Designing a combined reporting regime for a state corporate income tax: A case study of Louisiana

Louisiana Law Review

Volumn 61, Issue 4, 2001, Pages 700-761

  McIntyre, Michael J ^a   Mines, Paull ^b   Pomp, Richard D ^c  

^a WAYNE STATE UNIVERSITY   (United States)

^b Multistate Tax Commission

^c UNIVERSITY OF CONNECTICUT   (United States)

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EID: 23044533847     PISSN: 00246859     EISSN: None     Source Type: Journal    
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References (213)

1. The two leading combined-reporting cases decided by the U.S. Supreme Court are Container Corp. of America v. Franchise Tax Bd. of California, 463 U.S. 159, 103 S. Ct. 2983 (1983), and Barclays Bank PLC v. Franchise Tax Bd. of California, 512 U.S. 298, 114 S. Ct. 2268 (1994). In Container, California successfully defended its combined-reporting regime, as applied to a U.S.-based multinational enterprise, against attacks based on the Commerce Clause and the Due Process Clause. Barclays Bank upheld the California system as applied to a foreign-based multinational enterprise against attacks based on the Foreign Commerce Clause.
2. Container, 463 U.S. at 164-65, 103 S. Ct. at 2940 (citations omitted). These sentiments were repeated in part in Barclays Bank, 512 U.S. at 303-04, 114 S. Ct. at 2272.
3. La. R.S. 47:287.94(C)(2001). Some administrative flexibility may be required to prevent an unconstitutional tax on extraterritorial values. See Hans Rees' Sons, Inc. v. North Carolina ex rel. Maxwell, 283 U.S. 123, 51 S. Ct. 2933 (1931) (allowing the taxpayer to introduce evidence to challenge the apportionment resulting under a one-factor (property) apportionment formula based on an offer of proof that the formula produced an unreasonable and arbitrary result, out of all appropriate relationship to the business activities in the state).
4. See Unif. Div. of Income For Tax Purposes Act § 18, 7A U.L.A. 331 (1985) [hereinafter UDITPA] (providing similar escape hatch). The Louisiana corporate tax statute is not based on UDITPA, although UDITPA and the Louisiana statute have many common elements. We do not discuss in this Article whether Louisiana should adopt UDITPA.
5. One significant exception to the equal treatment of similarly situated unitary groups is the result of the protection against state income taxation provided in Act of Sept. 14, 1959, Pub. L. No. 86-272, 1986 U.S.C.C.A.N. (73 Stat. 555) 613 (codified as 15 U.S.C. § 381 et seq.). That Federal law limits the ability of a state to tax a corporation when the corporation's only connection with the state is through the solicitation of sales within the state. That protection extends, however, only to the corporation itself - not to the unitary group of which it is a member. As a result, a corporate group that is organized as a single corporation might be ineligible for protection under Pub. L. No. 86-272, whereas a corporate group that placed its purely solicitation activities inone corporation and its disqualifying activities in another corporation might obtain at least some protection.
6. Examples of the tax-planning advantages available to the multistate enterprise under the separate reporting system are addressed infra in Section II.B.
7. In Exxon Corp. v. Dept. of Revenue of Wisconsin, 447 U.S. 207, 100 S. Ct. 2109(1980), the Court held that combined reporting and formulary apportionment is preferred to the arm's length method of apportionment even in the face of good price data.
8. See Butler Bros. v. McColgan, 315 U.S. 501, 62 S. Ct. 701 (1942).
9. In SYL, Inc. v. Comptroller of the Treasury, Circuit Court for Baltimore City, No. 24-C-99-002389AA (Mar. 17, 2000), aff'g Maryland Tax Court, No. C-96-0154-01 (Apr. 26, 1999), the court indicated that it would not stretch the letter of the law to prevent tax avoidance when the state could have prevented that avoidance by adopting a combined reporting regime.
10. For discussion of the wash rule, see infra Part IV.C.1.
11. There are many types of holding companies. Here we are concerned primarily with companies organized in a tax-haven jurisdiction that hold intellectual property or other intangible property made available for a fee to affiliated companies engaged in business in the taxing state.
12. Del. Code Ann. tit. 30, § 1902(b)(8) (1997). As an alternative to Delaware, a holding company could be based in a state without an income tax, such as Nevada. An even better strategy, because it is less of a red flag to auditors, may be to create a holding company in a state in which the taxpayer is already filing a combined report.
13. The creation and operation of Delaware holding companies has become a specialty of certain Wilmington-based banks. A pamphlet of one of these banks promises to arrange for the rental of office space, telephone answering services, secretarial help, and accounting and legal services through Delaware's top accounting and legal firms. "By developing relationships with these Delaware professionals, the substance of your Delaware holding company will be further reinforced." See Richard D. Pomp and Oliver Oldman, State & Local Taxation 10-34 n.204 (4th ed. 2001) [hereinafter Pomp & Oldman, State & Local].
14. See, e.g., Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E.2d 13 (1993).
15. Under the Internal Revenue Code, a foreign corporation licensing a trademark for use in the United States would be subject to federal tax on the amount of the royalties, typically at a rate of 30 percent. See I.R.C. §§ 861(a)(4); 881(a)(1)(2001); Treas. Reg. § 1.861-5(as amended in 1975). Many U.S. tax treaties provide an exemption or reduced withholding rate for residents of the Contracting States on a reciprocal basis. See, e.g. Convention with Respect to Taxes on Income and Capital, Sept. 26, 1980, U.S.-Canada, T.I.A.S. No. 11087 at 15 (enforceable Aug. 16, 1984) (reducing withholding rate in both countries to 10 percent); Convention on Taxes on Income and Capital Gains, Dec. 31, 1975, U.S.-U.K., 31 U.S.T. 5681 (enforceable Apr. 25, 1980) (reducing withholding rate to zero). Unlike the states, the Federal government is free to tax royalties without the constraints imposed by the dormant Commerce Clause.
16. Some states have recently adopted anti-holding company legislation disallowing deductions for payments made to certain related entities. See Ohio Rev. Code Ann. § 5733.052 (West Supp. 2001); Iowa Code Ann. § 422.61 (West 1998); Conn. Gen. Stat Ann. § 12-218c (West 2000).
17. For a sampling of cases in which a state challenged a holding company arrangement, see In the Matter of the Petition of Sherwin-Williams, No. 816712 (N. Y. Tax App. June 7, 2001), SYL, Inc. v. Comptroller of the Treasury, No. C-96-0154-01, 1999 WL 322666 (Md. Tax Ct. Apr. 26, 1999); Crown Cork & Seal v. Comptroller of the Treasury, No. C-97-0028-01, 1999 WL 322699 (Md. Tax Ct. Apr. 26, 1999); In re Burnham Corp., DTA No. 814531, 1997 N.Y. Tax Lexis 304 (N.Y. Tax App. July 10, 1997); In the Matter of the Petition of Express, Inc. et al., DTA Nos. 812330, 812331, 812332, 812334,1995 N.Y. Tax Lexis 493 (N.Y. Tax. App. Sept. 14, 1995); Kmart Properties, Inc. (KPI). Decision of Hearing Officer, New Mexico Taxation and Revenue Department, No. 00-04, NM ID. No. 01-287446-006 (Feb. 1, 2000), available at 〈http://www.state.nm.us/tax/d&o/dno2000_04.htm〉 (citing memorandum from Detroit office of Price Waterhouse that concluded that "if structured properly, a company formed to hold and license Kmart's intellectual property could generate significant state and local income tax savings for Kmart in states which allow separate entity filing for corporate income taxes as well as other non-tax benefits").
