Opinion
No. B065778
8-19-1993
Previously published at 17 Cal.App.4th 1521, 22 Cal.App.4th 1048, 27 Cal.App.4th 1800, 32 Cal.App.4th 1368 17 Cal.App.4th 1521, 22 Cal.App.4th 1048, 27 Cal.App.4th 1800, 32 Cal.App.4th 1368 Mervin G. MORRIS et al., Plaintiffs and Respondents, v. FRANCHISE TAX BOARD etc., Defendant and Appellant.
Daniel E. Lungren, Atty. Gen., Edmond B. Mamer, Supervising Deputy Atty. Gen., and Richard W. Bakke, Deputy Atty. Gen., for defendant and appellant. Irell & Manella, Joel Rabinovitz, Martin N. Gelfand and Richard C. Wirthlin, Los Angeles, for plaintiffs and respondents.
Mervin G. MORRIS et al., Plaintiffs and Respondents,
v.
FRANCHISE TAX BOARD etc., Defendant and Appellant.
Aug. 19, 1993.
Review Granted Nov. 10, 1993.
Review Dismissed and Cause Remanded to the Court of Appeal March 30, 1995.
Daniel E. Lungren, Atty. Gen., Edmond B. Mamer, Supervising Deputy Atty. Gen., and Richard W. Bakke, Deputy Atty. Gen., for defendant and appellant.
Irell & Manella, Joel Rabinovitz, Martin N. Gelfand and Richard C. Wirthlin, Los Angeles, for plaintiffs and respondents.
SPENCER, Presiding Justice.
INTRODUCTION
Defendant Franchise Tax Board appeals from a summary judgment entered in favor of plaintiffs Mervin G. Morris and others. FACTUAL AND PROCEDURAL BACKGROUND
In 1954, plaintiff Mervin G. Morris incorporated in California and became the sole shareholder of Mervyn's, a department store. This was a closely held corporation. The principal office of Mervyn's was in San Lorenzo. Through December 31, 1967, Mervyn's had fewer than 500 employees.
A trust agreement executed on November 1, 1967 created share trusts in favor of Diane Linn Morris, Jeffrey Albert Morris, James B. Morris and John G. Morris, the children of Mervin G. Morris. The trusts, which were irrevocable and were to terminate no later than 21 years from the date of the agreement, were funded with gifts of shares of Mervyn's stock.
Initially, the articles of incorporation authorized the issuance of 5,000 shares of common stock. On April 24, 1970, an amendment to the Mervyn's articles of incorporation authorized a common stock split of 267 to 1. Thereafter, a second set of share trusts was created on December 30, 1976 in favor of the same beneficiaries. These trusts were funded with 139,000 shares of Mervyn's common stock.
By April 1971, Mervyn's had 900 full-time and 600 part-time employees working at 7 stores in the San Francisco Bay area. Mervyn's continued to grow in size and wealth. By April 1975, there were 2500 full-time and 1500 part-time employees working at 24 stores throughout California.
Grantor trusts were created for the benefit of James B. Morris and John G. Morris on March 21, 1977. The trusts were to terminate no later than the 35th birthday of the beneficiaries and, as with the other trusts, were irrevocable. As before, these trusts were funded with shares of Mervyn's stock.
On May 28, 1978, Mervyn's merged into Dayton-Hudson Corporation. The shareholders of Mervyn's received .8 shares of Dayton-Hudson stock for each share of Mervyn's stock exchanged. The merger qualified as a tax-free exchange under California and federal tax law. Dayton-Hudson issued a 100 percent common stock dividend on November 30, 1981 and, on July 22, 1983, existing shares of Dayton-Hudson common stock split 2 for 1.
A grantor trust was created on July 20, 1979 in favor of Jeffrey A. Morris. This trust was to terminate no later than 25 years from the date of its creation. It was funded with 9,314 shares of Dayton-Hudson stock and other property.
During 1981 through 1985, plaintiffs sold shares of Dayton-Hudson stock received in the merger. Sales made in 1981 were installment sales; the cash proceeds were not received until 1982. Plaintiffs reported the income from these sales on their tax returns for the years 1982 through 1985, excluding 50 percent of the long-term capital gain from their ordinary income. Plaintiffs treated the excluded gains as tax preference items and paid California preference tax on them.
In the belief that Revenue and Taxation Code section 17063.11 exempts these gains from preference tax, plaintiffs thereafter filed amended tax returns and sought refunds. Defendant denied the refund claims on the ground that the shares of Dayton-Hudson stock plaintiffs had sold did not qualify as small business stock. Plaintiffs appealed the denial of their refund claims to the State Board of Equalization. The instant litigation followed the rejection of their appeal. CONTENTIONS
I
Defendant contends the trial court erred in interpreting Revenue and Taxation Code section 17063.11 as applying to all small business stock regardless of the date of acquisition. II
Defendant further contends the trial court erred in applying section 17063.11 to the gain from sales of plaintiffs' stock which occurred before the statute's operative date of January 1, 1982.
III
Defendant asserts the trial court erred in permitting plaintiffs to carry forward the small business stock attributes of the Mervyn's stock to the Dayton-Hudson shares they received in the nontaxable exchange.
DISCUSSION
I
Defendant contends the trial court erred in interpreting Revenue and Taxation Code section 17063.11 1 as applying to all small business stock regardless of the date of acquisition. We disagree.
As originally enacted, section 17063.11 2 provided: "For the purpose of Section 17063 [listing items of tax preference], that portion of capital gains attributable to the sale of small business stock, as defined in Section 18161.5, is not an item of tax preference." Section 18161.5 3 contained only the definitions of "small business stock" (in subd. (a)) and of "nonproductive assets" (in subd. (b)). At that time, section 18162.5 4 provided preferential capital gains exclusions for small business stock and detrimental exclusions for nonproductive assets. Section 4 of Statutes 1981, chapter 534, provided "the provisions of this act shall be applied in the computation of taxes for taxable years beginning on or after January 1, 1982...."
