10 Cal.App.4th 1768, C007044, Colgate-Palmolive Co. v. Franchise Tax Bd.

Docket Nº:C007044
Citation:10 Cal.App.4th 1768, 13 Cal.Rptr.2d 761
Opinion Judge:[10] Davis
Party Name:Colgate-Palmolive Co. v. Franchise Tax Bd.
Attorney:[7] John K. Van de Kamp and Daniel E. Lungren, Attorneys General, Robert F. Tyler and John D. Schell, Deputy Attorneys General, and Eric J. Coffill for Defendant and Appellant. [8] Morrison & Foerster, Franklin C. Latcham, James P. Kleier and Clare M. Rathbone for Plaintiff and Respondent.
Case Date:November 20, 1992
Court:California Court of Appeals

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10 Cal.App.4th 1768

13 Cal.Rptr.2d 761

COLGATE-PALMOLIVE COMPANY, INC., Plaintiff and Respondent,


FRANCHISE TAX BOARD, Defendant and Appellant.


California Court of Appeal, Third District

November 20, 1992

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John K. Van de Kamp and Daniel E. Lungren, Attorneys General, Robert F. Tyler and John D. Schell, Deputy Attorneys General, and Eric J. Coffill for Defendant and Appellant.

Morrison & Foerster, Franklin C. Latcham, James P. Kleier and Clare M. Rathbone for Plaintiff and Respondent.



The principal issue in this appeal is whether California's worldwide unitary method of taxation (based on Rev. & Tax. Code, §§ 25101, 25120-25139), as applied to domestic-parent unitary corporate groups, is unconstitutional under the foreign commerce clause of the United States Constitution. (U.S. Const., art. I, § 8, cl. 3.)1 Using the dormant foreign commerce clause analytical framework set forth in Japan Line, Ltd. v. County of Los Angeles (1979) 441 U.S. 434 [60 L.Ed.2d 336, 99 S.Ct. 1813]

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and Container Corp. v. Franchise Tax Bd. (1983) 463 U.S. 159 [77 L.Ed.2d 545, 103 S.Ct. 2933], we originally concluded that the tax method does not violate that clause. Several months after we issued our decision, the California Supreme Court issued its decision in Barclays Bank Internat., Ltd. v. Franchise Tax Bd. (1992) 2 Cal.4th 708 [8 Cal.Rptr.2d 31] (Barclays). On June 18, 1992, the Supreme Court directed us to vacate our original decision in this case and refile it after modification in light of Barclays. The parties then filed supplemental briefs. As we explain, Barclays effects a substantial change in our foreign commerce clause analysis but no change in our original result. Consequently, we still reverse that part of the judgment regarding the foreign commerce clause issue and affirm that part of the judgment regarding the statutory and constitutional distortion issues.


The Methods of Allocating Income

When a corporation, either on its own or through subsidiaries, conducts business across state or national boundaries, the allocation of income to each relevant jurisdiction for purposes of taxation becomes an issue. To resolve this issue, two general methods of income allocation have been created: the arm's length/separate accounting method and the unitary business/formula apportionment method. Each of these two general methods can be applied in varying ways. (Container Corp. v. Franchise Tax Bd., supra, 463 U.S. at pp. 182, 191, 196 [77 L.Ed.2d at pp. 564, 570, 573]; Langbein (1986) 23 Tax Notes 625, 626; Note, State Worldwide Unitary Taxation : The Foreign Parent Case (1985) 23 Colum. J. of Transnat'l L. 445, 451, hereafter 23 Columbia Journal.)

Under separate accounting, the related corporations of a multijurisdictional enterprise are viewed as distinct from one another; taxable income is determined separately for each individual corporation by the jurisdiction in which that corporation actually conducts business or has a permanent establishment. Any improper shifting of value between the related corporations to avoid taxes is corrected by requiring "arm's length" pricing in

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related corporate transactions. In other words, the related corporations must act as if they were unrelated entities dealing at arm's length in the market-place.

In contrast, under the unitary business/formula apportionment method of allocating income at issue in this case—the worldwide unitary method—the related corporations of a multijurisdictional enterprise are treated as units of a single business—that is, as a "unitary group." (Cal. Code Regs., tit. 18, § 25137-6.)2 If a corporation doing business in California is deemed to be part of a unitary group, the total income for that group worldwide, including corporations operating wholly outside the United States, is apportioned to California by a three- factor formula. Under the formula, the property, payroll, and sales figures for the group in California are arithmetically compared to the property, payroll, and sales figures for the group worldwide. (See Rev. & Tax. Code, §§ 25128-25136.) This comparison results in a proportion that is multiplied against the unitary group's worldwide income, producing an apportioned amount of such income taxable by California.3 Simply put, if 25 percent of the property, payroll, and sales of the unitary group is located in California, then 25 percent of the group's worldwide income is apportioned to California. Under this method, it is unnecessary to make "arm's length" corrections because intercorporate transactions are disregarded.

