California Attorney General Opinion No. 80-1213

_________________________ ________________________________________________________________________ TO BE PUBLISHED IN THE OFFICIAL REPORTS OFFICE OF THE ATTORNEY GENERAL State of California GEORGE DEUKMEJIAN Attorney General : OPINION : No. 80-1213 : of : SEPTEMBER 4, 1981 : GEORGE DEUKMEJIAN : Attorney General : : Jack R. Winkler : Deputy Attorney General : : The Honorable Gerald H. Goldberg, Executive Officer, Franchise Tax Board, has requested an opinion on a question we have phrased as follows: Is the income of a lawyer’s referral service generated by that part of a referral fee measured by the amount of recovery resulting from litigation arranged for at the referral conference and received before 1981 exempt from state bank and corporation taxes? CONCLUSION The income of a lawyer’s referral service generated by that part of a referral fee measured by the amount of recovery resulting from litigation arranged for at the referral conference and received before 1981 is exempt from state bank and corporation taxes. 1 80-1213 ANALYSIS A lawyer referral service (hereinafter, “service’) is designed to make legal services available to the general public by providing a convenient and systematic method by which any person may be referred to a member of the bar. The service establishes panels of attorneys to serve in a given area of expertise. The panel may be composed of attorneys who have “special qualifications,” including attorneys certified by the California Board of Legal Specialization, and a panel may be established to provide free legal service to indigents or reduced-fee services to those who qualify. References are made on a rotational basis within the area of law relevant to the particular matter. A mutually convenient appointment between the participating attorney and the person seeking counsel is then arranged. Clients are not obligated to return after their initial consultation, but additional time spent on a matter is negotiated between the client and the participating attorney without any further involvement by the service. Lawyer referral services are authorized by rule 2–102 of the Rules of Professional Conduct of the State Bar of California adopted by the Board of Governors of the State Bar and approved by the Supreme Court pursuant to the State Bar Act. (See Bus. & Prof. Code, § 6076 et seq.) Rule 2–102 provides that participation of a member of the State Bar in a lawyer’s referral service established, sponsored, supervised and operated in conformity with the Minimum Standards for a Lawyer Referral Service in California (referred to herein as the “standards’) is encouraged. A copy of the standards is attached as the appendix. Section 8.1 of the standards governs the fees of a service. The attorney panel members may be required to pay to the service as a condition to panel membership: (1) a registration fee, (2) a “referral fee” (computed on a percentage basis or otherwise), (3) or other like referral fee, (4) or any two or more of such fees. The client applicants may be required to pay to the service as a condition to a lawyer referral: (1) a registration fee, (2) an initial consultation fee, 2 80-1213 (3) or other like referral fee, (4) or any two or more of such fees. The question presented relates to the fee paid to a service which is measured by the amount of recovery resulting from litigation arranged for at the referral conference. This has reference to the “referral” fee (computed on a percentage basis) paid the service by the lawyer panel member as a condition to his panel membership pursuant to section 8.1(a) of the standards.1 The question is whether such referral fees paid to the service are taxable under the Bank and Corporation Tax Law. (Rev. & Tax. Code, § 23001 et seq.) The Revenue and Taxation Code2 provides for exemptions from the Bank and Corporation Tax in sections 23701–23710. A lawyer referral service is exempt under section 23701e as a business league, which is defined by regulations of the Franchise Tax Board (hereinafter “board”) as: “ . . . an association of persons having some common business interest, the purpose of which is to promote such common intest and not engage in a regular business of a kind ordinarily carried on for profit.” However, not all income that may be earned by these organizations is exempt because section 23731 imposes a tax on the unrelated business taxable income” of such organizations. Prior to 1980 the sole definition of unrelated business taxable income was contained in subdivision (a)(1) of section 23732 as follows: “Except as otherwise provided in this subdivision, the term unrelated business taxable income’ means the gross income derived by any organization from unrelated trade or business (as defined in section 23734) regularly carried on by it, less the deductions allowed by this article which are directly connected with the carrying on of such trade or business, both computed with the modifications provided in subdivision (b). “ . . . . . . . . .” (Emphasis added.) 1 We assume this referral fee is a percentage of a contingent fee the client agrees to pay the attorney from any judgment or award to the client for the attorneys services in obtaining such award. We do not address the propriety of such a fee splitting arrangement under the Rules of Professional Conduct. 