The First District Court of Appeals in San Francisco California reversed a lower court decision dismissing state income tax refund claims worth millions of dollars from multiple companies including Gillette, Kimberly-Clark, Procter-Gamble and others. The three judge panel unanimously overturned the lower court decision.
In 2006, Gillette filed a refund claim for income taxes paid to the state of California. Under California Revenue and Tax Code Section 251218 states that all business income shall be apportioned to California based fraction, the numerator of which is the property factor plus the payroll factor plus twice the sales factor over a denominator of four. However, prior to Governor Brown signing California Senate Bill 1015 California was a member of the Multistate Tax Compact. Under the Multistate Tax Compact (Compact) and California Revenue and Tax Code Section 38006, companies were allowed to choose an equally weighted, three factor apportionment formula.
Before addressing the first issue Judge Reardon writing for the court provided some discussion of interstate compacts. While some interstate contracts require Congressional consent others do not. When those not requiring Congressional consent are enacted “they have dual functions as enforceable contracts between member states and as statutes with legal standing within each state,” wrote Judge Reardon.
One issue addressed by the court was whether California’s apportionment formula under Section 25128 superseded the Compact. The court held that the Compact trumps California’s formula and emphasized that the Compact equally weighted, three factor apportionment formula is required option of Compact member states. “If a state could unilaterally delete this baseline uniformity provision, it would render the binding nature of the compact illusory.”
The court also dismissed the Franchise Tax Board’s other arguments that the Compact was invalid.
Repeal of the Multistate Tax Compact
On June 28, 2012, California Governor Jerry Brown signed the 2012-2013 California State Budget and with that Senate Bill 1015 that repeals the Compact. The new law also contained Legislative declarations that: under the “the doctrine of election” an election affecting the computation of tax made on an original return is binding and that the repeal of the Multistate Tax Compact shall be construed to create an inference of a change in law with respect to the Compact prior to it repeal. The bill did not pass either the house with a two-thirds vote, which has led some tax professionals to believe the bill is susceptible to challenge under Proposition 26, which requires revenue-raising bills to pass each house by a two-thirds vote.
Judge Reardon discusses the role of the interstate compacts within state legislation. “Upon entering a compact, it takes precedence over the subsequent statutes of signatory states and, as such, a state may not unilaterally nullify, revoke or amend one of its compacts if the compact does not so provide.” The Compact provides that a state may withdrawal by enacting a statute to repeal like California did. However, Judge Reardon states that “any repealing legislation must be prospective in nature, because it cannot ‘affect any liability already incurred by or chargeable to a party State prior to the time of such withdrawal.”
Read the full opinion: The Gillette Company v. Franchise Tax Board