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General Mills v. Franchise Tax Board

April 15, 2009


(City and County of San Francisco Super. Ct. No. CGC 05-439929), Trial Judge Honorable A. James Robertson II.

The opinion of the court was delivered by: Stevens, J.*fn11


This appeal presents the issue of whether commodity futures sales that are made to hedge against price fluctuations should be included in the sales factor of the Uniform Division of Income for Tax Purposes Act (Rev. & Tax. Code, § 25120 et seq; UDITPA) apportionment formula. We conclude that, in the tax years at issue, the full sales price of these futures contracts (number of bushels times price per bushel) are gross receipts within the meaning of the UDITPA sales factor and we vacate the trial court's denial of the taxpayer's claims for refund.


General Mills and its subsidiary corporations (hereafter, General Mills) seek refunds from the California Franchise Tax Board for the tax year ending May 31, 1992 through the tax year ending May 25, 1997. Because General Mills is a unitary group of corporations operating both within and outside of California, the proportion of its income that is subject to California taxation is determined by the UDITPA. The Franchise TaX Board calculates General Mills' total business income*fn1 (as distinguished from its nonbusiness income), and uses an apportionment formula to determine the percentage of the income that will be subject to California taxation. (Rev. & Tax. Code, §§ 25120, subds. (a), (d), 25128.)*fn2

The apportionment formula recognizes three factors: property, payroll, and sales. (§ 25128.)*fn3 Each factor is a fraction where the numerator is the amount attributable to California and the denominator is the total amount. (§§ 25129, 25132, 25134.) When combined,*fn4 the factors establish the fraction (apportionment percentage) of the unitary business's total business income that is subject to California taxation. (§ 25128.) Collectively, the property, payroll and sales factors are intended to represent the taxpayer's business activity within California. (See § 25137.) If the taxpayer or the Franchise Tax Board can demonstrate that the factors do not fairly represent the taxpayer's business activity within California, the taxpayer may request and the Franchise Tax Board may require that an alternative allocation and apportionment formula be applied. (§ 25137; see generally Microsoft, supra, 39 Cal.4th at pp. 755-757.)

Only the sales factor is at issue in this litigation. As to the sales factor, the only issue is the treatment of General Mills' sales on commodity futures markets. All of those sales take place outside of California and affect only the denominator of the sales factor. Any increase in the denominator of the sales factor decreases the percentage of General Mills' business income that is taxable in California. That is, it reduces General Mills' California taxes.

For tax years beginning before January 1, 2011, the UDIPTA defines ―sales‖ as ―all gross receipts of the taxpayer‖ not allocated as nonbusiness income. (§ 25120, subd. (e).)*fn5 General Mills argues that the full sales price of each of its futures sales contracts (i.e., the number of bushels sold under the contract multiplied by the price per bushel in the contract) should be counted as gross receipts for purposes of calculating the sales factor, regardless of whether the contract results in actual physical delivery of the commodity, is offset before delivery, or is used to offset an open futures purchase contract. (We describe ―offset‖ below.) The Franchise Tax Board maintains that no amount from these futures sales contracts should be counted as gross receipts in the sales factor.

We will first describe General Mills' trading activity on the commodity futures markets. As the parties agree the relevant facts are undisputed, our description is based on the parties' joint stipulation of facts and trial court testimony and exhibits. We then describe how General Mills accounts for the transactions in its financial books and on its tax returns, as well as the procedural background of this appeal. Finally, we address the substance of the appeal.

General Mills' Futures Trading

General Mills is engaged in the principal trade of manufacturing and marketing branded finished consumer food products. It also sells raw grain and grain products to third parties.

The company engages in futures trading as a hedger. As we will explain, the process of hedging protects it against the risk of fluctuations in the price of agricultural commodities General Mills uses in its business. To understand General Mills' hedging transactions, we define several concepts involved in the hedging process. A futures contract is ―an agreement to purchase or sell a commodity for delivery in the future:

(1) at a price that is determined at initiation of the contract; (2) that obligates each party to the contract to fulfill the contract at the specified price; (3) that is used to assume or shift price risk; and (4) that may be satisfied by delivery or offset.‖ ― ‗Offset' means liquidating a purchase of futures contracts through the sale of an equal number of contracts of the same delivery month, or liquidating a short sale of futures through the purchase of an equal number of [purchase] contracts of the same delivery month.‖

" ‗Hedging' means (1) taking a position in the futures market opposite to a position held in the cash market to minimize the risk of financial loss from an adverse price change;‖ or (2) purchasing or selling commodities on the futures market as a temporary substitute for a cash transaction that will occur later. The purpose of hedging is to smooth out price fluctuations so General Mills can operate despite the price volatility in the agricultural commodities it uses to manufacture its consumer products. If General Mills did not hedge the price of grain, it would encounter severe fluctuations in its costs of goods. In such instances, General Mills would have to choose between selling at a loss or not selling at all, particularly for products such as flour where the cost of grain is about 85 percent of the selling price. Although General Mills may not make any profit on its futures trades, and may in fact experience a net loss, it would not be ...

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