2 All unidentified section references are to the Revenue and Taxation Code. 3 80-1213 The term “unrelated trade or business” is defined by section 23734: “The term ‘unrelated trade or business’ means, in the case of any organization subject to the tax imposed by section 23731, any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under article 1 . . . .” (Emphases added.) The board has undertaken to define the term substantially related” in its regulations. Regulation 23734–23734a(1), subdivisions (d)(1) and (2), provides: “(1) . . . The presence of this requirement [substantially related] necessitates an examination of the relationship between the business activities which generate the particular income in question . . . and the accomplishment of the organization’s exempt purposes. “(2) Trade or business is ‘related’ to exempt purposes, in the relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income), and is substantially related for purposes of section 23734, only if the causal relationship is a substantial one. Thus, for the conduct of a trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which the exemption is granted, the production or distribution of the goods or the performance of services from which the gross income is derived must contribute importantly to the accomplishment of those purposes. Where the production of services does not contribute importantly to the accomplishment of the exempt purposes of an organization, the income from the sale of the goods or the performance of the services does not derive from the conduct of a related trade or business. Whether activities productive of gross income contribute importantly to the accomplishment of any purpose for which an organization is granted exemption depends in each case upon the facts and circumstances involved.” (Emphases added.) Originally the board interpreted these statutes and regulations as exempting all of the income of a lawyer’s referral service. In 1979 the United States Internal Revenue Service (I.R.S.) issued Letter Ruling No. 7952002 which, for the first time, ruled that any income of a lawyer referral service derived from the lawyer-client relationship subsequent to the initial consultation arranged by the service was subject to federal income tax as 4 80-1213 unrelated business income not exempt under federal tax law.3 Following the I.R.S. ruling the board adopted a similar interpretation of the California tax law taxing those referral fees of a service which were measured by the amount of recovery in subsequent litigation as unrelated business taxable income under section 23731. The Legislature intervened in 1980 by adding section 23734d to read as follows: “In determining the unrelated business taxable income of an organization for any taxable year, there shall be excluded all income of an organization described in Section 23710e which is derived from the operation of a lawyer referral service in conformance with the Minimum Standards for a Lawyer Referral Service promulgated by the State Bar of California.” (Emphasis added.) This statute effectively reversed the board’s interpretation for future income of lawyer referral services making all of such income exempt from taxes. Since chapter 439 was not an urgency measure it became effective on January 1, 1981. (Art. IV, § 8, of the Cal. Const.) The Legislature did not stop there, however. In the same statute which added section 23734d (ch. 439, Stats. 1980) the Legislature provided: “SEC. 3. The addition of Section 23734d to the Revenue and Taxation Code by Section 2 of this act does not constitute a change in, but is declaratory of, preexisting law.” It was this provision which prompted the board to request this opinion. It is settled that an expression by the Legislature of the intent of an earlier act is not binding upon the courts. (California Emp. etc. Comm. v. Payne (1947) 31 Cal. 2d 210, 213–214; Bd. of Soc. Welfare v. County of Los Angeles (1945) 27 Cal. 2d 90, 97; Stockton Savings & Loan Bank v. Massanet (1941) 18 Cal. 2d 200, 204.) This rule has been applied with regard to statutory declarations similar to that contained in section 3. (See, e.g., Learner v. County of Alameda (1965) 234 Cal. App. 2d 278, 284–285.) As stated in People v. Grazer (1956) 138 Cal. App. 2d 274, 279, “[if the existing law taxed these transactions . . . then the Legislature could not change the [preexisting) law by declaring that it never intended to tax them.” It therefore follows that the declaration contained in section 3 of chapter 439 can be accepted only to the extent it is found to be consistent with the law in effect before 1980. 3 We do not address the propriety of the I.R.S. interpretation of federal law but confine this analysis to California law. 5 80-1213 Our task thus narrows to an interpretation of section 23731, 23732 and 23734 and specifically the meaning of unrelated business taxable income” used therein as applied to lawyer referral services prior to January 1, 1981, the effective date of chapter 439, Statues 1980. We have found no cases which interpret these statutes so we must resort to the rules of statutory construction. The applicable rules were summarized in Moyer v. Workmen’s Comp. Appeals Bd. (1973) 10 Cal. 3d 222, 230, as follows: “We begin with the fundamental rule that a court should ascertain the intent of the Legislature so as to effectuate the purpose of the law. In determining such intent the court turns first to the words themselves for the answer. We are required to give effect to statutes according to the usual, ordinary import of the language employed in framing them. If possible, significance should be given to every word, phrase, sentence and part of an act in pursuance of the legislative purpose; a construction making some words surplusage is to be avoided. When used in a statute words must be construed in context, keeping in mind the nature and obvious purpose of the statute where they appear. Moreover, the various parts of a statutory enactment must be harmonized by considering the particular clause or section in the context of the statutory framework as a whole.” (Citations and quotations omitted.) Section 23731 imposes a tax on the “unrelated business taxable income” of otherwise tax exempt organizations. Section 23732 defines “unrelated business taxable income” as “the gross income derived by any organization from any unrelated trade or business . . . regularly carried on by it” less certain deductions. Section 23734 defines “unrelated