Barclays Bank Internat., Ltd. v. Franchise Tax Bd., S019064

CourtUnited States State Supreme Court (California)
Citation8 Cal.Rptr.2d 31,2 Cal.4th 708,829 P.2d 279
Decision Date11 May 1992
Docket NumberNo. S019064,S019064
Parties, 829 P.2d 279, 60 USLW 2725 BARCLAY'S BANK INTERNATIONAL, LTD., Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant. BARCLAY'S BANK OF CALIFORNIA, Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant.

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8 Cal.Rptr.2d 31
2 Cal.4th 708, 829 P.2d 279, 60 USLW 2725
BARCLAY'S BANK INTERNATIONAL, LTD., Plaintiff and Respondent,
FRANCHISE TAX BOARD, Defendant and Appellant.
BARCLAY'S BANK OF CALIFORNIA, Plaintiff and Respondent,
FRANCHISE TAX BOARD, Defendant and Appellant.
No. S019064.
Supreme Court of California,
In Bank.
May 11, 1992.

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[2 Cal.4th 712] [829 P.2d 280] John K. Van de Kamp and Daniel E. Lungren, Attys. Gen., Timothy G. Laddish, Asst. Atty. Gen., Robert F. Tyler and Robert D. Midlam, Deputy Attys. Gen., for defendant and appellant.

Alan H. Friedman and Scott D. Smith, Washington, D.C., as amici curiae, on behalf of defendant and appellant.

Heller, Ehrman, White & McAuliffe, Joanne M. Garvey, Joan K. Irion and Theresa A. Maloney, San Francisco, for plaintiffs and respondents.

David F. Levi and Richard H. Jenkins, U.S. Attys., Sacramento, William S. Rose, Jr., and Shirley D. Peterson, Asst. Attys. Gen., Gary R. Allen, David English Carmack, John J. McCarthy, Richard A. Correa, Washington, D.C., Lawrence V. Brookes, San Francisco, Valentine Brookes, Orinda, Lawler, Felix & Hall, Arter, Hadden, Lawler, Felix & Hall, Jane H. Barrett, Gene R. Gambale, Los Angeles, F. Eugene Wirwahn, Washington, D.C., Brobeck, Phleger & Harrison, Roy E. Crawford, Russell D. Uzes, San Francisco, McShane & Felson, Robert E. Borton, Oakland, James Merle Carter, Chadds Ford, Pa., Morrison & Foerster, Prentiss Wilson, Jr., San Francisco, Amy Eisenstadt, Washington, D.C., and Paul H. Frankel, New York City, as amici curiae, on behalf of plaintiffs and respondents.

ARABIAN, Justice.

We granted review to decide whether the use by the state Franchise Tax Board of a three-factor formula to apportion the income of a foreign-parent multicorporate unitary enterprise for state tax purposes violates the foreign commerce clause of the federal Constitution (art. I, § 8, cl. 3). We conclude that relevant treaty and other materials manifest a federal intent not to prohibit the states from employing formula apportionment in taxing the income of such a multinational unitary business. We therefore reverse the judgment of the Court of Appeal.


Plaintiff taxpayers, Barclays Bank of California and Barclays Bank International, Ltd. (collectively, the Bank), brought this refund action to recover assessments of $152,420 and $1,678 levied against them by the Franchise Tax Board (Board) for the 1977 tax year. The basis for the assessments was a finding by the Board that, together with their United Kingdom-based corporate parent and related worldwide subsidiaries, the Bank comprised a [2 Cal.4th 713] unitary enterprise, thereby subjecting it to the three-factor mathematical formula used by the Board to apportion the interjurisdictional income of a unitary business for state corporate income tax purposes. 1 Although the Bank did not contest the Board's predicate finding of corporate unity, it did claim that application of California's apportionment formula to such a unitary group--that is, one whose corporate parent is a foreign domiciliary--violates the foreign commerce clause of the federal Constitution.

Following a bench trial, the superior court ruled in favor of the Bank; the Court of Appeal affirmed, holding that California's formula apportionment method was

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[829 P.2d 281] unconstitutional as applied to foreign-based unitary groups. In the view of the Court of Appeal, use of the Board's method in such a case violated the foreign commerce clause in two respects. First, its application to a so-called "foreign parent" unitary business implicated foreign policy issues that were constitutionally required to be left to the federal government. Second, use of the formula apportionment method in the Bank's case was at odds with a clear federal directive embodied in presidential and cabinet-level statements, letters, and press releases, task force reports and the congressional testimony of senior executive officials to the effect that American foreign commercial policy supported the use of an alternative accounting method to determine the taxable income of foreign-based corporations, one that is incompatible with formula apportionment.

