Appellants Reply Brief — Container Corp. of America v. Franchise Tax Bd.

No. 81-523 To four,

DEC 23 1992

In the pe Court ae.

United States ; bie

Ocroser Term, 1982

ConTarneR CorPoraTION OF AMERICA,

Appellant,

vs.

Francuise Tax Boarp,

- Appellee.

On Appeal from the Court of Appeal

of the State of California

for the First Appellate District

APPELLANT'S REPLY BRIEF

Frankurn C. LatcHam

COUNSEL OF RECORD

Prentiss WILSON, JR.

James P. Kierer

One Market Plaza

Spear St. Tower,

34th Floor

San Francisco, CA 94105

Telephone: (415) 777-6000

Of Counsel Counsel for Appellant

Moraison & ForrsTER Container Corpora-

One Market Plaza tion of America

Spear Street Tower

San Francisco, CA 94105

BOWNE OF SAN FRANCISCO, INC. © 190 NINTH ST. © %.F.,CA 94103 © (415) 864-2300

Introduction : Foot ERO OT RT ES Ste ae ae ES

I. There is no substantial operational interdepend-

ence between Container and its foreign. subsidi-

aries; consequently, the due process clause pro-

hibits the taxation of Container and its foreign

subsidiaries as a single unitary business ..................

II.

III.

A.

B.

The FTB and its amici disregard the

ASARCO and Woolworth decisions ..................

The FTB and its amici rely entirely on the

sweeping California definition of a unitary

business, refusing to recognize the definition

provided by the court in Exxon, ASARCO

and Woolworth under the due process clause

The functional integration test of a unitary

business responds to the reasons for the resort

to apportionment; the flow of goods element

of that test provides a badly needed objective

standard of apportionment —_—

Not only does the FTB build its case on an

erroneous legal standard, but also its argu-

ment is based in substantial part on supposi-

tions and distortions, not on facts of record

California’s apportionment violates the due proc-

ess clause because it taxes income earned in for-

eign countries and not in California

California’s apportionment violates the commerce

clause because it results in multiple taxation of

foreign source income ....

ae

11

ii

TABLE OF AUTHORITIES CITED

Cases

Page

ASARCO Ine. v. Idaho State Tax Commisvion, 50

U.S.L.W. 4962, 73 L. Ed. 2d 787 (1982) ............ 1, 2, 4, 5, 6,

sisasniadiaiedniatacceaionbiadieatiedianisbiadichcaiiceldiaaatiinds 7,9, 11, 20

Butler Bros. v. MeColgan, 315 U.S. 501 (1942) -...... 3, 12, 13

Chicago Bridge and Iron Co. v. Caterpillar Tractor

RT 18

Exxon Corp. v. Wisconsin Department of Revenue,

KR enrere 2, 3, 4, 6, 12, 13

F.W. Woolworth Co. v. Taxation and Revenue Depart-

ment, 50 U.S.L.W. 4957, 73 L. Ed. 2d 819 (1982)

ssttednitieineninasseaplicadatmemnitianitsitissiisininiail 1, 2, 3, 4, 5, 6, 7, 9, 10, 11, 20

Hans Rees’ Sons, Inc. v. North Carolina, 283 U.S. 123

STII. ccninsaresntanntiadiitinsannimnemaintttneseamiiivmmasiininiia 12, 14, 20

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

IUD bneinccctnqsanstinnciminagaidiainaiclnnmniniints 1, 15,18

John Deere Plow Co. v. Franchise Tax Board, 38 Cal.

2d 214, 238 P.2d 569 (1951), appeal dismissed, 343

i EDD :senticeneenscnpepricratinarecasinvsininiminnimediensiaiinnen 16

Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S.

425 (1980) ...... snliadiiniseadapaniatiiteniahincsiiiiapeintiiimatintties 2, 3,19

Moorman Manufacturing i, v. Bair, 437 U.S. 267

IED ccicintetntnninsiihisiddintasiedbimunntenpatsitiieipiatimesseidinantinns 12

Norfolk & Western Railway Co. v. Missouri State Tax

Commission, 390 U.S. 317 (1968) -..............-..--.-.... 12, 14, 20

Norfolk & Western Railway Co. v. North Carolina, 297

ED CUED cnccencrevcssiennnieastinetateanccriniatinnseisnatamninniitiis 16

Russell Stover Candies, Inc. v. Department of Revenue,

vacated and remanded, 51 U.S.L.W. 3251 (U.S. Oct.

4, 1982) (No. 81-2080) a 2

Zschernig v. Miller, 389 U.S. 429 (1968) ainaiisidiellaidiatedlite 1

iii

Tasie or Autrnorittes Crrep

Statutes

Page

California Revenue and Taxation Code, Section 24725 10

Internal Revenue Code: :

Section 482 .. 10

Section 901 19

SUITES EEIINEIIEE ‘<dsniguinitiveeutebinchessenaadseniinielninidibedionseias 19

Other Authorities

Harvard University, World Tax Series—Taxation in

Italy 335 (1964) —.......... . 18

Hellerstein and Hellerstein, State and Local Taxation,

I Us TUITE scieniiccsiinesienipaninechimatnitiidinndininmettil 10, 15

Hellerstein, “Recent Developments in State Tax Ap-

portionment and the Cireumscription of Unitary

Business,” 21 National Tax Journal 487 (1968) ....... 6

Parent and Non-100 Percent Owned Affiliates

A list of appellant’s parent and non-100 percent owned

affiliates is found in Appendix C to the Jurisdictional State-

ment at A-34, and there have been no changes to that list.