trade or business” as any trade or business the conduct of which is not substantially related to the performance of the purpose or function which constitutes the basis for the organization’s tax exemption. Of course, such trade or business must be that of the exempt organization and not that of others for its income to be unrelated business taxable income of that organization under section 23732. Applying these statutory definitions to the question presented we must first ascertain whether the lawyer’s referral service is engaged in some unrelated trade or business from which it derives income. A service operating pursuant to the standards does two things. First, it provides a panel of attorneys and charges those attorneys a “referral” fee for panel membership. Second, it refers prospective clients to the panel members and charges those clients a referral fee therefor. The service does not become engaged in or involved with any business relationship which the client and panel attorney may agree upon following the referral. The fact that the “referral” fee the service charges the attorney for his panel membership is measured by the amount of any award which may result from a business relationship between the panel attorney and the client does not mean that the 6 80-1213 service is engaging in the business of that attorney and his client. We know of no reason why the charge to the attorney for panel membership must be a fixed amount or why it cannot be contingent upon or measured by some independent event such as the outcome of litigation which may or may not result from the referral. The income to the service from the attorney is for the panel membership, not from some unrelated trade or business the service is conducting. The fact that it is measured by an independent business transaction to which the service is not a party does not alter its status as consideration for the directly related business of panel membership, an essential feature of the service which is substantially related to the purpose and function for which the service is tax exempt. We are mindful of the rule of statutory construction which provides that the contemporaneous administrative construction of a statute, while nor controlling, is entitled to great weight and courts will generally not depart from such construction unless the interpretation is clearly erroneous or unauthorized. (Cullegan Water Conditioning v. State Bd. of Equalization (1976) 17 Cal. 3d 86, 92; Coca-Cola Co. v. State Board of Equalization (1945) 25 Cal. 2d 915, 921.) But which of the administrative constructions of the board are we to use in applying this rules. Since the original interpretation exempting all income from lawyer referral services had the acquiescence of the Legislature while the new interpretation following the I.R.S. ruling was immediately rejected by the Legislature, we believe the original interpretation was more indicative of the original legislative purpose. And while the courts are not bound by later expressions of an earlier legislative interest, nevertheless, section 3 of chapter 439, Statutes 1980 is a formal expression by the Legislature that it believed it had exempted all the income of lawyer referral services by its earlier exemption statutes and should not be ignored in ascertaining the legislative purpose of those earlier statutes. We conclude that a referral fee paid to a lawyer’s referral service before 1981 which was measured by the amount of recovery resulting from litigation arranged for at the referral conference was not “unrelated business taxable income” within the meaning of section 23731 prior to the effective date of section 23734d (Jan. 1, 1980) and was therefore not subject to tax under that section. 7 80-1213 APPENDIX MINIMUM STANDARDS FOR A LAWYER REFERRAL SERVICE IN CALIFORNIA (Effective May 14, 1976, Amended December 16, 1978) Policy of the State Bar 1.1 It is the policy of the State Bar of California that every community be served by a Lawyer Referral Service (hereinafter referred to as “Service”). Where the size of the community or the number of lawyers serving it make the establishment of a separate Service impractical, the State Bar encourages the establishment of a regional Service embracing two or more such communities. 1.2 The purpose of the Service shall be to make legal services more available to the general public by providing a way in which any person may be referred to a member of the Bar consistent with relevant circumstances, such as the type and degree of difficulty of the legal problem presented by such person, and his or her spoken language, geographical convenience and financial ability to pay for desired services. Authority to Operate a Service 2.1 A Service may be established, sponsored, and supervised or operated upon specific authorization by the Board of Governors of the State Bar, provided, however, that each Service operating as of the effective date of these Minimum Standards pursuant to the Standards previously in effect since January 19, 1973, shall automatically be authorized to continue such operation if the Service complies with Sections 3 through 9 hereof on or before January 1, 1977. Authorization to establish and operate a Service shall be granted only to a bar association that meets the requirements specified in Article VII, Section 1, subdivisions A(1), B, C, D, E, G and H(1) of the Rules and Regulations of the State Bar, or to a legal aid plan or program for the furnishing of services to indigents or to a nonprofit organization formed for charitable or other public purposes which furnished legal services to persons only in respect of their civic or political or constitutional rights and not otherwise in furtherance of such charitable or other public purposes of such organization. Such authorization shall be considered on the basis of a written application which contains an adequate showing that the proposed Service will conform to these Minimum Standards. 