California Corporations Score Big Tax Win with Gillette Ruling

On July 24, 2012, a California Court of Appeals ruled in Gillette Company v. Franchise Tax Board that Gillette – and any other California corporate taxpayer with multistate operations – is entitled to calculate its income tax based on methods set forth in the Multistate Tax Compact adopted by the state in 1974.

First, the background, from law firm Morrison & Foerster:

“In 1966, the California Legislature adopted the Uniform Division of Income for Tax Purposes Act (‘UDITPA’), a model law which had been promulgated in 1957 by the National Conference of Commissioners on Uniform State Law. UDITPA contained a corporate apportionment formula consisting of equally weighted payroll, property and sales factors. In 1974, the California Legislature adopted the Multistate Tax Compact (‘Compact’), which incorporates UDITPA nearly word for word. However, in 1993, the California Legislature enacted a statute which moved away from an equal weighting of the payroll, property and sales factors to require corporate taxpayers, with certain exceptions, to apportion income using a double-weighted sales factor.”

That law didn’t sit well with Gillette. Again, Morrison & Foerster:

“The Gillette Company filed suit in California against the California Franchise Tax Board (‘FTB’), arguing it was entitled to elect to use an equally weighted apportionment formula, notwithstanding the California Legislature’s attempt to require use of a double-weighted sales factor, because the Legislature had not and could not amend the Compact and had not repealed the Compact. Gillette lost in the California trial court, and then appealed to the Court of Appeal, First District.”

This week’s ruling came down on the side of Gillette. Law firm Reed Smith:

“The [appeals] court held that when a state enters into a compact with another state, the state enters into a contractual obligation, evidenced by all the indicia of a contract… The only way for a state to be released from this obligation is to withdraw completely from the compact in a manner prescribed by the compact itself. The court stated this is done by repealing legislation that may only be prospective in nature. Thus, short of the drastic measure of withdrawing completely from the compact, California must continue to uphold its contractual bargain by permitting taxpayers to apportion and allocate income under the terms of the compact.”

In plain English, the state must allow Gillette to determine its income tax based on the methods set forth in the Multistate Tax Compact. And that’s good news for corporations in California, writes Dan Walters in the Sacramento Bee:

“The decision gives the corporations relief from a 1993 state law that gave double weight to sales, thereby increasing corporate income taxes on out-of-state corporations doing business in California while giving those based in the state some tax relief.”

But the news isn’t so good for the state of California, which according to Walters, could lose “hundreds of millions of dollars” in tax revenues.

But any celebrations may be short-lived. Again, Morrison & Foerster:

“There are two very large ‘unknowns’ at the moment regarding the election issue presented in the Gillette Court of Appeal decision. First, the FTB may ask the California Supreme Court to accept the Gillette case for review. While the California Supreme Court is not required to accept the case for hearing, the odds would seem in favor of the Court accepting the case… Second, On June 27, 2012, and while Gillette was pending at the Court, Governor Brown signed S.B. 1015, which repealed the Compact… S.B. 1015 essentially guarantees that even assuming Gillette ultimately prevails on the merits, there will be further litigation on whether an election under the Compact can be made on an amended return, with FTB arguing the answer is ‘no’ based on S.B. 1015, and taxpayers arguing ‘yes’ because S.B. 1015 cannot retroactively change the law on that issue.”

The bottom line? From Reed Smith:

“We encourage any taxpayer with positive taxable income whose California property and payroll factors are less than their sales factor to file a refund claim. Refund claims for the 2007 year will be due soon for calendar-year taxpayers that filed on extension: California’s four-year statute of limitations expires on the fourth anniversary of when the original return was filed on extension.”

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