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

No. 92-1384 + DEC 1

In The

Supreme Court of the United States

October Term, 1993

+

BARCLAYS BANK PLC,

Petitioner,

VS.

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

In And For The Third Appellate District

+

BRIEF OF THE CONFEDERATION OF

BRITISH INDUSTRY AS AMICUS CURIAE

IN SUPPORT OF THE PETITIONER

7

Lee H. Spence

Counsel of Record

SHERMAN, MEEHAN & Curtin, P.C.

Suite 600

1900 M Street, N.W.

Washington, D.C. 20036-3565

(202) 331-7120

COCKLE LAW BRIEF PRINTING CO, (800) 225-4964

OR CALL COLLECT (402) 342-2831

TABLE OF CONTENTS

Page

INTEREST OF AMICUS CURIAE .................. 1

SUMMARY OF ARGUMENT..................5005. 3

ee eta e ica reekhsndeeees bussed inya's 4

“8 EE ee 4

Il. BECAUSE IT CONFLICTS WITH THE INTER-

NATIONAL STANDARD, WORLDWIDE COM-

BINED REPORTIN©® CAUSES DOUBLE

6 Gu CC CECE RNC CONGSASe tw sd ew vesess 5

A. Worldwide Combined Reporting is Funda-

mentally Different from Separate Account-

ing, the International Standard............ 5

B. Because Separate Accounting Takes Differ-

ences In Profitability Into Account and

Worldwide Combined Reporting Does Not,

the Interaction of the Two Systems Natu-

rally Results In Multiple Taxation......... 9

Ill. WORLDWIDE COMBINED REPORTING

IMPOSES EXCESSIVE COMPLIANCE BUR-

DENS. THESE BURDENS DETER INVEST-

EE SU ReNGS DOS bes Wes behescasedbuedeteesecees 12

IV. WORLDWIDE COMBINED REPORTING

INCREASES THF LEVEL OF UNCERTAINTY,

AND THEREBY DETERS INVESTMENT ...... 18

ED Gere Vessbis ¢aveucetsubedcoaseescés 20

TABLE OF AUTHORITIES

Page

Cases

Capitol Industries-EMI, Inc. v. Bennett, 681 F.2d

1107 (Sth Cis. 1962). ....+0sse05sun eee 16

Container Corp. of Am. v. Franchise Tax Board, 463

U.S. 159 (1963) .......+000000s 0s eee 5

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

(1979) ......cceccesceecveee se seunnnnnnnanan 5

STATUTES AND REGULATIONS

Cal. Rev. & Tax. Code § 25128 ....:.ssseseueueeeeee 8

Internal Revenue Code, 26 U.S.C., § 482 ............. 6

United Kingdom Taxes Act 1988, § 770............... 6

Cal. Code Reg., Title 18, § 251357-6......ssseesnuuuus 15

OTHER AUTHORITIES

Benjamin F. Miller, Worldwide Unitary Combination:

The California Practice, in The State Corporate

Income Tax, 132 (Charles E. McLure, Jr., ed.,

1984). .......0c00s00005ee0 00h enna 15

Brief of Respondent, Franchise Tax Board v. Impe-

rial Chemical Industries PLC, No. 88-1400 ........ 16

Hearings before the Senate Com. on Foreign Rela-

tions, 95th Cong., Ist Sess., 34 (1977) .............. )

International Economic Report of the President,

Government Printing Office (Jan. 1977)............ 10

Report to the President of the United States from

the Task Force on Promoting Increased Foreign

Investment in United States Corporate Securi-

ties and Increased Foreign Financing for United

States Corporations Operating Abroad, Govern-

ment Printing Office (1964) ...............ceeeee eee 4

TABLE OF AUTHORITIES - Continued

Page

Roy E. Crawford, Supreme Court Should Grant Cer-

tiorari in Barclays — Even if Clinton Sides with

California, 60 Tax Notes 1503 (Sept. 13, 1993)...... 14

1 State Tax Guide, All States (CCH) 4 10-110.......... al

State Taxation of Multinational Corporations,

Study by the Advisory Commission on Inter-

governmental Relations (Nov. 1982).............---. 4

Statement by Allen Wallis (Under Secretary of

State for Economic Affairs) Concerning the

Chairman's Working Group Report, taken from

the Final Report of the Worldwide Unitary Tax-

ation Working Group (August 1984) .............. 12

Statistical Abstract of the United States, 12th ed.,

Government Printing Office (1992)................. 2

No. 92-1384

°

In The

Supreme Court of the United States

October Term, 1993

+

BARCLAYS BANK PLC,

Petitioner,

Vs.

