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

AEE Se al - - -T Office-Supreme Court, U.s.

fishy | FILED

No. 81-523 OCT 15 1982

ye aa : ALEXANDER L. STEVAS,

CLERK

IN THE

SUPREME COURT OF THE UNITED STATES

October Term, 1982

CONTAINER CORPORATION OF AMERICA,

Appellant,

Vv.

FRANCHISE TAX BOARD,

Appellee.

ON APPEAL FROM THE COURT

OF APPEAL OF THE STATE

OF CALIFORNIA, FOR THE

FIRST APPELLATE DISTRICT

APPELLEE'S BRIEF ON THE MERITS

GEORGE DEUKMEJIAN

Atcorney General

NEAL J. GOEAR

Deputy Attorney General

110 West A Street, Ste 790

San Diego, California 92101

(714) 237-7308

Counsel for Appellee

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~90-

III

CCA HAS NOT SHOWN

DISTORTION BY THE

FORMULA

CCA advances three arguments in

support of its position that the use of

the unitary business principle by California

in this case results in substantial

misattribution of income in violation of

the Due Process Clause. First, it argues

that formula apportionment attributes

significantly more inczome to California

than was determined for federal income

tax purposes by applying the "sophisticated"

accounting techniques prescribed by the

Internal Revenue Service. Second, it

argues that there are significant

differences in wage rates between the

United States and foreign countries

resulting in misapportionment of income.

Finally, it argues that profitability of

foreign operations, expected and actual,

is higher and this fact is not reflected

in the formla.

CCA's failu:-e to set out any facts

pertaining to these a:-guments in its

Statement of the Case should cause peremptory

rejection of these arguments. Additionally,

examination of each o= the arguments and

the evidence submitted in support of

them demonstrates that CCA has not

established that any misattribution of

income occurs.

A. Separate Accounting Data

Does Not Impeach the Formula

The use of separate accounting

data to impeach formula results was

recently rejected by t:he court in Exxon.

"As this court has on

several occasions recognized, a

conpeny 8 internal accounting

techniques are not binding on

a State for tax purposes. For

example, in Butler Bros. v.

McColgan, supra, an interstate

business challenged the application

of the California apportionment

Statute. The company was engaged

in the wholesale dry goods and

general merchandise business as

a middleman,and it had distributing

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houses in seven States, including

one in California. Each house

maintained stocks of goods, had

a cognizable territory, had its

own sales force, did its own

solicitation of sales, made

its own credit and collection

arrangements, and kept its own

books. There was, however, a

central buying division that

was able to purchase goods for

resale at a lower price. The

company used 'rezognized accounting

principles,' [citation] to allo-

cate all costs aid charges to

each house, with certain

centralized expenses allocated

among the houses. Based on that

‘separate accounting system,'

[citation] the business asserted

there was no net income in

California.

"We concluded that California

could constitutionally apply its

apportionment formula to the

company's total net income to

establish taxable income, rather

than being limited to the income

shown by the tax>ayer's

accounting methods to be

attributable to che one house in

that State. The company had the

‘distinct burden of showing y

"clear and cogen: evidence” that

it results in extraterritorial

values being taxed, '[quoting

Norfolk and Western R. Co. v. North

Carolina 297 U.S. 682] and the

taxpayer's accounting evidence was

insufficient to meet that burden.

-93-

""lWle need not impeach the

integrity of tha: accounting system

to say that it does not prove

appellant's assextion that extra-

territorial values are being taxed.

Accounting pract:ices for income

statements nay vary considerably

according to the problem at hand.

. » A particular accounting

system, though useful or necessary

as a business aid, may not fit the

different requirements when a

State seeks to tax values created

business within its borders .

at may be due to the fact, as

stated by Mr. Justice Brandeis

in Underwood Typewriter Co. v.

Chamberlain, 254 U.S. 113, that a

State in attempting to place upon

a business extencing into several

States "its fair share of the

burden of taxaticn" is "faced with

the impossibility of allocating

specifically the profits earned

by the processes conducted within

its borders." Furthermore, the

particular systen used may not

reveal the facts basic to the

State's determination. [Citation.]

In pe Mt Si aspect of the matter,

the results of the accounting system

employed by appellant do not

impeach the bigernees | or propriety

of the formula which California

has applied here.'"

xon Corp. v. Wisconsin, supra,

Sa 7, ni

Evidence of the merit of the

Court's analysis exists both in a general

-94-

context and in the specifics of this

case. The General Accounting Office (GAO)

has recently released a study of the

Internal Revenue Service's administration

of the arm's-length standard and found:

"Multinational corporations have

both the incentive and the

opportunity to shift income

between jurisdictions to take

advantage of disparate corporate

tax rates. One incentive is

minimization of taxes. The

opportunity lies in the pricing

of interorganizational trans-

actions. Obviously, possession

of incentive and opportunity

does not axiomatically lead to

abuse--but to tax administrators,

American and foreign, it repre-

sents a vulnerability to guard

against.

"IRS, however, has not yet

developed baseline information on

the incidence and magnitude of

multinational corporation non-

compliance in terms of improper

shifting of income. Thus, IRS

has no sound basis for determining

the amount of audit resources to be

assigned to address the problem,

nor for gauging the suc. ess of

those resources that are applied

to it.

"Further, IRS enforcement

difficulties are compounded by

-95-

the complexities involved in

measuring the amount of income

misallocated in those instances

where this is believed to have

occurred. ldeally, interorganiza-

tional pricing is to be adjusted

to that for similar transactions

between unrelated parties--the

so-called ‘arm's length standard.'

"However, in the modern

economic system of multinational

corporate business, a true arm's

length price can rarely be

identified. When an arm's length

price cannot be identified,

Department of Treasury regulations

for Internal Revenue Code Section 482

provide both the corporate taxpayer

and the IRS examiner some guidance

for arriving at a constructed

price. The regulations and the

resulting enforcement process,

however,create an unacceptable

level of uncertainty and a

significant administrative burden

both for corporate taxpayers and

IRS examiners."

(Report to the Chairman, House

Committee on Ways and Means by the

Comptroller General, Sept. 30, 1981,

pp. 24, 53-54.)

In at least three cases, Bass,

Butler Bros. and Exxon, this Court has

sustained a state's attribution of income

to activities in that state even though

the company's separate accounting (federal

-96-

tax return) showed that it earned no net

income in that state.

For a further comparison of the

unitary met:hod and the so-called "arm's

length" standard and, specifically, the

inadequacies of the érm's-length method,

see "Multinational Corporation and Income

Allocation Under Section 482 of the

Internal Revenue Code," 89 Harvard Law

Review 1202 (1975) ard the Harley

Treatise, appendix E hereto.

In the case at bar, the parties

have stipulated to the accuracy of the

data contained in a number of exhibits

filed with the Califcrnia courts. CCA

argues that: this separate accounting data

should be controlling in determining the

amount of its California income. Similar

stipulations and arguments were

specifically made in Butler Bros., supra,

and in many other cases and have not been

found controlling. Examination of the

-97=

documents and the stipulation in this

case discloses why they are not.

CCA was not fully compensated for

various services rendered to and benefits

it conferred upon its foreign subsidiaries.

Specifically, CCA stipulated that the

value of many such services could not be

ascertained; reimbursement received under

some Technical Service Agreements was only

to the extent allowec by the foreign

governmencs; used equipment was sold at

book, not fair market value; CCA brokeraged

equipment at a fee less than would be

charged by a third party; no fees were paid

for loan guarantees; interest paid to CCA

by its subsidiaries was apparently far

below normal interest: rates; other services

were provided without: being paid for.

(See pp. 32-35, supra.) There were

-98-

substantial amounts of Subpart F income .23/

(J.A.:Ex p. 7.)

In sum, CCA has not established

that net income either shown in its

Separate accounting records or reported for

U.S, income tax purpores accurately reflects

the many contributions made by CCA to its

subsidiaries, but on the contrary, substantial

contributions by CCA «re not reflected

accurately or at all.

Further, even accepting CCA's

separate accounting figures, the formula

only apportions less than .01 more of the

unitary worldwide net income to California

over the .07 which CCA concedes that

23. Subpart F income is determined

under Internal Revenue Code, sections 951l-

964. In general it is income ang by

a corporate group to a controlled foreign

corporation which is redetermined for

federal purposes to be taxable to the

ent company in the United States. Appellant,

its presentation on pages 16 andl7, has not

included this income in its calculations of

U.S. source income.

-99-

California may tax. (See pp. 36-37, supra.)

B. Differing Wage Rates and

oA

The second and third arguments

advanced by CCA in support of its misattrib-

ution of income arguments are dependent

upon separate accounting data for their

analysis. Such data ias already been

shown to be inaccurat2 and in any event,

inappropriate for use in state tax on

income of a unitary bisiness. Furthermore,

even assuming arguend) the separate

results of the variou; entities provided

valid data for comparative purposes, these

arguments fail becaus2 the premise on

which they are based is false and because

CCA has not offered any supporting

relevant data.

The premise on which these

arguments is based is that a dollar of

payroll or property expended or used in

one state, and a dollar of sales realized

-100-

in one state, typically produced roughly

the same amount of income as a dollar so

spent or sales made in other states.

(J.S. p. 17.)

This premise is false, as both

the California courts and this Court have

recognized.

