# 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

IN THE

Supreme Court of the United States

OCTOBER TERM, 1981

CONTAINER CORPORATION OF AMERICA,
Appellant,
V.

FRANCHISE TAX BOARD,
Appellee.

On Appeal from the Court of Appeal
of the State of California

BRIEF FOR FINANCIAL EXECUTIVES INSTITUTE
AS AMICUS CURIAE

WILLIAM H. ALLEN *

JOHN B. JONES, JR.

MARK I. LEVY
COVINGTON & BURLING
1201 Pennsylvania Avenue, N.W.
P.O. Box 7566
Washington, D.C. 20044
(202) 662-6000

July 1982

* Counsel of Record
ee ee

QUESTION PRESENTED

Whether a state transgresses the constitutional reser-
vation to the national law-making body of the power
“([t]o regulate Commerce with foreign Nations“ when it
taxes the income of a corporation with foreign affiliates
by treating the entire corporate family as a unit, com-
bining the separate incomes of all its members, and mak-
ing an apportionment of the total to determine the state’s
share, in contradistinction to treating separate national
corporate income accounts separately save as some re-
,allocation may be needed to prevent distortion, which is
the method of income taxation adopted by the national
authorities of the United States and by the United States’
foreign trading partners and which represents the inter-
national norm.

(i)

TABLE OF CONTENTS

Page
Interest of Financial Executives Institute 1
Introduction and Summary of Argument 2
r nSnr c e ee NeeCar ce RN OER DET 4

A State’s Unitary, Combined-Reporting Appor-
tionment of Worldwide Income Violates the For-
eign Commerce Clause Because It Deviates From
and Is Inconsistent With the International
Norm of Separate-Source, Arm’s-Length Alloca-
tion Adopted by the United States Government
and Its Foreign Trading Partners .......................... 4

A. The Federal Government’s Authority Over
Foreign Commerce and International Affairs
Is Preeminent and Fxclusive ..............0000000.0..... 4

1. As this Court Has Recognized From the
Earliest Days to the Present, the Need to
Establish National Control of Foreign
Trade and Other Intercourse Was a Prin-
cipal Animating Reason for the Writing
and Adoption of the Constitution 5

2. This Court Has Recognized the Paramount
Role of the National Government in Inter-
national Matters, Including Foreign Trade,
as an Outgrowth of the Nation’s Constitu-
RATE ec 8

3. This Court in Japan Line Reaffirmed and
Applied the Principles of Exclusive Na-
tional Competence in Foreign Trade Mat-
ters in Invalidating a State Tax That Re-
sulted in Taxation Duplicative of That of
a Foreign Nation and Impaired the Ability
of the United States to Speak With One
Voice in Regulating Commercial Relations
With Foreign Government?́ 10

(iii)

iv

TABLE OF CONTENTS—Continued

B. Because It Deviates From the International
Norm of Separate-Source, Arm’s-Length Al-
location Adopted by the United States and
Other Nations, California’s Worldwide-Com-
bined-Reporting Method of Apportionment
Violates the Foreign Commerce Clause

1.

Conclusion

Congress Has Provided in the Rel want
Provisions of the Internal Revenue Coue for
Separate-Source, Arm’s-Length Taxation of
Multinational Incounmmm

In Treaties as Well as in the Internal Reve-
nue Code, the National Government Has
Commited Itself to Separate-Source, Arm's-
Length Accounting for Income Tax Pur-

California’s Worldwide-Combined-Appor-
tionment Method Results in Duplicative
Taxation and Is at Odds With the Method
of Aliocating Income for Income-Tax Pur-
poses Used by the United States and Its
Trading Partners in the International Com-
.

The Flaws That Inhere in the Worldwide-
Combined-Apportionment Method Under-
score Its Constitutional Impermissibility...

—— ̃ MMUũMm«k«kkkkk˖kk˖lauAkAſ eee rere ee eee eee eee eee eee

Page

13

13

17

19

29

Vv

TABLE OF AUTHORITIES
Cases: Page

American Chicle Co. v. United States, 316 U.S.

r aa a 15
ASARCO, Inc. v. Idaho State Tax Comm., No. 80-

9015 (U.S. June 39, 1968) ...............0...2..-.......... 13, 28, 29
Associated Tel. & Tel. Co. v. United States, 306

F.2d 824 (2d Cir. 1962), cert. denied, 371 U.S.

I I a ode eneiasieanddatiniion 15
Bass, Ratcliff & Gretton, Ltd. v. State Tax Com-
mission, 266 U.S. 271 (192 28
Board of Trustees v. United States, 289 U.S. 48
CEE peer eae ene ee 3, 5, 8
Brown v. Maryland. 25 U.S. (12 Wheat.) 419
%%% ͤ—T— ——. 8 6

Burnet v. Chicago Portrait Co., 285 U.S. 1 (1932) 15
Chase Brass & Copper Co. v. Franchise Tax
Board, 400 UB. 961 (19900 ———— 1
Chicago Bridge & Iron Co. v. Caterpillar Tractor
Co., restored to the calendar for reargument,

PS fF ff ee 1, 23
Chinese Exclusion Case, The, 130 U.S. 581 (1889).. 8
Chy Lung v. Freeman, 92 U.S. (2 Otto) 275

SERRA SURES ae misc ye Pr «Kir sence a 9,10
Commissioner V. First Security Bank of Utah,

ee 5 El re 16
Cook v. Pennsylvania, 97 U.S. (7 Otto) 566

%%%%%%XTTTTTTT—T—T—TV—VT—T—T—T—VTV—T—V—T—TV—T—TVTT—T oR eee 6
County of Mobile v. Kimball, 102 U.S. (12 Otto)

r ͥ T 9

Department of Revenue v. Association of Wash-
ington Stevedoring Companies, 435 U.S. 734

%% PTT 8
Exxon Corp. v. Wisconsin Department of Reve-
r 25

F. W. Woolworth Co. v. Taxation and Revenue De-
partment of New Mexico, No. 80-1745 (U.S.
EPR AENEs ne-ttaee ee e 9

Hines v. Davidowitz, 812 U.S. 52 (1941) 8, 10

Inman Steamship Line v. Tinker, 94 U.S. (4 Otto)
Ec 9

vi
TABLE OF AUTHORITIES—Continued

Page
Japan Line, Ltd. v. County of Los Angeles, 441
U.S. 434 (1979) 3, 6, 10-12, 19, 20, 21, 22, 25
Kassel v. Consolidated Freightways Corp., 450
e EP a eElP SRR ereen 9
Kenrecott Copper Corp. v. State Tax Comm'n,
e aoe 1
Lewis v. BT Investment Managers, Inc., 447 US.
r REA PERSO 6 aca 29
Maryland v. Louisiana, 451 U.S. 725 (1981).......... 23
Merrion v. Jicarilla Apache Tribe, 102 S. Ct. 894
Ecce 9
Michelin Tire Corp. v. Wages, 423 U.S. 276
reer 6, 9, 11, 23
Mobil Oil Corp. v. Commissioner of Taxes, 445
.. rae ene 22, 28
Moorman Manufacturing Co. v. Bair, 437 U.S.
267, leave to file briefs as amici curiae granted
and reh. denied, 439 U.S. 885 (1978) ................ 1
National Paper & Type Co. v. Bowers, 266 U.S.
EERE RRR NSIT ane tees see EET OCD 14
New England Power Co. v. New Hampshire, 102
S. Ct. 1096 (1982) „F 29
Railroad Co. v. Maryland, 88 U.S. (21 Wall.)
e NH nEh Sens ERNE A 6
Reeves, Inc. v. Stake, 447 U.S. 429 (1980) 3, 10, 11
Underwood Typewriter Co. v. Chamberlain, 254
r SSE ae Pree 3 21. 28
United States v. Arjona, 120 U.S. 479 (1887) 8
United States v. Belmont, 301 U.S. 324 (1937) 5, 8
United States v. Curtiss-Wright Corp., 299 U.S.
ccc — 5, 9
United States v. Pink, 315 U.S. 203 (194277 8
Zschernig v. Miller, 389 U.S. 429 (1968) 8, 10, 29
Constitution, statutes, treaties, and regulations:
U.S. Constitution:
r / ( 5
D 5, passim

