Publication 216, The First 100 Years
The 1929 Bank and Corporation Franchise Tax Act
While the fuel tax constituted a significant addition to the duties of the Board and to the general tax structure, the most significant change of sources during the “separation of sources” period (1910-1933) was instituted with the passage of Bank and Corporation Franchise Tax Act of 1929. The 1910 Amendment Number One had called for a one percent tax rate on all franchises not specifically enumerated in the amendment. This rate was to be based on an assessment of each franchise’s actual cash value, the valuation to be determined by the Board.
Under the original “separation of sources” amendment the banks were to be taxed (under the “share tax” method) one percent on their capital stock shares as a share tax. The rates were subsequently raised in 1921. Pursuant to a 1924 constitutional amendment, the Legislature enacted the 1925 Solvent Credits Act, which provided that specified intangibles be assessed at seven percent of their full cash value.50 Many banks declared this act to be discriminatory and protested that the act constituted a violation of Section 5219 of the Revised Statutes of the United States which “permitted taxation of bank shares but at a rate no higher than that imposed upon ‘other moneyed capital‘ coming into competition with national banks.” 51
Certain banks paid taxes on their stock under protest at the 1921 rate of 1.45 percent and brought suit against the state. In an effort to placate these banks, the Legislature enacted a 1927 law which placed a 1.45 percent tax rate on the full cash value of all intangibles. However, in 1928 the State Supreme Court declared both the 1925 and the 1927 acts unconstitutional.52 The invalidation of these acts raised serious doubts about the validity of the entire Bank Tax Act as provided for in Amendment Number One (1910).
Taxation difficulties with the banks were no less perplexing than those arising from corporations. In 1905 California had begun a practice of levying a license tax on all corporations doing business in the state. This flat $10 fee eventually evolved into a graduated levy, ranging from $10 to $250, based on the par value of the authorized capital stock. The Mulford Case ruled this license tax invalid with respect to foreign corporations carrying on interstate as well as intrastate business and with respect to domestic corporations doing both interstate and intrastate business and having property situated outside the state.53 This prompted the Legislature to repeal the tax in 1913.
In his report of 1914, the State Controller sums up the attitude of corporations toward the license tax:
“Again, even before the Mulford decision had been rendered there had been a good deal of opposition, as a mere matter of policy, to the continuance of the corporation license tax, because that and the franchise tax assessed by the State Board of Equalization are so much alike as to seem like two franchise taxes, and a great deal of confusion has arisen therefrom. Having the two taxes has appeared to most corporation taxpayers to be more obnoxious than a single tax would be even if it were double the amount of either one.” 54
The Board conceded that “there were so many different taxes on corporations that they were justly annoyed by the multiplicity of tax bills and reports,” 55 and added: “As the Constitution provided that foreign corporations should not be allowed to do business in California on any more favorable terms than domestic corporations, it seemed necessary to equalize the taxes by repealing the tax on domestic companies.” 56
The Board was nevertheless quick to point out that recent court decisions—the State Supreme Court’s decision in Albert Pick Company v. Jordan, Secretary of State, and the U. S. Supreme Court’s decision in The Baltic Mining Company and S. S. White Dental Manufacturing Company v. Commonwealth of Massachusetts—would warrant reenacting the tax. In 1915 the Legislature followed this advice by reenacting the corporation license tax at substantially higher rates.
In March 1927, the California State Supreme Court again invalidated the 1915 corporation license tax with respect to foreign corporations.57 Accordingly, the 1927 Legislature repealed most of the provisions of the tax because, as the Board stated in its 1927-28 report, “of the manifest inequity of continuing to exact these payments from domestic corporations . . .”
Solutions to these and other problems regarding both corporations and banks were soon forthcoming. In 1927 the Legislature authorized Governor Clement Young to appoint a tax commission to study the state’s tax system and submit a report making whatever recommendations the commission deemed necessary. The Governor chose Stockton publisher Irving Martin as chairman of this eight-man commission, which came to be known as the “Martin Commission.”
Upon the recommendation of this commission, which submitted a special report on August 10, 1928, the Legislature proposed an amendment that banks and general corporations be taxed on the basis of net income. The amendment was adopted November 6, 1928 as Section 16 to Article XIII of the California Constitution, and in 1929, the Legislature enacted the Bank and Corporation Franchise Tax Act which embodied the provisions of this amendment.
