California Appellate Court Affirms Ability to Elect MTC Three-Factor Apportionment Formula and State’s Response
August 10, 2012
The California Appellate Court, in its recent case The Gillette Company et al v. Franchise Tax Board, First District No. A130803, July 24, 2012, ruled that the State of California as a signatory member of the Multistate Tax Compact (“MTC”) must follow the MTC’s provisions and allow the taxpayers to elect to use either the MTC’s apportionment formula (three-factor equally weighted) or the state’s alternative formula (four-factor double weighted sales, adopted with the 1993 passage of Section 25128). This was a solid win for the taxpayers whose California apportionment factor as filed exceeded the MTC’s formula.
However, the State anticipated this result during the court proceedings and the Legislature preemptively passed SB 1015, which was signed into law by the Governor on June 27, 2012. SB 1015 repealed California’s participation on the MTC and all the tax provisions adopted in the California Code, Section 38006. SB 1015 also included a clarifying provision related to the “doctrine of elections.” The doctrine of elections states that an election affecting the tax calculation must be made on the original timely filed return. The State’s position is that if the taxpayer filed a return using the Section 25128 four-factor double weighted sales method, a valid election was made with that filed return and the taxpayer is bound by that election and unable to file an amended return electing the MTC formula. The FTB’s position was not upheld.
The FTB has some options available to it regarding the Gillette case, such as to petition for a rehearing with the Appellate Court and/or petition for a hearing with the California Supreme Court. We and others expect that the FTB will appeal. The taxpayers have some options available as well. Taxpayers should consider filing amended returns requesting refunds for all open tax years. Under California’s four-year statute of limitations, taxpayers might go all the way back to 2007, which was probably filed on extension. Technical arguments exist refuting the State’s position that the taxpayer is not allowed by the doctrine of elections to go back and amend its election. Therefore, until all the issues are finalized, it may be worthwhile to consider filing protective refund claims with amended returns that now elect the MTC apportionment formula. It is important to acknowledge that the FTB will fight long and hard against any refund.
For the California 2011 return not yet filed, or the ability of amending an early filed 2011 return within the extension period, we suggest considering both methods before finalizing the return.
Interestingly there are other MTC member states that have modified their allocation and apportionment provisions to something other than the MTC three-factor formula. For example Michigan as a Compact member, last year adopted a new corporate income tax and specifically stated it had not adopted the MTC’s provisions for allocation and apportionment. Time will tell how this California ruling might impact such other Member states.
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