No. 81-523

In the Supreme Court

OF THE

United States

OcroserR TERM, 1982

CoNnTAINER CORPORATION OF AMERICA,

Appellant,

vs.

Francuise Tax Boarp,

Appellee.

On Appeal from the Court of Appeal

of the State of California

for the First Appellate District

APPELLANT'S REPLY BRIEF

INTRODUCTION

Appellant, Container Corporation of America (Con-

tainer), will discuss arguments made by Appellee, Fran-

chise Tax Board (FTB), and amici supporting the FTB

in three areas: (i) the due process clause and the unitary

concept; (ii) the due process clause and taxation of extra-

territorial income; and (iii) the commerce clause and

multiple taxation. Container believes no further argument

is necessary regarding its position that worldwide unitary

combination violates the commerce clause because it

impairs the foreign policy of the United States. The

FTB primarily asserts that the Court cannot prevent such

interference unless Congress specifically forbids state

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

U.S. 434 (1979) and Zschernig v. Miller, 389 U.S. 429

(1968) are clear authority to the contrary.

I. THERE IS NO SUBSTANTIAL OPERATIONAL IN-

TERDEPENDENCE BETWEEN CONTAINER AND

ITS FOREIGN SUBSIDIARIES; CONSEQUENTLY,

THE DUE PROCESS CLAUSE PROHIBITS THE

TAXATION OF CONTAINER AND ITS FOREIGN

SUBSIDIARIES AS A SINGLE UNITARY BUSI-

NESS

A. The FTB and Its Amici Disregard the ASARCO and

Woolworth Decisions

In its opening brief, Container demonstrated that there

is no substantial operational interdependence between

Container and its foreign subsidiaries. Container argued

that under the most recent decisions of this Court, par-

ticularly ASARCO Inc. v. Idaho State Tax Commission,

50 U.S.L.W. 4962, 73 L. Ed. 2d 787 (1982), and F.W.

Woolworth Co. v. Taxation and Revenue Department,

50 U.S.L.W. 4957, 73 L. Ed. 2d 819 (1982), the lack of any

substantial operational interdependence prohibited Cali-

fornia from taxing Container and its foreign subsidiaries

as a single unitary business. Appellant’s Br. at 40-49.

The FTB and its amici, however, ignore the real meaning

2

of the ASARCO and Woolworth decisions, claiming that

“these decisions are not directly applicable or controlling,”

Appeliee’s Br. at 62, and that the issues in those cases

were “erroneously resolved.” Multistate Tax Commission

(MTC) Br. at 22, n.37.

Realizing that their position was untenable under

ASARCO and Woolworth, the FTB and its amici chose

to ignore the impact of those decisions, and conducted no

comparison of the facts in those cases with the facts in

the present case.’ As set forth in Appellant’s Brief on the

Merits, when the proper factual comparison is made,

it is clear that Container and its foreign subsidiaries

operated as discreet businesses much like Woolworth and

its foreign subsidiaries. Appellant’s Br. 42-43. Thus, under

Woolworth as well as ASARCO, Container and its foreign

subsidiaries are not a single unitary business.’

ASARCO, Woolworth, Exxon Corp. v. Department of

Revenue, 447 U.S. 207 (1980), and Mobil Oil Corp. v.

Commissioner of Taxes, 445 U.S. 425 (1980), all indicate

that a state may justify taxing an enterprise as a unitary

business only if there exist “factors of profitability” aris-

ing “from the operation of the business as a whole.”

Woolworth, 73 L. Ed. 2d 828, quoting Mobil, 445 U.S. at

*While California and its amici hint that ASARCO and Wool-

worth have no relevance outside the area of apportionment of divi-

dends, the Court has indicated that the opposite is true, remanding

a case conceining the permissibility of unitary combination for

consideration in light of ASARCO and Woolworth. Russell Stover

Candies, Inc. v. Department of Revenue, vacated and remanded,

51 U.S.L.W. 3251 (U.S. Oct. 4, 1982) (No. 81-2080).

*The FTB ignores the impact of ASARCO and Woolworth not

only in connection with the substantive issue of the definition of

a unitary business under the due process clause, but also in its

numerous unsupported statements regarding the manner in which

this Court should review the decision of the court below. Appellee’s

Br. 2-5, 45-56. Those statements are unsupported by relevant au-

thority and inconsistent with the obvious care and completeness

with which this Court reviewed the records in ASARCO and Wool-

worth.

3

438. These factors of profitability, all of which must exist

to a substantial extent, are “functional integration, cen-

tralization of management, and economies of scale.” 7d.

In Container’s case, “there was little functional integra-

tion,” as the Court in Woolworth defined this element. 73

L. Ed. 2d at 828. The subsidiaries located in each particu-

lar country operated as fully integrated, self-sustaining

business operations, conducting every element of business

operations themselves. Stip. f/f 61, 111-113, 118, J.A. 30,

56-7, 59. In describing functional integration, the Court

referred to Exxon, where there was a “highly integrated

business” involving “a unitary stream of income of which

the income derived from internal transfers of raw ma-

terials ...is a part.” Woolworth, 73 L. Ed. 2d at 828. Con-

tainer and its foreign subsidiaries do not fit this deserip-

tion.*

There was no centralization of management or any other

economy of scale. As in Woolworth, “each subsidiary op-

erated as a distinct business enterprise at the level of full-

time management.” Zd. at 829. The management of the

foreign subsidiaries had complete authority and control

over day-to-day business decisions. Stip. {J 127, 130, J.A.

