Amicus Brief — Container Corp. of America v. Franchise Tax Bd.

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d No. 81-523

In Tue

Supreme Court of the United States

Ocroszr Trerm, 1981

CONTAINER CORPORATION OF AMERICA,

Appellant,

FRANCHISE TAX BOARD,

Appellee.

ON APPEAL FROM THE SUPREME COURT

OF THE STATE OF CALIFORNIA

MOTION FOR LEAVE TO FILE

BRIEF AS AMICI CURIAE IN SUPPORT OF

APPELLANT'S JURISDICTIONAL STATEMENT

and

BRIEF AS AMICI CURIAE IN SUPPORT OF

APPELLANT'S JURISDICTIONAL STATEMENT

FRANCIS D. MORRISSEY

BAKER & McKENZIE

2700 Prudential Plaza

Chicago, Illinois 60601

(312) 861-2819

Attorney for Amici Curiae,

CANADIAN IMPERIAL BANK

OF COMMERCE

HIRAM WALKER RESOURCES LIMITED

Neo LIMITED

MacMILLAN BLOEDEL LIMITED

NORTHERN TELECOM LIMITED

WAWANESA MUTUAL INSURANCE

COMPANY

Of Counsel:

PETER B. POWLES

BAKER & McKENZIE

2800 Prudential Plaza

Chicago, Illinois 60601

(312) 861-2952

— SES AR NM

Midwest Law Printing Co., Chicago 60611, (312) 321-0220

In Taz

Supreme Court of the Anited States

Ocroszr Tt, 1981

CONTAINER CORPORATION OF AMERICA,

ON APPEAL FROM THE SUPREME COURT

OF THE STATE OF CALIFORNIA

MOTION FOR LEAVE TO FILE

BRIEF AS AMICI €URIAE

Canadian Imperial Bank of Commerce, Hiram Walker

Resources Limited, Inco Limited, MacMillan Bloedel

Limited, Northern Telecom Limited, and Wawanesa

Mutual Insurance Company hereby respectfully move

for leave to file their brief as amici curiae. Consent of

the attorney for the Appellant has been obtained. Con-

sent of the attorney for the Appellee has been denied.

Your amici are incorporated under the laws of Can-

ada, and conduct extensive business operations, either

directly or through subsidiary corporations, in Canada,

in other countries, and in the State of California.

In 1980, your amici had gross assets of approximately

69 billion Canadian dollars and total revenues of ap-

proximately 17 billion Canadian dollars. Your amici

control aproximately 270 significant subsidiaries through-

out the world.

Each amicus is a substantial representative of the

industry in which it operates. Canadian Imperial Bank

of Commerce is the second largest bank in Canada.

Hiram Walker Resources Limited is the second largest

Canadian distillery and a producer and distributor of

natural gas and petroleum. Inco Limited is the free

world’s largest producer of nickel. MacMillan Bloedel

Limited is the iargest forest products company in Can-

ada. Northern Telecom Limited is the largest telecom-

munications equipment supplier in Canada, and the

second largest in North America. Wawanesa Mutual

Insurance Company is the tenth largest casualty in-

surance company in Canada.

The California unitary tax has world-wide trade and

investment ramifications, including adverse effects on

your amici. The issues presented are critical to every

foreign corporation doing business either in California

or in any other state that applies a similar unitary

method of apportionment of income derived from

foreign commerce. That method of apportionment con-

flicts with uniform Federal policy governing the alloca-

tion of income between the United States and foreign

countries. The international political, trade, and com-

mercial consequences attendant upon California’s inter-

national application of the unitary method of appor-

tionment require this Court’s examination of the extent

to which Federal powers, Federal law, and international

treaties and customs constitutionally preclude California

from using its method of apportionment in a global

context which conflicts with Federal policy.

In supporting the Appellant, your amici request that

this Court restore the supremacy and uniform voice of

the Federal government in the conduct of foreign rela-

tions and thereby effect an improvement in the interna-

tional investment climate and minimize possible retalia-

tory trade actions.

Under the United States Constitution, your amici,

other international enterprises, and sovereign nations

cannot resolve their income apportionment disputes with

California or with any other state either by treaty or by

litigation in an international forum. Only a Federal

solution is Constitutional.

