# Amicus Curiae Brief — Barclays Bank PLC v. Franchise Tax Bd. of Cal. > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385013_0384%3A28 ## Record - **Collection:** Supreme Court brief - **Document type:** Amicus Curiae Brief - **Published:** January 1, 1994 - **Citation:** 512 U.S. 298 ## Text No. 92-1384 In The Supreme Court of the United States October Term, 1993 BARCLAYS BANK PLC, Petitioner, Vv. FRANCHISE TAX BOARD, An Agency of the State of California, Respondent. On Writ of Certiorari to the Court of Appeal of the State of California for the Third Appellate District BRIEF FOR KEIDANREN (JAPAN FEDERATION OF ECONOMIC ORGANIZATIONS) AS AMICUS CURIAE IN SUPPORT OF PETITIONER C. David Swenson’ Dennis I. Meyer Leonard B. Terr Harry A. Franks, Jr. BAKER & MCKENZIE 815 Connecticut Avenue, N.W. Washington, D.C. 20006-4078 (202) 452-7000 Attorneys for Keidanren ‘Counsel of Record December 15, 1993 “] BEST AVAILABLE COPY TABLE OF CONTENTS Page INTEREST OF THE AMICUS CURIAE ............ l ISSUES ADDRESSED BY THE AMICUS CURIAE ..... 3 INTRODUCTION AND SUMMARY OF ARGUMENT... 3 REDE 660 66s eee see 7 I. THE CALIFORNIA SUPREME COURT'S RELIANCE UPON UNITED STATES TAX TREATIES AS SUPPORTING THE UNITARY METHOD IS INCORRECT. ............... 7 A. The California Supreme Court’s Interpretation That Congressional Silence on State Taxation in United States Tax Treaties Negatively Implies Congress’ Acquiescence in the Unitary Method Is eT re eer een Pee 8 B. The Failure of Congress to Adopt the U.S.-U.K. Tax Treaty Without the Limitation on State Taxation Contained in Article 9(4) Cannot Be Interpreted as Congress’ Acceptance of the Unitary ME sed eenue we SECue eee 11 C. Even If This Court Accepts the California Supreme Court’s Interpretation of the Ratification of the U.S.-U.K. Tax Treaty with the Reservation to Article 9(4), Such Interpretation Should Have No Effect upon a Tax Treaty (Such as the U.S.- Japan Tax Treaty) Adopted Prior to California’s Adoption of the Unitary Peres a Caw ebecceece scare 14 D. Uniformity in the Taxation of Foreign- based Multinational Groups Is Essential in Order for the Federal Government to Speak with One Voice Through the United States Tax Treaty Network and in Order to Prevent Double Taxation ........... 15 Il. THE CALIFORNIA SUPREME COURT'S RELIANCE UPON PROVISIONS OF THE INTERNAL REVENUE CODE AS SUPPORTING THE UNITARY METHOD IS DE Cee eGG hd ees bnsensccscece 21 Il. THE CALIFORNIA SUPREME COURT'S RELIANCE UPON UNITED STATES TREATIES OF FRIENDSHIP, COMMERCE AND NAVIGATION AS SUPPORTING THE UNITARY METHOD IS INCORRECT ....... 26 i aa ak ie sus 66 6656 606+ Ws 0c 29 TABLE OF AUTHORITIES Page(s) CASES Aiken Indus., Inc. v. Commissioner, gM 13 Barclays Bank int’! Lid. v. Franchise Tax Bd., No. 325059, Cal. Super. Ct. (Aug. 20, 1987) reprinted in Appendix A to Petitioner's Cert. Brief... .. 2... .....002200... 2, 15 Barclays Bank Int'l, Lid. v. Franchise Tax Bd., 3 Cal. App. DTT sepadceeee@ecccececccececss 11, 12 Barclays Bank Int'l, Ltd. v. Franchise Tax Bd., 829 P.2d 279 EE passim Colgate-Palmolive Co., Inc. v. Franchise Tax Bd., 4 Cal. App. 4th 1681 (1991)... .. 10, 16 Complete Auto Transit, Inc. v. Brady, ee 5 Container Corporation of Am. v. Franchise Tax Bd., 463 U.S. 159 (1983)... . 4,5, 10, 17, 21 Estate of Burghardt v. Commissioner, SE on eebcabetbeucencceececcu’ 13 Hines v. Davidowitz, 312 U.S. 52 (1941) ......... 10, 28 Itel Containers Int'l Corp. v. Huddleston, 122 L. Ed. 2d 421 (1993)... 2... 2... eee 19 iv Japan Line, Lid. v. County of Los Angeles, ee es SEE occu reece care eee be e849 5, 6, 15 Johansson v. United States, 336 F.2d 809 cea i i a Se de eee en 13 Maximov v. United States, 299 F.2d 565 a eh es ee es GD 6s ooo oa ewes vous 13 Moline Properties, Inc. v. Commissioner, er 6 ona ede Nenad ww we dal sie eiies 26 Rocca v. Thompson, 223 U.S. 317 (1912) ......... 