Section 18161.5 was repealed by Statutes 1983, chapter 488, section 64, at which time section 18162.5 was repealed as written 5 and replaced with a substantially similar section 18162.5 6. The definitions of "small business stock" and "nonproductive assets" formerly contained in section 18161.5 were incorporated into subdivisions (e) and (f) of section 18162.5. 7 Thereafter, section 17063.11 was amended by Statutes 1984, chapter 938, section 8, to delete "as defined in Section 18161.5" and replace it with "as defined in Section 18162.5."
It is a cardinal rule of statutory construction that the meaning of a statute must initially be sought in the language of the statute; if that is plain and unmistakable, the courts' function is solely to enforce the statute according to its terms. (Leroy T. v. Workmen's Comp. Appeals Bd. (1974) 12 Cal.3d 434, 438, 115 Cal.Rptr. 761, 525 P.2d 665; County of Sacramento v. Pacific Gas & Elec. Co. (1987) 193 Cal.App.3d 300, 308, 238 Cal.Rptr. 305.) Stated otherwise, when the language of a statute is clear, there is no room for interpretation. (Ibid.; accord, Building Industry Assn. v. City of Camarillo (1986) 41 Cal.3d 810, 818, 226 Cal.Rptr. 81, 718 P.2d 68.)
The language of section 17063.11 could not be more clear: that portion of capital gains attributable to the sale of small business stock, as defined in section 18161.5 and, after its repeal, in section 18162.5, is not an item of tax preference within the meaning of section 17063. The definition of "small business stock," originally found in subdivision (a) of section 18161.5, was transferred without change to subdivision (e) of section 18162.5.
Nonetheless, defendant urges this court to read into the definition of "small business stock" formerly found in subdivision (a) of section 18161.5 and now found in subdivision (e) of section 18162.5 the phrase "if acquired after September 16, 1981." Subdivision (b) of section 18162.5 sets forth the preferential capital gains exclusions applicable to the sale of small business stock. Subdivision (d) provides: "Subdivision (b) shall apply with respect to small business stock acquired after September 16, 1981." It is this provision which provides the foundation for defendant's argument and for the recent decision in Lennane v. Franchise Tax Board (1993) 16 Cal.App.4th 1335, 21 Cal.Rptr.2d 25.
To be sure, courts are not required "to adhere to the narrowest possible literal reading of the phrase despite the absurdity of the result or manifest proof of a contrary legislative intent. [Citation.] Consequently, ... the meaning of a statutory phrase ... may be expanded or contracted in order to fulfill the objective of the entire statutory scheme. [Citation.]" (County of Sacramento v. Pacific Gas & Elec. Co., supra, 193 Cal.App.3d at p. 310, 238 Cal.Rptr. 305.) The fundamental flaw in defendant's argument, however, is that the phrase "as defined in" cannot, by any stretch of logic, be interpreted as encompassing the contents of subdivision (d) of section 18162.5 as well as those of subdivision (e). Moreover, the structure of the statutes since the enactment of chapter 534 of Statutes 1981 argues against such an interpretation.
The definition of "small business stock" originally was contained in a separate statute, section 18161.5, while subdivision (d) of section 18162.5 provided ab initio that subdivision (b) of that section applied to small business stocks acquired after September 16, 1981. If the acquisition date limitation were intended to be part of the definition of a small business stock, it logically would have been included in subdivision (a) of section 18161.5.
Additionally, if the Legislature intended that the application of section 17063.11 be limited to small business stocks acquired after September 16, 1981, it logically would have added the phrase "if acquired after September 16, 1981" to section 17063.11. Indeed, the Legislature's failure to include an acquisition date limitation in section 17063.11 after including one in section 18162.5 is a significant indication that the Legislature entertained a different intention with respect to the former section. (People v. Drake (1977) 19 Cal.3d 749, 755, 139 Cal.Rptr. 720, 566 P.2d 622.) This is particularly true where, as here, the statutes are closely related and were enacted at the same time. (Ibid.)
Notwithstanding the impossibility of torquing the language of section 17063.11 to encompass the contents of section 18162.5, subdivision (d), and the historical structure of the statutes, the Lennane court undertakes just such a feat of legerdemain. Defendant argues in this case and the Lennane court decided the language of section 17063.11 was ambiguous by looking to the most recent reference in section 17063.11 to small business stock "as defined in Section 18162.5" and the language of subdivision (d) of section 18162.5, which stated: "Subdivision (b) shall apply with respect to small business stock acquired after September 16, 1981." Relying on the general principle of statutory construction that meaning is to be determined by construing words in context and harmonizing provisions relating to the same subject matter, and looking to the declaration of legislative purpose contained in the original enactment (Stats.1981, ch. 534, § 1), the Lennane court concludes the language of section 17063.11 is ambiguous and requires construction. (16 Cal.App.4th at p. 1342, 21 Cal.Rptr.2d 25.) This approach ignores equally settled principles.
In Western Pioneer Ins. Co. v. Estate of Taira (1982) 136 Cal.App.3d 174, 185 Cal.Rptr. 887, the court was faced with the question of whether requirements of " 'permissive user coverage' extend to self-insurers as well as all policies of automobile liability insurance," in the face of a very strong public policy to require such coverage. (At p. 179, 185 Cal.Rptr. 887.) The court noted that, if the question were before it for the first time, it might be inclined to so find. (Ibid.) There was, however, a considerable body of authority to the contrary. (Ibid.)