Your amici therefore respectfully request permission

to present to this Court their perspective as interna-

tional companies whose substantial investment in, and

trade with, the United States is particularly vulnerable

to action by individual states, which action results in

double taxation and impedes the free flow of inter-

national investment and trade.

Respectfully submitted,

FRANCIS D. MORRISSEY

BAKER & McKENZIE

2700 Prudential Plaza

Chicago, Illinois 60601

(312) 861-2819

Attorney for Amici Curiae,

CANADIAN IMPERIAL BANK

NORTHERN TELECOM LIMITED

WAWANESA MUTUAL INSURANCE

COMPANY

Of Counsel:

PETER B. POWLES

BAKER & McKENZIE

Prud

In Tue

Supreme Court of the United States

Ooronnn Term, 1981

CONTAINER CORPORATION OF AMERICA,

Appellant,

v.

FRANCHISE TAX BOARD,

Appellee.

ON APPEAL FROM THE SUPREME COURT

OF THE STATE OF CALIFORNIA

BRIEF AS AMICI CURIAE IN SUPPORT OF

APPELLANT'S JURISDICTIONAL STATEMENT

TABLE OF CONTENTS

QUESTIONS PRESENTED .

INTEREST OF THE AMICI CURIAE 2

SUMMARY OF ARGUMENT . . 3

ARGUMENT:

I.

Pervasive Federal Control Of Allocation Of

Taxable Income Between The United States

And Foreign Nations Pre-empts State Regu-

lation Of International Allocation Of Taxable

. 5

The International Application Of California's

Unitary Method Of Apportionment Of Taxable

Income Infringes Upon The Conduct Of

Foreign Relations, Which Is An Area Of

Exclusive Federal Authority . 9

III.

California’s Unitary Method Of Income Ap-

portionment, Applied Internationally, Inevita-

bly Results In Double Taxation And Im-

permissible Burdens On International Com-

merce In Violation Of The Due Process

And Commerce Clauses Of The Constitu-

tion ͤ—— 12

„ — — 18

TABLE OF AUTHORITIES

CASES:

Campbell v. Hussey, 368 U.S. 297 (1961) 5

Chy Lung v. Freeman, 92 U.S. 550 (1876) 11

Henderson v. Mayor of New Vork, 92 U.S. 543

I cecal latent ata aia lalallala 12

Hines v. Davidowitz, 312 U.S. 52 (1941) 5, 8, 11

Hoeper v. Tax Commission of Wisconsin, 284 U.S.

r snediniaeaiaiiade 15

Japan Line, Ltd. v. County of Los Angeles, 441

ee 4, 7, 8, 11, 12, 13, 14

Michelin Tire Corporation v. Wages, 423 U.S. 276

11ꝓ%%ͥͤ1i: ?“] . . ] ‚—,. .. 8. 12

Washington Revenue Department v. Association

of Washington Stevedoring Cos., 435 U.S. 734

1 ˙¹AA 12

Zschernig v. Miller, 389 U.S. 429 (1968) 9, 11

CONSTITUTIONAL PROVISIONS AND TREATIES:

I — ea 4, 13, 15

r 4

e 4,5

5 U.S. T. 2768, T.LAS. No. 3133; 16 U.S. T.

Dr iol 6

I 7

14 6

Press Release By British Information Depart-

ment, Hearings On H.R. 5076 Before The

House Comm. On Ways And Means, 96th

Comma, 6 Camm. SET CIGD cccccccsccesseccssccsccescessssees 11

State Taxation Of Foreign Source Income: Hear-

ings On H.R. 5076 Before The House Comm.

On Ways And Means, 96th Cong., 2d Sess.

. K 2 10

State Taxation Of Foreign Source Income: Hear-

ings On H.R. 5076 Before The House Comm.

On Ways And Means, 96th Cong., 2d Sess.

eee

State Taxation Of Interstate Commerce And

Worldwide Corporate Income: Hearings On S.