"In the agpereionnent of a unitary

business the formula used must

give adequate weight to the

essential elemen-:s responsible

for the earning of the income .

but its propriety in a given

case does not require that the

factors appropriately employed

be equally productive in the

taxing state as <hey are for

the business as a whole.

Varying conditions in the different

states wherein the integrated

rts of the whole business

mction must be expected to

cause individual deviation from

the national average of the

a in the formula equation,

Pa the mutual dependency

of the interrela-ed activities

in furtherance of the entire

business sustain; the apportion-

‘ment process." (John Deere Plow Co.

of Moline v. Franchise Tax Board,

Cal.2d 214,app.dis. 343 U.S. 939.)

Formula apportionment dces not

assume that a dollar spent in Latin America

-101-

had the same value as a dollar spent in Cal-

ifornia, or that a dollar in wages has some

relative productivity as a dollar of property.

Property, labor and sales all contribute

to the ultimate net income of a business.

A state provides services to protect

property and workers as well as sales,

which would have some rational relationship

to the quantities of property, labor and

Sales activity present: in the taxing state.

A unitary business mav have none to a great

deal of any of the thiree factors, depending

on how and where a business operates.

In support of its wage differential

argument, CCA submitted evidence to the

California courts that the average hourly

wages paid in various countries were less

than those paid in the United States,

both absolute and when adjusted for pro-

ductivity. But the data submitted and

studies referred to involve a variety of

--102-

years, none of which is involved in this

appeal.

Where machinery is automated, the

number of workers (and wages) will be

reduced substantially, but a single machine

operator will probably be more highly paid

and (together with his machine) will produce

more. A research facility with many

expensive scientists will raise the wage

factor substantially wherever it is

located; but it will produce no sales

there. The three factors are interdependent

and cannot be analyzed separately. Nothing

is proven by simply comparing wage rates in

one place to those in another .24/

24. The wage figures which CCA tries

to use are in part just general statistics

by countries which have not been shown to

apply to CCA. CCA's own figures are for

different years from those in issue. FTB

disputes the correctness and applicability

here of such figures and the testimony on

which they are based. Since the

California courts ruled against CCA they

may not be treated as correct on appeal.

-103-

As this Court stated in Norfolk &

W. R. Co. v. North Carolina, supra, 297 U.S.

682, in the context of a different apportion-

ment formula, but the same logical consider-

ation:

"The lications of the formula

being what they are, a taxpayer

does not escape the application of

the statute by evidence directed

to only one of the related terms.

Its evidence to be effective must

be directed to each of them alike,

for only thus can the assumed

relation between them be proved

to be unreal." (Id, at p. 688,

emphasis added. )

The third argument advanced by

CCA in support of its misattribution theory

is that the expected and actual rate of

return on foreign investments is higher

than the return on United States investments.

The use of the return-on-invest-

ment analysis for foreign subsidiaries was

subject to criticism is a Harvard Business

Review article by Sidney M. Robbins and

Robert B. Stobaugh entitled "The Bent

Measuring Stick for Foreign Subsidiaries."

-104-

(Sept-Oct 1973, p. 80.) The article was

directed to the problem of evaluating

management performance, but is equally

. applicable to the present setting.

"[T]heir underlying assumption

typically is that a subsidiary can

can be reviewed by using a

companywide return-on-investment

O1) criterion, with only a

ew necessary adjustments.

Such an approach not only

neglects significant aspects

of subsidiary operations but

also fails to consider the

reasons for which the

ubeisiagy was originally

founded .25/

25. "The use of an

enterprisewide criterion such

as return on investment as a

yardstick against which to

measure performance implies

that the financial statements

of a subsidiary reflect its

performance. However, to do so

accurately, these statements

must be adjusted to take into

account the extent to which

the subsidiary influences the

profits of the other units in

the system. Yet any enterprise

attempting to make such

adjustments encounters acute

complexities."("The Bent

Measuring Stick . . .", supra,

at p. 83.) Fn. cont'd

-105-

The investment return analysis

ignores the substantial contributions by

the

the parent of a unitary business to the

Fn. 25 cont'd

Such adjustments have not been made by

CCA and probably could not be made.

Companies make investments in

foreign operations fcr long-range

strategic considerations,

[H]owever, they tend to forget

this fact when subsequently

a * their foreign

subsidiaries’ performance.

The system in all its inter-

relationships is liable to

be hidden under an account

book when the moment arrives

to add up the score and judge

the performance of individual

foreign units...

(Bent “Measuring eed es

supra, at p.

Items which can affect the analysis are:

". . . @ parent's ,ouarantee

of a loan .

(Id., at p. 81)

"Then there are the

intagible items, such as the

strategic considerations

discussed earlier, whose

worth or cost is even more

2lusive; to date they have

universally been omitted

-106-

foreign subsidiary's book profits which

do not take into consideration the

substantial costs of developing a business

Fn. 25 cont'd

from the initial formal

calculations. For example,

no manager of a major oil

compary would want to risk

being left out of a potentially

iant oil field that one of

is company's rivals is

exploring, even if the calcu-

lations of expected costs and

returns might show a loss when

discounted cash flow procedures

are used. The risk of a

rival finding a huge, low-cost

oil field, and thereby gaining

a superior long-run competitive

position, is too big for the

manager to take. Likewise, in

manufacturing, there is a long-

run risk that a rival will

expand. more rapidly and

therety achieve greater economies

of scale." (Id., at p. 81)

""'In considering a new

foreign investment, we take

into account all profit over

the marginal cost of all

coupqnente shipped from our

Michigan factory to the

foreign plant. But later,

when we report the profit or

loss of the subsidiary, we use

a standard intercompany price

-107

and products which for small incremental

costs can be produced very profitably

(using separate account by a new subsidiary .26/

Fn. 25 cont'd

that is based on average costs

plus a profit.'"

(Bent Measuring Stick .. ., supra,

at Pp. .

In the transfer and valuation of

used equipment that had little value on

the market,

", , . the incremental costs to

a parent of providing services

for a subsidiary usually are

quite low; but the value to a

subsidiary can be substantial."

(Id., at p. 84.)

26. The San Diego Union (Aug. 14,

1982, p. C-9) reported that Oak Industries

is shifting production of its most

sophisticated product lines to Taiwan. Its

spokesperson stated, "As long as we've

been in Taiwan - 20 years or more - it

has always been our practice to get

production started here [in the U.S.]

work out the bugs and then take a 99.

perfected product to Taiwan."

CCA's evidence on ROI totally

ignores the unitary nature of the business.

It is disputed, was rejected by the

California courts and should not be

considered here.

~108-

CCA's arguments do not impeach

the formula apportionment or establish

that California has taxed more income of

CCA's unitary business than is reasonably

related to CCA's substantial business

activity (property, employees and sales)

in Califorria.

-109-

IV

THE COMMERCE CLAUSE

ae

CCA contends that (1) California's

formula apportionment here results in

taxation of income also taxed by foreign

countries (AB pp. 21-27), and (2) prevents

the federal government from speaking with

one voice in foreign policy. (AB 27-36),

both alleged in violation of the Commerce

Caluse. Both concepts are taken from

language in Japan Line Ltd. v. County of

Los Angeles (1979) 441 U.S. 434 (hereinafter

“Japan Line") FTB submits that the Japan

Line rulings are inapplicable to this

case and facts properly before this

Court show neither double taxation nor

interference with foreign policy.

A. Here No Tax is Imposed

on Foreign Commerce

CCA is a Delaware corporation

with its headquarters in Illinois. It

-110-

does business in California. In addition,

CCA owns a number of subsidiaries which

are incorporated in foreign countris and

do business in foreign countries.

California has assessed a tax against CCA,

but it has neither asserted nor assessed

a tax against any of CCA's foreign

subsidiaries. Under the unitary business

principle, California has included the

property, payroll, seles and net income

attributed by CCA to its foreign

subsidiaries under CCA's separate

accounting methods ir. the formula used to

determine the amount of income properly

attributable co California, because the

subsidiaries are part of CCA's unitary

business.

If CCA could establish that its

foreign subsidiaries were not part of its

unitary business, California would not

require their inclusion in the combined

-111-

report. The apportionment method used was

an effort by California to reach that

income, and only that income, which was

earned or properly attributable to

eetivities within its borders. California,

in attempting to put upon this business its

fair share of the burcien of taxation, was

faced with the impossibility of allocating

specifically the profits earned by the

process conducted within its borders. It

therefore adopted a method of apportion-

ment which, for all that appears in the

record, reached, and was meant to reach,

only the profits earned within the state.

(Underwood Typewriter v. Chamberlain,

supra, 254 U.S, 113; Fass, Ratcliff, etc.,

supra, 266 U.S. 271.)

CCA averagec over $10 million

in California payroll, $15 million in

property and almost $30 million in sales in

California (J.A.Ex, pp. 2,4,6) in each

-112-

year in issue, for the government services

to which California has requested about

$200,000 per year in tax based on CCA's

California income. This does not tax

extraterritorial values. The tax totals

only 6% of the California sales, a

reasonable payment for the substantial

services provided by the state by any

standard.