Art. I, § 8, cl. 10 — 5

vii
TABLE OF AUTHORITIES—Continued

Page
. 5
, 5
e ee eae ee mone 5
SER SL a RR a ce a 5
26 U.S.C
r 16, 17, 20
r 15
r AEA OC ATER 15
Es -- 15
Cal. Rev. & Tax. Code (West) :
%% — Rs SEP Oe NRE 2
. „ 2
( 2
1 2
1 CCH Tax Treaties:
"151 (OECD Model Income Tax Conven-
B AAA —— tial ataasins 18
7 158 (Treasury Department’s Model Income
. 18
7171 (U.N. Model Income Tax Convention) 18
. ER SEIT 17
. si hasiiinninlinbeeendddeaesabiniés 17
SESE CRS arenes an ree ne 17
EE SR OE eee eens esos es 17
RET AT te nee OOO a ee 17
2 CCH Tax Treaties:
78103A (United Kingdom)) 17
Treasury Regulations (26 C.F.R.) :
r RE se ee a 16
ER REE OS NE ST 17
Miscellaneous:
Abel, The Commerce Clause in the Constitutional
Convention and in Contemporary Comment, 25
II/ 6

viii
TABLE OF AUTHORITIES--Continued

Page
1 Beveridge, The Life of John Marshall (1916).... 7
3 Bittker, Federal Taxation of Income, Estates
, . ve 14, 17
2 Bittker, Emory, & Streng, Federal Income Tazxa-
tion of Corporations and Shareholders (Forms)
ES . 13, 14, 15, 16
Bittker & Eustice, Federal Income Taxation of
Corporations and Shareholders (4th ed. 1979) 15
Farrand, The Framing of the Constitution of the
ts atenaiie 7
Federalist, The (J. Cooke ed. 19611) 7,9
GAO Report on Determining the Income of Multi-
national Corporations (Sept. 30, 19817 25, 28
J. Hellerstein & W. Hellerstein, State and Local
Taxation (4th ed. 19789 n 21, 24, 25, 27
H.R. Rep. No. 1480, 88th Cong., 2d Sess. (1964) 25
S. Rep. No. 94-938, 94th Cong., 2d Sess. (1976) 15

State Taxation of Foreign Source Income: Hear-
ings on H.R. 5076 Before the House Comm. on
Ways and Means, 96th Cong., 2d Sess. (1980) .. 19, 22,
23
State Taxation of Interstate Commerce: Hearings
Before the Subcomm. on State Taxation of the
Senate Comm. on Finance, 93d Cong., 1st Sess.
STI incedestecsnceseninidndteninndunsiciiaigtiasesnianbariedtabsenitintesinincusies 25
State Taxation of Interstate Commerce and World-
wide Corporate Income: Hearings on S. 983
and S. 1688 Before the Subcomm. on Taxation
of the Senate Comm. on Finance, 96th Cong.,

, RE sna NCR 19, 23
Swisher, American Constitutional Development
ESTERS AISI CRE a Sao 7

Tax Conventions with Belgium, Finland, Trinidad
and Tobago, and the Netherlands: Hearings
Before the Senate Comm. on Foreign Relations,
ge ss 14

ix

TABLE OF AUTHORITIES—Continued
Page

Tax Treaties with the United Kingdom, the Re-
public of Korea, and the Republic of the Philip-
pines: Hearings Before the Senate Comm. on
Foreign Relations, 95th Cong., Ist Sess. (1977) .. 19, 22,

25, 26, 27

Thompson, Federal Income Taxation of Domestic
and Foreign Business Transactions (1980) ....13, 14, 16

Warren, The Making of the Constitution (1937).. 7

1 Watson, The Constitution of the United States
RIN 0s ARP ERIE ER eon ee Rea eh oe 6

IN THE

Supreme Cuurt of the United States
OCTOBER TERM, 1981

No. 81-523

CONTAINER CORPORATION OF AMERICA,

- Appellant,

FRANCHISE TAX BOARD,
Appellee.

On Appeal from the Court of Appeal
of the State of California

BRIEF FOR FINANCIAL EXECUTIVES INSTITUTE
AS AMICUS CURIAE

INTEREST OF FINANCIAL EXECUTIVES INSTITUTE

Amicus Financial Executives Institute is the profes-
sional association of 12,000 senior financial and adminis-
trative officers of 6,000 organizations, large and small,
throughout the United States and Canada. FEI’s mem-
bers represent a broad spectrum of commerce, trade, and
industry. FEI has filed briefs as amicus curiae in Chi-
cago Bridge & Iron Co. v. Caterpillar Tractor Co., re-
stored to the calendar for reargument, No. 81-349 (O. T.
1981); Moorman Manufacturing Co. v. Bair, 437 U.S.
267, leave to file briefs as amici curiae granted and reh.
denied, 439 U.S. 885 (1978); Kennecott Copper Corp. v.
State Tax Comm’n, 409 U.S. 973 (1972); and Chase
Brass & Copper Co. v. Franchise Tax Board, 400 U.S.
961 (1970).

FEI members’ companies do business in more than
125 foreign countries and in each of the 50 states, includ-
ing California and other states that tax on the basis of a
unitary, combined-reporting method for apportioning
worldwide income. In addition, FEI members’ companies

2

are involved in pending litigation concerning the validity
and application of the worldwide-combined-reporting
method. Accordingly, FEI is vitally interested in the
sound and informed resolution of the constitutional issues
raised by appellant.

The written consent of the parties has been obtained
and is being filed with the Clerk of the Court.

INTRODUCTION AND SUMMARY OF ARGUMENT

Appellant Container Corporation of America is a cor-
poration organized under the laws of Delaware with its
principal executive offices in Illinois. (J.A. 6-7.) Con-
tainer engages in business in California and other states
of the Union. In addition, during the years in question
here, Container had a controlling interest in a number of
subsidiaries that were organized under the laws of, and
did business in, foreign countries in Western Europe and
Latin America. (J.A. 7, 14-15, 30.)

California imposes upon corporations doing business
within the state a franchise tax based upon net income—
a state income tax. See Cal. Rev. & Tax. Code § 23151
(West). In accordance with governing provisions of state
law, id. §§ 25101, 25102, 25128, the California Franchise
Tax Board determined Container’s tax liability in the
following way. First, it concluded that Container and its
foreign subsidiaries constituted a unitary business enter-
prise. It then computed the combined worldwide income
of Container and its subsidiaries. Next, the Board calcu-
lated Container’s California income by apportioning a
part of this total worldwide income to the state according
to a three-factor formula. Finally, it applied to the cal-
culated California income the California tax rate. The
state courts rejected Container’s federal constitutional
challenges to this manner of determining its California
income tax and sustained the validity of the worldwide-
combined-reporting method of apportionment.

California’s method of worldwide-combined-apportion-
ment is unconstitutional under the Foreign Commerce
Clause. Federal authority over foreign commerce and

international relations is “exclusive and plenary” and
may not be “limited, qualified, or impeded to any extent
by state action.” Board of Trustees v. United States, 289
U.S. 48, 56-57 (1933). No less is demanded by the his-
tory and purpose of the relevant sections of the Constitu-
tion and the necessary role of our national government in
its relations with other nations. As the Court has re-
cently affirmed:
“Foreign commerce is preeminently a matter of na-
tional concern. . [T]he Framers’ overriding con-
cern [was] that the Federal Government must speak
with one voice when regulating commercial rela-
tions with foreign governments.” Japan Line, Ltd.
v. County of Los Angeles, 441 U.S. 434, 448-49
(1979).
Accordingly, there is a “more rigorous” standard for
judging the validity of state action that impinges on
foreign commerce than state action that affects only in-
terstate commerce, Reeves, Inc. v. Stake, 447 U.S. 429,
438 n.9 (1980). Even in the absence of affirmative fed-
eral preemption, the Commerce Clause serves to protect
the preeminent power of the national government over
foreign commerce by ensuring “federal uniformity .. .
where federal uniformity is essential. [The states]
may not tell this Nation or [foreign countries] how to
run their foreign policies.” Japan Line, Ltd. v. County of
Los Angeles, supra, 441 U.S. at 448, 455.

