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

No. 92-1384

IN THE _-

Supreme Court of the Gnited States

OCTOBER TERM, 1993

BARCLAYS BANK PLC,

Petitioner,

Ta

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 GOVERNMENT OF THE

UNITED KINGDOM AS AMICUS CURIAE

IN SUPPORT OF PETITIONER

JEROME B. LIBIN

(Counsel of Record)

WILLIAM H. Morris

SUTHERLAND, ASBILL & BRENNAN

1275 Pennsylvania Avenue, N.W.

Washington, D.C. 20004

(202) 383-0100

Counsel for the Government of

the United Kingdom

December 16, 1993

a

PRESS OF BYRON S. ADAMS, WASHINGTON, D.C. (202) 347-8203

COSC, wl NE I mn ee og Ee

TABLE OF CONTENTS

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

Gs, Ee

ITED -thndcnintennctcncnnssantansestininddciditldiieiemencetetsoccseos

I. Congress Has Not Authorized States to Im-

II.

pose Mandatory Worldwide Unitary Taxation

on Foreign-Owned Groups .................::0000008+

ie. ITI aseihtchierictetadnitnietinnsebienbncdideniinsatitionteoses

1. Regulation of Foreign Commeree ......

2. Dormant Commerce Clause Analysis .

B. Ratification of the U.K.-U.S. Treaty ......

1. The Senate Reservation ..................44.

2. Approval by the U.K. Parliament ......

Issues Under the Dormant Foreign Com-

ST IIIT sri ititncecetiamenindnianibebheninnsenages

A. Substantial Risk of Internationa] Multiple

SE ee

Te

2. Alternative Taxing Methods ...............

B. Speaking with One Voice ....................6+.

SS a. See

2. Retaliation and the United Kingdom .

3. Reaction of Other Governments .........

Oe ia etcmeniaiionioens

ERENUNEY snucmniidcsunnsesdsatesnscccssscsctesosscnestosénesesnesone

**

TABLE OF AUTHORITIES

Cases: Page

Bass, Ratcliff & Gretton, Ltd. v. State Tax Comm'n,

266 U.S. 271 (16B4) ..cccccccnssccesssccensssnsans 11

Complete Auto Transit, Inc. v. Brady, 430 U.S. 274

(LOTT) .ccccccccoccscoccccscccscssscesseseccneeseeneneneeeeennnnnnn 4,6

Container Corp. v. Franchise Tax Board, 463 U.S.

1GD (1OBB) ..cccccocccocccccescsccssccsescessnnmesnnanennnnna passim

Itel Containers Int'l Corp. v. Huddleston, 113 $.Ct.

LOBE (1GGB) ..cccocceccccoccscccessscssenssnnsnssnnennaaeneenane 5

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

ABE (1DTD) ..cccccssescesecccccccoosscecencensnnninsnnannn passim

Kraft Gen. Foods, Inc. v. lowa Dep't of Revenue

and Fianance, 112 S.Ct. 2365 (1992) ............. 5

Michelin Tire Corp. v. Wages, 423 U.S. 276

(197) ....0000cccccccsssscesessecceccessssninnnnninnnnnnnnnnnn 17

Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978) .. 15,16

Quill Corp. v. North Dakota, 112 S.Ct. 1904

(1GBE) .20000000csesesesescssesesececsssnusunennnal 4,24,25,27

Wardair Canada, Inc. v. Florida Dep't of Revenue,

477 U.S. 1 (1066) ...cocccsccvrsesscssssecsssneeee 5,10

U.S. Constitution:

Ast. 1, § @, CB cccccccccecccecccccsccsssssscnsssnnnnenan 5

Legislative Material:

United Ki.gdom-United States Double Taxation

Treaty debates, 124 Cong.Rec. 16892 (1978) . i)

Treaties:

United Kingdom-United States Double Taxation

Treaty Ast. G4) (19TE) ..csccccecssscssscesesrssssmnmuns 7-10

Other Authorities:

Brief for Franchise Tax Board in Opposition to

Certiorari (filed Apr. 23, 1993), Barclays Bank

PLC v. Franchise Tax Board, Dkt. No. 92-

BIBS ..cccccccccocccccccccnsscesssccsescnsessssessenannananannnal 11

iii

Table of Authorities Continued

Brief for United States as Amicus Curiae (filed Oct.

7, 1993), Barclays Bank PLC v. F

Board, Dit. No’ 92-1384... 7

Letter from Chancellor of the Exchequer. th Rt

Hon. Sir Geoffrey Howe, oc NE os the

U.S. Secretary of the Treasury, the Hon. Don-

ald T. Regan, December 17, 1981...

