In Gillette Company et al. v. Franchise Tax Board, No. A130803 (Ct. App., July 24, 2012), the California Court of Appeal held that taxpayers are allowed to elect to use the equally weighted income apportionment formula provided in the Multistate Compact (“Compact”), notwithstanding California legislation which requires use of a double-weighted sales factor. The Court found that the Compact is a valid multistate compact, and California is bound by the Compact and its apportionment election provision unless and until California withdraws from the Compact by enacting a statute that repeals California Revenue and Taxation Code section 38006, which allows for election.
As background, California enacted the Compact in 1974. Cal. Rev. & Tax. Code § 38001. The Compact was created in response to a need for uniformity in the apportionment of corporate income for tax purposes among the various taxing states. Its purposes are to: (1) facilitate proper determination of state and local tax liability of multistate taxpayers, including the equitable apportionment of tax bases and settlement of apportionment disputes; (2) promote uniformity or compatibility in significant components of tax systems; (3) facilitate taxpayer convenience and compliance in the filing of tax returns and in other phases of tax administration; and (4) to avoid duplicative taxation. The Compact adopts the Uniform Division of Income for Tax Purposes Act (“UDITPA”) apportionment formula, which provides that to apportion a multistate corporation’s business income among the various taxing states, the taxpayer should use a three-factor, equally weighted apportionment formula consisting of property, payroll, and sales receipts. The Compact, however, also gives taxpayers the option of electing to apportion and allocate income pursuant to the UDITPA formula or pursuant to a given state’s alternative apportionment formula. In California, the legislature enacted a statute for this alternative formula, apportionment using a double-weighted sales factor in 1993. Cal. Rev. & Tax. Code § 25128.
Gillette sued the Franchise Tax Board (“FTB”), arguing that notwithstanding the 1993 statute promulgating a double-weighted sales factor formula, it was entitled to elect to use the equally weighted apportionment formula. The trial court dismissed Gillette’s claims by granting the FTB’s demurrer without leave to amend. On appeal, the Court reversed, holding that California cannot vary the terms of the Compact as long as it is part of California law, and that, as a result, under the terms of the election provision of the Compact, Gillette was entitled to elect to use the equally weighted apportionment formula.
Although Gillette represents a significant victory for taxpayers, a few uncertainties remain. First, given the importance of the issue and the dollar amount at stake, the FTB may petition the California Supreme Court for review, which means that we may not have a final decision for a while. Second, on June 27, 2012, while Gillette was pending before the Court of Appeal, California Governor Jerry Brown signed S.B. 1015, which repealed the Compact. Anticipating the potential refund opportunities that would result from a taxpayer-friendly decision in Gillette, S.B. 1015 codified the doctrine of elections providing that under the Compact, a California election to use UDITPA must be made on an original timely filed return, and that election, once made, is binding. S.B. 1015 raises questions regarding whether an election under the Compact can be made on an amended return, and, if not, whether such retroactive legislation raises due process concerns. Finally, the Gillette decision may have an impact on taxpayers in other Compact member states, including Michigan, Texas, and the District of Columbia, and their right to elect Compact treatment for income tax purposes.