WASHINGTON -- The California Supreme Court is set to decide the constitutionality of the state's worldwide unitary business tax, and several U.S. senators want the federal government to intervene on behalf of the plaintiff, a domestic multinational firm.
The case, Colgate-Palmolive Co. v. Franchise Tax Board, is being watched closely by multinational businesses, which for decades have fought largely losing battles against state unitary taxes.
A California appeals court ruled the tax is constitutional as applied to U.S. multinational firms, but in a companion dispute involving a foreign multinational company -- Barclay Bank International Ltd. v. Franchise Tax Board --it held that the tax violated the Constitution's foreign commerce clause.
The disparate rulings attracted the attention of several senators, who noted that the Department of Justice did not file a friend-of-the-court brief in the Colgate case but did file a brief on behalf of Barclay Bank.
In Oct. 8 letters to Solicitor General Kenneth W. Starr, Treasury Secretary Nicholas Brady, and Secretary of State James A. Baker, the senators urged the Bush administration to state its views on the Colgate case in a brief to the California Supreme Court. The authors of the letters are: Max Baucus, D-Mont.; David L. Boren, D-Okla.; Charles E. Grassley, R-Iowa; David Pryor, D-Ark.; William V. Roth Jr., R-Del.; and Malcolm Wallop, R-Wyo.
"It's an issue of competitiveness," said Thomas C. Rodgers, tax counsel to Sen. Baucus. "U.S. corporations are at a disadvatange if they have to allocate greater resources to state and local taxes than foreign firms."
Mr. Rodgers also said that since the Justice Department filed a brief on behalf of Barclay, a firm based in the UNited Kingdom, "it's only fair that the administration let the country and the [California] Supreme Court know where they stand on the Colgate case."
Ferdinand P. Schoettle, a law professor at the University of Minnesota, said the Colgate and Barclay cases carry "extremely important symbolic" weight but "may not be of enormous practical importance."
He noted that California now allows multinational firms to file tax returns based solely on revenues attributable to U.S. operations -- a provision referred to as the domestic water's edge election. Moreover, he said, California's corporate income tax, of which the worldwide unitary tax is a part, accounts for just 7% of state revenues.
However, Paul Mines, counsel with the Multistate Tax Commission, said some corporate taxpayers "may prefer a complete victory," meaning a court ruling that the tax is unconstitutional.
In a unitary tax system, a three-factor formula including corporate property, payrolls, and sales is used to determine a firm's tax liability. The factors are converted into fractions, with the activity for each factor forming the numerators. The firm's total activity, regardless of location, makes up the denominators. The fractions are then divided by three, yielding the firm's liability to the taxing state.
That approach can yield significantly higher liabilities for firms if total worldwide operations are included.
Several years ago, the U.S. Supreme Court ruled in Container Corp. of America v. Franchise Tax Board that California could combine the worldwide income of Container Corp. to determine the firm's state taxes. Consequently, the California Supreme Court may feel constrained to follow the high court's decision in its review of the Colgate case, regardless of the views of the U.S. government.
"In my opinion, the California courts are really not free in Colgate to deviate from the Supreme Court's ruling," Mr. Schoettle said.
Mr. Schoettle agreed that it would be "sort of anomalous" for the California high court to uphold the tax in the case of a domestic multinational firm and strike it down in the case of a foreign multinational.
But he noted that in the case of domestic firms, the U.S. Supreme Court has jurisdiction to take up cases if things go awry. And in cases where foreign firms are involved, the court does not have the same authority to resolve disputes.
Both the Barclay and Colgate cases hinge on interpretation of the Constitution's commerce clause, which vests in Congress sole authority to regulate interstate and international flows of goods and services. The provision also is understood to bar states from erecting barriers to commerce. The Supreme Court generally places a higher burden on states in justifying their tax practices when they affect foreign-based firms because of the importance of the federal government's ability to speak with one voice on foreign policy.
Regardless of how the California Supreme Court rules in the two cases, both are expected to make their way to the U.S. Supreme Court.
