California Gillette Decision and Other Cases Demonstrate, Again, Why Congress Must Impose Strict Uniformity Requirements for State Taxes through Federal Legislation

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California Gillette Decision and Other Cases Demonstrate, Again, Why Congress Must Impose Strict Uniformity Requirements for State Taxes through Federal Legislation


The old saying cautions that “when the cat’s away, the mice will play.” When it comes to state taxation of interstate commerce, Congress is the “cat” that the Framers of the Constitution designated as the protector of our national marketplace under the Commerce Clause. The States, unfortunately, prove time and again that they are the “mice” who run rampant – even when they agree among themselves to play nice – in the absence of strict federal requirements for the fair and uniform state tax treatment of interstate businesses. Consequently, any federal legislation that would authorize the unruly States to expand their taxing jurisdiction and require state sales tax collection by Internet sellers and other multistate businesses must have strict uniformity and simplification requirements that can control the States. Federal legislation must not, as is the case with both the “Main Street Fairness Act” (MFA) and the “Remote Transactions Parity Act” (RFA) now pending in Congress, have mere token provisions that the states can easily avoid, after federal lawmakers turn their attention to other matters.

The December 31, 2015 decision of the California Supreme Court in The Gillette Co. v. Franchise Tax Board, [link: court opinion ] drives home the point. A little background is necessary to understand why. In 1966, the States were panicked over the prospect that Congress might impose comprehensive rules for uniform state taxation of interstate business income. They convened an “unprecedented” special meeting of the National Association of Tax Administrators and conceived a plan for a multistate agreement among the states that would promote the “uniformity and compatibility of state and local tax laws.” The result, in 1967, was the Multistate Tax Compact (“Compact”), which nine states quickly adopted, with others following suit in subsequent years, including California in 1974. The Multistate Tax Commission (“MTC”) was created by the Compact to administer it. In the wake of the Compact, Congress did not pursue federal uniformity legislation regarding interstate income, nor did it ratify the Compact.

Another central feature of the Compact was the adoption of the three-factor apportionment method of the Uniform Division of Income for Tax Purposes Act (UDITPA), which provides that a company with income from interstate operations will allocate its income among the states based on three, equally-weighted factors: property, payroll, and sales. In 1974, when California joined the Compact, it already used the UDIPTA equal-weighted, three-factor method, which remained in place under the Compact.

Fast forward to 1993, when California’s legislature decided—in keeping with a trend in other states—that it preferred to weigh more heavily the sales factor, a change which tends to shift the state income tax burden onto out-of-state companies. The California legislature determined that, notwithstanding anything in its laws adopting the Compact, all multistate companies would be required to use the new, double-weighted sales apportionment method.

Gillette and a number of other companies paid their taxes under the double-weighted sales method but sought refunds on the grounds that California’s membership in the Compact gave the businesses the option of using the Compact’s equal-weighted apportionment method (an approach that would save the companies over $34 million in taxes). After their claims were rejected by the California Franchise Tax Board, the California Court of Appeal approved their requests for refund, finding that the Compact was a binding, multistate agreement entered into by the State that required allowing businesses the option of the Compact’s equal-weighted apportionment method.

The taxpayers’ victory was short-lived. On appeal before the California Supreme Court, both the State and, importantly, the MTC itself disavowed the Compact as creating any sort of binding obligation upon the State. The commitment to uniformity, they argued, was something that California—or any Compact member state, for that matter—was free to abandon whenever it chose. Relying heavily on the MTC’s characterizations of the Compact, the Court in Gillette held that, in the absence of Congressional ratification of the Compact, and because the Compact lacked the other features of a binding agreement, the State of California was not bound by its provisions to permit use of equal-weighted, three-factor method.

It should be noted that the decision in Gillette parallels recent decisions in other states, including Michigan, Minnesota and Oregon, that denied taxpayers the right to use the Compact’s apportionment methodology. The legislatures in at least two of those states outright repealed, on a retroactive basis, their state’s adoption the relevant portions of the Compact, a step that California’s legislature took for tax periods after those disputed in Gillette.

Putting aside whether the Gillette decision is wrong as a matter of state or federal constitutional law, what it shows is that states have no genuine, abiding interest in the principles of uniformity, simplicity and fairness in the state tax treatment of multistate businesses. Their voluntary agreement to follow such fundamental principles of a healthy interstate marketplace is worth little more than the paper it is printed on, because their legislatures can, as sovereign bodies, change the rules at any time.

Congress, however, has the power to make the States behave, through its authority under the Commerce Clause. Examples like federal law P.L. 86-272 and the Internet Tax Freedom Act prove that Congress can reign in the states when it acts clearly and forcefully. In the context of sales and use taxes, where 10,000 different state and local taxing jurisdictions have the inherent incentive to disregard uniformity whenever it suits them, Congressional oversight and control must be particularly strict. The bills now before Congress (the MFA and RTPA), do not do the job. For the sake of our national economy, Congress needs to build a better mouse trap.

By Matthew Schaefer

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