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

In the Supreme Court

of the United States

OCTOBER TERM, 1982

CONTAINER CORPORATION OF AMERICA,

Appellant,

V.

FRANCHISE TAX BOARD,

Appellee.

On Appeal From the Court of Appeals

of the State of California

BRIEF OF THE STATE OF OREGON AS AMICUS

CURIAE IN SUPPORT OF BRIEF OF

FRANCHISE TAX BOARD

TABLE OF CONTENTS

Page

Statement of Interest of State of Oregon as Amicus Curiae 1

D. x —— 3

„ 4

I. Worldwide formulary apportionment does not violate

the Due Process Clause and does not produce extra-

territorial taxation. There is no violation of the Commerce

Clause because no multiple taxation of foreign source

income can be proven. There are no enforceable uniform

standards with respect to the states and this country and

with respect to the international scene. Before an argu-

ment can be made that the federal government is prevent-

ed from speaking with one voice in regard to foreign

Z ee GIIIINGIED ccccccccessentesese conosedenseonennnesessnnesscseese 4

II. The ASARCOand Woolworth decisions indicate unreal-

istic and unreasonable due process standards for the utili-

zation by the states of the unitary business principle in

combining and apportioning of the net income of affiliated

- „„ 23

III. The facts in this case support the conclusion that Con-

tainer is unitary with its foreign subsidiaries .................... 30

TABLE OF AUTHORITIES

Table of Cases Page

ASARCO, Inc. v. Idaho State Tax Commission, — U.S. —,

102 S. Ct. 3103, 73 L. Ed.2d 787, 50 U.S.L.W. 4962

ne . Ä passim

Bass, Ratcliff & Gretton Ltd. v. State Tax Comm., 266 U.S.

r 21

Butler Bros. v. McColgan, 315 U.S. 501, 62 S. Ct. 701

(1942), affg. 17 Cal.2d 664, 111 P.2d 3344. 5, 6, 26

Caterpillar Tractor Co. v. Dept. of Rev., 289 Or. 885, 618 P.2d

r 2

Chicago Bridge & Iron v. Caterpillar Tractor Co., 84 III. 2d

2 ĩðxEvy —— 2

Coca-Cola Co. v. Dept. of Rev., 271 Or 517, 533 P. 2d 788

ene . 2, 6, 8

Container Corp. v. Franchise Tax Bd., 173 Cal. Rptr. 121, 117 ;

. 2...0ccccccreccseccescvesccseocscocscccscccscccscccsccees 10

Donald M. Drake Co. v. Dept. of Rev., 263 Or. 26, 500 P.2d

D 2

TABLE OF AUTHORITIES—Continued

Table of Cases—Continued Page

Exxon Corp. v. Wisconsin Dept. of Rev., 447 U.S. 207

. ——ͤ ——̃ —ů — 11, 16, 26, 28

F. W. Woolworth Co. v. Taxation & Revenue Dept.. — U.S.

—, 102 S. Ct. 3128, 73 L. Ed. 2d 819, 50 U.S. L. W. 4957

(1982) — passim

Humble Oil & Refining Co. v. Dept. of Rev., 4 O. T. R.

rr 11. 16

Japan Line, Ltd. v. County of Los Angeles, 441 U.S. 434

——— — — passim

Mobil Oil Corp. v. Commissioner of Taxes of Vermont,

— 22, 29

Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978) . 8,10

Northwestern States Portland Cement Co. v. Minnesota,

KPR 19, 22

Underwood Typewriter Co. v. Chamberlain, 254 U.S.

KKK 6, 19, 24

Wisconsin v. J. C. Penney, 311 U.S. 435 (1940 22

Zale-Salem, Inc. v. Tax Comm., 237 Or. 261, 391 P. 2d 601

. ⁰ aß ̃ ˙dä K 0 2

Constitutional and Statutory Provisions

x == === 2

, 2

Art. I, § 32, Oregon Constitution . .. . . 24

Art. IX, § 1, Oregon Constitution 24

Fourteenth Amendment, U.S. Constitution 24

Other Authorities

Altman & Keesling, Allocation of Income and State Taxation

re. 7

Kesling A Current Look at the Combined Report and Uni-

formity and Allocation Practices” 42 J. of Tax. 106 (Febru-

/ / (( eee ee ee 8

G. J. Harley, International Division of the Income Tax Base of

Multinational Enterprise (Jume 1980) ...... . . . .. 14

Comptroller General's Report to the Chairman,“ House

Committee on Ways and Means of the United States, IRS

Could Better Protect U.S. Tax Interests in Determining

the Income of Multinational Corporations” ........................ 14

ii

TABLE OF AUTHORITIES—Continued

Other Authorities—Continued Page

H.R. Rep. No. 2508, 87th Cong., 2d Sess. 18 (1962) .................. 13

H.R. 10650, 87th Cong., “id Sess. § 6 (1962 13

“Development in Intercompany | ..cing under § 482”,

Seventh Annual Institute on International

TSR TET TE AAR ⅛—i OnE 14

“Multinational Corporations and Income Allocation

under § 482 of the Internal Revenue Code”, 89 Harv. L.