By statute and treaty, the United States and its
foreign trading partners have adopted the method of
separate-source, arm’s-length allocation for taxing the
income of multinational entities. In essence, this method
consists of determining the national or geographic source
of income for each separate taxpayer and, if necessary,
reallocating income between related taxpayers as if they
had dealt with each other at arm’s-length. By these
means, priority is given to the taxing authority of the
jurisdiction in which income was earned, and duplicative
taxation of income is avoided. The separate-source, arm’s-
length method is the prevailing international norm for
the taxation of multinational enterprises.

4

In contrast, worldwide-combined-apportionment aban-
dons altogether the approach of separate-source account-
ing and arm’s-length reallocation. Instead, it assumes
that income cannot be accounted for by source, and it
seeks to apportion to a state a part of the combined
worldwide income of the separate entities engaged in a
unitary business. It does not recognize the separateness
of taxing jurisdictions let alone give priority to the juris-
diction where income is earned, and it virtually ensures
duplicative taxation of income. Thus, worldwide-combined-
apportionment is irreconcilably at odds with the interna-
tional standard of separate-source, arm’s-length allocation.

The worldwide-combined-apportionment method adopted
by California threatens to impair federal supremacy in
this area and to disturb relations between the United
States and foreign countries. Indeed, a number of for-
eign governments have already complained to the United
States about the use of worldwide-combined-apportionment.
Because of the severe problems it raises—including dupli-
cative taxation, distortion and misapportionment of in-
come, and onerous burdens of compliance—the California
tax interferes with international trade and foreign af-
fairs and should not be allowed to stand.

ARGUMENT

A sTATE’S UNITARY, COMBINED-REPORTING
APPORTIONMENT OF WORLDWIDE INCOME VIO-
LATES THE FOREIGN COMMERCE CLAUSE BE-
CAUSE IT DEVIATES FROM AND IS INCONSIST-
ENT WITH THE INTERNATIONAL NORM OF
SEPARATE-SOURCE, ARM’S-LENGTH ALLOCATION
ADOPTED BY THE UNITED STATES GOVERNMENT
AND ITS FOREIGN TRADING PARTNERS

A. The Federal Government’s Authcrity Over Foreign
Commerce and International Affairs Is Preeminent
and Exclusive

Few constitutional principles are as well-established
as the preeminent authority of the federal government
in the area of foreign commerce and international af-
fairs. The Constitution expressly vests in Congress the

Power . . To regulate Commerce with foreign Na-
tions....” Art. I, 58, el. 3. Likewise, the federal gov-
ernment, acting through the President and the Sent te,
has the power “to make Treaties” with foreign nations.
Art. II, § 2, el. 2. And even where the Constitution is
not explicit, the foreign-affairs power of the federal gov-
ernment has been recognized. See, e.g., United States v.
Curtiss-Wright Corp., 299 U.S. 304, 315-18 (1936);
United States v. Belmont, 301 U.S. 324, 330-31 (1937).'

Concomitant with this authority conferred upon the
federal government, the Constitution removes from the
states the power to act in matters of international com-
merce and foreign relations. Thus, states are generally
prohibited “without the Consent of the Congress” from
laying “any Imposts or Duties on Imports or Exports,”
and any such duties or imposts that are allowed as “abso-
lutely necessary for executing [a state’s] inspection
Laws” are expressly made “subject to the Revision and
Controul of the Congress,” with the revenues therefrom
“for the Use of the Treasury of the United States
Art. I, S 10, el. 2. Similarly, Inlo State shall, without
the Consent of Congress, lay any Duty of Tonnage,”
“enter into any Treaty, Alliance, or Confederation,” or
“enter into any Agreement or Compact . . with a for-
eign Power Art. I. S 10, cl. 3. These specific
inhibitions underscore the majestically simple conferral
on Congress of the affirmative and exclusive power to
regulate commerce with foreign nations. See, e.g., Board
of Trustees v. United States, 289 U.S. 48, 57 (1933).

1. As this Court Has Recognized From the Earliest
Days to the Present, the Need to Establish Na-
tional Control of Foreign Trade and Other Inter-
course Was a Principal Animating Reason for the
Writing and Adoption of the Constitution

The establishment of exclusive federal authority over
foreign affairs, and especially foreign commerce, was a

With respect to federal authority over foreign commerce and
international relations, see also Art. I. § 8, cl. 1; Art. I. §8, cl. 10;
Art. II, § 2, el. 2; Art. II. 5 3.

major reason for the adoption of the Constitution. As
Chief Justice Marshall explained:

“The oppressed and degraded state of commerce pre-
vious to the adoption of the constitution, can scarcely
be forgotten. It was regulated by foreign nations,
with a single view to their own interests; and our
disunited efforts to counteract their restrictions, were
rendered impotent, by want of combination. Con-
gress, indeed, possessed the power of making treaties;
but the inability of the federal government to en-
force them had become so apparent, as to render that
power in a great degree useless. Those who felt the
injury arising from this state of things, and those
who were capable of estimating the influence of com-
merce on the prosperity of nations, perceived the
necessity of giving the contro] over this important
subject to a single government. It may be doubted,
whether any of the evils proceeding from the feeble-
ness of the federal government [prior to the Consti-
tution], contributed more to that great revolution
which introduced the present system, than the deep
and general conviction, that commerce ought to be
regulated by congress.” Brown v. Maryland, 25 U.S.
(12 Wheat.) 419, 445-46 (1827). See also Cook v.
Pennsylvania, 97 U.S. (7 Otto) 566, 574 (1878);
Michelin Tire Corp. v. Wages, 423 U.S. 276, 283
(1976).

At the time of the Convention, “the major concern was
with extranational traffic, with only incidental and minor
regard to interstate commerce. . . . [T]he major preoc-
cupation [regarding trade and commerce] was with for-
eign trade and . . . the power over interstate commerce,
while coordinate in expression, was distinctly secondary
in scope and intended operation.” Abel, The Commerce
Clause in the Constitutional Convention and in Contem-
porary Comment, 25 Minn. L. Rev. 432, 465, 469 (1941),
cited with approval in Japan Line, Ltd. v. County of
Los Angeles, 441 U.S. 434, 448 n.12 (1979). See also
1 Watson, The Constitution of the United States 479-80,
483 (1910); cf. Railroad Co. v. Maryland, 88 U.S. (21
Wall.) 456, 470 (1874).

7

The records of the adoption of the Constitution con-
firm the central importance of the establishment of fed-
eral authority over commercial and diplomatic relations
with foreign governments. See generally 1 Beveridge,
The Life of John Marshall 304-05, 308-12 (1916); Far-
rand, The Framing of the Constitution of the United
Statee 5-12 (1913); Swisher, American Constitutional
Development 25-27 (2d ed. 1954); Warren, The Making
of the Constitution 567-90 (1937). The Federalist Papers
reflect that importance. Madison thought that “[t]he
powers delegated by the proposed Constitution to the
Federal Government. . . will be exercised principally on
external objects, as war, peace, negociation, and foreign
commerce.” The Federalist No. 45, at 313 (J. Cooke
ed. 1961). As Madison observed, [if we are to be one
nation in any respect, it clearly ought to be in respect
to other nations. . The regulation of foreign commerce
. . . [is] properly submitted to the federal administra-
tion.” The Federalist No. 42, at 279, 281 (J. Cooke ed.
1961). Hamilton also recognized the importance of this
matter. He said that “(t]he want of a power to regulate
commerce is by all parties allowed to be” one of “the
defects . . in the existing Federal system . . which
concur in rendering it altogether unfit for the adminis-
tration of the affairs of the Union.. . . It is indeed evi-
dent, on the most superficial view, that there is no object,
either as it respects the interests of trade or finance
that more strongly demands a Federal superintendence.”
The Federalist No. 22, at 135-36 (J. Cooke ed. 1961).
Without federal superintendence, he went on,

“(njo nation acquainted with the nature of our po-
litical association would be unwise enough to enter
into stipulations with the United States, by which
they conceded privileges of any importance to them
. . . [because t]he treaties of the United States,
under the present constitution, are liable to the in-
fractions of thirteen different Legislatures... .” Id.
at 136, 144. See also id., No. 11, at 65 (Hamilton).