The Bank and Corporation Franchise Tax Act marked a significant change in the California tax structure.
“With this act the ‘separation of sources’ between state and local government characterizing tax history between 1911 and 1928 was modified, and a new approach to business taxation was initiated with net income as the basis for taxation.
“Prior to 1929, incorporated businesses were reached by two separate taxes. The first of these was the license tax administered by the Secretary of State and finally invalidated by the State Supreme Court in 1927. The other was a franchise tax adopted in 1911. Assessment was made by the Board of Equalization while collection and general administration was by the Controller.
“The tax burden varied widely with different types of business and with different income groups leading to dissatisfaction with this method of levying business taxes. The California Tax Commission, a study group authorized by the Legislature in 1927, was instrumental” in changing the tax structure.58
Like most other tax programs, it was generally assumed that the new Bank and Corporation Franchise Tax Act would be administered by the Board of Equalization. However, State Controller Ray Riley wanted administration of the Act assigned to the Controller’s office which was already administering the inheritance tax. The other four Board Members led by Fred Stewart wanted the Act to be administered by Equalization. Controller Riley had considerable influence with the Legislature but not enough to obtain the necessary votes to have the Act administered by his office. When it became apparent that his will would not prevail, he proposed the creation of an independent commission. That suggestion won the few additional votes he needed, and a compromise was eventually effected whereby the Act would be administered by a newly created Franchise Tax Commission, but the appellate jurisdiction was assigned to the Board of Equalization.
The Commission did not actively administer the Franchise Tax Act, but instead delegated its administration to a Franchise Tax Commissioner. The Act specified an unprecedented procedure for selecting the Commissioner: instead of appointment by the Governor, he was to be selected by a committee composed of the Controller, the Director of Finance, and the Chairman of the Board of Equalization. The Act also provided that the Commissioner would serve at the pleasure of the committee.59
Reynold Blight, a nationally prominent accountant from Los Angeles, was appointed Franchise Tax Commissioner effective April 1, 1929. Blight served until late December 1930, when he resigned and was succeeded by his assistant, Deputy Franchise Tax Commissioner Albert A. Manship, who was designated acting commissioner. Manship held the position until July 30, 1931, when Charles J. McColgan won permanent appointment. McColgan had been elected to the Assembly from the 23rd District in San Francisco in 1919. At the time of his appointment as Franchise Tax Commissioner, he was chief of the income tax division of the Federal Internal Revenue Department in San Francisco. In 1949, the Legislature voted to remove McColgan from office “for inefficiency and inexcusable neglect of duty.” McColgan had had his position reclassified as civil service and could not be removed. In 1949, the Legislature instead abolished the office of Franchise Tax Commissioner and created the Franchise Tax Board. The Board selected as its Executive Secretary John J. Campbell, sales tax administrator for the Board of Equalization.
The creation of the Franchise Tax Commission in 1929 marked a significant change for the Board of Equalization; although the Board had been chosen as appellate agency for the new franchise tax, its role had been substantially diminished by the Bank and Corporation Franchise Tax Act. First of all, this was the first time since the adoption of the 1879 Constitution that a new agency had been created for tax administration; traditionally, new taxes had always been assigned to the Board of Equalization. Secondly, the Board's function in assessment had now been reduced to only public utilities and insurance companies. Thirdly, even the public utilities taxes seemed destined for extinction. Indeed, the final report of the 1929 Martin Commission was a threat to the very existence of the Board.
50 California Statutes, 1925, p. 13.
51 Stockwell, Marvel M., Studies in California State Taxation 1910-1935, p. 136
52 Arnold v. Hopkins, 203 Cal 553
53 H. K. Mulford v. Curry, Secretary of State, 163 Cal 276, 1912.
54 BienniaI Report of the State Controller, 1914, p.17
55 Report of the State Board of Equalization, 1913-1914, p. 56
57 Perkins Mfg. Co. v. Jordan (1927). 200 Cal 667
58 The Need for A Department of Revenue in California—Report of the Subcommittee of the Assembly Interim Committee on Government Organization to the 1955 General Session of the California Legislature, p.57
59 Laws of 1929, Chapter 13, Section 22