65-66, 67-68. Such business decisions were not reviewed or

subject to review by Container. Major policy matters,

defined as consisting exclusively of capital appropriations,

were also the responsibility of the foreign subsidiaries, but

were generally subject to review by Container. Even in

matters involving a major capital expenditure, the initia-

tive rested with the foreign subsidiary, and local manage-

*The FTB argues that no transfers of product occurred in either

Exxon or Butler Bros. v. McColgan, 315 U.S. 501 (1942). Appellee’s

Br. at 83-85. However, as noted in ASARCO, substantial transfers of

product were essential to Exxon’s business. 73 L. Ed. 2d at 803 n.24.

Similarly, the central purchasing of inventory in Butler Bros. con-

stitutes the transfer of product and provides the same functional

integration and economies of scale as the transfers of raw mate-

rials in Exxon.

4

ment reserved the right to forego actual implementation

of projects authorized by Container. All other policy

matters were the complete responsibility of the foreign

subsidiaries. Stip. { 74, J.A. 39-40.

The FTB argues that Container’s review and approval

of capital appropriations resulted in centralization of man-

agement. Appellee’s Br. at 23-24, 69-70. However, Container

simply reviewed and generally approved such decisions

made by the management of the foreign subsidiaries. Stip.

74, J.A. 39-40. This review and approval did no more

than protect Container’s interests as an investor in the

subsidiaries. Thus, as in Woolworth, “[t)here were some

managerial links,” but these links do not rise to the level

of management centralization or achievement of a signifi-

cant economy of scale. “Except for the type of occasional

oversight—with respect to capital structure, major debt

and dividends—that any parent gives to an investment in

a subsidiary, there is little or no integration of the business

activities or centralization of the management of these...

corporations.” 73 L. Ed. 2d at 830-31.

B. The FTB and Its Amici Rely Entirely on the Sweeping

California Definition of a Unitary Business, Refusing

to Recognize the Definition Provided by the Court in

Exxon, ASARCO and Woolwezth Under the Due

Process Clause

The FTB’s argument regarding unity is based upon the

sweeping premise that “taxpayers [are] operating a uni-

tary business .... [iJf the in-state business is dependent

upon or contributes to the out-of-state business in any

material respect” and that “the due process requirements

of unity should be no greater tu. California’s contribu-

tion test.” Appellee’s Br. at 59, 60. The FTB makes no

reference to the standards set forth in. ASARCO, Wool-

worth, and Exxon, and ignores the fact that pursuant to

the FTB’s standard this Court would have reached a dif-

ferent conclusion with regard to some of the businesses

in ASARCO and Woolworth. For example, in ASARCO

5

one of the subsidiaries, Southern Peru Copper Corp., sold

about 35% of its output to ASARCO. 73 L. Ed. 2d at 798.

Thus, under the FTB’s standard, Southern Peru and

ASARCO clearly “contributed” to, and perhaps were “de-

pendent” upon the operations of one another.

Similarly, in Woolworth, the parent had common di-

rectors with some of the subsidiaries, reviewed all major

financial decisions by the subsidiaries, such as the amount

of dividends to be paid by the subsidiaries and the crea-

tien of substantial debt, and reinvested dividends in some

of the subsidiaries. In addition, there was frequent “com-

munication between the upper echelons of management of

the parent and the subsidiaries.” 73 L. Ed. 2d at 829, 830.*

Despite any “contribution” which the parent may have

made to the cperations of the subsidiaries, the Court found

that Woolworth was not engaged in a single unitary busi-

ness with its foreign subsidiaries.

The constitutional deficiency of California’s contribution

test is aggravated by the FTB’s continued reliance on its

administrative presumption that companies engaged in the

same line of business are conducting a single unitary busi-

ness. Appellee’s Br. at 82. The FTB ignores the fact that

defining a unitary business in terms of a sweeping “con-

tribution” test “would destroy the concept.” ASARCO,

72 L. Ed. 2d at 801. Particularly when applied in com-

bination with an administrative presumption such as

California’s, “this conception of the ‘unitary business’

limitation becomes. no limitation at all,” or is at best

“arbitrary.” Id; see also Appellant’s Br. at 44-45. In short,

the FTB, sub rosa, asks this Court to overrule its recent

decisions in ASARCO and Woolworth.

‘The upper echelon of Container’s management had significantly

less contact with its subsidiaries. Compare Stip. {{ 126-130, J.S.

65-68.

6

C. The Functionai Integration Test of a Unitary Business

Responds to the Reasons for the Resort to Apportion-

ment; the Flow of Goods Element of that Test Pro-

vides a Badly Needed Objective Standard of Appor-

tionment

In giving content to the “functional integration” require-

ment of a unitary business, the Court in ASARCO, Wool-

worth, and Exxon emphasized the substantial flow of raw

materials, manufactured products, or inventoriable goods

between subsidiaries or divisions of a manufacturing, pro-

ducing or mercantile enterprise. This implementation of

the functional integration test of a unitary business re-

sponds to the historical reasons for the development of

apportionment. Apportionment was developed by the

States because they found it difficult to localize, State

by State, by cost accounting or any other method, the

profits derived from businesses that manufacture or pro-

duce goods in one State and market them in others, or by

mercantile businesses that buy goods in one State and sell

them in others, and in other integrated industries. Conse-

quently, the States found it necessary to resort to appor-

tionment to divide the income of a unitary business.’ How-

ever, where, as in this case, each of the companies

essentially conducted all its basic operations—the produc-

tion or purchase of raw materials, manufacturing and

marketing—within a single country, the profit earned in

each country can be determined by looking solely to the

operations in that country, without taking into account

the operations conducted in other countries. Indeed, to

attribute income by the apportionment method in such

cases tends to produce the type of misattribution and dis-

tortion of income that the facts of the instant case disclose.

