I. Combined Reporting Aggregates the Income of an Interstate Unitary Business and Permits California to Tax a Proportionate Amount of the Income Attributable to California
A state may tax the value that a corporation earns within its state borders. But in
an enterprise such as Harley-Davidson, that consists of a number of commonly owned
and functionally controlled entities, it is difficult to assess the value earned throughout
the entire interconnected enterprise that is attributable to the state. The unitary business
principle was developed to permit the states "to tax a corporation on an apportionable
share of the multistate business carried on in part in the taxing [s]tate." (Allied-Signal v.
Director, Div. of Taxation (1992) 504 U.S. 768, 778 (Allied-Signal) [history of unitary
business principle].) It protects an enterprise from being taxed for value not attributable
to the state, while allowing the state to collect its fair share of taxes attributable to the
1 In a motion filed December 1, 2017, the Board requested we take judicial notice of the Judgment and Statement of Decision after trial in Abercrombie & Fitch v. Franchise Tax Board, Fresno Superior Court No. 12CECG03408, now on appeal in the Fifth District Court of Appeal, case No. F074873. That court's ruling was not before the trial court when it rendered its decision in this case. It is not part of the record on appeal. That case involved a different plaintiff, and the decision came after a trial of the facts. The record before the Fresno Superior Court was different from the record that is before us in this appeal. The decision of the Fresno Superior Court in a different case is not relevant to our appellate review of the summary judgment before us. The Board's request for judicial notice is therefore denied. 5
enterprise's connection to the state. (Ibid.) Under this system, the interstate unitary
business must calculate the income of all of its functionally integrated components, and
apportion to the state that income proportionate to the business conducted within the
state. (Container Corp. of America v. Franchise Tax Board (1983) 463 U.S. 159, 165
(Container Corp.).) A proportionate share of the income that is attributable to California
activities is determined by an apportionment formula that uses objective measures of the
corporation's activity within California — payroll, property, and sales. (Id. at p. 170.)
The United States Supreme Court has long upheld the constitutionality of this combined
reporting/formula apportionment method under the commerce and due process clauses.
(Id. at p. 165, and cases cited therein, dating back to 1920; Allied-Signal, supra, 504 U.S.
at pp. 778–779 [history of unitary business principle].)
California's combined reporting method has been found constitutional under the
commerce and due process clauses for interstate unitary companies and for foreign
unitary companies. (Barclays Bank PLC v. Franchise Tax Bd. of Cal. (1994) 512 U.S.
298, 311–312 (Barclays); Container Corp., supra, 463 U.S. at pp. 164–165; Butler
Brothers v. McColgan (1942) 315 U.S. 501, 506–507 [no due process violation].)
In Barclays, a foreign international corporation claimed that California's
worldwide combined reporting scheme was discriminatory, due to the compliance costs
and administrative burdens it imposed on foreign unitary enterprises. (Barclays, supra,
512 U.S. at pp. 312–313.) The Supreme Court found that California's tax scheme did not
systematically overtax foreign corporations. (Id. at p. 314.) Barclays complained of the
compliance and administrative burdens it bore in preparing the combined accounting and
6
reporting required by California. (Id. at pp. 312–314.) But regulations that have only
incidental effects on interstate commerce are valid. (Oregon Waste Systems v. Dept. of
(Handlery).) The intrastate taxpayers contended that they were denied the benefits of
combined reporting that were available to interstate unitary businesses. Specifically, the
intrastate taxpayers alleged that they were denied the benefits of offsetting losses against
gains between different entities. (Id. at p. 984.) The appellate court found no violation of
equal protection because the state tax laws had a reasonable basis. (Id. at p. 983.) It
explained, "the 'formula' apportionment of unitary business income has not only been
found to be constitutionally permissible, but that it is often the only reasonable and
practical manner in which a state may levy and collect taxes to which it is constitutionally
entitled. It might be described as a sort of rule of necessity, having its origin in the
accommodation of a state's constitutional right to tax income derived from within the
state, to constitutional due process of law and interstate commerce provisions." (Id. at
p. 974.) It found no violation of equal protection, because "the formula-unitary business
reporting method has but one purpose—determination of the income from interstate
operations properly allocable to California. Where intrastate operations only are
concerned such intrastate income is readily discernible from the books of the enterprise,
without resort to any formula or other device." (Id. at p. 979.) Interstate and intrastate
unitary businesses were not similarly situated for purposes of the equal protection law.