Statement of the Chancellor of the Exchequer, the

Rt. Hon. Norman Lamont, M.

oe mont, M.P., May 13,

eee eee eee

PSSSSSOSSOSSO SSCS SS SESE TOOSESEOSESEESE COO SOOSECCEOCOCCS

.

Statement of the Chancellor of the Exchequer, the

Rt. Hon. Kenneth Clarke, Q.C. MP.‘ .

ber 15, 1993 eel

CP PHSHHOOEH OOOOH EEE EEE EE EE OE EEEEESeESESeses

eee ee ee eee

Page

19

IN THE

Supreme Court of the Anited States

OCTOBER TERM, 1993

No. 92-1384

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

in and for the Third Appellate District

BRIEF OF THE GOVERNMENT OF THE

UNITED KINGDOM AS AMICUS CURIAE

IN SUPPORT OF PETITIONER

INTEREST OF AMICUS CURIAE

The United Kingdom is one of the major trading part-

ners of the United States. It has for many years been the

largest direct investor in the United States, with an es-

timated $110 billion in such investments on an historical

cost basis. Almost one thousand U.K.-owned multinational

groups do business through approximately three thousand

subsidiaries in virtually all the states of the Union. In

order to encourage still greater investment and trade which

would redound to the benefit of both nations, the United

Kingdom and the United States have sought consistently

to apply the principles of the arm's length-separate ac

counting method in determining the proper international

division of income for tax purposes. Both Nations believe

application of this method protects their respective fises

while preventing inappropriate double taxation of their tax.

payers. It also creates a mechanism for resolving disputes

and, more generally, provides the certainty in the taxation

of international commerce that is sought by international

investors.

The State of California, in the year in question, imposed

mandatory worldwide unitary taxation—a system com-

pletely inconsistent with the arm's length-separate ac:

counting method—on all corporations doing business in

California. Barclays Bank of California (“Barcal’’), a Cal-

ifornia corporation, and Barclays Bank International Lim.

ited (“BBI"), a U.K. company, subsidiaries of petitioner's

predecessor, both did business in California. They were

required to pay tax on their California income calculated

with reference to the worldwide profits of the entire Bar-

clays group—over 220 corporations conducting more than

98 percent of their business outside the United States.

This resulted in substantially higher tax than would have

arisen under application of the arm’s length-separate ac-

counting method.

The United Kingdom has a significant and legitimate

interest in protecting U.K. multinational groups from dam-

age caused by the imposition of worldwide unitary tax. It

is greatly concerned that if mandatory worldwide unitary

taxation of the type imposed by California were to be

upheld, its multinationals would be adversely affected, the

imposition of worldwide unitary taxation by the states

would multiply, and, in seeking to protect its legitimate

interests and those of its multinationals, its relations with

the United States as a whole would be severely impaired.

The Government of the United Kingdom believes that this

case provides the opportunity for this Court definitively

to hold unconstitutional the imposition of mandatory world-

wide unitary taxation by any State on companies that are

part of a foreign-owned multinational group.

The Government of the United Kingdom submits this

brief amicus curiae in support of petitioner.’

SUMMARY OF ARGUMENT

The Government of the United Kingdom believes that

the instant case requires application of this Court’s Dor-

mant Foreign Commerce Clause analysis. Despite the as-

sertions of the FTB and the holding of the California

Supreme Court, the Government of the United Kingdom

believes that Congress has not authorized the States of

the Union to impose mandatory worldwide unitary taxation

on foreign owned-groups. In particular, nothing in the rat-

ification process of the U.K.-U-S--Tax Treaty can be con-

strued as approval—either affirmatively or by ‘“‘negative

implication.”

The California worldwide unitary tax fails both of the

tests specifically fashioned for Dormant Foreign Commerce

Clause analysis in Japan Line, Ltd. v. County of Los An-

geles, 441 U.S. 434 (1979): substantial risk of international

multiple taxation and interference with the ability of the

Federal Government to speak with one voice when regu-

lating foreign commerce.

There can be no doubt that California’s imposition of

worldwide unitary taxation creates for foreign-owned

groups a substantial risk of international double taxation

in every case. While it may not always produce actual

double taxation (although it did in the instant case), the

risk is inevitable. The constitutional significance of the

“mere risk” of double taxation was specifically reserved

' Petitioner and Respondent have consented to the filing of this brief

amicus curiae in letters filed with the Clerk of this Court.

by this Court in Japan Line, and should be resolved now.