In addition to being basic to the underlying reason for

formulary apportionment, the substantial flow of goods

*See Hellerstein, “Recent Developments in State Tax Apportion-

ment and the Circumscription of Unitary Business,” 21 National

Tax Journal 487 (1968).

7

requirement® has the further advantage of introducing an

objective factor into an otherwise largely subjective deter-

mination as to whether the business is unitary. Adopting

such an objective standard would reduce the number of

eases in which it is necessary to refer to factors such as

centralized management and services, which are often not

operational in character, but directed to protection of the

parent’s interest as a shareholder.

D. Not Only Does the FTB Build its Case on an Errone-

ous Legal Standard, But Also its Argument is Based

in Substantial Part on Suppositions and Distortions,

Not on Facts of Record

Having ignored the proper test enunciated in ASARCO

and Woolworth, the FTB proceeds to apply its unique

view of the facts to its erroneous legal standard. The

heart of its factual argument is a forty-six page review

of sixteen items which the FTB contends demonstrate Con-

tainer’s “contribution” to its foreign subsidiaries. Appel-

lee’s Br. 5-36, 68-83. Some of the items do not show any

contribution by Container at all.’ The others either show

only that Container took precautions to protect its interest

as an investor, or that Container took no significant role

*A flow of goods or products needs to be substantial to make

the business unitary, but that is not an issue in the instant case.

Here there is no need to determine what constitutes a substantial

flow of goods or products since by any standard the flow of goods

and products between Container and its subsidiaries was so incon-

sequential as not to be substantial. Appellant's Br. at 4.

"E.g., Item 2 refers to procedures Container established for the

subsidiaries to use in transmitting financial reports from their own

complete accounting records to Container. Item 5 shows that Con-

tainer and the subsidiaries used different law firms and that Con-

tainer’s general counsel spent part of his time handling Container’s

(not the subsidiaries’) international legal affairs. Appellee’s Br. at

69, 7]

E.g., Item 1 refers to procedures in acquiring or forming new

subsidiaries. Item 4 refers to auditing by an accounting firm. Item

5 discusses loans by Container to the subsidiaries. Item 15 men-

tions the review by Container’s management of capital appropria-

tions. Appellee’s Br. at 69, 71, 77.

8

in the operations of the subsidiaries (these are discussed

hereinafter). Moreover, in order to make these items seem

important the FTB has overstated or misstated the facts

in a number of instances.°

A typical example of overstatement is found in

Item 12 of the FTB’s list, at page 75 of its brief, where

it attempts to demonstrate that “the paperboard/packaging

function was integrated under CCA’s control.” In support

of this contention the FTB states that Container contracted

to “and did, provide all technical, management and other

assistance needed by the subsidiaries to function in that

business.” Appellee’s Br. at 75. This statement is contra-

dicted by the Stipulation. The FTB’s effort to support its

position by reference to the contracts to provide technical

services (i.e., Technical Service Agreements) ignores this

*There are two particularly offensive misstatements. First, on

page 69 of its brief the FTB sets out what purports to be a quota-

tion from paragraph 28 of the Stipulation of Facts as support for

its contention that “site selection and expansion of markets was

[sic] centrally controlled.” What the FTB has set forth as a quota-

tion, however, appears nowhere in the record, but is instead a

description which has been created by the FTB and represented to

this Court to be part of the Stipulation of Facts. Moreover,

the actual language of paragraph 28 of the Stipulation of. Facts,

J.A. 16-17, shows that there is no mention of any review or control

over site selection, nor does the paragraph refer to a direct market

expansion by an existing subsidiary. Instead, the paragraph explains

the procedures followed in acquiring or forming new subsidiaries

and expanding markets by that means.

Similarly cavalier treatment of the record is found elsewhere.

Thus, on page 70 of its brief the FTB contends that Container cen-

tralized and integrated financial planning for its foreign subsidi-

aries, and quotes the Stipulation as stating, “The budgets were sub-

mitted to CCA . . . . These were usually reviewed by CCA in con-

nection with its annual meeting.” Convenient use of ellipsis aids the

FTB here, since the omitted language states that the budgets were

submitted to CCA “for information but not specific approval.” Stip.

¢ 134, J.A. 70 (emphasis added). Elsewhere paragraph 134 states

that, “During these years there was little profit planning,” and that

the subsidiaries’ directors had fina: approval of capital projects and

substantial control over borrowing funds. Id.

stipulated evidence.” Very little in the way of technical

assistance was provided pursuant to the Technical Ser-

vice Agreements, even though those agreements were

worded very broadly. Furthermore, such agreements were

not entered into with the important Colombian and Vene-

zuelan subsidiaries. Stip § 146, J.A. 76."

The FTB makes an additional overstatement by its re-

peated references to Container’s “concession” that the fair

*°Container offered little material assistance in developing tech-

niques for processing raw material and for adapting machinery to

different grades of paperboard. Stip. {{ 76, 84, 85, 146, J.A. 41, 44-5,

45-6, 75-6. Similarly, Container had little or no role in the produc-

tion of paperboard-based packaging by its subsidiaries, since the

functional and graphic designs of the packages which Container

manufactured were generally ill-suited to the products and markets

served by the foreign subsidiaries. Stip. {{ 56, 57, 66-70, 73, J.A.

27-8, 34-7, 39.

