II. Inclusion of Net Securities Proceeds in “Gross Receipts”
We conclude that the trial court correctly decided that the return of principal from securities transactions in the repurchase agreements and maturities categories should not be included as “gross receipts” in the denominator of the sales factor in apportioning income to California. The reason for this conclusion is that such a return of principal does not arise out of a sales transaction.
Section 25120, subdivision (e), defines “ ‘[s]ales' ” as “all gross receipts of the taxpayer····” The parties have excluded from our concern GM's “direct sales” of securities. It is reasonably clear that such transactions do constitute sales. However, the UDITPA does not otherwise define “gross receipts.” Thus, aside from the obvious determination that “gross receipts” must be sales, we are left without statutory guidance. The question we face then is whether GM's transactions involving repurchase agreements and maturities constitute sales. We conclude that they do not. . . .
In our view, the activity represented by these Treasury Department transactions is not akin to a sale at all but rather is more easily comparable to a taxpayer who takes “idle cash” or, merely to remain liquid, repeatedly deposits and withdraws his cash from his bank or savings and loan accounts. As decided in American Tel. & Tel. v. Taxation Div. Director (A.D.1984) 194 N.J.Super. 168, 476 A.2d 800, 802: “We uphold as a general matter the exclusion of gross revenues received by plaintiff from the sale or maturity of investment paper. As [the trial judge] observed, idle cash can be turned over repeatedly by investment in short term securities. It is no true reflection of the scope of AT & T's business done within and without New Jersey to allocate to the numerator or the denominator of the receipts fraction the full amount of money returned to AT & T upon the sale or redemption of investment paper. To include such receipts in the fraction would be comparable to measuring business activity by the amount of money that a taxpayer repeatedly deposited and withdrew from its own bank account. The bulk of funds flowing back to AT & T from investment paper was simply its own money. Whatever other justification there is for excluding such revenues from the receipts fraction, it is sufficient to say that to do otherwise produces an absurd interpretation of [the statute]. ‘It is axiomatic that a statute will not be construed to lead to absurd results. All rules of construction are subordinate to that obvious proposition. [Even the rule of strict construction] does not mean that a ridiculous result shall be reached because some ingenious path may be found to that end.’ [Citation.]”
We agree with the trial court that the Sherwin-Williams line of cases provides ample precedent from other states to uphold the trial court's interpretation of the statute. (Sherwin-Williams v. Dept. of State Revenue (Ind.Tax 1996) 673 N.E.2d 849, 853; Sherwin-Williams Co. v. Johnson (Tenn.App.1998) 989 S.W.2d 710.)
In Sherwin-Williams v. Dept. of State Revenue, supra, 673 N.E.2d at page 850, the Indiana Tax Court reviewed the Indiana State Department of Revenue's determination that apportionment cannot result from an inclusion of “rolled over” securities in the sales factor. The question was therefore whether the denominator of Sherwin-Williams's sales factor should be increased to include the principal or capital element of investments. The court's analysis centered on how to define “gross receipts.” (Id. at p. 851.) The court especially focused on the notion that repeated rolling over of the investment would amount to an absurd abuse if these “same funds” could be included several times over in the gross receipts denominator. (Id. at p. 852.) The court thus concluded that “ ‘gross receipts' for the purpose of the sales factor includes only the interest income, and not the rolled over capital or return of principal, realized from the sale of investment securities. Thus, the Department was correct in including only the interest earned as part of the total receipts in the denominator of the sales factor of the apportionment formula.” (Id. at p. 853.)
Certainly, as the FTB posits, the return of one's own funds is not a receipt from a sale. Therefore, while interest thereon is income, the taxpayer's capital funds are not proceeds from a sale. (See County of Sacramento v. Pacific Gas & Elec. Co. (1987) 193 Cal.App.3d 300, 311, 238 Cal.Rptr. 305, and City of Los Angeles v. Clinton Merchandising Corp. (1962) 58 Cal.2d 675, 681, 25 Cal.Rptr. 859, 375 P.2d 851.) The regulations pertaining to section 25134 also support the FTB view. Section 25134, subdivision (a)(1)(A), describes what is includable and excludable as gross receipts. That section states that “[g]ross receipts for this purpose means gross sales, less returns and allowances and includes all interest income.” (Cal.Code Regs., tit. 18, § 25134, subd. (a)(1)(A).) As the FTB asserts, the procedure of subtracting returns recognizes that any sale is negated and that there is no receipt, except the interest. Although, the judiciary must take ultimate responsibility for the construction of a statute, we accord great weight and respect to the administrative construction. (Yamaha Corp. of America v. State Bd. of Equalization (1998) 19 Cal.4th 1, 12, 78 Cal.Rptr.2d 1, 960 P.2d 1031.)
Respondent FTB also points out that GM did not report the proceeds from Treasury Department activities as sales on their federal tax returns, financial statements, or annual reports. It only reported the interest it received from the securities transactions. Section 448 of the United States Internal Revenue Code (26 U.S.C. § 448) allows taxpayers with under $5 million of gross receipts to compute their income using the cash method of accounting. Section 448 is incorporated into the California Revenue and Taxation Code by section 24654. The federal regulations relating to section 448 include the following provision: “Gross receipts do not include the repayment of a loan or similar instrument ( e.g., a repayment of the principal amount of a loan held by a commercial lender).” (26 C.F. R. § 1.448-1T(f)(2)(iv)(A).)
We are not persuaded by GM's argument invoking IRC section 1271, which provides that maturing securities are “exchanges.” That provision does not relate to apportionment of income; instead it merely ensures that gain from discounted corporate debt instruments is treated as capital gain rather than as ordinary interest income. (KVP Sutherland Paper Company v. United States (1965) 170 Ct.Cl. 215, 344 F.2d 377, 382.) Indeed, it is well settled that payment of an obligation or retirement of a maturity is not a sale or an exchange other than with regard to the limited exception of section 1271. (Ibid; Graham v. C.I.R. (2d Cir.1962) 304 F.2d 707, 708, citing Fairbanks v. United States (1939) 306 U.S. 436, 59 S.Ct. 607, 83 L.Ed. 855.)
California has also concluded that security repurchase transactions should be considered loans. “Repurchase agreements, commonly known as ‘repos,’ ” the California Supreme Court has held, “are ··· nothing more than financing arrangements by which one party provides funds to another for a short period of time. There are two parties to a repurchase agreement: one has money to lend, the other needs cash and has securities. The repurchase agreement itself consists of two transactions that are agreed to simultaneously, but are performed at different times: (1) the seller-borrower agrees to transfer securities to the buyer-lender in exchange for cash; and (2) the seller-borrower agrees to repurchase the securities from the buyer-lender at the original price plus ‘interest’ on a specified future date or upon demand.” (Bewley v. Franchise Tax Bd. (1995) 9 Cal.4th 526, 529, 37 Cal.Rptr.2d 298, 886 P.2d 1292.) The United States Supreme Court came to essentially the same conclusion with regard to repurchase transactions. (Nebraska Dept. of Revenue v. Loewenstein (1994) 513 U.S. 123, 134, 115 S.Ct. 557, 130 L.Ed.2d 470 [noting that “in economic reality the [taxpayer] receive[s] interest on cash [it has] lent ···”].)
Thus, we conclude that maturities and so-called “repos” are not sales, but rather secured monetary transactions that are the equivalent of loans. Since the transactions are not sales, the return of capital is not includable in the sales factor as “gross receipts.”