13, 27 Seminole Flavor Co. v. Commissioner, Se SE cen ccccmhieeereusectSeauhs 24 Sumitomo Shoji America, Inc. v. Avagliano, ee Ee ec cuescde eee ene neue ees 27 Union Pac. R.R. v. Commissioner, Py a EE 8 4 BAN Obs 000366068665 408 23 Wardair Canada Inc. v. Florida Dep’t of Se ae Ss OED Wieeceveeneucestese 5-9 STATUTES te? alc en Dea. eae 5, 6, 22 EE re ae 25 DPE? oosenteadeesvscseuceeeees 18 26 U.S.C. 68 1501, ISOC) ... ee eee eee 25 PP ED Goad oceeeeésuvatdesseceeer 21 : 23: U.S.T. 967, T.A.LS. No. 7365 (March 8, 1971). * 4 U.S.T. 2065, T.1.A.S. No. 2863 (Apr. 2, 1953). Other nations have entered into Treaties of Friendship, Commerce and Navigation with the United States. These treaties are referred to herein as “FCN Treaties.” * Barclays Bank Int’! Lid. v. Franchise Tax Bd., No. 325059, Cal. Super. Ct. (Aug. 20, 1987) reprinted in Appendix A to Petitioner’s Cert. Brief., at A-17. * Convention Between the Government of the United States and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains (herein “U.S.-U.K. Tax Treaty”), 31 U.S.T. 5668, T.A.1.S. No. 9682 (Dec. 31, 1975). Congress’ acquiescence in the Unitary Method as applied to United Kingdom corporations, this Court should reserve on the issue of whether the same result should apply in the case of Foreign-based Multinational Groups that are entitled to protection provided by a different United States tax treaty. Further, a decision against Petitioner in this case should not control the issue of the Unitary Method’s validity in the case of Japan-based Multinational Groups entitled to the benefits of the U.S.-Japan FCN Treaty because there is no FCN Treaty between the United Kingdom and the United States and the U.S.-Japan FCN Treaty proscribes application of the Unitary Method. ISSUES ADDRESSED BY THE AMICUS CURIAE Whether the basis for the California Supreme Court s finding Congressional approval of the Unitary Methoc and upholding the constitutional ity of the Unitary Method as applied to Foreign-based Multinational Groups was fatally flawed? If so, whether a correct analysis leads to the conclusion that the Unitary Method, as applied to Foreign-based Multinational Groups, is unconstitutional under the Foreign Commerce Clause, because the Unitary Method results in double taxation and prevents the Federal Government from speaking with “one voice when regulating commercial relations with foreign governments,” as evidenced by recent foreign government retaliation against the United States in response to continued use of the Unitary Method? If not, whether the issue nevertheless should be reserved as to whether a different result is appropriate in the case of Japan-based Multinational Groups entitled to the protections of the U.S.-Japan Tax Treaty and the U.S.-Japan FCN Treaty? INTRODUCTION AND SUMMARY OF ARGUMENT Under the Unitary Method, Japanese and other foreign parent corporations are required to file a combined return with all of their worldwide subsidiaries (the “combined report”). A portion of the total worldwide income of the combined group is then allocated to California under a “three-factor formula” apportionment method that is based on the proportion of property, payroll and sales in the taxing state compared to the same factors of the worldwide consolidated group.’ Under California’s Unitary Method, corporations that are more than fifty percent foreign-owned are included in the combined report without regard to whether they have (i) engaged in business in California or elsewhere in the United States, (ii) derived income from sources within California or elsewhere in the United States, or (iii) engaged in any transactions with a related corporation incorporated in California or elsewhere in the United States.* The Unitary Method is fundamentally different from and irreconcilable with the arm’s length standard and the separate entity accounting method (the “arm’s length method”). The arm’s length method is the international standard universally used and accepted by the nations of the world and by multinational corporations. It is the method required by United States tax treaties, FCN treaties and the Internal Revenue Code. The arm’s length method treats each corporation as “an independent entity dealing at arm’s length with its affiliated corporations, and subject to taxation only by the jurisdictions in which it operates and only for the income it realizes on its own books.” Container Corporation of Am. v. Franchise Tax Bd., 463 U.S. 159, 185 (1983). In the international context, the arm’s length method allocates income to a single taxing jurisdiction rather than arbitrarily apportioning the income among jurisdictions, and treats intercorporate