Nonetheless, the respondent urged the court "that the obvious intent of the Legislature was to make the provisions of the Insurance Code applicable to self-insureds." (Western Pioneer Ins. Co. v. Estate of Taira, supra, 136 Cal.App.3d at p. 180, 185 Cal.Rptr. 887.) The court noted that one insurmountable problem with this approach was that subdivision (g) of section 11580.9, which provided that " 'For purposes of this section, a certificate of self-insurance issued pursuant to Section 16053 of the Vehicle Code ... shall be considered a policy of automobile liability insurance' " (Western Pioneer Ins. Co., supra, at p. 180, 185 Cal.Rptr. 887), "was specifically limited to section 11580.9 when it said 'for purposes of this section....' Had the Legislature intended the amendment to apply to other sections it could have used the term 'for purposes of this part' or 'for purposes of this chapter.' " Thus, the Legislature's failure to do so implied it had no such intent. (Western Pioneer Ins. Co., supra, at p. 181, 185 Cal.Rptr. 887.) This principle clearly applies to the instant matter.
Subdivision (d) of Revenue and Taxation Code section 18162.5 expressly and narrowly states only that "Subdivision (b) shall apply with respect to small business stock acquired after September 16, 1981." (Emphasis added.) Subdivision (b) lists the percentages of gain to be recognized upon the sale or exchange of small business stock, while the definition of such stock appears in subdivision (e) of section 18162.5, just as it originally appeared in section 18161.5, the provision to which section 17063.11 originally referred. The date limitation provision of section 18162.5, subdivision (d), however, has been there since the entire legislative scheme was enacted originally in 1981. Given these circumstances, there is no reasonable conclusion to be drawn other than that the Legislature knew what it was doing when it limited the operation of subdivision (d) to subdivision (b), and did not intend it to have any more far-reaching effect. (Western Pioneer Ins. Co. v. Estate of Taira, supra, 136 Cal.App.3d at p. 181, 185 Cal.Rptr. 887.)
Additionally, as this court noted in Interinsurance Exchange v. Spectrum Investment Corp. (1989) 209 Cal.App.3d 1243, 258 Cal.Rptr. 43, it is a venerable principle "that a court must follow the language used in a statute and give it its plain meaning, ' " 'even if it appears probable that a different object was in the mind of the legislature.' " ' " (At p. 1254, 258 Cal.Rptr. 43, quoting from People v. Weidert (1985) 39 Cal.3d 836, 843, 218 Cal.Rptr. 57, 705 P.2d 380.) Even if one looks only to the most recent version of section 17063.11, reading it in harmony with section 18162.5, the Lennane court has violated this precept.
Section 18162.5 clearly, unambiguously and unequivocally limits the operation of subdivision (d) to subdivision (b); it does not say "for purposes of this part [or chapter or article or title--or even for purposes of this section--], small business stock is only that which is acquired after September 16, 1981." Thus, even though the declaration of legislative purpose in the original enactment states that preexisting tax laws "provide insufficient incentive for many investors to risk their savings in new businesses, and excessive incentive to place their savings into nonproductive assets" (Stats.1981, ch. 534, § 1) and thus could be interpreted as suggesting that the Legislature meant all the tax breaks provided in the act to apply only to purchases of small business stock after that date, the plain statutory language does not permit that interpretation. 8
The principle expressed in People v. Weidert, supra, 39 Cal.3d at page 843, 218 Cal.Rptr. 57, 705 P.2d 380 exists because a legislative " 'intent that finds no expression in the words of the statute cannot be found to exist.' " (Woodmansee v. Lowery (1959) 167 Cal.App.2d 645, 652, 334 P.2d 991, cited with approval in Weidert, supra, 39 Cal.3d at p. 843, 218 Cal.Rptr. 57, 705 P.2d 380.) This is a sound principle, which is squarely applicable to this case.
Great mischief can be wrought by reference to legislative history as an expression of legislative intent. "The greatest defect of legislative history is its illegitimacy. We are governed by laws, not by the intentions of legislators. As the Court said in 1844: 'The law as it passed is the will of the majority of both houses, and the only mode in which that will is spoken is in the act itself....' Aldridge v. Williams, 3 How 9, 24, 11 L Ed 469 (emphasis added). But not the least of the defects of legislative history is its indeterminacy. If one were to search for an interpretive technique that, on the whole, was more likely to confuse than clarify, one could hardly find a more promising candidate than legislative history...." (Conroy v. Aniskoff (1993) 507 U.S. 511, ----, 113 S.Ct. 1562, 1567, 123 L.Ed.2d 229, 238, conc. opn. of Scalia, J., emphasis in the original.) So it is in this case.
Were it not for the legislative history found in the declaration of legislative purpose, there could be no possible confusion as to the meaning of the statutes. One would look at section 18162.5, discover one's shares met the definition of a small business stock, but then realize one could not take advantage of the special capital gains exclusions because one had acquired the stock before the date specified. One then would apply the general exclusions. Upon exploring what preference tax provision applied, one would discover section 17063.11, realize it referred back to the definition in section 18162.5, but only to that definition, and conclude one was eligible for the benefit conferred by section 17063.11. There would be no confusion.
The existence of the "history" embodied in the declaration of legislative purpose, however, which shows the Legislature is reacting to a perceived lack of incentives for entrepreneurial investment, inclines some to think it cannot possibly have been the Legislature's intent to have any portion of this scheme apply to previously purchased small business stock--notwithstanding the Legislature's repeated failure to make use of simple tools which would make such an intent unequivocally clear. This obscures the most fundamental tenet of all: when the language of statutes is plain, the courts should not indulge in "interpretation," for none is necessary. (Atlantic Richfield Co. v. Workers' Comp. Appeals Bd. (1982) 31 Cal.3d 715, 726, 182 Cal.Rptr. 778, 644 P.2d 1257.)