Furthermore, the provision of technical services by ASARCO to

its subsidiaries appears to have been far more significant. Explora-

tion services were provided on a centralized basis. ASARCO Joint

Appendix at 90. In addition, ASARCO’s central research depart-

ment made its findings available to all of the subsidiaries. Id.

“Similarly overstated are the FTB assertions that “CCA pro-

vided a centralized source of key personnel” and that “centralized

personnel training at CCA was provided.” Appellee’s Br. at 73.

Compare, Stip. 119, J.A. 60-1 (limited number of former Con-

tainer employees employed by foreign subsidiaries); Stip. { 123,

J.A. 64 (difficulty of adjusting to foreign countries); Stip. { 132,

J.A. 69 (no U.S. training program for foreign subsidiaries).

There are other examples of overstatements. Item 10 ( Appellee’s

Br. at 74) alleges that key subsidiary employees “in substance”

remained employees of Container. In fact, this was done as a ser-

vice to a few employees; at their request Container paid them in

dollars due to special circumstances. Container was reimbursed by

the subsidiaries for both the payroll costs and Container’s account-

ing costs. Stip. § 125, J.A. 65. There is no evidence Container con-

trolled these employees. Container’s efforts to accommodate these

employees is comparable to Woolworth’s action in keeping some

employees of the Spanish and Mexican subsidiaries in the parent's

pension plan. Woolworth Joint Appendix, pp. 50-51. In fact, Wool-

worth itself made contributions to the plan on behalf of these

employees. Id.

10

market value of some of the services it provided to sub-

sidiaries could not be determined. See, e.g., Appellee’s Br.

at 81-82. However, the Stipulation makes clear that in

those instances charges were made by apportioning “the

overhead of the relevant staff department”. Stip. § 144,

J.A. 74-75. Furthermore, the FTB has stipulated that

all reasonable charges for services and other items which

should have been made were in fact made. The parties

stipulated that the figures in Exhibits A and B to the

Stipulation, including the net incomes of Container and the

subsidiaries “are accurate.” Stip. J 21, J.A. 11. For the net

income figures to be “accurate” they must obviously take

into account all adjustments which would be appropriate

The FTB’s claim that in some instances reasonable charges

were not made by Container to the subsidiaries is unimpressive.

See Appellee’s Br. 32, et seq. Reference is made to the fact that

Container charged inadequate interest on certain loans to foreign

subsidiaries. The effect of such “loans” is thus similar to Wool-

worth’s policy of reinvesting dividends in its German subsidiary.

73 L. Ed. 2d at 829 n.14; Woolworth Joint Appendix at 31, 51.

As to the remainder of the claimed undercharges, it is questionable

whether Container should have made any charges at all, or, if they

should have been made, whether the revised charges would have

made any significant difference in determining the net income of

Container or the subsidiaries. It is stipulated that “no adjustments

to income or deductions pursuart to Internal Revenue Code Section

482 were proposed by the Internal Revenue Service” for the years

in issue. Stip. § 151, J.A. 78-79. Furthermore, one of the claimed

undercharges is incorrect; the Colombian subsidiary repaid the ad-

vances made by Container and the Colombian government to the

joint venture discussed at Stip. § 158, J.A. 81-82. In addition, even

if a reasonable charge had not been made in certain instances, this

would not indicate, as the FTB contends, that a single unitary busi-

ness existed under the standards enunciated by this Court. Rather,

such a fact would indicate that the IRS and/or the FTB might have

grounds for adjusting the income of Container and the foreign sub-

sidiaries in accordance with normal separate accounting, arm’s-

length principles, pursuant to Section 482 of the Internal Revenue

Code and Section 24725 of the California Rev. & Tax. Code. See

Hellerstein and Hellerstein, State and Local Taxation, 501-02 (4th

ed. 1978).

11

under the separate accounting, arm’s-length method. It is

far too late in the day for the FTB to challenge the stipu-

lated figures.

While in this case, as in ASARCO and Woolworth, there

are undoubtedly some ways in which a parent contributed

to its foreign subsidiaries, the FTB’s list of alleged con-

tributions is not an accurate representation of any such

contributions, and, even if it were, it does not demonstrate

any substantial operational interdependence. A review by

this Court of the Stipulation and the other evidence of

record contained in the Joint Appendix will demonstrate

that “‘no phase of any subsidiary’s business was integrated

with the parent’s,” 73 L. Ed. 2d at 828, so that the FTB

may not tax Container and its foreign subsidiaries as a

single unitary business.

II. CALIFORNIA’S APPORTIONMENT VIOLATES

THE DUE PROCESS CLAUSE BECAUSE IT

TAXES INCOME EARNED IN FOREIGN COUN.

TRIES AND NOT IN CALIFORNIA

Container’s opening brief demonstrated that world-wide

unitary combination frequently (including in this case)

misapportions income to the United States members of a

unitary group, resulting in extra-territorial taxation in

violation of the due process clause. In an effort to confuse

this issue, the FTB and its amici have disputed Container’s

analysis, notwithstanding that it is based upon stipulated

figures. Before answering the arguments of the FTB and

its amici, certain undisputed facts should be reviewed.

1. For the years in dispute, the FTB determined an

additional franchise tax liability for Container by adding

approximately $41 million of foreign subsidiary income to

the apportionable tax base. J.A. Ex. 7. The FTB used the

book income of the subsidiaries (taken from the federal

income tax Forms 2952) in computing this sum. Stip. { 21,

J.A. 11-12.

