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

Office . Supreme Cour’, U.S

LED

No. 81-523 JUL 28

‘MEXANDER 1, ercy

at

~-LERK

In Tue

Supreme Court of the Gnited States

Octoser Term, 1982

CONTAINER CORPORATION OF AMERICA,

Appellant,

Vv.

FRANCHISE TAX BOARD,

Appellee.

———eSSSeeeeeeeeeeeeeeeeOaele*"“"*"$S@O™™"

ON APPEAL FROM THE SUPREME COURT

OF THE STATE OF CALIFORNIA

BRIEF AS AMICI CURIAE IN SUPPORT OF BRIEF

OF CONTAINER CORPORATION OF AMERICA

FRANCIS D. MORRISSEY

BAKER & McKENZIE

2700 Prudential Plaza

Chicago, Illinois 60601

(312) 861-2819

Attorney for Amici Curiae,

CANADIAN IMPERIAL BANK

OF COMMERCE

HIRAM WALKER RESOURCES LIMITED

INCO LIMITED

MacMILLAN BLOEDEL LIMITED

WAWANESA MUTUAL INSURANCE

COMPANY

Of Counsel:

PETER B. POWLES

BAKER & McKENZIE

2800 Prudential Plasa

Chicago, Illinois 60601

(312) 861-2952

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

QUESTIONS PRESENTED

Whether the allocation of taxable income between the

United States and foreign nations for income tax pur-

poses is a subject of such dominant federal interest and

responsibility that regulation of the subject must be

prescribed by the United States government, to the

exclusion of any regulation by individual states; and

Whether world-wide combined reporting for state

unitary tax purposes is unconstitutional because it

obstructs the prerogative of the United States govern-

ment to conduct foreign relations.

TABLE OF CONTENTS

QUESTIONS PRESENTED ou... .cccssssssssssseseeeees i

TABLE OF AUTHORITIES. ...........ccccssssssssseseeses iv

INTEREST OF THE AMICI CURIAE ............. 1

SUMMARY OF ARGUMENT 2... ccsssesseeesesees 3

ARGUMENT:

I

The Allocation Of Texable Income Between

Nations Is A Field Of Such Primary Federal

Interest And Is So Closely Involved With The

Conduct Of Foreign Relations That Any State

Regulation Of This Subiect Is Constitution-

ally Barred Under The Commerce Clause

And The Supremacy Clause ..............::scceeeeeeee 4

Il.

State Income Tax Apportionment Formulae

Must Reach Results Consistent With Inter-

national Income Tax Treaties ...........cc::ccees0- 11

ITI.

World-Wide Combined Reporting Is Unneces-

sary For State Income Tax Purposes ........... 14

IV.

World-Wide Combined Reporting And The

Unitary Method Of Apportionment Frequent-

ly Produce Multiple Taxation, Thus Im-

posing Impermissible Burdens On Interna-

eee tanel 17

V

The States Cannot Provide Due Process To

Enterprises Subject To International Double

, ERATE RSE Erne Or ete INeO 18

GEREPEIEIINIEY ccoresscusensesnsevessesnmecsecssensnnmienmeeneneenen 20

iv

TABLE OF AUTHORITIES

Cases

Bass, Ratcliff & Gretton, Ltd. v. State Tax

Commission, 266 U.S. 271 (1924) ...........c:cceeeee 12, 13

Chae Chan Ping v. United States, 130 U.S. 581

ESR ee eer eon 5

Chy Lung v. Freeman, 92 U.S. 275 (1876) ........ 5

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

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

Ff | eee Caesar 5, 9, 10, 12

Knox v. Lee, 79 U.S. 457 (1870) ..........cccccceseeeeeees 5

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

I cicada aa a A aa 5

Southern Pacific Co. v. Arizona, 325 U.S. 761

ERR RS SNR SP eee 5, 6, 9

Western Livestock v. Bureau of Revenue, 303

REE ee meen 17

Zschernig v. Miller, 389 U.S. 429 (1968) .............. 5, 8,9

Constitutional Provisions

Se, GUI, CG. BE OG, G & ccecerensesncceensncinctecceseens 4

aa eases 18

a R. - oe ee 8 eee 4

Statutes

Internal Revenue Code § 482 ...........cccccccccceeeseeeeeees 14

Internal Revenue Code § 551-558 0.0.0... cceeeeeeees 16

Internal Revenue Code § 951-964 .0............cceccceeeees 16

Treasury Regulation § 1.482-1(D)X1) .........ccceeeeees 14

Vv

Other Authorities

CCH Tax Treaties, Vol. 1, 11317P (1980) ...........

ae Treaties, Vol. 2,18103DC, 8107-29

I iii a te

Defendant’s Reply to Plaintiff's Opposition Brief

in Alean Aluminum Ltd. v. The Franchise Tax

Board of the State of California, United States

District Court, S.D.N.Y. 81 Civ. 3911 (L.W.P.)