Clearly, by structuring the statutory scheme as it did, the Legislature recognized that a security could be a small business stock though acquired before September 16, 1981. The Legislature determined that the availability of the preferential capital gains exclusions set forth in subdivision (b) would be restricted to stocks acquired thereafter, while the removal of the capital gains exclusion as a tax preference item would be available to all small business stocks regardless of their date of acquisition. Notwithstanding the conclusion in Lennane that this interpretation would undermine the Legislature's articulated economic policy (16 Cal.App.4th at p. 1344, 21 Cal.Rptr.2d 25), this approach is not inimical to the Legislature's stated purpose of encouraging private investors to provide capital for small business entrepreneurs. Providing a partial reward for those who already have made such investments can serve as an incentive to reinvestment of the same sort.
In short, expanding the phrase "as defined in section 18162.5" in the manner defendant urges is not necessary either to avoid an absurd result or to effectuate the statutory objective. That the Legislature subsequently rejected an opportunity to adopt an amendment which would give section 17063.11 the meaning defendant urges upon this court only buttresses this conclusion. (Contrast Ingersoll v. Palmer (1987) 43 Cal.3d 1321, 1349, 241 Cal.Rptr. 42, 743 P.2d 1299.) 9 Accordingly, the trial court did not err in its interpretation of section 17063.11. 10 (But see Lennane v. Franchise Tax Board, supra, 16 Cal.App.4th 1335, 21 Cal.Rptr.2d 25 .) II
Defendant further contends the trial court erred in applying section 17063.11 to the gain from sales of plaintiffs' stock which occurred before the statute's operative date of January 1, 1982. The contention lacks merit.
As noted in part I, ante, those provisions enacted by Statutes 1981, chapter 534, "shall be applied in the computation of taxes for taxable years beginning on or after January 1, 1982." (Id., § 4, emphasis added.) Those plaintiffs who sold a portion of their shares in 1981 did so in installment sales, receiving payment in 1982. Under the installment method, gain is recognized and taxed in the year the payments are received. (§ 17577.) Generally, the tax effect of installment sales is determined by the law in effect at the time the installment payment is received and the gain is recognized and reported, not by the law in effect in the year of the sale. (Andrews v. Franchise Tax Board (1969) 275 Cal.App.2d 653, 659, 80 Cal.Rptr. 403.) Inasmuch as the gains from the installment sales properly were recognized and reported in the 1982 tax year, after the proceeds were received, section 17063.11 applied to the computation of the taxes--if plaintiffs did indeed sell small business stock.
III
Defendant asserts the trial court erred in permitting plaintiffs to carry forward the small business stock attributes of the Mervyn's shares to the Dayton-Hudson shares they received in the nontaxable exchange. We agree.
Subdivision (e) of former section 18162.5 defines a small business stock as "an equity security issued by a corporation which has [enumerated] characteristics at the time of acquisition by the taxpayer." The question is the meaning to be given the phrase "at the time of acquisition" as used in subdivision (e) of section 18162.5.
Ordinarily, "one acquires property when one obtains ownership, possession, or control over it." (Knowlton v. C.I.R. (11th Cir.1986) 791 F.2d 1506, 1508.) However, the term "acquired" has a different meaning when the "acquisition" represents nothing more than " 'a substitution for, or additional shares of the same type as, shares previously acquired' "(ibid.), or "a change in the nature or form of stock previously held" (id. at p. 1510). This is the character of certain tax-free exchanges pursuant to a plan of reorganization, such as a recapitalization or "a mere change in identity, form, or place of organization of one corporation, however effected" (Int.Rev.Code, § 368(a)(1)(E) and (F)), but not of others. In the former case, there is "no change of substance in the rights and relations of the interested parties to one another or to the corporate assets." (Bazley v. Commissioner (1947) 331 U.S. 737, 740, 67 S.Ct. 1489, 1491, 91 L.Ed. 1782.)
Other tax-free exchanges pursuant to a plan of reorganization, such as statutory mergers or consolidations, an exchange of stock after which the acquiring corporation has control of the acquired corporation or an exchange of stock for substantially all of the property of another corporation (Int.Rev.Code, § 368(a)(1)(A), (B) and (C)), are categorized as continuous investments rather than a divestment and reinvestment notwithstanding that the rights and relations of the interested parties to one another or to corporate assets may change substantially. In these cases, " '[t]he theory ... is that the transaction is merely "a continuance of the proprietary interests in the continuing enterprise under modified corporate form." [Citations.]' " (Commissioner v. Clark (1989) 489 U.S. 726, 741, 109 S.Ct. 1455, 1464, 103 L.Ed.2d 753.) That is, when one corporation merges with another, a shareholder in the acquired corporation has not exchanged his or her interest in the corporation for a completely disparate investment such as a portfolio of government bonds; the shareholder has merely exchanged it for a proportionate interest in a similar corporate enterprise, albeit one which may be larger and more successful. Plaintiffs' exchange of their Mervyn's shares for Dayton-Hudson shares occurred pursuant to a plan of reorganization, a merger as defined in Internal Revenue Code section 368(a)(1)(A) or (B), and thus was a transaction of the sort described in Clark. (§ 18151.)
