Amicus Curiae Brief — Barclays Bank PLC v. Franchise Tax Bd. of Cal.

No. 92-1384

In the Supreme Court

OF THE

United States

OCTOBER TERM, 1992

BARCLAYS BANK PLC

Petitioner,

vs.

FRANCHISE TAX BOARD,

An Agency of the State of California

Respondent.

ON PETITION FOR A WRIT OF CERTIORARI TO

THE COURT OF APPEAL OF

THE STATE OF CALIFORNIA

IN AND FOR THE THIRD APPELLATE DISTRICT,

BRIEF OF THE CONFEDERATION OF BRITISH

INDUSTRY AS AMICUS CURIAE IN SUPPORT

OF THE PETITION FOR CERTIORARI

Lee H. SPENCE

Counsel of Record

SHERMAN, MEEHAN & CurrTIN, P.C.

Suite 600

1900 M Street, N.W.

Washington, D.C. 20036-3565

(202) 331-7120

BOWNE OF SAN FRANCISCO INC + 343 SANSOME ST + SF CA 94104 + (415) 362 2300

i

TABLE OF CONTENTS

INTEREST OF AMICUS CURIAE ..................

INTRODUCTION AND SUMMARY OF ARGUMENT 2

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TABLE OF AUTHORITIES

Cases

Page

Boston Stock Exch. v. State Tax Comm'n, 429 U.S. 318

Di ciechivlindusebes shes eeepeentscacedoenes 6

Container Corp. of America v. Franchise Tax Bd., 463

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

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Kraft General Foods, Inc v. Iowa Dep't of Revenue and

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Statute

Internal Revenue Code, § 482 ..................0000- 4

No. 92-1384

In the Supreme Court

OF THE

United States

OcTOBER TERM, 1992

BARCLAYS BANK PLC

Petitioner,

vs.

FRANCHISE TAX BOARD,

An Agency of the State of California

Respondent.

ON PETITION FOR A WRIT OF CERTIORARI TO

THE COURT OF APPEAL OF

THE STATE OF CALIFORNIA

IN AND FOR THE THIRD APPELLATE DISTRICT

BRIEF OF THE CONFEDERATION OF BRITISH

INDUSTRY AS AMICUS CURIAE IN SUPPORT

OF THE PETITION FOR CERTIORARI

Pursuant to Rule 37 of the Rules of this Court, this brief is

respectfully submitted in support of the Petition for a Writ of

Certiorari by amicus curiae the Confederation of British Industry.

The parties have consented to the filing of this brief, and their

written consents have been filed with the Clerk of this Court.

INTEREST OF AMICUS CURIAE

The Confederation of British Industry (“CBI”) is an indepen-

dent, non-party, non-political body organized in the United King-

dom. Its members include industrial, commercial, and public

sector companies; employer organization and trade associations

that represent individual manufacturing industries; and commer-

cial associations. The CBI represents more than 250,000 busi-

2

nesses which together employ about half of the British workforce.

The CBI is the effective voice of business in Britain.

A number of the CBI's members do business in the United

States or own subsidiary companies that do business in the United

States. The CBI, on behalf of its members, has a substantial and

direct interest in taxation of United Kingdom companies. Califor-

nia’s use of worldwide combined reporting has a direct and

adverse impact on those members of the CBI that operate in the

United States and on their U.S. affiliates.

The CBI values highly the maintenance of free world trade and

positive economic links between the United Kingdom and the

United States. The CBI believes worldwide combined reporting

to be fundamentally destructive of foreign investment in the

United States and therefore of broader trade relationships be-

tween the United States and other countries. The CBI actively

opposes the use of worldwide combined reporting and has sought

to eliminate worldwide combined reporting’s discriminatory taxa-

tion system as applied to U.K. corporate groups.

INTRODUCTION AND SUMMARY OF ARGUMENT

California’s system for apportioning the income of a multina-

tional business, worldwide combined reporting, is inconsistent and

incompatible with the system found by this Court to be the

accepted international standard, arm's length separate accounting.

Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159,

184 (1983). The purpose of this accepted standard is to mitigate

or eliminate the many problems which can arise when nations

claim jurisdiction over the profits of international business for

taxation. Without such a standard nations cannot properly protect

their domiciliary enterprises or their own fiscs when such enter-

prises trade abroad. Double taxation, uncertainty of treatment and

undue compliance costs may make such international businesses

less competitive and hence less profitable. The United States as

the largest international trader is the most exposed.