983 Before The Sub-Comm. On Taxation And

Debt Management Generally Of The Senate

Comm. On Finance, 96th Cong., 2d Sess. 75

TIT iss stoi nbadactemededaasinneibsidbeneeitisiinieiinehibiameaibiedduigthdid

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11

10

2

17

a

QUESTIONS PRESENTED

Whether allocation of income for tax purposes be-

tween the United States and foreign nations has been

pre-empted by the Federal government so that the

international application of the California formula

violates the Supremacy Clause;

Whether application of the California formula inter-

nationally interferes with accepted international and

Federal practice, thus preventing a uniform Federal

policy in the area of international taxation of income,

disrupting foreign trade relations, and thereby violating

the Commerce Clause; and

Whether application of the California formula to

income derived by a foreign-controlled unitary group

produces a substantial risk of international multiple tax-

ation in violation of both the Commerce Clause and the

Due Process Clause.

*

INTEREST OF THE AMICI CAE

Your amici are among the largest corporations in the

world and are leading companies in their own industries

and in Canada. All conduct the major part of their busi-

ness activities outside the United States, but have signif-

icant business interests in the United States, usually

through American subsidiaries. All are California tax-

payers.

Foreign multi-national corporations wishing to do

business in the United States face greater problems

with the international application of California’s unitary

method of apportionment than do domestic corporations.

The interest of your amici in this case arises from the

arbitrary results of the international application of Cali-

fornia’s unitary method of apportionment. This method

includes in the apportionment formula the sales, property,

and payroll of a foreign parent company, as well as

most, if not all, of its foreign subsidiaries, none of which

conducts business in California. The result in many

instances is that California imposes its income tax on an

apportioned amount of income far in excess of the actual

economic gain derived in California, and, in some

instances, in excess of the actual economic gain derived

from all business conducted in the United States.

A decision to note prebable jurisdiction would permit

this Court to review the merits of the Constitutional

issues and to prohibit the application of California’s

unitary method of income allocation internationally

where it contradicts a clearly defined Federal policy to

employ the “arm’s length—independent entity” method in

allocating income between the United States and foreign

—3—

nations. Such a result would limit the imposition of

California income tax to a properly apportioned amount

of income actvally derived within the United States by

your amici.

SUMMARY OF THE ARGUMENT

In exercising its exclusive control of foreign com-

merce, the Federal government has created an extensive

network of international agreements that pre-empt state

regulation of income allocation among nations. The Fed-

eral regulatory framework, expressed in over 40 income

tax treaties with governments around the world, creates

a comprehensive and coherent Federal policy of income

allocation on an “arm’s length—independent entity”

basis that entirely pre-empts state apportionment of in-

come between the United States and foreign nations on

any inconsistent basis. The instant case thus also

presents an important issue of Federal pre-emption

under the Supremacy Clause of the Constitution.

California’s unitary income apportionment scheme ap-

plied to foreign corporations constitutes state regulation

of foreign commerce, in violation of the Constitution’s

exclusive grant of such authority to the Federal govern-

ment. In regulating foreign commerce, California jeop-

ardizes the ability of the Federal government to define

and implement United States trade policy and interferes

with the conduct of international relations. Such state

regulation violates an exclusive Constitutional grant of

power to regulate foreign commerce and ignores the

justifications of that grant, articulated in this Court’s

—

recent opinion in Japan Line, Lid. v. County of Los

Angeles, 441 U.S. 434 (1979).

Additionally, the California system of apportioning

income internationally ebridges the Due Process Clause

of the Constitution through arbitrary and substantial

misallocation and double taxation of income.

The instant case presents, in a heretofore unconsidered

international context, the unconstitutionality of such

arbitrary misallocations as burdens on international

commerce under the Commerce Clause, and a denial of

due process.

Constitutionally, your amici and their government must

rely upon Federal definitions of United States trade

policy. The global application of the California system

demonstrates state action compromising United States

foreign relations. Your amici respectfully urge this

Court to note probable jurisdiction and to reaffirm the

Constitutional allocation of power to the Federal govern-

ment, and to redress the unconstitutional effects of state

regulation.

*

ARGUMENT

I

PERVASIVE FEDERAL CONTROL OF ALLOCA-

TION OF TAXABLE INCOME BETWEEN THE UNITED

STATES AND FOREIGN NATIONS PRE-EMPTS STATE

REGULATION OF INTERNATIONAL ALLOCATION

OF TAXABLE INCOME.

Under the Supremacy Clause, Federal pre-emption of

state regulation results from either a prevalent need for

uniform Federal regulation or the existence of a perva-

sive scheme of Federal controls. Both criteria are met in

the regulation of international allocation of taxable in-

come and require this Court’s review of California regu-

lation of a federally pre-empted field.

