Tax News

CCH (cch.taxgroup.com) reports:

  A California court of appeal ruled that commodity futures sales that were made to hedge against price fluctuations in the agricultural materials used in a cereal company's manufacturing operations should be included in the taxpayer's corporation franchise and income tax apportionment formula's sales factor for purposes of apportioning the taxpayer's business income to California. The court held that the full sales price of these futures contracts constituted gross receipts includable in the sales factor during the tax years at issue, but remanded the case back to the trial court to determine whether a distortion adjustment under California Revenue & Taxation Code §25137 was appropriate.

  In so ruling, the court reversed the lower court's decision, which held that the futures contracts had no value and therefore should not be included in the sales factor gross receipts. The appellate court found that the futures sales contracts were legally binding obligations to sell a commodity and that a trader received consideration at offset. The taxpayer either received money or other consideration for goods sold, which were includable in the sales factor gross receipts.

  The court determined that the hedging transactions were undertaken for the ultimate purpose of obtaining profits and therefore should be included in the apportionment formula's sales factor in order to properly reflect the taxpayer's income producing activities. The Franchise Tax Board (FT unsuccessfully argued that the receipts from futures trades should be considered adjustments in the taxpayer's costs of goods rather than sales because the company engaged in hedging as a form of price insurance, not as a profit-making venture. The court reasoned that the hedging transactions were undertaken to smooth out the price fluctuations of the raw goods used by the taxpayer so that the taxpayer could operate profitably despite the price volatility in the agricultural commodities it used to manufacture its consumer products. Although the taxpayer did not make any profit on its futures trades, it would not have been able to achieve its profit margins on its ultimate product sales without the price protection of hedging. Furthermore, the fact that the taxpayer accounted for its trades as adjustments in its costs of goods on its financial statements was irrelevant as it is well settled that a company's financial accounting treatment of the trades is not binding for tax purposes.

  Finally, under the plain language of the statute, the court found that the taxpayer's gross receipts from the futures sales contract were equivalent to the full sales price of the contract, and not the net gains on futures contracts as the FTB had proposed. However, as the lower court never reached the issue of whether including such gross receipts in the sales factor denominator would result in distorting the percentage of the taxpayer's actual business activity conducted in California, the appellate court remanded this issue back to the trial court for further consideration.

General Mills v. Franchise Tax Board , California Court of Appeal, First Appellate District, No. A120492, April 15, 2009, ¶404-894

  Other References:

  Explanations at ¶11-525