This case taxes a domestic

corporation doing substantial business

here. It taxes no foreign business or

instrumentality. Japan Line is totally

foreign to the case at: bench. In Japan Line

the tax was directly on a container, an

instrumentality which was moving in foreign

commerce. it was owned by a Japanese

Company. The property tax under discussion

in Japan Line was directly on a foreign

instrumentality moving in foreign commerce

which "remain outside Japan only so long

as needed to complete their international

-113-

missions." (Japan Line, supra 441 U.S.

at p. 452.) The Japan Line decision stated,

"The question here is a much

more narrow one, that is,

whether instrumentalities of

commerce that are owned, based,

and registered abroad and that

are used exclusively in

international commerce, may be

subjected to apportioned ad

valorem Rroperty taxation by

a State." 27/

Japan Line itself thus severely restricted

its application to a situation not present

here. In Mobil this Court reiterated the

distinction which makes Japan Line

inapplicable to income taxation of unitary

businesses.

"Appellant's attempted analogy

between this case and Japan Line

strikes us as forced. t case

involved ad valozem property

taxes assessed directly upon

27. “Accordingly, we do not

reach questions as to the

taxability of foreign-owned

instrumentalities engaged in

interstate commerce or of

domestically owned instrumen-

talities engaged in foreign

commerce." (Japan Line, at p.

-114-

instrumentalities of foreign

commerce. As has been noted,

the factors favo:--ing use of

the allocation method in

property taxation have no

immediate applicability to

an income tax." obil, supra,

445 U.S. at p. 448.

Japan Line itself said that multiple tax

and impairment of federal uniformity are

additional considerations, when a "state

seeks to tax the instrumentalities of

foreign comnerce." (Japan Line at p. 446.)

Here California is taxing no instrumentality

of foreign commerce.

B. CCA Has Not Proven

constitutional Double

axation Here

Japan Line distinguished income

taxation of a unitary business by formula

saying,

"In Moorman, the problem arose,

not from lack of apportionment,

but from mathematical imprecision

in the formulae. Yet, this Court

consistently had held that the

Commerce Clause ‘does not call

for mathematical exactness .. .;

onty if the resulting valuation

is palpably excessive will it

-115~

be set aside. [Citations.]

This case, by contrast, involves

no mere mathematical imprecision

in apportionment; it involves

a situation where true sppoytion-

ment does not exist . °

(Id., at p. 455.)

In contrast the division of the income of

a unitary business among the several

taxors is necessarily a task of apportion-

ment, whether by formula, attempt to

reconstruct a fictional arm's length

separate accounting, acceptance of the

taxpayers own separate accounting, or

otherwise. The Japan Line discussions of

double tax were not intended to apply here.

The Japan Line court discussed and

approved its earlier Moorman decision which

recognized <hat different methods of

apportionment which could result in

multiple taxation are permitted by the

Commerce Clause. (441 U.S. at p. 455.)

It noted, however, that Japan Line

". . .concerns foreign commerce.

Even a slight overlapping of tax --

-116-

a problem that might be deemed

de minimis in a domestic context --

‘assumes importance when sensitive

matters of foreign relations and

national sovereignty are concerned."

(Id., at p. 456. ,

As shown above, here California is merely

taxing CCA, a domestic corporation.

Unlike Japan Line, there are no "sensitive

matters of foreign relations and national

sovereignty" involved in determining the

amount of income taxa>le by California to

CCA.

In the field of income taxation

(unlike property taxation) taxation of the

same income at both state and federal

levels is specifically permitted.

"Concurrent federal and state taxation of

income, of course, is a well established

norm" (Mobil, supra, 445 U.S. at p. 448.)

CCA has not attempted to show any state

-117-

level income tax other than California's .29/

Multiple taxation at a federal

(country) level does not invalidate Calif-

ornia's tax. In practice, the United

States gives tax credits for taxes paid to

foreign countries to mitigate (if not

eliminate) such national level double

taxation. Where U.S.A. has already given

a credit for a foreign income tax, the

result should be the same as if both

California & U.S.A. had originally taxed

the same income.

Where a credit has been given once

(by U.S.A.) for a foreign income tax,

28. California t:axed about 8% of the

eoaty income. The soreign countries

taxed less than one-third. (AB p. 17.)

Less than half of CCA's unitary income has

been taxed by California and the foreign

countries (even using the evidence which

has been rejected by the trial court and

is not properly before this Court). CCA

has not properly shown any actual double

taxation or any reasonable risk of it,

(except by both U.S.A. and California

perhaps. )

-118-

allowing a second credit against California's

would be totally unjustified.22/ no

unconstitutional multiple tax results from

allowing both a federal and state level

tax on the same income.

Risk of double taxation of

income is inevitable because there is, in

fact, not uniformity of tax laws (let alone

in their application.) Only if absolutely

identical income tax laws were identically

applied could double tax be certainly

avoided. The record shows no such identical

tax laws between any two countries (let

29. Assume a taxpayer paid $5 foreign

country tax and $20 U.S. tax (minus $5

credit), and $7 California tax, he would end

up paying $5 foreign, $15 U.S. and $7 state

level tax. If California were required to

avoid double tax he would pay $5 foreign

$15 U.S, and only $2 state level. But if

he paid no foreign tax he would pay $20 U.S.,

and $7 California taxes. A tax credit should

be allowed only once, i.e., against federal

income tax.

-119-

alone as to all of them.) Nor do we

believe it can. In this writer's

experience, income tax laws vary substan-

tially from country to country both as to

income taxed and deductions and credits

allowed. CCA concedes that even the

accounting methods (by which the income

and deductions are calculated) vary from

country to country. There is no such

thing as a uniform "arm's length" method.

Indeed, U.S.A. made no "arm's length"

adjustments in CCA's income for payments

(or lack thereof) by its subsidiaries

which were not full value for services

rendered by CCA. (J.A. pp. 78-79,4 151.)

This shows both non-uniformity in

application and inadequacy of the so-called

arm's length method. The fect that this

Court has no control over the methods of

calculating tax used in foreign countries

does not deprive the United States or any

-120-

state of the right to tax a fair share

of the income of a multinational unitary

enterprise.

CCA has proven no unconstitutional

double taxation.

"Appellant's reasoning tracks the

rationale of Japan Line, that is,

that separate accounting is

required because apportionment

necessarily entails some inaccuracy

and duplication. This inaccuracy

may be tolerable for businesses

operating solely within the United

States, it is said, because this

Court has power <o correct any

gross overreaching. The same

inaccuracy, however, becomes

intolerable when it is added

to the risk of duplicative

taxation abroad, which this

Court is erless to control.

Accordingly, the only means of

alleviating the burden of

overlapping taxes is to adopt

an allocation rule. . .

at . (NJ othing about the logic

of Mobil’s position is limited

to dividend income. The same

contention could be advanced

about any income arguably

earned from foreign commerce.

If appellant's argument were

accepted, state taxing

commissions would face substan-

tial difficulties in attonpting

to determine what income does

-121-

or does not have a foreign

source."

obit, supra, 447 U.S. at pp.

C. CCA Has Not Proven

Interference in Violation

of the Commerce Clause

With Foreign Relations

As has been pointed out already,

California is simply here taxing a domestic

corporation. No foreign sovereign has

any legitimate interest or concern with

California's taxation of CCA. Nor do

those in the federal zgovernment who handle

foreign relations.

The Commerce Clause provides

that "the Congress shall have the power

- « « to regulate commerce with foreign

Wations ...." (U.S. Const., art I,

§ 8, cl. 3.) The Conzress has expressed

its foreign policy on use by states of

formula apportionment of income of

multinational unitary businesses. It has

rejected all attempts to limit its use.

-122-

Particularly, the Senate even rejected a

clause in a treaty with Great Britain which

would have stopped use of formula appcrtion-

ment only where British corporations had

no contact with U.S.A. except through a

subsidiary, but would have continued to

permit it here and in all other cases.

(Reservation of Art. 9 °4) of the U.K.

Convention for Avoidance of Double

Taxation.)

This Court has recognized that

absent action by Congress, formula

apportionmen: does not interfere with

federal foreign policy.

"Absent some explicit directive

froiw Congress, we cannot infer

that treatment of foreign

income at the federal level

mandates identical treatment

by the States. The absence of

any explicit directive to that

effect is attested by the fact

that Congress has long debated,

but has not enacted, legisla-

tion designed to regulate

state taxation of income.

{Citations.] Legislative

proposals have provoked debate

over issues closely related to

-123-

the present contreversy. See,

e.g., New York Stete Bar Assn.

Tax Section Committee on

Interstate Taxation, Proposals

for Improvement of Interstate

Taxation Bills (H.R. 1538 and

S. 317), 25 Tax Lewyer 433

(1971). Congress in the

future may see fit to enact

legislation requiring a

uniform method for state

taxation of foreicn dividends.

To date, however, it has not

done so." (Mobil, supra, 445

U.S. at pp. 448-449.

To the extent that the actions

of the executive branch should be

considered ,22/ during the period in issue,

formula apportionment was clearly

considered proper. Subsequent policies

should not afect this case. However, by

notice dated December 20, 1979, the

30. There is nothing on this

properly before this Court.

-124-

Department of State stated to the

Ambassador of the Netherlands that, "This

Department is not in a position to conclude

that [formula apportionment involving a

Dutch company and U.S. subsidiaries is]

inconsistent with either the standards

set forth in the trea:y or general principles

of international law."

The Solicitor General has, in the

pending Chicago Bridge & Iron (CBI) case

No. 81-349, expressed concerns about

situations involving foreign businesses

headquartered abroad. He conceded in oral

argument that formula apportionment of

multi-national unitary business income

"does not violate any provision of any

particular treaty." (Apr. 19, 1982,

RT p. 18.) Various attorneys for the

federal government are too often diverse

in their opinions. (See Sullivan v. United

States (1969) 395 U.S. 169, 185 fn. 2.)

