE has followed this analysis in subsequent cases. (See, e.g., In the Matter of the Appeal of American General Realty Investment Corp., Inc., (June 25, 2003) [2003-2005 Transfer Binder] Cal.Tax Rptr. (CCH) ¶ 403-483, p. 31,022 [a nonprecedential summary decision stating, “establishment of the proper allocation of interest expense may involve an inquiry into both the purpose of the borrower and an accounting as to what use or uses the borrowed funds were put”].)
We again find the SBE analysis on this issue persuasive. The issue is not whether FTB may seek to allocate otherwise deductible expenses between taxable and nontaxable income. Unquestionably it can. (See Hunt-Wesson, supra,
FTB’s approach would ignore Zenith, and would instead implement an effectively conclusive presumption that if a domestic corporation borrows at all, it has done so at least in part to support its other unitary operations, regardless of any contrary showing by the taxpayer. We decline to adopt a position that would push the concept of fungibility of money “past reasonable bounds.” (Hunt-Wesson, supra,
E. Attorney Fees
Apple sought an award of attorney fees of $683,492.73 under section 19717, subdivision (a) and Code of Civil Procedure section 1021.5. Section 19717, subdivision (a) permits an award of reasonable litigation costs to a prevailing party in an action such as this for refund of a tax. Code of Civil Procedure section 1021.5 encompasses the so-called “private attorney general” doctrine, allowing the court to award fees to a successful litigant who has enforced an important right affecting the public interest. The trial court declined to award- fees on either basis.
We review the court’s ruling denying fees for abuse of discretion. (Agnew v. State Bd. of Equalization (2005)
1. Section 19717
We assume for our discussion that Apple meets the statutory threshold criteria under the Revenue and Taxation Code as a “prevailing party” in that it “substantially prevailed with respect to the amount in controversy.” (§ 19717, subd. (c)(2)(A)(i).)
The trial court stated in its final statement of decision that “FTB’s interpretation of ... § 24425 stretches the meaning of ‘allocable’ beyond a reasonable construction.” Nevertheless, the court also found that FTB’s position in the litigation was substantially justified.
Apple insists that FTB could not be substantially justified in pursuing the “fungibility of money” argument, because it took a position “repeatedly rejected” by the SBE and the courts. It urges that an award of attorney fees is necessary “as a disincentive to the FTB to take positions that it cannot substantially justify.” (Fujitsu, supra,
Apple overstates the significance of the principal case authorities upon which it relies. For example, Apple contends that the Supreme Court decision in Hunt-Wesson, supra,
Likewise, Apple attempts to draw too much from the SBE’s holding in Zenith. Far from outright rejecting FTB’s indirect allocation formula for apportioning deductible expenses, the SBE held that “[u]nless the taxpayer can establish its dominant purpose and a sufficiently direct relationship between the expense and the income, [FTB’s] allocation formula will provide the best means to allocate interest expense between taxable and nontaxable activities.”
Among other reasons, the trial court found FTB’s position was substantially justified and that it was not unreasonable or frivolous because it did not contravene any binding authority. It similarly rejected Apple’s contention that Hunt-Wesson was dispositive, and recognized and accepted Zenith's holding that FTB’s indirect allocation formula could still be used where the taxpayer failed to establish the dominant purpose of its borrowing either through direct tracing or by consideration of the totality of facts and circumstances. But because Apple had successfully demonstrated direct allocation, the court found that here there was “[no] need to use FTB’s indirect allocation formula.”
We find no abuse of discretion in the court’s denial of fees under section 19717.
2. Code of Civil Procedure Section 1021.5
Section 19717 is not the exclusive means or measure of attorney fees in a tax refund action. (Northwest Energetic Services, LLC v. California Franchise Tax Bd. (2008)
The statute specifically requires that the action result in a significant benefit to the general public or a large class of persons. Its purpose is to provide an incentive for “ ‘the plaintiff who acts as a true private attorney general, prosecuting a lawsuit that enforces an important public right and confers a significant benefit, despite the fact that his or her own financial stake in the outcome would not by itself constitute an adequate incentive to litigate.’ [Citation.]” (Flannery, supra,
The trial court found that Apple failed to show that the ruling in its favor had provided a significant benefit to the public or a large class of persons. “At most the ruling is only beneficial to those corporations, like Apple, who conduct business in both California and abroad, record profits from their non-United States subsidiaries and engage in borrowings in California that are not ‘allocable’ to those overseas profits. I have no idea how many such businesses there are and, of that unknown number, how many could or would benefit from the decision on the interest expense issue. . . . Moreover, ... I perceive nothing inappropriate or unfair about requiring Apple [to bear its own litigation attorney fees].”