TITIES TE sustidihibainebiiiihtinatanettauiiehinaetaiaiaiiatialinateabianeieddaene

OECD, International Investmert and Multi-na-

tional Enterprises—Recent International Direct

Investment Trends 103 (1981) ........cccccccccee sseeeeee

Press Release by British Information Depart-

ment, Reprinted in Hearings on H.R. 5076

Before the House Comm on Ways and Means,

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

State Taxation of Foreign Source Income: Hear-

ings On H.R. 5076 Before the House Comm. on

Ways and Means, 96th Cong., 2d Sess. 360

— RRBRE ORE RIES Se ena eT eee RRC

Titlow, Richard E., International Double Taxa-

tion and the United States, 46 Taxes, The Tax

I

United States Department of Commerce, Bureau

of Economic Analysis, Vol. 61, No. 8, Survey of

Current Business 21 (1981) ......cccccccccoccoscsssccccees

8, 10

8

19

17

12

17

IN THE

Supreme Court of the United States

OCTOBER TERM, 1982

CONTAINER CORPORATION OF AMERICA,

Appellant,

FRANOHISE TAX BOARD,

Appellee.

ON APPEAL FROM THE SUPREME COURT

OF THE STATE OF CALIFORNIA

BRIEF AS AMICI CURIAE IN SUPPORT OF BRIEF

OF CONTAINER CORPORATION OF AMERICA

INTEREST OF THE AMICI CURIAE

Your amici are major Canadian companies engaged

in the banking, distilling, nickel mining, forest products,

and casualty insurance industries. All conduct the major

part of their business activities outside the United

States, but have significant business interests in the

United States, primarily through American subsidiaries.

All are detrimentally affected by world-wide combined

reporting, imposed by various states of the United States.

niles

The interest of the amici in the instant case arises

from the following factors:

i)

ii)

iii)

iv)

v)

Their grave concern that if the various states

of the United States are permitted to require

world-wide combined reporting under varying

allocation formulae, subordinate taxing author-

ities of other countries may adopt similar pro-

cedures, thus severely impairing the flow of

international commerce:

The irreconcilable problems of multiple taxa-

tion that necessarily result from applying dif-

ferent methods of allocating income among the

states of the United States and foreign nations:

The absence ci any international tax court to

resolve problems of multiple taxation and the

unconstitutionality of resolving such problems

by treaties between foreign nations and the in-

dividual states of the United States;

The arbitrary and inaccurate allocation of

income, frequently resulting from world-wide

combined reporting under the unitary method

of apportionment, together with the onerous

expense and the diversion of management time

required to prove by clear and cogent evidence

that an allocation of income is totally dispro-

portionate;

The substantial compliance problems that con-

front your amici who are required to gather

and present, in varying state-required formats,

world-wide financial data, which must be con-

verted into United States currency in the

context of constantly fluctuating exchange

rates and presented in accordance with local

state income tax principles.

Your amici are not concerned with the use of com-

bined reporting for a unitary enterprise within the

United States. They are very concerned with interna-

tional use of world-wide combined reporting by various

states of the United States.

— =

SUMMARY OF ARGUMENT

The allocation of income and related expense between

the United States and other nations for income tax

purposes is so integral to the conduct of foreign relations

that it constitutes a field of dominant federal interest,

prohibiting any state regulation. This dominant federal

interest precludes world-wide combined reporting and

apportionment of taxable income by the unitary method

because this procedure not only conflicts with the estab-

lished federal “arm’s length-independent entity” method

of allocation but also prejudices the conduct of foreign

relations.

World-wide combined reporting in compliance with

the unitary method is totally inconsistent with the inter-

nationally accepted “arm’s length-independent entity”

principle. The multiple taxation that inevitably arises

imposes burdens on international commerce that are

impermissible under the Commerce Clause.

