GMG Knowledge Base

Salt Spotlight
16 Jan, 2013

California – Implications of the Gillette Decision

Posted by Admin on Jan 16, 2013 1:30:00 PM

A California Court of Appeals recently held that California's adoption of the Multistate Tax Compact (the "Compact") prevented the California legislature from statutorily precluding a corporate taxpayer from electing to use the Compact's three-factor apportionment formula contained in UDITPA.  Prior to the decision inGillette, California took the position that use of the State's four-factor apportionment formula, with double-weighted sales, was mandatory, and that taxpayer's were not permitted to use the Compact's three-factor methodology.  The Court held that adoption of the Compact was a valid contract entered into with other states which could not be unilaterally changed or modified by the California legislature.  The Court stated that a taxpayer could be precluded from using the Compact's provisions only if the State withdrew from the Compact.  The Court of Appeals, on its own motion, vacated the decision, and issued a revised decision on October 2, 2012.  While the revised decision does not materially alter the conclusions reached in the first opinion, it appears to clarify that California's statute mandating the use of the State's four-factor formula is unconstitutional only to the extent it that it seeks to supersede the use of the UDITPA apportionment formula.   

After oral arguments in the case, but prior to the rendering of the first decision, the California legislature passed SB 1015 (effective June 27, 2012) which withdraws California from the Compact.  SB 1015 was adopted in part to prevent taxpayers from using the Compact's three- factor formula after the State's withdrawal from the Compact.  In an attempt to prevent taxpayer's from filing refund claims based on the Compact's apportionment methodology, SB 1015 also codifies the "Doctrine of Election" which generally provides that a taxpayer is bound by proper elections made on an original tax return.  It is unclear whether SB 1015 will withstand judicial scrutiny as the law was passed without the requisite two-thirds vote necessary to increase corporate taxes.  In addition, it is unclear whether codification of the Doctrine of Election can be used to deny refund claims where the State has consistently taken the position that no election was available under the Compact. 

In light of Gillette and SB 1015, California taxpayers should review returns filed for years beginning prior to 2011 to determine if it is beneficial to file amended returns or protective refund claims utilizing the Compact's apportionment methodology.  In this regard, the FTB has recently issued guidance outlining the methodology for filing protective refund claims based on the Gillette decision.  See FTB Notice 2012-01

For returns filed for tax years beginning in 2011, taxpayers should take into account the different souring rules for sales other than sales of tangible personal property.  Taxpayers should also be aware that electing to use the Compact's apportionment formula on an originally filed 2011 return (in conformance with the Doctrine of Election) may create an uncertain tax position with respect to any tax liability and related penalties.  With respect to the large corporate understatement penalty, the State has taken the position that the Gillette decision is not final until November 1.  As a result, on October 15 (when many calendar year 2011 returns are due), the ruling in Gillette is not yet the law in the State.  As a consequence, the FTB believes that if the Gillette decision is eventually overturned, there will be no "change in law" on which the taxpayer can rely in order to avoid the imposition of the large corporate understatement penalty (see  Fiscal year taxpayers with originally filed returns due after October 31, 2012 should consider whether they can make the election on such returns and avoid the penalty.

Update:  On January 16, 2013, the California Supreme Court granted the FTB's petition for review.