“When the record indicates that the primary effect of a lawsuit was to advance or vindicate a plaintiff’s personal economic interests, an award of fees under [Code of Civil Procedure] section 1021.5 is improper. [Citations.]” (Flannery, supra,
We find no abuse of discretion in denial of fees under Code of Civil Procedure section 1021.5.
The judgment is affirmed. The parties will bear their own costs.
Jones, P. J., and Simons, J., concurred.
A petition for a rehearing was denied October 5, 2011, and the petition of appellant Apple, Inc., for review by the Supreme Court was denied January 4, 2012, S197381. Chin, J., did not participate therein.
Notes
See Dullforce, FT Global 500 (June 24, 2011) Financial Times <http://www.ft.com/intl/ cms/s/2/1516dd24-9d3a-lle0-997d-00144feabdc0.html#axzzlUfTtHutq> (as of Sept. 12, 2011).
All further code references are to the Revenue and Taxation Code unless otherwise indicated. Also, unless otherwise indicated, statutory revisions subsequent to the tax year at issue here do not affect the substance of our analysis.
“The prevailing party may be awarded a judgment for reasonable litigation costs incurred, in the case of any civil proceeding brought by or against the State of California in a court of record of this state in connection with the determination, collection, or refund of any tax, interest, or penalty under this part.” (§ 19717, subd. (a).)
“Upon motion, a court may award attorneys’ fees to a successful party against one or more opposing parties in any action which has resulted in the enforcement of an important right affecting the public interest if: (a) a significant benefit, whether pecuniary or nonpecuniary, has been conferred on the general public or a large class of persons, (b) the necessity and financial burden of private enforcement, or of enforcement by one public entity against another public entity, are such as to make the award appropriate, and (c) such fees should not in the interest of justice be paid out of the recovery, if any. . . .” (Code Civ. Proc., § 1021.5.)
A United States shareholder is required to report the constructive dividend income even if the controlled foreign corporation has not made any actual distribution to the shareholder. (IRC, § 951.)
Section 25106, subdivision (a)(1) states that “[i]n any case in which the income of a corporation is or has been determined under this chapter with reference to the income and apportionment factors of one or more other corporations with which it is doing or has done a unitary business, all dividends paid by one to another of any of those corporations shall, to the extent those dividends are paid out of the income previously described of the unitary business, be eliminated from the income of the recipient and, except for purposes of applying Section 24345, shall not be taken into account under Section 24344 or in any other manner in determining the tax of any member of the unitary group.” (See also fn. 18.)
“A CFC, generally, is organized in a foreign country and is more than 50 percent owned by [United States] shareholders.” (Fujitsu, supra,
During the 1989 tax year in issue, the inclusion ratio was found in subdivision (a)(7) of section 25110. It was renumbered as subdivision (a)(6) in 1995, and is currently found at subdivision (a)(2)(A)(ii).
As we discuss post, FTB initially characterized the majority of the CFG dividends as partially deductible under section 24411. During Apple’s administrative appeal before the state Board of Equalization (SBE), the Second District Court of Appeal issued a decision in Farmers Bros. Co. v. Franchise Tax Bd. (2003)
If LIFO proration is applied, only a portion of the dividends would be eliminated, and the remainder treated as deductible. This is significant because deductible dividends are treated less favorably than eliminated dividends in several respects. (See Fujitsu, supra,
Section 24411, subdivisions (a) and (b) provide: “(a) For purposes of those taxpayers electing to compute income under Section 25110, 100 percent of the qualifying dividends described in subdivision (c) and 75 percent of other qualifying dividends to the extent not otherwise allowed as a deduction or eliminated from income. ‘Qualifying dividends’ means those received by the water’s-edge group from corporations if both of the following conditions are satisfied: [ft] (1) The average of the property, payroll, and sales factors within the United States for the corporation is less than 20 percent, [ft] (2) More than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by the water’s-edge group, [ft] (b) The water’s-edge group consists of corporations whose income and apportionment factors are taken into account pursuant to Section 25110.” (Cf. former § 24411, subds. (a), (g), as amended by Stats. 1988, ch. 989, § 1, p. 3222.)