18. See generally Peter L. Faber, Planning for the Use of Intangible Holding Companies, 14 State Tax Notes 1931 (1998). For a recent case interpreting the meaning of business purpose, see Ex parte Sonat, 752 So. 2d 1211 (Ala. 1999).
19. For discussion of whether a holding company is part of a unitary business, see Eric J. Coffill & Clare M. Rathbone, "Unitary" Holding Companies: Uncertainty and Pitfalls Under Current California Law, 6 State Tax Notes 757 (1994).
20. See e.g., Container Corp. of America v. Franchise Tax Bd. of California, 463 U.S. 159, 103 S. Ct. 2983 (1983)(clear and cogent evidence required). For recent cases involving holding companies, see Shaklee Corp. v. Dept. of Revenue, 738 N.E.2d 236 (Ill. App. 1st Dist 1998) (Japanese holding company unitary with Shaklee); Extrusion Dies, Inc. v. Wisconsin Dept. of Revenue, Nos.94-I-1463, 94-I-1464 (Wis. Tax App. Comm'n Aug. 21, 1996) (corporation acting as a holding company and owning stock in a subsidiary unable to deduct net losses because it lacked nexus with Wisconsin and was not subject to the Wisconsin franchise tax).
21. As discussed infra in Part III.E., we recommend that Louisiana permit a water's edge election, under which an enterprise conducting a unitary business partly in Louisiana could exclude certain foreign corporations from the unitary group. In this situation, special anti-avoidance rules are necessary to prevent use of foreign holding companies for tax avoidance purposes. See Part III.E. and especially text at infra note 137.
22. Taxpayers would also enjoy some gains from simplification. One commentator, writing during a period when separate accounting was commonly used, described it as so expensive to implement that the bookkeeping costs could far exceed the tax due under formulary apportionment. Charles W. Gerstenberg, Allocation of Business Income, 1931 Nat'l Tax Assoc. Proc. 301, 306.
23. Nearly every state allows its tax administration to adjust transfer prices to reallocate income among companies in order to reflect income accurately. In some states, this power is more constrained than that possessed by the IRS under I.R.C. § 482 (2001). The states seem to be getting more aggressive in adjusting intercorporate pricing and related expenses. The courts have not always supported these efforts. For recent cases, see SLI Int'l. Corp. v. Crystal, 671 A.2d 813 (Md. 1996); New York Times Sales, Inc. v. Comm'r of Rev., 667 N.E.2d 302 (Mass. 1996); Petition of Express, Inc., Nos. 812330, 812331, 812332, 812334, 1995 N.Y. Tax Lexis 493 (N.Y. Tax App. Sept 14, 1995); Aaron Rents, Inc. v. Collins, No. D-96025 (Super. Ct., Fulton County, Ga., 1994); Comm'r of Revenue v. AMIWoodbroke Inc., 634 N.E.2d 114 (Mass. 1994); Trans-Lux Corp. v. Meehan, 652 A.2d 539 (Conn. 1993); Petition of Bausch & Lomb, Inc., No. TSB-D-90(11)C, 1990 N.Y. Tax Lexis 325 (N.Y. Tax App. July 19, 1990); Petition of Hilton Hotels Corp., 1989 N.Y. Tax Lexis 63 (Feb. 24, 1989); Commonwealth v. General Electric Co., 372 S.E.2d 599 (Mass. 1988). For a survey of these issues, see Mary Jane Egr, State Section-482 Type Authority, 11 State Tax Notes 1547 (1996).
24. In planning a transaction at the state level, advisers cannot focus solely on the nominal tax rates in the relevant states. The focus should be on the corporation's effective tax rate in each state.
25. Although the example in the text involved the sale of tangible personal property, the same shifting of profits can occur using management fees, consulting fees, royalty payments, or interest charges.
26. For a full discussion of the IRS efforts at preventing transfer pricing abuses, see Michael J. McIntyre, The International Income Tax Rules of the United States ch. 6 (2d ed. 2000) [hereinafter McIntyre, Int'l Treatise].
27. For a comparison of the Federal rules on separate accounting and the state rules on formulary apportionment, see Michael J. McIntyre, Contrasting Methodologies: A Systematic Presentation of the Differences Between An Arm's-Length/Source-Rule System and a Combined-Reporting/Formulary-Apportionment System, Proceedings of the 86th Annual Conference, National Tax Association 226 (1994) (excerpted in Pomp & Oldman, State and Local, supra note 13, at 11-142).
28. See UDIPTA, supra note 4, at § 1(e).
29. It is possible that some or all of the members of a group of entities would be engaged in more than one unitary business. In that event, a combined report typically would be prepared for each unitary business. For simplicity, our discussion in this part assumes that the combined group is engaged in only one unitary business. For discussion of issues arising when members of a combined group are engaging in more than one unitary business, see infra Section III.B.3.
30. For discussion of this wash rule, see infra Part IV.C.1.
31. Louisiana should specifically provide that a combined group may exist if the members are owned by one or more individuals acting in concert. See Rain Bird Sprinkler Mfg. Corp., California State Board of Equalization, June 27, 1984, 84-SBE-094 (upholding the tax department's position that unity of ownership exists if a group of corporations is owned by members of a family); but see True v. Hietkamp, State Tax Comm'r, 470 N.W.2d 582 (N.D. 1991) (upholding the tax department's position that a unitary combined group must be controlled by a single entity that is a member of that group). As a matter of tax policy, we agree with the result in Rain Bird and disagree with the result in True.
32. See, e.g., Cal. Rev. & Tax. Code § 25105(b)(West Supp. 2001). The Federal government has given considerable attention to the issue of defining control for purposes of its controlled foreign corporation rules. See I.R.C. § 958 (2001) (defining indirect and constructive ownership for purposes of defining a controlled foreign corporation). Similar rules should be adopted by Louisiana in determining ownership for purposes of a control test.
33. See, e.g., Cal. Rev. & Tax. Code § 25105(b)(1) and (2) (West Supp. 2001); Idaho Code § 63-3027B(b)(1) and (2) (Michie 2000). But see Utah Code Ann. § 59-7-101(28)(a) (2000) (defining a unitary group as a group of corporations that are related through common ownership and are economically interdependent). For a comparable definition of control under Federal tax law, see I.R.C. § 957(a) (2001) (defining a controlled foreign corporation).
34. Cal. FTB Legal Ruling 95-7 (Nov. 29, 1995); Cal. FTB Legal Ruling 95-8 (Nov. 29, 1995).
35. See Treas. Reg. 1.957-1(b)(2)(as amended in 1997)("Any arrangement to shift formal voting power . . . will not be given effect if in reality voting power is retained"). The Federal government defines control for purposes of adjusting intra-group prices without reference to any ownership percentage. Treas. Reg. § 1.482-1(i)(5) (1994). Two entities are presumed to be controlled if income or deductions are artificially shifted between them. Treas. Reg. § 1.482-1(i)(4) (1994). See also Idaho Tax Regulation 63-3027C(b)(giving the tax commissioner authority to include or exclude a corporation from a combined group).
