On March 20, the California Court of Appeal for the Second District ruled against Abbott Laboratories in Abbott's challenge to the Franchise Tax Board's Farmer Brothers remedy. The unpublished opinion is available at www.reedsmith.com/Abbott.
Back in 2003, the same Court of Appeal had held that Cal. Rev. & Tax § 24402, which allowed a deduction only for the portion of a dividend paid out of income that had already been taxed by California, was unconstitutional because it discriminated against interstate commerce.1 For years ending after Nov. 30, 1999, the FTB's Farmer Brothers remedy has been to disallow any dividend-received deduction under Cal. Rev. & Tax § 24402.
Abbott Laboratories challenged this remedy, arguing that the proper remedy is to allow a dividend-received deduction under § 24402—regardless of whether the dividend is paid out of income that had already been taxed. On March 20, the Court of Appeal ruled against Abbott and upheld the FTB's remedy.
All is not lost for taxpayers, however: Abbott can petition the Court of Appeal for rehearing and, if unsuccessful, can ask the California Supreme Court to review the decision. (The California Supreme Court has discretion to review the case.) Further, another case involving the same issue, River Garden Retirement Home v. FTB, is pending in the First Appellate District.
Moreover, a taxpayer dealing with dividend issues in California must remember that the Abbott case only involves the dividends-received deduction under Cal. Rev. & Tax § 24402. It does not affect the deduction under Cal. Rev. & Tax § 24411, which applies to water's-edge taxpayers that receive dividends from foreign subsidiaries. That 75 percent deduction (100 percent for certain construction projects) is still available. Furthermore, some taxpayers that received dividends from subsidiaries may be entitled to eliminate the dividends altogether under Cal. Rev. & Tax § 25106.2 Many of those taxpayers (including those that repatriated large foreign dividends under IRC § 965) are watching the litigation involving Apple Inc. to determine what portion of the dividend may be eliminated. The trial in that case took place Feb. 25 and 26.
Finally, even if one or more of these cases ends badly and taxpayers must include dividend income in their tax base, taxpayers should consider claiming factor representation related to the property, payroll, and sales of the companies that paid the dividend. In January, the State Board of Equalization itself ordered factor representation in Appeal of Argonaut Group, Inc.3