California – Appeals Court Upholds Taxpayer’s Right to Use Multistate Tax Compact’s Apportionment Formula

SALT Report 1766 – A California appeals court upheld a taxpayer’s right to use the Multistate Tax Compact’s apportionment formula to apportion their California net income for corporate franchise and income tax purposes. The taxpayer is a multistate corporation that originally filed using California’s double-weighted sales factor apportionment formula, but later filed refund claims for several tax years on the basis that they should have been allowed to make an election to use the Compact’s equally-weighted apportionment formula.

The Franchise Tax Board denied the taxpayer’s claim for refund because of California’s 1993 enactment of Tax Code §25128, which states that, “all business income must be apportioned to California utilizing the double-weighted sales-factor formula.”  The FTB asserted that tax code §25128 essentially rescinded the taxpayers’ option to use the equally-weighted formula.

The taxpayer appealed the FTB’s decision however, a lower court ruled in favor of the FTB affirming the state’s authority to repeal the provision allowing taxpayers to use the MTC’s equally-weighted apportionment formula.  The taxpayer appealed again.

This time, the court determined that the Multistate Tax Compact was a valid compact as the following three components that determine the existence of a valid interstate compact were met:

  • The Multistate Tax Commission was established to oversee the implementation of the Compact,
  • The Compact included a binding reciprocal agreement that advances uniformity, such as the provision specifying how income is to be apportioned among the signatory states, and
  • The Compact clearly specifies how member states must withdraw from the Compact

Finding that the Compact was a valid compact that bound the signatory states, the court held that the state did not have the authority to enact subsequent legislation that “amended, modified, or partially repealed any provision of the Compact.”  The court stated that the plain language of the Compact clearly gave taxpayers the option to choose either the MTC formula, or the state’s alternative apportionment formula; and to rule otherwise would disregard the sole purpose of the Compact, which was to provide uniformity among the states.

Ultimately, the court concluded that since the Compact is a valid multistate compact, California is bound by it and the apportionment provisions within, unless California fully withdraws from the Compact or enacts legislation that repeals section 38006.  Since California has not repealed section 38006, nor has it withdrawn from the Compact the election allowed under the compact remains a valid choice for taxpayers.  Therefore, the Judge granted the taxpayer’s refund claim and the FTB was ordered to pay court costs.

For Further Information:

Court of Appeal of California First District – Docket No. A130803

Multi State Tax Compact – Division of Income