-125-

The Solicitor General does not dictate

what is the policy of this country on

foreign relations. The Executive Branch

has specifically indicated its acceptance

of the states’ use of the unitary business

principle in its negot:iation of Conventions

to Prevent Double Taxation and Friendship

Commerce and Navigation Treaties. With

respect to the Convention between the

United States and the Soviet Union for the

Avoidance of Double Taxation, the Treasury

Department stated:

"With respect to the Soviet

Union, the taxes and dues

covered by the Convention

are defined in subparagraph (a)

of paragraph 1 as those provided

for by the All-union legislation

of the Soviet Union. The term

"All-Union legislation" is not

meant to refer to a specific

law or code but is a generic

term covering les‘slation at

the national level that applies

throughout the Soviet Union.

The taxes imposed by the Union

Republics of the Soviet Union

(comparable to states of the

United States) are not covered

by the Convention because, in

-126-

keeping with past U.S. policy

the taxes of the state and local

governments of t:he United States

are excluded from the scope of

the Convention, except for

purposes of Article X (Non-

discrimination).

Standard Friendship, Commerce

and Navigation Treaties contain general

language dealing wit! the subject of

taxation, including © anguage providing the

contracting, states "shall not impose or

apply any tax, fee o1 charge upon any

income, capital or other basis in excess

of that reasonably allocable or apportionable

to territories "of the taxing authority]"

on citizens of the foreign country. (FCN

Treaty with the Netherlands, Art. XI q 4.)

Department of State «nnotations explaining

the standard treaty language clearly

shows that formula apportionment by states

is anticipated and ac ceptable. 2+/ -We have

31. A State Department study in

1980 ges the terms "reasonably

allocable or apportionable" in footnotes.

fn. cont'd

-127-

found no restrictions on any country's

, #er to tax its own citizens (including

domestic corporations like CCA) in any way

it chooses. Indeed, the Department of State

Fn. 31 cont d.

"This provision provides an

elementary, although incomplete,

safeguard agains* double taxation

by stipulating tat taxes shall

be imposed on onjy ctiiat portion

of a nonresident alien or alien

corporation's income that is

truly 1:epresentat:ive of the

income or profits derived from

operat:.ons within the taxing

country. The int:ent is to

prevent: taxation of global

income. It does not necessarily

preclude taking into account

the ent:ire incom:, capital

and property of in enterprise,'

whereever situated, as, for

er.ample, in dete:mining the

rate o:; tax. It does seek to

prevent: the asce)'tainment or

measurement of the tax base,

te which such rat:e is to be

ayplie!, on the lasis of what

is. outside the country.

"Article XI 4) does not

=— to provicle a set

formula by which the allocation

or apportionment shall be made.

It takes into consideration

the accounting complexities and

-128-

has argued that FCN Treaty provisions

do not apply to companies incorporated

in U.S.A. (See Sumitomo Shaji America,

Inc. v. Avagliano (Jure 15, 1982) 50 U.S.L.

Week 4643, 4645.) This Court also noted in

Fn. 31 cont*d/7

and problems of value judgment

that are unavoidable, for example,

in attempting to determine a

reasonable allocation for a

large multinational corporation.

No single formula for this

calculation has been agreed on.

There are a variety of systems

that meet the test of reasonable-

ness as that test has come to be

applied in United States

jurisprudence. The various

states have adopt:ed a variety

of tax bases which have received

the sanction of the courts,

including gross product, net

sales, turnover, amount of

property held in the State, and

combinations of these various

bases. The crucial element

is that some test be et

and that it be ‘reasonable.'

The intent in employing that

term by courts in this country.

For the relationship of State

actions in this field to the

overall question of the States'

treatment of ‘foreign’ and alien

corporations, see Article XXII(4).

-129-

Sumitomo that the interpretations of

similarly worded FCN Treaties may vary

because of different negotiating histories.

(Id., at p. 4646, fm. 12.) Thus, a thorough

examination of all n2gotiations and treaties

and other documents »ertaining to the "one

voice" assertions must preceed any

conclusion that U.S.A. has adopted some

so-called “arm's length" method as the

exclusively permitted means of taxing

income of businesses engaged in foreign

commerce.

Fn. 3L cont'd

"The term ‘allocable’ is

considered as a a or

applying a share of total

income on a percentage basis,

which conceivably could be

somewhat arbitrary and uneven

in proportion.

"The term ‘apportionable' is

considered as implying an

po division among the various

elements involved. The two

terms, taken in conjunction,

are intended to cover all the

various methods, proportionate

or otherwise, = which a

reasonable tax base might be

determined."

-130-

With respect to both of the

state taxes involvec in Washington Rev.

Dept. v. Stevedoring Assn. (1978) 435 U.S.

734 and Michelin Tire Corp v. W. L. Wages

(1976) 423 U.S. 276, this Court stated:

"It did not ustrp the Federal

Government's authority to

regulate "~ig relations since

it did not fall on imports as

such because of their place

of origin. [Citation.] As a

general tax tg ry to all

property in the State, it

could not have been used to

create special protective

tariffs and could not have

been applied selectively to

encourage or discourage

importation in a manner

inconsistent with federal

policy.

". , .[T]he tax does not

restrain the ability of the

Federal Government to conduct

foreign policy. As a general

business tax that applies to

virtually all businesses in

the State, it has not created

any special protective tariff.

The éssessments in this case

are cnly upon business conducted

entirely within Washington. No

foreign business or vessel is

taxed. Respondents, therefore,

-131-

have demonstrated no impediment

imposed by the tax upon the

regulation of foreign trade

by the United States."

(egeusgorsn gupra, at pp.

. :

Similarly here, CCA has not

demonstrated any impediment on federal

regulation of foreign trade or any

Constitutional viola‘ion.

kee kw &

-132-

V

AMICI SUPPORTING

APPELLANT SHOW NO

UNCONS ITUTIONALITY

Because of space limitation,

response to much of Amici arguments is

integrated into the preceeding responses

to appellant's brief. Most factual matter

referred to by Amici supporting appellant

is not properly before this Court and

should be ignored; however, even considering

it, no unconstitutionality is shown.

Specific comment is made on

briefs of Firestone, EMI and Shell

Petroleum N.V. ("SPVN") because each has

litigation now pending in California

courts.

1. Firestone, like CCA, is simply an

American-owned and based multi-national

enterprise concucting a unitary business

(producing rubber products and rubber)

through subsidiaries. It makes basically

the same arguments as CCA.

-1353-

2. EMI is a U.K. corporation doing

business in U.S.A. solely through a wholly-

owned subsidiary, Capitol-EMI. California

has included a unitary recording business in

its formula when taxing Capitol-EMI. EMI's

primary argument, that international law and

custom prevents use of formula apportionment,

is directly refuted »y Congress‘ recent

rejection of Article 9(4) of the U.K. Con-

vention which would have created

the insulation of British parent corpor-

ations fron combination by states’ with

their unitary American subsidiaries.

3. It is asserted in the amicus

curiae brief of Shell Petroleum N.V.

that worldwide combination "can have

particularly spectacular distorting

effects" where the foreign company is.

the parent and the operations of a

domestic subsidiary are relatively small

in comparison with overseas operations.

-134-

(Brief A.C., Shell Fetroleum, pp. 9-10.)

SPNV cites by way of illustration the

FTB's treatment of two of its subsidiaries,

Scallop Nuclear, Inc. and Shell Oil

Company, which has teen challenged by

SPNV in Shell Petroleum N.V. v. Mary Ann

Graves, et al., No. C 81 4302 MPH (N.D.Cal.).

On August 10, 1982, the District Court

dismissed SPNV's action on the grounds that

SPNV lacked standing to sue and that the

controversy was not ripe for decision.

An appeal to the Court of Appeals for the

Ninth Circuit (Docket No. 82-4535) was

filed by SPNV on September 3, 1982.

SPNV's illustration of the

"spectacular distorting effects" of

worldwide combination is itself a

distortion of the facts in the Shell

case. As of the present time, the FTB

has not sought to tax Scallop Nuclear

on $46,000,000 of apportioned income, as

SPNV claims; in fact, the FTB has issued

~135-

no assessments at all against Scallop

Nuclear. (See Complaint 432 (N.D. Cal.

Nov. 4, 1981.) Proposed assessments for

six of ten years under audit were issued

against Shell Oil, but only after officials

of that company not only refused to

furnish information on Shell's operations

relevant to the question of unity, but

also refused to extend the statute of

limitations applicable to a reassessment

of taxes. (See Kashiwagi Aff. 44 13-15;

Watson Aff. 44 (N.D. Cal. Apr 19, 1982.)

Under the circumstances, the FTB auditor

assigned to Shell Oil was forced to

protect the revenue by issuing proposed

assessments in which all doubts were

resolved against the taxpayer. (Kashiwagi

Aff., supra, at ¥ 15.) As a result of

pending adninistrative proceedings,

multimillion dollar adjustments already

have been proposed. (Watson Aff., supra,

at q 7.)

