In a unanimous decision in Gillette Co. v. Franchise Tax Board, the California Supreme Court on December 31 held that the Multistate Tax Compact is not a binding reciprocal agreement among its members. Therefore, the California State Legislature had the authority to unilaterally eliminate the Compact's election, which allowed corporations to apportion their income to California based on a three-factor formula. By this decision, California's mandatory double-weighted sales factor formula enacted in 1993 to amend the Compact, was held to be a proper method to tax the income of corporate taxpayers. The typical result is that out-of-state corporate taxpayers who have significant in-state sales will incur higher taxes. Officials and others had projected that a decision against the state would ultimately cost California significantly more than US$1 billion in refunds.

The holding in Gillette reverses the 2012 California Court of Appeals decision in favor of the taxpayers, which held that the Compact's election provision was binding on member states. That decision triggered not only a flood of tax refund claims, but also the filing of similar litigation in several states and a quick succession of state withdrawals from the Compact, starting with California's in 2012. The crux of the matter centers on whether California's adoption of the Multistate Tax Compact in 1974, including its method of formulary apportionment of corporate income, is binding on the state, such that a member state is precluded from changing such method while it remained a member of the Compact.

One of the key provisions of the Compact allows a company to elect to apportion its total income to the state based on a three-factor apportionment fraction consisting of property, payroll and sales. In 1993, the California legislature changed that provision to a four-factor formula whereby it counted the sales factor twice. The result was that out-of-state corporations with relatively little presence in the state generally paid more income tax than they did prior to the 1993 law change. Gillette, an out-of-state company, naturally preferred the formula dictated by the Compact's election which gave equal weight to the company’s property, payroll and sales, and filed a refund claim to reflect that election. When California denied its refund claim, Gillette along with several other companies sued the state. (In 2012, as a result of this very case, California in fact pulled out of the Multistate Compact entirely.)

The legal issue centered on whether a tax compact such as this one is binding among its members, such that a member state does not retain a unilateral ability to amend the agreement while it remains a member. The focus of such determination centered essentially on the nature of what a compact is, and on what the legislative intent was at the time the Compact was adopted. In particular, did the legislature understand and intend to be bound to the Compact's terms at the time of enactment back in 1974?

In explaining its decision against the taxpayer, the court said it agreed with the amicus brief filed by the Multistate Tax Commission where it argued that the Compact failed to satisfy any of the classic indicia of a binding interstate compact as described in the case law. The court also devoted pages to discussing the Compact, which it said has no authority ordinarily associated with a regulatory body. The court also found that California's reenactment rule, which states that "a section of a statute may not be amended unless the section is reenacted as amended," did not bar the legislature's adoption of the double-weighted sales factor formula in 1993 because the rule does not apply to statutes amending others only by implication. As the court articulated, "Indeed, no express language of the Compact or any California enabling statute proscribes unilateral amendment of our own state law." The court believed that compacts can be unilaterally amended unless the compact explicitly states otherwise.

The opinion raises many questions under both the federal contract clause and the common law, and so one issue arises as to whether the US Supreme Court might find the case worthy of review. A number of state appeals courts are considering the same issue, including those in Michigan, Oregon and Texas. Oral argument at the Minnesota Supreme Court is scheduled for January 11 in the case of Kimberly-Clark Corp. v. Comm'r of Revenue, Minn. In light of this activity, a US Supreme Court review of the issue could perhaps be in the future, particularly if other state appeals court decisions contradict California's.