Multi-national enterprises are denied due process at

the international level because no international tax court

or administrative procedures exist to resolve the mul-

tiple taxation arising from the conflict between world-

wide combined reporting and the unitary method of

apportionment as used by certain states of the United

States and the “arm’s length-independent entity” prin-

ciple applied by all industrialized foreign nations. At the

federal level, “competent authority” procedures to avoid

double taxation have been established by tax treaties

with those foreign nations that constitute the major

trading partners of the United States. Some measure of

due process is thus afforded under the federal scheme.

astien

The problems of state involvement in foreign relations,

multiple taxation and lack of due process would cease to

exist if this Court were to prohibit state allocation

of a greater amount of taxable income to the United

States than is permitted by international tax treaties of

the United States or the Internal Revenue Code of the

United States.

World-wide combined reporting is unnecessary since

the United States Internal Revenue Service establishes

the fair share of global income subject to original taxing

jurisdiction in the United States in accordance with the

tax treaties of the United States and the Internal

Revenue Code. The states can apply their apportionment

formulae to this fair share of global taxable income

already apporticned to the United States. Further, given

stringent United States enforcement of tax treaties and

the tax avoidance provisions of the Internal Revenue

Code, world-wide combined reporting is not required to

prevent tax avoidance.

ARGUMENT

THE ALLOCATION OF TAXABLE INCOME BE-

TWEEN NATIONS IS A FIELD OF SUCH PRIMARY

FEDERAL INTEREST AND IS SO CLOSELY IN-

VOLVED WITH THE CONDUCT OF FOREIGN RELA-

TIONS THAT ANY STATE REGULATION OF THIS

SUBJECT IS CONSTITUTIONALLY BARRED UNDER

= CLAUSE AND THE SUPREMACY

CLAUSE.*

When called upon to constrain state infringement of

the exercise of federal authority, this Court has returned

repeatedly to its statement that:

* U.S. Const. Art. I, § 8, cl. 3 and Art. VI, el. 2.

—§—

“The United States is not only a Government, but it

is a national Government, and the only Government

in this country that has the character of nationality.

It is invested with power over all the foreign rela-

tions of the country, war, peace and negotiations

and intercourse with other nations; all which are

forbidden to the state governments.”

Chae Chan Ping v. United States, 130 U.S. 581, 605

(1889); See also Knox v. Lee, 79 U.S. 457, 555 (con-

curring opinion) (1870).

States exceed their constitutional power in our federal

system when they attempt to regulate commerce among

nations, particularly when such regulation affects the

conduct of foreign relations. This Court recently reiter-

ated in Japan Line, Ltd. v. County of Los Angeles, the

long-accepted constitutional doctrine that:

“(T]he commerce clause, without the aid of Con-

gressional! legislation . . . affords some protection

from state legislation inimical to the national com-

merce. . . . [IJn such cases, where Congress has not

acted, this Court, and not the state legislature, is

under the commerce clause the final arbiter of the

competing demands of state and national interests.”

441 U.S. 434 at 454, quoting Southern Pacifie Co. v.

Arizona, 325 U.S. 761, 769 (1945).

In functioning as such an arbiter, this Court has been

keenly sensitive to the federal government's need to

“speak with one voice when regulating commercial rela-

tions with foreign governments,” Michelin Tire Corp. v.

Wages, 423 U.S. 276, 285 (1976); to the potential magni-

tude of repercussions that could be precipitated by “real

or imagined wrongs to another’s subjects inflicted, or

permitted, by a government,” Zschernig v. Miller, 389 U.S.

429, 441 (1968); and to the likelihood that any adverse

response provoked by state interference in matters of

foreign affairs would be directed at the United States

rather than toward any individual state or locality, Chy

Lung v. Freeman, 92 U.S. 275, 279 (1876).

<altine

If the allocation of taxable income between nations for

state income tax purposes is a “matter of local concern

[that] is local in character and effect,” insignificantly im-

pacting upon foreign commerce, and if the incentive to

deal with the subject nationally is slight, state regulation

of this field should be held constitutional; otherwise it is

unconstitutional. Southern Pacific Co. v. Arizona, 325

U.S. 761, 767. Your amici respectfully submit that world-

wide combined reporting in pursuance of the unitary

method of taxation cannot be regarded as a “local con-

cern” nor one “local in character and effect.”

