Multistate Companies Lose California Tax Refund Bid

Publication February 8, 2016

Companies operating in multiple US states lost a bid to get back income taxes paid in California.

Each US state taxes income earned in the state. Because the states have different approaches to determining how much income a large company operating nationally earned in each, there is the potential for double taxation. A House subcommittee recommended in 1965 that Congress impose a uniform apportionment regime on the states. State tax administrators from nine states drafted a multistate tax compact in 1967 in an effort to avoid federal action. The multistate compact adopts a three-factor formula in which a company apportions income to the state based on the share of the company’s total property, payroll and sales in the state. The three factors are given equal weight.

California adopted the multistate compact in 1974. However, in 1993, it changed its law to require double weighting be given to the sales factor.

Gillette and five other companies sued the state for $34.6 million in refunds in 2010 arguing that they are entitled by law to use the formula in the multistate tax compact. 

The California Supreme Court disagreed in a decision on December 31.

The state enacted a bill in July 2012, shortly before a decision by a state appeals court in favor of the companies, withdrawing from the multistate compact and barring refund claims unless a company elected use of the apportionment formula in the multistate compact when it filed its tax return. 

The California Supreme Court said the state remains free to change its tax law, including overriding the formula in the multistate compact. The companies argued that the compact is a binding reciprocal agreement among states that the California legislature cannot change unilaterally. The court disagreed. It said adoption of the compact made it state law, and the state remains free to change its law. The companies also argued that it is not clear the state legislature intended to eliminate the ability of companies to elect the compact formula. The court disagreed.

The companies plan to appeal to the US Supreme Court. The case is Gillette Co. v. Franchise Tax Board. California could be exposed to about $750 million in total refund claims if it loses. 

Multistate compact cases are also before the courts in at least four other states: Oregon, Minnesota, Michigan and Texas. 

Review by the US Supreme Court is uncertain. The latest decisions in all the states have been against the taxpayers. The Supreme Court usually focuses on cases where there is disagreement among courts that have considered an issue.

The Minnesota Supreme Court heard oral arguments in January in another multistate compact case in that state involving a $1.2 million refund claim by Kimberley-Clark. The company argued it overpaid income taxes in the state between 2007 and 2009 because it should have been allowed to use the formula in the multistate tax compact. The Multistate Tax Compact filed a brief supporting the state’s position that Minnesota remains free to alter the formula in the compact.

At least five companies have asked the Michigan Supreme Court to review a state appeals court decision in September in 50 consolidated tax refund cases by multistate companies that the companies were not entitled to continue using the three-factor apportionment formula in the multistate compact after the state switched to a sales-only formula. The companies all have large sales, but little payroll or property in Michigan. Michigan is facing as much as $1.1 billion in refunds if it loses in the courts. 

The Michigan Supreme Court may wait until the summer to decide whether to hear the appeal. It held in another case in July 2014 that IBM was entitled to use the three-factor formula for calculating its taxes in 2008 after concluding there was no evidence that the state legislature wanted to repeal the multistate compact provision allowing companies to elect use of the three-factor formula when it adopted a single-factor approach in 2008. The state legislature responded to the Supreme Court decision by quickly repealing the multistate compact retroactively the start of 2008.

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