Opinion
10-22-1951
Allen v. Franchise Tax Board
Edmund G. Brown, Atty. Gen., James E. Sabine, Edward Summer, Deputy Attys. Gen., for appellants. Harold E. Prudhon, Los Angeles, for respondent.
Allen
v.
Franchise Tax Board
October 22, 1951
Hearing Granted December 18, 1951.
Edmund G. Brown, Atty. Gen., James E. Sabine, Edward Summer, Deputy Attys. Gen., for appellants.
Harold E. Prudhon, Los Angeles, for respondent.
WHITE, Presiding Justice.
In this appeal from a judgment directing the refund of personal income taxes paid by respondent under protest to the State of California, the official charged with administration and enforcement of the Personal Income Tax Law (Rev. & Tax. Code, Part 10, Div. 2, § 17001 et seq.), at the time of the institution of the suit was Charles J. McColgan, Franchise Tax Commissioner. By Statutes of 1949, p. 2108, Chapter 1188, section 1, effective January 1, 1950, the powers and duties of the Franchise Tax Commissioner were transferred to the 'Franchise Tax Board', it being further provided that pending actions against the Franchise Tax Commissioner as of January 1, 1950, should continue in the name of the Franchise Tax Board and that the board should be substituted for the commissioner by the court wherein the action is pending. The superior court failed to make an order of substitution. While Rule 48(a) of Rules on Appeal provides that when a substitution of parties becomes necessary in a pending appeal, such substitution shall be made by the superior court, and upon presentation of a certified copy of such order made in the superior court a like order shall be made in the reviewing court, we conclude that the aforesaid statute, providing as it does for substitution of parties in cases such as this 'by the court wherein the action is pending' is self-executing. We have therefore made the appropriate order of substitution.
In March, 1933, respondent, an attorney, entered into an oral agreement with his client, Sutphin, whereby respondent was retained to prosecute Sutphin's claim to a 5% royalty interest in an oil leasehold, and was to receive as compensation in the event he established the claim one-half of the 5% interest and one-half of any accumulations thereon. The litigation was brought to a successful conclusion in the year 1940, and respondent received as his share of the accumulated royalties $32,178.64 and an assignment of one-half of the five per cent interest.
In his state income tax return for the calendar year 1940, Allen reported his fee received in the following manner:
1. He reported the one-half of the 5% royalty interest as being of no value.
2. He reported as income for 1940 one-eighth of the accumulated royalties, and one-eighth thereof on each of five amended returns for the five preceding years, 1935 to 1939. (The state income tax was first imposed for the year 1935.)
3. He deducted from the one-eighth accumulated royalties reported on his amended returns and his 1940 return a 'depletion allowance' of 27 1/2 per cent.
In auditing the return, the Franchise Tax Commissioner notified respondent that an additional assessment would be made against him upon the grounds that (1) the entire accumulated royalties should have been reported as taxable income for the year 1940; (2) the royalty interest should be valued at $3,483.90 instead of as being of no value; and (3) that respondent was not entitled to take the depletion allowance of 27 1/2 per cent. After due hearings before the Franchise Tax Commissioner and the State Board of Equalization, in which the proposed additional assessment was up-held, respondent paid the additional taxes under protest, and thereupon brought this action to recover the amount so paid. The trial court found on all issues in favor of respondent.
The issues presented in the court below and now presented in this court are as follows:
1. Should the entire fee received by respondent in 1940 have been reported by him on his return for that year, or did section 7.1 of the Personal Income Tax Act, Gen.Laws, Act 8494, which was added in 1941, constitutionally apply to the computation of taxes for the year 1940?
2. Was respondent entitled to deduct 27 1/2 per cent of his fee as a 'depletion allowance' pursuant to the provisions of sections 8(j) and 9.5(3) of the Personal Income Tax Act?
3. Should the portion of respondent's fee consisting of one-half of his client's 5% royalty interest be valued at $3,483.90, as determined by the Franchise Tax Board, or at nothing, as reported by respondent?
