California Court Of Appeal Allows Taxpayers To Elect Equally- Weighted Three-Factor Apportionment Formula Under Multistate Tax Compact

The California Court of Appeal has ruled in favor of a group of taxpayers electing to use the equally-weighted three-factor apportionment formula that is provided by the Multistate Tax Compact, in lieu of an apportionment formula requiring use of a double-weighted sales factor.1 California originally adopted the Compact's equally-weighted three-factor apportionment formula, but enacted mandatory use of a double-weighted sales factor for most California taxpayers in 1993, notwithstanding the provisions in the Compact. Despite this legislation, the Court of Appeal held that California is contractually bound by the Compact and its apportionment election provision until it withdraws from the Compact.

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, 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. California ratified the Compact in 19743 and required corporations to apportion their business income to the state using the standard equally-weighted three-factor formula.4 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.5

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.6 The FTB argued that the amended California apportionment statute required the exclusive use of the double-weighted sales factor and negated the taxpayers' claim of entitlement to elect the UDITPA formula. 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...