F. A Saar aee nee ee 13

Internal Revenue Code (5482) . . . . . . . . 12, 13, 15, 24

Internal Revenue Code (§§ 901-907) .. . . . . 15

Internal Revenue Code, “Subpart F” (§§ 951 to 964) 15

“Recommendations of the Task Force on Foreign Source

Income,” § 28, Committee on Ways and Means, U.S. House

of Representatives, March 8, 1977 . .. . . . .. 25

United States United Kingdon Treaty, Art. 94) 21

iii

In the Supreme Court

of the United States

OCTOBER TERM, 1982

No. 81-523

CONTAINER CORPORATION OF AMERICA,

Appellant,

V.

FRANCHISE TAX BOARD,

Appellee.

On Appeal From the Court of Appeals

of the ‘State of California

BRIEF OF THE STATE OF OREGON AS AMICUS

CURIAE IN SUPPORT OF BRIEF OF

FRANCHISE TAX BOARD

STATEMENT OF INTEREST OF STATE OF

OREGON AS AMICUS CURIAE

The State of Oregon, through its tormer State Tax

Commission and present Department of Revenue has,

since approximately 1955, applied the principles of

formulary apportionment of the income of a corpora-

tion conducting a single unitary business. The state

has applied principles of combined reporting and for-

mulary apportionment of the income of a parent corpo-

ration and its subsidiaries likewise conducting a unit-

ary multistate or multinational business. The state

has established offices in New York, Chicago, San

Francisco and Los Angeles to aid in the auditing of

multistate and multinational corporations. In 1965

2

the state adopted the Uniform Division of Income for

Tax Purposes Act (ORS 314.605 to 314.670). In 1967, it

enacted the Multistate Tax Compact (ORS 305.655 to

305.685). Application of the unitary business principle

and formulary apportionment has been upheld by the

Oregon Supreme Court.

Thus, the State of Oregon has an immediate and

direct interest in this case as well as Chicago Bridge &

Iron v. Caterpillar Tractor Co., 84 III. 2d 102, 417

N.E.2d 1343 (1981); oral argument in this Court April

19, 1982; reargument ordered by this Court May 3,

1982. (81-349). Oregon’s raising and expenditure of

revenue will be affected by the determination of the

issues raised in this case and in Chicago Bridge, with

regard to the constitutionality of nondomiciliary state

taxation of worldwide combination.

In addition, after this case was decided by the lower

court, the previously accepted methods of determining

what constitutes a unitary operation for purposes of

combined reporting have been put into question by the

recent decisions of this Court in ASARCO, Inc. v.

Idaho State Tax Commission, — U.S. —, 102 S. Ct.

3103, 73 L. Ed.2d 787, 50 U.S.L.W. 4962 (1982); and F.

W. Woolworth Co. v. Taxation & Revenue Dept., — U.S.

—, 102 S. Ct. 3128, 73 L. Ed.2d 819, 50 U.S. L. W. 4957

TTC

Caterpillar Tractor Co. v. Dept. of Rev., 289 Or. 885, 618 P. 2d 1261 (1980);

Donald M Drake Co. v. Dept. of Rev., 263 Or. 26, 500 P.2d 1041 (1972).

3

(1982). These cases are being relied upon by Appellant

Container Corp. [hereinafter “Container”] in this case.

Oregon has a vital interest in the applicability and

correctness of the standards announced in these

cases.”

SUMMARY OF ARGUMENT

At stake in this case is a state’s authority to use the

only reasonable and economically feasible method for

determining the portion of a corporation’s net income

that is attributable to the activities of the corporation

in the state, where the corporation is a part of an

affiliated group engaged in a unitary business. Oregon

supports the following propositions:

1. Combination and apportionment on worldwide

basis is constitutional and does not violate either the

Commerce Clause or the Due Process Clause. There is

no extraterritorial taxation or multiple taxation of

foreign source income through the use of combined

reporting. Until Congress acts to prohibit the states

from utilizing the unitary principle and each foreign

country acts with respect to political subdivisions or

entities within its territories, there can be no violation

of the Commerce Clause.

Thus, even if this Court should grant Idaho’s and New «ico’s petition

for rehearing and redetermine the due process standard fo: including divi-

dends and other intangible income of a subsidiary in the apportionable

income tax base of a parent to accord with the “business purpose” test

advanced by the states, the ASARCO and Woolworth decisions need re-

examination in light of the Court's basic determination of what constitutes

the test of a unitary business for purposes of combined reporting and

formulary apportionment.

4

2. The ASARCO and Woolworth decisions, if cor-

rectly understood, indicate unrealistic and unreason-

able due process standards for the utilization by the

states of the unitary business principle in combining

and apportioning the net income of affiliated corpora-

tions. If applied to this case, clarification of the Court’s

language is needed.

3. The facts in this case support the conclusion

that Container is unitary with its foreign subsidiaries,

unless a prohibitive standard is erected on the basis of

this Court’s recent decisions in ASARCO and Wool-

worth.

ARGUMENT

I

WORLDWIDE FORMULARY APPORTION-

MENT DOES NOT VIOLATE THE DUE PROCESS

CLAUSE AND DOES NOT PRODUCE EXTRATER-

RITORIAL TAXATION. THERE IS NO VIOLATION

OF THE COMMERCE CLAUSE BECAUSE NO

MULTIPLE TAXATION OF FOREIGN SOURCE IN-

COME CAN BE PROVEN. THERE ARE NO EN-

FORCEABLE UNIFORM 3TANDARDS WITH RE-

SPECT TO THE STATES AND THIS COUNTRY

AND WITH RESPECT TO THE INTERNATIONAL

SCENE. BEFORE AN ARGUMENT CAN BE MADE

THAT THE FEDERAL GOVERNMENT IS PRE-

VENTED FROM SPEAKING WITH ONE VOICE IN

REGARD TO FOREIGN POLICY, CONGRESS

MUST ACT.