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

In And For The Third Appellate District

¢

BRIEF OF THE CONFEDERATION OF

BRITISH INDUSTRY AS AMICUS CURIAE

IN SUPPORT OF THE PETITIONER

°

INTEREST OF AMICUS CURIAE

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

independent, non-party political body organized in the

United Kingdom. Its members include industrial, commer-

cial, and public sector companies; employer organizations

and trade associations that represent individual manufactur-

ing industries; and commercial associations. CBI represents,

directly and indirectly, more than 250,000 public and private

companies and more than 200 trade associations, employer

1

th

organizations and commercial associations. CBI's members

employ more than 10 million people.

Many of CBI’s members do business in the United

States or own subsidiaries that do business in the United

States. In 1990, United Kingdom business accounted for

almost 27 percent of the $403.735 billion in direct foreign

investment in the United States, or $108.055 billion. Sta-

tistical Abstract of the United States, 12th ed., Government

Printing Office (1992). Thus CBI, on behalf of its mem-

bers, has a substantial interest in state taxation of U.K.

companies and their affiliates. State use of unitary taxa-

tion on a worldwide basis (“worldwide combined report-

ing”) has a direct and adverse impact on those members

of CBI that do business in the United States or have

affiliates that do so.

CBI prizes, and its members have a very strong inter-

est in maintaining, positive economic relationships

between the United Kingdom and the United States.

Worldwide combined reporting is fundamentally destruc-

tive of foreign investment in the United States and of

broader trade relationships between the United States

and other nations, including the United Kingdom. For

these reasons, CBI has for many years actively opposed

the use of worldwide combined reporting by some States

(including California) and has sought to eliminate the

negative practical effects — including multiple taxation

and excessive and discriminatory compliance burdens -

which worldwide combined reporting imposes on foreign

multinationals.' Through this brief, CBI seeks to draw the

Court’s attention to the enormous problems created by

worldwide combined reporting for U.K. and other for-

eign-based corporate groups.

e

SUMMARY OF ARGUMENT

The United States has a longstanding policy to promote

free trade and encourage foreign investment. Adoption of

the arm's length method of taxation has been a part of that

policy. Worldwide combined reporting discourages foreign

investment in jurisdictions that impose it.2 Worldwide com-

bined reporting acts as a disincentive to investment primar-

ily in three ways. First, because it is incompatible with the

method used by all nations of the world to allocate income, it

leads inevitably to double taxation. Second, worldwide com-

bined reporting subjects foreign multinationals to extraordin-

ary compliance burdens. The fact that these burdens are not

imposed by the arm’s length, separate accounting method is

a major reason that separate accounting was adopted as, and

continues to be, the international standard for the division of

income. Finally, worldwide combined reporting introduces

uncertainty, inimical to sound business planning.

! The terms “foreign multinational” and “foreign-based

multinational” are used herein to refer to a group of corpora-

tions that are ultimately controlled by a parent company resi-

dent in a foreign country and owned predominantly by non-U.S.

citizens.

2 Hereafter, a jurisdiction imposing worldwide combined

reporting will be referred to as a “WWCR jurisdiction.”

Because it discourages investment, worldwide com-

bined reporting is directly at odds with United States

policy. It has no place in the international sphere.

o

ARGUMENT

I. INTRODUCTION

A major goal of United States foreign and economic

policy has been and continues to be to promote the free

international flow of capital and technology and to

increase direct foreign investment in the United States.

The Advisory Commission on Intergovernmental Rela-

tions described the benefits of international trade in the

following terms:

[International] capital investments and income

flows contribute significantly to increasing

worldwide standards of living. The capital

importing or host country benefits from the use

of foreign capital in its production processes

because the resulting higher capital-to-labor

ratios can increase productivity and raise real

earnings. The capital exporting country benefits

from the rate of return that can be earned on

capital employed abroad.

State Taxation of Multinational Corporations, Study by the

Advisory Commission on Intergovernmental Relations (Nov.