2. This Court Has Recognized the Paramount Role
of the National Government in International Mat-
ters, Including Foreign Trade, as an Outgrowth
of the Nation’s Constitutional History

Consistent with our federal system of government and
the history and intendment of the Constitution, this
Court has long recognized the paramount role of the
national government in international affairs:

“(T]he supremacy of the national power in the gen-
eral field of foreign affairs . . is made clear by the
Constitution, was pointed out by the authors of the
Federalist in 1787, and has since been given con-
tinuous recognition by this Court... The Federal
Government, representing as it does the collective
interests of the . . . states, is entrusted with ful’ and
exclusive responsibility for the conduct of affairs with
foreign sovereignties. ... Our system of government
. . - imperatively requires that federal power in the
field affecting foreign relations be left entirely free
from local interference.” Hines v. Davidowitz, 312
U.S. 52, 62, 63 (1941).

What was said in general terms in Hines v. Davidowitz
of the preeminence of federal power in international
affairs is true in particular regard to the federal power
over foreign commerce. We have quoted above from
Board of Trustees v. United States, 289 U.S. 48, 56-57
(1933), the Court’s forceful comment that the national
power over foreign commerce is “exclusive and plenary”
and “may not be limited, qualified or impeded to any
extent by state action.” The Court went on there to say:

“In international relations and with respect to for-
eign intercourse and trade the people of the United
States act through a single government with unified
and adequate national power.... [This] single con-

2 See also, e.g., Department of Revenue v. Association of Wash-
ington Stevedoring Companies, 435 U.S. 734, 754, 758 (1978);
Zschernig v. Miller, 389 U.S. 429, 440-41 (1968) ; United States v.
Pink, 315 U.S. 203, 232-34 (1942); United States v. Belmont, 301
U.S. 324, 330 (1937); The Chinese Exclusion Case, 130 U.S. 581,
606 (1889); United States v. Arjona, 120 U.S. 479, 483 (1887).

9

trol... [of foreign commerce] was one of the domi-
nant purposes of the Constitution to create.” Id. at
59.*

For this reason, as the Court recently noted, It Ihe
States. . are subject to limitations on their taxation
powers that do not apply to the Federal Government.”
F.W. Woolworth Co. v. Taxation and Revenue Depart-
ment of New Mexico, No. 80-1745 (U.S. June 29, 1982),
slip op. 8. And the Commerce Clause of its own force
protects the paramount authority of the national govern-
ment to regulate commerce even though the federal power
has not been affirmatively exercised by the Congress or
the Executive to limit the actions of the states. See, e. g.,
Kassel v. Consolidated Freightways Corp., 450 U.S. 662,
669 (1981) (plurality opinion); Merrion v. Jicarilla
Apache Tribe, 102 S. Ct. 894, 910 (1982).

The broad federal authority over foreign commerce
and international affairs reflects the realization that
“Tijn this vast external realm” the Nation is confronted
with “important, complicated, delicate and manifold prob-
lems ... United States v. Curtiss-Wright Corp., 299
U.S. 304, 319 (1936). The problems can only be exacer-
bated if states are allowed to chart their own course.
As Hamilton cautioned, The Federalist No. 80, at 536
(J. Cooke ed. 1961), foreign powers have no special re-
gard for our federal system and will hold the national
government accountable for what the states do. In the
context of disabling states from acting in foreign affairs,
this Court has described the potential results of the ac-
countability of the national government for the wrongs
of member states. It has said that “‘[e}xperience has
shown that international controversies of the gravest
moment, sometimes even leading to war, may arise from
real or imagined wrongs to another’s subjects inflicted,

See also, e.g., Michelin Tire Corp. v. Wages, 423 U.S. 276,
285-86 (1976); County of Mobile v. Kimball, 102 U.S. (12 Otto)
691, 696-97 (1880) ; Inman Steamship Co. v. Tinker, 94 U.S. (4 Otto)
238, 245 (1876); Chy Lung v. Freeman, 92 U.S. (2 Otto) 275, 280
(1875).

10

or permitted, by a government.’” Zschernig v. Miller,

389 U.S. 429, 441 (1968), quoting Hines v. Davidowitz,

312 U.S. 52, 64 (1941). And if there should arise
“a difficulty which would lead to war, or to suspen-
sion of intercourse, would California alone suffer, or
all the Union? .. [Tjhe power to regulate com-
merce with foreign nations . . . belongs solely to the
national government. If it be otherwise, a single
State can, at her pleasure, embroil us in disastrous
quarrels with other nations.” Chy Lung v. Freeman,
92 U.S. (2 Otto) 275, 279, 280 (1875).

It is natural, then, given the significance of the foreign
commerce power to the adoption of the Constitution, the
greater importance of foreign commerce than that of in-
terstate commerce at the time the Nation was founded,
and the recognition of the paramount authority of the
federal government in all foreign affairs, that Commerce
Clause inhibitions on state action are “more rigorous
when a restraint on foreign commerce is alleged than
when all that is involved is an interference with inter-
state commerce.” Reeves, Inc. v. Stake, 447 U.S. 429,
438 n.9 (1980).

3. This Court in Japan Line Reaffirmed and Applied
the Principles of Exclusive National Competence
in Foreign Trade Matters in Invalidating a State
Tax That Resulted in Taxation Duplicative of
That of a Foreign Nation and Impaired the Ability
of the United States to Speak With One Voice in
Regulating Commercial Relations With Foreign
Governments

The issue in Japan Line, Ltd. v. County of Los Angeles,
441 U.S. 434 (1979), was the validity of a California
county’s fairly apportioned tax on its small, transient
share of the vaiue of Japanese cargo containers that
were used in international trade. The Court assumed
that such a tax on containers in interstate commerce
would have been constitutional, 441 U.S. at 445, 451.
But the mere fact that Los Angeles County’s tax was
fairly proportional to the length of the containers’ stay
in the county was not enough to save it under the For-

11

eign Commerce Clause as it would have had only inter-
state commerce been involved. The duplication, however
insignificant in amount, mattered in principle because
“Telven a slight overlapping of tax—a problem that
might be deemed de minimis in a domestic context—
assumes importance when sensitive matters of foreign
relations and national sovereignty are concerned.” Id. at
456. The Court emphasized that “[f]oreign commerce is
preeminently a matter of national concern,” and that,
allthough the Constitution . . grants Congress power
to regulate commerce ‘with foreign Nations’ and ‘among
the several States’ in parallel phrases, there is evidence
that the Founders intended the scope of the foreign com-
merce power to be the greater.” Id. at 448.

The Japan Line Court noted that the greater scope of
the foreign commerce power—equivalent to the “more
rigorous” standard of Reeves, Inc. v. Stake, supra—im-
plicates at least two considerations in foreign commerce
tax cases unique to them as opposed to interstate com-
merce tax cases. 441 U.S. at 446. One is the enhanced
risk of double taxation that results from the inability of
this Court or any other tribunal to ensure that, to take
the example then at hand, other jurisdictions capable of
taxing the containers would defer to Los Angeles Coun-
ty’s fairly apportioned tax. Id. at 447, 454. The other
is the necessity of barring exertions of state taxing power
that would prevent “the Federal Government from ‘speak-
ing with one voice when regulating commercial relations
with foreign governments.’” Id. at 451, quoting Michelin
Tire Corp. v. Wages, 423 U.S. 276, 285 (1976).

The fairly apportioned Los Angeles County tax both
resulted in double taxation and prevented the Nation
from speaking with one voice in regulating foreign com-
merce.

It resulted in double taxation because Japan—as was
its right under the custom of nations as the country
of domicile—taxed the containers on their full value with
no allowance for even the most fairly apportioned tax

12

levied by some jurisdiction through which they passed.
441 U.S. at 447, 451-52, 454.