36. In defining a controlled foreign corporation, ownership of over 50 percent of the stock by vote or value is sufficient to constitute control. I.R.C. § 957(a)(1) and (2) (2001).
37. California has a "stapled stock" rule that treats two or more corporations as members of a control group if over 50 percent of the shares of stock are "stapled" togetheras a result of restrictions on their transfer. The stock of two companies is stapled if a person acquiring a share of stock in one corporation must also acquire a share of stock in the other corporation. Cal. Rev. & Tax. Code § 25105(b)(3) (West Supp. 2001). We endorse the California rule. For a related Federal stapled-stock rule, see I.R.C. § 269B (2001) (treating a foreign corporation stapled to a U.S. corporation as a U.S. corporation).
38. Under Federal rules, certain eligible corporations that are related to one another through common ownership under an 80 percent-control test may elect to file a consolidated return rather than separate returns. See I.R.C. §§ 1501-1505 (2001).
39. See generally, William L. Goldman et al., 1130 T. M. Income Taxes: Consolidated Returns and Combined Reporting (revised 2001).
40. Some states permit corporations that file - or could have filed - a federal consolidated return to file a similar state return. The taxpayer is not required to file a consolidated return; indeed, a mandatory rule probably would be unconstitutional in some situations because the unitary business principle both empowers and limits the tax jurisdiction of states.
41. See supra Parts II.A. and II.C.
42. See supra Part II.B.
43. See Richard D. Pomp, The Future of the State Corporate Income Tax: Reflections (and Confessions) of a Tax Lawyer, in The Future of State Taxation 49, 64-65 (David Brunori ed. 1998) [hereinafter Pomp, Future of State Taxation].
44. See UDITPA, supra note 4.
45. See, e.g., Caterpillar Tractor Co. v. Lenckos, 395 N.E.2d 1167 (Ill. 1979); Pioneer Container Corp. v. Beshears, 684 P.2d 396 (Kan. 1984). For discussion, see Laura L. Farrell, The State of Combined Reporting Today, 11 State Tax Notes 635 (1996); 2000 Multistate Corporate Tax Guide at I-533 to I-550; I-613 to I-623 (J. Healy ed.).
46. The Supreme Court has not addressed the issue of whether a constitutional right exists to file a combined report The taxpayer raised this issue in Mobil, but the Court did not address it on the grounds that it was not presented in a timely manner. Mobil Oil Corp. v. Comm'r of Taxes of Vermont, 445 U.S. 425, 441 n.15, 100S. Ct 1223, 1233 (1980). The state courts have uniformly rejected taxpayer arguments that they have a constitutional right to file a combined report. See, e.g., Ashland Pipe Line Co. v. Marx, 623 So. 2d 995 (Miss. 1993). Some courts have rejected attempts by the tax administration to impose a combined report if a statute did not explicitly authorize it. Polaroid Corp. v. Comm'r of Revenue, 472 N.E.2d 259 (Mass. 1984); Sears Roebuck & Co. v. State Tax Assessor, 561 A.2d 172 (Me. 1989).
47. Miller Bros. Co. v. Maryland, 347 U.S. 340, 344-45, 74 S. Ct. 535, 539 (1954).
48. Mobil, 445 U.S. at 439, 100 S. Ct. at 1232.
49. Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U.S. 768, 112 S. Ct. 2251 (1992).
50. For state cases interpreting and applying the concept of a unitary business, see Earth Resources Co. v. Alaska, Dept. of Revenue, 665 P.2d 960 (Alaska 1983); Appeal of the Leland Corp., California State Board of Equalization, No. 94A-0916(Feb. 5, 1997); Dental Ins. Consultants, Inc. v. Franchise Tax Bd., 1 Cal. Rptr. 2d 757 (Cal. Ct App. 1991); Arizona Dept. of Revenue v. Talley Indus., 893 P.2d 17 (Ariz. Ct App. 1994); Pledger v. Ill. Tool Works, Inc., 812 S.W.2d 101 (Ark. 1991); AMAX, Inc. v. Groppo, 550 A.2d 13 (Conn. App. Ct 1988); McLean Gardens Corp. v. District of Columbia, No. 3158-82 (D.C. Sup. Ct. Jan. 31, 1983);Albertson's Inc. v. Idaho Dept. of Revenue, 683 P.2d 846 (Idaho 1984); Citizens Utils. Co. v. Dept. of Revenue, 488 N.E.2d 984 (Ill. 1986); Super Value Stores, Inc. v. Iowa Dept. of Revenue, 479 N.W.2d 255 (Iowa 1991); Texas Co. v. Cooper, 107 So. 2d 676 (La. 1958); Md. Comptroller of Treasury v. Dlebold, 369 A.2d 77 (Md. 1977); Russell Stover Candies, Inc. v. Dept. of Revenue, 665 P.2d 198 (Mont. 1983); Cox Cablevision Corp. v. Dept. of Revenue, No. 3003, 1992 Ore. Tax Lexis 17(Ore. Tax Ct. June 10, 1992); Homart Dev. Co. v. Norberg, 529 A.2d 115 (R.I. 1987); Exxon Corp. v. S.C. Tax Comm'n., 258 S.E.2d 93 (S.C. 1979), appeal dismissed, 447 U.S. 917, 100 S. Ct 3005(1980); Corning Glass Works, Inc. v. Va. Dept. of Taxation, 402 S.E.2d 35 (Va. 1991), cert. denied, 502 U.S. 900, 112 S. Ct. 277 (1991); Interstate Finance Corp. v. Wis. Dept. of Taxation, 137 N.W.2d 38 (Wis. 1965); see generally Franklin C. Latcham, 1110 T.M., Income Taxes: Definition of a Unitary Business (revised 2001) [hereinafter Latcham, Unitary Business].
51. Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 460, 79 S. Ct 357, 363 (1959) ("[T]he entire net income of a corporation, generated by interstate as well as intrastate activities, may be fairly apportioned among the States for tax purposes by formulas utilizing in-state aspects of interstate affairs.").
52. The unitary business principle grew out of the "unit rule" of the late 19th century, which was used for apportioning the property tax of railroads, telegraph and express companies. Under the unit rule, the value of the entire enterprise was first determined and then apportioned to a taxing jurisdiction through the use of a formula. Allied-Signal, 504 U.S. at 778-79, 112 S. Ct. at 2258-59. See Elcanon Isaacs, The Unit Rule, 35 Yale L.J. 838 (1926). The unit rule respected the self-evident reality that the value of an assembled whole may be greater than the value of the individual elements that constituted the interconnected system being taxed. The Supreme Court at one point made the observation in defense of the unit rule that "[c]onsidered as distinct subjects of taxation, a horse is, indeed, a horse; a wagon, a wagon; a safe, a safe; a pouch, a pouch; but how is it that $23,430 worth of horses, wagons, safes and pouches produces $275,446 in a single year? . . . The answer is obvious." Adams Express Company v. Ohio State Auditor, 165 U.S. 194, 222-23, 17 S. Ct 305, 310 (1897).