Indeed, protests by many of our nation’s major trading

partners demonstrate that international applications of

state-imposed unitary apportionment methods are “inim-

ical to the national commerce.” 325 U.S. at 769. Almost

universally, foreign governments and corporations per-

ceive the international application of state unitary ap-

portionment schemes as unjustified attempts by indi-

vidual states to extend their taxing power beyond the

territorial boundaries of the United States.* The Italian

government, on its own behalf and on behalf of nine

EEC governments, expressed this concern as follows:

“Our Governments are concerned about the appli-

cation to US subsidiaries of foreign companies of

the unitary basis of taxation as applied in California

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

* Anger at what is perceived to be extra-territorial foreign

taxation can be a United States, as well as a foreign

sentiment. This is vividly demonstrated by the experience

between the United States and France in the late 1920's.

The French took a view that state world-wide combined

reporting enthusiasts might well understand, arguing that

dividends or interest — by United States corporations,

in part out of income from French operations, were to that

extent French source income, subject to French securities

taxes. Complaints about extra-territorial taxation by the

French flooded the State Department. International consulta-

tions were held. Ultimately, the United States’ first bilateral

Tax Convention was signed on April 27, 1932. Under the

Convention, France abandoned her security tax.

_

This method is incompatible with the principles ac-

cepted by all OECD member [countries] and recom-

mended to all [countries] as a basis for the taxation

of subsidiaries or permanent establishments of for-

eign enterprises. These principles require that a

subsidiary should be taxed only on the profits it

actually has made, provided that these sre based on

dealing at ‘arm’s length’ between the subsidiary and

related enterprises.” (Emphasis added.)*

The British government has stressed the risk of con-

tinued state interference with pre-existing federal policy

concerning the allocation of income between nations,

emphasizing the destructive impact of such interference

on prior international agreements and the adverse effect

of such state action on otherwise attainable goals of

international cooperation.

“Unless common rules for determining the alloca-

tion of profits between different taxing jurisdictions

are followed internationally it will be impossible to

preserve the essential objective of providing a consis-

tent and coherent international tax framework for

business and investment, for which the United States

and the United Kingdom have striven together with

their fellow members of the Organization for Eco-

nomic Co-operation and Development. It is the view

of Her Majesty’s Government that the unitary basis,

which is not a practical international alternative to

the ‘arm’s length’ basis, could undo the important

and patient international work that has been achieved

in regulating international tax practices, and that

every effort is required to discourage the use [or]

the extension of that basis.” (Emphasis added.)**

In connection with the new Income Tax Treaty with

Canada signed September 26, 1980, the Deputy Prime

* State Taxation Z Foreign Source Income: Hearings on H.R.

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

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

** Press Release by British Information Department, Re-

—— in Hearings on H.R. 5076 Before the House Comm. on

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

caline

Minister and Minister of Finance for Canada, Allan J.

MacEachen, by letter dated September 26, 1980, advised

the United States Treasury that:

“It is the position of Canada that the so-called

‘unitary apportionment’ method used by certain

states of the United States to allocate income to

United States offices or subsidiaries of Canadian

companies results in inequitable taxation and

imposes excessive administrative burdens on Cana-

dian companies doing business in those states... .

Canada continues to be concerned about this issue

as it affects Canadian multi-nationals.”*

In the face of such undeniable international com-

plaints, the United States Department of State has

expressly categorized the issue of international income

apportionment as a subject for resolution through the

only constitutional mechanism for formulating interna-

tional agreements—the exercise of the treaty power of

the United States government. In his letter transmitting

the 1975 Income Tax Treaty between the United States

and the United Kingdom to the President, C. W.

Robinson, acting Secretary of the Department of State

reported:

“The [state unitary] method of assessment, which

includes the burden of producing worldwide rec-

ords of all of the affiliated companies, has raised

many objections by our treaty partners and we are

now seeking to deal specifically with this problem

in our treaties.”**

State regulation that impacts upon foreign relations or

jeopardizes the power of the United States government

to deal comprehensively with international problems

must be invalidated. This Court thus held in Zschernig v.

Miller, 389 U.S. 429, when presented with a state statute

that had received far less international attention than has

* See CCH Tax Treaties, Vol. 1. ]1317P (1980).

** See CCH Tax Treaties, Vol. 2, 18103DC at 8107-29 (1976).

ative

world-wide combined reporting for unitary tax purposes.

Invalidating an Oregon statute that had limited the right

of East German residents to inherit from a decedent

resident in Oregon, this Court concluded that the Ore-

gon statuie was “an intrusion by the State into the field

of foreign affairs which the Constitution entrusts to the

President and to the Congress.” Jd. at 432.