“If income of the taxpayer which is derived from or attributable to sources within this state is determined pursuant to Section 25101 or 25110, the interest deductible shall be an amount equal to interest income subject to apportionment by formula, plus the amount, if any, by which the balance of interest expense exceeds interest and dividend income (except dividends deductible under Section 24402 and dividends subject to the deductions provided for in Section 24411 to the extent of those deductions) not subject to apportionment by formula. Interest expense not included in the preceding sentence shall be directly offset against interest
“The portion of dividends which may be deducted under this section shall be as follows: [H (1) In the case of any dividend described in subdivision (a), received from a ‘more than 50 percent owned corporation,’ 100 percent. [][] (2) In the case of any dividend described in subdivision (a), received from a ‘20 percent owned corporation,’ 80 percent. [][] (3) In the case of any dividend described in subdivision (a), received from a corporation that is less than 20 percent owned, 70 percent.” (§ 24402, subd. (b); cf. former § 24402, as amended by Stats. 1984, ch. 193, § 131, p. 618.)
“No deduction shall be allowed 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 part, regardless of whether that income was received or accrued during the taxable year.” (§ 24425, subd. (a); cf. former § 24425, added by Stats. 1955, ch. 938, § 20, pp. 1577, 1588.)
By order of May 26, 2010, we denied FIB’s motion to dismiss Apple’s appeal, without prejudice to consideration of the issue on the merits of the appeal.
Code of Civil Procedure section 902 provides in relevant part that “[a]ny party aggrieved may appeal in the cases prescribed in this title.”
Apple states that it is engaged in a present controversy involving the same issues (the distribution ordering issue and the interest expense issue) against the same party (FTB) in administrative proceedings currently pending before the SBE for the same tax year (1989) due to federal income tax adjustments to Apple’s 1989 tax year made by the Internal Revenue Service subsequent to the FTB audit of Apple that gave rise to the instant litigation. (SBE case No. 432901.) We grant Apple’s May 13, 2010 request to take judicial notice of documents related to this proceeding—exhibits A through G to Apple’s motion for judicial notice in appeal No. 128091. We also note that Apple’s water’s-edge election was required to be made, under then applicable statute, by written contract with FTB for an initial term of five years. (Former § 25111, subd. (a), as amended by Stats. 1989, ch. 362, § 13, p. 1494.) Apple asserts that it is at various stages of administrative review before the FTB for its tax years 1990 through 2007.
For the 1989 tax year at issue in this case, section 25106 (added by Stats. 1967, ch. 326, § 1, p. 1520) provided in relevant part: “In any case in which the tax of a corporation is or has been determined under this chapter with reference to the income and apportionment factors of another corporation with which it is doing or has done a unitary business, all dividends paid by one to another of such corporations shall, to the extent such dividends are paid out of such income of such unitary business, be eliminated from the income of the recipient and shall not be taken into account under Section 24344 or in any other manner in determining the tax of any such corporation.”
Each party submits illustrative examples of their positions based on allocations between hypothetical distinct “pools” of income, included and excluded, and within and among various tax years. “The reality is that the dividends ... are paid from a single pool of income to which a mathematical ratio (that is unrelated to the amount of dividends paid) is applied as a function of tax law.” (Appeal of Apple Computer, Inc. (Nov. 20, 2006, 2006-SBE-002) [2006 Transfer Binder] Cal.Tax Rptr. (CCH) ¶ 404-085, p. 34,115 [2006 Cal. Tax Lexis 431].)
