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Sept 1992

California lower court upholds worldwide combined reporting. (State & Local Taxation)

by Fielding, John J.

    Abstract- The practice of a domestic taxpayer with a foreign parent of worldwide combined reporting (WWCR) is not in violation of the US Constitution's Foreign Commerce Clause. This decision was made by the California Superior Court in the 'Alcan Aluminum Corp v. Franchise Tax Board' case. The court based this decision on the theory supported in the case of 'Wardair Canada Inc v. Florida Department of Revenue.' This theory holds that the application of 'one voice' tests and the risk of multiple taxation is unnecessary after the federal government has taken an affirmative action allowing the state tax. The lower court's ruling on the WWCR method should be considered by taxpayers in weighing the advantages and disadvantages of refund claims and reporting on the 'water's-edge' basis in the state of California.

The Superior Court found that the federal government had affirmatively acted on this issue through its failure to include a provision prohibiting states from applying WWCR in a 1978 foreign treaty with the United Kingdom, as well as subsequent treaties, and in failing to pass proposed legislation which would have prohibited the methodology. Based on its finding that WWCR does not violate the Foreign Commerce Clause under the principles set forth in Wardair, the court declined to analyze the tax scheme under the principles set forth in Japan Line.

The California Superior Court reached a contrary result on the same issue in Barclays Bank International v. Franchise Tax Board, County of Sacramento, No. 325059, 325061, June 16, 1987. That decision was subsequently affirmed by the California Court of Appeals. Relying on the Japan Line tests, both courts found that the taxing method violated the Foreign Commerce Clause. In the Barclays decision, the Superior Court stated that the U.S. Supreme Court decision in Wardair had no "sufficient similarity . . . to suggest its application to Barclays . . ." In addition, the court commented that the failure of Congress to explicitly prohibit the WWCR method in foreign treaties and the lack of legislation to prohibit the WWCR method were not indicative signs of accepting or condoning the WWCR method.

A Higher Authority

The California Supreme Court accepted review of Barclays. It is anticipated that whatever decision is rendered by the California Supreme Court, the defeated party will appeal the decision to the U.S. Supreme Court. Until the California Supreme Court act and the case is appealed to the U.S. Supreme Court, the issue of WWCR as applied to corporations with foreign parents is far from decided.

In the case of a U.S. parent company with foreign subsidiaries, the California Court of Appeals overturned the Superior Court decision. In Colgate-Palmolive, Inc. v. Franchise Tax Board, No. 3 Civil C007044, California Court of Appeals, Third Appellate District, August 20, 1991, the appellate court held that WWCR as applied to a domestic parent with foreign subsidiaries does not violate the Foreign Commerce Clause of the U.S. Constitution. The court based its conclusion on the issues of multiple taxation and the federal government "speaking with one voice" to foreign governments.

The issue of multiple taxation, in Colgate, was decided mainly on the basis of the findings of the court in Container Corp. v. Franchise Tax Board, (1983) 463 US 159, 103 S. Ct. 2933. In Container the court noted that either a separate accounting method or WWCR could result in double taxation and to require one method over another would be "perverse constitutionally."

In addressing the second issue of whether WWCR prevented the federal government from speaking with "one voice" in regulating commercial relations with foreign governments, the court concluded that the failure of the Justice Department to file an amicus curiae brief or otherwise make known its position was neither indicative of acceptance nor rejection of the WWCR method.

In light of these recent decisions, taxpayers should assess the propriety of refund claims, as well as the relative benefits and detriments of electing to report on the "water's-edge" basis in California. The potential benefits of making the water's-edge election must be considered against the cost of the election fee, the administrative and compliance burdens associated with preparing the Domestic Disclosure Spreadsheet, and the binding election for a five year period.

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