53. Container Corp. of America v. Franchise Tax Bd. of California, 463 U.S. 159, 167, 103 S. Ct. 2983, 2941 (1983).
54. Butler Bros. v. McColgan, 315 U.S. 501, 508, 62 S. Ct 701, 704 (1942).
55. Container, 463 U.S. at 166, 103 S. Ct. at 2940.
56. Mobil Oil Corp. v. Comm'r of Taxes of Vermont, 445 U.S. 425, 438, 100 S. Ct. 1223, 1232 (1980).
57. F.W. Woolworth Co. v. Taxation and Revenue Dept. of New Mexico, 458 U.S. 354, 371, 102 S. Ct. 3128, 3139 (1982).
58. Container, 463 U.S. at 166, 103 S. Ct. at 2940. For a detailed treatment of the definition of a unitary business, see Latcham, Unitary Business, supra note 48.
59. We certainly are not suggesting by this example and those that follow that similarity of the actual products being sold determines whether two separate entities are in a unitary relationship. California has recognized that businesses diverse in what they sell can be in a unitary relationship. See Mole Richardson Co. v. Franchise Tax Bd., 269 Cal. Rptr. 662 (1990) (rental of lighting for Hollywood and Colorado ranching held to be unitary).
60. Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U.S. 768, 112 S. Ct. 2251 (1992).
61. In defending its broad characterization of the business of Allied Signal, New Jersey did little to help the Court see that selecting the appropriate level of generality in defining a unitary business is
62. an application of a more pervasive problem in the law. See, e.g., Brace Ackerman, Levels of Generality in Constitutional Interpretation: Liberating Abstractions, 59 U. Chi. L. Rev. 317 (1992);
63. Laurence H. Tribe & Michael C. Dorf, Levels of Generality in the Definition of Rights, 57 U. Chi. L. Rev. 1057 (1990);
64. Richard D. Pomp, Issues in the Design of Formulary Apportionment in the Context of NAFTA, 49 Tax L. Rev. 795, 802-03 (1995) [hereinafter Pomp, NAFTA]; Pomp & Oldman, State and Local, supra note 13, at10-21.
65. Container, 463 U.S. at 175, 103 S. Ct. at 2945.
66. Id. at 176, 103 S. Ct. at 2946.
67. See Allied-Signal, 504 U.S. 768, 112 S. Ct. 2251 (1992). For discussion, see Benjamin Miller, Allied-Signal - A Cursory Examination, 2 State Tax Notes 888 (1992).
68. See Richard D. Pomp & Rebecca S. Rudnick, Federal Tax Concepts as a Guide for State Apportionment of Dividends: Life After ASARCO, 18 Tax Notes 411 (1982) (excerpted in Pomp & Oldman, State and Local, supra note 13, at 11-67); Allied-Signal, 504 U.S. at 787, 789, 112 S. Ct. at 2263, 2264. Louisiana currently deviates from the general principle that the label attached to a corporation's business income should not control the way it is taxed. Louisiana does not treat dividends and interest as apportionable income even if the income is related to a unitary business. For discussion of the treatment of allocable income under Louisiana law, see Section III.C.
69. See Pomp, NAFTA, supra note 59, at 802-03.
70. The appropriate function of an apportionment factor is to measure the business activities in a taxing state relative to the business activities in the other states where the unitary business is conducted. When an apportionment factor is being used in two unitary businesses, the question arises as to how much of the value of that factor should be included in the apportionment formula of each business. One possibility would be to bifurcate the factor and allocate it between the two businesses. For example, if an employee spends forty percent of his time on one unitary business and sixty percent of his time on the other unitary business, it would seem appropriate to include forty percent of his salary in the payroll factor of the first business and sixty percent in the payroll factor of the other business. In other circumstances, bifurcating the factor may be inappropriate. For example, if an asset provides full benefits to both businesses without any diminution in the value to either business from the dual use, then it may be appropriate to include the full value of the factor in the apportionment formula of each business.
71. The fact that affiliates set their transfer prices in accord with the arm's length principle does not negate in any way the existence of a unitary business. See Exxon Corp. v. Dept. of Revenue of Wisconsin, 447 U.S. 207, 100 S. Ct. 2109 (1980).
72. See text at supra note 32.
73. See, e.g., Conn. Gen. Stat. Ann. §§ 12-218 (West 2000); Md. Tax-Gen. §§ 10-401,402(1997); N.J. Stat. Ann. §§ 54:10E-6, 54:10A-6 (West Supp. 2001); R.I. Gen. Laws § 44-11-14 (1999).
74. See Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U.S. 768, 112 S. Ct. 2251 (1992).
75. Container Corp. of America v. Franchise Tax Bd. of California, 463 U.S. 159, 176, 103 S. Ct. 2983, 2946 (1983).
76. A presumption against the taxpayer has long been recognized by the Supreme Court. See id. at 164, 103 S. Ct. at 2939-40. "[T]he taxpayer has the distinct burden of showing by clear and cogent evidence that [the state tax] results in extraterritorial values being taxed." Id. at 175, 103 S. Ct. at 2945 (internal quotation marks and citations omitted). See Adams Express Co. v. Ohio State Auditor, 165 U.S. 194, 227, 17 S. Ct. 305, 311 (1897) ("Presumptively all the property of the corporation or company is held and used for the purposes of its business . . . .").
77. These presumptions are not suitable for statutory enactment but instead should be included in authorized regulations.
78. Information on the PPWG and on the Definition of a Unitary Business is available on line at 〈http://www.mtc.gov/PPWGs/ppwglist.html〉 (last visited May 14, 2001).
79. An instant unitary relationship might be established for example, when the acquired company was previously an unaffiliated supplier to, or buyer from, the acquiring unitary business.
80. A newly formed affiliate might lack instant unity when the new affiliate was a separate business that had no ties to the existing business of the unitary business.
81. For an analogous Federal rule, see I.R.C. § 982 (2001) (prohibiting a taxpayer that fails to comply with a formal document request without reasonable cause from later using the requested document in a court of law to resist a tax assessment).
82. La. R.S. 47:287.92(A) (2001) ("items of gross income, not otherwise exempt, shall be segregated into two general classes designated as allocable income and apportionable income").
83. Id.
84. The definition of unitary-business income is addressed in supra Section III,B.
85. UDITPA, supra note 4, at § 1(e) ("'Non-business income' means all income other than business income.").
86. The rules allocating these categories of allocable income will vary, depending on the income at issue. See, e.g., Del. Code Ann. tit. 30, § 1903 (1995); La. R.S. 47:287.91-.93 (2001); Ohio Rev. Code Ann. § 5733.051 (West 1995). States that define allocable income in terms of income categories typically adopted their statutes in the distant past, when the constitutional landscape was quite different. In those earlier times, allocation was thought to be appropriate for interest, dividends, rents, and royalties because they formed "no part of the trading profit and do not need to be apportioned by formula, since they can readily be specifically allocated to their proper sources." Report of the Committee of the NTA on Allocation of Income, 1939 NTA Annual Conference 190, 207.