FTB applied pro rata ordering within the 1989 tax year to the dividends Apple received here, allocating first to otherwise included Subpart F income (and thereby excluding that portion of the dividend from income under § 251106), and then to excluded income, with a deduction allowed under section 24402 for that portion. Fujitsu requires exhaustion of included income on a dollar-for-dollar basis before any allocation to excluded income. (Fujitsu, supra,
FTB treated $4,824,500 of the $50 million dividend Apple received from ACL in that tax year as paid from the included income eligible for elimination from Apple’s income under section 25106, and the balance of the dividend ($45,175,500) as paid from excluded income and deductible under section 24402. Therefore none of the $50 million dividend was included in Apple’s corporate tax base subject to California tax. However, Apple is correct that there is still a significant difference between dividend exclusion and dividend deductibility because of the 75 percent limitation on deductibility under the now applicable section 24411. (See fn. 10, ante.) In addition, section 24425 disallows expense deductions allocable to deductible dividends. (See Great Western Financial Corp. v. Franchise Tax Bd. (1971)
“Section 316 of the [IRC], relating to the definition of dividends, shall apply.” (Former § 24495, added by Stats. 1987, ch. 1139, § 122, p. 4010 [operative for income years beginning on or after Jan. 1, 1987] and repealed by Stats. 1991, ch. 117, § 81, p. 778, eff. July 16, 1991.) For tax years beginning on or after January 1, 1991, the operative section was former section 24451 (added by Stats. 1991, ch. 117, § 82, p. 778 [“provisions of Subchapter C of Chapter 1 of Subtitle A of [IRC] [sections 301-386], relating to corporate distributions and adjustments, shall apply except as otherwise provided”]). Section 24451 was further amended for tax years
Section 24495 was originally added to the Revenue and Taxation Code in 1955 and largely mirrored the language of IRC section 316, and provided in relevant part that “Except as otherwise provided in this part, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits.” (Former § 24495, subd. (b), added by Stats. 1955, ch. 938, § 20, pp. 1577, 1599 & repealed by Stats. 1987, ch. 1139, § 121, p. 4010, eff. Sept. 25, 1987.)
FTB began the process of promulgating regulations for California’s water’s-edge statutes in 1987. (Former § 26422, as amended by Stats. 1951, ch. 374, § 30, p. 1177 & repealed by Stats. 1993, ch. 31, § 60, p. 318, eff. June 16, 1993 [“[FTB] shall have the power and it shall be its duty to administer this part. It shall prescribe all such rules and regulations as are necessary and reasonable to carry out the provisions of this part and may prescribe the extent, if any, to which any ruling or regulation shall be applied without retroactive effect”]; now found at § 19503, subd. (a).) The water’s-edge regulations were adopted and filed on January 3, 1989. (Cal. Reg. Notice Register 89, No. 2-Z, p. 94.)
As we note above, the SBE also concluded that dividends within a tax year are “deemed paid from included income and excluded income in the ratio that included and excluded income bear to total income.” (Appeal of Apple Computer, Inc., supra, Cal.Tax Rptr. (CCH) ¶ 404-085, p. 34,115 [2006 Cal. Tax Lexis 431 at p. *32].) This is inconsistent with Fujitsu’s
The SEE later clarified aspects of this opinion that are not relevant here. (See In re Appeal of Zenith National Ins. Corp. (June 25, 1998, 1998-SBE-001-A) [1995-1999 Transfer Binder] Cal.Tax Rptr. (CCH) ¶ 403-048 [1998 Cal. Tax Lexis 651].)
Expense disallowance under section 24425 does not apply to dividends eliminated under section 25106.
FTB acknowledged that its “audit file [of this case] reveals no information to directly allocate the interest expense to the excluded income—the dividends deducted under . . . § 24402.”
FTB cites statements in Apple’s September 1989 annual report acknowledging that “[a]mounts held by foreign subsidiaries would be subject to U.S. income taxation upon repatriation to the U.S. to meet domestic cash needs.”
Apple did not raise the interest expense issue in its appeal before the SBE, and the SBE’s opinion does not address it.
FTB argues that Apple fails to satisfy the further statutory requirement under section 19717, subdivision (b)(1) that the party must first have pursued and exhausted its administrative remedies, because Apple did not pursue the interest expense deduction issue before the SEE. Apple asserts that section 19717, subdivision (b)(1) requires only that it have pursued an administrative appeal on its refund claim, and contains no additional requirement that specific facts and issues must have been presented in that appeal. Apple also notes that paragraph 42 of
For the same reason, we also do not address FTB’s argument that Apple’s fees are “greatly inflated,” nor its contention that Apple failed to establish the “special factor” required to justify a higher hourly rate than the $125 per hour allowed under section 19717, subdivision (c)(l)(B)(iii).
The SBE also observed that “[e]ach party presents valid arguments in support of its position, and each argument is founded upon meritorious considerations.” (Zenith, supra, Cal.Tax Rptr. (CCH) ¶ 402-965, p. 28,992 [1998 Cal. Tax Lexis 1 at p. *13].)