Zschernig is consistent with this Court’s holdings that

state legislation must be held unconstitutional when it

“is in a field which affects international relations, the

one aspect of our government that from the first has been

most generally conceded imperatively to demand broad

national authority.” Hines v. Davidowitz, 312 U.S. 52, 68

(1941). This Court has never required a comprehensive

scheme of federal regulation as a prerequisite to invali-

dating state interference in an area of exclusive federal

concern.

As in Zschernig, wherein this Court relied on no fed-

eral descent statutes to invalidate the state scheme,

invalidation of state regulation in the instant case does

not require a finding that the federal government has

either exhausted, or begun to exercise, its regulatory

powers over the international allocation of taxable in-

come. The subject matter and its need for uniform treat-

ment trigger the need for federal control, regardless of

the extent of federal exercise of that control. See South-

ern Pacific Co. v. Arizona, 325 U.S. 761.

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

434, this Court found that taxation of the instrumental-

ities of international commerce was a direct regulation

of such commerce, requiring uniformity of approach and

centralization of authority, and, therefore, held that such

power was exclusively vested in the United States gov-

erment. Similarly, the instant case presents an issue of

critical international importance, which, although not

yet entirely regulated by treaties, is vital to the

—10—

maintenance of both international trade and interna-

tional relations.

The division of income and taxing power is at the core

of virtually every federal income tax treaty negotiated

by the United States. State regulation of international

income allocation has precipitated a level of interna-

tional frustration and complaint that should forewarn

those who would ignore this Court’s admonition in

Japan Line that:

“The risk of retaliation . .. is acute, and such retali-

ation of necessity would be felt by the Nation as a

whole. . . . California, by its unilateral act, cannot

be permitted to place these impediments before this

Nation’s conduct of its foreign relations and its for-

eign trade.”

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

453.

That Congress has not enacted legislation restricting

combined reporting to the territorial limits of the United

States and that efforts to do so through the treaty-

making power were denied ratification* does not render

constitutional state regulation that was inherently un-

constitutional from the outset. When a field is one of

exclusive federal interest and responsibility, the states

have no constitutional power to intervene. Concurrent

state regulation cannot be tolerated. Even when the

United States government has not acted, state conduct

that is inimical to the national commerce or disrupts the

conduct of foreign relations is unconstitutional. Your

* See letter of September 26, 1980, from G. William Miller,

Secretary of the Treasury, to Allan J. MacEachen, Deputy

Prime Minister and Minister of Finance for Canada, CCH

Tax Treaties, Vol. 1,1317P. The unitary method of appor-

tionment was not an international problem until 1970-1975;

consequently, earlier tax treaties did not attempt to deal with

this issue. states that created the problem then frustrated

an attempted treaty solution rather than remove the problem

by limiting combined reporting to the United States.

=—

amici submit that world-wide combined reporting is

both inimical to the national commerce and disruptive of

the conduct of foreign relations.

State regulation of international income tax matters,

which regulation is impermissible under the constitu-

tional division of power between the United States

government and the various states, does not become

constitutional merely because the United States govern-

ment has not acted or because individual states through

their Senators refuse to ratify an income tax treaty

intended to prohibit such regulation.

STATE INCOME TAX APPORTIONMENT FOR-

MULAE MUST REACH RESULTS CONSISTENT WITH

INTERNATIONAL INCOME TAX TREATIES.

Your amici urge this Court to hold, as a minimum,

that a state apportionment formula, if used consistently

by all states in relation to a particular foreign country,

must not allocate to the United States any greater

amount of taxable gross income, or lesser amount of ex-

pense related to that income, than is permitted or re-

quired by any United States income tax treaty with that

country. When the severity of international tax problems

has prompted the United States government to negotiate

an income tax treaty with a country, the dominant fed-

eral interest is clear.* The United States has negotiated

such treaties with approximately forty nations, creating a

comprehensive framework of understandings, between the

United States and other countries, regarding the means

by which taxable income will be allocated among them.

Individual state assertions of the power to allocate in-

come by means other than those used in treaties in-

* Since state income taxes are deductible for federal income

tax purposes, an adverse effect on federal revenue results

whenever world-wide combined reporting allocates more in-

come to the United States than is allocated by the United

States Internal Revenue Code.

uli

evitably undermine such understandings and expecta-

tions. The problem becomes increasingly acute as the

more commercially significant states of the United

States adopt world-wide combined reporting, often after

a tax treaty has been negotiated.

Foreign governments cannot enter into treaties with

individual states; they must rely upon the United States

government’s authority in negotiating trade policies. To

permit as many as fifty independent state assertions of

taxing authority over international commerce would

frustrate the United States government’s attempts

to speak with one voice in negotiating agreements deal-

ing with international trade, investment, and financing.

