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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Brief
- **Published:** January 1, 1983
- **Citation:** 463 U.S. 159

## Text

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385008_0362%3A23. Public record. Not legal advice.