2. Formulary apportionment determines the income of

each member of the group by multiplying the apportion-

able base by the factors attributable to each member of

the group. The effect of formulary apportionment in this

12

case is to apportion about half the income of the most

profitable subsidiaries in Colombia and Venezuela away

from those subsidiaries to Container, principally, and to a

lesser extent to certain European subsidiaries. Stip. re

Testimony, Sched. VI, J.A. 109-113; Appellant’s Br. 17.

3. The foreign subsidiaries filed income tax returns

in the countries in which they were located on a separate

accounting basis and paid substantial taxes to those coun-

tries. Stip. 77 140, 159, J.A. 72, 83-4.

4. The net incomes of Container and the subsidiaries

on a separate accounting basis are set out in the record

and stipulated by the parties to be accurate. Stip. § 21,

J.A. 11-12.

As a first attack upon Container’s due process argu-

ment, the FTB argues that separate accounting can never

be used to impeach formulary apportionment, citing, inter

alia, Exxon Corp. v. Wisconsin Department of Revenue,

447 U.S. 207 (1980), and Butler Bros. v. McColgan, 315 US.

501 (1942). However, this Court has endorsed use of sep-

arate accounting analyses to impeach formulary apportion-

ment in Norfolk & Western Railway Co. v. Missouri State

Tax Commission, 390 U.S. 317 (1968), and Hans Rees’ Sons,

Inc. v. North Carolina, 283 U.S. 123 (1931). See Moorman

Manufacturing Co. v. Bair, 437 U.S. 267, 272 (1978);

see also Exxon, 447 U.S. at 233. Of course, the Court has

held that in order to invalidate a formula the taxpayer

must do more than simply present its own separate

accounting analysis; the taxpayer must also introduce

evidence explaining why the formula is inadequate and

produces an unfair result. The taxpayers introduced such

evidence in the Hans Rees’ and Norfolk cases and Con-

tainer has done so here.”

*In its opening brief, Container argued that under these circum-

stances, at a minimum, the burden of proof shifts to the state, as

the Court held in Norfolk. Appellant’s Br. at 20. The FTB has

offered no response to this argument—nor did the FTB offer any

evidence at trial to meet its burden.

13

Container has explained the inadequacy of the formula

by showing that the subsidiaries operated under political

and economic conditions quite different from those in the

United States, particularly in regard to the subsidiaries

in Colombia and Venezuela; that the cost of labor is sig-

nificantly less in those countries than in the United States;

that those subsidiaries are much more profitable than

Container, and that their factors, particularly payroll and

sales, realize a considerably greater return than do those of

Container. Appellant’s Br. 11-21. The FTB has not denied

these basic facts. Nor has the FTB disputed that U.S.

businesses use a higher “hurdle rate” in making invest-

ments in foreign countries and that this greater rate of

return is generally achieved. Thus, Container’s explana-

tion for the unfairness resulting from combined apportion-

ment on a unitary basis remains unchallenged.”

The FTB next argues that even if separate accounting

may be used to impeach the formula, the separate account-

ing figures in the record are not accurate. Appellee’s Br.

at 96-8. As stated above, however, the parties have stipu-

lated to the accuracy of the figures in Exhibits A and B

and in making this stipulation the FTB was well aware

of the charges made by Container for whatever services

it provided the subsidiaries. The parties are bound by

those figures.

The FTB next attempts to justify the taxation of income

earned ovtside California on the ground that the extra-

territorial income apportioned to California is not sub-

stantial in amount and that formulary apportionment need

only achieve a “rough approximation” in apportioning

It must also be kept in mind that Container’s use of the sepa-

rate accounting method was not solely a matter of internal con-

venience, as in Exxon and Butler Bros. A separate accounting com-

putation was required of Container by the Internal Revenue Code,

and of the subsidiaries by the tax laws of the countries in which

the subsidiaries operated. See Stip. {{ 140, 151, J.A. 72, 78; Appel-

lant’s Br. 25 n. 11.

14

income to the State. F'.g., Appellee’s Br. at 98. However,

under the FTB’s method, about half of the income of the

most profitable subsidiaries (Colombia, Venezuela and Hol-

land) would be apportioned away from those subsidiaries

and, principally, to Container. In fact nearly 30 percent

ef all the income of the foreign subsidiaries is appor-

tioned to Container. Appellant’s Br. at 17. This hardly

amounts to “rough approximation.”” The FTB has not

attempted to defend this bald reallocation of income

earned outside California. Under these circumstances

Hans Rees’ and Norfolk require a holding that the FTB’s

method of apportionment violates due process.

There is a further consideration in regard to the “rough

approximation” rule. The Court’s statement that apportion-

ment is satisfactory if it roughly approximates income

earned in the State has been applied mainly in the context

The FTB complains that the computation on page 16 of Appel-

lant’s brief is not based on “tax” figures, and the MTC appears to

make a similar complaint in regard to the chart on page 17 of

Appellant's Brief. (Appellee’s Br. 36; MTC Br. 18-19) Container

used the net income and apportionment figures appearing in the

record and which were stipulated to be accurate. J.A. Exhibits 1-6;

Stip. § 21, j.A. 11. These figures are taken from the books of the

subsidiaries and Container. The tax figures for Container are set

forth at J.A. 7. Container used book figures because the FTB used

the book figures of the subsidiaries in computing Container’s world-

wide income. Stip. { 21, J.A. 11. Because, as the record shows, tax-

able net income may vary somewhat from book net income (Stip.

{ 161, J.A. 85), Container maintains that a valid comparison can

only be made by using Container’s income derived from its books

and the book income of the subsidiaries. However, if Container’s

taxable net income is used, the results do not vary greatly. It is

still clear that the formula method reapportions almost half of the

income of the Colombian, Venezuelan and Dutch subsidiaries away

from those countries and principally to Container. See Appendix A.

