HORWOOD MARCUS & BERK CHARTERED
TAXPAYERS MAY BENEFIT FROM
ELECTING THE UDITPA FORMULA
ON AMENDED RETURNS
August 27, 2012
If you have any questions regarding
this memorandum, or any other state
or local tax matter, please contact any
of Horwood Marcus & Berk’s state and
local tax professionals:
Fred O. Marcus
(312) 606-3210
fmarcus@saltlawyers.com
Marilyn A. Wethekam
(312) 606-3240
mwethekam@saltlawyers.com
Jordan M. Goodman
(312) 606-3225
jgoodman@saltlawyers.com
David A. Hughes
(312) 606-3212
dhughes@saltlawyers.com
David S. Ruskin
(312) 606-3235
druskin@saltlawyers.com
Jennifer A. Zimmerman
(312) 606-3247
jzimmerman@saltlawyers.com
Breen M. Schiller
(312) 606-3220
bschiller@saltlawyers.com
David A. Fruchtman
(312)281-1111
dfruchtman@hmblaw.com
Christopher T. Lutz
(312) 606-3222
clutz@saltlawyers.com
On July 24, 2012, a California Appeals Court ruled in Gillette Co.
& Subsidiaries v. Franchise Tax Board, Appeal A130803, that for
the years the State was a party to the Multistate Tax Compact, it had
to allow taxpayers to elect to use the equal weighted, three part
apportionment formula in Article IV of the Compact. California
had long taken the position that Cal. Rev. & Tax Code 25128(a)
modified the Compact such that taxpayers would be subject to a
double weighted sales factor. The taxpayers in Gillette argued that
California could not unilaterally modify a binding compact.
The taxpayers eventually prevailed, and the Appeals Court found
that the statutory modification of the Compact had no effect. A
compact is a contract, after all, and a state must choose to either
abide by its terms or completely withdraw- unilateral modification
is not an option. The court used three distinct arguments to support
its conclusion: (1) California contract law mandated that the State
abide by the terms of a binding contract, (2) unilateral modification
of the Compact would materially affect taxpayers’ rights under the
contract, thus violating the United States Contracts Clause, and (3)
California’s “re-enactment rule” does not allow the State to simply
amend the Compact by reference to its title in another statute. The
taxpayers were thus entitled to make the Article IV election for the
years at issue in the litigation.
Shortly before the Court’s holding, the California legislation
completely withdrew from the Compact. At first, the Court was
uninterested in this change because a withdrawal from the Compact
could only be prospective. Nonetheless, the Court vacated the
decision on its own motion shortly after issuing its ruling. Whether
this change was based on pragmatic concerns regarding preventing
a flood of amended returns or if new information came to the
court’s attention is unclear.
This case will likely reach the California Supreme Court. Although
it is unclear what form the Appellate Court’s revised opinion will
take, the rationale in the original opinion may be difficult to avoid.
The opinion was unanimous and rested on three rather persuasive
arguments. However, even if the Gillette decision is overturned in
California, virtually every other Compact member state prohibits
use of the equal weighted, three factor apportionment formula. A
very similar action, IBM v. Michigan Dept. of Treasury, has already
been filed in Michigan. Arguably, every Compact member state
should be bound by the rational in Gillette that states may not
unilaterally modify a valid, binding interstate compact.
Horwood Marcus & Berk Chartered
500 West Madison St.
Suite 3700
Chicago, IL 60661
Phone: (312) 606-3200
Fax: (312) 606-3232
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Certain procedural obstacles may remain as well.
Some
commentators have noted that the “election doctrine,” which
basically requires taxpayers to make an election on their initial
return, rather than on amended returns, might block taxpayers from
filing amended returns utilizing the election. However, for the
doctrine to take effect, a state must have incorporated it into its
laws, and there must be a free choice between two or more
alternatives when taxpayers file their original returns. Hence,
although the extent to which the doctrine forecloses taxpayers from
filing amended returns may not be very significant, taxpayers opting
to amend their returns should be aware of this potential obstacle and
be prepared to address it.
HMB COMMENT
Not all taxpayers will benefit from electing to use the equal
weighted, three factor formula, but those who may benefit should
consider filing amended returns electing to do so. Although it is
unclear just how far the bounds of this position can be pushed, there
are tenable arguments that suggest any deviations whatsoever from
the terms of the compact are simply optional to taxpayers. Utilizing
the election thus may prove to be a very valuable tool to taxpayers
looking to reduce their tax liability.
* * * Horwood Marcus & Berk Chartered * * *
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