The Los Angeles County tax also prevented the United
States from speaking with one voice to interested foreign
powers. The United States and Japan were parties to a
customs convention on containers, which reflect [ed] a
national policy to remove impediments” to international
traffic and under which American containers were not
taxed in Japan. Id. at 453. The Court found that in
these circumstances “California’s tax . . will frustrate
attainment of federal uniformity.” Ibid. For one thing,
the local tax on the containers “creates an asymmetry in
international maritime taxation operating to Japan’s dis-
advantage.” Ibid. The Court went on:

“The risk of retaliation by Japan, under these cir-
cumstances, is acute, and such retaliation of necessity
would be felt by the Nation as a whole. If other
States follow California’s example (Oregon already
has done so), foreign-owned containers will be sub-
jected to various degrees of multiple taxation, de-
pending on which American ports they enter. This
result, obviously, would make ‘speaking with one
voice’ impossible. California, by its unilateral act,
cannot be permitted to place these impediments be-
fore this Nation’s conduct of its foreign relations
and its foreign trade.” Ibid.

The Customs Convention, it should be noted, applied
only to federal and not to state taxes and therefore did
not by its own force invalidate the California tax. Id.
at 446 n.10. It was the prohibition, residing in the Com-
merce Clause, of state action that prevents the nation
from speaking with one voice in matters of foreign trade
that invalidated the Los Angeles County tax. The Court
made clear that in this area the absence of express fed-
eral preemption of action by the states does not leave the
states at liberty to act.

“We find no merit in th[e] contention ... that a
State is free to impose demonstrable burdens on com-
merce, so long as Congress has not pre-empted the
field by affirmative regulation. California may

13

not tell this Nation or Japan how to run their foreign
policies.” Id. at 454-55.

B. Because It Deviates From the International Norm of
Separate-Source, Arm’s-Length Allocation Adopted by
the United States and Other Nations, California’s
Worldwide-Combined-Reporting Method of Apportion-
ment Violates the Foreign Commerce Clause

The California worldwide-combined-reporting method
of apportionment is unconstitutional uader the Foreign
Commerce Clause.‘ Congress, by statute and treaty, has
adopted a different method—the separate-source, arm’s-
length allocation method—that accords with the custom
of nations and is inconsistent with the use of the world-
wide-combined-reporting method by any of the states.
California’s method, moreover, results in double taxation
and has other conceptual and practical flaws that aggra-
vate the interference it works with federal regulation of
international commerce.

1. Congress Has Provided in the Relevant Provisions
of the Internal Revenue Code for Separate-Source,
Arm’s-Length Taxation of Multinational Income

The United States, like other nations, rests its jurisdic-
tion to levy the national income tax on the domicile of
the taxpayer and, where a domiciliary connection with the
United States is lacking, on the fact thet the source of the
taxpayer’s income is in the United States. See, e.g., 2
Bittker, Emory, & Streng, Federal Income Taxation of
Corporations and Shareholders (Forms) 17-3 to 17-4
(rev. ed. 1982); Thompson, Federal Income Taxation of
Domestic and Foreign Business Transactions 512-14
(1980). Thus, natural persons who are citizens or verma-
nent resident aliens and corporations that owe their ex-
istence to the laws of the United States or any of the
states are obliged to pay tax to the United States on their

Because the California tax violates the Foreign Commerce
Clause, it is unnecessary for the Court to decide whether it also
offends the Due Process Clause. See ASARCO, Inc. v. Idaho State
Tax Comm., No. 80-2015 (U.S. June 29, 1982), slip op. 20 n.14
(O’Connor, J., dissenting).

14

income whatever its geographical source. Non-resident
aliens and foreign corporations that derive income from
the United States are also subject to the federal income
tax but only to the extent that their income does indeed
find its source in the United States. In parallel fashion,
foreign jurisdictions tax the income earned within their
borders, including the foreign-source income of American
corporations or foreign subsidiaries of American compa-
nies. Finally, to ensure that our domiciliaries are not
penalized by the source-based taxing systems of other na-
tions, the familiar foreign income tax credit provisions
allow the domestic corporation that does business abroad
—-te take the most typical example and the relevant ex-
ample for purposes of this case—to credit any taxes paid
to foreign countries in respect of “income from sources
without the United States” against what would other-
wise be its United States income tax liability.

That description summarizes—and no doubt oversimpli-
fies—many pages of technical provisions of the Internal
Revenue Code. But it captures, we believe, the essence of
separate-source income taxation, the system of income
taxation that, in the interest of comity, of the security of
multinational enterprises, and thus ultimately of world
economic development, is pursued almost everywhere the
world round.

We elaborate only so far as necessary to provide au-
thority for what we have just outlined by way of sum-
mary.

As this Court has said, “domestic corporations are re-
quired to pay a tax on their incomes from all sources.”
National Paper & Type Co. v. Bowers, 266 U.S. 373, 376
(1924). See also Bittker, Emory, & Streng, supra, at
17-4; Thompson, supra, at 512; 3 Bittker, Federal Taxa-

5 See Thompson, supra, at 557, quoting Draft Double Taxation
Convention Report of the O.E.C.D. (1963); Tax Conventions with
Belgium, Finland, Trinidad and Tobago, and the Netherlands:
Hearings Before the Senate Comm. on Foreign Relations, 91st
Cong., 2d Sess. 2 (1970) (statement of then Assistant Secretary
of the Treasury Edwin S. Cohen).

15

tion of Income, Estates and Gifts J 65.1, at 65-2 (1981).
The rule, however, is subject to the allowance of a credit
for taxes paid to foreign jurisdictions on income from
sources without the United States. 26 U.S.C. §§ 901 et
seq. Tne credit is also of long standing. This Court ex-
plained in a leading case that “the primary design of the
[eredit] provision was to mitigate the evil of double tax-
ation” resulting from the overlapping jurisdiction of the
United States and foreign countries to tax. Burnet v.
Chicago Portrait Co., 285 U.S. 1, 7 (1932); see also id.
at 8-10 nn.6, 7; American Chicle Co. v. United States,
316 U.S. 450, 451 (1942); Associated Tel. & Tel. Co. v.
United Sites, 306 F.2d 824, 832 (2d Cir. 1962), cert.
denied, 371 U.S. 950 (1963). The Senate Committee on
Finance more recently has explained that the “foreign
tax credit system embodies the principle that the country
in which a business activity is conducted . . . has the first
right to tax the income arising from” that activity even
if it is conducted by a company resident in another coun-
try. S. Rep. No. 94-988, 94th Cong., 2d Sess. 233 (1976).
The country where the company resides “has a residual
right to tax the income arising from” the activity in an-
other country, but the country of the corporation’s resi-
dence “recognizes the obligation to insure that double
taxation does not result.” Ibid. The United States uses
the tax credit to satisfy that obligation by ensuring that
income is caxed initially according to its source.

Foreign corporations “are ordinarily not taxed [in the
United States] on their foreign-source income
Bittker, Emory, & Streng, supra, at 17-3. The Congress
has defined “domestic” corporations and “foreign” cor-
porations. 26 U.S.C. S8 7701(a)(3), (5). Moreover, it has
established source-of-income and source-of-deduction rules,
26 U.S.C. §§ 861-63, which determine It] he geographical
source” of income and deductions, Bittker & Eustice,
Federal Income Taxation of Corporations and Share-
holders J 17.02, at 17.09 (4th ed. 1979). By these rules,
the foreign-source income of foreign corporations is dis-
tinguished from their United States-source income and

16

left to be taxed by the appropriate foreign jurisdiction.
Thompson, supra, at 514. Thus, because the United States
defers to the source jurisdiction’s taxation of the foreign-
source income of foreign corporations, inconsistent treat-
ment and multiple taxation are avoided. These rules
apply even if the foreign corporation is “wholly owned
by U.S. shareholders.” Bittker, Emory, & Streng, supra,
at 17-3. It is only when “the foreign income is repatriated
in the form of dividends to U.S. sharehold that it
will be subjected to U.S. taxation. bid. And in
that event, the United States allows, in accordance with
the credit provisions already discussed, “a credit for for-
eign income taxes... paid when the income was earned
in the foreign jurisdiction.” Ibid.

The separate-source system, then, is quite simple. It is
complicated only by the fact that the geographical source
of income earned by a multinational enterprise is not
always self-evident.