8 80-1213 2.2 Authority to operate a Service may be withdrawn by the Board of Governors if, after notice and an opportunity to be heard, it determines that the Service or its sponsor has violated any of these Minimum Standards. The Board of Governors may also issue such other remedial order as it deems appropriate under the circumstances. Supervision by the Lawyer Referral Committee 3.1 The Service shall be supervised in its establishment and operation by a committee or board of directors (hereinafter referred to as a “Lawyer Referral Committee”) having full authority to make all decisions necessary to the conduct of the Service Such decisions are subject to review or modification by the Service’s sponsor(s). 3.2 Members of the Lawyer Referral Committee shall be appointed by the sponsor(s) and may include non-lawyer public representatives. At least 50% of the Committee members must be active members of the State Bar of California. 3.3 The Lawyer Referral Committee shall meet at regular intervals. At least annually, the Committee shall review the operating records kept by the Service pursuant to Section 9.1 of these Standards, supplemented by a sampling of information as to whether appointments have been kept, whether the client was satisfied with the lawyer’s handling of the case and whether the fee was within the client’s means. Based on its review, the Committee shall make such alterations in the operation of the Service as it deems necessary. 3.4 Where two or more Services operate within the same county, their respective Lawyer Referral Committees shall seek to make cooperative arrangements in order to improve their collective capability for serving the public. Consideration should particularly be given to join efforts for providing emergency services. Eligibility and Approval of Panel Attorneys 4.1 Membership on any panel operated by the Service shall be open to all active members of the State Bar of California who regularly practice and maintain an office in the area served, except that the Service may impose additional requirements of experience or special education and training with respect to “special qualifications panels established and operated in conformity with Section 5.2 of these Standards, provided that the number of years an attorney has been admitted to practice shall not be the sole criterion or qualification for “special qualifications” panels. Membership on a panel may not be made contingent upon membership in a sponsoring association; however, a separate charge may be made to non-members of the sponsoring association to reimburse the association for services rendered by it to the Service. 9 80-1213 4.2 Each applicant for panel membership shall agree in writing to abide by all rules and regulations of the Service which shall include the requirement that each panel member submit any fee dispute arising between such member and a client referred by the Service, if the client so elects, to binding arbitration by a Fee Arbitration Committee or other body established or approved by the sponsor. 4.3 Each Service shall establish a uniform procedure for review of refusals to admit to, and decisions to suspend or remove from, membership on any panel. In every case where a Service refused to admit an attorney to a panel or suspends or expels an attorney from a panel, the Service must give the attorney a written statement of the reasons for its decision and offer the attorney a meaningful opportunity to be heard in his or her defense. 4.4 Every panel member shall be provided by the Service with a copy of the Minimum Standards for a Lawyer Referral Service in California that are then in effect at the time they become a member of the Service. Additionally, the Service shall continue to provide every panel member with copies of all changes that the Board of Governors thereafter may make to said Minimum Standards. Organization of Panels 5.1 Each Service shall establish such number and variety of panels as the Lawyer Referral Committee determines will best enable the Service to make referrals that are responsive to individual client needs (see Section l.2). 5.2 Each Service is encouraged to establish “special qualifications” panels representing different fields of law and limited to attorneys, found to be experienced or to have special education or training in the respective fields, provided that the number of years an attorney has been admitted to practice shall not be the sole criterion or qualification for “special qualifications” panels, and provided further that an attorney who is certified by the California Board of Legal Specialization as a specialist in a particular field shall be qualified for membership on the panel for such field by virtue of his or her certification. For each “special qualifications” panel, the Lawyer Referral Committee shall establish and file with the State Bar standards and procedures for: (a) determining the qualifications for membership on the panel; (b) reviewing the qualifications of a member to remain on or to be removed from the panel; and (c) appealing decisions to suspend or remove a member from the panel (see Section 4.3 of these Standards). 10 80-1213 5.3 Each Service is encouraged to establish other separate panels including, but not limited to a free-service-to-indigents panel, a reduced-fee panel, an inmate assistance panel, a legal services for the aged panel, or an attorney-to-attorney consultation panel Referral Procedures 6.1 The Lawyer Referral Committee shall establish procedures assuring that each referral is made by the Service in a fair and impartial manner to a member of the appropriate panel. To the extent feasible, such procedures shall be designed to respond to all circumstances of the client, including the type and degree of difficulty of the legal problem presented, geographical convenience, language needs and the ability to pay for desired services. 