This Court is respectfully urged to reaffirm the

exclusive authority of the United States in this field.

As this Court held in Japan Line, Ltd. v. County of

Los Angeles, 441 U.S. 434 (1979), the need for, as well as

the existence of, a uniform federal policy is imperative.

Only this Court can ensure that state law does not

frustrate the effectuation of that uniform federal policy.

This Court’s opinion in Bass, Ratcliff & Gretton, Ltd. v.

State Tax Commission, 266 U.S. 271 (1924), does not

deny the need to preclude state interference in the

allocation of taxable income between nations. Bass,

Ratcliff was decided on facts arising in 1918, only five

years after income taxation had been instituted in the

United States. The United States had not yet entered

into any income tax treaties with foreign nations and

did not do so until the first treaty with France in 1932.*

Conflicts between state income apportionment formulae

and the provisions of treaties, the consequent adverse

effect on foreign relations, and risks of international

multiple taxation were not considered in Bass, Ratcliff

because they did not exist or were not yet perceived as

* See Richard E. Titlow International Double Taxation and

the United States, 46 Taxes, The Tax Magazine 135 (1968).

==

national problems. This Court has never, however, failed

to update constitutional interpretation to meet the needs

of changed circumstances—in this case, the enormous

growth of international trade, investment, and financial

transactions since World War II, making necessary

numerous international tax treaties.

Under the current United States-United Kingdom In-

come Tax Treaty, if Bass, Ratcliff had not had federal

taxable income, under the proposition advocated by your

amici, Bass, Ratcliff would probably also have had no

taxable income in the State of New York. However, once

income and expense attributable to the United States

had been ascertained under the treaty provisions, New

York could have calculated a profit on the New York

state income tax return by denying a deduction

otherwise allowable on the federal return. In such a

situation, while the state and federal tax results would

not be consistent, no state interference in the treaty

allocation of income among nations would occur. This

result would be consistent with the constitutional

allocation of foreign commerce power exclusively to the

United States.

In the converse of Bass, Ratcliff, with an American

company selling ale in the United Kingdom through a

branch established there, the current Income Tax Trea-

ty between the United Kingdom and the United States

would permit the United States government to include,

for federal income tax purposes, all income and ex-

penses of the United Kingdom branch. The approach

urged by your amici would allow a state of the United

States to include in its apportionment all British income,

sales, property, and payroll, because the income and

expense incurred in England could be taken into account

for federal income tax purposes under the treaty.

afiGne

WORLD-WIDE COMBINED REPORTING IS UN-

NECESSARY FOR STATE INCOME TAX PURPOSES.

Conflicting state and national assertions of power to

allocate taxable income may be reconciled by applying

state unitary apportionment formulae only to that quan-

tum of taxable income that is allocated to United States

sources pursuant to international tax treaties of the United

States and the Internal Revenue Code of the United

States. Since most states use federal taxable income as

the starting point for computing state income taxes, this

limitation is practical, as well as fair.

Tax treaties and the regulations under Section 482

of the Internal Revenue Code use the “arm’s length-

independent entity” principle to allocate income and ex-

pense not only between the components of a “unitary”

business, but also between all entities under “common

control.”* Section 482 governs a wider range of

situations than those intended by the unitary principle.

The federal approach is based on the concept of “com-

° “The purpose of section 482 is to place a controlled tax-

payer on a tax parity with an uncontrolled taxpayer, by

determining, according to the standard of an uncontrolled

taxpayer, the true taxable income from the property and

business of a controlled taxpayer. The interests controlling

a group of controlled taxpayers are assumed to have com-

plete power to cause each controlled taxpayer so to con-

duct its affairs that its transactions and accounting

records truly reflect the taxable income from the preperly

and business of each of the controlled taxpayers. If,

however, this has not been done, and the taxable incomes

are thereby understated, the district director shall in-

tervene, and, by making such distributions, appor-

tionments, or allocations as he may deem necessary of

income, deductions, credits, or allowances, or of any

item or element affecting taxable income, between or

amen the controlled taxpayers constituting the group,

shall determine the true taxable income of each controlled

taxpayer. The standard to be applied in every case is

that of an uncontrolled taxpayer a at arm’s length

with another uncontrolled taxpayer.” (Emphasis added.)

Treasury Regulation 1.482-1(b\1).

alien

mon control,” a test easier to apply than the inquiry re-

quired to determine whether a business is “unitary.”