While the transaction at issue here represents a continuation of investment, however, it is more than a mere change in the form or nature of the investment. Mervyn's did not simply issue new stock to recapitalize the enterprise, reorganize from a closely held to a publicly traded corporation, change its identity or incorporate in another state. Hence, the shares plaintiffs received in the exchange do not represent a mere " 'substitution for, or additional shares of the same type as, shares previously acquired.' " (Knowlton v. C.I.R., supra, 791 F.2d at p. 1508.) Rather, Dayton-Hudson Corporation acquired substantially all of the Mervyn's voting stock or corporate assets in exchange for shares of Dayton-Hudson stock, thus destroying the entity known as Mervyn's and enveloping it completely in the Dayton-Hudson enterprise.
In a reorganization of this sort, the nature of the shareholder's investment has changed significantly, in that the company in which he or she now holds an investment is substantially different from that in which the shareholder formerly held an investment. (See, e.g., Role v. Commissioner (1978) 70 T.C. 341, 350, 1978 WL 3365; Rev.Rul. 76-392.) Accordingly, it is appropriate to give the term "acquisition" in this instance the usual, ordinary meaning of obtaining ownership, possession or control over the stock. It follows that plaintiffs acquired their shares of Dayton-Hudson stock on the date of the tax-free exchange.
In any event, were the acquisition date of plaintiffs' shares of Dayton-Hudson stock to relate back to the date on which they acquired their liquidated shares of Mervyn's stock, as they urge, it does not necessarily follow that the small business attributes of their shares of Mervyn's stock would carry forward to the shares of Dayton-Hudson stock. The only attributes of the acquired stock which carry over to the shares of the acquiring corporation for which the acquired stock is exchanged are the basis and the holding period. (§ 18151; Int.Rev.Code, §§ 358(a)(1), 1223(1).) The purpose of the basis carryover is to prevent tax avoidance, or the escape of gain from taxation. (See, e.g., Commissioner v. Phipps (1949) 336 U.S. 410, 417, 69 S.Ct. 616, 619, 93 L.Ed. 771.) It is a matter of logic and fairness that the holding period also carry forward, to be added to the holding period of the newly acquired shares.
That is not to say logic and fairness require that all attributes of the acquired stock must carry forward to the shares of the acquiring corporation received in the exchange. Some attributes are peculiar to the acquired stock. For instance, if one exchanged one's interest in a particular apartment house for a commensurate interest in another apartment house, it would be logical to carry forward the basis and holding period but not the status of one's original apartment house as a historic landmark or the credits afforded it for the instability of the soil on which it was constructed. The small business character of the acquired stock is such an attribute; it is a characteristic peculiar to the acquired corporation and not, in most instances, transferable to the acquiring corporation. 11
Carrying this attribute forward to the shares of the acquiring corporation is not necessary either to prevent tax avoidance or as a corollary of fundamental fairness. Neither is it essential to effectuate the purpose of the small business stock capital gains statutes. In the instant matter, plaintiffs have replaced the entrepreneurial risks attending their investment in small, closely held business stock with the substantially greater security of an investment in a large, publicly traded corporation. Consequently, they no longer require an incentive to or reward for small business investment. Had Mervyn's merged into a small, closely held business corporation, plaintiffs would have had available the added incentives for such an investment: the favorable capital gains treatment afforded a small business stock, thus serving the legislative purpose of encouraging such investments.
In summary, the acquisition date of plaintiffs' shares of Dayton-Hudson stock does not relate back to their acquisition of shares of Mervyn's stock. Moreover, the small business attributes of their Mervyn's stock would not carry forward to their shares of Dayton-Hudson stock. Accordingly, the trial court erred in treating plaintiffs' sales of shares of Dayton-Hudson stock as sales of small business stock.
Plaintiffs argue they are entitled at least to apply section 17063.11 to the pre-exchange portion of their gain, in that this was gain attributable to the sale of small business stock. While the term "sale" generally includes an exchange of property, including securities (Corp.Code, § 25017, subd. (a); Rev. & Tax.Code, § 6006), section 17063.11 cannot be read in a vacuum; it comes into play only after sections 18162.5 and 17063 have been applied.
Section 18162.5 categorizes the percentages of recognized gain which shall be taken into account in computing taxable income. Similarly, section 17063, subdivision (f) (as amended by Stats.1983, ch. 488, § 19.5), categorizes as a tax preference item the difference between total net capital gains and losses and net capital gains and losses "recognized by virtue of Section 18162.5 for the same taxable year." 12 (Emphasis added.) Gain or loss must be recognized upon the sale or exchange of property "[e]xcept as otherwise provided in this subtitle." (§ 18151; Int.Rev.Code, § 1001(c).) Thus, gain generally is not recognized upon an exchange of shares of stock pursuant to a plan of reorganization. (Id., § 354.) 13
As used in section 17063.11, "that portion of capital gains attributable to the sale of small business stock" clearly refers to the portion of gain recognized in a particular year which is attributable to gain recognized by virtue of a sale of small business stock. Accordingly, gain attributable to the sale of small business stock cannot be excluded as a tax preference item pursuant to section 17063.11 unless that "sale" has resulted in a recognition of gain pursuant to section 18162.5. Since plaintiffs' exchange of their shares of Mervyn's stock for shares of Dayton-Hudson stock did not result in a recognition of gain (Int.Rev.Code, § 354(a)), there was no "sale" within the meaning of section 17063.11 at that time and thus no basis for excluding as a tax preference item plaintiffs' pre-exchange gain.
Inasmuch as the acquisition date of plaintiff's shares of Dayton-Hudson stock does not relate back to the date on which they acquired their shares of Mervyn's stock and, in any event, the small business attributes of the Mervyn's stock would not carry forward to the Dayton-Hudson stock, plaintiffs were required to prove that Dayton-Hudson Corporation was a small business as defined in subdivisions (e) and (f) of section 18162.5 on the date they acquired those shares. Only then would plaintiffs be entitled to a refund pursuant to section 17063.11. Plaintiffs concede they cannot prove this. Accordingly, the trial court erred not only in granting plaintiffs summary judgment but also in denying the same to defendant.
