- The State of Florida is seeking to sue the State of California in the Supreme Court of the United States.
- The Supreme Court is the court of original jurisdiction for settling disagreements between the states.
- Florida claims that certain aspects of California’s apportionment rules violate the Due Process, Commerce, and Import-Export Clauses of the Constitution.
Background
California law contains a so-called “special rule” in calculating apportionment using a single sales factor. The regulation in question provides that when substantial amounts of gross receipts arise from an occasional sale of a fixed asset or other property held or used in the regular course of a trade or business, the gross receipts attributable to such sale are excluded from the sales factor, per Cal. Code Regs., tit. 18, § 25137(c)(1)(A). “Substantial amounts” are those that have a greater than five percent effect on the sales factor denominator.
In practice, out-of-state taxpayers engaging in significant transactions will not see these transactions in the California apportionment factor numerator or denominator. Transactions sourced out of state that are disregarded in this manner will not be reflected in the California denominator for apportionment purposes, resulting in a relative increase in California apportionment as a result. The income generated by these gross receipts is nonetheless included in business income that is subsequently apportioned in calculating the California tax due.
Forvis Mazars Insight: The operation of this rule results in inclusion of income subject to apportionment without factor representation in the apportionment factor.
Florida’s Constitutional Arguments
Florida alleges that the special rule violates the Commerce, Import-Export, and Due Process Clauses of the Constitution.
The Commerce Clause argument is that the special rule results in the taxation of activity that has no substantial nexus with California as required under Complete Auto Transit v. Brady, 430 U.S. 274 (1977); specifically, it claims that the special rule is intrinsically arbitrary and bears no rational relationship between the sales activity and its connection to California. It also argues that it violates the internal and external consistency tests as promulgated in Container Corp. of America v. Franchise Tax Bd.,463 U.S. 159 (1983). It also argues that it discriminates against interstate commerce because it operates to exert pressure on interstate businesses to transact business in California, and that the tax imposed is not fairly related to the services provided by the state in return.
Florida argues that the special rule is in violation of the Import-Export Clause in that it acts as a tariff against sales made into California by businesses commercially domiciled outside of California. The additional tax imposed by the operation of the special rule, according to the filing, imposes an additional tax, or tariff on businesses outside of California in violation of the Constitution. Its Due Process Clause argument is largely derivative of the Commerce Clause argument, but the filing notes that the special rule is essentially taxing extra-territorial sales by reference to unrelated, in-state sales such that there is no rational relationship between the income attributed to the state and the in-state activity of any given enterprise.
Forvis Mazars Insight: Florida’s arguments are compelling and raise issues that many taxpayers have with single sales factor apportionment, especially when combined with market sourcing for those sales – that by excluding the payroll and property factors, in-state businesses’ tax burdens are almost certainly lessened while those based outside the state invariably see their taxes increase.
Standing
A central issue, one briefly addressed by the filing, is the matter of standing – namely, is Florida itself injured by the operation of the special rule in such a way that the Supreme Court can redress the harm. Florida argues that it is losing tax revenue, since the special rule encourages taxpayers to move property and payroll away from other states (including Florida) and into California. Additionally, it argues that as an indirect shareholder in corporations adversely affected by the special rule, it is financially injured. Finally, it claims to have standing on behalf of its citizens who are losing money because of the special rule.
Forvis Mazars Insight: Standing may be a significant hurdle for Florida to overcome in this case even though Florida’s standard apportionment factor still includes elements of property and payroll. The very nature of a country with fifty states with differing tax methodologies used to apportion income means that one state’s approach can often have impacts on the other due to the interconnectedness between the states. The Supreme Court has historically blessed some of these differing approaches and given states some constitutional latitude as they design their income tax systems (e.g., Moorman Manufacturing, 437 U.S. 267 (1978) on the constitutionality of a single sales factor). Shareholders and citizens have other means by which they can seek redress – namely, by pursuing California in its own state courts as required by the federal Tax Injunction Act.
Next Steps
Procedurally, for the Supreme Court to hear this case, four justices must agree to grant the motion for leave to file the bill of complaint. It remains to be seen how the justices react to this filing.
How Forvis Mazars Can Help
We can help you understand the implications of this filing for your business, especially should the Supreme Court grant Florida’s motion. Should the Supreme Court fail to do so, we can nonetheless help you understand the implications of the tax systems of the various states, including apportionment calculations, to help you determine whether it is advisable to seek relief from an onerous tax burden as a result of the rules in a particular state or states.