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Farmer Bros. Co. v. Franchise Tax Bd., 108 Cal.App.4th 976, 134 Cal.Rptr.2d 390, 03 Cal. Daily Op. Serv. 4309, 2003 Daily Journal D.A.R. 5481

Facts

Farmer Bros. Co., a California corporation, sought refunds from the Franchise Tax Board for overpaid taxes from 1992 to 1998, claiming that the dividends received deduction under section 24402 was unconstitutional. The deduction allowed corporations to deduct a portion of dividends received from other corporations based on whether those corporations were subject to California taxes. Farmer Bros. Co. received dividends from various corporations, some of which were not subject to California taxes, leading to a significant tax refund claim.

Taxpayer is a California corporation primarily engaged in the business of manufacturing and selling coffee and coffee-related products. For the years 1992 through 1998, Taxpayer timely filed California corporate income or franchise tax returns with the FTB. Each return reported a 'dividends received deduction' under section 24402, representing a portion of the dividends Taxpayer had received during the income year.

Issue

Does California Revenue and Taxation Code section 24402, which provides a tax deduction for dividends received from corporations subject to California taxes, violate the commerce clause of the United States Constitution?

Taxpayer asserted that section 24402 is unconstitutional under the commerce clause of the United States Constitution because it discriminates on its face against interstate commerce by improperly taxing income that is not attributable to business transacted in California and the deduction cannot be justified as a lawful compensatory tax.

Rule

A state law is considered discriminatory under the commerce clause if it taxes transactions more heavily when they cross state lines than when they occur entirely within the state, favoring in-state economic interests over out-of-state competitors.

A law that is discriminatory on its face must be invalidated unless the state can show that it advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.

Analysis

The court found that section 24402 discriminated against interstate commerce by allowing deductions only for dividends received from corporations that paid California taxes, thus favoring in-state corporations. This was deemed facially discriminatory as it imposed a greater tax burden on out-of-state corporations compared to in-state corporations, violating the principles established under the commerce clause.

We conclude that section 24402 is discriminatory on its face because it affords to taxpayers a deduction for dividends received from corporations subject to tax in California, while no deduction is afforded for dividends received from corporations not subject to tax in California.

Conclusion

The court affirmed the trial court's ruling that section 24402 is unconstitutional under the commerce clause, thereby upholding the taxpayer's right to a refund of the overpaid taxes.

We agree with the trial court's conclusion and affirm the judgment.

Who won?

Farmer Bros. Co. prevailed in the case because the court found that the dividends received deduction under section 24402 violated the commerce clause by discriminating against interstate commerce.

The judgment awarded Taxpayer a remedy consisting of the deduction set out in section 24402 for dividends received, as if the dividends were 'declared from income which [had] been included in the measure of the taxes imposed … upon the taxpayer declaring the dividends.'

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