5

A. There is no extraterritorial taxation. Con-

tainer cannot pick out certain factors based upon

separate accounting principles as showing ex-

traterritorial taxation.

In considering whether there can be any extrater-

ritorial taxation of income earned in foreign countries,

Container uses separate accounting to support its ar-

guments that the foreign subsidiaries operated at a

substantially higher rate of profitability than Con-

tainer. The arguments are that there are lower wage

rates in foreign operations and that Container’s net

income as a percentage of sales or a percentage of

invested capital is less than that attributable to

foreign operations. Container’s arguments have no

validity whatsoever if, in fact, Container and its

foreign subsidiaries are operating a unitary business.

As stated by this Court in Butler Bros. v. McColgan,

315 U.S. 501, 62 S. Ct. 701 (1942), g 17 Cal.2d 664,

111 P.2d 334, at page 507:

“It is true that appellant’s separate accounting

system for its San Francisco branch attributed no

net income to California. But we need not impeach

the integrity of that accounting system to say that

it does not prove appellant’s assertion that ex-

traterritorial values are being taxed. Accounting

practices for income statements may vary con-

siderably according to the problem at hand. Sand-

ers, Hatfield & Moore, A Statement of Accounting

Principles (1938), p. 26. A particular accounting

system, though useful or necessary as a business

aid, may not fit the different requirements when a

6

State seeks to tax values created by a business

within its borders. * * *”

If this Court finds that Container and its foreign

subsidiaries are truly operating a unitary business,

neither this Court nor California need attack the

integrity of Container’s accounting evidence.

When a group of affiliated corporations is truly

operating a unitary business, the several states face

“the impossibility of allocating specifically the profits

earned by the processes conducted within its borders.”

Butler Bros. u. McColgan, supra at page 507, quoting

Mr. Justice Brandeis in Underwood Typewriter Co. v.

Chamberlain, 254 U.S. 113, 121 (1920). In Coca-Cola

Co. v. Dept. of Rev., 271 Or. 517, 533 P.2d 788 (1974),

the Oregon Supreme Court quoted from the California

Supreme Court decision, affirmed by this Court in

Butler Bros. v. McColgan, supra, to the effect that:

* * * Tt is only if its business within this state

is truely separate and distinct from its business

without this state, so that the segregation of in-

come may be made clearly and accurately, that the

separate accounting method may properly be used.

Where, however, interstate operations are carried

on and that portion of the corporation’s business

done within the state cannot be clearly segregated

from that done outside the state, the unit rule of

assessment is employed as a device for allocating to

the state for taxation its fair share of the taxable

values of the taxpayer [citing authorities]. 17

Cal.2d 667-678.” 271 Or. at 523, 533 P.2d at 791.

Thus, if this Court determines that Container and its

foreign subsidiaries are a truly unitary business, it

7

may disregard any evidence as to differences in pro-

fitability or wage rates.

One may appropriately ask why it is that a United

States company would expect to receive a greater rate

of return on a foreign investment than on a similar

domestic investment. (App. Br. 14) Container does not

say that it is exclusively due to lower labor costs.

Container states at page 14 of its brief that “the

reasons for this include lower labor costs, more rapidly

expanding economies, greater market share, govern-

mental protection from compliance, efc.” Therein lies

the rub. It was recognized early in the development of

the theory of apportionment formulas that:

“* * * Business income is generally attribut-

able to a great number of factors or activities, the

relative importance of which may vary greatly in

different businesses. Any attempt to determine

precisely the factors and activities responsible for

the earning of income and their relative weight,

even in the case of a single business, is certain to

encounter serious difficulties. To make such a de-

termination in the case of all taxpayers subject to

any particular state’s taxing law is utterly out of

the question as a practical administrative matter.

Thus, in this field, as in many other fields, the

ideal cannot be obtained. Something less than per-

fection must suffice.” Altman & Keesling, Alloca-

tion of Income and State Taxation 107-108 (2d. ed

1950).

For these reasons, this Court has said on many occa-

sions that an apportionment formula — even a formu-

la utilizing a single factor — is “employed as a rough

8

approximation of a corporation’s income that is rea-

sonably related to the activities conducted within a

taxing State.” Moorman Mfg. Co. v. Bair, 437 U.S.

267, 273 (1978).

A successful domestic corporation setting up a new

business in a foreign country considers whether the

new business should operate as a branch or division or

as a separate legal entity. This decision may depend

upon the federal tax laws and the advantages and

opportunities contained in its provisions. But the

method of operation, as a single corporation or as

separate entities, should not determine the state tax

consequences.

See Keesling, A Current Look at the Combined Re-

port and Uniformity and Allocation Practices,” 42 J. of

Tax. 106, 107 (February 1975). Before this Court could

accept evidence based upon separate accounting sys-

tems determined and tailored to the corporation’s own

needs, as conclusively showing the importation of ex-

traterritorial income from overseas to California,

other offsetting factors contributing to the earning of

net income must be examined in some detail.

Container therefore, should be asked, for example,

what intangible values it exported to the foreign sub-

sidiaries when it created the new businesses in foreign

As succinctly stated in Coca-Cola u Dept. of Rev., supra 271 Or. at 528:

“The question is fundamentally one of whether a business should

stand in a better position for purposes of determining income merely

because it chooses to use a multiple corporation organizational scheme.