transfers of value between commonly controlled entities in accordance with the terms that would have been obtained ’ See CALIF. REV. & TAX CODE $§ 25128-25136 (West 1992). * Under legislation enacted in 1986 (and effective in 1988), California provided corporations with a “water’s edge” election to avoid application of worldwide formulary apportionment to income of their foreign affiliates anc! parents. See CAL. REV. & TAX CODE § 25110 (West 1992). California further limited the obligation to use the Unitary method in October 1993. Because the year in issue is prior to the legislative changes, we have not addressed whether these changes “cure” the constitutional defects of the Unitary Method. nn nt ally had such transfers occurred between uncontrolled entities in similar circumstances.° In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977), this Court found that if a state tax “is applied to an activity with a substantial nexus with the taxing state, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State,” no impermissible burden on interstate commerce will be found. In Japan Line, Lid. v. County of Los Angeles, 441 U.S. 434, 451 (1979), this Court identified two additional criteria under the Foreign Commerce Clause for testing the validity of a state tax affecting foreign commerce. A state tax will violate the Foreign Commerce Clause, notwithstanding its compliance with the four criteria in Complete Auto Transit, if it “creates a substantial risk of international multiple taxation” or “prevents the Federal Government from ‘speaking with one voice when regulating commercial relations with foreign governments.’” In Container, this Court held that California’s Unitary Method did not violate the Foreign Commerce Clause when applied to United States-owned domestic corporations with foreign subsidiaries (“U.S.-based Multinational Groups”). However, the Container opinion specifically reserved on the issue of whether California’s Unitary Method violated the Foreign Commerce Clause as applied to Foreign-based Multinational Groups." In Wardair Canada Inc. v. Florida Department of Revenue, 477 U.S. 1 (1986), this Court upheld Florida’s aviation fuels tax as applied to Canadian air carriers engaged in international commerce. The carrier and the United States had conceded that no risk existed of multiple taxation so that only the “one voice” ° The power to enforce such treatment by allocating income among related parties and jurisdictions under the arm’s length method is established by section 482 of the Internal Revenue Code, 26 U.S.C. § 482, and the Associated Enterprises article of United States tax treaties. 0 Container, 463 U.S. at 189 0.26, 195 n.32. test under Japan Line was applicable. The Court found it dispositive under this test that while a United States-Canada aviation treaty (and other similar treaties) were silent on limiting state taxation of aviation fuel, the Federal Aviation Act expressly permitted the states to tax such fuels. In the case below, the California Supreme Court concluded that Wardair had “reoriented” dormant Foreign Commerce Clause analysis so as to make such analysis inappropriate in this case. Specifically, the California Supreme Court cited a number of “negative implications” that it believed were created by United States Senate or Congressional actions. The California Supreme Court relied on these alleged “negative implications” to support its conclusion that Congress had in effect affirmatively approved of the Unitary Method." Among the actions from which the California Supreme Court extracted these “negative implications” were the Senate’s reservation to Article 9(4) of the U.S.