-136-

In view of the above facts, the

District Court held that the controversy

in Shell was not ripe for adjudication

because (1) no tax assessments have been

issued against Scal*op Nuclear, and (2)

though proposed tax assessments for some

of the years in question have been issued

against Shell Oil, such assessments are

still in the process of administrative

review. In ruling cn the question of

standing, the District Court rejected

the contention of SPNV that cited pro-

visions of the Treaty of Friendship,

Commerce end Navigation of 1956 between

the United States and the Netherlands

(which provisions refer to "nationals

and companies of the [Netherlands]"

apply to the taxation of a U.S. subsidiary

-127-

of a Netherlands parent .22/ The court

stated:

"It is clear that a company of

the Netherlands which itself

transacts business in the

United States falls within the

zone of interests sought to be

protected by the Treaty; but

it is also clear from Sumitomo

Shoji that a U.S. corporation

and its foreign parent are not

mere extensions of each cther,

for Treaty purposes."

(Memorandum Decision and Order

p. 10 (N.D, Cal. Aug. 5, 1982.)

The District Court concluded that neither

the FCN treaty with the Netherlands nor

the U.S.-Netherlands Double Taxation

Conventior. of 1948, as amended, vests

rights in Netherlands shareholders of a

domestic corporation to redress an

32. The Government of the Kingdom

of the Netherlands has made the same

contention both in the amicus curiae

brief filed in this Court and in an

amicus curiae brief filed in the Shell

case. (See Memorandum of the Government

of the —— of the Netherlands as

Amicus Curiae (N.D, Cal. April 19, 1982.)

-138-

alleged injury to the corporation.

CONCLUS ION

Most of the factual matter relied

on by appellant (and its Amici) is not

properly befere this Court and should not

be considered. However, even considering

such improper "evidence" no unconstitu -

tionality, overpayment of tax or any ground

for reversal has been shown.

The facts show substantial

technical, managerial and financial

services 4s well as capital assets and

raw materials were furnished by CCA to

its subsidiaries which are not adequately

reflected in separate accounting figures.

The foreign subsidiaries were part of CCA's’

unitary business. CCA's reliance on

separate accounting approaches which

ignore the integration and interdependence

within a unitary business fails to show

any distortion or extra territorial

-139

taxation by formula apportionment. No

due process violaticns are shown.

Nor have Commerce Clause

violations been shown. CCA has proven no

"double taxation" here; absence of

international uniformity of accounting

methods, tax laws and their application

makes some double taxation of unitary

multi-national enterprises inevitable;

neither this nor taxing the same income

at both state and national levels is

constitutionally prohibited. Congress,

the State Department and this Court have

all approved international use of

formula apportionment; it does not inter-

fere with federal conduct of foreign

-140-

relations; especially here where the

taxpayer is a domestically incorporated

and owned taxpayer.

The judgment should be affirmed.

Respectfully submitted,

GEORGE DEUKMEJIAN,

Attorney General

NEAL J. GOBAR,

Deputy Attorney General

Attorneys for Appellee,

Franchis2 Tax Board

A-1

Appendix A

MANAGEMENT THEORY:

SELECTED EXCERPTS

A-2

THE DECENTRALIZED PATTERN

[Excerpts from: Johi Pfiffner and Frank

Sherwood, Administrative Organization,

Prentice-Hall, Inc., Englewood Cliffs, N.J.,

1960, pp. 189-196.]

The contemporary trend in large-

scale organization is toward decentraliza-

tion, but we must realize that decentrali-

zation is several th:ngs to different

people. There are those who view it en-

tirely in terms of decision-making; others

see it from the standpoint of geographical

dispersion of plants and installations; and

still others approach it as a philosophy

of corporate life, a set of organization

values with sociologicai, psychological

and spiritual facets.

4lthough tke current wave of

conversions to the “gospel" of decentrali-

zation seems to have started during and

after World War II, there was a flurry

during the 1920's marked by the emergence

A-=

of perhaps the greatest of the prophets,

Alfred P. Sloan, Jr., and his enduring

monument, General Mctors.

II THE DECENTRALIZATION

PATTERN IN OUTLINE

An overview in outline at this

point may give the reader an understanding

of the whole pattern of decentralization

before we proceed to a fuller discussion

of its parts.

[. The Formal Structure

A. A flat job-task pyramid

1. Minimize number of

horizontal levels

B. Distinguish between corpor-

ate and production levels

1. Corsorate level keeps

out of production

2. Establish semi-

autonomous subsidiary

corporations or divi-

sions as the principal

A-4

operating units

C. Staff-end-line

| 1. Structure formal authority

according to the staff-

and-line model postulated

in the preceding chapter

D. Set up organization planning

as an instrumentality of

dynamic growth and change.

Il. Executive Behavior

A. Corporate executives

1. Major efforts devoted to

planning, policy-making

and evaluation of results

2. Refrain from that type of

interference in current

production matters which

weakens subordinates

k*

3. Set broad goals and

tarzets

4-5

Con-:rol by remote feedback

rather than inmediate

supervision

Production Executives

1. Funetion as autonomous

head of owh unit

Operate on flexible budget

mak:.ng executive virtually

an entrepeneur; cost cen-

ters, allocating profit-

and-loss, extend down into

the plants

Make and implement policy

subject to guide lines

esteblished at the cor-

porate level

Delegate and then absorb

heat generated by sub-

ordinates’ errors

Plan production goals

and controls by feedback

IIl,.

Ae)

6. Generate atmosphere of

self-reliance within a

framework of freedom in

which the main sanctions

are results

Policy and Decision

A,

Board guide lines are

established at corporate

level

There is a policy continuum

in whick each subordinate

level determines policy in

line with that set by superior

echelons |

Decisions are made at the

lowest level consistent with

the situation

Decisions are ar ived at only

after completed staff work

and consultation, but the

responsi>rility for decision

The

A-7

resides with the appropriate

executive

The superior behaves in such

a manner as to encourage sub-

ordinates to make decisions,

parryirg attempts to evade

responsibility

Social Climate

Relaxec freedom within the

rules of the game

Communication is two-way,

oblique, and horizontal

Democratic consultation and

interaction without under-

mining the essential needs

of leadership and discipline

Individual self-expression

and self-development are

encouraged within the limits

imposed by organization's

resources and needs

A-8

III THE DECENTRALIZATION

PATTERN IN DETAIL

The Formal Structure

Two general approaches. There

are in general two ways of decentralizing

‘ an industrial structure. One is by leaving

the decentralized urits as integral divi-

sions, there being only one corporation.

In general this is the policy followed by

General Motors. The other is to decentra-

lize by the organization of subsidiaries,

or affiliate companies. The Standard Oil

companies have tended to follow the latter

method.

Three bases of decentralization.

Smith's study found three general types

of decentralized structure in American

industry: (1) by functions; (2) by

geographical regions; and (3) by product

divisions. Firms organized by function

tend to have one main product. In them

A-9

the decentralized fectory manager and

sales maneger each report to separate

functional executives at headquarters, as

would other functional people, such as

finance. This type of organization has

three vertical levels, and the people

working in it seem to be less confused

about status because it is clear to whom

they report.

In the second, an organization

based on geographical decentralization,

everyone reports through the regional man-

ager. Functional lines to headquarters

are purely staff, similar to the line-and

staff model postulated in the previous

chapter. Such organizations tend to have

four levels. In spite of the fact that

this is the type of organization postulated

by our model for large comapnies with

diversified products, Smith points out

that it seems usual "to have strong dif-

ferences of opinion between the headquarters

A-10

officers, on the one hand, and the branch

officers, on the other, as to who should

have authority to do what." This is only

one more example of -he fact that the

decentralized way of life may not be the

easiest one.

Organization by product line is

represented by the Ford Motor Company,

General Motors, and Ju Pont. In each case

a major division is devoted to making and

selling a single product. Each division

is organized as an independent unit and

the structure of the field units may be

functional. geograph:.cal, or a mixture of

the two. Committees at the corporate level

work toward desirable standardization and

uniformity.

A-11

FEDERAL DECENTRALIZATION

{Excerpts from: Pet2r F, Drucker, Management:

Tasks, Responsibilities, Practices, Harper

& Row, New York, 1974, pp. 572-57°.]

In “federal decentralization" a

company is organized in a number of autono-

mous businesses. Each unit has responsi-

bility for its own performance, its own

results, and its own contribution to the

total company. Each unit has its ow

management which, in effect, runs its own

“autonomous business."

Federal decentralization (as has

been mentioned earlier, in Chapter 41) was

first worked out, thcugh only crudely, by

Pierre S. de Pont in 1920 in the reorgani-

zation of the family-owned Du Pont Company,

which had outgrown, during World War I, an

older functional structure. When Pierre S.

du Pont, shortly thereafter, took over the

presidency of General Motors, which was

A-12

then in desperate trouble, he found that

Alfred P. Sloan, thea GM's executive vice-

president, had arrived at a similar, though

far more polished version. Sloan's "de-

centralized operations with centralized

policy control"—put into effect during

1921-22-—became the prototype of decen-

tralization. Among the many imitations

and adaptations, the one made in 1950-52

for the reorganization of the General

Electric Company became, in the years of

the “management boom," the standard model

worldwide.

ket

The Strengths of Federal

Decentralization

Cf all design principles

available so far, federal decentralization

comes closest to satisfying all design

specifications. It also has the widest

scope. Both operating work and innovative

work can be organized as decentralized

A-13

autonomou; businesses. And while top manage-

ment can obviously not be set up as an

autonomous business, federal decentrali-

zation of the business, if done properly,

makes for strong and effective top manage-

ments. It frees top management for the

top-management tasks.

The Requirement: of

Federal Decentralization

Decentralization must not create

a weak center. On the contrary, one of

the main purposes oj federal organization

is to strengthen top management and to

make it capable of doing its own work

rather than be forced to supervise, co-

ordinate, and prop up operating work.

