The California Franchise Tax Board (FTB) has proposed an amendment to the California Code of Regulations (18 Prop. C.C.R. section 25100.5) that would revive a long-standing corporate income apportionment rule that had been in effect for more than 20 years until it was struck down by a board of equalization decision in 1988. The amendment may also signal a refund opportunity for some groups filing California corporate returns.
General Framework of the Unitary Concept
A member of a group of two or more related corporations is generally required to file a combined California return if the group meets the definition of a "unitary group." A unitary group exists where the corporations conduct business as a single economic enterprise. It is rare that related corporations can avoid combined reporting by contending that they do not constitute a unitary group. This is the mechanism California uses to ensure that the amount of income apportioned to the state is not easily manipulated by shifting income and deductions between multiple corporations.
The unitary group's combined business income is apportioned to California using the typical three-factor formula: property, payroll, and sales. These factors are calculated as percentages and averaged to determine an overall apportionment percentage that is then applied to the group's worldwide income. Sales are accorded double weight, except for groups engaged primarily in the extractive, agricultural, banking, and financial industries.
Sourcing of Sales
In general, sales of tangible personal property are considered California sales if the goods are shipped to a customer in California. However, when a unitary group of corporations is involved, it is often the case that one or more members of the group do not have nexus to California, because the members' activity is limited to solicitation of orders. In such a case, Federal law (P.L. 86-272, 15 U.S.C. sections 381-384) protects those members from California's tang jurisdiction. Conversely, group members that are subject to California tax may ship goods to customers in states that have no authority to tax the sale. Since use of the sales factor in apportioning income is quite common, the interplay of P.L. 86-- 272 with the sourcing of sales by destination could result in some of a corporation's sales being assigned nowhere. To combat this, many states, including California, have adopted throwback rules. Under these rules, sales are sourced in the state from which the goods were shipped (thrown back) if they cannot be sourced in the destination state due to P.L. 86-272 immunity.
Two approaches can be taken in determining whether the sales are protected from taxation in the destination state (and, therefore, thrown back): the member approach and the group approach. Under the member approach, sales are thrown back to the state from which they are shipped if that member has P.L. 86-272 protection, even if other group members are subject to the destination state's taxing jurisdiction. Under the group approach, sales are not thrown back if any member of the unitary group is subject to taxation in the destination state.
Evolution of California's Approach
In 1960, the California State Board of Equalization (SBOE) took the member approach in Appeal of Joyce, Inc. (Cal. SBOE, 69-SBE-069, Nov. 23, 1966). In Joyce, the SBOE ruled that including sales of a group member that was protected by P.L. 86-272 based on their California destination would effectively impose a tax on income that was immune under Federal law. Thus, it effectively ruled that these sales are properly assigned (or thrown back) to the state from which the goods were shipped.
In 1988, the SBOE reversed itself in Appeal of Finnigan (Cal. SBOE, 88-SBE022, Aug. 25, 1988). In Finnigan, the SBOE applied the group approach in finding that sales shipped from California to another state were not thrown back to California as long as any member of the unitary group was subject to taxation in the destination state, even if the corporation that made the sale was protected by P. …