Laws, Regulations & Annotations

Business Taxes Law Guide – Revision 2018

Sales And Use Tax Court Decisions

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Kaiser Steel Corporation v. State Board of Equalization . . . (1979)

King v. State Board of Equalization . . . (1972)

Knudsen Dairy Products Co. v. State Board of Equalization . . . (1970)

Kuykendall v. State Board of Equalization . . . (1994)


"Primary Purpose" Test Found Valid in Determining Taxability of Raw Materials Used in Manufacturing Process

Plaintiff, a manufacturer and producer of steel, pig iron and other products, purchased certain materials to charge its furnaces and remove impurities from the molten metal. The removal of impurities is accomplished by combining them with the materials to form slag. Portions of the materials were incorporated into the steel to achieve a specific quality; portions incidentally remained in the finished steel; portions were dissipated or lost in the manufacturing process; and portions became components of the slag. An independent company, which removed the slag and reprocessed it, paid plaintiff 1 cent for each ton removed and a 10 percent royalty on the net sales price of the reprocessed slag. After plaintiff either paid sales tax reimbursement on the materials or purchased them under a resale certificate and later paid use tax, it filed a claim for refund with the Board. The Board's position was that plaintiff purchased the materials for a purpose other than resale, namely to aid in the manufacture of steel. Plaintiff argued that the materials were properly purchased for resale in the form of slag, a by-product in the manufacture of steel.

The Supreme Court, relying on Sales and Use Tax Regulation 1525 and the applicable Sales and Use Tax Annotations, upheld the trial court's finding that plaintiff's "primary purpose" for purchasing the raw materials determines the application of tax. The court found the Board's conclusion that plaintiff purchased the materials to aid in manufacturing steel was reasonable, and held that if property is purchased as an aid in the manufacturing process, it is taxable despite some portion remaining in the finished product or an incidental waste or by-product results. Kaiser Steel Corporation v. State Board of Equalization (1979) 24 Cal.3d 188.

Contract for Construction of Electrical Power Transmission Line Taxable as a "Construction Contract"

Taxpayer had been assessed tax on its labor charge in erecting and fastening electrical power transmission lines to towers furnished by the power authority and installed by the contractor, and on charges for conductors, insulators, and hardware supplied by taxpayer. The Board, relying on ad valorem property tax rulings, characterized the line as "tangible personal property," and thus regarded the labor as taxable "fabrication labor" under Revenue and Taxation Code Section 6006(b), which provides that "sale" includes the fabrication of tangible personal property for a consumer who furnishes the materials.

The court found the Board's reliance on the property tax provisions to be misplaced, since there was no relationship between the property tax and sales tax provisions. In affirming the trial court's decision that tax applied to the tangible components but did not apply to that portion of the contract price attributable to labor, the court held that the transaction in question did not have the statutory characteristics of a "sale" but was taxable as a "construction contract" under regulation 1521. Tax was thus inapplicable to the contractor's labor charges. The court also held that taxpayer's defense of limitations was untimely, since the defense was not raised in taxpayer's claim for refund filed with the Board. Further, the facts did not establish an estoppel against the Board with respect to the application of interest and penalties, since the Board consistently took the position that the transaction was taxable as a "sale." King v. State Board of Equalization (1972) 22 Cal.App.3d 1006.

Related Corporation Subject to Liability as Successor

Taxpayer had made substantial sales on credit to a debtor corporation which subsequently became unable to remain current in its obligations. To avoid a loss, taxpayer acquired ownership of the outstanding stock of the debtor corporation and then directed the debtor corporation to transfer its operation assets to a wholly-owned subsidiary of taxpayer. The subsidiary issued a promissory note to taxpayer equivalent to the value of the assets which it received. Taxpayer then credited the debtor corporation, as reduction of its indebtedness, in the amount of the note.

An audit of the debtor corporation disclosed additional taxes due on sales made prior to its liquidation into the subsidiary. The amount was assessed against the subsidiary, as successor, by authority of Section 6812 of the Revenue and Taxation Code which imposes a liability upon any "purchaser of a business [who] fails to withhold purchase price" sufficient to cover any amount owed by the seller of the business under the Sales and Use Tax Law. The court, in holding that the subsidiary was properly liable for tax liabilities of the debtor corporation arising prior to the transfer of the assets, concluded that the fact that the purchase price did not flow directly to the seller was immaterial, noting that to hold otherwise would permit a taxpayer to avoid liability by the simple device of having the purchase price paid through an intermediary. Further, in the circumstances of present day business practice, it would be illogical to hold that a "purchase price" must take the form of cash or tangible personal property. Knudsen Dairy Products Co. v. State Board of Equalization (1970) 12 Cal.App.3d 47.

Statutory Procedure for Refund of Unconstitutionally Imposed Sales Tax Is Valid

In Rider v. County of San Diego (1991) 1 Cal.4th 1, the Supreme Court declared unconstitutional the San Diego County Regional Justice Facility Financing Agency supplemental sales and use tax (Jail Tax) because it was not approved by at least two-thirds of San Diego's voters as required under Article XIII A, section 4 of the California Constitution. Plaintiff thereafter filed this consumer class action lawsuit seeking direct reimbursement plus interest to consumers who effectively paid the Jail Tax. During the pendency of this action, the Legislature adopted SB 263 (codified as Revenue and Taxation Code Section 7275 et seq.) which provides a scheme for refunding the illegally collected tax. Three days after the trial court entered judgment for the plaintiff, SB 263 became effective.

The court of appeal held that the legislative scheme for refunds displaced the trial court's refund plan, and that such displacement did not violate the separation of powers doctrine. Kuykendall v. State Board of Equalization (1994) 22 Cal.App.4th 1194.

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