Federal decentralizetion will work only

if the top-managemert job is clearly

defined and thought through.

kk *

In ether words, there must be

a kind of “supremacy clause" reserving

A-14

to central management the decisions that

affect the business as a whole and its

long-range future welfare, and allowing

central management to override, in the

common interest, local ambitions and pride.

Specifica’ly, there must be three

reserved areas if the business is to remain

a whole rather than splinter into fragments.

Top management, and top management alone,

can make the decision what technologies,

markets, and product's to go into, what

businesses to start and what businesses

to abandon, and also what the basic values,

beliefs, and principles of:the company are.

Second, top management must re-

serve to itself the control of the allo-

cation of the key resource of capital.

Both the supply of capital and its invest-

ment are top-managerent responsibilities

which cannot be turned over to the

autonomous units of a federal organization.

A-15

The other key resource is people.

The people in a fedsrally organized company,

and especially manazers and key profes-

sionals, are a resoirce of the entire

company rather than of any one unit. The

company's policies with respect to people

and decisions on key appointments in the

decentralized autonomous businesses are

top-management decisions—though of course,

autonomous business managers need to take

an active part in them. And a decentra-

lized company needs to have a strong, re-

spected, and senior executive in top

management who is the company’s conscience

with respect to peorle.

Top management in a decentralized

structure has to be separate. It cannot

also run any of the autonomous businesses

no matter how big or important they are.

A-16

Appendix 8

CONTAINER CORPORATION OF AMERICA

CCA EMP WORKING

IGN IDIARI

{Exhibit D to Stipulation of Facts in

Evidence]

Name, company, position, and date

foreign employment commenced,

Frank Angeles Cartoenvases de Mexico,

Mexico City

Art Director - D

Septembe:: 1962

Otto H. Atkinson Cartoenvases de Mexico,

October 1963

Louis M. Crandall Carton y Papel, corru-

gated Carton y Papel,

Re foi:ma

Division Manager - D

August 1963

Donald D. Hartman Carton y Papel, Reforma

General Manager - P

October 1958

John T. Hutton Carton y Papel, Los

Reyes

General Manager - P

May :.963

Melvin L. Johnson Carton y Papel, Los

Reyes .

General Manager - P

December 1960

Carl Philhower - Carton y Papel, Cerro

Gordo

Plant Manager - P

November 1958

A-17

Ernest A. Robinson Cartoenvases de

Mexico, Mexico City

General Manager - D

July 1959

Stanley B. Tamkin Carton y Papel,

Reforma .

Vice President - C

September 1959

William D. Thorpe Carton y Papel,

Corrugated

Plant Manager - P

February 1961

Epigmenio Guzman Carton y Papel,

Corrugated

April 1961

Ernest W. Briggs Carton de Colombia,

Cali 7

Staff Engineer - P

January 1966

Francis J. Sauer Carton de Colombia,

Cali

General Manager - P

April 1962

T. J. Hosted Carton de Colombia,

Cali

Controller - P

May 1965

Edward N. Jacobs + ae de Colombia,

Cal

Director of Manufac-

turing - D

August 1950

A-18

Stanley Karpinski

Jerry Sanders

Donald C. Corse

Robert F. Donegan

Gordon Healea

John Manzella

Delos G. Morton

Glendie E. Osborne

Cartones Nacionales,

Valencia

February 1961

Fibras, Caracas

Resident Manager - P

April 1960

Cartones Nacionales,

Valencia

Division General

Manager - D

September 1952

Union Grafica,

Caracas

Vice President - C

April 1961

Cartones Nacionales,

Valencia

Plant Manager - P

March 1964

Carton de Venezuela,

Petare

Division General

Manager - D

December 1955

Cartones Nacionales,

Valencia

General Controller-C

June 1959

Carton de Venezuela,

Petare

Mill Manager - P

January 1963

A-19

Robert G. Ridings Cartones Nacionales

Valencia

General Manager - P

August 1963

Russell W. Wilson Union Grafica, Caracas

Director of Marketing

- D

July 1962

Richard A. Witte Europa Carton,

Heppenheim

Generali Manager - P

September 1957

C - Corporate

D - Division

P - Plant

A-20

Appendix C

Source Variations Computed on the

Basis of Taxable Income

On page 16 of Appellant's Brief,

various figures are set forth by Appellant

to demonstrate the amount of foreign in-

come allegedly erronously apportioned

by California to itself and the United

States. Appellee does not believe that

Appellant's analysis is relevant in con-

text of the unitary theory and in any

event is not probative given the admitt-

ed inaccuracies of separate accounting

data in this case. Nonetheless, the

Court should be aware that Appellant's

calculations are based upon financial or

book income (profits on JA:E Ex A-1 through

A-6) not on taxable income as defined by

California. As a result, Appellant has

overstated the alleged misapportionment.

If the Court wishes to consider the argu-

ments raised by Appellant in the context

of consistent and correct figures,

respondent respectfully suggests the following substitutions:

1963 1964 1965

1,470,105 4,675,478 3,660,163

1. Worldwide income

apportioned to

California 3,355,141 3,835,868 3,704,499

2. Domestic income

apportioned to

California 3,243,891 3,323,252 3,316,892

3. Increase of 1 over 2 141,250 512,616 387,607

T@-7

£-22

These figures were computed on

the following basis:

The first set of figures were

calculated by Multiplying the United States

Apportionnent Factors times Adjusted Unitary

Business Income JA:& Ex A-7 and Subtracting

United States Source Income.

The figures on 1. were calcula-

ted by multiplying California Worldwide

Apportionment Factors times Adjusted

Unitary Business Income JA:E Ex A-/7.

The figures of 2. were calcu-

lated by multiplying California Domestic

Apportionment Factors Times the Total of

Unitary Business Income per Return and

Federal RAR Adjustments JA:E Ex A-7.

The various items involved in

these calculations are defined as follows:

California Domestic Apportionment Factors

CCA Calfornia Factors JA:E Ex A-2,

A-4, A-6 * CCA Factors JA:E Ex A-2, A-4, A-6

A-23

Californi.a Worldwide Apportionment Factors

CCA California Factors JA:E Ex

A-2, A-4, A-6 = CCA Factors JA:E Ex A-2,

A-4, A-6 + Total Fectors JA:E Ex:-A-1, A-3,

A-5 (Property & Payroll) and Combined CCA

Sales JA:E Ex A-2, A-4, A-6 + Total Sales

JA:E Ex A-1, A-3, A-5

United States Apportionment Factors

CCA Factors JA:E Ex A-2, A-4,

A-6 (Property & Payroil) and Combined CCA

Sales JA:E Ex A-2, A-4, A-6 + Denominator

Figures for Worldwide Above

*

United States Source Income

Unitary Business Income per

Return JA:E Ex A-7 + Federal RAR adjust-

ments JA: Ex A-7

*An even more appropriate comparison

would be Income Subject to Tax by

the IRS Adjusted to a California

Tax Base which equals Federal

Taxable Income per Form 1120 JA:E

A-24

Ex A-7 + RAR Adjustments JA:E Ex A-7

+ State Taxes Based on Income JA:E

Ex A-7 + Interest on Government

Obligations JA:E Ex A-7. On this

basis, the first set of figures on

page 16 of Appellant's Brief would

be:

1963 1964 1965

961,922 2,464,394 (1,215,898)

A-25

Appendix D

Nos. 52818, 52828, 52903

IN THE SUPREME COURT OF ILLINOIS

CATERPILLAR TRACTOR CO.,

CATERPILLAR AMERICAS CO.,

CATERPILLAR CREDIT CORP.,

CATERPILLAR FINANCE CORP.,

and CATERPILLAR MACHINERY CORP.,

Plaintiffs-Appellants,

Cross-Appellees,

Vv.

ILLINOIS DEPARTMENT OF REVENUE,

et al,

Defendants-Appellants,

Cross-Appellees,

and

COCA-COLA COMPANY, et al,

Intervening Plaintiffs-

Appellants.

On Appeal from the specs sone

Court of Illinois, Third District,

No. 79-104

There Heard on Appeal from the

Circuit Court of the Tenth

Judicial Circuit, Peoria County

Illinois.

Case No. 78L5615

A-26

Honorable

Stephen J. Covey,

Presiding Judge

BRIEF OF AMICI CURIAE

EDWARD C. RUSTIGAN

DAVID K. STAUB

MARTIN G, ROSENSTEIN

Attorneys for Continental Illinois

National Bank and Trust Company

of Chicago, Anchor Hocking

Corporation, Clark Oil and Refining

Corporation, Marshall Field &

Company, McDonald's Corporation,

Nalco Chemical Company, The

Northern Trust Company, The

Richardson Company, and Zenith

Radio Corporation,

Amici Curiae.

Of Counsel:

MAYER, BROWN & PLATT

231 South LaSalle Street

Chicago, Illinois 60604

(312) 782-0600

ORAL ARGUMENT REQUESTED

[The following pages contain

only Argument I of the

brief. ]

COMBINED REPORTING IS REQUIRED

TO FAIRLY APPORTION INCOME

OF A UNITARY BUSINESS

Where a unitary business is

conducted through a number of separate

corporations, each corporation in the

group will generally maintain separate

accounting records. Opponets of the com-

bined method of apportionment argue that

the existence of such separate records

solves the problem of allocating specific

items of income and expense to different

segments of a unitary business. They

conclude that apportionment on a separate

basis (corporation by corporation) is the

appropriate method for dividing the income

of a multicorporate enterprise among the

states in which it operates.