1982). As early as 1964, the United States government

expressed its desire to make evident to the world that the

United States welcomes foreign investment. See Report to

the President of the United States from the Task Force on

Promoting Increased Foreign Investment in United States Cor-

porate Securities and Increased Foreign Financing for United

States Corporations Operating Abroad, Government Printing

Office (1964).

From a business perspective, three things act as

major de wncentives to investment: (i) a risk of double

taxation; (ii) high compliance burdens; and (iii) uncer-

tainty of treatment. Worldwide combined reporting cre-

ates all three. Because it deters foreign investment,

worldwide combined reporting frustrates United States

policy and prevents the Nation from speaking with one

voice. This is unconstitutional. See Japan Line, Ltd. v.

County of Los Angeles, 441 U.S. 434 (1979); Container Corp.

of Am. v. Franchise Tax Board, 463 U.S. 159 (1983).

Il. BECAUSE IT CONFLICTS WITH THE INTERNA-

TIONAL STANDARD, WORLDWIDE COMBINED

REPORTING CAUSES DOUBLE TAXATION.

A. Worldwide Combined Reporting is Fundamen-

tally Different from Separate Accounting, the

International Standard.

More than 60 years ago, the nations of the world

adopted a standard method to divide the income of mul-

tinational businesses. That method is arm’s length, sepa-

rate entity accounting.

The basic theory of separate accounting is that only

two countries have jurisdiction to tax income: the source

country (the country in which income arises)* and the

residence country (the country of domicile of the tax-

payer). The right of the source country to tax income

* As a general rule, income is deemed to “arise” where the

income-generating activity takes place.

arising therein generally is accepted as primary to the

right of the residence country to tax its domiciliaries.

Even if a source nation chooses not to impose a tax, the

income nevertheless is considered subject to the taxing

jurisdiction of that nation, and no other nation (with the

exception of the residence country) has the right to tax it.

Under separate accounting, each legal entity (or sub-

division thereof, such as a branch) is treated as a separate

taxpayer to which taxing jurisdiction applies separately.

Jurisdiction of a country to tax any particular legal entity

generally does not imply jurisdiction to tax related enti-

ties (or other subdivisions). The income and deductions

of each legal entity are calculated separately.

Separate entity treatment is applicable regardless of

the degree of relationship between affiliates in a group of

corporations. However, source nations customarily

reserve the right to examine individual transactions occur-

ring between related entities (or branches) to determine

whether they have been carried out on a basis which

realistically reflects what would have occurred had the

transaction been between unrelated parties dealing at

“arm's length.” Where it is found that the transaction was

not carried out on an “arm’s length” basis, tax adminis-

trators may make a deemed adjustment of the terms of

the transaction for tax purposes, so as to reflect what the

terms would have been had the transaction been at

“arm's length.”4 Underlying this right is the principle

* The Internal Revenue Service’s authority for this adjust-

ment is found in Section 482 of the Internal Revenue Code. The

United Kingdom grants the Inland Revenue similar power in

Section 770 of Taxes Act 1988.

eee

that income realized on transactions governed by the

marketplace is true economic income.

Separate accounting gives taxing pre-eminence to the

jurisdiction of the source nation to tax. The residence

country carries the burden of eliminating double taxation

on the income of its domiciliaries that is subject to tax by

another nation, either by granting a credit against its own

tax for the source country tax or by permitting a deduc-

tion for the income subject to the source country tax.

Under separate accounting, the tax base (the measure of

income to which the tax rate is applied) of a foreign multina-

tional in a particular country includes only the profits arising

in that country, less the deductions incurred in that country

and allowed by that country’s law. This approach ensures

that taxation reflects actual economic performance in the

marketplace in the relevant jurisdiction and also accords

with basic business principles.

In contrast, worldwide combined reporting does not

respect the separate legal existence of entities. It requires

aggregation of the income and deductions of all entities,

wherever located in the world, which California deems to

be members of a “unitary group.” California then applies

a mechanistic apportionment formula to allocate to the

California taxpayer entity a proportion of the worldwide

profits of all the entities in the group.