6.2 No referral shall be made on the basis of race, sex, age, religion or national origin. 6.3 No referral shall be made by the referrer to himself, his associates or employees. Publicity 7.1 Each service shall develop and maintain an active publicity program through communications media designed to inform the general public in the area served of the existence, purpose and advantages of the Service. Each Service should also make specific arrangements for receiving referrals from legal aid programs, criminal justice agencies, hospitals, jails, employers, and other appropriate public and private agencies and institutions in the area served. 7.2 The form and content of all publicity shall be dignified and shall not be misleading. In particular, any Service operating with special qualifications panels pursuant to Section 5.2 of these Standards may publicize that it will make referrals to attorneys “experienced in particular substantive areas, but shall not use such terms as “specialist” or “special qualifications” that may be confused with specialty certification conferred by the California Board of Legal Specialization unless such panels contain only the names of certified specialists. All advertising shall identify the sponsor(s) of the service. 7.3 No publicity about the Service shall identify the attorneys participating in it, except that this shall not prohibit a participating attorney from acting as a spokesperson for the Service if authorized by the Lawyer Referral Committee. Operating Fees and Use of Proceeds 8.1 A Lawyer Referral Service may require that: 11 80-1213 (a) each panel member pay to the Service a registration fee, “referral” fee (computed on a percentage basis or otherwise), or other like participating fee, or any two or more of such fees, as a condition to panel memberships; and (b) each applicant pay a registration fee, initial consultation fee, or other like referral fee, or any two or more of such fees, as a condition to referral; provided, however, that no Service may require any fee which is, or any combination of fees which are, either in conflict with statutory or other legal provisions for the award of attorney fees or unreasonable, whether those fees be required of applicants, panel members or both. The primary criterion for determining whether a Service has failed to comply with this provision shall be whether the fee or combination of fees in question increases an applicant’s cost for legal services beyond that which he or she would normally pay, or decreases the quantity or quality of services which he or she would otherwise receive, absent involvement of the Service. 8.2 The proceeds derived from the operation of the Service may be used only for the following: (a) payment of the actual expenses of operating, conducting, promoting and developing the Service, including expenditures for capital purposes for the Service, as determined on a reasonable accounting basis and with provision for reasonable reserves; (b) support of activities or programs (i) for the furnishing of legal services to persons and entitles financially unable to pay for all or part of such services or conducted by a legal aid plan or program for the furnishing of services to indigents or by a nonprofit organization formed for charitable or other public purposes which furnishes legal services to persons only in respect of their civic or political or constitutional rights and not otherwise in furtherance of such charitable or other public purposes or such organization, or (ii) designed to educate members of the public with respect to the law, the judicial system, the legal profession, or the need, manner of obtaining and availability of legal services, or (iii) designed to advance the science of jurisprudence, improve the 12 80-1213 administration of justice, or aid in relations between the bar and the public; or (c) support of other activities in the public interest. In no event shall proceeds from the Service be used to defray the costs of operating the sponsoring association (other than those properly apportionable as expenses for the purposes described in subsection (a), (b) and (c) hereof) or be used solely for the benefit of the members of such association or members of the State Bar. Records and Reports 9.1 Each Service shall maintain records of its operation including at least the following: information: (a) the name, address and pertinent qualifications of each panel member, and the number and types of matters referred to such panel members; (b) the name, address and type of matter presented by each client referred, the name of the panel member to whom the referral was made, the date the referral was made and the date the case was resolved or otherwise closed as reported by the panel member; (c) the total fee charged as shall be reported by the panel member in the event such member is required to pay a forwarding fee to the Service. 9.2 The Lawyer Referral Committee of each Service shall annually file with the State Bar, on a form to be supplied by it, a report on the activities of the Service and of the Committee. Such report shall include at least the following: (a) statistics derived from the operating records required by Section 9.1 hereof and what, if any, alterations have been made in the conduct of the Service by the Lawyer Referral Committee pursuant to Section 3.3 hereof; (b) a detailed accounting of all income to the Service (and sources thereof), all expenses related to the operations or promotion of the Service, the amount of current reserves held by the Service, and the specific disposition over the past two years of any reserves and/or surpluses derived from the Service. 13 80-1213 The State Bar shall have the right at any time to conduct an independent audit or investigation of any Service at State Bar expense, and the Service and its sponsoring association shall have the obligation to cooperate fully therewith ***** 14 80-1213