When finding pre-emption as a result of a pervasive

scheme of Federal controis, this Court has never re-

quired a direct conflict between express language of

state and Federal regulations. Campbell v. Hussey, 368

U.S. 297 (1961). Particularly in foreign relations and

other areas of exclusively Federal competence, Federal

action can entirely pre-empt even those state regulations

that appear on their face to be consistent with Federal

action. Hines v. Davidowitz, 312 U.S. 52 (1941)

The United States maintains a pervasive scheme for

the international allocation of income for tax purposes.

The United States has entered into income tax treaties

with approximately 40 foreign nations. These treaties

create a detailed and sophisticated set of rules designed

to allocate income between the United States and each

treaty nation. Tax issues covered by the treaties include

the circumstances under which an enterprise of one

country becomes subject to taxation in another, agreed

exemption of certain kinds of income from taxation,

a

allocation of income among related enterprises, and

arrangements to prevent double taxation of the same

income.

Income tax treaties are negotiated to avoid and re-

solve conflicts as to which nation shall tax income. Such

treaties necessarily include rules allocating taxable

income. These income tax treaties of the United States

establish a uniform Federal policy under which taxable

income is allocated between the United States and

foreign countries according to the “arm’s length—

independent entity” principle.

Nearly all income tax treaties contain language to the

following effect:

Where an enterprise of one of the contracting

States is engaged in trade or business in the other

State through a permanent establishment situated

therein, there shall be attributed to such permanent

establishment the industrial or commercial profits

which it might be expected to derive if it were an

independent enterprise engaged in the same or

similar activities under the same or similar con-

ditions and dealing at arm’s length with the enter-

prise of which it is a permanent establishment.'

The United States Internal Revenue Service Office of

International Operations, in common with similar foreign

authorities, actively implements these and other tax

treaty provisions, which are closely integrated with the

Internal Revenue Code of the United States.2 The

1 See Article III(2) of Income Tax Treaty between the United

States and Germany, as amended by December 27, 1965,

rotocol. 5 U.S. T. 2768, T. I. A. S. No. 3133; 16 U.S.T. 1865,

.AS No. 5920.

2 See I. R. C. § 482 and Treas. Reg. § 1.482-1(a\1):

The purpose of section 482 is to place a controlled

taxpayer on a tax parity with an uncontrolled taxpayer,

(Footnote continued on following page)

=

treaties also provide for resolution of alleged double

taxation by referring conflicts to the competent author-

ities of each contracting nation.

The need for international income tax treaties is well-

illustrated by several industries. The income tax treaty

between the United States and Canada recognizes the

economic realities of international commerce involving

the operation of ships and aircraft. Under the treaty,

earnings derived from the operation of ships and air-

craft in international traffic by enterprises registered in

one country are exempt from tax in the other country on

a reciprocal basis.“ This provision thus allocates taxable

income between the two countries according to an ex-

plicit Federal policy. Cf. Japan Line, Ltd. v. County of

Los Angeles, 441 U.S. 434 (recognizing Federal policy

regarding the susceptibility of instrumentalities of

commerce to property taxation). The need for inter-

national agreement in allocating income in other

industries is equally prevalent and is recognized by the

treaties. Inconsistent state regulation is incompatible

with this need. As is discussed later, California’s unitary

method of apportionment of income is clearly incon-

sistent with the Federal “arm’s length—independent

entity” policy.

The pervasive scheme of Federal control that has tradi-

tionally led this Court to find Federal pre-emption is

readily apparent in the extensive network of inter-

2 continued

by determining, according to the standard of an un-

controlled taxpayer, the true taxable income from ihe

property and business of a controlled taxpayer.

8 See Article VIII of the Tax Treaty between the United

States and Canada dated March 4, 1942, 56 Stat. 1399, T.S.

983. The new treaty between the U.S. and Canada, now in the

process of ratification, contains the same policy.

—$—

national income tax treaties. That network reveals a

Federal policy to regulate, at the international level, the

allocation of taxable income between the United States

and any particular foreign nation, excluding inconsistent

or supplementary state regulation of the same subject

matter. As this Court stated in Hines v. Davidowitz, 312

U.S. 52, 62-63 (1941):

When the national government by treaty or statute

has established rules and regulations touching the

rights, privileges, obligations or burdens of aliens

as such, the treaty or statute is the supreme law of

the land. No state can add to or take from the force

and effect of such treaty or statute.