California determines its share of the group’s world-

wide income by multiplying that income by a fraction

equal to the average of three factors: property, payroll,

and sales (receipts).5 The numerator of each factor is the

unitary group’s California property, payroll, or sales, and

the denominator is the group’s worldwide property, pay-

roll, or sales.®

Worldwide combined reporting does not, and by its

very nature cannot, take into account differences in prof-

itability. Income is divided according to the monetary

value of payroll, property, and sales located in the

WWCR jurisdiction, regardless of the actual return

derived therein. As described by the United States Assis-

tant Secretary of Treasury Laurence N. Woodworth:

Implicit 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. This is

clearly not the case. And when it is not the case,

the unitary system will misallocate income.

Whenever profit rates are higher in foreign affil-

iates than in domestic activities, the unitary sys-

tem 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 foreign corporation.

5 California recently amended its formula to double-weight

the sales factor for most taxpayers. Cal. Rev. and Tax. Code

§ 25128.

© The factors used by those states that use formulary appor-

tionment vary widely. While most use some combination of

payroll, property, or sales, they do not weight the factors

equally. The rules for determining when a given item (such as a

sale) should be attributed to a taxing jurisdiction (and therefore

included in the numerator of the factor) also vary greatly. See 1

State Tax Guide, All States (CCH) ¥ 10-110.

Hearings before the Senate Com. on Foreign Relations,

95th Cong., 1st Sess., 34 (1977).

Thus, the tax base under worldwide combined

reporting is computed by (i) aggregating all profits

derived from around the world (as computed under the

accounting principles of the WWCR jurisdiction), (ii) sub-

tracting the expenses incurred worldwide that are

allowed by the law of the WWCR jurisdiction, and (iii)

multiplying the result by the apportionment percentage.

Separate accounting and worldwide combined

reporting fundamentally conflict.

B. Because Separate Accounting Takes Differences

In Profitability Into Account and Worldwide

Combined Reporting Does Not, the Interaction

of the Two Systems Naturally Results In Multi-

ple Taxation.

The basic objective of devising rules to allocate

taxing capacity between different jurisdictions where

cross-border trade and investment occur is to ensure both

that each nation obtains its fair share of tax and that

taxpayers are not subjected to double taxation. The arm’s

length separate accounting principle was devised and

adopted by the United States, the United Kingdom, and

other nations to achieve this result. It is the agreed inter-

national standard. Its application by fiscal authorities

enables double taxation to be avoided. California’s appli-

cation of worldwide combined reporting is incompatible

and makes exposure to multiple taxation inevitable.

Separate accounting, by focusing on the actual results

of transactions in each jurisdiction, automatically takes

10

into account differing economic conditions in different

source nations. For example, if a multinational enterprise

generates the same gross receipts in two countries, but

because of differing labor or property costs has lower

expenses in one country than in the other, the separate

accounting method would reflect the fact that there is

more net income in one country than in the other.

Worldwide combined reporting, on the other hand,

assigns the group’s global income based on the dollar

value of property and the dollar amount of payroll and

sales in the WWCR jurisdiction. It ignores the differing

“rates of return” in different economies. Therefore, where

rates of return differ, overlap is inevitable.

It is undeniable that differences in market conditions

exist in the world. They result from different labor and

property costs, tax rates, other costs imposed on com-

panies by governments including environmental regula-

tion, currency exchange regulations, worker safety and

administrative compliance, and a host of other variables.”

Double taxation is the natural and inevitable result of the

use of these incompatible systems.

7 The United States in general and California in particular

tend to be high cost, low rate-of-return jurisdictions. Payroll

and property costs are higher in the United States than in many

other nations. See International Economic Report of the President,

Government Printing Office (Jan. 1977). California, a leader in

environmental regulation, causes industries to internalize costs

that they would not bear directly in other countries. Moreover,

California-style factor apportionment is inherently unfair. By its

very nature, a factor formula will attribute the highest profit to

countries which have the highest factor values, i.e., rich nations.

For this reason alone, worldwide combined reporting could

never be accepted on a global basis.

1]

The problem of double taxation is especially severe if

the entity operating in the WWCR jurisdiction incurs a

loss. Separate accounting would permit the entity to

report this loss for tax purposes. Under worldwide com-

bined reporting, if the entity were part of an overall

group which realized a profit, the worldwide combined

reporting jurisdiction would allocate to itself some of that

overall profit. Because the separate accounting jurisdic-

tions in which the profits arose would also source to

themselves and tax 100 percent of the profits, the multi-

national enterprise would pay a double tax.