As the Court of Appeal recognized, this suit is not the first litigation challenging on foreign commerce clause grounds the Board's use of a three-factor formula to apportion the worldwide income of a multinational enterprise. In Container Corp. v. Franchise Tax Bd. (1983) 463 U.S. 159, 103 S.Ct. 2933, 77 L.Ed.2d 545 (Container ), the United States Supreme Court sustained against foreign commerce clause challenge the Board's use of [2 Cal.4th 714] formula apportionment to determine the taxable income of a domestic-based unitary business group with foreign-domiciled subsidiaries. Despite the outcome in Container, the Bank successfully contended before the Court of Appeal that issues implicated by its foreign parentage are dispositive of the constitutional question and compel the opposite result in this case.

Although presented with a question left open in Container, supra, 463 U.S. at p. 189, fns. 26 & 32, 103 S.Ct. at p. 2952, fns. 26 & 32, we approach its resolution along a path illuminated by the high court's analysis in a series of recent opinions, Container among them, in the contemporary evolution of the "dormant foreign commerce clause" doctrine. Our opinion has two parts. As a prelude to the constitutional question, we first examine the extralegal issues raised by competing methodologies used to distribute multijurisdictional corporate income for state tax purposes; we then address the Bank's central contention that a dormant foreign commerce clause analysis is appropriate here and that the Board's application of formula apportionment to the Bank's unitary business does not survive that analysis.

As we explain, neither of the two competing models used to allocate interjurisdictional income for state tax purposes is demonstrably superior to the other, even in an international multicorporate setting. Both methods meet the constitutional standard of avoiding "unreasonably" attributing extrastate value to the taxing jurisdiction. Moreover, the high court's recent foreign commerce clause jurisprudence reflects a diminution in the reach of dormant foreign commerce clause analysis in favor of an expanded recognition that, under circumscribed conditions, governmental silence may constitute a ratification of state taxation of foreign commerce, rendering a dormant analysis inapposite. In our view, this is such a case.


Background: State Taxation of International Income


Limitations on taxation by the states of the income of corporations doing business in more than one jurisdiction inevitably implicate the sufficiency of quantitative measures used to identify that portion of taxable value reasonably attributable to the taxpayer's intrastate activities. This pivotal role of technique arises from the stricture of the commerce and due process clauses of the federal Constitution that "a State may not tax value earned outside its borders." (ASARCO Inc. v. Idaho State Tax Comm'n (1982) 458 U.S. 307, 315, 102 S.Ct. 3103, 73 L.Ed.2d 787 (ASARCO ).) To meet [2 Cal.4th 715] this limitation, state tax schemes must comply with multiple criteria designed to produce a substantially accurate distribution of income so that only "values created by business within its borders" are taxed. (Butler Bros. v. McColgan

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(1942) [829 P.2d 282] 315 U.S. 501, 507, 62 S.Ct. 701, 704, 86 L.Ed. 991 (Butler Bros.).)

Two distinct models have long competed for supremacy in identifying the required division of multijurisdictional income. One model, known as the "arm's length/separate accounting" or "AL/SA" method, calculates income on a discrete and circumscribed basis, whether geographical, transactional, or functional. In a multicorporate interjurisdictional setting, the AL/SA method allocates income to a single taxing "sovereign" rather than apportioning it among jurisdictions, and treats intercorporate transfers of value between commonly held or related entities as if they were "arm's length" transactions between unaffiliated businesses. There seems little reason to doubt that, as an operational matter, the AL/SA model is the dominant method employed by corporations both in the United States and internationally; that is, a majority of businesses use the AL/SA or a variant method for their own internal accounting purposes.

The competing model for taxation purposes is the "unitary business/formula apportionment" method. Founded on the perception that "[i]n the case of a more-or-less integrated business enterprise operating in more than one State ... arriving at precise territorial allocations of 'value' is often an elusive goal, both in theory and in practice" (Container, supra, 463 U.S. at p. 164, 103 S.Ct. at p. 2939), formula apportionment relies on mathematical generalization to distribute an aliquot share of income or taxable value among taxing jurisdictions. The dominant variation of formula apportionment--the so-called "three-factor" model employed by the Board in this case--defines the multijurisdictional scope of the unitary enterprise of which the taxable intrastate activities are a part, calculates the combined income of the components of the unitary group, and distributes a portion of that result to the taxing state using a mathematical formula based on an averaged ratio of property, payroll, and sales in the taxing jurisdiction to that of the unitary enterprise overall. 2 (See Container, supra, 463 U.S. at p. 165, 103 S.Ct. at p. 2940.)

So far as taxation of United States-derived income is concerned, the use of formula apportionment is both established and noncontroversial, being the [2 Cal.4th 716] preferred method of a majority of the states; a substantially smaller number of American jurisdictions--California among them--combine and apportion the worldwide income of...

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