There are at least two basic

reasons why apportionment on a separate

A-28

basis in unsound for a truly unitary

business. First, apportionment on a

separate basis would be extremely

difficult, and often impossible, to

administer fairly. Second, apportion-

ment on a separate >»asis does not result

in a fair distribution of profits and

losses of individual members of a unitary

business among all members of the group.

A. Apportionment on Separate

Basis Cannot Be Policed

Any failure to maintain arm's-

length dealings in transactions between

members of a multicorporate unitary

business will result in distortion of the

income of the individual members. With

combined reporting, the potential problem

of distortion is eliminated by combining

the income of each member of the unitary

group prior to apportionment. If appor-

tionment is made on a corporation by

corporation basis, however, any distortion

4-29

is preserved. Thus, if apportionment on

a separate basis is permitted, the Depart-

ment must closely police all transactions

between members of the unitary group to

insure that the transactions are conducted

at arm's length.

If apportionmerit on a separate

basis is permitted, some taxpayers may be

tempted to manipulate prices in order to

reduce tax liability in the taxing state.

Although e taxpayer is entitled to struc-

ture its transactions to reduce its tax

liability, it may not do so by arbitrarily

assigning non-arm's-length prices to its

goods or services. Without combined

reporting, the Department might be forced

to sort through thousands of transactions

to determine the proper income of a single

unitary business.

While the overwhelming majority

of taxpayers make every effort to comply

with the tax laws, it is often very

A-30 :

difficult to determine proper pricing of

intercorporate transactions and there will

inevitably be many good faith disagreements

between taxpayers and revenue collection

agencies. Policing of transactions between

related companies to insure that they are

arm's-length is particularly difficult

when there is a lack of competitive pricing

information. In some instances, a product

may be unique (e.g., a manuscript, motion

picture, or master recording) and informa-

tion on property of a similar type may not

be very helpful in determining an arm's-

length price. In other instances, a

product may be transferred at an interim

stage in the manufacturing process when

no similar sale would be made by unrelated

parties, and thus no arm's-length price

would be available. Thus, even after the

non-arm's-length transactions are identi-

fied, the Department may still have

A-31

difficulty in determining a proper arim's-

length pri.ce.

The scope of the problem of

policing transactions between related

parties is shown by the myriad cases

under Section 482 of the Internal Revenue

Code, which allows the Internal Revenue

Service tc reallocate various items among

separate corporations in order to clearly

reflect the income of the corporations

for Federal income tax purposes. One

commentator has noted that such policing

at the state level "would require an arny

of agents greater than the total number

of agents employed by all the states and

*

the Federal Government combined."

Accordingly, permitting a

unitary group of corporations to report

*Keesling, A Current Look at the

Combined Report and Uniformity in

Kl lccation Practices. G2 J. Taxation

106 (1975)

4-32

income or a separate basis will create

substantial administrative burdens for

the Departnent and will prevent fair

enforcement of the law. The Court should

require combined reporting so that the

Department will not he forced to rely on

a hit-or-miss method of determining the

amount of income atti-ibutable to Illinois.

B. Unitary Met:hod Essential

for Fair Allocation of

Profits anc Losses

Even if the state could determine

that all transactions among members of a

unitary group were conducted at arn's

length, reporting the income of each cor-

poration on a separate basis is still

inappropriate for a unitary business. The

cornerstone of unitary apportionment is

the assumption that the various segments

of a unitary business are interrelated and

vital parts of the whole business. Even

A--33

though a portion of a unitary business

may only »reak even or even be unprofit-

able on a separate basis, it may contrib-

ute to the profitability of the larger

enterprise in numerous ways which may not

be recogn:.zed under any separate account-

ing systen.

The courts of several states

have recognized that a unitary business

is inseparable even where segments of the

business are separately incorporated,

The Suprere Court of California concluded

in the leading case of Edison California

Stores, Inc. v. McColgan, 183 P.2d 16

(Cal. 1947), that a California subsidiary

corporation, engaged in selling merchan-

dise, contributed to the profits of the

whole unitary enterprise in the same way

that a California branch contributed to

the profits of the unitary business in

Butler Brothers v. McColgan, 315 U.S. 501

A-34

(1942), i.e., by enabling the enterprise

to obtain more favorable prices on its

purchases. Thus, the court applied

combined formulary apportionment to the

business despite a finding that the sub-

sidiary corporation's separate accounts

were reasonable and accurate.

Contributions to a unitary

enterprise may even be less tangible: a

rember of the unitary group may be an

excellent training ground for management

personnel who later ‘work for another

member of tle group; a member of the

unitary group may serve a role in attain-

ing a "national" status for the unitary

enterprise.

The impossibility of identify-

ing, let alone quantifying, the contribu-

tions of a segment o:° a unitary business

to the enterprise as a whole makes report-

ing on a separate basis undesirable. Thus,

A-35

combined reporting provides a better means

of achieving the lezislature's goal of an

equitable method of apportionment.

It.

COMBINED REPORTING APPROPRIATELY

STRESSES SUBS'TANCE OVER FORM

Intervenors concede that formu-

lary apportionment :.s proper under the

Illinois “ncome Tax Act. However, they

argue that where a unitary group member

is a separate corporate entity, formulary

apportionment should apply to that corpo-

ration separately. Amici Curiae contend

that because of the interdependence of

the entities which nake up the unitary

group combined reporting is essential to

achieve a fair apportionment of income.

This interdependence exists whether the

unitary group is made up of corporate or

noncorporate entities. Accordingly,

formulary apportionment should apply on

A-36

a combined basis.

The application of formulary

apportionment to ezch corporate member

of a unitary group on a separate basis

would elevate form over substance.

Assuming that the enterprise is unitary,

its tax liability should be the same

whether it is structured (i) as a single

corporation consisting of separate divi-

sions, or (ii) as a multicorporate enter-

prise in the form of a parent corporation

with separate subsidiary corporations.

In applying formulary apportionment

Intervenors would distinguish (i) from

(ii). Im sitvation (i), they would

combine the separaty divisions of the

single co:poration and apportion the

divisions’ income as a unit. Yet in

situation (ii), Intervenors would treat

the parent corporation and each of its

subsidiaries separately. They would

A-37

apply fornulary apportionment to the

parent corporation 9n a separate basis

and to each subsidiary corporation on a

separate »basis. The emphasis on struc-

tural form in Intervenors’ argument is

apparent.

The Illinvis Income Tax Act

should be interpreted so that the tax-

payer's decision whether to operate his

business as a corpoxation with divisions

or a corporation with subsidiaries is

made on the basis of economic and not tax

considerations. Separate reporting might

encourage some taxpayers to fracture their

business into subsidiaries solely because

of the advantage gained under the Illinois

Income Ta>: Act.

The following example illustra-

tes the consequences of ignoring the sub-

stance of the unitary enterprise and

stressing its structural form.

£.-38

EXAMPLE

Widget Corporation, Inc. is an

Illinois corporation engaged in the isanu-

facture and sale of widgets. Widget

Corporation, Inc. has a separate unincor-

porated division, W2stern Widget Division,

which conducts all sales operations for

Widget Corporation, Inc. on the West Coast

of the United States. Widget Corporation,

Inc., also has a wholly-owned subsidiary

corporation, Eastern Widget Subsidiary,

which conducts all sales operations for

its parent corporation on the East Cost

of the United State:.

The opera-:ions of Eastern Widget

Subsidiary are identical to those of Western

Widget Division. Neither Western Widget

Division nor Eastern Widget Subsidiary

manufactures widgets. Widget Corporation,

Inc. manufactures all of the widgets which

are sold by its division and corporate

A-39

subsidiary. Widget Corporation, Inc.

engages in no sales operations on its

own. It is assumed that Widget Corpora-

tion, Inc., its division and its corporate

subsidiary constitue a unitary business.

Western Widget Division and Eastern Widget

Subsidiary are comp:.etely dependent on

Widget Corporation, Inc. for the widgets

which they sell.

In a given year, Western Widget

Division and Eastern Widget Subsidiary

each earn income of $100,000 on sales.

Widget Corporation, Inc. earns no income

since it sells at cost. (It is recog-

nized that: Widget Corporation, Inc.

probably should not sell at cost since

it normally would be entitled to a manu-

facturing profit. However, see the |

discussion of administrative problems

in I.A. of the argument at page 8 above).

Western Widget Division and Eastern

4-40

Widget Subsidiary each have property,

payroll, and sales of $200,000, all of

which is the result of sales operations

outside Illinois. Widget Corporation,

Inc. has $200,000 of property, payroll,

and sales inside Illinois as a result

of the location of its manufacturing

facilities there. ‘fable I summarizes

*

the amounts set forth above.

*The apportionment formula under

the Illinois Income Tax Act is a three

factor formula based on property, pay-

roll and sales. For purposes of

simplification, this example treats

the factors in the aggregate.

Widget

Corporation, Inc.

Western

Widget Division

Eastern

Widget Subsidiary

TABLE I—FACTS

Property Propert

Payroll Payroli

Sales Sales

Income Inside Ill. Outside I1l.

$200,000

$100 ,000 $200 ,000

$100,000 $200 ,000

Under the combined method of reporting, formulary apportionment

would apply to the income of the unitary group as presented in

Table II.