87. La. R.S. 47:287.93(A)(4) (2001). In 1993, Louisiana adopted a special apportionment rule for certain dividend and interest income received by a corporation from a controlled subsidiary. La. R.S. 47:287.94(I)(1) and (2) (2001). Under the 1993 amendment, interest paid by a subsidiary on indebtedness having a situs in Louisiana generally would be apportioned pro rata to the payer's real and tangible personal property within and without Louisiana. A dividend from a subsidiary would be apportioned pro rata to the place where the profits out of which the dividend was paid had arisen. The Louisiana Supreme Court held that the 1993 amendment violated Article III, Section 2 of the Louisiana Constitution, which prohibits the legislature from levying a new tax in an odd-numbered year. See Dow Hydrocarbons & Resources v. John Neely Kennedy, et al., 694 So. 2d 215 (La. 1997). With the demise of the 1993 amendment, the pre-1993 allocation rule applies.
88. The statutory phrase is "corporeal movable property."
89. La. R.S. 47: 287.92(B) (2001).
90. For development of the concept of nonbusiness income as residual and subordinate to the concept of unitary-business income, see Michael J. McIntyre, Constitutional Limitations on State Power to Combat Tax Arbitrage: An Evaluation of the Hunt-Wesson Case, 18/1 State Tax Notes 51, 63-64 (Jan. 3, 2000) (reprinted 86/14 Tax Notes 1907-1922 (Mar. 27, 2000)).
91. UDITPA, supra note 4, § 1 (a); Multistate Tax Commission Allocation and Apportionment Regulations, Reg. IV.1 (adopted February 21, 1973, as revised through July 30, 1993) [hereinafter MTC].
92. See Pomp & Oldman, State & Local, supra note 13, at 10-28.
93. Multistate Tax Commission Allocation and Apportionment Regulations (Integrating Amendment regarding Classification of Income as Business or Nonbusiness - April 1995 Proposal), available at 〈http://www.mtc.gov/uniform/Busnonbs.pdf〉 (visited May 5, 2001).
94. The Supreme Court of California disagrees. See Hoechst Celanese Corp. v. Franchise Tax Board, 22 P.3d 324 (Cal. 2001) (holding that the California statutory definition of business income, which "mirrors" the UDITPA definition, establishes separate transactional and functional tests and that the reversion to the taxpayer of surplus pension plan assets satisfies only the latter test).
95. UDITPA, supra note 4, at § 7. A common definition of "commercial domicile" is the place from which the business is directed or managed. UDITPA, supra note 4, at § 1(b).
96. Id. at § 6(c).
97. UDITPA, supra note 4, at §§ 5(b), 6(b), 8.
98. George N. Carlson et. al., Perspectives on the Reform of UDITPA, in State Taxation of Business: Issues and Policy Options (Thomas F. Pogue ed. 1992).
99. Conn. Gen. Stat. § 12-217(a)(1) (2000); N.Y. Tax Law § 209(9) (1998).
100. Allocation rules are a type of source rule. One hallmark of a good source rule is that it locates income in a jurisdiction that is willing and able to tax it. See McIntyre, Int'l Treatise,supra note 25, at § 3/C.4. Under this standard, the UDITPA allocation rules are defective.
101. Intangible assets and income from such assets are not easily located in a specific state except through legal fictions. One old doctrine, known as mobilia sequuntur personam, treats intangibles as being attached to the person that owns the intangible. See Pullman's Palace Car Co. v. Com. of Penn., 141 U.S. 18, 11 S. Ct. 876 (1891); St. Louis v. Ferry, 78 U.S. 423 (1870). That doctrine may be the source of the domiciliary rule of UDITPA that we have criticized. The Supreme Court has described that doctrine as falling into desuetude. Japan Line, 441 U.S. 434, 442, 99 S. Ct 1813, 1818(1979). See also Mobil Oil Corp. v. Comm'r of Taxes of Vermont, 445 U.S. 425, 445, 100 S. Ct. 1223, 1235 (1980) ("the maxim mobilia sequuntur personam, upon which these fictions ofsitus are based, 'states a rule without disclosing the reasons for it'").
102. Mississippi uses separate accounting more than most states. Miss. Code Ann. § 27-7-23(c)(2)(B)(iii) (1999).
103. UDITPA, supra note 4, at §§ 10-17. The evenly weighted, three-factor formula is known as the Massachusetts formula, presumably because the drafters of UDITPA used that State's law as its model. Massachusetts has abandoned an evenly-weighted three-factor formula, moving first to a double-weighted receipts factor and most recently to a one-factor receipts formula for certain industries.
104. La. R-S. 47:287.95(F)(1)(c) (2001).
105. Colo. Rev. Stat. § 39-22-303(4)(a) (2000).
106. See, e.g., 1993 Cal. Stat. 946; Cal. Rev. & Tax. Code § 25128 (West 2001).
107. This statement assumes the nearly uniform practice of the states in assigning sales of tangible personal property to the state where the goods are delivered. See UDITPA, supra note 4, at § 16. We do not address in this Article the issue of how the place of sale should be determined on the sale of intangible property or services.
108. La. R-S. 47:287.95(F)(2) (2001).
109. La.R.S. 47:287.95(A)(C) (2001).
110. La. R.S. 47:287.95(D) (2001).
111. La.R.S.47:287.95(E) (2001).
112. La. R.S. 47:287.95(F)(1) (2001).
113. Container Corp. of America v. Franchise Tax Bd. of California, 463 U.S. 159, 192, 103 S. Ct. 2983, 2954 (1983).
114. MTC, supra note 86, Reg. IV.18.(c).(3).
115. This list is provided for illustrative purposes and is not intended to be exhaustive. In addition, the text does not address the treatment of allocable income.
116. La. R.S. 47: 287.12 (2001). The use of progressive corporate rates, like those used by Louisiana, is criticized in Richard D. Pomp, Reforming a State Corporate Income Tax, 51 Alb. L. Rev. 375, 484-508 (1987).
117. The example ignores the possibility that the State might include the value of inventory in the property factor. In principle, a formula that seeks to allocate half of the profits to the production states and the other half to the market states should exclude inventory and assets related to the sale of inventory from the property factor because inventory property relates to marketing profits and not to production profits. Only "production assets" should be included in the formula. See McIntyre, Int'l Treatise, supra note 25, at § 3/A.2.3.3. The Federal government included inventory and related assets in its apportionment formula for over 70 years but finally got the correct theoretical answer in 1998. See Treas. Reg. § 1.863-3(c)(1)(i)(B) (as amended by T.D. 8786 (1998)).
118. In the UDITPA three-factor apportionment formula, the sum of the three fractions is multiplied by 1/3. That sum is multiplied by 1/4 in the example because of the double weighting of sales.
119. As long ago as 1924, the United States Supreme Court upheld the inclusion of foreign source income in the pre-apportionment income of a corporation operating within the United States through a branch. See Bass, Ratcliff & Gretton, Ltd. v. State Tax Commission, 266 U.S. 271, 45 S. Ct. 82 (1924). See also Container Corp. of America v. Franchise Tax Bd. of California, 463 U.S. 159, 103 S. Ct. 2983 (1983), and Barclays Bank PLC v. Franchise Tax Bd. of California, 512 U.S. 298, 114 S. Ct. 2268 (1994).