(Id. at p. 983.)
8
In response to Handlery, the Legislature in 1980 amended the Revenue and
Taxation Code to permit intrastate unitary groups to choose either the combined reporting
or the separate accounting methods. (Harley I, supra, 237 Cal.App.4th at p. 200.)
Interstate unitary groups do not have that choice. Harley-Davidson contends that this
differential treatment of interstate and intrastate unitary enterprises violates the commerce
clause.
II. The Commerce Clause Prohibits Economic Protectionism and Interference with Interstate Commerce
We provided an overview of the commerce clause in Harley I:
"The commerce clause provides that '[t]he Congress shall have Power . . . [¶] [t]o regulate Commerce . . . among the several States.' (U.S. Const., art. I, § 8, cl. 3.) 'Though phrased as a grant of regulatory power to Congress, the [c]lause has long been understood to have a "negative" aspect that denies the [s]tates the power unjustifiably to discriminate against or burden the interstate flow of articles of commerce.' (Oregon Waste, supra, 511 U.S. at p. 98.) In this negative, or dormant, aspect, 'the [c]ommerce [c]lause "prohibits economic protectionism—that is, 'regulatory measures designed to benefit in[-]state economic interests by burdening out-of-state competitors.' " ' (Fulton Corp. v. Faulkner (1996) 516 U.S. 325, 330 (Fulton); Bacchus Imports, LTD v. Dias (1984) 468 U.S. 263, 268 ['A cardinal rule of [c]ommerce [c]lause jurisprudence is that "[no] [s]tate, consistent with the [c]ommerce [c]lause, may 'impose a tax which discriminates against interstate commerce . . . by providing a direct commercial advantage to local business' " '].) . . .
" '[T]he first step in analyzing any law subject to judicial scrutiny under the negative [c]ommerce [c]lause is to determine whether it "regulates evenhandedly with only 'incidental' effects on interstate commerce, or discriminates against interstate commerce." ' " (Oregon Waste, supra, 511 U.S. at p. 99.) In this context, ' "discrimination" simply means differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter." ' (Ibid.) 'By contrast, nondiscriminatory regulations that have only incidental effects on interstate commerce are valid unless
9
"the burden imposed on such commerce is clearly excessive in relation to the putative local benefits. . . ." '
" 'If a restriction on commerce is discriminatory, it is virtually per se invalid,' (Oregon Waste, supra, 511 U.S. at p. 99) unless the 'justifications for discriminatory restrictions on commerce pass the "strictest scrutiny" ' (id. at p. 101; see South Central Bell Telephone Co. v. Alabama (1999) 526 U.S. 160, 169 (South Central Bell)). Accordingly, a discriminatory regulation must be invalidated unless its proponent can ' "show that it advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives." ' (Oregon Waste, at pp. 100–101.)"
(Harley I, supra, 237 Cal.App.4th at pp. 201–202, fns. omitted.)
III. Harley I Did Not Rule on the Discriminatory Effect of California's Reporting Requirements
Harley-Davidson contends that we held in Harley I that the difference in
permissible methods of reporting facially discriminated against interstate unitary
enterprises. We could not have made such a decision on the bare allegations of the
complaint, without determining the veracity of the allegations. We held only that
"Harley-Davidson has sufficiently alleged for purposes of surviving the Board's demurrer
that the differential treatment of intrastate and interstate unitary businesses is
discriminatory within the meaning ascribed by commerce clause precedent." (Harley I,
supra, 237 Cal.App.4th at p. 207.) Harley-Davidson's complaint alleged that the option
to use the separate reporting method benefitted intrastate unitary taxpayers by allowing
"the ability to more efficiently use credits and net operating losses, reduced tax burden,
increased administrative ease and lower compliance costs in preparing returns. . . ."