The results achieved are also more precise than the

often rough approximations necessitated by mechanical

application of mathematical formulae to combined in-

come.

Internal Revenue Service procedures under Section

482 of the Internal Revenue Code and the regulations

promulgated thereunder include in United States gross

income all amounts properly attributable to United

States sources, allocating to foreign sources all expenses

not properly attributable to United States sources and

denying United States deductions for those expenses.

The result maximizes taxable income in the United

States.

The detailed and sophisticated rules applied by the In-

ternal Revenue Service govern, for example, the imputa-

tion of interest on otherwise interest-free loans; the ap-

propriate charges by a United States parent company to

its foreign subsidiary for use of managerial, technical,

or financial services or for royalties on patents or

trademarks; and the calculation of a fair price for goods

sold between a parent and its subsidiary. Although dif-

ficult to apply in some instances, when the rules are

applied, they focus on economic realities, and their

application can be dealt with item by item at the audit

level. These precise results render unnecessary the

rough approximations of formulary apportionment.

When the United States government has performed

the task of allocating taxable income and expense to the

United States, no need exists for totally different ap-

portionment formulae nor for imposing on taxpayers the

additional expense and diversion of management time

required to prove by clear and cogent evidence that the

state allocation of income is totally disproportionate.

oti

The states argue that apportionment of income by the

unitary method is essential to prevent taxpayers from

manipulating separate geographical accounting and

from distorting taxable income, and also because an

army of state revenue agents would be required to

enforce the “arm’s length-independent entity” method.

These considerations are totally irrelevant in the inter-

national context, because the task of allocating a fair

share of global taxable income and expense to the

United States is performed routinely every year by the

Int.rnal Revenue Service, and its Office of International

Operations which was created for this express purpose.

To avoid misallocation of income and expense and to

effect compliance with tax treaties and domestic tax

law, the tax authorities of the United States and foreign

governments also exchange tax information. Moreover,

the Internal Revenue Service has “simultaneous exami-

nation programs” with Canada, Germany, France, and

the United Kingdom, providing for the separate but

simultaneous audit of the same multi-national enter-

prise. In addition to Section 482 of the Internal Revenue

Code and these audit procedures, the “foreign personal

holding company” and “Sub-Part F” provisions of the

Internal Revenue Code* include within United States

taxable income the earnings of foreign subsidiaries in

tax haven countries.

With such comprehensive regulation by the federal

government, state systems for world-wide combined re-

porting cannot be justified by any alleged need to pre-

vent tax avoidance. Moreover, with approximately

seventy to seventy-three percent of investment flow-

ing from the Unitec States to Japan, Canada, and

European countries whose corporate income tax rates

nearly all equal or exceed those in the United States,

* I.R.C. §§551-58, 951-64.

==

and with eighty-eight percent of foreign source invest-

ment originating in those same countries, shifting of

income out of the United States tends to increase, rather

than to reduce, tax rates.*

In summary, your amici contend that state-imposed

world-wide combined reporting cannot be i»stified as a

necessary evil that is required to eliminate ur reduce tax

avoidance.

IV.

WORLD-WIDE COMBINED REPORTING AND THE

UNITARY METHOD OF APPORTIONMENT FRE-

QUENTLY PRODUCE MULTIPLE TAXATION, THUS

IMPOSING IMPERMISSIBLE BURDENS ON INTER-

NATIONAL COMMERCE.

As this Court noted in Western Livestock v. Bureau of

Revenue, 303 U.S. 250, 255-56 (1938), unconstitutional

multiple taxation arises where the tax burdens are of:

“[SJuch a nature as to be capable, in point of sub-

stance, of being imposed . . . with equal right by

every state which the commerce touches, merely

because interstate commerve is being done, so that

without the protection of the commerce clause it

would bear cumulative burdens not imposed on

local commerce.”

Combined reporting ignores the individual commer-

cial reaiities of particular corporate branches and sub-

sidiaries, apportioning combined income on the basis of

factors such as sales, property, and payroll. World-wide

combined reporting assumes that a dollar of sales,

property, and payroll in one country will produce ap-

proximately the same amount of income in any other

country. Although arguably true as between the states

of the United States, this assumption ignores interna-

* US. and OECD statistics are approximately the same.