120. Pomp and Oldman, State & Local, supra note 13, at 10-36.
121. See, e.g., Reuven S. Avi-Yonah, Slicing the Shadow: A Proposal for Updating U.S. International Taxation, 58 Tax Notes 1511 (Mar. 15, 1993);
122. Richard Bird & Donald Brean, The Interjurisdictional Allocation of Income and the Unitary Taxation Debate, 34 Canadian Tax Journal 1377 (1986);
123. Paul R. McDaniel, Formulary Taxation in the North American Free Trade Zone, 49 Tax Law Review 691 (1994);
124. Michael J. McIntyre, Design of a National Formulary Apportionment Tax System, 84th Conf. on Tax'n, Nat'l Tax Ass'n 118 (Frederick D. Stocker ed. 1991); Pomp, Future of State Taxation, supra note 41, at 63-64.
125. Container, 463 U.S. 159, 103 S. Ct. 2983; Barclays, 512 U.S. 298, 114 S. Ct. 2268.
126. The Treasury Department convened a working group on formulary apportionment that recommended that the states not include foreign corporations in their combined report See The Final Report of the Worldwide Unitary Taxation Working Group: Chairman's Report and Supplemental Views (1984) (reprinted in Charles E. McLure, Jr., Economic Perspectives on State Taxation of Multijurisdictional Corporations 235 (1986)).
127. 1986 Cal. Stat. 660.
128. 1993 Cal. Stat 881. For discussion of the 1993 legislation and the combination of pressures that led to its enactment, see Eric J. Coffill, A Kinder, Gentler 'Water's Edge' Election: California Wards off Threats of U.K. Retaliation as Part of Comprehensive Business Incentive Tax Package, 61 Tax Notes 477 (Oct. 25, 1993)
129. (also published in 7 Tax Notes Int'l 1049 (Oct. 25, 1993)).
130. Jerome R. Hellerstein, Federal Income Taxation of Multinationals: Replacement of Separate Accounting With Formulary Apportionment, 60 Tax Notes 1131, 1139 (Aug. 23, 1993) (referring to the water's edge legislation as "a 'shotgun' marriage arrangement" because of the Federal and other pressures brought to bear on California).
131. Cal. Rev. & Tax. Code § 25110(a)(2) and (3) (West Supp. 2001) (including domestic corporations in the water's edge election without limitation as their income).
132. See, e.g., Ariz. Rev. Stat § 43-1122(7) (1998) (exempting foreign dividends).
133. For example, the Colorado Legislature overrode the governor's veto to adopt a water's edge election. 1985 Colo. Sess. Laws 309. Florida, which had adopted worldwide combined reporting in 1983, abandoned it in 1984. 1983 Fla. Laws ch. 83-349; 1984Fla. Laws ch. 84-549. Oregon limited its combined group to corporations filing federal consolidated returns, from which foreign corporations are generally excluded. OR. VAB. 3029, 1984 Or. Spec. Sess. 1, ORS section 317.715.
134. Alaska Stat. § 43.20.072 (Michie 2000); Cal. Rev. & Tax Code §§ 25104-25137(West Supp. 2001); Idaho Code 63-3027B(Michie 2000); Mont. Code Ann. §§ 15-31-301, 15-31-305 (1999); N.H. Rev. Stat. Ann. § 77-A:1,I(Supp. 2000); N.D. Cent. Code § 57-38-14.3(2000); Utah Code Ann. § 59-7-403 (2000).
135. Alaska Stat. § 43.20.073 (Michie 2000); Cal. Rev. & Tax.Code 25110 (West Supp. 2001); Idaho Code 63-3027(t) (Michie 2000); Mont. Code Ann. § 15-31-322 (1999); N.H. Rev. Stat Ann. 77-A:2-b (1991); N.D. Cent. Code § 57-38.4-02 (2000); Utah Code 59-7-402 (2000).
136. States that generally require unitary business groups to file a combined report only for their domestic members include Arizona, Hawaii, Illinois, Kansas, Maine, Minnesota, and Nebraska.
137. Under a purely domestic combination regime, a foreign incorporated enterprise would not have the same right to combine its affiliates as would a domestic enterprise. A foreign corporation that would have been better off under a combined report arguably would have a foreign commerce clause complaint. We note, however, that state statutes limiting combined reports to U.S. corporations have been upheld against foreign commerce clause attacks. See Caterpillar, Inc. v. C.I.R. of Minnesota, 568 N.W.2d 695 (Minn.), cert. denied, 522 U.S. 1112, 118 S. Ct. 1043 (1998); Appeal of Morton Thiokol, Inc., 864 P.2d 1175 (Kan. 1993); E.I. DuPont De Nemours & Co. v. State Tax Assessor, 675 A.2d82 (Me. 1996).
138. Under Federal concepts, a foreign corporation is taxable on its business income that is effectively connected with a U.S. trade or business. See I.R.C. § 871(b)(1). For discussion of the Federal engaged-in-business concept, see McIntyre, Int'l Treatise, supra note 25, at § 2/B.3. California requires that a unitary foreign corporation be included in the water's edge combined report to the extent of its U.S. source business income. Cal. Rev. & Tax. Code § 25110(a)(5) (West Supp. 2001); 18 Cal. Code of Regs. § 25110(d)(2)(G)(i)(1).
139. Taxpayers have asserted that California's worldwide combined reporting system imposed unreasonable burdens on them. No doubt there are some special burdens, but the extent of those burdens is unclear. In the Barclays Bank case, Barclays estimated, and the trial court found, that it would have to pay $5 million to set up an appropriate accounting system and an additional$2 million annually to maintain that system. In contrast, the California Court of Appeal found that Barclays' actual annual compliance costs ranged from $900 to $1,250. See Barclays Bank PLC v. Franchise Tax Bd. of California, 512 U.S. 298, 313-14, 114 S. Ct. 2268, 2277-78 (1994).
140. California provides a useful summary of its water's edge rules, including copies of required forms, in California Franchise Tax Board, "FTB100W Booklet - 2000 Water's-Edge Booklet (2000) [hereinafter FTB Water's-Edge Booklet], available on-line at 〈http://www.ftb.ca.gov/forms/ 00_forms/00_100Wbk.pdf〉 (last visited Mar. 11, 2001).
141. 18 Cal. Code of Regs. § 25111-1(d)(2) (1998).
142. Cal. Rev. & Tax. Code § 25112(b) (West Supp. 2001). The members of the water's-edge combined group should also be required to provide the tax department with copies of any combined report filed with any other state. North Dakota requires an electing group to provide a spreadsheet showing its tax position in every state. N.D. Cent. Code 57-38.4-02.1.d (2000).
143. See Cal. Rev. & Tax. Code § 25111(a) (West Supp. 2001). As adopted in 1986, the election period was ten years. 1986 Cal. Stat. 660. It was reduced to five years bya 1988 amendment. 1988 Cal. Stat. 989 and increased to seven years in 1993. The election period is five years under North Dakota's water's edge regime. N.D. Cent Code § 57-38.4-02.1.c (2000).
144. Idaho makes the water's edge election irrevocable, unless the intervening consent of the tax administrator is obtained. Idaho Code § 63-3027C(a) (Michie 2000). Utah follows the same rule. Utah Code § 59-7-402(2)(c) (2000). We do not favor this rule because we see some advantage in the tax department making periodical reviews of an electing group's status and modifying, when appropriate, certain terms of a water's edge renewal agreement.
145. California automatically renews an election for an additional year if the taxpayer has not given notice of an intent to terminate within 90 days of the anniversary date. Cal.Rev. & Tax. Code § 25111(a) and (d) (West. Supp. 2001).