This Court found a uniform Federal policy in Japan

Line after examining a far less extensive international

regulatory framework than is applied to the inter-

national allocation of taxable income. Your amici

respectfully suggest that the uniform adherence to the

“arm’s length—independent entity” method in more than

40 income tax treaties to which the United States has

become a party reveals an even greater Federal policy

of uniformity, which cannot tolerate the diverse and

contradictory state regulations exe:nplified by the Cali-

fornia decision.

Applying traditional pre-emption analysis, Federal

pre-emption of state control of international taxable

income allocation is justified by the prevalent need for a

uniform international policy, as well as by the existing

Federal controls. The need for a uniform policy and

“speak{ing] with one voice” in international affairs has

been recognized by this Court. Michelin Tire Corpo-

ration v. Wages, 423 U.S. 276, 289 (1976). California’s

unitary method of apportioning income on an inter-

national basis prevents this need from being met. This

8

issue of Constitutional supremacy of Federal over state

regulation of international tax matters merits review by

this Court.

II.

THE INTERNATIONAL APPLICATION OF CALI-

FORNIA’S UNITARY METHOD OF APPORTIONMENT

OF TAXABLE INCOME INFRINGES UPON THE CON-

DUCT OF FOREIGN RELATIONS, WHICH IS AN

AREA OF EXCLUSIVE FEDERAL AUTHORITY.

California regulation of taxable income allocation

among nations has affected “international relations in a

persistent and subtle way.” Zschernig v. Miller, 389 U.S.

429, 440 (1968). State “regulations must give way if they

impair the effective exercise of the Nation’s foreign

policy.” Id.

Foreign sovereigns perceive the global application of

state unitary apportionment schemes as unjustified at-

ternpts by individual states to extend their tax reach far

beyond the territorial boundaries of the United States.

As expressed by the Italian government, on its own

behalf and on behalf of the nine EEC governments:

Our Governments are concerned about tne applica-

tion to U.S. subsidiaries of foreign companies of the

unitary basis of taxation as applied in California

and in varying degrees by certain other States... .

This method is incompatible with the principles

accepted by all OECD member [countries] and

recommended to all [countries] as a basis for the

taxation of subsidiaries or permanent establish-

ments of foreign enterprises. These principles re-

quire that a subsidiary should be taxed only on the

profits it actually has made, provided that these are

based on dealing at “arm’s length” between the sub-

—10—

sidiary and the related enterprises. (Emphasis

added.).

The same concerns were echoed by the British Na-

tional Committee of the International Chamber of Com-

merce. Referring to the unitary apportionment of inter-

national income by California, the Committee's repre-

sentative testified:

Such actions by the States also violate the treaties of

friendship and commerce which we have entered

into in the United States with 25 foreign nations. This

fairly invites retaliation by foresem governments against

U.S. companies, with serious potential burdens on

U.S. business overseas. (Emphasis added.)

California’s involvement in apportioning income inter-

nationally has significant effects on international rela-

tions. Tax policy, foreign trade, and foreign policy are

all intimately related.

The British government has underscored the potential

risks of continued California interference with a pre-

existing Federal policy that is the result of careful nego-

tiation among the trading partners of the United States.

Unless common rules for determining the allocation

of profits between different taxing jurisdictions are

followed internationally it will be impossible to

preserve the essential objective of providing a con-

sistent and coherent international tax framework

4 State Taxation of Foreign Source Income: Hearings on

H.R. 5076 Before the House Comm. on Ways and Means, 96th

Cong., 2d Sess. 360 (1980).

