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    • California’s new retroactive corporate tax law triggers two lawsuits
    Idaho

    California’s new retroactive corporate tax law triggers two lawsuits

    Madoc Meredith Posted on

    Daniel Walters
    | CalMatters commentary

    During Jerry Brown’s first term as governor of California, he became embroiled in a highly complicated dispute over how the state should tax the income of multinational corporations.

    More than four decades later, the issue has resurfaced in a corporate tax case against Microsoft, one of the country’s largest corporations. A draft law was also semi-secretly included in the state budget in June and two subsequent court cases have ensued.

    The result could require refiling of tax returns from past years and potentially force companies to pay billions of dollars in retroactive taxes. Alternatively, it could eliminate unexpected corporate taxes that Gov. Gavin Newsom is counting on to help eliminate the state’s budget deficit.

    In the 1970s, Brown faced the question of whether corporations should report their worldwide income in California and subject a calculated percentage of it to state tax, or whether they could limit their reporting of taxable income to their actual activities within the state.

    At that time, the first method, called “Unitary Taxation,” was used by the Franchise Tax Board, the Californian equivalent of the IRS. However, foreign companies, especially those based in Japan and the United Kingdom, strongly opposed this and looked for an alternative, which was called “Water’s Edge.”

    Brown initially supported the IRS, but after a visit to Japan he reversed course and accused the agency’s executive director, Martin Huff, of providing him with “unreliable data.” Huff responded by essentially accusing Brown of lying, which led Brown and legislative leaders to promptly change a unique state law that had protected the IRS’s executive branch from political interference.

    Huff also unfairly encroached on lawmakers by publicly proposing that their “per diems” be subject to income tax. After the law was changed to facilitate Huff’s dismissal, he resigned.

    The dispute over corporate taxation continued. At one point, it even became an issue in a tax treaty the US government negotiated with the UK government. In the 1980s, companies were finally given the option of using either the unitary or water’s edge method. Microsoft chose the latter method for its 2017-18 tax return, but got into a dispute with the tax authority over how to treat dividends from foreign subsidiaries.

    The dispute escalated when Microsoft demanded a refund of $90.9 million, but the IRS denied the claim and the company appealed to the Office of Tax Appeals, a tax court. Last year, a three-judge appeals panel ruled unanimously in Microsoft’s favor after extensive trial-like hearings.

    It could have forced the state to repay $1.3 billion immediately, and perhaps more as the decision trickled through the state’s corporate tax process. But the tax agency did not admit defeat and instead turned to Newsom and the Legislature for help.

    That resolution came in the form of Senate Bill 167, one of dozens of “supplemental bills” attached to the state budget, which declares that the Franchise Tax Board’s position on the dividend issue is state law, regardless of what the appeals panel ruled.

    Two lawsuits were filed this month challenging the constitutionality of SB 167, one by the California Taxpayers Association in Fresno, the other by the National Taxpayers Union in Sacramento.

    “This bill would impose a retroactive tax increase that would last for decades, allowing California tax collectors to penalize businesses that have already paid every cent of taxes owed under the laws in effect at the time,” said CalTax President Robert Gutierrez. “This egregious violation of taxpayers’ rights cannot go unchallenged.”

    It is very disturbing that California officials, after a defeat in court, are claiming the right to raise taxes retroactively by changing the law.

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    Madoc Meredith
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