146. The Federal rule on entity classification under the so-called check-the-box regulations is that a change in classification can only be made every five years. Treas. Reg. § 301.7701-3(g)(1)(ii). In the California water's-edge system, the fact that a taxpayer has terminated its election does not affect its ability to make a later election. 18 Cal. Code of Regs. § 25111-1(a)(4) (1998).
147. Cal. Rev. & Tax. Code § 25110(a)(7) (West Supp. 2001). The CFC includes in the water's edge combined report its tainted income and the apportionment factors that relate to earning that income.
148. I.R.C. §§ 951-964(2001). These sections are contained in subpart F of Part III of subchapter N of chapter 1 of the Internal Revenue Code. The anti-avoidance rules applicable to certain foreign funds, contained in I.R.C. §§ 1291-1297 (2001), are usually treated as part of the subpart F regime.
149. For a detailed discussion of Subpart F and related rules, see McIntyre, Int'l Treatise, supra note 25, at ch. 7.
150. In Barclays Bank, 512 U.S. 298, 114 S. Ct. 2268 (1994), California successfully imposed worldwide combined reporting on a foreign corporation that had affiliates in many tax-haven countries, including Bahamas, Barbados, Bermuda, Cayman Islands, Channel Islands, Gibraltar, Hong Kong, Isle of Man, Nauru, Netherlands Antilles, New Hebrides, Singapore, Turks and Caicos, and the Virgin Islands. See Barclays International, A World of Banking - List of Offices (Nov. 1977). California's water's edge regime generally would not reach income deflected to affiliates organized in such countries.
151. The main category of income subject to the earnings-stripping rule would be income of the type classified as foreign personal holding company income, as defined in I.R.C. § 954(c)(1) (2001) and Treas. Reg. § 1.954-2(a)(1) (as amended in 1997). Absent special relief provisions, the Federal govern ment typically would treat such income as periodical income subject to withholding under I.R.C. § 881 when received by a foreign corporation from U.S. sources.
152. The Federal government denies a deduction to foreign controlled domestic corporations with respect to certain interest payments made to foreign related persons in order to prevent earnings stripping. See I.R.C. § 163(j) (2001).
153. Cal. Rev. & Tax. Code section 25110(a)(3). Sales are not double weighted for purposes of calculating the 20 percent figure. See FTB Water's Edge Booklet, supra note 130, at 8. Utah has a similar rule except that only payroll and property are taken into account. Utah Code Ann. §§ 59-7-101(26) and (33), 59-7-401(2)(a).
154. The term "80-20 company" probably was borrowed from the Federal tax lexicon. Under I.R.C. § 861(a)(1)(A) (2001), interest paid by a domestic company is foreign source income if 80 percent or more of its gross income for a three-year testing period is active foreign business income. A domestic corporation meeting the 80-percent active foreign business requirement is referred to as an 80-20 company. See McIntyre, Int'l Treatise, supra note 25, at 3/A.1.
155. Id.
156. See Cal. Rev. & Tax. Code § 25110(a)(5) (West Supp. 2001).
157. See, e.g., Utah Code Ann. §§ 59-7-101(33)(a)(i)(B).
158. See I.R.C. § 1504(d) (allowing certain Canadian and Mexican real property holding companies to join a consolidated group). See, e.g., Idaho Code 63-3027B(a).
159. I.R.C. § 114(a) and (b) (2001). Foreign trade income is defined in I.R.C. §§ 941-943 (2001).
160. This export incentive replaces the foreign sales corporation (FSC) rules that were found to be a prohibited export subsidy by the World Trade Organization. In 2001, a WTO dispute settlement body held that the new incentive scheme was a prohibited export subsidy. The United States appealed that decision to the WTO Appellate Body and lost. Under California's water's-edge regime, FSCs are included in the water's edge combined group. See Cal. Rev. & Tax Code § 25110(a)(1) (West Supp. 2001).
161. See Cal. Rev. & Tax. Code § 25110(b)(2)(B) (West Supp. 2001) (treating certain dividends received by a water's edge combined group as business profits). Louisiana currently treats certain categories of income as allocable income without reference to the relationship of those income items to the taxpayer's unitary business. This aspect of Louisiana's allocation rules may present constitutional problems that need to be addressed whether or not Louisiana adopts a combined reporting regime.
162. The proposed rule is similar in function to the look-through rules used by the Federal government in characterizing dividends, interest, rents, and royalties as general business income under the separate basket rules of I.R.C. § 904(d) (2001).
163. For discussion, see supra Part III.A.
164. Under some circumstances, a state may permit the unitary group to file a consolidated tax return. For a description of the California election rule, see Cal. FTB Pub. 1061 (1999) at 4, available at 〈www.ftb.ca.gov/forms/misc/index.htm〉 (last visited Feb. 25, 2001) [hereinafter Cal. FTP Pub. 1061].
165. It is useful to designate one member of a unitary group as the principal member for the purpose of determining the annual accounting period to be used by the unitary group in preparing its combined report. See infra Section IV.B.1.
166. Some may also object to this approach on esthetic grounds for it is not entirely consistent with the theory of the unitary business principle.
167. For an application of this simplified formula, see California Schedule R (Apportionment and Allocation of Income) (2000), available at 〈http://www.ftb.ca.gov/forms/00_forms/00_100R.pdf〉 (last visited Feb. 27, 2001).
168. In this respect, we propose that Louisiana follow the Federal consolidated return rule, which makes each member of the consolidated group severally liable for the tax on the consolidated income of the group. Treas. Reg. § 1.1502-6(a) (1966). Our recommendation on joint and several liability is based on practical realities and is not grounded on the unitary business principle. The fact that consolidated reporting is consensual and combined reporting is mandatory does not dissuadeus from recommending this useful rule.
169. Many issues arise in determining the proper treatment of NOLs that are outside the scope of this Article. We focus here on general principles and not on the myriad of issues that arise in applying those principles.
170. In a combined report, losses, like income, are apportioned under the applicable apportionment formula. 161. This example assumes that NOLs should be assigned to members of a combined group using the current apportionment factors rather than the factors that existed when the losses were incurred. If the change from the historical factors to the current factors is sufficiently large, it may be appropriate to use the historical factors for assigning losses in order to reflect fairly the extent of the taxpayer's business activities in the taxing state. A tax department should have the authority to achieve equitable apportionment in such circumstances. See UDITPA, supra note 4, at § 18 (allowing adjustments if the apportionment rule otherwise applied does not "fairly represent the extent of the taxpayer's business activity in the state"); La. R.S. 47:287.94(C) (2001) (permitting separate accounting in certain circumstances to prevent a "manifestly unfair result").
171. A comparable result is achieved under the Federal consolidated return rules through a consolidated tax credit. See Treas. Reg. § 1.1502-3 (as amended in 2000).
172. We do not address in this Article whether this familiar locational bias presents potential discrimination under the Commerce Clause. For discussion of that issue, see Peter D. Enrich, Saving the States from Themselves: Commerce Clause Constraintson State Tax Incentives for Business, 110 Harv. L. Rev. 377 (1996) [hereinafter Enrich, Saving the States];
173. Walter Hellerstein & Dan T. Coenen, Commerce Clause Restraints on State Business Development Incentives, 81 Cornell L. Rev. 789 (1996).