5 State Taxation of Interstate Commerce and Worldwide

— rate Income: Hearings on S. 983 Before the Sub- Comm.

axation and Debt Management Generally of the Senate

8 on Finance, 96th Cong., 2d Sess. 75 (1980). The same

group has also concluded that the California system “creates

major barriers to United Kingdom investment in the United

a and to international trade between our two countries.”

for business and investment, for which the United

States and the United Kingdom have striven together

with their fellow members of the Organization for

Economic Co-operation and Development. It is the

view of Her Majesty’s Government that the unitary

basis, which is not a practical international alterna-

tive to the “arm’s-length” basis, could undo the

important and patient international work that has

been achieved in regulating international tax practi-

ces, and that every effort is required to discourage

— 4 LI or the extension of that basis. (Emphasis

Consistent with the Constitution, this Court has pro-

hibited state regulation of issues that impact upon for-

eign relations. Experience has shown that international

controversies of the gravest moment, sometimes even

leading to war, may arise from rea! or imagined wrongs

to another’s subjects inflicted, or permitted, by a govern-

ment.” Hines v. Davidowitz, 312 U.S. 52, 64 (194 1). Policies

risking foreign retaliation should be pursued only upon

a Federal evaluation of the consequences and a Federal

decision to proceed. Chy Lung v. Freeman, 92 U.S. 550

(1876). This Court’s opinion in Japan Line, Ltd. v.

County of Los Angeles, 441 U.S. 434 (1979), reiterated

the Constitutional requirement of reserving to the

United States all power over issues that might pre-

cipitate dramatic retaliation by foreign sovereigns

acting on behalf of their commercial constituents. State

regulation that potentially impacts upon foreign rela-

ticns or jeopardizes the power of the Federal govern-

ment to deal comprehensively with those problems must

be invalidated. Zschernig v. Miller, 389 U.S. 429 (1968).

6 Press Release by British Information Department, Hear-

ings on H.R. 5076 Before the House Comm. on Ways and

Means, 96th Cong., 2d Sess. 317 (1980).

= =

In international relations, the political and the eco-

nomic are inseparable; indeed, one is often the induce-

ment for the other. The complicated interface of United

States trade policy with foreign nations dictates ex-

clusive Federal responsibility for diplomatically tailor-

ing the regulation of foreign commerce in pursuit of

United States foreign policy. Henderson v. Mayor of New

York, 92 U.S. 543 (1876).

The United States must “speak with one voice,” 423

U.S. at 285, and only the exclusive Federal control of

foreign commerce can produce that result. See Javan

Line, Ltd. v. County of Los Angeles, 441 U.S. 434 (1979);

Michelin Tire Corporation v. Wages, 423 U.S. 276 (1976);

Washington Revenue Department v. Association of Wash-

ington Stevedoring Cos., 435 U.S. 734 (1978).

Your amici respectfully request this Court to note

probable jurisdiction and review the California decision

in this case.

CALIFORNIA’S UNITARY METHOD OF INCOME

APPORTIONMENT, APPLIED INTERNATIONALLY,

INEVITABLY RESULTS IN DOUBLE TAXATION AND

IMPERMISSIBLE BURDENS ON INTERNATIONAL

COMMERCE IN VIOLATION OF THE DUE PROCESS

AND COMMERCE CLAUSES OF THE CONSTITUTION.

Application of the California unitary method of appor-

tionment leads to taxation of more than the actual eco-

nomic gain of a unitary group in any instance where

profitability’ is higher outside the United States than

inside the United States. In such circumstances, the uni-

7 Ascertained under the “arm’s length—independent entity”

— and expressed as a percentage of sales, property, and

=x =

tary method of apportionment has the effect of shifting

taxable income into the United States.“ However,

foreign countries do not decrease income taxable in their

countries merely because a state of the United States

has used the unitary method of apportionment to

increase its share of taxable income. The inevitable

result is double taxation of the amount of income shifted

into the United States.

In Japan Line, this Court observed:

In addition to answering the nexus, apportionment,

and nondiscrimination questions posed in Complete

Auto, a court must also inquire, first, whether the

tax, notwithstanding apportionment, creates a sub-

stantial risk of international multiple taxation, and,

second, whether the tax prevents the Federal Govern-

ment from “speaking with one voice when regulat-

ing commercial relations with foreign governments.”

If a State tax contravenes either of these precepts,

it is unconstitutional under the Commerce Clause.

Japan Line, Ltd. v. County of Los Angeles, 441 U.S. at

451.

