CA – California issues gillette opinion: taxpayers not entitled to use equally-weighted apportionment formula

The California Supreme Court has reversed an earlier appellate court decision and held that multistate corporate taxpayers may no longer elect to use the Multistate Tax Compact’s equally-weighted three-factor formula to apportion net income for California corporation franchise and income tax purposes. Instead, taxpayers must use the apportionment formula required under California law (i.e., a double-weighted sales factor formula for tax years beginning before to 2013, or a single-sales factor formula for tax years beginning after 2012). In so holding, the court determined that (1) the Compact was not a binding contract between the signatory states, (2) the California Legislature had the authority to repeal the Compact’s election provision, (3) the California Legislature intended to repeal the election provision, and (4) the legislation repealing the election provision did not violate the state’s “reenactment rule.”


California became a member of the Compact in 1974, several years after the Compact was adopted by the requisite seven states. At that time, the state enacted the Compact provisions, including Rev. & Tax Code §38006, which allowed taxpayers to elect to use either an equally-weighted three-factor apportionment formula or an alternative apportionment formula adopted by the state. However, in 1993, California enacted Rev. & Tax. Code §25128, which states that “notwithstanding Section 38006,” all business income must be apportioned to California using a double-weighted sales-factor formula. Rev. & Tax. Code §25128.7, which requires use of a single-sales factor formula for tax years beginning after 2012, was added by Proposition 39 in 2012.

The taxpayers in the case at hand are all multistate corporations that had originally filed returns utilizing California’s double-weighted sales factor formula under §25128, but subsequently filed refund claims for several tax years on the basis that they should have been allowed to make an election to use the Compact’s equally-weighted formula. The Franchise Tax Board (FTB) claimed that the 1993 amendment repealed the taxpayers’ option to elect to use the equally-weighted formula and, therefore, denied the taxpayers’ refund claims. However, in 2012, a California court of appeal held that the state was bound by the Compact and did not have the authority to unilaterally enact subsequent legislation that amended, modified, or partially repealed any provision of the Compact.

Compact Not Binding

In determining that the Compact is not a binding contract among its members, the California Supreme Court applied a test derived from Northeast Bancorp v. Board of Governors, 472 U.S. 159 (1985), which looks for certain “indicia of binding interstate compacts” such as the establishment of reciprocal obligations, whether its effectiveness depends on the conduct of other members, the prohibition of unilateral member action, and the creation of regulatory organizations. First, the court noted that the Compact creates no reciprocal obligations, especially with respect to maintaining the election provision, since it does not create an obligation of member states to each other. In addition, even if maintenance of the election provision in one Compact member state might benefit taxpayers in another state, that benefit to the taxpayer applies whether the taxpayer is from a member or nonmember state. This application, said the court, is more akin to the adoption of a model law rather than the creation of any mutual obligations among Compact members.

With respect to the Compact’s effectiveness being dependent on the conduct of its members, the court pointed out that the Compact has not required member action since 1967. By its terms, the Compact became effective once it had been enacted into law by any seven states. Nine states other than California enacted the Compact within six months of its initial draft. Thereafter, the Compact was effective as to any other state upon that state’s enactment of it. Thus, said the court, the Compact had long been effective when California joined it in 1974, and no action by existing members was required to admit California.

Furthermore, the court agreed with the FTB’s position that the ability of member states to unilaterally join or leave the Compact without notice prevents a finding that the Compact is a binding interstate agreement. The court also pointed to the fact that many member states have adopted different apportionment formulas to show that the Compact does not prohibit unilateral state action. According to the court, the freedom of members to engage in such unilateral conduct is inconsistent with the type of binding agreement contemplated by Northeast Bancorp.

Finally, although the taxpayers argued that the Compact’s establishment of the Multistate Tax Commission (MTC) is a “classic characteristic of an interstate compact,” the court pointed out that the MTC has no authority ordinarily associated with a regulatory organization. The MTC’s powers are limited to advisory and informational roles. Even the MTC’s regulations are only “advisory” and have no force in any member state unless formally adopted by that state. According to the court, the MTC’s inability to bind member states to adopt its regulations further confirms it is not a regulatory organization within the meaning of Northeast Bancorp. Similarly, the MTC may conduct taxpayer audits, but only if the member state has passed separate authorizing legislation and expressly requests the audit.

Intent to Repeal Election Provision

Having concluded that the California Legislature had the unilateral authority to eliminate the Compact’s election provision, the court then addressed the question of whether it intended to do so. The court determined that both the language of §25128 and its legislative history indicated that the Legislature did intend to repeal the election provision. First, §25128(a) explicitly provides that the double-sales factor formula is to be used “[n]otwithstanding Section 38006 [i.e., the Compact].” According to the court, there is no ambiguity in this language. The court also noted that legislative analysis of the bill explaining the need for the amendment showed that proponents of the bill believed that California’s continued reliance upon the Compact’s formula would result in discriminatory taxation against California-based companies, particularly given the additional weight given to sales factors by other states. Thus, the court dismissed the argument that the Legislature intended to retain the Compact’s election provision.

Reenactment Rule

As an alternative argument, the taxpayers claimed that the 1993 amendment of §25128 is invalid because it violates the California Constitution’s reenactment rule, which states that a “section of a statute may not be amended unless the section is re-enacted as amended.” Generally, however, the reenactment rule does not apply to statutes that act to “amend” others only by implication. The amendment of §25128 expressly referenced the Compact, stating that it applied “[n]otwithstanding Section 38006.” Although the taxpayers noted that the legislative bill analyses did not refer to the Compact or the election provision expressly, the court said that reference to the Compact in §25128(a) itself is strong evidence that the Legislature acted with the Compact in mind. Thus, even without a reenactment of §38006, the legislators and the public were reasonably notified of the changes in the law so that the amendment of §25128 did not violate the reenactment rule. The Gillette Company v. Franchise Tax Board,California Supreme Court, No. S206587, December 31, 2015