The rules, which California has been using for a decade to channel more than $ 7 billion in corporate taxes into the state each year, are in danger of being turned on their heads.
One Technologies LLC, a Texan company that sells consumer credit reporting services, is filing with a California court to overturn a 2012 poll that established income tax rules for more than 100,000 companies that sell goods or services in the state.
The challenge, which depends on how pieces of the measure were bundled, would reduce state tax revenues, make California rules out of sync with most other states, and potentially jeopardize the legality of other tax measures. It could also put state-owned companies at a disadvantage compared to overseas companies, which could more easily lower their tax bills without having offices or employees in the state.
“From a tax point of view, it’s the worst of both worlds,” says Jared Walczak, Vice President for State Projects at the Conservative Tax Foundation. “The state would lose revenue without gaining a competitive advantage.”
“The result would not be what the anti-tax community wants,” said Darien Shanske, a professor at the University of California, Davis School of Law.
Tax office calls for dismissal
The California Franchise Tax Board is calling on the court to dismiss the lawsuit as One Technologies failed to provide a valid cause of action. A hearing in the Los Angeles County Superior Court is scheduled for December 8th.
Marty Dakessian of Dakessian Law, who represents One Technologies, declined to comment.
One Technologies is questioning the validity of Proposition 39, a move approved by 61% of voters in November 2012 after investor and activist Tom Steyer contributed $ 29.5 million of the $ 32 million to the campaign would have. Steyer and other supporters said it would close a loophole benefiting out of state companies that have no employees or property in California but sell in the California market.
Steyer did not respond to requests for comments.
The voter-approved approach requires companies from multiple states to calculate their California taxable income solely on the basis of their sales in the state versus sales elsewhere, an approach known as single revenue pegging. In addition, companies must map revenue from the sale of intangible goods such as services to the location of the customer, which is known as market-based sourcing.
Twenty-seven of the 44 states with corporation tax have similar apportionment rules based solely on sales in their states versus sales elsewhere. Most of the others use a three-factor system, but Walczak said they weight sales more than the other two factors – ownership and payroll.
If One Technologies is successful, companies could go back to the pre-Prop 39 situation and choose the apportionment formula that cuts their taxes the most. Only Arizona and North Dakota offer such a broad option.
According to the tax authorities, 106,390 corporate taxpayers calculated their California income using the retail sales formula and paid approximately $ 7.2 billion in taxes in 2018, the most recent year with full data. The FTB cannot say how much revenue could be lost if the rules were changed, as it is not known how many companies would choose the alternative formula.
Companies had a choice
Before 2013, companies could choose between the single sales formula and the three-factor formula, which double-weighted California sales. If they opted for an individual sales factor allocation, they used market-based procurement. When they chose the three-factor formula, they allocated the income from the sale of intangible assets to the location where the company incurred the cost of providing the services.
One Technologies wants to use the three-factor formula and performance cost to keep a larger portion of its income in Texas, where its offices and employees are located.
If the court overturned the law, California would again allow companies to choose the formula that would result in the lowest tax liability. And the state could owe repayments to companies that have tried to use the three-factor formula in previous years, for which the statute of limitations has not yet expired.
Legislators could step in to re-enact the retail sales formula or develop a remedy to reduce lost revenue, as they did when courts in the past invalidated other tax laws.
If companies allowed the application of performance cost rules based on the three-factor formula, California companies that sell services or intangible assets – especially those in the technology sector – would be disadvantaged compared to companies outside of the state, Walzcak said. Companies based in other states, he added, have an incentive to refuse employees to work remotely in California because their presence in the state could increase tax liabilities.
At the heart of One Technology’s lawsuit is the allegation that Proposition 39 violates the one-topic rule of the California Constitution.
Proposition 39 contained two other elements in addition to the retail sales formula: $ 550 million of the estimated annual revenue of $ 1 billion for five years was allocated to energy efficiency projects such as the retrofitting of schools and government buildings, and cable television companies a permanent one, making them half allocate their sales of intangible assets based on market rules and the other half based on performance cost rules.
One Technologies claims that these three elements are not sufficiently connected in two different ways. Either the rules for the single-sales factor are important for funding clean energy jobs, so that the cable tax outsourcing remains independent; or single sales factor and the cable carve-out matter, so the clean energy fund is not related.
Thomas W. Hiltachk, an electoral lawyer at Bell, McAndrews and Hiltachk LLP, said in an email that the complaint was justified, in particular the argument that the cable company’s spin-off was not related to the purpose of the measure. Instead of generating revenue for the energy program, it reduced the revenue. A 1999 California Supreme Court ruling invalidated an election for doing the opposite of its stated purpose.
“In other words, the proponent’s attempt to get the cable companies out of the tax that is imposed on everyone else could bite his butt,” said Hiltachk.
The tax authority argued the opposite in its objection, saying the courts had confirmed much broader initiatives facing unilateral challenges. Voting actions can have a common purpose without including provisions that interfere with a functional relationship, the agency said.
Shanske of UC Davis agreed with the tax authorities, saying California has special apportionment rules for many industries and the outsourcing of cables is closely related to the substance of the proposal. Many other court rulings show that the courts have a broad view of the one-subject rule, he said.
Other tax reconciliation efforts could be vulnerable if One Technologies succeeds as it would expand the interpretation of the rule even further, Shanske said. At the top of the list is Proposal 26, passed by voters in 2010 to reclassify many government fees, levies, levies, and grants as taxes that require a two-thirds majority in lawmakers. A two-thirds majority is required if a bill increases taxes for even just one person or company.
Shanske and a colleague, law professor Chris Elmendorf at UC Davis, argue that Proposition 26 may violate the one-person rule because proponents did not mention the new super-majority requirements in the ballot papers and the rule was created to be one To prevent “bamboozlement” of voters.
A win in court for One Technologies would be a Pyrrhic victory, given the tax policy and franchise implications, Shanske said.
“If you want friends at the Chamber of Commerce Jamboree, that’s not a good thing,” he said.
The case is One Technologies LLC v Franchise Tax Board, Cal. Super. Ct., 21STCV21844, Tax Refund Request 6/11/21