To protect the integrity of the source rules for taxing
income, Section 482 of the Code authorizes the Internal
Revenue Service to reallocate income between two or more
entities owned or controlled by the same interests if “nec-
essary in order to prevent evasion of taxes or clearly to
reflect the income of any of suck [entities].” 26 U.S.C.
§ 482. See Commissioner v. First Security Bank of Utah,
N.A., 405 U.S. 394, 400 (1972). When any reallocation
has to be made, it is done by treating the commonly
owned or controlled entities as if they had dealt with
each other at arm’s length. As explained in the Treasury
regulations implementing Section 482:

“The purpose of section 482 is to place a controlled
taxpayer on a tax parity with an uncontrolled tax-
payer, by determining, according to the standard of
an uncontrolled taxpayer, the true taxable income
from the property and business of a controlled tax-
payer.... The standard to be applied in every case
is that of an uncontrolled taxpayer dealing at arm’s
length with another uncontrolled taxpayer.” Treas.
Reg. § 1.482-1 (b) (1) (emphasis added).

17

Arm’s-length reallocation pursuant to Section 482 is
authorized in “any case in which either by inadvertence
or design the taxable income, in whole or in part, of a
controlled taxpayer, is other than it would have been had
the taxpayer in the conduct of his affairs been an uncon-
trolled taxpayer dealing at arm’s length with another un-
controlled taxpayer.” Treas. Reg. § 1.482-1(c). The ob-
vious case, and the case where the IRS has employed Sec-
tion 482 most extensively in recent years, is that of a
foreign corporation selling products to an affiliated do-
mestic corporation at spurious prices that result in larger
profits abroad, thereby producing smaller profits and
smaller taxable income in the United States. See 3
Bittker, Federal Taxation of Income, Estates and Gifts
79.1, at 79-2 (1981).

2. In Treaties as Well as in the Internal Revenue
Code, the National Government Has Committed
Itself to Separate-Source, Arm’s-Length Account-
ing for Income Tax Purposes

In addition to their inclusion in the Internal Revenue
Code, the two fundamental standards of federal taxation
of multinational enterprises—(1) avoidance of multiple
taxation by deference to the taxing authority of the juris-
diction where the income originated (geographical-source
allocation), and (2) where necessary, arm’s-length re-
allocation to determine the true income for commonly
controlled taxpayers (arm’s-length accounting)—are also
embodied in international tax treaties. They are the
standards of the tax treaties between the United States
and its trading partners, such as Canada, France, Ger-

many, Italy, Japan, and the United Kingdom.“

The Treasury Department’s Model Income Tax Treaty
“for the Avoidance of Double Taxation and the Preven-

* See 1 CCH Tax Treaties, e. g., J 1203 (Canada) (see also J 1301);
2803 (France); 3003 (Germany); 4303 (Italy); {4393
(Japan); 2 CCH Tax Treaties J 8103A (United Kingdom).

Appellant has stated that the arm’s-length method was used in
those foreign countries in which its subsidiaries operated. See J.S.
8.

18

tion of Fiscal Evasion With Respect to Taxes on Income
and Capital” provides that business profits arising in a
foreign country may be taxed in that country and that
the domiciliary country of the taxpayer will not impose
a second tax on that income. 1 CCH Tax Treaties {| 158,
at 257 (Art. 7), 263 (Art. 23) (1981). The Treasury
Model Treaty, having thus described the separate-source
method, goes on to describe the arm’s-length reallocation:
for “associated enterprises” between which “conditions
are made or imposed . . . in their commercial or financial
relations which differ from those which would be made
between independent enterprises, . any profits which,
but for those conditions would have accrued to one of the
enterprises, but by reason of those conditions have not
so accrued, may be included in the profits of that enter-
prise and taxed accordingly.” Id. at 258 (Art. 9). See
also id. at 257 (Art. 7). Similar provisions are also con-
tained in the “Model Convention for the Avoidance of
Double Taxation With Respect to Taxes on Income and
Capital” of the Organization for Economic Co-operation
and Development (of which the United States is a mem-
ber) and in the United Nations “Model Double Taxation
Convention Between Developed and Developing Coun-
tries.“ —

In view of the foregoing, it is clear that separate-
source, arm's-length allocation is the prevailing inter-
national norm adopted by the United States and its in-
ternational trading partners. As Assistant Secretary of
the Treasury Woodworth explained:

“The Federal Government and virtually all other gov-
ernments in the world determine taxable income on
the basis of what are arm’s length transactions in
— related companies. This is the gen-

[T]he arm’s length rule is generally applicable in
the world today .... [It is] the general rule with

71 CCH Tax Treaties $151 (1980).
1 CCH Tax Treaties § 171 (1982).

19

which [other countries and companies of other coun-
tries] are acquainted [and is] used by the Federal
Government.

[T]he Federal Government, and practically all of the
rest of the world, uses the arm’s length procedure.“

3. California’s Worldwide-Combined-Apportionment
Method Results in Duplicative Taxation and Is
at Odds With the Method of Allocating Income
for Income-Tax Purposes Used by the United
States and its Trading Partners in the Interna-
tional Community

In the face of this international acceptance of the
separate-source, arm’s-length method, California’s unitary,
combined-reporting apportionment of worldwide income
cannot be allowed to stand. Like Los Angeles County’s
fairly apportioned property tax, it must be condemned
under the Foreign’ Commerce Clause because it “im-
pairs] federal uniformity in an area where federal
uniformity is essential” and “prevents the Federal Gov-
ernment from ‘speaking with one voice when regulating
commercial relations with foreign governments.’” Japan
Line, Ltd. v. County of Los Angeles, 441 U.S. 434, 448,
451 (1979).

The California method of apportionment includes the
earnings of foreign subsidiaries in the combined world-
wide total of income to be apportioned. The result is to
impose a tax on income that has already been taxed by

Ta Treaties with the United Kingdom, the Republic of Korea,
and the Republic of the Philippines: Hearings Before the Senate
Comm. on Foreign Relations, 95th Cong., Ist Sess. 20-21, 24 (1977);
See also id. at 33, 105; State Taxation of Interstate Commerce and
Worldwide Corporate Income: Hearings on S. 983 and S. 1688
Before the Subcomm. on Taxation of the Senate Comm. on Finance,
96th Cong., 2d Sess. 44 (1980) (statement of then Assistant Secre-
tary of the Treasury Donald C. Lubick); State Taæat ion of Foreign
Source Income: Hearings on H.R. 5076 Before the House Comm. on
Ways and Means, 96th Cong., 2d Sess. 4, 5, 7, 9 (1980) (statement
of Assistant Secretary Lubick).

the source jurisdiction abroad on an unapportioned, full-
value basis. (See pp. 14, 16 supra.) Thus, as in Japan
Line, Ltd. v. County of Los Angeles, supra, a second tax
on the identical income “inevitably results . . . if a State
should seek to tax . . . [that foreign-source income] on
an apportioned basis,” 441 U.S. at 447, and this is true
even though the state tax is fairly apportioned,’” id.
at 448.

Nor can it be said recognizing that the duplication is
likely to be of the greatest concern to the other members
of the international community when a foreign parent's
income is attributed to a California subsidiary that this
duplicative tax is of no concern to the foreigi-source
country even in the case of a United States parent with
a foreign subsidiary. In comparison to separate-source
accounting, California’s method of taxation will discour-
age foreign investment by United States companies and
make it less likely that they will establish foreign sub-
sidiaries. Consider an example in which no arm’s-length
adjustment is needed between a domestic parent and its
foreign subsidiary because the intrafamily transfer prices
fairly approximate arm’s-length prices.“ If the unitary,
combined-reporting system attributes to California an
amount of foreign-source income that has been fully
taxed by the foreign jurisdiction, then this duplicative
tax by the state will require the overall operation of the
parent and subsidiary to be more profitable than it would
have to be under the separate-source method in order to
produce the same total after-tax income. Such a disin-
centive to United States investment abroad, as a conse-

10 In this case, appellant’s foreign subsidiaries paid taxes in the
foreign countries on the amounts earned in each country (J.A. 72).
Nevertheless, California attributeſd] to other countries approxi-
mately one-half of the income produced in Colombia and Venezuela
according to arm’s-length principles applied in those countries”
(J.S. 11).

11 In this case, the Internal Revenue Service audited Container
for the years in question here. It accepted Container’s income
figures as accurate and proposed no adjustments to income or de-
ductions under § 482. (J.A. 78-79.)

