California ~ Corporate Income Tax: Taxpayers Were Entitled to Use Multistate Tax Compact’s Equally-Weighted Apportionment Formula

In a decision issued on rehearing, a California court of appeal once again upheld the taxpayers’ right to utilize the Multistate Tax Compact’s (Compact) equally-weighted apportionment formula to apportion net income for California corporation franchise and income tax purposes. The court found that during the tax years at issue the state was a member of the Compact, which was a binding contract between the signatory states, and the subsequently enacted California provision that required taxpayers to utilize a double-weighted sales factor apportionment formula was invalid because it precluded taxpayers from making the election to use the equally-weighted apportionment formula, which was a key component of the Compact.


The taxpayers were numerous multistate corporations that had originally filed utilizing the state’s double-weighted sales factor apportionment formula, but subsequently filed refund claims for several tax years on the basis of the fact that they should have been allowed to make an election to use the Compact’s equally-weighted apportionment formula. California had become a member of the Compact during 1974, several years after the Compact was adopted by the requisite seven states. States entered into the Compact to promote uniformity among the states, facilitate the proper determination of state and local taxes for multistate taxpayers, facilitate taxpayer convenience and compliance in the filing of tax returns, and avoid duplicative taxation. A key provision of the Compact was to provide taxpayers the option of utilizing the Uniform Division of Income for Tax Purposes Act (UDITPA) equally-weighted apportionment formula or an alternative apportionment formula adopted by the state.

California became a signatory member of the Compact in 1974 and enacted the Compact provisions, including Rev. & Tax Code §38006, which provided taxpayers with the option to elect either the equally-weighted formula or the double-weighted sales factor formula discussed above. However, in 1993, California enacted Rev. & Tax. Code §25128, which states that “notwithstanding Section 38006,” all business income must be apportioned to California utilizing the double-weighted sales-factor formula.

The Franchise Tax Board (FTB) contended that the 1993 amendment repealed the taxpayers’ option to elect to use the equally-weighted formula and, therefore, denied the taxpayers’ refund claims. The taxpayers appealed the decision, and the lower court granted the FTB’s demurrer, finding that the state had the authority to repeal the provision allowing taxpayers to use the MTC equally-weighted apportionment formula.


The FTB argued that the taxpayers did not have standing to challenge the state’s repeal of the MTC election as they were not signatory members of the Compact. The court rejected this contention as the Compact gave the taxpayers the explicit option to make that election and, therefore, they were directly harmed by the state’s repeal of the provision. Furthermore, two of the key purposes of the Compact were to assist taxpayers in properly determining their state and local tax liability and to provide taxpayer convenience.

Multistate Tax Compact

The court held that the Multistate Tax Compact was a valid compact and, therefore, the state could not enact subsequent legislation that altered, modified, or partially repealed the Compact’s provisions. The MTC was a valid compact as it did not encroach on a federal area of control and, therefore, did not require federal consent. The three primary components to indicate the existence of a valid interstate compact as laid out by the U.S. Supreme Court were satisfied. The Multistate Tax Commission, composed of representatives from the signatory states, was established to oversee the implementation of the Compact. The Compact builds in binding reciprocal obligations that advance uniformity, such as the provision specifying how income is to be apportioned among the signatory states. Finally, the Compact clearly specifies how member states may withdraw from the Compact.

The FTB contended that the Compact was not a valid compact because it allows members to unilaterally withdraw and, therefore, was not truly a binding agreement. However, challenges to other interstate compacts with similar provisions have been upheld by the courts. Furthermore the FTB argued that the Compact was merely a model law and not really a true compact. The court agreed that the Compact did serve as a model law for the associate members who had not signed onto the Compact but who had enacted similar provisions. However, it held that for the signatory states, the Compact was indeed a binding contract. Finally, the court rejected the FTB’s contention that under California’s constitution the state could not surrender its power to tax by entering into a contract, finding that by signing onto the Compact the state retained its full power to tax, but it had agreed to allow taxpayers to elect to utilize the equally-weighted apportionment formula until it withdrew form the Compact.

State’s Authority

Finding that the Compact was a valid compact that bound the signatory states, the court held that the state did not have the authority to unilaterally enact subsequent legislation that amended, modified, or partially repealed any provision of the Compact. The plain language of the Compact only allows for complete withdrawal from the Compact, and the withdrawal may only be made prospectively. The court rejected the FTB’s contention that the U.S. Supreme Court had held that a compact cannot limit a state’s exercise of its right to withdraw from a compact, finding that the issue in the case cited by the FTB concerned the issue as to whether the state was withdrawing from the Compact in bad faith, not whether the state could make a piecemeal withdrawal from the Compact. Similarly, the court rejected the FTB’s argument that the Compact’s severability clause required a liberal construction of the withdrawal provision, finding that the severability clause and the provisions governing the withdrawal from the Compact involved two separate issues.

The court also refused to entertain the FTB’s position that the fact that 14 of the 20 signatory members had adopted similar legislation mandating the use of the state’s apportionment formula demonstrated that the Compact’s apportionment provision was nonbinding. The court reasoned that the plain language of the Compact clearly provided taxpayers with the option of using the MTC formula or the state’s alternative apportionment formula and refused to consider extrinsic evidence to the contrary. Furthermore, the court stated that to rule otherwise would contravene the very purpose of the Compact, which was to provide uniformity among the states.

Finally, the court found that the FTB’s interpretation would violate the federal and state constitutions’ prohibition against the impairment of contracts and the state constitution’s reenactment rule, which prohibits the Legislature from enacting a statute that changes the meaning of another provision unless the affected provision is also reenacted.

The Gillette Co. v. Franchise Tax Board, Court of Appeal of California, First District, No. A130803, October 2, 2012, ¶405-722


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