We do not feel that it should. * * *”

9

countries. Were the plants and machinery and equip-

ment utilized overseas selected, purchased, set up and

put into operation independently of any supervision,

advice, or credit guarantees of the parent company?

Were the manufacturing processes employed devel-

oped solely and exclusively by the foreign subsidiary

and its personnel, or did parent know-how contribute

to the adoption of such processes? Did the experience

of highly parent technicians, and the top management

of Container have anything to do with the profitability

expectation and realization? Did the careful selection

of local personnel and local management by the parent

company have anything to do with the profitability?

Did the existence of a relationship between Container,

the parent, and the foreign subsidiary, play a part in

the business dealings between the foreign subsidiary

and its creditors, customers or others?

An incongruity is created by the representation in

Container’s statement of the case (App. Br. 44-45) that

major policy matters were the responsibility of the

foreign subsidiaries but were generally subject to re-

view by Container. If major policy matters were gener-

ally reviewed by Container, it must follow that they

were the.responsibility of Container.

An incongruity is created by Container’s statement

(App. Br. 5) that each subsidiary had total responsibil-

ity for its own performance, yet was overseen by

Container’s foreign operations staff. How many critic-

10

al and significant decisions about the proper manage-

ment and profitability of any one subsidiary in any

one year were made by the two full-time operations

officers and the senior executive officer, comptroller

and lawyer during the course of each tax year in

question?

Some of these questions are answered by the evi-

dence. Some might be answered if the case is remand-

ed for further evidence. Some may never be answered.

The use of the unitary business principle and formul-

ary apportionment obviates the need to answer all of

the questions raised above.

The evidence presented by Container does not show

by clear and convincing evidence that there was a

distortion of apportionment result and that extrater-

ritorial values were imported to this country. Contain-

er should not be permitted to pick out income-

contributing factors favorable to itself, based on sepa-

rate accounting principles. Net income does not have a

single identifiable source. Container Corp. v. Fran-

chise Tax Bd., 173 Cal. Rptr. 121, 132, 117 Cal. App.3d

988 (1981). The three factors of property, payroll and

sales must “represent” all income earning factors,

including “contributions to income which result from

If California had used a constitutionally acceptable single factor for-

mula based only on sales (the method sustained by this Court in

supra), what significance would there be in the wage differential between

the foreign subsidiaries and the United States, or as a matter of fact, any

wage differential within this country?

11

the functional integration and centralization which

exist in a unitary operation.” Id., 132.

B. California’s apportionment of income on a

worldwide, combined basis does not result in tax-

ation of income also taxed by foreign countries.

There is no violation of the Commerce Clause.

Container’s argument, that worldwide apportion-

ment results in taxation of income also taxed by

foreign countries, is completely dependent upon the

use of separate accounting systems adopted by the

federal government and separate accounting systems

utilized by foreign countries in which Container’s sub-

sidiaries operate. Container’s brief leaves the impres-

sion that something more than the income attribut-

able to Container’s activities in California is being

determined. In order to disprove the correctness of

California’s apportionment formula method, the Court

is asked to assume that separate accounting and the

figures presented in the record by Container as to

amounts of income attributable to various countries

and to this country are above question and correct.

In Exxon Corp. v. Wisconsin Dept. of Rev., 447 US.

207 (1980), Exxon’s separate accounting showed no

profit from Exxon’s Wisconsin marketing operation.

Oregon has had the same experience. In Humble Oil &

Refining Co. b. Dept. of Rev., 4 O.T.R. 284 (1970) the

separate books of account maintained by Humble for

the Oregon operations showed a net operating loss.

12

Application of formulary apportionment on the unit-

ary basis showed a profit in both Exxon and Humble.

Separate accounting does not fairly determine the

amount of income attributable to activities in a taxing

state. Separate accounting is more likely to result in

misattribution than formulary apportionment. On

page 17 of Container’s brief, separate accounting attri-

butes $1,286,000 of income to Panama, even though

the company had no property, payroll or sales in that

country. There is no reason to believe that the United

States Treasury was not shorted the taxation of

$2,407,000 in 1963, $3,996,000 in 1964 and $5,466,000

in 1965 (App. Br. 16) because Container used separate

accounting in reporting to the Internal Revenue Serv-

ice. Container claims an average pretax income

throughout the world for the tax years in question of

$41,710,000 (App. Br. 17). For 1963, the increase in

income attributable to California under its worldwide

combination method was 6/10 of one percent of the

worldwide income; for 1964 was one percent of

worldwide income and for 1965 was 1.38 percent. This

is hardly a staggering change.

The United States itself does not accept separate

accounting for tax purposes at face value. Section 482

of the Internal Revenue Code provides for adjustments

to prevent improper shifting of income by multina-

tional corporations. In 1962 the United States House

13

of Representatives passed a version of the Revenue

Act of 1962 that contained specific authorization to

use a unitary method and apportionment with respect

to foreign affiliates. The Conference Committee de-

termined that there was sufficient authority under

LR. C. § 482, which includes the words “apportion” or

“allocate”,® to accomplish the same result by regula-

tion.