21

quence of the application of the combined-reporting
method instead of the separate-source standard, would
surely be of considerable importance to foreign govern-
ments. And any repatriation of funds to the United
States necessary to satisfy the duplicative state tax could
well interfere with the internal policies of foreign-source
countries in such areas as the development and retention
of capital for local reinvestment by the subsidiary itself
or by foreign minority shareholders.”

Beyond duplication of tax is the effect of the California
method in preventing the United States from speaking
with one voice. The “custom of nations,” 441 U.S. at
447, 454, in this area—deviated from only by the world-
wide-combined-reporting states — is to avoid overlapping
or duplicative taxation of the same income by according
priority to the jurisdiction that is the source of income
and reallocating income, when required to avoid distor-
tion, on an arm’s-length basis. In essence, this approach
rests on the determination of the geographic source of
income for each separate taxpayer and, if necessary, the
arm’s-length readjustment of income between related
taxpayers.

In contrast, the central premise of unitary, combined-
reporting apportionment is that moat “income . . . cannot
be satisfactorily allocated by source,” J. Hellerstein &
W. Hellerstein, State and Local Taxation 399 (4th ed.
1978)—in other words, “the impossibility of allocating
specifically the profits earned by the processes conducted
within [the state’s] borders,” Underwood Typewriter Co.
v. Chamberlain, 254 U.S. 113, 121 (1920). Under this
system, the worldwide business income of the entire multi-
national unitary enterprise is combined in a single total

12 We note that a substantial number of appellant’s overseas sub-
sidiaries had foreign minority stockholders—in some cases as much
as 33% of total ownership. (J.A. 7, 14-15.)

18 FEI estimates that approximately 10 states have adopted a
system of worldwide-combined-apportionment. Compare Japan Line,
Ltd. v. County of Los Angeles, supra, 441 U.S. at 453 & n.19.

22

and then apportioned to California according to a three-
factor formula, that is, according to how much the Cali-
fornia part of the enterprise represents of its total prop-
erty, payroll, and sales. (See J.S. App. A6 n.2.) It
is thus apparent that California’s unitary, combined-
reporting apportionment of worldwide income is irrec-
oncilably at odds with the international standard of
separate-source allocation. As the Court observed in
Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425,
444-45 (1980), “[t]axation by apportionment and taxa-
tion by allocation to a single situs are theoretically in-
commensurate, and if the latter method is constitutionally
preferred, a tax based on the former cannot be sus-
tained.” The Court held that specific allocation was not
constitutionally preferred in the circumstances of that
case. Here it must be preferred because state unitary
taxation of worldwide income “is not ceding the primacy
of foreign source income . . . to the foreign government.”
State Taxation of Foreign Source Income: Hearings on
H.R. 5076 Before the House Comm. on Ways and Means,
96th Cong., 2d Sess. 10 (1980) (hereinafter Foreign
Source Income Hearings) (statement of then Assistant
Secretary of the Treasury Donald C. Lubick).

Moreover, California’s method “creates an asymmetry
in international . . . taxation,” 441 U.S. at 453, that
threatens to impair federal supremacy in this area and
to disturb relations between the United States and for-
eign countries. As Assistant Treasury Secretary Wood-
worth noted, “it becomes very disconcerting for other
countries and for companies of other countries doing busi-
ness in the United States to have the general rule [of
separate-source accounting] with which they are ac-
quainted used by the Federal Government and to find
that certain State governments do not follow that rule
[I]t is important that we all use the same test.” Tax
Treaties with the United Kingdom, the Republic of Korea,
and the Republic of the Philippines: Hearings Before the
Senate Comm. on Foreign Relations, 95th Cong., Ist Sess.
21, 24 (1977) (hereinafter Tax Treaties Hearings) ;

see also id. at 33. In fact, the state “practice has created,
and continues to create, an irritant in the international
relations of the United States. A number of foreign gov-
ernments have complained, both officially and informally,
that the unitary system differs from the arm’s-length
method which is used by the Federal Government and is
generally accepted in international practice.” State Taæ-
ation of Interstate Commerce and Worldwide Corporate
Income: Hearings on S. 983 and S. 1688 Before the
Subcomm. on Taxation of the Senate Comm. on Finance,
96th Cong., 2d Sess. 44 (1980); see also Foreign Source
Income Hearings 5, 7 (statement of Assistant Secretary
Lubick).“

We recognize, of course, that the problems caused by
worldwide-combined-apportionment are exacerbated in the
ease of a foreign parent corporation with a domestic sub-
sidiary doing business in California. But application of
the California tax even to a domestic parent and its for-
eign subsidiaries, which is what this case involves, inter-
feres with the federal government’s authority over in-
ternational trade and diplomatic affairs and therefore is
unconstitutional under the Foreign Commerce Clause.“

14 The background and details of these protests by foreign gov-
ernments are set out in the Brief for Appellant (at 23-28) and
the Memorandum for the United States as Amicus Curiae (at 16-
17) in Chicago Bridge & Iron Co. v. Caterpillar Tractor Co.,
No. 81-349 (0.T. 1981).

15 In addition, to create a special rule that discriminates against
domestic companies in favor of foreign organizations would be a
misguided construction of the Constitution, since the Commerce
Clause “cannot be read to accord . [foreign entities] prefer-
ential treatment.” Michelin Tire Corp. v. Wages, supra, 423 U.S.
at 287. See also Maryland v. Louisiana, 451 U.S. 725, 754 (1981)
(the Commerce Clause contains an “antidiscrimination principle
[which] ‘follows inexorably from the basic purpose of the Clause’
to prohibit the multiplication of preferential trade areas destructive
of free commerce anticipated by the Constitution”).

24

4. The Flaws That Inhere in the Worldwide-
Combined-Apportionment Method Underscore Its
Constitutional Impermissibilit

California, one may concede, is seeking only to tax its
fair share of the income of Container Corporation and
other companies that do business both in California and
in foreign lands. Within the community of the states of
the Union, the method it has chosen, we may assume,
would be a permissible one because any distortions it
would yield are likely to be within tolerable bounds and
this Court sits to ensure that California and its sister
states do not unduly burden or discriminate against busi-
nesses that operate across state lines. In this case, how-
ever, the Court’s writ runs only to California and not to
the nations whose taxing systems would have to be ac-
commodated to California’s if the California system were
allowed to stand.

Moreover, the distortions that system yields, when ap-
plied beyond the borders of the United States, far exceed
tolerable limits. The California method, in short, cannot
be defended on the ground that, though different from the
federal and the international system, it comes out at
about the same place. The California method is not cal-
culated to produce a fair or reasonable result when ap-
plied to income earned abroad.

Worldwide-combined-apportionment is impermissibly
susceptible of seriously distorting the income attributed
to the jurisdiction using the method. “The underlying
premise of formulary apportionment under the . . . three-
factor formula is that. ., 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 taxing jurisdictions.”
J. Hellerstein & W. Hellerstein, supra, at 539. As the
Treasury Department has correctly pointed out, [il m-
plicit in the unitary system is the assumption that profit
rates in different units of a corporate family, engaged in
different activities and in different locations, are always

the same.” Tax Treaties Hearings 34 (statement of
Assistant Secretary Woodworth).

Whatever the validity of formula apportionment within
the largely-homogeneous United States, this approach is
unsound and arbitrary in the international context.!“ As
Assistant Treasury Secretary Woodworth explained, it is

“clearly not the case [that multinational profit rates
are the same]. And when it is not the case, the
unitary system will misallocate income. Whenever
profit rates are higher in foreign affiliates than in
domestic activities, the unitary system allocates too
much income to the domestic member or members of
the group. The result is tantamount to taxation by
a state government of the foreign income of a for-
eign corporation.” Tar Treaties Hearings 34; see
also id. at 21, 24; J. Hellerstein & W. Hellerstein,
supra, at 539; H.R. Rep. No. 1480, 88th Cong., 2d
Sess. 168 (1964) ; State Tuxation of Interstate Com-
merce: Hearings Before the Subcomm. on State Tax-
ation of the Senate Comm. on Finance, 93d Cong.,
Ist Sess. 160 (1973) (statement of Professor Jerome
R. Hellerstein) ."7

16 In the context of interstate commerce, “a State may apply an
apportionment formula to the taxpayer’s total [unitary] income in
order to obtain a ‘rough approximation’ of the corporate income that
is ‘reasonably related to the activities conducted within the taxing
State.“ Exxon Corp. v. Wisconsin Department of Revenue, 447
U.S. 207, 223 (1980). In the case of foreign commerce, however,
“felven a slight overlapping of tax—a problem that might be
deemed de minimis in a domestic context—assumes importance
when sensitive matters of foreign relations and national sovereignty
are concerned.” Japan Line, Ltd. v. County of Los Angeles, 441
U.S. 434, 456 (1979).