-U.K. Tax Treaty, the Senate’s ratification of other United States tax and FCN treaties, and Congress’ enactment of certain provisions of the Internal Revenue Code, particularly section 482. The California Supreme Court’s interpretation and analysis are incorrect. In fact, the Unitary Method, when applied to Foreign- based Multinational Groups such as the Petitioner herein, is completely irreconcilable with the relevant provisions of United States tax and FCN treaties, as well as the Internal Revenue Code. In addition, the taxation of a Foreign-based Multinational Group’s income demands that the Federal Government speak with “one voice” to foreign governments. The failure to find the Unitary Method violative of the Foreign Commerce Clause will result in our treaty partners hearing “many voices” on the issue of the appropriate taxation of Foreign-based Multinational Groups. All treaty jurisdictions must follow the internationally agreed norm of the arm’s length method as embodied in tax treaties in order for multinational corporations to engage in international commerce and '! $29 P.2d 279, 295 (1992). att oe hed Sow Rad > alien avoid multiple taxation of the same income. Further, while certain practical problems may exist with the application of the arm’s length method, only the arm’s length method makes possible a mechanism to prevent double taxation—the Competent Authority procedures contained in United States tax treaties. If this Court finds California’s Unitary Method constitutional when applied to United Kingdom-based Multinational Groups, this Court should nevertheless reserve on the issue of whether the same interpretation applies to Japan-based Multinational Groups entitled to the protections of the U.S.-Japan Tax Treaty and the U.S.-Japan FCN Treaty. ARGUMENT I. THE CALIFORNIA SUPREME COURT’S RELIANCE UPON UNITED STATES TAX TREATIES AS SUPPORTING THE UNITARY METHOD IS INCORRECT. In upholding the Constitutionality of California’s Unitary Method, the California Supreme Court cited two instances of Senate inaction in the tax treaty context which the court believed created decisive “negative implications.” Based upon these “negative implications,” the court concluded that Congress had affirmatively approved the Unitary Method. As the opinion stated, paraphrasing Wardair: (I]nternational agreements demonstrate that the Federal government has affirmatively acted, rather than remained silent, with respect to the power of the states to employ formula apportionment in so-called foreign parent cases"? 2 $29 P.2d at 294. According to the California Supreme Court’s opinion, the “din of ‘governmental silence’ that cannot be ignored”” was evidenced by two treaty-related phenomena. First, the court found it decisive that United States tax treaties uniformly obligate the Federal Government to utilize the arm’s length method, but uniformly exclude the state governments from all treaty obligations except those contained in the non-discrimination article. Second, the court found decisive the Senate’s lodging of a reservation to Article 9(4) of the U.S.-U.K. Tax Treaty, which would have prohibited the states’ use of the Unitary Method with respect to U.K.-based Multinational Groups. Based in significant part on these “negative implications” the California Supreme Court ruled that the case at bar was not an appropriate case for dormant Foreign Commerce Clause analysis, because that analysis “‘only operates where the Federal Government has not spoken.’”* According to the court, in this case, the Federal Government had indeed spoken and had approved the states’ use of the Unitary Method. The ensuing sections of this brief address why the California Supreme Court’s analysis is wrong, why such analysis should not be applied in any event under earlier tax treaties (such as the U.S.- Japan Tax Treaty), and why the correct analysis leads inescapably to the conclusion that the arm’s length method must prevail over the Unitary Method. A. The California Supreme Court’s Interpretation That Congressional Silence on State Taxation in United States Tax Treaties Negatively Implies Congress’ Acquiescence in the Unitary Method Is Incorrect. The California Supreme Court noted that the “bilateral income tax treaties negotiated by the United States with many of its trading partners typically prescribe use of the [arm’s length] method by the - @ '* $29 P.2d at 293 (quoting Wardair, 477 U.S. at 12). ah: ia ditwthntigs, ee ee eh et ae, signatory governments” but “they do not ... impose such a requirement on taxation by subnational levels of government.”"