Your amici submit that the application of the Califor-

nia unitary method of apportionment in the interna-

tional context inevitably falls within the language quoted

above. Taxing “more than one full value,” Id. at 448, is

no less repugnant to the Commerce Clause when the

This situation can be mathematically illustrated by as-

es 2 Canadian company that has a 28 owned Califor-

nia subsidiary engaged in business only in California. Assume

further that true economic gain of the combined group is 8100

and under the — 1 entity arm's length approach, 890

is earned in Canada and $10 in California but that 20% on

average of combined sales, property, and r is in Califor-

nia. In such circumstances, income subjected to tax in Canada

would be $90 and income subjected to tax in California would

be $20 for a combined taxable income of $110.

8

subject matter of the tax is total income than when it is

tangible personal property as in Japan Line.

In many instances, the international operation of

California’s unitary method of income apportionment will

result in substantially higher tax burdens for subsi-

diaries of foreign corporations than for their domesti-

cally owned competitors. This result denies due process.

As an exampie, assume two domestically owned inde-

pendent manufacturers with identical California opera-

tions. If one of them is purchased by a more profit-

able foreign corporation with no other operations in

the United States, and operations of the purchased

California company remain the same, it will be burdened

with higher taxes than its California competitor. The

additional taxes paid will be exclusively the result

of the higher profitability of its new foreign parent

in another country. Its domestically owned competitor

will not suffer this increased tax. In effect, the

purchased company is being penalized by California

for being owned by a more profitable foreign enterprise.

A second example involves a profitable foreign corpo-

ration attempting to enter the United States market and

incurring significant start-up losses as a result. Not-

withstanding actual economic loss in the United States,

the California segments of the business will be required

to pay California taxes on income that is being earned in

Canada, has remained in Canada, and is not the product

of the California operation. As a result, California opera-

tions are clearly being required to pay tax on income

earned by a different entity outside the United States.

There are numerous other examples of events occur-

ring outside the United States which do not affect

California sales, property, or payroll in any way but never-

—15—

theless have an arbitrary effect on California taxable

income. For example, a change in exchange rates, nation-

alization of a profitable foreign subsidiary, discovery of

a new oil field, destruction of a plant or loss of a timber

stand to fire, or the purchase of new profitable operations

overseas all have this effect.

Many of the above examples are commonplace. The

effect of the unitary method of apportionment applied

internationally is to tax United States subsidiaries of

more profitable foreign corporations on income that is

earned by the foreign parent company, or its foreign

subsidiaries, rather than by the United States sub-

sidiary.

This Court has held that taxation of one person on the

basis of the income of another person is unconstitutional.

In Hoeper v. Tax Commission of Wisconsin, 284 U.S. 206

(1931), while determining the validity of a state income

tax law that imposed combined reporting on members of

a family, this Court held:

We have no doubt that, because of the fundamental

conceptions which underlie our system, any attempt

by a state to measure the tax on one person’s prop-

erty or income by reference to the property or

income of another is contrary to due process of law

as guaranteed by the 14th Amendment. That which

is not in fact the taxpayer’s income cannot be made

such by calling it income.

284 US. at 215.

In reality, the unitary method of apportionment, at

least as applied on an international basis, results in an

apportionment of taxable income to California, which in

many cases is so arbitrary as to result in a denial of due

process and a violation of the Commerce Clause.

==

Whether a result is “arbitrary” must be measured

against what is possible or practical. Your amici take no

position as to what may be practical or possible with

respect to allocation of previously determined Federal

taxable income between the various states of the United

States. Your amici strongly contend, however, that the

Federally adopted “arm’s length—independent entity”

approach for allocation of income between the United

States and all foreign nations® achieves fewer arbitrary

results than California’s unitary method. The California

method results in a global averaging of income in pro-

portion to sales, property, and payroll. This method is

totally insensitive to economic realities; results in

obvious misallocation of income as illustrated above;

ignores tax exemptions, cash grants and other incentives

offered to investors by a number of foreign governments;

and is further distorted by fluctuations in international

currency exchange rates, which fluctuations are now

substantial and frequent. The results of the California

unitary method of apportionment are inconsistent with

the Federal “arm’s length—independent entity” approach.

The arguments advanced to support application of

California’s method to foreign subsidiaries of United

States corporations reveal the inequities of applying that

method to United States subsidiaries of foreign corpo-

rations. The primary theoretical justification for Cali-

fornia’s use of the unitary method internationally is that

foreign subsidiaries of the unitary group do not

adequately compensate their United States parent

company for “intangible benefits” such as research and

In addition to : set out hg all i ae tax treaties of the

United States, this approach 11 to non-treaty nations

also, pursuant to Section 482 “of Internal Revenue Code

and regulations thereunder.

afin

development, management expertise, know-how, finan-

cial support, and the provision of administrative services,

the expense of which may be borne by the parent

without corresponding payment from the subsidiary.