The ineffectiveness of § 482 methods has been

recognized. See “Multinational Corporations and In-

come Allocation under § 482 of the Internal Revenue

Code”, 89 Harv. L. Rev. 1202 (April 1976). This article

concludes, at page 1238:

“The use of the arm’s length standard of the

current section 482 regulations has been accom-

panied by serious problems most clearly evidenced

by the surprisingly frequent reliance of revenue

agents and courts on ad hoc fourth method ap-

proaches, based not on the theory of the regulation,

but on the unitary entity theory. While the unitary

entity theory itself is not free from difficulty, it has

sufficient theoretical appeal that it deserves seri-

ous consideration as a formalized alternative to

HR. 10650, 87th Cong., 2d Sess. § 6 (1962).

® “In any case of two or more organizations, trades, or businesses

(whether or not incorporated, whether or not organized in the United

States, and whether or nor affiliated) owned or controlled directly or

indirectly by the same interests, the Secretary may distribute, apportion,

or allocate gross income, deductions, credits, or allowances between or

among such organizations, trades, or businesses, if he determines that

such distribution, apportionment, or allocation is necessary in order to

prevent evasion of taxes or clearly to reflect the income of any of such

organizations, trades, or businesses.” (§ 482, IRC).

H.R. Rep. No. 2508, 87th Cong., 2d Sess. 18 (1962). A new regulation

was promulgated which expanded upon the arm's length standard. See

discussion in 89 Harv. L. Rev. 1202, 1212, cited in text, infra.

14

current practice. At least in a short run, such

consideration may take the form of its adoption as

an optional safe-haven rule.”

See, also, “Development in Intercompany Pricing

under § 482”, Seventh Annual Institute on Interna-

tional Taxation 103 (July 16, 1976); and G. J. Harley,

International Division of the Income Tax Base of Mul-

tinational Enterprise (June 1980) (a treatise submit-

ted for the degree of Doctor of the Science of Law at

the University of Michigan Law School and published

by the Multistate Tax Commission, Boulder, Col-

orado).*

The Comptroller General’s “Report to the Chair-

man,” House Committee on Ways and Means of the

United States, entitled “IRS Could Better Protect U.S.

Tax Interests in Determining the Income of Multina-

tional Corporations”, constitutes an indictment of the

§ 482 separate accounting method utilized by the In-

ternal Revenue Service. This study, as well as the

Harvard Law Review article and the Harley treatise

referred to above, demonstrate that Container cannot

reasonably represent to this Court that the arm’s

length method of reporting income results in an accu-

rate determination for either the United States or any

N ®Mr. Harley's thesis is that the unitary method is theoretically superior

to arm’s length transactional analysis and is suitable for international

adoption by the world’s trading nations, acting in concert through a common,

centralized, international administrative agency. Such adoption would sim-

plify the Internal Revenue Code and its regulations, eliminate most of the

present double taxation issues between nations, simplify tax treaty struc-

tures and encourage developing countries to join an international tax treaty

structure.

15

of the foreign countries. There is no way for this Court

to determine whether the figures presented by Con-

tainer accurately attribute its domestic and foreign

income to the United States and to other nations. Nor

is there any way of determining whether the amount

apportioned to California under the unitary theory,

together with other amounts reported to the other

several states, overstate or understate its domestic

income. Conceivably, the total amount reported to the

50 states by Container does not constitute full accoun-

tability of its domestic income even under its reporting

methods. In other words, if Container alleges that

$28,121,000 is taxable as United States income, how

do taxing officials and this Court know that this has

been reported to the several states and that California

has more than its proper share?

Any possibility of double taxation is alleviated not

only by I.R.C. § 482, to the extent it effectively reallo-

cates income, but by other provisions of the Internal

Revenue Code, such as “Subpart F“ (I R. C. §§951 to

904) and the foreign tax credit (I R. C. §§ 901-907). The

foreign tax credit equalizes the tax burden between

domestic corporations and corporations operating both

domestically and overseas. The United States does not

control the tax policies of the foreign country. Both

countries have jurisdiction to tax the income. There-

fore, in the absence of some accommodation by the

foreign country, the United States, by unilaterally

16

permitting a foreign tax credit on foreign source in-

come against the amount of the United States tax

guarantees parity of treatment.

In summary, this Court should not conclude that

the evidence and assertions of Container clearly and

convincingly show that (1) Container and its sub-

sidiaries have fully accounted for all of their taxable

income to all foreign countries and to this country; (2)

the distribution by separate accounting formula is

proper as between the United States and foreign coun-

tries; and (3) the amount attributable to the corpora-

tion’s activities in California through formulary ap-

portionment, which is in excess of the amount at-

tributable through separate accounting, is double tax-

ation. It may not be reported anywhere. It may be

income that should be reported to California because

the separate accounting systems, as illustrated by the

Exxon and Humble cases, supra, attribute income the

way the corporation wants. Separate acco! g, in

essence, is a corporate determination of where it

thinks the profits should lie and nothing else.

C. California’s use of unitary worldwide com-

bined reporting does not prevent the federal gov-

ernment from speaking with one voice in regard

to foreign policy, thereby violating the Commerce

Clause.

Container’s argument is based upon the erroneous

assumption that the separate accounting method cor-

17

rectly attributes income to the various foreign coun-

tries and to the United States in such a way that any

different system constitutes a system of double taxa-

tion. Container basically relies upon Japan Line, Ltd.