174. For a brief analysis of fairness issues arising in the design of tax transition rules, see Michael J. McIntyre, Transition Rules: Learning to Live with Tax Reform, 4 Tax Notes 7 (Aug. 30, 1976).
175. For a more detailed treatment, see Michael J. Graetz, Legal Transitions: The Case of Retroactivity in Income Tax Revision, 126 U. Pa. L. Rev. 47 (1977).
176. A case with somewhat analogous facts is Firstar Corp. v. Comm'r of Revenue, 575 N.W.2d 835 (Minn. 1998). In that case, the Minnesota Supreme Court granted relief to the taxpayer - a result we approve, at least in principle. Unfortunately, the Minnesota Supreme Court, in an attempt to avoid a constitutional question, improperly interpreted the Minnesota apportionment statute. The Firstar problem can be avoided by giving the tax department the discretion proposed in the text.
177. See I.R.C. § 1501 et seq.
178. Treas. Reg. § 1.1502-76(a)(1) (as amended in 2000) ("[t]he consolidated return of a group must be filed on the basis of the common parent's taxable year . . . .").
179. The Federal consolidated group is based on stock ownership; no federal concept of a unitary business exists. Corporations not eligible to be included in a consolidated return may be members of the combined group.
180. Cal. Code Reg. § 25106.5(b)(12). Fora detailed explanation of the California rule, see FTB Pub. 1061, supra note 154, at 5.
181. Id. The Federal approach is similar. See Treas. Reg. § 1502-76(a)(1)(as amended in 2000) ("each subsidiary must adopt the common parent's annual accounting period for the first consolidated return year for which the subsidiary's income is includible in the consolidated return").
182. See supra Part III.D.
183. See UDITPA, supra note 4, at § 11.
184. La. R.S. 47:287.95(G) (2001).
185. FTB Pub. 1061, supra note 154, at 5.
186. California allows a more comprehensive election. See Cal. Code Reg. § 25106.5(b)(12)(B) (allowing a combined group to electits principal member in the initial year of a combined report "so long as consistently treated as such for the year of the election and thereinafter").
187. We are assuming that nonconforming members cannot adopt the accounting period used by the principal member without excessive difficulty. If that assumption is not valid, we would expect nonconforming members to adopt the accounting period of the principal member of their unitary group.
188. Extensions of time to file the combined report may lessen the magnitude of having to prepare a combined report before all data from non-conforming members are available.
189. This is the California rule. See Cal. Code Reg. § 25106.5-4(c)(4).
190. See Cal. Code Reg. § 25106.5-4(b).
191. We proposed in Section IV.B.1. that the tax department be granted the right to impose a particular accounting period on a combined group when necessary to reflect clearly the income of the combined group. The department might find it necessary to invoke this power if a combined group selects an inappropriate principal member simply to forestall application of the combined reporting regime.
192. The tax authorities should have the discretion to adjust the terms of a transaction between members of a combined group to reflect income properly if the wash rule is not applicable to that transaction.
193. See Cal. FTB Pub. 1061, supra note 154, at 6.
194. For a more complete description of the types of transactions that are treated as a wash, see Cal. FTP Pub. 1061, supra note 154, at 5-6; 18 Cal. Code Reg. § 25106.5-1.
195. La. R.S. 47:287.95(G) (2001).
196. Under some circumstances, sales of capital assets are not reflected in the sales factor. See MTC, supra note 86, Reg. IV.18.(c).(1).
197. In the absence of a vigilant tax department, a combined reporting regime that permits a water's edge election may encourage some taxpayers to try to secure advantages in the apportionment formula through transactions with an affiliated company that is excluded from the combined group because of the water's edge election. This possibility is one of the unfortunate costs of permitting a water's edge election. As noted in supra Part III.E., we recommend the water's edge election for practical and political reasons, not for tax policy reasons.
198. Cal. FTB Pub. 1061, supra note 154, at 5-6.
199. See 18 Cal. Code Reg. § 25106.5-1 (2001).
200. See Treas. Reg. § 1.1502-13(c)(7)(ii)(Ex. 4) (as amended in 2000).
201. See Treas. Reg. § 1.1502-32(b) (as amended in 1999).
202. The basis adjustment rules for earnings and distributions are strongly analogous to the rules developed by the Federal government for preventing duplicative taxation of gain derived from the sale of a CFC. I.R.C. § 961(a) (2001). See McIntyre, Int'l Treatise, supra note 25, at § 7/B.4.2.
203. Appeal of Safeway Stores, Inc., No. 62-SBE 014 (Cal. State Bd. of Eq. Mar. 2, 1962). In Safeway Stores, the second loss (on the stock) occurred as a part of a liquidation of the subsidiary. Under California law, the loss may possibly have been a nonbusiness loss. If so, Safeway Stores may not prevent the California tax authorities from requiring a basis adjustment when both of the losses clearly constitute business losses includible in a combined report.
204. A state may prefer to deal with the duplicative gain and loss issue entirely by regulation. In that case, the statute's delegation of regulatory authority to the tax department should be unambiguous so that the resulting regulations would be given the force of law by the courts.
205. The adjustment to basis should be made whether the distribution is made by payment of a dividend or through some alternative mechanism.
206. La. R.S. 47:287.73(C)(1)(2001)and L.A.C. 61:1115. This method of eliminating duplicative taxation is being litigated in California in Farmer Brothers Co. v. FTB, Los Angeles Superior Court Case No. BC237663,as violating the Commerce Clause because relief is extended only to dividends paid from in-state sources.
207. We are not necessarily endorsing the practice of Louisiana and many other states of exempting only that portion of a dividend that is paid out of income previously taxed by the state. The proper treatment of such dividends is a matter beyond the scope of this Article.
208. Cf. Cal. Rev. & Tax. Code § 25106 (West Supp. 2001).
209. I.R.C. § 316(a) (2001) (flush language).
210. Id.
211. Roy Orbison, "Blue Bayou" (1963).
212. One recent study indicates that $1 of investment in tax planning typically results in a cut in state taxes of $100. See Sanjay Gupta & Lillian F. Mills, Multistate Tax Planning: Benefits of Multiple Jurisdictions and Tax Planning Assistance (unpublished study, June, 2000).
213. In his Senate confirmation hearings, Treasury Secretary-designate Paul O'Neill stated: "As a businessman I never made an investment decision based on the tax code . . . If you give money away I will take it, but good business people don't do things because of inducements." Joseph Kahn, Treasury Choice Varies from Bush on Tax Outlook, N. Y. Times, Jan. 18, 2001, at A-1, A-16. Roger Smith, former Chairman of General Motors, whose Saturn plant was sought after by nearly every governor, stressed that "tax breaks can't make a silk purse out of a sow's ear." Detroit Free Press, Mar. 18, 1985, at 1A. According to Smith, "we're going to be in business for the long term . . . you've got to look at more than just what the great big cookie is that's coming in on the plate." Id. Consistent with this philosophy, the first state GM eliminated as a site for the Saturn plant was Florida,a state that is perceived as having an extremely favorable tax climate (e.g., nopersonal income tax, no estate tax, a double-weighted receipts factor, and no worldwide combined reporting). For an overview of the business climate literature, see Enrich, Saving the States, supra note 163, at 392-97; Pomp, supra note 111, at 393.