California Supreme Court Denies Use Of Multistate Tax Compact's Equally-Weighted Three-Factor Apportionment Election

On December 31, 2015, the California Supreme Court unanimously reversed a 2012 decision reached by the California Court of Appeal, and held that taxpayers are precluded from making the election under the Multistate Tax Compact to use the equally-weighted three-factor apportionment formula for purposes of the California franchise (income) tax.1 After determining that the Compact is not a binding contract among its members, the Court concluded that the California legislature had the unilateral authority to eliminate the Compact's election provision. Also, the Court determined that the 1993 legislation enacting a double-weighted sales factor did not violate the state's reenactment rule. Finally, the legislature's intent to supersede the Compact's election provision was supported by the statutory language adopting the double-weighted sales factor and the accompanying legislative history.

Background

The Uniform Division of Income for Tax Purposes Act (UDITPA) was promulgated in 1957 in an effort to provide uniformity in the apportionment of corporate income among states. Under UDITPA, income is apportioned to a state using an equally-weighted formula that consists of property, payroll and sales factors.2 The Compact, which was created in 1967, created the Multistate Tax Commission (MTC) and adopted the apportionment methodology from UDITPA. Specifically, Article IV of the Compact provides for an equally-weighted three-factor formula. Article III of the Compact expressly allows taxpayers the option of apportioning income under the standard UDITPA formula or a state's alternative apportionment provisions. In 1966, the California legislature codified the UDITPA provisions.3 California ratified the Compact in 19744 and required corporations to apportion their business income to the state using the standard equally-weighted three-factor formula.5 For tax years beginning on or after January 1, 1993, California adopted a three-factor apportionment formula consisting of property, payroll and double-weighted sales, notwithstanding the Compact.6

In January 2010, the taxpayers filed claims with the California Franchise Tax Board (FTB) for the refund of taxes and argued that the California apportionment statute did not override or repeal the standard UDITPA apportionment formula. The taxpayers appealed the FTB's denial of their refund claims to the trial court.7 The FTB argued that the amended California apportionment statute required the exclusive use of the doubleweighted sales factor. The trial court ruled in favor of the FTB and agreed that the California apportionment statute clearly expressed an intention to eliminate the alternative apportionment formula allowed under the Compact. The taxpayers appealed this decision to the California Court of Appeal.

On June 27, 2012, in contemplation of a decision adverse to the state, California enacted legislation, S.B. 1015, repealing the Compact.8 The legislation, which was an attempt to limit potential tax refunds, clarified that since 1993, the use of an equally-weighted threefactor formula by a multistate taxpayer has been disallowed.

Court of Appeal Allowed Three-Factor Election

The California Court of Appeal reversed the trial court and agreed with the taxpayers that California was bound by the provisions of the Compact and could not override and eliminate the taxpayers' ability to elect the equally-weighted three-factor apportionment formula.9 In reaching its decision, the Court rejected the FTB's argument that the plain language of the California apportionment statute required the exclusive use of the doubleweighted sales apportionment formula. According to the Court, California could only eliminate a taxpayer's election to use the equally-weighted three-factor formula by completely withdrawing from the Compact. California could not enact a statute that repealed the provisions of the Compact to the extent necessary to impose a mandatory apportionment formula on taxpayers. The California Supreme Court granted the FTB's petition to review the decision.

Supreme Court Holds Legislature Eliminated Election Provision

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