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

decision in that case hinged on the fact that “all

appellants’ containers are subject to property tax in

Japan and, in fact, are taxed there” (/d. at 452). A

similar fact situation is an absolute prerequisite to

any parallel holding in the income tax field. The Court

cannot find a violation of the Commerce Clause unless

Container has made a satisfactory showing that Con-

tainer and its subsidiaries have fully accounted for all

their taxable income, both domestically and in all

foreign countries in which they do business, and that

no part of the net income attributed to foreign sub-

sidiaries in fact constituted the domestic net income of

Container Corporation. In Japan Line, there was no

question that the instrumentality in foreign commerce

was fully taxed by Japan. It was so stipulated. In the

instant case, the state is dealing with a domestic

corporation which has attempted to disassociate its

foreign activities by the device of foreign subsidiaries.

California is attempting to determine the portion of

the net income of Container Corporation that is at-

tributable to Container’s activities within the state.

The attribution of net income under separate account-

ing can shift back and forth as various methods are

18

used under I.R.C. § 482 to reallocate income and ex-

pense items between related corporations.

The concept of what is “net taxable income” is

abstract in nature. The final sale of the product is the

ultimate realization of net taxable income. Until that

time it is impossible to determine whether income is

earned. For example, income taxation of a vertically

integrated metals operation involves the question

whether the income is “earned” by the mining opera-

tion, the smelting operation, the refining operation,

the creation of the finished product (such as a pot or

pan) or the efforts of the sales organization, to name

only a few factors contributing to the earning of that

net income. The question is different from an issue of

the physical location of a container making its way

from its home port in Japan to various ports around

the United States and the world.

Container has not alleged, nor could it assert, that

there is some internationally accepted administration

cf the arm’s length standard. There is no international

body to enforce the uniform arm’s length standard

among all nations and their political subdivisions,

notwithstanding the existence of numerous treaties.

The situation in this case would be analogous to the

posture of Japan Line only if an international stand-

ard of separate accounting were a part of the law of

every nation and the standard were uniformly ad-

ministered by an international staff making adjust-

19

ments on behalf of nations competing for the same

taxable net income, subject to the jurisdiction of an

international tribunal recognized by all nations. In

Japan Line, this Court could be certain that the con-

tainer was fully taxed by Japan. In this case, there can

be no certainty, under the separate and independently

administered income tax systems of the many nations

and their political subdivisions, that all income is

reported, that the same standards of determining net

income are followed, or, in short, that there is any

double taxation.

This Court determined in the Japan Line case that

when a state seeks to tax the instrumentalities of

foreign commerce, two additional considerations come

into play: First, the enhanced possibility of multiple

taxation; and, second, that a state tax on the in-

strumentalities of foreign commerce may impair fed-

eral uniformity in an area where federal uniformity is

essential. The tax that California seeks to impose is

“levied only on that portion of the taxpayer’s net

income which arises from its activities within the

taxing state.” Northwestern States Portland Cement

Co. v. Minnesota, 358 U.S. 450, 464 (1959).

To repeat, income does not have a single identifi-

able source. The question is the same as considered by

this Court in Underwood Typewriter Co. v. Chamber-

lain, 254 U.S. 113 (1920), cited with approval in

Northwestern States Portland Cement Co. v. Minneso-

20

ta, supra. In the Underwood case the Court described

the dilemma facing the state:

“* * * The profits of the corporation were large-

ly earned by a series of transactions beginning

with manufacture in Connecticut and ending with

the sale in other states. In this it was typical of a

large part of the manufacturing business conduct-

ed in the State. The legislature in attempting to

put upon this business its fair share of the burden

of taxation was faced with the impossibility of

allocating specifically the profits earned by the

processes conducted within its borders. It therefore

adopted a method of apportionment which, for all

that appears in this record, reached and was meant

to reach, only the profits earned within the state.”

254 U.S. 120-121. (Emphasis added)

This dilemma is compounded by the fact that Contain-

er operates through foreign subsidiaries. California or

any other state using formulary apportionment is not

“sourcing” to the state income earned in a foreign

jurisdiction by a foreign subsidiary.

The first test of Japan Line is whether there is a

substantial risk of multiple taxation. Because Con-

tainer cannot show that separate accounting accurate-

ly accounts for all of its taxable income and may result

in underreporting, the first test of Japan Line cannot

be met.

The second test of impairment of federal uni-

formity is not implicated here. In the Japan Line case,

California and other states had imposed property tax-

es on Japanese-owned containers as they moved

21

through the states in international commerce. The

national policy, expressed in a Custom Convention on

Containers, was to remove barriers to the use of con-

tainers in international traffic. The Court found that

the state taxation of the Japanese containers con-

stituted “an asymmetry in international maritime

taxation operating to Japan's disadvantage.” 441 U.S.

at 453.

No such asymmetry can be found here. Congress

has not acted to preclude the states from employing an

accounting method to determine the amount of net

income attributable to activities within a particular

state. The use of an accounting method in a situation

where net income cannot be sourced, as containers can

be, creates no impediment or interference with the

United States acting as it has, in adopting separate

accounting for federal purposes in agreement with the

adoption by foreign countries of separate accounting.

Indeed, Congress rejected the only attempt made to

date to include a specific prohibition in a treaty

against the states’ use of combined reporting. That

was the rejection of Art. 9(4) by Congress of that

provision in the United States-United Kingdom Trea-

ty, in 1977.8

Notwithstanding Container’s assertions that this

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

Convention between the Government of the United States of America

and the United Kingdom of Great Britain and Northern Ireland for the

Avoidance of Double Taxation. Signed at London December 3, 1975; entered

into force April 25, 1980.