15

of interstate commerce. Here we are concerned with foreign

commerce, where, as the Court said in Japan Line, Ltd.

v. County of Los Angeles, 441 U.S. 434, 455-6, “true appor-

tionment does not exist and cannot be policed by this Court

at all.” Thus, the efforts by the states to tax income earned

outside their borders should be guarded against more

vigorously in connection with foreign commerce than inter-

state commerce.

The FTB next argues that even if the facts show dif-

ferent rates of return for the factors as between Container

and its foreign subsidiaries, this does not impeach form-

ulary apportionment. The FTB attacks Container’s state-

ment that formulary apportionment is based upon the

premise that a dollar of payroll or property expended or

used in one state and a dollar of sales realized in one state

typically produce roughly the same amount of income as

a dollar so spent or sales realized in another state. Ap-

pellee’s Br. at 99-100. The premise, however, is confirmed

by the leading commentators on state and local taxation.”

Furthermore, a moment’s reflection will show that the

premise must be correct. After all, the three-factor formula

cannot validly operate over a substantial period of time

if the return on payroll, property or sales in one geograph-

Hellerstein & Hellerstein, supra note 12, at 539 states:

The underlying premise of formulary apportionment under

the Massachusetts three-factor formula is that (using UDITPA

as illustrative), by and large, every dollar of wages or property

spent in one taxing jurisdiction, along with receipts from sales

in the area, will produce the same amount of profit in all tax-

ing jurisdictions. Wide disparities in unit labor or unit prop-

erty costs between taxing jurisdictions tend to attribute to the

high wage-property cost jurisdictions, such as the United

States, income which is attributable to other jurisdictions. . . .

16

ical area will be much less or much greater than in another

geographical area.”

The FTB cites an article which argues that a return on

investment analysis may be inappropriate for evaluating

the performance of the management of foreign subsidi-

aries. Appellee’s Br. at 103-07. To the extent that com-

mentary has any relevance here, the record in this case

is to the contrary. Professor McDonald testified that he

reviewed the return on investment analysis in Schedule VI

to the Stipulation re Testimony (J.A. 109-13), and that the

method used is appropriate and “the generally accepted

way of calculating return on investment.” J.A. 177.

The FTB also argues that while the three factors of

property, payroll and sales are interdependent, Container

is attacking the payroll factor independently of the others.

Appellee’s Br. at 102-03. The FTB cites Norfolk and

Western Railway Co. v. North Carolina, 297 U.S. 682

(1936), for the proposition that a taxpayer cannot demon-

strate the invalidity of a formula by attacking only one

element of the formula. The short answer to the FTB’s

argument is that Container has not limited its attack to

the payroll factor; all of Container’s computations show-

ing distortion take into account all three factors. Thus,

Norfolk and Western is not applicable.

Finally, contrary to the FTB’s assertion, all of the data

pertaining to Container involve the years in suit except

for the unit cost comparison, which involves the year

1974. Container’s assistant controller testified, however,

11John Deere Plow Co. v. Franchise Tax Board, 38 Cal. 2d 214,

238 P.2d 569 (1951), appeal dismissed, 343 U.S. 939 (1952), cited

by the FTB (Appellee’s Br. 100), does not militate against the

premise. There, a corporation operating within the United States

incurred greater costs in California as a result of the introduction of

a new product. In the present case the distortion occurs not as a

result of such short-term differences but because of substantial

economic differences between the United States and the countries

in which the subsidiaries operate, especially in regard to payroll

costs and rates of profitability.

17

that in his opinion the comparison for the year 1974 would

be substantially the same, or even more favorable to Con-

tainer, if the comparison could have been made for the

years in suit. Stip. re Testimony, J.A. 115. Furthermore,

the other figures presented by Container are all specifically

for the years in suit, or closely related to those years,

except where a comparison with more recent figures is

deliberately made.

III. CALIFORNIA’S APPORTIONMENT VIOLATES

THE COMMERCE CLAUSE BECAUSE IT

RESULTS IN MULTIPLE TAXATION OF FOR-

“GN SOURCE INCOME

The f 1B does not seriously dispute that, in the present

case, multiple taxation of the same income occurs by Cali-

fornia and the countries where the most profitable sub-

sidiaries are located (Colombia, Venezuela, Holland and

Mexico). The facts are as follows:

1. Each subsidiary filed income tax returns on a sepa-

rate accounting basis with the country wherein the subsidi-

ary operated. Stip. 7 140, J.A. 72.

2. The actual amounts of income taxes paid by the sub-

sidiaries in Colombia, Venezuela, Holland and Mexico are

set out in a table in the record. Stip. 159, J.A. 83-84. In

only minor instances in Venezuela, and one instance in

Mexico, does the table show a provision for taxes stated

on Form 2952, rather than the actual taxes paid by the

subsidiaries. The record states, however, that the provision

for taxes is very close to the actual taxes paid. Stip. {/ 160,

J.A. 85.

3. The record contains the net income of the subsidi-

aries computed in accordance with generally accepted ac-

counting principles. Stip. 160, J.A. 85. This net income

was included in the Forms 2952 filed by Container with its

federal income tax returns, and it is the net income which

the F' TB auditor used in combining the income of the sub-

sidiaries with that of Container. Stip. § 21, J.A. 11. As a

18

consequence, the record contains the book net income of

the subsidiaries which was used to compute the California

tax, the California franchise tax paid on that income and,

with minor exceptions, the actual net income taxes paid

by the Colombian, Venezuelan, Dutch and Mexican sub-

sidiaries to their governments.” There can be no question,

therefore, that the net income of the subsidiaries was taxed

once by the foreign countries involved and again by Cali-

fornia. The FTB does not rebut the above,” but simply

reiterates that California is only taxing Container and not

the foreign subsidiaries, conveniently ignoring the undis-

puted evidence of multiple taxation.