Taking up the first issue just stated, it appears that prior to 1941, under the Personal Income Tax Act, a person who received compensation in a given year for services covering a number of previous years, was required to report and pay a tax upon the full amount for the year in which the compensation was received. In 1941 the Legislature added section 7.1, Stats.1941, p. 471, Ch. 31, to the Act, which section became effective February 4, 1941, prior to the time that returns were due for the calendar year 1940. This section provided as follows: 'In the case of compensation (a) received for personal services rendered by an individual in his individual capacity, or as a member of a partnership, and covering a period of five calendar years or more from the beginning to the completion of such services, (b) paid (or not less than 95 per cent of which is paid) only on completion of such services, and (c) required to be included in the gross income of such individual for any taxable year, beginning after December 31, 1939, the tax attributable to such compensation shall not be greater than the aggregate of the taxes attributable to such compensation had it been received in equal portions in each of the years included in such period.'
Appellant contends that the Legislature could not constitutionally provide that section 7.1 supra, should apply to the computation of taxes for the calendar year 1940, for the reason that, as asserted by appellant, the tax liability for that year was accrued and fixed as of December 31, 1940; and the reduction or cancellation of such accrued taxes amounts to the making of a gift of public money to an individual, in violation of section 31, Article IV of the California Constitution, which provides, so far as here pertinent, that the Legislature shall have no power 'to make any gift or authorize the making of any gift, of any public money or thing of value to any individual, municipal or other corporation whatever; * * *.'
Concededly, section 7.1, by its terms, purports to apply to the computation of income tax for the calendar year 1940, and the Legislature unequivocally stated its intention in this respect by the following language of its enactment:
'Sec. 2. This act is hereby declared to be an urgency measure, necessary for the immediate preservation of the public peace, health and safety within the meaning of Section 1 of Article IV of the Constitution of the State of California, and therefore shall take effect immediately. The facts constituting such necessity are as follows:
'There are many taxpayers in this State who have received in the past year lump sum payments for services rendered by them over the preceding five years or more. Since the State income tax rates are graduated, these individuals will be required to pay considerably more upon their income than they would have had to pay in the aggregate if their income had been received in equal portions during the years in which it was actually * * * earned. There is thus a clear disparity in the treatment of taxpayers who receive the same income, merely because of the fortuitous circumstance that some of them are paid all at once. Such a situation leads to economic inequality and is productive of unrest, thus directly affecting the public peace, health and safety.
'This act will eliminate the inequality now existing, but since income tax returns must be filed and the tax for 1940 be paid on April 15 of this year, it is imperative that this act go into effect immediately.'
Appellant's basic position is that respondent's tax liability for the year 1940 had accrued under the Personal Income Tax Act as of December 31, 1940, and that the reduction of such liability by the enactment which took effect February 4, 1941, permitting the spreading of income earned over a period of years, amounted to a gift of public money in contravention of section 31 of Article IV of the Constitution of California. We are convinced that appellant's contention is unsound. The cases hereinafter discussed and quoted from, to our minds, illustrate and typify the type of legislation which is permissible under the Constitution as not constituting a gift of public money, but a salutary enactment in aid of the public welfare. We are further convinced that the legislation here in question falls within the category of legislation for the public welfare and does not constitute a 'gift' of public money.
First, there is the line of cases upholding legislation granting tax relief to distressed tax districts or municipalities. Gartner v. Roth, 26 Cal.2d 184, 157 P.2d 361; S. Siwell & Company v. County of Los Angeles, 27 Cal.2d 724, 167 P.2d 177; City of Ojai v. Chaffee, 60 Cal.App.2d 54, 140 P.2d 116. Second, we find a series of decisions defining public welfare and holding that various appropriations by the Legislature did not violate the constitutional prohibition for the reason that the questioned appropriation was for 'a public purpose'. County of Los Angeles v. La Fuente, 20 Cal.2d 870, at page 877, 129 P.2d 378, at page 382, and cases cited.
The Legislature, in providing that the legislation in question should go into effect immediately--that is, in February, 1941, and should apply to the computation of 1940 personal income taxes, set forth facts (which we have hereinabove quoted) which in its view justified the legislation as an enactment for the public welfare.
In County of Los Angeles v. La Fuente, supra, 20 Cal.2d at pages 876, and 877, 129 P.2d at page 382, the supreme court declared: 'In determining whether an appropriation of public money is to be considered a gift within the constitutional prohibition, the primary question is whether the funds are to be used for a public or a private purpose. If the money is for a public purpose, the appropriation is not a gift even though private persons are benefited by the expenditure.'