(Harley I, at pp. 200–201.) In Harley I, we reversed the order sustaining the demurrer
10
because if these facts were true, they stated a valid cause of action to be determined in the
trial court. (See Perez, supra, 209 Cal.App.4th at p. 1235.)
IV. Because Harley-Davidson Has Made a Facial Challenge, It Need Not Specify the Amount of the Excess Burden on It
We reject the Board's contention that Harley-Davidson must show the amount of
taxes it overpaid as a result of the alleged discriminatory statutes. We agree with Harley-
Davidson that it need not show that Harley-Davidson, itself, was burdened, because it
raises a facial challenge to the statutes. (Tobe v. Santa Ana (1995) 9 Cal.4th 1069, 1084.)
But it must show that the different choice of reporting methods has an actual
discriminatory effect on interstate commerce. "To support a determination of facial
unconstitutionality, voiding the statute as a whole, petitioners cannot prevail by
suggesting that in some future hypothetical situation constitutional problems may
possibly arise as to the particular application of the statute . . . . Rather, petitioners must
demonstrate that the act's provisions inevitably pose a present total and fatal conflict with
applicable constitutional prohibitions." (Ibid., citations and internal quotation marks
omitted.) It is disputed here whether the reporting requirements of California's tax law
facially show a factual dispute about an inevitable, present, total and fatal conflict with
the commerce clause.
V. There Are Triable Issues of Fact About the Existence of Discriminatory Effect
The gravamen of discriminatory action is "differential treatment of in-state and
out-of-state economic interests that benefits the former and burdens the latter." (Oregon
Waste, supra, 511 U.S. at p. 99.) Discrimination that puts a higher tax burden on in-state
11
businesses than on interstate businesses does not violate the commerce clause because it
does not discourage commerce among the states. (See Direct Marketing Association v.
effects such as compliance costs and administrative burdens are not generally
discriminatory. (Barclays, supra, 512 U.S. at pp. 313–314.)
The trial court made no factual finding here about the discriminatory effect of the
different reporting requirements of California's tax law. The trial court concluded that
there were triable issues of fact on this question. We decline the Board's invitation to
make a factual determination on direct appeal of the possibility of discriminatory effect
from the disparate reporting choices.
VI. Legitimate State Interests Justify the Disparate Reporting Rule
A tax scheme that burdens the flow of interstate commerce must generally be
invalidated unless "it advances a legitimate local purpose that cannot be adequately
served by reasonable nondiscriminatory alternatives." (Oregon Waste, supra, 511 U.S. at
pp. 100–101.)
The trial court found that the state had a legitimate interest in requiring combined
reporting for interstate unitary businesses in order to accurately measure and fairly
apportion the income from all functionally integrated entities, and to prevent the
manipulation and hiding of taxable income. (Barclays, supra, 512 U.S. at p. 303; see
also Container Corp., supra, 463 U.S. at p. 164.) The court in Container Corp. explained
that separate accounting "often ignores or captures inadequately the many subtle and
largely unquantifiable transfers of value that take place among the components of a single
12
enterprise." (Container Corp., at pp. 164–165.) While these compelling reasons were
stated in the context of a due process claim, they provide the same rational basis for
supporting the state's legitimate interest in requiring combined reporting when it is
challenged as discriminatory under the commerce clause. Harley-Davidson has, in any
event, agreed that these are "worthy goals."
Harley-Davidson contends, however, that there are reasonable nondiscriminatory
alternatives to the disparate reporting system. But separate accounting cannot be
extended to interstate corporations because it "ignores or captures inadequately" the
transfers of value that take place among the many entities that that can make up a unitary
enterprise, and can lead to "the manipulation and hiding of taxable income." (Barclays,
supra, 512 U.S. at p. 303; Container Corp., supra, 463 U.S. at p. 164.) Harley-Davidson
has not pointed us to facts in the record that cast doubt on these findings. (See Lewis v.