° Because subnational levels of government are included for purposes of the nondiscrimination article, the California Supreme Court concluded that: We think this latter evidence substantially parallels the Wardair paradigm, where the high court concluded that the “negative implications” arising from the Convention's ~ limited ban on state taxation of fuel “on board” arriving foreign aircraft demonstrated an awareness of subnational taxation issues and represented “a decision by the parties ... to address the problem by curtailing and limiting only some of the localities’ power to tax, while implicitly preserving other aspects of that authority.”"* The convention referred to was the Convention on International Civil Aviation.” This Court found that Article 24(a) of that convention “by its terms precluded the imposition of local taxes on fuel only when the fuel is ‘on board an aircraft ... on arrival ... and retained on board on leaving’ a contracting party.” In Wardair this Court found direct language contained in an international agreement that limited a state’s power to tax. This Court found that the negative implication of this limitation was Congress’ approval of state taxation that was not directly proscribed in the agreement. In the case at bar, the California Supreme Court, citing the absence of any explicit tax treaty limit on the power of states to tax (except that the states not discriminate), found such Federal Government silence on state taxation to be evidence of the Federal '" open for signature Dec. 7, 1944, art. 24(a), 61 Stat. 1180, 1186, 3 Bevans 944, 950. " Wardair, )(3). 26 shareholders must be respected.*” In short, there is no basis for the California Supreme Court’s suggestion that section 482 supports or authorizes the use of the Unitary Method or indeed any method other than the arm’s length method. Ill. | THECALIFORNIA SUPREME COURT’S RELIANCE UPON UNITED STATES TREATIES OF FRIENDSHIP, COMMERCE AND NAVIGATION AS SUPPORTING THE UNITARY METHOD IS INCORRECT. Another factor relied upon by the California Supreme Court for the proposition that Congress has evidenced its “approval” of California’s Unitary Method was Congress’ ratification of a number of United States Treaties of Friendship, Commerce and Navigation. The California Supreme Court noted that these treaties, dating from the late 1940's, incorporated provisions that “preserve the states’ freedom to employ methods that produced a tax ‘reasonably allocable or apportionable’ to the taxing jurisdiction...“ The California Supreme Court cited in particular an annotated draft of a FCN Treaty with Portugal. It should be clarified that the U.S.-Portugal FCN Treaty has never entered into force. Unlike the draft U.S.-Portugal FCN Treaty, the U.S.-Japan FCN Treaty did enter into force and thus is an appropriate subject of analysis. If the California Supreme Court, rather than relying on the uneffectuated draft treaty with Portugal, had examined the U.S.- Japan FCN Treaty, coupled with a later FCN Treaty negotiated with France, the court would have been unable to conclude that the U.S.-Japan FCN Treaty supports the Unitary Method. In fact, the U.S.-Japan FCN Treaty requires the states to utilize the arm’s length method with respect to the taxation of Japanese corporations. “ Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 439 (1943). * 829 P.2d at 297. 27 FCN Treaties generally provide restrictions on the taxation of corporations resident in the other country.” The U.S.-Japan FCN Treaty provides that: In the case of companies of either Party engaged in trade or other gainful pursuit within the territories of the other party ... such other Party shall not impose or apply any tax, fee or charge upon any income, capital or other basis in excess of that reasonably allocable or apportionable to its territories, nor grant deductions and exemptions less than those reasonably allocable or apportionable to its territories.” Although the California Supreme Court found that similar language in the draft U.S.-Portugal FCN Treaty was consistent with a finding that Congress approved of the Unitary Method, this interpretation is in error. The U.S.-Japan FCN Treaty was negotiated in the 1950’s prior to the widespread adoption of the Unitary Method, and as this Court has held, a treaty must “be read in light of the conditions and circumstances existing at the time they were entered into... Because the arm’s length method was, and is, the only internationally accepted method, the reasonably allocable or apportionable amount must be determined on the basis of the arm’s length method. This conclusion becomes inescapable in view of the effect of the taxation provision in the later ratified U.S.