United States: When "Gross" is Really Not "Gross" And Other Anomalies

In General Motors Corp. v. Franchise Tax Board, Case No. B165665 (June 30, 2004), the California Court of Appeals held that the Franchise Tax Board ("FTB") properly excluded returns of principal from certain sales of securities.

General Motors ("GM"), a Delaware corporation, maintains a "Treasury Department" in New York City. The Treasury Department manages the excess cash of GM and its various related corporate entities and subsidiaries in the United States. During the years at issue, GM’s net corporate income totaled over $7 billion, of which the Treasury Department generated over a half billion dollars in income. Specifically, the Treasury Department used its excess cash to purchase various marketable securities such as U.S. Treasury bonds, notes and bills, as well as bank certificates of deposit (CDs), etc. The investments were categorized as follows: (1) direct sales¹, (2) maturities, and (3) repurchase agreements². Approximately 90% of the Treasury Department’s proceeds from security transactions are from repurchase transactions.

Initially, GM treated the majority of the income from the investments as non-business income. However, upon audit, the FTB treated all of the treasury income as business income. Moreover, in its audit adjustments, the FTB considered as gross receipts only the net proceeds from the Treasury Department’s securities transactions, thus excluding the return of principal.

GM filed suit in superior court claiming that the gross proceeds should be included in the sales factor, not just the net proceeds. On a motion for summary judgment, the court held that only the net proceeds should be included in the sales factor. However, during oral argument, the FTB distinguished direct sales of securities and conceded that the entire gross proceeds from such sales should be included in the sales factor. As a result, the court awarded GM a refund of approximately $7.5 million. Both parties then appealed.

The court of appeals affirmed the trial court’s holding that "the return of principal from securities transactions in the repurchase agreements and maturities categories should not be included as ‘gross receipts’ in the denominator of the sales factor in apportioning income to California" because "such a return of principal does not arise out of a sales transaction." Specifically, the court concluded that because Revenue and Taxation Code § 25120(e) defines "sales" as "all gross receipts of the taxpayer . . . ." and the term "gross receipts" is not otherwise defined in UDITPA, then "gross receipts" must be sales. The court reached this "obvious determination" without any other discussion or analysis.

The court then concluded that GM’s transactions involving purchase agreements and maturities do not constitute sales, notwithstanding a number of cases cited by GM where courts in other UDITPA states held that "gross receipts" necessarily include all investment transactions of this sort. According to the court, these cases "uncritically decide that the statute is without any ambiguity and conclude without lengthy analysis that the transactions constitute ‘gross receipts." This "analysis is faulty insofar as it deems these ‘receipts’ to be sales without scrutinizing the nature of the transactions."

Ironically, when making the "obvious determination" that "gross receipts" must be sales, the court engaged in this same type of analysis. That is, it determined that because the term "gross receipts" was not otherwise defined in UDITPA, then "gross receipts" must be sales. However, there was no "lengthy analysis" to support such a finding.

Further, the cases cited by GM do not stand for the proposition that transactions involving repurchase agreements and maturities are sales, rather they stand for the proposition that receipts from such transactions are "gross receipts" and as such must be included in the sales factor. Indeed, none of the cases cited by either party "deemed these ‘receipts’ to be [or not to be] sales" because they never reached the "obvious determination" that this court did in that "gross receipts" must be sales. Query whether this is because such an obvious determination is inconsistent with the position of many states, including California, that items such as rents and dividends are included in the sales factor even though these transactions do not involve sales.

Finally, the court concluded that maturities and repurchase agreements are not sales, but rather "securitized monetary transactions that are the equivalent of loans." According to the court, "while interest thereon is income, the taxpayer’s capital funds are not proceeds from a sale" because "the return of one’s own funds is not a receipt from a sale."

The court declined to address Revenue & Taxation Code § 25137 having found on the statute.

This general issue is currently before three other courts of appeals in California. Stay tuned