California's use of an incompatible system justifiably enrages

other nations. Perpetuation of that system will remove all incen-

3

tive for such nations to continue to use the accepted and consis-

tent international standard in dealings with the United States.

Conflict among nations undoubtedly will occur as countries adopt

systems modified to suit themselves or retaliate against United

States business.

The California Supreme Court, in upholding California's use of

its aberrant system, ignored this Court's historic concern for and

sensitivity to international conflicts such as these. The California

Court of Appeal recognized that the added compliance burden

imposed by worldwide combined reporting justified foreign pro-

test — but still did not overturn the California method. This

Court must not allow California to destroy decades of consistent

United States effort. This Court must review this case.

ARGUMENT

The major trading nations of the world have adopted the arm's

length method as the international standard to divide income

among nations for tax purposes. This Court has found this method

to be the internationally accepted method. Container, 463 U:S. at

184.

Under separate accounting, each legal entity is a separate

taxpayer to whom taxing jurisdiction applies separately. A nation

taxes a foreign entity only when the entity does business in the

nation directly rather than through a subsidiary, and then taxes

only the profits arising in that nation. Jurisdiction of a country to

tax any particular legal entity does not imply jurisdiction to tax

related entities. The aim of the arm’s length approach is to ensure

that profits of multinational enterprises are allocated in such a

manner that each country is able to tax the profits (but no more

and no less) actually earned in the country.

Separate entity treatment is not absolute. Nations customarily

reserve the right to examine transactions between related entities

(or branches) to determine whether the transactions were at

“arm's length” (that is, comparable to transactions between

unrelated entities). The theory is that income realized on transac-

tions governed by the marketplace is true economic income.

Where a transaction was not carried out on an “arm's length”

4

basis, tax administrators may reallocate income or deductions

between the entities to reflect marketplace amounts. The funda-

mental purpose and reach of the arm’s length standard, however,

is to fairly determine the marketplace profits ascribable to the

trade or business carried out by the foreign entity (or subsidiary)

within the taxing jurisdiction. '

California's worldwide combined reporting, on the other hand,

requires aggregation of the income and deductions of each entity

which is a member of a “unitary group”, whether or not the other

members carry on operations directly in the taxing jurisdiction. Its

reach is worldwide and encompasses entities and activities with

no real connection to California. California determines its

“proper” share of the aggregate income by formula. In making

this allegedly “proper” division, formulary apportionment rejects

the experience of the marketplace. Implicit in the unitary system

is the unwarranted assumption that profit rates in different units

of a corporate family, engaged in different activities and in

different locations, are always the same.

As a marketplace-based system, the arm's length method takes

into account differing economic conditions in different source

nations that can create different rates of return on investments.

Rates of return clearly do differ. For example, in developing

countries, property and payroll costs may be very low relative to

those in the United States, with correspondingly higher profits.

Companies investing in these countries will often demand higher

profits to reflect the risks of expropriation, currency exchange

limitations, or other factors. Even among developed nations,

differences in market conditions result from different economic

conditions, different standards of living, different payroll and

property costs, and different tax rates; as well as from other costs

imposed on companies by governments including environmental

regulation, currency exchange regulations, worker safety, welfare,

administrative compliance, and a host of other variables.

'The Internal Revenue Service’s authority for this reallocation is

found in Section 482 of the Internal Revenue Code (26 U.S.C. § 482).

The United Kingdom grants the Inland Revenue similar power.

5

Double taxation is the one easily perceived result of incompati-

ble systems.’ Over many years the major trading nations, led by

the United States, have adopted a single standard to eliminate or

at least to mitigate double taxation between nations. The interna-

tional network of bilateral income tax treaties — not just between

the United States and its treaty partners but also between other

nations’ — defines the jurisdiction of nations to tax resident

companies of other nations. The standard also is embodied in the

internal laws of nations and in model treaties. Thus, the standard

provides a framework for resolution of disputes and fosters coop-

eration rather than conflict.

However, treaties and other tax harmonization techniques are

capable of resolving conflicts only when the two jurisdictions have

generally similar rules for dividing income. When a jurisdiction

uses worldwide combined reporting, it has no common ground for

working out differences with separate accounting jurisdictions.

Elimination of double taxation, at a minimum, would require

complex adjustment to the apportionment factors to take into

account the varying profitability in each jurisdiction. Such adjust-

ments necessarily would differ from jurisdiction to jurisdiction

and from industry to industry. Harmonization is not practically

possible.