17 See also GAO Report on Determining the Income of Multi-
national Corporations, App. IX, at 93 (Sept. 30, 1981) (letter from
Assistant Secretary of the Treasury John E. Chapoton) (“formula
apportionment has little merit because a corporation could have an
increased tax burden merely as a result of its affiliates becoming
more profitable or as a result of paying higher wages in the juris-
diction applying the formula”).

26

Such a misapportionment of worldwide income can
occur for any reason that causes the overseas operations
to be more profitable than domestic operations. One
well-recognized example is the significant disparity around
the world in wage rates and payroll costs—one of the
factors employed in California’s apportionment formula.
Once again, this has been acknowledged by the Treasury
Department:

Labor costs vary substantially among countries
very much more so than among regions in the United
States.... [The foreign] labor cost element in the
formula will probably be lower than the California
labor cost. A disproportionate amount of income will
be apportioned to California.” Tax Treaties Hear-
ings 34 (statement of Assistant Secretary Wood-
worth).

Indeed, the record in the instant case clearly proves
this defect in worldwide apportionment. It was demon-
strated below that Container’s overseas businesses were
more profitable than its United States business. (See
J.S. 18-19.) Expert testimony also illustrated the rea-
sons why corporate operations abroad are in general
more profitable than domestic operations. (See J.S. 19-
20.) And, with particular regard to wage rates, Con-
tainer showed that its “workers in California are paid
2½ times the amount paid to workers in Colombia to
produce the same quantity of . . . containers” (J.S. 18),
that worldwide wage rates vary widely and that wage
rates in the United States exceed those in other countries
(J.S. 18 & n.11; J.S. App. A41-A42), and that in 1969-
70 the average hourly worker compensation in developed
countries, as adjusted for differences in productivity, was
only 40 to 82 percent of the average hourly compensation
in the United States (J.S. 18 & n.11; J.S. App. A43).

Such misapportionment is objectionable on several
grounds. As Assistant Treasury Secretary Woodworth
observed, it allows the state effectively to tax the foreign-
source income of a foreign corporation over which the
state would not otherwise have jurisdiction. It also is

27

manifestly unfair to the domestic taxpayer to be required
to pay taxes on the foreign-source income of a separate
corporate entity. And, of particular significance for pur-
poses of the Foreign Commerce Clause, it discourages
American investment in countries in which the profit-
ability rate is significantly different than in the United
States and thereby discriminates against those countries
(generally the developing countries) in favor of nations
(generally the industrialized nations) where profitability
is more comparable to that in the United States.

Furthermore, worldwide-combined-apportionment raises
insurmountable problems of application. It requires that
corporate books and records from all over the world be
converted from foreign currencies and accounting prac-
tices into United States dollars and accounting conven-
tions. The burden of such an undertaking can be enor-
mous,'* and the results of the conversion are often, at
best, arbitrary and inexact. See J. Hellerstein & W.
Hellerstein, supra, at 539; Tax Treaties Hearings 34
(statement of Assistant Secretary Woodworth). In fact,
the record in this case discloses that “[a]ccounting pro-
cedures and methods [for Container and its foreign sub-
sidiaries] were far from standardized . . . . The books
and records of the foreign subsidiaries are kept in accord-
ance with the generally accepted accounting principles,
if any, of the country in which the subsidiary is located.
These accounting principles may vary in material re-
spects from generally accepted accounting principles in
the United States.” (J.A. 40, 72. See also J.S. App.
A29.)

Undoubtedly, of course, foreign subsidiaries already
supply some information to their domestic parent in a
form in which these conversions have been made. But

18 See Tax Treaties Hearings 105 (letter from Secretary of the
Treasury Blumenthal). Moreover, because of foreign laws pro-
hibiting or restricting the disclosure of certain information, it is
sometimes not possible to provide the information required by the
taxing state. Ibid. See also Tax Treaties Hearings 213 (statement
of Valentine Brookes) (United Kingdom Official Secrets Act).

28

that process—which certainly varies for each company—
is a far cry from the detailed and voluminous material
on property, payroll, and sales necessary for California
to apply its method of worldwide-combined-apportion-
ment. Moreover, under the theory that the separate cor-
porations are part of a unitary business enterprise, the
combined-reporting system eliminates all intra-enterprise
dealings and transactions between these entities. Cf.
' ASARCO, Inc. v. Idaho State Tax Comm., No. 80-2015
(U.S. June 29, 1982), slip op. 5; Mobil Oil Corp. v.
Commissioner of Taxes, 445 U.S. 425, 441 n.15 (1980).
To effect the required elimination would impose on a
taxpayer an extraordinary burden, well beyond anything
corporations usually do in the ordinary course of business.

For all these reasons, the worldwide-combined-report-
ing method of apportionment violates the Foreign Com-
merce Clause.“ Congress, we may assume, could author-
ize the states to apply worldwide-combined-apportionment
—despite its inconsistency with Congress’ own chosen
method and despite its inherent defects—for “Congress,
if it chooses, may exercise [its Commerce Clause] power
. .. by conferring upon the States an ability to restrict
the flow of . . . commerce that they would not otherwise

19 The validity of the California tax is not saved by the decision
of this Court in Bass, Ratcliff & Gretton, Ltd. v. State Tax Com-
mission, 266 U.S. 271 (1924). Bass presented no conflict between
state apportionment of worldwide income and the international
norm of separate-source, arm’s-length accounting, since it was not
until “1934 [that] the Department of the Treasury adopted the
‘arm’s length standard’ for allocating income.” GAO Report on
Determining the Income of Multinational Corporations, at 2 (Sept.
30, 1981). The ensuing development of tax treaties and the inter-
national acceptance of the arm’s-length method that now prevails
make the instant case a much different one than Bass. Moreover,
Bass was “controlled,” 266 U.S. at 280, by the decision in Underwood
Typewriter Co. v. Chamberlain, 254 U.S. 113 (1920), which involved
the apportionment of interstate income; but as the Court has now
held (see pp. 10, 11, 25 n.16 supra), a more rigorous test is applicable
to foreign commerce than to interstate commerce. Finally, unlike
the instant case, the taxpayer in Bass had “not even attempted
to show,” 266 U.S. at 282, any misapportionment of income.

29

enjoy.” Lewis v. BT Investment Managers, Inc., 447
U.S. 27, 44 (1980). See also New England Power Co. v.
New Hampshire, 102 S. Ct. 1096, 1101 (1982) ; ASARCO,
Inc. v. Idaho State Tax Comm., supra, slip op. 20 n.14
(O'Connor, J., dissenting). But, “{i]f there are to be
such restraints, they must be provided by the Federal
Government.” Zschernig v. Miller, 389 U.S. 429, 441
(1968). Unless and until Congress grants this authority,
the states may not depart from the international norms
of commerce recognized by tie United States and its
trading partners.
CONCLUSION

The California method of unitary, combined-reporting
apportionment of worldwide income is unconstitutional
under the Foreign Commerce Clause. Accordingly, the
judgment below should be reversed.

Respectfully submitted.

WILLIAM H. ALLEN *
JOHN B. JONES, JR.
MARK I. LEvy

COVINGTON & BURLING
1201 Pennsylvania Avenue, N.W.
P.O. Box 7566
Washington, D.C. 20044
(202) 662-6000 2°
July 1982

* Counsel of Record

20 We gratefully acknowledge the able and invaluable assistance
of Joseph Neuhaus in the preparation of this brief.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385008_0362%3A32. Public record. Not legal advice.