The FTB’s efforts to limit the Court’s decision in Japan

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

to property taxes on containers is unavailing. Japan Line’s

holding that state taxation in the area of foreign commerce

raises the additional issues of multiple taxation as between

the state and foreign governments and of impairment by

the state of federal policy is certainly not limited to prop-

erty taxes. In this regard see the amicus memorandum filed

for the United States in Chicago Bridge and Iron Company

v. Caterpillar Tractor Co., No. 81-349, set forth in pertinent

part in Appendix F to Appellant’s Brief on the Merits.

**A simple comparison of taxes paid by the subsidiaries to their

book net income demonstrates that substantial taxes were paid on

that income for the years in question. Compare Stip. § 159, J.A. 84

with Exhibits A-1 to A-6, J.A. Exhib. 1-6.

°Because the record in the main shows actual taxes paid; rather

than a provision for taxes, thy »~founded attack by the MTC and

other amici supporting the FTB on the provision for taxes of the

Italian subsidiaries is unimportant. (MTC Br. 7, 21 n. 35.) In any

event, the MTC erroneously offsets the losses of some subsidiaries

against the profits of others, thereby showing that the Italian sub-

sidiaries as a group had an average net income of only $34,000 for

the years, whereas the average tax provision was over $121,000.

The MTC overlooks the fact, inter alia, that under ihe Italian net

income tax law the losses of one corporation cannot be offset

against the profits of another. See Harvard University, World Tax

Series—T axation in Italy 335, 423-24 (1964).

19

The Court’s decision in Mobil Oil Corp. v. Commissioner

of Taxes, 455 U.S. 425 (1980), does not bar the application

of Japan Line to this case. Mobil did not involve worldwide

unitary combination where a conflict between taxation of

income by a state and foreign governments is a major

issue. Mobil involved a conflict in taxation of dividends as

between the states; a conflict between the State of Vermont

and foreign governments was not involved.

In a confusing argument the FTB appears to concede

that some of the same income is being taxed twice, once

when apportioned to California as income of Container

and once by the foreign countries which tax the subsidiar-

ies on a separate accounting basis. Appellee’s Br. at 116-18.

However, the FTB equates taxation by the federal govern-

ment and the states of the same income of a United States

corporation with the taxation by California and foreign

countries of the same income of foreign subsidiaries of a

United States parent. Those foreign countries are not

members of a federal system with California wherein

both governments are supplying governmental services to

a taxpayer. Moreover, while the same dollar of income

could be “earned” in both California and the United States,

thereby justifying taxation by both jurisdictions, the same

dollar of income cannot have been earned in both California

and Colombia. Thus, California is not entitled to tax sub-

sidiary income which is earned in a foreign country and

taxed by the foreign government.”

2°The FTB’s reliance upon the foreign tax credit against Con-

tainer’s federal income tax is misplaced. I.R.C. § 901. The foreign

tax credit only helps to prevent multiple taxation where the fed-

eral government is taxing income also subject to tax by a foreign

government. Since the federal government does not tax the undis-

tributed income of foreign subsidiaries of U.S. parents (except for

Subpart F, Sections 951-964, I.R.C., which does not apply to Con-

tainer’s operating subsidiaries), no foreign tax credit would be

available for the type of multiple taxation being imposed in this

case, Furthermore, the foreign tax credit applies only to the federal

income tax. California does not provide such a credit.

CONCLUSION

Container submits that the issues in this case are clearly

resolved by application of leading decisions of this Court.

ASARCO and Woolworth require a holding that Container

and its foreign subsidiaries are not unitary because of the

lack of substantial operational interdependence. Hans

Rees’ and Norfolk & Western Railway v. Missouri compel

a decision that worldwide unitary combination violates the

due process clause because of the resulting state taxation

of extraterritorial income, and Japan Line similarly re-

quires a holding that such combination violates the com-

merce clause becaus: of ‘he resulting double taxation and

impairment of the ability uf the federal government to

speak with one voice in regard to foreign policy.

For the foregoing reasons, Container submits that the

decision of the California Court of Appeal should be

reversed.

Dated: December 23, 1982.

Respectfully submitted,

Frankuw C. Latrcuam

COUNSEL OF RECORD

Prentiss WILLSON, JR.

James P. Kuerer

Counsel for Appellant

Container Corpora-

tion of America

Of Counsel

Morrison & Foerster

APPENDIX A

Restatement of Chart, Appellant’s Brief on the Merits

page 17, based on taxable separate accounting income for

Container and book separate accounting income for the

subsidiaries.

1963 - 1965

(000’s omitted )

—— ye Pre-Tax

Dice ps ere

1. Container (United States) ....... $31,549 $34,704

Sere ee 4,253 2,383

a ag oe doh ee hee 1,605 1547

RRR rire Bee. 4,246 2,064

ee ot cc cad emeuneell 1,286 0

<< oes pwede onnudouseeuie (13) 12

SpE” Woo dvccanks counneniunen 1,793 3,145

Aye veeee 384 214

De Blending enaks tunis ewesonton 34 1,069

§ re 13,588 10,433°

By FE vn cos cc ccndocess 45,137 45,137

* Rounding-off of numbers in multiplication causes slight dis-

crepancy from addition of the column.