County of Sacramento (2001) 93 Cal.App.4th 107, 116 (Lewis) [appellants bear burden to
support claims by citations to record and to authority].) Harley-Davidson argues that the
Board has "tools at [its] disposal" to seek out all the "subtle and largely unquantifiable
transfers of value" among the entities of a unitary business (Container Corp., at pp. 164–
165) and to prevent manipulation. This basic ability to capture fraud is not broadly
effective in the way that the combined reporting method prevents and limits the potential
fraud and manipulation facing the Board. As the Supreme Court has repeatedly held, the
combined reporting / apportionment method is a rule of necessity that conforms to and
fulfills "two imperatives: the States' wide authority to devise formulae for an accurate
assessment of a corporation's intrastate value or income; and the necessary limit on the
13
States' authority to tax value or income that cannot in fairness be attributed to the
taxpayer's activities within the State." (Allied Signal, supra, 504 U.S. at p. 780; see also
Handlery, supra, 26 Cal.App.3d at p. 974 ["[T]he 'formula' apportionment of unitary
business income has not only been found to be constitutionally permissible, but . . . it is
often the only reasonable and practical manner in which a state may levy and collect
taxes to which it is constitutionally entitled"].)
Nor has Harley-Davidson convinced us that prohibiting intrastate unitary
companies from choosing either the solitary accounting or the combined method would
be a reasonable alternative. There are no undisputed facts to support this suggestion. (See
Lewis, supra, 93 Cal.App.4th at p. 116.) All income earned by an intrastate unitary
business is taxed by California, without apportionment. Intrastate unitary businesses
have less opportunity for hiding and manipulating taxable income among separate
entities, because all of their income is earned and value added within the state's borders,
subject to general state corporate regulation. Intrastate entities are not similarly situated
to interstate entities for purposes of filing taxes. Harley-Davidson has given us no facts
supporting its claim that requiring intrastate unitary businesses to always file by the
combined reporting method would be a reasonable nondiscriminatory alternative.
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DISPOSITION
We affirm the judgment of the trial court.
BENKE, J.
WE CONCUR:
McCONNELL, P. J.
HUFFMAN, J.
15
Filed 9/14/18
CERTIFIED FOR PUBLICATION
COURT OF APPEAL, FOURTH APPELLATE DISTRICT
DIVISION ONE
STATE OF CALIFORNIA
HARLEY-DAVIDSON, INC., et al., D071669
Plaintiffs and Appellants,
v. (Super. Ct. No. 37-2011-00100846- CU-MC-CTL) FRANCHISE TAX BOARD, ORDER GRANTING Defendant and Respondent. PUBLICATION
THE COURT:
The opinion in this case filed August 22, 2018, was not certified for publication. It appearing the opinion meets the standards for publication specified in California Rules of Court, rule 8.1105(c), the People's request pursuant to California Rules of Court, rule 8.1120(a) for publication is granted.
IT IS HEREBY CERTIFIED that the opinion meets the standards for publication specified in California Rules of Court, rule 8.1105(c); and
ORDERED that the words "Not to Be Published in the Official Reports" appearing on page one of said opinion be deleted and the opinion herein be published in the Official Reports.
McCONNELL, P. J.
Copies to: All parties
AI Brief
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Holding. The court held that California's requirement that interstate unitary businesses use combined reporting is constitutional because it serves a legitimate state interest in accurately measuring and apportioning income that outweighs any potential discriminatory effect. The court further determined that interstate and intrastate unitary businesses are not similarly situated, justifying the state's disparate tax reporting requirements.
Issues
Does California's tax scheme, which requires interstate unitary businesses to use combined reporting while allowing intrastate businesses to choose between combined or separate accounting, violate the commerce clause?
Does the state have a legitimate interest in requiring combined reporting for interstate unitary businesses that outweighs any discriminatory effect?
Are there reasonable nondiscriminatory alternatives to the state's current tax reporting requirements for unitary businesses?
Disposition. Affirmed
Quotations verified verbatim against the opinion
“we also find that there is a legitimate state interest to require combined reporting of taxable income of interstate unitary businesses, to accurately measure and tax all income attributable to California, that outweighs any possible discriminatory effect.”