Business and trade suffer when enterprises are forced to comply

with inconsistent systems. One advantage of the international

*Because the two systems will assign different amounts of income to

jurisdictions in which rates of return differ, double taxation undoubtedly

will occur. The problem of double taxation is especially severe where the

entity operating in the worldwide combined reporting jurisdiction incurs

a loss. The arm's length method would permit the entity to report this

loss for tax purposes. Under worldwide combined reporting, if the entity

were part of an overall group which realized an aggregate profit, the

worldwide combined reporting jurisdiction would allocate to itself some

of that overall profit. Because the separate accounting jurisdictions in

which the profits arose would also source to themselves 100 percent of

the profits, the multinational enterprise would pay a double tax.

*In 1986, the United Kingdom had over 70 treaties, each using the

arms’ length standard.

6

standard is that it does not force a foreign enterprise to recon-

struct its worldwide information gathering systems (and those of

its affiliates) in order to comply with tax reporting requirements

in the nations in which it does business. California’s system forces

a business to do exactly that, requiring recomputation of world-

wide income in accordance with U.S. accounting principles rather

than those applicable locally, conversion into U.S. dollars, and

translation of records into English. The California Court of

Appeal recognized that foreign businesses do not have informa-

tion systems needed to comply and would not create such system

but for the California method. Petitioner's Appendix D at D-9,

Appendix B at B-25 to B-26.

Further, the purpose of an international standard is not only to

eliminate disputes among nations as to how and what they will

tax, but also to provide a framework of certainty to businesses

making foreign investments. Because there are no precise guide-

lines for determining when California will deem related entities to

constitute a unitary enterprise, an enterprise considering an in-

vestment in California cannot know whether it will be subject to

worldwide combined reporting. Assuming that the enterprise is

deemed unitary, its California tax liability will depend not solely

upon its activities in California (or even in the United States),

but also upon its rates of return in any other nations in which the

“unitary” enterprise has operations. Such variables are incapable

of accurate estimation, and severe distortions inevitably will

result.

These compliance burdens and uncertainties make the enter-

prise substantially less likely to make the proposed investment.‘

“This Court has held that a state tax violated the interstate commerce

clause when it “foreclose[d] tax-neutral decisions.”” Boston Stock Exch.

v. State Tax Comm'n, 429 U.S. 318, 331 (1977). Worldwide combined

reporting does just that.

7

California’s excursion into international tax has had predictable

results. Nations have protested vociferously and have threatened

retaliation. This Court anticipated this result in Japan Line, Lid.

v. County of Los Angeles, 441 U.S. 434, 450-51 (1979):

If the State imposes an apportioned tax, international dis-

putes over reconciling apportionment formulae may arise. If

a novel state tax creates an asymmetry in the international

tax structure, ‘s*eign nations disadvantaged by the levy may

retaliate against American-owned instrumentalities present

in their jurisdictions.

More recently, in Kraft General Foods, Inc. v. lowa Dep't of

Revenue and Fin., 112 S.Ct. 2365, 2370 (1992), this Court

reaffirmed that the protection granted foreign commerce was

broader than that granted to interstate commerce, “in part be-

cause matters of concern to the entire Nation are implicated.”

As this Court noted in both Japan Line and Container, there is

no ultimate international arbiter who can reconcile disputes

among nations over tax systems. 441 U.S. at 447; 463 U.S. at 192.

The nations themselves, led by the United States, have adopted

the international arm's length standard to avoid exactly this

problem. They have substituted cooperation for conflict. Califor-

nia is not a nation; it cannot participate in the dialogue of nations.

If allowed to stand, California’s aberrant system will continue to

act as an irritant until other nations retaliate, not just against

California, but against the United States as a whole. Further,

California’s system runs counter to established United States

foreign tax policy and threatens, by its extraterritorial reach, the

comity of nations.

CONCLUSION

The California Supreme Court and the Court of Appeal on

remand did not even make a pretense of taking into account the

important national policies which the international standard rep-

resents. It requires an affirmative act of Congress, not the nega-

tive inference by inaction perceived by the California Court, to

unravel over sixty years of international effort. That is the poten-

tial effect of the California Court's decision. This Court should

grant the Petition For a Writ of Certiorari.

Respectfully submitted,

By: Lee H. SPENCE

Counsel of Record

SHERMAN, MEEHAN & Currin, P.C.

Suite 600

1900 M Street, N.W.

Washington, D.C. 20036-3565

(202) 331-7120