State Justices Reject Challenge to Unitary Tax

In a decision that could help revenue-starved California retain billions of tax dollars, the state Supreme Court on Monday rejected a major challenge to a method used to tax foreign multinational corporations.

The court granted an important victory to state officials in rejecting claims by multinational firms, backed by the Bush Administration, that the so-called “unitary tax” improperly interfered with the federal executive branch’s authority to conduct foreign policy. The justices held unanimously that Congress’ repeated refusal to bar the states from using the method demonstrated implicit and conclusive federal approval of the system.

Nonetheless, the high court ordered further proceedings before a state appeal court on a separate, relatively minor question remaining in the case: whether furnishing the financial data required under the unitary system is so costly and burdensome that it violates the right to due process.

Officials said Monday’s ruling could prove a pivotal step in providing significant revenue to a state facing a $4-billion deficit at the end of the fiscal year.

Provided the state wins on the issue before the appeals court, California will retain the $792 million in revenue owed or paid under protest by foreign-based firms until 1988, when the system was modified.

And if the state also prevails in a separate case raising similar issues that is pending before the justices--a challenge to the tax involving domestic-based multinational firms--it will be assured of about $2.8 billion more in revenue that it risked losing.

“It’s a good day for the state of California,” said state Assistant Atty. Gen. Timothy G. Laddish. “The court has agreed with us that Congress has acquiesced in California using its method of taxation. . . . I consider this to be the most important battle in this case yet.”

Joan K. Irion of San Francisco, an attorney for the foreign-based firm challenging the tax, conceded that the company had “lost the battle.” But he added that it will continue to press its case, if necessary before the U.S. Supreme Court. “We still feel we have a meritorious position and are committed to pursuing this all the way,” Irion said.

Brad Sherman, chairman of the State Board of Equalization, welcomed the ruling and expressed confidence that the state would win on the remaining issue in the appeals court and in the related case involving domestic-based firms. “It’s nice to win, even if it’s not yet the final round,” Sherman said.

Under the unitary taxation system, the state collected income tax from multinational firms on a formula based on the California proportion of their worldwide property, payroll and sales activity. Most other states--as well as the United States and most other nations--base their taxes on profits reported within the state. California maintained that this system encourages companies to shift profits among subsidiaries to avoid taxation.

In 1988, the state relaxed the system to allow multinational firms, by paying a fee, to use an alternative method based only on U.S. operations.

In the case before the court, Barclays Bank of London brought suit against the state, challenging the tax and seeking a refund on grounds that the unitary system was burdensome to administer and unfairly permitted California to tax its worldwide income.

The bank was backed by a coalition of foreign governments--including the United Kingdom, Germany and Japan--and a host of international firms. The Administration supported the challenge, noting that four Presidents had opposed the tax and that if allowed to stand it would invite retaliation by the nation’s trading partners.

In December, 1990, a state Court of Appeal struck down the tax, agreeing with the challengers that the unitary method prevented the United States from speaking with “one voice” on foreign commerce. The Court of Appeal did not decide the question of whether the tax was unduly burdensome.

On Monday, the state high court acknowledged that the executive branch had consistently opposed the tax--but pointed out that Congress, which under the Constitution holds power over foreign commerce, had not opposed the tax.

In an opinion by Justice Armand Arabian, the court noted that in 1978 the Senate refused to approve a treaty with the United Kingdom until a provision barring the tax was removed.

The law, wrote Arabian, gives Congress the authority to bar state taxes that interfere with foreign commerce, but “it does not give executive officials carte blanche to declare state tax methods null when they irritate our trading partners.”