California Taxpayers Limited to Statutory Apportionment Formula
On October 11, 2016, the U.S. Supreme Court denied review of the California Supreme Court’s decision in The Gillette Company, et al. v. Franchise Tax Board. The California Supreme Court had previously ruled Gillette wasn’t permitted to use the Multistate Tax Compact’s (MTC) equally weighted, three-factor apportionment formula, as the MTC wasn’t a binding reciprocal contract among its members and the California Legislature may properly eliminate the MTC’s election provision. The California Supreme Court decision will stand.
Therefore, taxpayers no longer have a right to elect to use the MTC’s equally weighted, three-factor apportionment formula, as opposed to California’s statutory apportionment formula, i.e., single sales factor. Taxpayers who made the MTC election on their original returns may be subject to steep penalties, including a 20 percent large corporate understatement penalty. The State of California Franchise Tax Board has indicated that it’s developing guidance for potentially affected taxpayers.
In addition, although the California Supreme Court’s decision appears to address the MTC’s election provisions in their entirety, it’s possible some taxpayers may continue to claim certain MTC-based positions, e.g., allocation of certain nonbusiness gains, applicability of special industry apportionment regulations, etc. These are unrelated to equally weighted, three-factor apportionment formula usages—the only aspect of the MTC specifically addressed by the court. In wake of the California Court of Appeals decision in favor of Gillette, the Legislature passed House Bill 1015 in 2012, repealing its adoption of the MTC and requiring that an election affecting the computation of tax must be made on a timely filed, original return. However, the validity of House Bill 1015 has been questioned, as the bill only passed by a simple majority and not the two-thirds majority vote required by Proposition 26 of the California Constitution related to changes to the state’s statutes that result in any taxpayer paying a higher tax. The California Supreme Court noted its decision did not involve the application of House Bill 1015.
Although California taxpayers aren’t currently allowed to elect the MTC’s equally weighted, three-factor apportionment formula, this issue may not entirely be dead. The U.S. Supreme Court could still decide to address this issue as court decisions in states such as Michigan, Minnesota, Oregon and Texas are likely to be appealed.
Contact your BKD advisor to learn more about how this decision could affect your organization.