California Supreme Court Vindicates California and Commission in Gillette

On December 31, 2015, the California Supreme Court ruled unanimously that California was not barred from disabling the corporate income tax apportionment election contained in Article III of the Multistate Tax Compact and mandating that all taxpayers apportion their income to California by double-weighing the sales factor.

California enacted the Uniform Division of Income for Tax Purposes Act (UDITPA) in 1966.  Pursuant to UDITPA, California taxpayers were required to use an equally weighted three factor formula (property, payroll and sales) to apportion their income.  In 1974, California joined the Multistate Tax Compact.  Article III of the Compact provided an election for taxpayers to apportion their income using either the UDITPA formula or any other apportionment formula allowed by state law.  At the time, the election was superfluous because the only apportionment formula in California was the UDITPA formula.

In 1993, the California legislature adopted an apportionment formula that double weights the sales factor (property, payroll, and sales times two).  The legislature also provided that the double-weighted apportionment formula applied “notwithstanding” the UDITPA formula or the election, both of which remained in the statutes as part of the Compact. 

Between 1993 and 2005, six corporate taxpayers apportioned their income using the double weighted apportionment formula.  They then filed refund claims, asserting that they continued to have a right to elect to apportion their income using the UDITPA apportionment formula notwithstanding the 1993 legislation.  The California Court of Appeal agreed, ruling that the Compact is a binding contractual obligation under the Contract Clause of the U.S. and California Constitutions and that the 1993 legislature had no authority to disable the election.  The appellate court ruled that California must withdraw from the Compact entirely if it wished to adopt a mandatory apportionment formula other than UDITPA.

The California Supreme Court reversed the decision of the Court of Appeal.  The Supreme Court ruled that the Multistate Tax Compact is not a binding contract.  Rather, the court found that the Compact is an advisory compact because (1) the Commission is not a regulatory body with the power to regulate state taxation in the member states, (2) the Compact does not require its members to take any reciprocal action in order to carry out its purposes, and (3) each member is free to modify or repeal its laws unilaterally.

Recent opinions in other states—such as the Oregon Tax Court in HealthNet and the Minnesota Tax Court in Kimberly-Clark—reached similar conclusions as the California Supreme Court.  Kimberly-Clark will be argued in the Minnesota Supreme Court on January 11th.