-France FCN treaty. Article XI(3) of the U.S.-Japan FCN Treaty provides that Japanese corporations shall not be subject to taxes more burdensome than those borne by companies of any third country. This “most favored nation” clause in effect restricts subnational Sumitomo Shoji Am., Inc. v. Avagliano, 457 U.S. 176 (1982). U.S.-Japan FCN Treaty, Article X1(4). Rocca v. Thompson, 223 U.S. 317, 331-32 (1912). $1 28 (e.g., state) taxation of Japanese corporations as a result of the taxation provisions of other international agreements to which the United States is a party, including the Convention of Establishment Between the United States of America and France.” Article 9(4) of this Convention provides that: [French corporations] shall not be subject, within the territories of the [United States], to any form of taxation upon capital, income, profits or any other basis, except by reason of the property which they possess within those territories, the income and profits derived from sources therein, the business in which they are there engaged, the transactions which they accomplish there, or any other basis of taxation directly related to their activities within those territories. By reason of the “most favored nation” clause in the U.S.-Japan FCN Treaty, this Article in the Convention with France imposes the obligation to utilize the arm’s length method, including at the state level,” in determining the tax liability of Japanese corporations. The Article is entirely consistent with the arm’s length method as reflected in United States tax treaties and the Internal Revenue Code. It provides for source taxation, taxation of business profits derived from an active trade or business, and transaction based taxation. Failure to require the application of the arm’s length method demanded by this provision, when applied to a Japanese company, will violate the U.S.-Japan FCN Treaty. The California Supreme Court never considered the effect of this later treaty with France, and therefore misinterpreted the “negative implication” of Congress’ ratification of FCN Treaties. The existence of FCN Treaties not only fails to support the 2 11: U.S.T. 2398, T.1.A.S. No. 4625 (Nov. 25, 1959). *% Hines v. Davidowitz, 312 U.S. at 64-65 (“This country ... has entered into numerous treaties of amity and commerce since its incepuon—treates entered into under express constitutional authority, and binding upon the states as well as the nation.”). 29 California Supreme Court’s conclusion; it directly supports the Opposite conclusion. ' The United Kingdom and the United States are not Parties to an FCN Treaty. Therefore, if this Court concludes that the Unitary Method as applied to the Petitioner is constitutional, this Court should reserve on the issue of whether the Unitary Method is nevertheless invalid when applied to a Japanese company protected by the U.S.-Japan FCN Treaty. CONCLUSION The California Supreme Court incorrectly upheld the Uni Method on the basis of “negative imp ications.” re Peder Government silence is actually Federal Government speech. It declared Federal Government inaction to be Federal Government action. This analysis is wrong and dangerous, and must he rejected. Absent such “negative implications,” the application of this Court’s “one voice” and multiple taxation tests demonstrates that the Unitary Method violates both of these tests, while the arm's length method does not. If, however, this Court determines that the Unitary Method as applied to U.K.-based Multinational Groups is constitutional, this Court should reserve on the issue of whether the same conclusion may be reached when applied to a 30 Japan-based Multinational Group entitled to the protections of the U.S.-Japan Tax Treaty and the U.S.-Japan FCN Treaty. ‘Counsel of Record December 15, 1993. Respectfully submitted. C. David Swenson’ Dennis I. Meyer Leonard B. Terr Harry A. Franks, Jr. BAKER & MCKENZIE 815 Connecticut Avenue, N.W. Washington, D.C. 20006-4078 (202) 452-7000 Counsel for Keidanren --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385013_0384%3A28. Public record. Not legal advice.