California: Tax Board issues guidance after court ruling on election provision
Late last month, the California Franchise Tax Board (Board) issued guidance that was necessary after the state Supreme Court’s December 31, 2015, decision in the case Gillette Co. v. Franchise Tax Bd. The guidance comes in response to numerous taxpayer inquiries on what action to take after Gillette’s conclusion, but is subject to further notice because Gillette, one of the plaintiffs, intends to seek review in the United States Supreme Court.
The Gillette case centers on the Multistate Tax Compact (Compact), which contains an apportionment formula to calculate income taxes for businesses that have income in multiple states. The original 1967 version of the Compact permitted a taxpayer to choose whether it wanted to use the Compact’s apportionment formula or one provided under California state law. In 1974, the California legislature adopted the entire text of the Compact and made California a member state of the Compact.
In 1993, lawmakers amended the tax code to specify that a different apportionment formula would apply, notwithstanding the Compact’s provisions. Despite the mandatory language requiring the use of one particular apportionment formula, the legislature did not remove California from the Compact as a member state, nor did it modify the Compact’s election language or apportionment formula.
Gillette and several other taxpayers, including Proctor & Gamble and Kimberly-Clark, calculated their income tax liabilities in accordance with the 1993 apportionment law. However, on the grounds that this formula caused them to overpay, they sued for $34 million in refunds, contending that the election provision contained in the Compact remained a valid choice for their income tax computations.
The Court’s rationale
The California Supreme Court ruled against Gillette and the other plaintiffs. Starting with the premise that “the Legislature is supreme in the field of taxation,” the Court determined that the Compact was advisory, not binding, on its member states, and that its underlying regulations may play but a persuasive role in shaping policy.
In addition, the court recognized that lawmakers used unambiguous language when they amended the tax code eliminating the election provision, as follows: “all business income shall be apportioned to this state by using the formula it sets out, “[n]otwithstanding… [the Compact]…”
Thus, the court concluded that lawmakers had not only the authority to eliminate the Compact’s election provision, but that they had intended to do so.
The Board’s Guidance
The Board acknowledged that in response to the Gillette holding, taxpayers are seeking direction as to what action it will take on cases that involve the Compact’s apportionment election provision.
Until litigation is complete, the Board will take no action on claims for refund, and will defer administrative appeals currently pending.
The Board will continue to hold administrative protests, but will not take action on them until litigation is complete.
As for audits, the Board will proceed with them in the normal course of business. For taxable years before the repeal of the Compact, staff will conclude audits to the greatest extent possible, but will not issue Notices of Proposed Assessment or denials of claims for refunds until the conclusion of litigation. Where statutes of limitations may become an issue, staff will request a waiver to extend them, which the taxpayer must execute.
To stop the accrual of interest on deficiency assessments, taxpayers may make deposits in cases where such interest will accrue.
Finally, the Board reserves the right to impose penalties on a case-by-case basis, as is lawful.