Further the court said, 20 Cal.2d at page 877, 129 P.2d at page 382: 'The courts will not disturb a legislative determination of what constitutes a public purpose so long as it has a reasonable basis. Nebbia v. [People of State of] New York, 291 U.S. 502, 54 S.Ct. 505, 78 L.Ed. 940; Powell v. [Commonwealth of] Pennsylvania, 127 U.S. 678, 8 S.Ct. 992, 1257, 32 L.Ed. 253; * * *.'
Surely the purpose indicated by the Legislature in its enactment, viz., the rectification of an inequity in the income tax law, is as much a public purpose as the various public purposes set forth by the supreme court, 20 Cal.2d on page 877, 129 P.2d 378, County of Los Angeles v. La Fuente, supra, in each of which cited instances private persons were directly benfited. Further, the decision of the Legislature that the public welfare required such equitable readjustment of the tax burden should take effect retroactively has a reasonable basis. We conclude, therefore, that the legislative enactment presents no constitutional infirmity.
Bearing in mind the familiar rule that in the face of conflicting evidence the power of the appellate tribunal begins and ends with a determination as to whether there is any substantial evidence in the record, contradicted or uncontradicted, to support the judgment, we find that the record reflects testimony which, if believed by the court, was sufficient to sustain the finding and conclusion of law that respondent's leasehold had no value at the time of its receipt by him and that appellant board was in error in determining that the portion of respondent's fee consisting of one-half of his client's five per cent royalty interest be valued at $3,483.90.
The remaining issue confronting us, as to the right of respondent to take a 'depletion allowance', presents the greatest difficulty. We have concluded that on this point the judgment of the court below was in error. In a proceeding instituted by petitioner and respondent herein against the Commissioner of Internal Revenue. Allen v. Commissioner, 5 T. C. 1232, the issue was decided against him on the theory that he was not entitled to the depletion deduction because he was not possessed of an interest in the oil and gas during the time the royalties were being accumulated. On this issue we find ourselves in accord with the decision of the United States Tax Court, wherein it is stated:
'In computing his tax petitioner took a depletion deduction of 27 1/2 per cent of the cash fee received in 1940. Respondent disallowed this deduction. Whether petitioner is entitled to such a deduction depends upon whether he had an economic interest in the oil in place. Helvering v. O'Donnell, 303 U.S. 370 [58 S.Ct. 619, 82 L.Ed. 903], and cases there cited. Oil and gas reserves, like other minerals in place, are recognized as wasting assets. A deduction for depletion of such assets is allowed to one who has a capital investment in the minerals in place. The deduction is intended as compensation for the capital assets consumed in the production of income through the severance of the minerals. The holder of a royalty interest has an economic interest which entitles him to a deduction for depletion. Anderson v. Helvering, [Commissioner of Internal Revenue] 310 U.S. 404 [60 S.Ct. 952, 84 L.Ed. 1277]. Allen's client held such a royalty interest. In 1933 Allen by contract acquired the right, contingent upon successful completion of his services, to receive a fee consisting of two parts, (1) a part of his client's royalty interest, and (2) any accumulations on that part of the interest, if there was production. Allen made no capital investment in the oil and gas in place in 1933. The conditions upon which his rights depended were satisfied in 1940 and at that time his interest in the property and his right to any accumulations from production from that interest became fixed. The right to accumulations was the right to a cash sum measured by half the accumulated royalties upon his client's 5 percent interest. Petitioner did not have an economic interest in the oil in place during the years prior to 1940. His client had such an interest to the extent of the entire 5 percent share. In 1940 petitioner acquired an economic interest in any oil or gas thereafter extracted, but the assignment could not convey an economic interest with respect to the prior production represented by the accumulations. This was not subject to depletion. Cf. Massey v. Commissioner [of Internal Revenue, 5 Cir.,], 143 F.2d 429, affirming B.T.A. memorandum opinion on this point. In the cases cited by petitioner in support of his position * * * the taxpayers had acquired present interests in the property by contract for the performance of services to be rendered. Allen, however, had a contract to receive an interest at a future date if his services met with success.
'We conclude that petitioner is not entitled to the deduction for depletion.'
The judgment is reversed and the cause remanded with directions to the court below to amend its findings of fact Nos. XIV and XV and its Conclusion of Law No. II to find that plaintiff is not entitled to an allowance for depletion, and thereupon to enter an appropriate judgment in accordance with the views herein expressed. Costs on appeal to respondent.
DORAN and DRAPEAU, JJ., concur.