See, e.g., United States Department of Commerce, Bureau of

Economic Analysis, Vol. 61, No. 8, Survey of Current Business

(1981) 21, 41; OECD, International Investment and Multi-

national Enterprises—Recent International Direct Investment

Trends, (1981) 103, 105.

tional realities. Varying economic conditions and profit-

ability levels in different countries ensure that world-

wide combined reporting and the “arm’s length-inde-

pendent entity” method will produce substantially dif-

ferent results on the same facts. These differences are

often exacerbated by currency values fluctuating inter-

nationally by up to twenty percent or more in any year.

Whenever combined reporting and the unitary method

of apportionment allocates to the United States a greater

amount of taxable income than the “arm’s length-inde-

pendent entity” method, multiple taxation inevitably fol-

lows because foreign nations do not correspondingly

decrease the amount of taxable income allocated to them

by the latter method.

V.

THE STATES CANNOT PROVIDE DUE PROCESS

TO ENTERPRISES SUBJECT TO INTERNATIONAL

DOUBLE TAXATION.

Within the United States, this Court can prevent mul-

tiple taxation arising from conflicting methods of alloca-

tion of taxable income between the states, thereby in-

suring fundamental fairness to the taxpayer. Conflicts

between world-wide combined reporting and the “arm’s

length-independent entity” approach, resulting in mul-

tiple taxation at the international level, cannot be re-

solved either by this Court or by any other court. No

international tax court or administrative procedures

exist to resolve conflicts in allocation of taxable income

between individual states and foreign nations. In the ab-

sence of a forum in which he can be heard, the taxpayer

can have no due process.* Asking the courts of the indi-

vidual state or foreign nation to resolve the conflict is

ineffective as each must be guided by its domestic law.

An allocation of income by the unitary method may not

be sufficiently disproportionate to require it to be set

aside as a denial of due process, and yet such an alloca-

* Required by U.S. CoNsT. amend. V.

anion

tion is frequently totally different in result from the

“arm’s length-independent entity” method.

States cannot defend the resulting multiple taxation

by alleging that such multiple taxation is the fault of

foreign nations that use the “arm’s length-independent

entity” method. It is not the prerogative of an individual

state of the United States to tell a foreign nation that it

should deviate from accepted international practice and

subordinate the “arm’s length-independent entity” method

of allocation to the unitary method.* Further, the ab-

sence of any international tax court with jurisdiction

to hear such questions emphasizes the need for interna-

tional tax treaties to establish the administrative review

procedures necessary to resolve such conflicts and the

need to require the individual states of the United

States to adhere to the constitutional scheme that vests

the United States government with exclusive power to

conduct international relations.

If individual states were required to apply their ap-

portionment formulae and individual tax rules to gross

income and expense allocable to the United States in ac-

cordance with federal tax treaties and the Internal

Revenue Code, taxpayers would be afforded some mea-

sure of due process. The international tax treaties of the

United States provide that when conflicting allocations

of income and expense occur between two countries, the

taxpayer has a right to require the “competent author-

ities” (as defined in the tax treaty) of each country to

meet and reconcile conflicts.

Such procedures are not applicable to double taxation

caused by state deviation from accepted international

methods of allocating income. Foreign nations and their

taxpayers cannot constitutionally enter into treaties with

* This is the position taken by California in its Defendant's

my J to Plaintiff's Opposition Brief in Alean Aluminum Ltd.

v. Franchise Tax rd of the State of California, United

States District Court, Southern District of New York, 81 Civ.

3911 (L.W.P.) page 18.

—20—

individual states to establish procedures for solving such

conflicts. Your amici, therefore, respectfully request a

remedy from this Court.

CONCLUSION

Your amici urge this Court to hold that state

apportionment formulae must not allocate to the United

States any greater amount of taxable income or lesser

amcunt of expense than is permitted or required by the

international tax treaties and Internal Revenue Code of

the United States.

This result is dictated by the need for this nation to

speak with one voice in international affairs. This need

cannot be met if the issue of international income al-

location remains susceptible to the parochial preferences

of up to fifty different states.

Respectfully submitted,

FRANCIS D. MORRISSEY

BAKER & McKENZIE

2700 Prudential Plaza

Chicago, Illinois 60601

(312) 861-2819

Attorney for Amici Curiae,

CANADIAN IMPERIAL BANK

OF COMMERCE

HIRAM WALKER RESOURCES LIMITED

INCO LIMITED

MacMILLAN BLOEDEL LIMITED

WAWANESA MUTUAL INSURANCE

COMPANY

Of Counsel:

PETER B. POWLES

BAKER & McKENZIE

2800 Prudential Plaza

Chicago, Illinois 60601

(312) 861-2952