The judgment is reversed and the trial court is directed to enter summary judgment in favor of defendant. Defendant is to recover its costs on appeal.
ORTEGA, J., concurs.
MIRIAM A. VOGEL, Associate Justice, concurring and dissenting.
In my view, section 17063.11 of the Revenue and Taxation Code applies only to the sale of small business stock acquired after the effective date of the statute, September 16, 1981. Accordingly, I would decide the issue discussed in Part I of the majority opinion in favor of the Franchise Tax Board and I would not reach the other issues. I would nevertheless reach the same result, a reversal and remand with directions to enter judgment for the Franchise Tax Board.
FACTS
In 1954, Mervin G. Morris incorporated Mervyn's, a department store. On May 28, 1978, Mervyn's merged into Dayton-Hudson Corporation and Mervyn's shareholders received shares of Dayton-Hudson stock in exchange for their Mervyn's stock. During 1981, 1982, 1983, 1984 and 1985, Morris sold the Dayton-Hudson shares he received in the merger. On amended California income tax returns filed for these years, Morris claimed the benefits afforded by section 17063.11 of the Revenue and Taxation Code 1 and sought a refund of taxes previously paid. The Franchise Tax Board denied the claim. Morris appealed to the State Board of Equalization and, when that failed, he filed a complaint for a refund of personal income taxes. On cross-motions for summary judgment presented on undisputed facts, the trial court agreed with Morris. The Franchise Tax Board's appeal is from the judgment thereafter entered.
DISCUSSION
The Franchise Tax Board contends that, by reason of the date the Dayton-Hudson stock was acquired (1978), section 17063.11 does not apply to the sale of that stock. I agree. I.
In 1981, the Legislature amended section 18162.5 and added sections 17063.11 and 18161.5 to create a new class of capital assets called "small business stock" which would be granted preferential tax treatment to provide an incentive for investors to risk new equity capital for starting and expanding small businesses. (Sen. Bill No. 690, § 1 (Stats.1981, ch. 534).) 2 To this end, the Legislature provided that capital gains from the sale of "small business stock" would receive preferential tax treatment by generally including a smaller portion of these gains in a taxpayer's income (§ 18162.5) and then exempting from the preference tax that portion of the gains which was not included in the taxpayer's income (§ 17063.11). 3
The dispositive issue, in my view, is whether the preferential tax treatment afforded by this statutory scheme applies to all sales of small business stock without regard to when the stock was acquired by the taxpayer (as asserted by Morris and accepted by the majority's dicta) or whether (as the Franchise Tax Board asserts) it applies only to sales of small business stock acquired after September 16, 1981, the date referred to in section 18162.5, subdivision (d) ("Subdivision (b) [the percentages recognized on the sale of small business stock] shall apply with respect to small business stock acquired after September 16, 1981....") The majority looks only at section 17063.11 and concludes that the Legislature's failure to impose an acquisition date limitation within its four corners means that stock acquired at any time before the statute's effective date is entitled to preferential tax treatment. Conversely, the Franchise Tax Board claims the statute is ambiguous, which justifies a resort to rules of statutory construction which, in turn, leads ineluctably to the conclusion that section 17063.11 applies only to stock acquired after September 16, 1981. II.
When this case was briefed, the issue was one of first impression. In the interim, the identical issue was decided by Division Two of the First District, which agreed with the position asserted by the Franchise Tax Board. In Lennane v. Franchise Tax Board (1993) 16 Cal.App.4th 1335, 21 Cal.Rptr.2d 25, the court interpreted section 17063.11 "to exempt from the preference income tax (§ 17062) [ ] only that small business stock which was purchased after September 16, 1981." (Id. at p. 1338, 21 Cal.Rptr.2d 25.) I agree with Lennane's reasoning as well as its result and, seeing no reason to reinvent the wheel, simply quote from Justice Phelan's opinion:
"While it is true section 17063.11 does not contain any threshold date for the sale of the stock, that section refers to section 18162.5 for a definition of small business stock. By incorporating section 18162.5 into the statute, we may reasonably infer the Legislature intended the two statutes to be read in pari materia. Moreover, since this section (§ 17063.11) was part of the same bill which reduced the capital gains tax on small business stock (§ 18162.5), we must attempt to harmonize the two laws keeping the single statutory purpose in mind. '[T]he meaning of the enactment may not be determined from a single word or sentence; the words must be construed in context, and provisions relating to the same subject matter must be harmonized to the extent possible. [Citation.].' (Title Ins. & Trust Co. v. County of Riverside (1989) 48 Cal.3d 84, 91, 255 Cal.Rptr. 670, 767 P.2d 1148.) In light of the foregoing rules of statutory construction, we conclude the language is ambiguous, and we look to extrinsic sources to determine if the Legislature intended to limit the preference tax exemption to small company stocks purchased after September 16, 1981.
"As stated above, the legislative purpose behind the exemption and the favorable capital gains treatment was to increase 'the willingness of private investors to provide the start-up equity capital for entrepreneurs' and to reverse the 'insufficient incentive for many investors to risk their savings in new businesses....' ... We believe this is a reasonable use of the government's taxing power to further desirable social goals, and [the taxpayer does] not contend otherwise....