Because double taxation reduces an enterprise’s

after-tax return from an investment, the high likelihood

of double taxation will discourage an enterprise from

investing in WWCR jurisdictions. The disincentive is

even greater because worldwide combined reporting will

not respect a loss incurred in the jurisdiction. An enter-

prise otherwise willing to operate at a loss for an initial

period to establish itself in a new market faces the deter-—

rent of having to pay tax on the profits of established

profitable affiliates elsewhere in the world despite the

local loss.

The deterrent is real. As a representative of the

United States Department of State noted:

Foreign governments have informed us that,

“The (unitary tax) method can chill international

investment and decrease efficient allocation of

resources and employment opportunities. In

particular, the unitary method can impede for-

eign entry into the United States market.” In

their view a unitary tax constitutes “ ... a

serious obstacle to the further development of

our trade and investment relationships.” (Note

12

signed by the Ambassadors of fourteen of our

major trading partners). There have also been

calls for retaliation.

Added to this are the statements from foreign

business organizations like the Keidandren,

which represents over 800 Japanese corpora-

tions: “Unitary taxation is the single most

serious deterrent to new investment by Japanese

enterprises in some states of the United States.”

The French Patronat, which represents a wide

range of the biggest French industries with

investment in the United States, described the

unitary taxation method in a demarche to our

Ambassador in Paris as “ . . . not suited to the

reality nor to the development of foreign invest-

ment, particularly between industrialized coun-

tries.”

State government officials have also criticized

the effects of unitary taxation. The unitary basis

of taxation “ ... is contrary to the long estab-

lished traditional spirit of welcoming foreign

investment in the United States . . . We urge

those states which have the law to repeal it.”

(News release of the American States Offices

Association, whose members represent 21 states’

offices and port authorities in Japan, 12/15/83).

Statement by Allen Wallis (Under Secretary of State for

Economic Affairs) Concerning the Chairman’s Working

Group Report, taken from the Final Report of the World-

wide Unitary Taxation Working Group (August 1984).

III. WORLDWIDE COMBINED REPORTING

IMPOSES EXCESSIVE COMPLIANCE BUR-

DENS. THESE BURDENS DETER INVESTMENT.

Businesses necessarily take compliance costs into

account in deciding whether to invest in a particular

13

location. The costs of complying with worldwide com-

bined reporting are excessive, and act as a deterrent to

investment.

As described above, separate accounting respects the

separate legal existence of entities, and taxes only the

profits arising in the taxing jurisdiction. Reporting under

separate accounting, therefore, generally requires foreign

corporations to report information only on the operations

of the entity actually doing business in the jurisdiction.

Worldwide combined reporting, in contrast, requires

aggregation of the worldwide income of all entities that

are members of a “unitary group”, whether or not those

entities have any presence or carry on operations in the

WWCR jurisdiction. Accordingly, compliance with world-

wide combined reporting requires the gathering and

reporting of world\vide information for every foreign

corporation in the group, not just those doing business in

the WWCR jurisdiction. This information must be sup-

plied by those foreign corporations.

Moreover, as noted above, worldwide combined

reporting requires that the tax base be determined by

computing income under the accounting principles of the

WWCR jurisdiction, and by subtracting only those deduc-

tions allowed by the law of the WWCR jurisdiction.

Reports also must be in English and in U.S. dollars. This

is extremely burdensome in practice.

Each country has its own accounting rules, for both

financial and tax accounting. An entity doing business in a

country typically keeps its accounts using local language and

observing local legal and accounting principles. Under

worldwide combined reporting, a foreign multinational must

14

“convert” the accounts of each of its foreign affiliates from

the various local rules into U.S. accounting principles and

U.S. tax accounting rules. In practice, such “conversion” is

impossible without the documentation from which the origi-

nal reports were created. For example, because depreciation

allowances differ under different accounting procedures, a

French company would have to add back to its income its

French depreciation deduction and then subtract out its

WWCR jurisdiction depreciation deduction. To do this, the

company would have to know (in dollars) the original cost of

the depreciable property and the depreciation deductions

already taken. The same is true of many other deductions,

such as the bad debt reserve. See Roy E. Crawford, Supreme

Court Should Grant Certiorari in Barclays — Even if Clinton Sides

with California, 60 Tax Notes 1503 (Sept. 13, 1993).*

Thus, in practical terms, to comply fully with world-

wide combined reporting a foreign multinational would

have to keep a separate set of books for each foreign

corporation using the accounting rules of each WWCR

jurisdiction in which any member of the group operates.”

