Pacific Co. v. Johnson

Background

A California corporation sued the state tax authorities to recover part of a franchise tax it paid. The tax was an annual charge on the privilege of doing business, measured by net income. The state statute defined gross income to include interest from federal, state, municipal, or other bonds. California’s constitution, adopted in 1902, declared bonds issued by local governments “free and exempt from taxation.” The corporation had received interest from improvement district bonds issued after that constitutional exemption, and the Franchise Tax Commissioner included that interest in the 1928 franchise tax computation.

Reasoning

The Court addressed whether a franchise tax can be measured by net income that includes income from constitutionally tax-exempt bonds. The majority relied on long-standing precedents distinguishing a tax on the corporate privilege from a tax directly on property or income. Because the franchise is a taxable privilege, measuring it by all net income without discrimination against exempt income does not, in the Court’s view, impair the constitutional exemption. The Court found no conflicting state decision, read grants of immunity narrowly, and affirmed the judgment denying recovery.

Real world impact

The decision lets California include interest from tax-exempt local bonds when computing a net-income franchise tax, so corporations may face higher franchise taxes. Bond issuers and buyers lose a legal claim that such franchise taxes defeat the prior constitutional exemption. The ruling hinges on the absence of discrimination and the franchise-versus-property distinction.

Dissents or concurrances

A dissent warned the legislature and tax commission intended to reach tax-exempt income by indirection and argued that imposing the tax violated the contractual promise of tax immunity to bond purchasers.