Assuming the doubtful validity of this justification,’

when the parent company providing the “intangible

benefits” is located outside the United States, this theo-

retical justification should apportion more income to the

foreign parent from the United States subsidiary. None-

theless, by applying its system as it does, California

imputes income to United States subsidiaries of your

amici that are in start-up loss situations in the United

States, and thereby ignores the identical arguments

used in the instant California decision to justify

California’s unitary method of apportionment.

The injustice of California’s global application of the

unitary method is compounded by the fact that a

corporation’s presence in California subjects all foreign

components of a non-American multi-national group to

substantial additional expense. Foreign corporations, for

example, may prepare their accounts in foreign currency

rather than in dollars; may not use United States

accounting conventions; and may compute taxable

income in accordance with the laws of the foreign

nations where they are doing business. Substantial costs

and unproductive diversion of expertise unduly and

harshly burden foreign multi-national groups that are

subjected to the conversion of foreign operating results

into United States currency in accordance with United

10 The validity is doubtful because of the Internal Revenue

Service practice of imputing income to cover such items. See,

2 Treasury Reg. § 1.482-2(c) requiring an arm's length”

charge for use of intangible property.

’

— 1

States accounting conventions, and recalculation of those

results in accordance with United States tax principles

merely because the enterprise has a minor subsidiary in

California. The United States Treasury Department has

also long since recognized the inherent difficulties of

unitary reporting."

1 This practice creates three types of probleris: (1) It can

result in a determination of income for state tax purposes

which is substantially different than the income which

would be attributed the corporation doing business in the

state if an arm’s-length or se te accounting method

were — the r . —y «gen 4 — —

three apportionmen rs (payroll, property, an es

and the income to be apportioned differs markedly in

foreign countries from the relationsnip which generally

applies within the United States, the measurement of

income by this method can result in serious distortions. In

practice, the unitary apportionment system appears in

comparison to an arm’s-length or separate accounting

me to generate substantially more taxes for the states.

(2) The practice can im a substantial administrative

burden, involving annual translation of the books of what

may be a substantial number of foreign corporations into

U.S. accounting concepts and U.S. currency. (3) The

ractice has created, and continues to create, an irritant

in the international relations of the United States. A

number of foreign governments have complained, both

officially and informally, that the unitary system differs

from arm’s-length method used by the Federal

Government and generally accepted in international

practice.

State Taxation of Foreign Source Income: Hearing on H.R.

5076 Before the House Comm. on W and Means, 96th

Cong., 2d Sess. 7 (1980) (Statement of Donald C. Lubick,

former Assistant Secretary of Treasury for Tax Policy).

atin

CONCLUSION

While this Court has addressed issues of unitary taxa-

tion in the domestic context, this case underscores the

greater and different Constitutional issues raised by

application of the unitary method internationally.

Your amici and their government are prohibited by

the United States Constitution from effecting treaties

with any of the 50 states and must, therefore, depend upon

the Constitutional supremacy of the single voice with

which the Federal government speaks in international

affairs. Accordingly, your amici respectfully urge this

Court to not probable jurisdiction so that this Court

may decide the substantial Constitutional questions

presented by the California court. Without review of this

case, a California scheme of apportionment that burdens

international commerce, that offends trading partners of

the United States, and that imposes unconstitutional

double taxation will be permitted to interfere in an area

subject solely to Federal regulation.

Respectfully submitted,

FRANCIS D. MORRISSEY

BAKER & McKENZIE

2700 Prudential Plaza

Chicago, Illinois 60601

(312) 861-2819

Attorney for Amici Curiae,

CANADIAN IMPERIAL BANK

MacMILLAN BLOEDEL LIMITED

NORTHERN TELECOM LIMITED

WAWANESA MUTUAL INSURANCE

COMPANY

Of Counsel:

PETER B. POWLES

BAKER & McKENZIE

2800 Prudential Plaza

Chicago, Dlinois 60601

(312) 861-2952