22

State Tax Comm., 266 U.S. 271 (1924) (App. Br. fn. 2)

is out of date, that case still represents this Court’s

recognition (as in Wisconsin v. J. C Penney, 311 US.

435 (1940)), and Northwestern States Portland Cement

Co. v. Minnesota, supra, that the nature of the prob-

lem of determining net income attributable to sources

within a state does not impede or touch upon inter-

state or international commerce. An accounting

method does not increase or decrease the flow of inter-

national trade. It neither affects the enforceability of

tax treaties between the United States and other na-

tions, nor violates any prohibition contained in any

treaty or law enacted by the United States Congress. It

cannot be shown that the income “attributed” to Cali-

fornia is anything but part of the domestic income

reported by Container to the United States Treasury,

and certainly it cannot be shown that the income

constitutes a part of any foreign source income.

Because Mobi Oil Corp. v. Commissioner of Taxes

of Vermont, 445 U.S. 425 (1980) did not answer serious

questions about the taxability of dividends by various

states, the true question in this case might be whether

the method used by California and 12 other states

(App. Br. 34) is in conflict with other methods utilized

by other states, in attributing Container’s domestic

income to the states in which it does business in this

country. Domestic taxation may be the only real issue

here. Container has not shown that the income attrib-

23

uted by California to Container’s activities in Califor-

nia has a foreign source. There is no actual multiple

taxation, and problems of multiple taxation at the

international level are not germane in this case. The

concurrent federal and state taxation of income is a

well-established norm. If the United States Govern-

ment is fearful of California and other states’ at-

tempts to obtain information for purposes of applying

the unitary business principle and formulary appor-

tionment, it may speak with one voice through Con-

gress. The employment of an accounting method and

the request for information to effectuate that method

is not frustration of international tax policy nor pro-

hibition of the United States’ enforcement of that

policy at the international level.

II

THE A SAN CO AND WOOLWORTH DECISIONS

INDICATE UNREALISTIC AND UNREASONABLE

DUE PROCESS STANDARDS FOR THE UTILIZA-

TION BY THE STATES OF THE UNITARY BUSI-

NESS PRINCIPLE IN COMBINING AND APPOR-

TIONING OF THE NET INCOME OF AFFILIATED

CORPORATIONS.

Even if this Court should reverse ASARCO and

Woolworth on rehearing with respect to the due pro-

cess determinations on the inclusion of dividends and

other intangible income in the apportionable income

tax base, there remains for the states the barriers of

the Court’s language with respect to the unitary busi-

ness principle as applied to affiliated corporations.

24

The applications of these decisions to the outcome of

this case are not clear.

In dealing with the problem of attributing net

income to the activities of a multinational corporation

affiliated either with domestic or foreign corporations

or both, state administrators are in a different position

than the federal government. Oregon and other states

may not operate at a deficit. States are faced with the

necessity of treating taxpayers uniformly, whether it

be due to application of the Fourteenth Amendment to

the United States Constitution or state constitutional

provisions such as Art. I, § 32 and Art. IX, § 1 of the

Oregon Constitution. The federal tax system is based

upon the residency theory of taxation. A state may not

tax a corporation upon all of its net income, as it may

tax individuals. In Underwood Typewriter v. Chamber-

lain, supra, this Court recognized that the states are

“faced with the impossibility of allocating specifically

the profits earned by the processes conducted within

its borders,” and that the method of apportionment is

meant to reach “only the profits earned within the

state.” 254 U.S. at 121. This is the problem California

faced in attempting to determine the taxable income

of Container.

The inadequacies of I. R. C. § 487 adjustments based

upon a “true” arm’s length pricing system are notori-

ous. The United States Congress Committee on Ways

and Means has recognized that § 482 type adjustments

25

will not work for the states and that the states must

utilize formulary apportionment. Section 28 of

“Recommendations of the Task Force on Foreign

Source Income,” Committee on Ways and Means, U.S.

House of Representatives, March 8, 1977, states in

part that:

“* * * There is no significant disagreement

that States must use some type of apportionment

formula (as distinguished from making an alloca-

tion of income and deductions by separate account-

ing), since there would be no practical way of

determining what income of a company is earned

within a State as opposed to being earned within

other States.”

Taxation is a practical matter. If the Due Process

Clause, as interpreted by this Court, prohibits utiliza-

tion of the unitary business principle and formulary

apportionment, non-uniformity of taxation must fol-

low. Consequently, a substantial share of the tax bur-

den must be shifted from the multistate and multina-

tional corporations to domestic corporations and indi-

viduals within the taxing state. The due process re-

quirements announced in the ASARCO and Wool-

worth cases may constitute standards which the states

cannot meet with any reasonable personal resources

and of auditing procedures.

Two areas are of particular concern: (1) What does

this Court mean by “potential to operate a company as

a part of a unitary business” and “actual control”; and

26

(2) what must be the relationship of the subsidiary’s

activities to the activities in the taxing state?

1. “Potential” as contrasted with “actual” control.

The court in W. Woolworth Co. v. Taxation and

Revenue Dept., supra, (slip op. at 7) states:

Our decision in ASARCO makes clear, howev-

er, that the potential to operate a company as part

of a unitary business is not dispositive when, look-

ing at ‘the underlying economic realities of a unit-

ary business,’ the dividend income from the sub-

sidiaries in fact is derive[d] from ‘unrelated busi-

ness activities’ which constitutes a ‘discrete busi-

ness enterprise.’”. (Referring to ASARCO and its

subsidiary M.I.M. in which ASARCO owned 52.7

percent of the stock.)