* Financial accounting information, even when in U.S.

GAAP, is not the same as tax accounting. The California trial

court found in this case that using financial accounting informa-

tion for foreign affiliates led to “inaccurate” income tax results.

Appendix A to the Petition for Certiorari, No. 92-1384, at 33.

Thus, a foreign corporation cannot use its financial accounts to

prepare tax returns.

* Benjamin Miller, on the legal staff of the California Fran-

chise Tax Board, has acknowledged that:

Actual adjustments to income, to be completely pre-

cise, would require the preparation of a separate set

15

The deterrent this creates for businesses considering

investment in a WWCR jurisdiction easily can be envisioned.

For example, assume a foreign multinational that does busi-

ness in 30 different nations establishes a subsidiary in a

WWCR jurisdiction. To file the subsidiary’s tax return, the

foreign multinational must set up a separate bookkeeping

system in each of its 30 different operations which will keep

records from those 30 operations in English, in U.S. dollars,

and using U.S. accounting principles.

In addition, currency translation introduces particularly

burdensome complications. Because currency exchange rates

fluctuate over the course of a year, a simple translation of

bottom-line amounts into U.S. dollars does not express accu-

rately the dollar equivalent of income earned by different

subsidiaries in different currencies during the year. Some

sort of contemporaneous translation is necessary, and this

must cover translation of each of the thousands (perhaps

millions) of transactions engaged in by the subsidiaries over

the course of the year.'°

of books and records on a California tax basis. This is

administratively infeasible.

Benjamin F. Miller, Worldwide Unitary Combination: The California

Practice, in The State Corporate Income Tax, 132, 156 (Charles E.

McLure, Jr., ed., 1984).

10 The California regulations provide for either an end-of-

year exchange rate or a simple average exchange rate. Cal. Code

Reg., Title 18, § 25137-6. Neither of these is completely accurate.

One problem is that each currency creates its own separate

economic world, with its own monetary conditions, inflation

rate, and interest rates. Comparing profitability between two

territories with different currencies is necessarily inaccurate.

16

Further, it may be not even be possible for U.S.

subsidiaries of foreign-based companies to obtain the

required information. A U.S. subsidiary may be unable to

convince its foreign parent to develop the data needed to

comply with the worldwide method, especially becaus-

the method is contrary to the internationally accepted

method. Moreover, the foreign parent may be prohibited

by foreign law from disclosing the information, for

instance in relation to defense contracts with its own

government.!!

The problems compound when a foreign multina-

tional group does business in numerous countries, each

with its own currency and its own accounting standards.

For a foreign multinational, such as the petitioner here,

with more than 98 percent of its business overseas, the

cost of complying with a state taxing system like this one

is out of all proportion to the profit it can derive from

business in the state.!?

1! See Capitol Industries-EMI, Inc. v. Bennett, 681 F.2d 1107

(9th Cir. 1982), in which the taxpayer argued that it could not

disciose information requested by California because the infor-

mation was confidential under the United Kingdom’s Official

Secrets Act.

12 This is not a hypothetical cost. The trial court in this case

found the costs to establish a compliance system were $5 million

to set up and $2 million annually to maintain. Similarly, in its

brief in Franchise Tax Board v. Imperial Chemical Industries PLC,

Dkt. No. 88-1400, Imperial estimated that its annual cost to

establish and maintain the required accounting system was £ 2

million, an amount that exceeded the total amount of franchise

tax assessed by California over a ten-year period.

17

It has been urged that these compliance costs are

only the indirect costs of doing business overseas: a

foreign taxpayer must expect to comply with the rules of

the jurisdiction in which it does business, and foreign

taxpayers suffer only because foreign nations do some-

thing different.'%

This argument is fallacious. All nations, including the

United States, have espoused separate accounting, in part

because it avoids the massive compliance burdens of

worldwide combined reporting. Worldwide combined

reporting simply could not work as the global standard.

