Heads I Win, Tails You Lose: California Supreme Court Brings an End to MTC Election (For Now)
On December 31, 2015, the California Supreme Court issued its decision in The Gillette Company v. Franchise Tax Board, Case No. S206587 (Cal. Dec. 31 2015), reversing the California Court of Appeal decision (see Andersen Tax’s previous tax release on the Court of Appeal decision here). In its decision, the Court held that the Multistate Tax Compact (the Compact) did not constitute a binding reciprocal agreement among member states, and therefore the California Legislature may preclude a taxpayer from relying on the Compact’s election provision. The Court further held that the Legislature’s amendment of the state apportionment formula statute that precluded taxpayers from making an MTC election did not violate the California Constitution.
In its opinion, the Court addressed the issue of whether the California Legislature was bound by the provisions of the Compact that allowed taxpayers to elect between an evenly-weighted, three-factor apportionment formula as outlined in the Compact in lieu of the statutory apportionment formula requiring a double-weighted sales factor. The Court held that the Compact functions like a model law and was therefore advisory rather than mandatory. The Court noted that the Compact did not require member action since its inception in 1967, and any state may join or leave the Compact without notice.
The Court also found that the statutory language and legislative history clearly indicated that the California Legislature intended to eliminate the Compact’s election language.
While it is an open question whether Gillette will make its way to the United States Supreme Court, multistate taxpayers may not currently elect to apportion California income using the Multistate Tax Compact apportionment formula in lieu of the statutorily prescribed formula. Taxpayers that utilized the MTC election on an originally filed return should review the impact on tax attributes and cash taxes. Further, in addition to discretionary penalties that may be imposed, any election resulting in an understatement of corporate tax in excess of $1 million or 20% of the original liability may subject the electing corporation to the 20% Large Corporate Understatement Penalty (LCUP). (See Andersen Tax’s prior guidance on the MTC election here).
The full California Supreme Court opinion can be found here.