"The manifest intent to encourage investors to risk their savings in start-up and small capitalization companies can only be realized if the investments are made after the effective date of the statute. The tax breaks provided by the statute are not justified for those investors who purchased small business stocks 10, 20, and 30 years or more before the statute was enacted. As perceived by the Legislature, those investors were not hindered with periods of high inflation and did not sacrifice a high rate of return compared to other investments. In contrast, the investor who purchased small business stock after September 16, 1981, not only was taking the risk associated with every new business, but his or her dollar was loosing [sic ] value to high inflation. It was because of this greater risk to an investors' total return that the Legislature created these tax benefits. By enacting the 1981 bill, the Legislature sought to reverse the investment trend, which was to hedge against high inflation by investing in 'nonproductive assets which add nothing to the strength of the economy....' ...
"[The taxpayer's acquisition] of small business stock before the enactment of the statute did not help the state meet its perceived need to create and expand small businesses at the time of the statute.[ 4 In short, [the taxpayer] did not risk [his] capital entitling [him] to the tax benefits created by the Legislature.
"In fact, [the taxpayer's] interpretation would undermine the very economic policy articulated in the enactment. For example, if [the taxpayer] purchased [his] small business stock before September 16, 1981, but sold it on January 1, 1982, [he] would pay no preference tax on [his] capital gains. But, this sale of the stock would remove scarce investment capital from targeted businesses at the most critical time, as perceived by the Legislature. In essence, [the taxpayer] would reap the benefit of the exemption from the preference tax while, simultaneously, harming the very business interests the statute was created to protect. Viewing section 17063.11 ' "in the context of the entire statutory system of which it is a part ..." ' (People v. Woodhead [1987] 43 Cal.3d [1002,] 1009 [239 Cal.Rptr. 656, 741 P.2d 154] ), we hold that the preference tax exemption in section 17063.11 does not apply to small business stock purchased before September 16, 1981." (Lennane v. Franchise Tax Board, supra, 16 Cal.App.4th at pp. 1342-1344, 21 Cal.Rptr.2d 25.) 5
In my view, the majority's interpretation clashes with the manifest purpose of the statute (DaFonte v. Up-Right, Inc. (1992) 2 Cal.4th 593, 601, 7 Cal.Rptr.2d 238, 828 P.2d 140) and I would therefore conclude that section 17063.11 applies only to the sale of small business stock acquired after the effective date of the statute, September 16, 1981. 6 --------------- 1 All references hereinafter are to the Revenue and Taxation Code unless otherwise specified. 2 Added by Statutes 1981, chapter 534, section 2; repealed by Statutes 1987, chapter 1138, section 40. 3 Added by Statutes 1981, chapter 534, section 3. 4 Amended by Statutes 1981, chapter 534, section 4. 5 Statutes 1983, chapter 488, section 64. 6 Statutes 1983, chapter 488, section 65. As amended, section 18162.5 provided in pertinent part: "(a) In the case of any taxpayer, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset, except gains from small business stock or nonproductive assets, shall be taken into account in computing taxable income: [p] (1) One hundred percent if the capital asset has been held for not more than one year. [p] (2) Sixty-five percent if the capital asset has been held for more than one year but not more than five years. [p] (3) Fifty percent if the capital asset has been held more than five years. "(b) In the case of any taxpayer, only the following percentages of the gain recognized upon the sale or exchange of small business stock shall be taken into account in computing taxable income: [p] (1) One hundred percent if the small business stock has been held for not more than one year. [p] (2) Sixty-five percent if the small business stock has been held for more than one year but not more than three years. [p] (3) Zero percent if the small business stock has been held for more than three years, and if at the time of sale, the fair market value ... of land owned or controlled by the corporation does not exceed 25 percent of the fair market value of the corporation.... "... "(d) Subdivision (b) shall apply with respect to small business stock acquired after September 16, 1981. "(e) For purposes of this section, 'small business stock' is an equity security issued by a corporation which has the following characteristics at the time of acquisition by the taxpayer: [p] (1) The commercial domicile or primary place of business is located in California. [p] (2) The total employment of the corporation is no more than 500 employees ... on December 31 of the year preceding acquisition of the small business stock.... [p] (3) The outstanding issues of the corporations, including those held by the taxpayer, are not listed on the New York Stock Exchange, the American Stock Exchange, or the National Association of Securities Dealers Automated Quotation system. [p] (4) No more than 25 percent of gross receipts in the immediate prior income year were obtained from rents, interests, dividends, or sales of assets. [p] (5) The corporation is not engaged primarily in the business of holding land...." 7 In 1984, section 18162.5 was amended again to renumber subdivision (f) as subdivision (g) and to add a new subdivision (f), which provides: "For purposes of this section, 'small business stock' does not include an equity security issued by a corporation which has either of the following characteristics in the income year immediately prior to the taxpayer's sale or exchange of the equity security: [p] (1) More than 25 percent of its gross receipts were obtained from rents, interest, dividends, or sales of assets. [p] (2) The corporation was primarily engaged in the business of holding land." (Stats.1984, ch. 1575, §§ 1, 2.) These amendments apply to the computation of taxes for taxable years beginning on or after January 1, 1984. (Id., § 4.) 8 In any event, the declaration of legislative purpose could just as readily be interpreted as expressing the intent underlying the substantive provisions of section 18162.5, as originally enacted, only. Where legislative history gives rise to conflicting inferences, the court must not depart from the plain language of the statute. (People v. Boyd (1979) 24 Cal.3d 285, 295, 155 Cal.Rptr. 367, 594 P.2d 484.) 