Aside from a few minor exceptions, the income allocation method used by the United States and all of the other nations of the world is the separate accounting method, although, as noted, this method varies in practice. However, the United States has basically limited the application of its tax treaties to federal taxes. (Container Corp. v. Franchise Tax Bd., supra, 463 U.S. at p. 196 [77 L.Ed.2d at p. 573].)4

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The present controversy involves Colgate-Palmolive Company, Inc. (Colgate), a domestic-parent unitary corporate group with approximately 75 foreign subsidiaries operating in about 54 foreign counties.5 Colgate was directed to pay additional taxes for the years 1970 through 1973 after California applied the worldwide unitary tax method to the group. Under protest, Colgate paid the additional taxes and this suit ensued.

The Issues on Appeal

At trial, Colgate challenged the federal constitutionality of these additional taxes on foreign commerce clause grounds. The thrust of Colgate's argument below was that the federal executive branch acted decisively after

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the Container decision to communicate its longstanding position that California's worldwide unitary tax method impermissibly interferes with American foreign policy; according to Colgate, this decisive action eliminated the factual ambiguity that resulted in the Container decision. The trial court agreed with this argument and determined that California's worldwide unitary tax method was unconstitutional on this ground. The Franchise Tax Board (the Board) appeals that decision here.

Colgate also argued at trial that California's three-factor unitary formula unlawfully "distorted" the amount of Colgate's income apportioned to California. The trial court found against Colgate on this issue, which Colgate again raises in its respondent's brief.6

Finally, two peripheral issues are raised by the Board in this appeal. First, the Board claims the trial court abused its discretion in denying the Board's motion for discovery sanctions. Secondly, the Board asserts the court below erroneously awarded certain costs to Colgate.

The Foreign Commerce Clause

Article I, section 8, clause 3 of the United States Constitution empowers Congress "To regulate commerce with foreign nations, and among the several states, and with the Indian tribes." As the United States Supreme Court has long emphasized, this clause limits the power of the states even in the absence of congressional legislation. (Boston Stock Exchange v. State Tax Comm'n. (1977) 429 U.S. 318, 328 [50 L.Ed.2d 514, 523, 97 S.Ct. 599]; Freeman v. Hewit (1946) 329 U.S. 249, 252 [91 L.Ed.2d 265, 271, 67 S.Ct. 274].) In this respect, the commerce clause indirectly allocates the relative powers of states and the federal government. (Star-Kist Foods, Inc. v. County of Los Angeles (1986) 42 Cal.3d 1, 9 [227 Cal.Rptr. 391].)

As noted in Star-Kist, "[d]etermining whether a state tax exceeds the bounds of permissible state action under the [commerce] clause is often a difficult task." (42 Cal.3d at p. 10.) In the context of the foreign commerce clause, there are three United States Supreme Court decisions that have delineated the test under which this determination is made: Japan Line, Ltd. v. County of Los Angeles, supra, 441 U.S. 434; Container Corp. v. Franchise Tax Bd., supra, 463 U.S. 159; and Wardair Canada v. Florida Dept. of Revenue (1986) 477 U.S. 1 [91 L.Ed.2d 1, 106 S.Ct. 2369].

Applying the foreign commerce clause test it created, the court in Japan Line held that instrumentalities of commerce—in that case, seagoing cargo

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containers—which are foreign-owned, - based, and -registered and which are used solely in international commerce may not be subjected to a state's apportioned ad valorem property tax. (441 U.S. at pp. 436, 444 [60 L.Ed.2d at pp. 340, 345].)

In creating the foreign commerce clause test, the Japan Line court noted that the issue of taxation between nations is more complicated than the issue of taxation between American states. This increased complexity results from a number of factors, including the greater sensitivity to national as opposed to state sovereignty, the lack of an authoritative tribunal capable of resolving transnational disputes, and the fact that actions by individual states can work to the detriment of the whole country. (441 U.S. at pp. 447-451, 456 [60 L.Ed.2d at pp. 347-350. 352].) In light of these circumstances, said Japan Line, the foreign commerce power of Congress is greater than its interstate commerce power and the need for one national voice in regulating commercial relations with foreign nations is paramount. (Id. at pp. 448-449 [60 L.Ed.2d at pp. 347-348].)

From this comparison of the interstate and the foreign contexts, the foreign commerce clause test was born. That test was engendered by adding two inquiries onto the already existing four-part test for interstate commerce clause review. (Japan Line, supra, 441 U.S. at pp. 444- 445, 451 [60 L.Ed.2d at pp. 345-346, 349-350].)

Under the four-part interstate test, a state tax will survive an interstate commerce clause...

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