If worldwide combined reporting were adopted by every

nation in the world, every company in a unitary group

would be forced to keep a set of books in the language,

currency, and accounting rules of every nation in which

any member of the group did business. For example, if a

multinational group had 60 subsidiaries doing business

in 60 different nations,'4 each subsidiary would have to

keep 60 sets of records, for a total of 3,600 sets of records.

The group’s worldwide profits would quickly be

devoured in accounting fees and compliance costs. Costs

would increase even further if the group had more than

one subsidiary or branch operating in a jurisdiction.'5

'3 This was essentially the position of the California Court

of Appeal in its second opinion. See Appendix D to the Petition

for Certiorari, No. 92-1384.

14 Petitioner Barclays in this case had more than 220 subsid-

iaries doing business in 60 nations.

'S Furthermore, if nations were to adopt worldwide com-

bined reporting, each would undoubtedly vary the factors of the

apportionment formula so as to allocate more income to that

nation. This would work to the disadvantage of the United

18

Separate accounting is the only possible method for

global use. Worldwide combined reporting is not just a

“different” method, but an incompatible method that was

rejected by nations as unworkable. It has no place in the

international arena.

A business facing the complete revamping of its

accounting systems, and the creation of new group data

gathering and reporting systems at exorbitant cost, will

be deterred from making an investment in a WWCR

jurisdiction. The United States’ policy of encouraging

foreign investment is undermined by state use of world-

wide combined reporting.

NG

IV. WORLDWIDE COMBINED REPORTI

INCREASES THE LEVEL OF UNCERTAINTY,

AND THEREBY DETERS INVESTMENT.

Governments, both foreign and the United States,

have recognized the need for a sound international tax

structure to foster international free trade and investment

by providing business certainty. The arm's length sepa-

rate accounting standard is the foundatioa of the resul-

tant accord. Experience has reinforced its soundness in

principle and practice.

The networks of international tax treaties give practi-

cal effect to the arm’s length standard on a bilateral basis.

These treaties create mechanisms for the treaty partners

to resolve questions of taxing jurisdiction at the level of

States, the world’s largest trading nation. This Court must strike

down worldwide combined reporting now, to prevent its

spread.

19

the particular taxpayer. Treaties also typically contain a

“mutual agreement” procedure to protect taxpayers who

believe that the actions of one or both of the treaty

partners might result in double taxation. The taxpayers

may present their case to the competent authority (the

governmental body charged with administrating the

treaty) of the treaty partner of which the taxpayer is a

resident or national, to resolve the conflict by mutual

agreement with the other treaty partner. In some cases,

countries may run simultaneous audits of a taxpayer, to

ensure that transfer pricing is carried out on the agreed

arm's length basis.

Such mechanisms are predicated upon the arm’s

length separate accounting standard and are unavailable

to jurisdictions imposing worldwide combined reporting.

Because worldwide combined reporting rests on a differ-

ent theory from separate accounting, differences cannot

be reconciled by adjusting the income or expenses arising

from particular transactions. Thus, the double taxation

that will almost certainly occur cannot be so relieved.

Worldwide combined reporting also introduces uncer-

tainty in two additional ways. First, because there are no

objective guidelines for determining when an enterprise will

be deemed “unitary,” an enterprise will not know whether a

WWCR jurisdiction will seek to subject it to worldwide

combined reporting. Further, if an enterprise is deemed to be

unitary by a WWCR jurisdiction, such as California, its tax

liability in California will depend upon its income, property,

payroll and sales not only in California but wherever it does

business. Such variables will be incapable of accurate estima-

tion in the course of the everyday decision-making process.

Moreover, should the enterprise thereafter wish to invest in

20

another nation, it would have to consider not only the cost

and return of that investment in its own right, but also its

potential effect on its tax bill in the WWCR jurisdiction.

¢

CONCLUSION

Worldwide combined reporting, such as the California

system at issue in this case, interferes with the United States’

longstanding policy of promoting free trade and encouraging

foreign investment. It discourages investment by creating a

high risk of double taxation, causing uncertainty in taxation,

and imposing excessive compliance burdens. It is incompat-

ible with the international standard for taxing multinational

enterprises agreed upon by the United States and other

sovereign nations. It must not be allowed to stand.

Respectfully submitted,

Lee H. Spence

Counsel of Record

SHERMAN, MEEHAN & Curtin, P.C.

Suite 600

1900 M Street, N.W.

Washington, D.C. 20036-3565

(202) 331-7120