T9-V¥

TABLE II—Combined Reporting

Illinois

ate tae spent

)

Widget Corporation, Inc.

Western Widget Division

Eastern Widget Subsidia

Tilinois oe No “Tilinote

ow oe ayrcoli-Sales

Widget Cemmeuenion. Inc.

Western Widget Division

Eastern Widget Subsidiary

$200,000 xX $200,000

$600 , 000

Income of

Widget Corporation, Inc.

Western Widget Division

Eastern Widget Subsidiary

$66,667 subject to Illinois

Income Tax

Income of Unitary Group Subject to Illinois

Income Tax = $66,667.

>

..

nN

Table III illustrates how formulary apportionment would

apply to the unitary group on a separate basis.

TABLE III—Separate Reporting

(1) Application of Formulary Apportionment to Widget Corporati

Inc. and its unincorporated division, Western Widget Division.

Tilinois

a

fr)

Widget Corporation, Inc. Income of

Western iidget Division X Widget Corporation, Inc.

Tilinois ana Non-IIlinois Western Widget Division

eS eee

°

Widget Corporation, Inc.

Western Widget Division

Sraeene X $100,000 = $50,000 subject to

Illinois Income Tax

TABLE III (Cont'd)

€7-V

TABLE I1I—Separate Reporting

(Cont'd)

(2) Application of Formulary Apportionment to Eastern

Widget Subsidiary.

Illinois

ead pean,

°

Eastern Midget Subsidiary 4 Income of >

nois anc Non- nois Dasiern Widget Subsidiary 5

vias cagned? degectal -Sales

Eastern Wideet Subsidiary

$0 X $100,000 = #£$0 subject to Illinois

$200 , 000 Income Tax

Income of Unitary-Group Subject to Illinois

Income Tax = $50,000.

£-45

As Table III illustrates, appor-

tionment of the income of the unitary group

on a separate basis results in all of the

income earned by Eastern Widget Subsidiary

escaping apportionment under the Illinois

' Income Tax Act, even though the manufac-

turing facilities upon which this’ income

depends are located within Illinois.

On the other hand, all of the income

earned by Western Widget Division is

subject to the Illinois apportionment

formula because it operates as a division

of Widget Corporation, Inc. rather than

as a subsidiary corporation. Hence, if

the income of the uritary group is appor-

tioned on a separate basis, Widget Cor-

poration, Inc. will have benefited under

the Illinois Income Tax Act simply by

incorporating its East Coast sales opera-

tions into a separate corporation.

£-46

If the exemple were altered so

that either (i) Widget Corporation, Inc.

and Western Widget [Division were located

outside Illinois while Eastern Widget

Subsidiary was located inside Illinois

or (ii) Widget Corpcration, Inc. was

located outside Illinois while Western

Widget Division and Eastern Widget Sub-

sidiary were locatec inside Illinois, a

greater Illinois tax liability would

result under separate reporting than

under the combined method.

The point of this example,

however, is not to show that Illinois

exacts a greater or lesser tax depending

on which rethod is used. The respective

parties would agree there is a difference.

Amici Curiae merely wish to illustrate

that, given the fact that formulary

apportionment has been adopted in

Illinois, basing the tax liability of a

A-47

group of interdependent and inseperable

business activities on whether a particu-

lar activity is structured as a separate

corporation places a wholly unwarranted

emphasis on the structural form of the

enterprise.

Courts ir other states have

recognized that the structural form of

the unitery enterprise should not affect

the apportiomment cf income and, there-

fore, have requirec use of combined

reporting. See, Ecison California Stores,

Inc. v. McColgan, 183 P.2d 16, 21 (Cal.

1947); Coca-Cola Company v. Department

of Revenue, 533 P.2d 788, 792-94 (Ore.

1974); Montana Department of Revenue v.

American Smelting & Refining Company,

567 P.2d 901, 908-09 (Mont. 1977).

Similar recognition has been accorded

in legal commentary. Frank M. Keesling

explains that the purpose of the combined

A--48

report is to assure that where a business

is conducted both inside and outside the

taxing st:ate, the business’ income will

be apportioned in the same fashion

whether the business consists of one

corporation or multiple corporations.

He notes that in bcth cases the income

of the business is computed as a unit,

apportioned by applying the appropriate

formila, and the amount so apportioned

is added to any nonbusiness income which

the taxpayer derives from sources within

the taxing state. Thus, in determining

the amount of business income attribu-

table to a particular state, "no advantage

is obtained, and no detriment suffered,

as the result of employing a number of

corporations rather than one to operate

a business," Keesling, A Current Look

at the Combined Report and Uniformity

in Allocation Pract:.ces, 42 J. Taxation

A-49

106 (1975).

Furthermore, the United States

Supreme Court's recent opinion in Mobil

Oil Corp. v. Commissioner of Taxes, 48

U.S. L.W. 4306 (March 19, 1980), reflects

unwillingness to permit the structural

form of a unitary enterprise to affect

issues of taxation. In Mobil Oil, the

taxpayer argued tha: the inclusion, by

a non-domicillary st:ate, of dividends

received from the taxpayer's foreign

subsidiaries and affiliates in the

income tax base subject to apportionment

violated the Due Process and Commerce

Clauses of the United States Constitution.

In the context of the taxpayer's due

process challenge, the Court refused to

draw any distinctior. on the grounds that

the income was received in the form of

dividends from separately incorporated

entities rather thar derived from

A-50

intracorp ?rate divisions. The Court

stated:

"Superficially, intercor-

orate division might appear to

e a more attractive basis for

limizing apporcionability. But

the form of business organization

may have nothing to do with the

unde:-lying unity or diversity of

business enterprise. Had appel-

lant chosen to operate its for-

eign subsidiar:.es as separate

divisions of a legally as well

as a functiona:.ly integrated

enterprise, there is little

doubt: that the income derived

from those divisions would meet

due process requirements for

apportionability. ot General

Motors Corp. v. Washington, 3/7

U.S. 436, 441 (1964). Trans-

forming the same income into

dividends from legally separate

entities works no change in the

underlying economic realities

of a unitary business, and ac-

cordingly it ought not to affect

the ~epportionatility of income

the parent receives." 48 U.S.

L.W. at 4310.

*Amici Curiae acknowledge that the

Court refused to decide whether the Due

Process Clause requires combined re-

oe 48 U.S.L.W. 4306, n. 15.

owever, Amici Curiae believe that the

Court's distaste for arguments emphasiz-

ing form over substance bears noting.

A-51

The purpose of formulary

apportiorment under the Illinois Income

Tax Act is to fairly and equitably

attribute the income earned by a’ unitary

enterprise to the business activities

which it conducts within the State.

Amici Curiae submit that fairness and

equity cannot be achieved if a distinc-

tion is made merely because a segment

of the unitary enterprise operates as a

separate corporation,

A-52

CONCLJSION

In light of the foregoing policy

considerations, Amici Curiae respectfully

request tnat this Court affirm that por-

tion of tie decision of the Aprellate

Court which would require the combined

method of reporting in the State of

Illinois.

Respectfully submitted,

EDWARD C. RUSTIGAN

DAVID K. STAUB

MARTIN G. ROSENSTEIN

Attorneys for Continental

Illinois National Bank

and Trust Company of

Chicago, Anchor Hocking

Corporation, Clark Oil &

ae Corporation,

Marshall Field & Company,

McDonald's Corporation,

Nalio Chemical Company,

The Northern Trust Com-

any, The Richardson

ompany, and Zenith Radio |

Corporation, Amici Curiae.

Of Counsel:

Mayer, Brown & Platt

231 South LaSalle Street

Chicago, Illinois 60604

(312) 782-0600

A-53

Appendix E

THE THEORY OF THE UNITARY

BUSINESS PRINCIPLE

[Excerpt from International Division of

the Income Tax Base o tinationa

Enterprise, Publ. Multistate Tax Commission,

Ceofiey John Harley, 1981, p. 6.]

The unitary enterprise theory

rests on economic analysis. Its focus is

on the geographic locations of the

comp nents of the multinational enterprise

itself. It views a group of enterprises

under common ownership as components of

a single integrated business operation,

arranged in a particular way purely to

accommodate legal requirements. The

central operational premise is that all

parts are coordinated by a central

management policy and structure which

seeks to maximize profits over-all.

Accordingly, intercorporate business is

irrelevant and profit or loss is determined

by transactions with third parties. The

intercorporate transactions are

A-54

essential factors in producing profit,

in the sense that without them, and the

peculiar advantages associated with

integrated enterprises, there would be no

product at the end, but it is the profit

itself that: counts. The transactions up

to the point of sale to the unrelated

third party are irrelevant for tax

purposes because profit or loss can only

be determined when the entire enterprise

completes the process of production.

The basic question addressed

by the unitary method is how the overall

profit of the enterprise is to be assigned,

given the fiact that separate tax juris-

dicticns do exist. The separate entity

theory requires that profits be assigned

to the particular units of the organization

in each location. The unitary theory

treats the units as being irrelevant;

what counts is the extent of the profit

A-55

making activity in any given location,

based on a measure of territorial

contribution, The unitary method seeks

to assess what factors of production were

located in each country, measuring

objectively how much labor was used, how

much capitéel was employed, and where the

sales took place. The formula, based on

these factcrs, assigns income to each

geographic location on these bases, dividing

the entire group's total income among the

jurisdictions in which the units happen to

be located.