This Court then turns to the discussion of function-

al integration, centralization of management, and

economies of scale. The Court refers to Butler Bros. v.

McColgan, supra, 315 U.S. at 508-509. Butler Bros., is

a decision involving only a single domestic corpora-

tion. The Woolworth decision also relies heavily upon

this Court’s decision in Exxon, supra, another case

involving only a single domestic corporation.

The “underlying economic realities” in the case of a

domestic parent and foreign subsidiaries are entirely

different. It is possible that, in a worldwide operation

where a product may not flow from overseas to this

country, the market place in a particular country may

be serviced by local production or by an exchange

agreement such as was found in Exxon. In the instant

27

case, practical economic realities would dictate that

purchase of wholesale goods for resale to final custom-

ers would take place at the market place closest to the

retail operation, due to the economies of transporta-

tion and the tastes and habits of the local consumers.

These factors do not foreclose characterization of the

operation as unitary. This question could be super-

vised by one or two officers of the parent company, and

adequate controls could be maintained by the usual

and ordinary lines of communication and financial

reporting made by a subsidiary to its parent.

There might be good reasons by Woolworth, for

example, would not engage in a centralized purchas-

ing, warehousing and merchandise operation encom-

passing such far flung operations as Germany and

Mexico. However, economies of scale with respect to

the market place in a particular country could still

obtain, and final decision making and approval could

come from the parent’s place of business. Such appears

to be the case with Container. This is the economic

reality.

With respect to the utilization of separate corpora-

tions rather than divisions in one company, common

sense and economic realities dictate that, especially

with a foreign country, foreign personnel be utilized as

much as possible. As in the case of Container, it made

political sense to have local operations conducted by

efficient and well trained local personnel. An efficient

28

parent could still maintain control of its subsidiaries.

Regulation of its own day-to-day activities by a sub-

sidiary is not the exception; it is the rule. Where

distance, language differences and diverse markets

intervene, there are going to be different methods of

operation and management. But this does not mean

that the parent corporation is not exercising control

and that it is not a unitary operation.

The question is how a state may apply the test in

Exxon, 447 U.S. at 207, on a worldwide basis where a

state must prove:

“* * * long-range planning for the company,

maximization of overall company operations, de-

velopment of financial policy and procedures,

financing of corporate activities, maintenance of

the accounting system, legal advice, public rela-

tions, labor relations, purchase and sales of raw

** * materials and coordination between

operating functions. * * *”

To do this on an year-to-year basis, with regard to the

parent and each of its subsidiaries, the state will have

to have its auditors examine the affairs of each corpo-

ration on a day-to-day basis, read corporate and com-

mittee minutes of the corporation, inquire about tele-

phone calls, and otherwise gather the intimate indi-

cators of control. It is no secret that control may be

effectively maintained by several persons through

selection of like-minded subordinates, directed

through telephone communications and internal

memoranda. American business has numerous

29

examples of “one man” operations. Certeinly a small

staff in the office of Container could control the ac-

tivities of foreign subsidiaries for all practical pur-

poses.

2. Relationship of the activities of the foreign cor-

poration to activities within the taxing state.

This Court should explain that its language in the

ASARCO and Woolworth cases requires only a “ra-

tional relationship”, in the sense that the activities in

the taxing state and the activities of the subsidiary are

links in a common chain even though the chain has

several links. In a unitary business, such as a verti-

cally integrated operation, mining in one state is, in

turn, connected to a smelting operation in another

state, a refiniag operation in a third state, a manufac-

turing operation in a fourth state, and a sales organi-

zation in a fifth state from which the final product is

marketed in 50 states and in several foreign countries.

This Court’s statement in Mobil, 445 U.S. at 441-442,

about business activities of a foreign subsidiary hav-

ing “nothing to do with the activities of the * * *

taxing state”, cannot mean that the states have a due

process burden of showing that the mining activities

on a day-to-day basis are connected to the sales opera-

tion, other than as a part of the “chain of events”

running through the vertically integrated operation.

In considering this case, the Court should disting-

uish clearly ASARCO and Woolworth and set its due

30

process standard no higher than necessary to recog-

nize the true, economical realities of international

corporate operations. The Court should consider that

intangible methods of control may defy discovery un-

less a state audit department resorts to unreasonable

audit time and unrealistic staff requirements, which

have the potential to harass the taxpayer.

III

THE FACTS IN THIS CASE SUPPORT THE

CONCLUSION THAT CONTAINER IS UNITARY

WITH ITS FOREIGN SUBSIDIARIES.

The brief of Appellee Franchise Tax Board ade-

quately presents the factual situation presented here.

Amicus believes that the lower court’s opinion correct-

ly analyzed the factual situation. Barring estab-

lishment of a prohibitive standard based upon lan-

guage in ASARCO and Woolworth, this Court should

find that the state sufficiently demonstrated that Con-

tainer conducted a unitary operation. The judgment of

the lower court should be affirmed.

Respectfully submitted,

DAVE FROHNMAYER

Attorney General

STANTON F. LONG

Deputy Attorney General

WILLIAM F. GARY

Solicitor General

THEODORE W. de LOOZE

Assistant Attorney General

Counsel for Amicus Curiae