Recent Decisions Continue Controversy in Multistate Tax Compact Litigation

Author:  Jeff Farrell

Jeff Farrell

Senior Managing Consultant

SALT Services

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Kansas City, MO 64106-2246

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With the recent judicial activity related to the Multistate Tax Compact, now is a good time to review the status of compact litigation in various states. The compact, which took effect in 1967, is intended to promote uniformity and efficiency in the administration of its member states’ tax regimes, in part to shield taxpayers from double taxation. The compact gives taxpayers in member states the option to elect an equally weighted, three-factor apportionment formula for income tax purposes. However, some member states have attempted to supersede or de facto repeal the compact via state legislation.


The California Supreme Court heard oral arguments on October 6 in Gillette Co. v. Franchise Tax Board. The court’s focus was whether the compact was a binding agreement between member states and whether lawmakers intended to cede the state’s right to set tax policy when they joined the compact. The Franchise Tax Board appealed the case after the Court of Appeals found in favor of the taxpayer in 2012. In that ruling, the court decided the compact was a valid and binding contract that the state had not repealed and withdrawn. As such, legislation adopting a double-weighted sales factor in 1993 did not invalidate the three-factor option available to taxpayers in the compact. The California Supreme Court has 90 days to issue an opinion on the matter, assuming it does not take a 60-day extension.


The Michigan Court of Appeals heard combined arguments in Gillette Commercial Operations North America & Subsidiaries v. Department of Treasury on September 2 regarding the validity of the Michigan legislature’s retroactive repeal of the compact in 2014. The Court of Appeals quickly found in favor of the Department of Treasury, concluding the compact was not a binding contract under state law and dismissing other constitutional arguments. Notably, the court felt a 6.5-year retroactive repeal was a modest time frame and did not violate the Due Process Clause. A repeal of this magnitude not only appears to empower the legislature to overrule a Michigan Supreme Court ruling but also appears to undermine taxpayer ability to rely on tax laws as written. The ruling is expected to be appealed to the Michigan Supreme Court, which initially upheld use of the compact election in its July 2014 decision in IBM v. Department of Treasury.


On June 19, the Minnesota Tax Court found in favor of the Commissioner of Revenue in Kimberly-Clark v. Commissioner. The section of the compact that allowed three-factor apportionment was explicitly repealed in 1987 by the Minnesota legislature. The taxpayer argued, in part, that a partial repeal of the compact was not constitutional, impairing a contract made by the state. However, the court reasoned government contracts must be construed, where possible, to avoid relinquishment of the sovereign powers of the state; allowing the compact provisions to trump the partial repeal enacted by the legislature would violate this principle. Kimberly-Clark filed an appeal of its claim with the Minnesota Supreme Court on August 14.


The Oregon Tax Court denied a taxpayer’s election to use the compact’s three-factor method, granting summary judgment to the Oregon Department of Revenue on September 9 in Health Net, Inc. v. Department of Revenue. The Oregon legislature had enacted changes to its apportionment formula in 1993. The statutory language directed taxpayers that the revised Oregon law would apply in lieu of the compact in the event of conflicting language between the two sources. The court found the legislation effectively disabled the compact election. The taxpayer may file an appeal with the Oregon Supreme Court.


On July 28, the Texas Court of Appeals affirmed in Graphic Packaging Corporation v. Combs that the compact formula is not available for use in the revised Texas Franchise Tax. The court ruled the franchise tax does not meet the definition of an income tax as contained in the compact, making the three-factor election not applicable. Graphic Packaging Corporation is preparing to file a petition for review with the Texas Supreme Court.

Litigation on the compact issue is far from complete. However, future state Supreme Court decisions in California and Michigan could indicate whether the adverse nature of recent rulings will continue to be the trend in state proceedings. This issue may even find its way to the U.S. Supreme Court. Affected taxpayers should keep an eye on the issues as these cases progress. More importantly, taxpayers should consider filing protective refund claims if the outcomes could have a significant impact on prior tax liabilities in these states.

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