9 Assembly Bill No. 3424, 1986 Regular Session, section 2, proposed the amendment of section 17063.11 to add, after "as defined in Section 18162.5," the phrase "and acquired after September 16, 1981." On June 4, 1986, it failed to pass in the Assembly Ways and Means Committee; no further action was taken. 10 Defendant argues this leads to an absurd result in the application of section 18162.5, for small business stock acquired prior to September 16, 1981 would not qualify for the exclusions set forth in subdivision (b) and could not qualify for those set forth in subdivision (a) which, by its terms, applies to capital assets other than small business stock. However, absurdity in the interpretation of a statute is to be avoided by expanding or contracting the meaning of a phrase to fulfill the objective of the statutory scheme as a whole. (County of Sacramento v. Pacific Gas & Elec. Co., supra, 193 Cal.App.3d at p. 310, 238 Cal.Rptr. 305.) The objective in this case is to reward small business investors, not to penalize them. Accordingly, the phrase "other than small business stock" in subdivision (a) of section 18162.5 can be expanded to mean "other than small business stock acquired on or after September 16, 1981" both to effectuate the statutory objective and to avoid an absurd result. In contrast, as noted above, neither the avoidance of an absurd result nor the effectuation of the statutory objective require reading a similar limitation into section 17063.11. 11 The Internal Revenue Code makes an exception for losses sustained on small business stock in reorganizations which are recapitalizations or merely changes in identity, form or the place of the corporation's organization. (Int.Rev.Code, § 1244(d)(2); Role v. Commissioner, supra, 70 T.C. at p. 347.) 12 Section 17063 was repealed by Statutes 1987, chapter 1138, § 40 and replaced by a wholly different section 17063, which deals with a minimum tax credit (Stats.1987, ch. 1138, § 41). 13 Not all such exchanges result in a nonrecognition of gain. (See Int.Rev.Code, § 368(b).) Consequently, a shareholder can receive shares by exchange pursuant to a plan of reorganization and still be compelled to recognize gain at that time. (Ibid.) This explains the reference in section 18162.5 to gain recognized upon the sale or exchange of a capital asset. 1 Unless stated otherwise, all section references are to provisions of the Revenue and Taxation Code as they existed at the times relevant to this case. 2 More specifically, the Legislature found "that a key element of California's economic growth and prosperity over the past several decades has been the founding and expansion of new private businesses. A majority of the increase in private employment in California has come as a result of the willingness of private entrepreneurs to take risks in starting and expanding small companies. Similarly, the willingness of private investors to provide the start-up equity capital for entrepreneurs has been a critical element in the ability of new and small companies to transform ideas into jobs and income for California. [p] The Legislature finds, however, that state and national tax laws, in an inflationary era, provide insufficient incentive for many investors to risk their savings in new businesses, and excessive incentive to place their savings into nonproductive assets which add nothing to the strength of the economy. The purely speculative returns on such investments as gold, silver, gems, paintings, stamps, and antiques represent the diversion of scarce capital from productive investment." (Stats.1981, ch. 534, § 1, p. 1903; emphasis added.) 3 All three sections were later repealed. (Stats.1983, ch. 488, § 64, eff. July 28, 1983 (§ 18161.5); Stats.1987, ch. 1138, §§ 40 (§ 17063.11), 131 (§ 18162.5), eff. Sept. 25, 1987.) Section 17063.11 provided that, "[f]or the purpose of Section 17063 [which listed items of tax preference], that portion of capital gains attributable to the sale of small business stock, as defined in Section 18162.5, is not an item of tax preference." (As originally enacted, section 17063.11 referred to section 18161.5 (which then contained the definition of "small business stock.") In 1983, the Legislature repealed section 18161.5, reenacted it as subdivision (e) of section 18162.5, and amended section 17063.11 to refer to the correct section. (Stats., 1983, ch. 488, § 65; Stats.1984, ch. 1575, § 1.) For the sake of simplicity and because this amendment is irrelevant to the issue before us, we refer only to section 18162.5.) Subdivision (a) of section 18162.5 listed the percentages of the gain or loss recognized upon the sale or exchange of "a capital asset" to be taken into account in computing taxable income, "except gains from small business stock or nonproductive assets." Subdivision (b) of section 18162.5 listed the percentages recognized on the sale or exchange of "small business stock." Subdivision (c) of section 18162.5 listed the percentages recognized on the sale or exchange of "nonproductive assets." Subdivision (d) of section 18162.5 provided that subdivision (b) "shall apply with respect to small business stock acquired after September 16, 1981." Finally, subdivision (e) of section 18162.5 defined "small business stock" as an "equity security issued by a corporation which has [specified] characteristics at the time of acquisition by the taxpayer." 4 Implicit in this sentence is the suggestion that an expansion of a business could qualify for the benefits afforded by section 17063.11. While I do not think that is what the court intended, I do want to note that, in my view, a post-acquisition expansion would be wholly irrelevant unless it occurred after the effective date of the statute. 5 As the court in Lennane also noted, its interpretation is consistent (1) with the Legislative Analyst's reading of Senate Bill No. 690 (Legis. Analyst's Analysis, Sen. Bill No. 690 (1981-1982 Reg.Sess.) p. 3); (2) with the conclusion reached by the Assembly Revenue and Taxation Committee (Assem. Revenue and Taxation Com., Analysis of Sen. Bill No. 690 (1981-1982 Reg.Sess. as amended May 5, 1981); and (3) with the Department of Finance's analysis (Cal. Dept. Finance Analysis, Sen. Bill No. 690 (1981-1982 Reg.Sess.) as amended Aug. 26, 1981, p. 2). 6 Lennane specifically rejected Morris' contention that the Legislature's failure to enact later legislation which sought to include September 16, 1981, as the acquisition date is evidence that section 17063.11 was never restricted as to acquisition date (Lennane v. Franchise Tax Board, supra, 16 Cal.App.4th at pp. 1342-1345, 21 Cal.Rptr.2d 25.) I agree with Lennane that the failure of the Legislature to amend may indicate that no clarification was needed.