The adverse impact of this risk on inbound foreign in-

vestment is manifest. Furthermore, as the dissent in Con-

tainer Corp. v. Franchise Tax Board, 463 U.S. 159 (1983)

pointed out, there is a reasonable alternative to worldwide

unitary taxation, namely, “water's edge.”’

Mandatory worldwide unitary taxation also interferes

with the Federal Government's ability to ‘‘speak with one

voice” in regulating the foreign commerce of the United

States. The most compelling manifestation of this inter-

ference has been the hostile reaction of foreign nations,

and the United Kingdom in particular, with possible ad-

verse consequences for this Nation as a whole. The United

Kingdom enacted retaliatory legislation in 1985, and in

1993 came to the very brink of activating it. The justifi-

cation for any such retaliation is clear—worldwide unitary

taxation has an extraterritorial reach that places all for-

eign-owned multinationals at risk of double taxation,

thereby requiring their residence countries either to allow

them to suffer that burden or provide relief to the det-

riment of their own fiscs.

The Government of the United Kingdom also believes

that California’s worldwide unitary taxation fails the first

of the Complete Auto Transit, Inc. v. Brady, 430 U.S. 274

(1977) tests, namely, ‘substantial nexus.”’ In Quill Corp.

v. North Dakota, 112 S.Ct. 1904 (1992), this Court estab-

lished that the Commerce Cluuse requires a more signif-

icant level of contact than the ‘minimal’ Due Process

nexus requirements considered by this Court in Container.

Because of the heavy burden a worldwide unitary tax im-

poses on foreign commerce, the requisite level of contact

between the taxing state and the activities it would tax

simply cannot be found with respect to those members of

foreign-owned unitary groups that operate in foreign ju-

risdictions and have no connection with the United States

other than through their corporate affiliation.

ARGUMENT

I. Congress Has Not Authorized States to Impose Man-

datory Worldwide Unitary Taxation on Foreign-

Owned Groups

A. General

1. Regulation of Foreign Commerce

| The Government of the United Kingdom regards the

issue presented by the instant case as posing the most

fundamental of constitutional questions in the areas of fed-

eral-state relations and foreign relations. Under the U.S.

Constitution, Congress is vested with the power “To reg-

ulate Commerce with foreign Nations... .” Art. I, § 8, ci.

3. Taxation is, of course, a form of regulation. Conse-

quently, on the face of it, there would seem to be no power

in the States to tax any aspect of foreign commerce in

the absence of Congressional authorization to do so.

Even in the absence of such authorization, however, the

States and their political subdivisions have undertaken to

impose certain forms of taxation on foreign commerce. As

a result, this Court has been called upon to determine the

constitutionality of a variety of such taxes—Los Angeles

County’s ad valorem property tax on containers (struck

down) in Japan Line, Ltd. v. County of Los Angeles, 441

U.S. 434 (1979); Florida’s sales tax on aviation fuel (up-

held) in Wardair Canada, Inc. v. Florida Dep’t of Revenue,

477 U.S. 1 (1986); lowa’s income tax on foreign subsidiary

dividends (struck down) in Kraft Gen. Foods, Inc. v. Iowa

Dep't of Revenue & Fin., 112 S. Ct. 2365 (1992); and

Tennessee's sales tax on container leases (upheld) in /tel

Containers Int’l Corp. v. Huddleston, 113 S.Ct. 1095 (1993).

The most directly pertinent decision, of course, is Con-

tainer Corp. v. Franchise Tax Board, 463 U.S. 159 (1983),

in which this Court, by a 5-3 majority, upheld California's

mandatory worldwide unitary income tax, but only in re-

lation to a domestic-owned group of corporations that in-

cluded foreign subsidiaries.

All of these cases make it clear that absent an expres-

sion of Congressional intent that a particular state tax on

foreign commerce is permissible, this Court will undertake

to test the validity of the tax under the so-called Dormant

Commerce Clause analysis that has been adhered to since

the mid-nineteenth century.

2. Dormant Commerce Clause Analysis

Under Dormant Commerce Clause analysis, as applied

to the Foreign Commerce Clause, this Court will strike

down a tax if it fails any one of six different tests. The

first four tests were originally set forth in Complete Auto

Transit, Inc. v. Brady, 430 U.S. 274 (1977), a case in-

volving the Interstate Commerce Clause. They were ex-

tended to the Foreign Commerce Clause in Japan Line,

supra. They require that (1) there must be “substantial

nexus” between the activities being taxed and the taxing

state, (2) the tax must be fairly apportioned, (3) the tax

must not be discriminatory against foreign commerce, and

(4) the tax must be fairly related to the services received

from the taxing jurisdiction.? Japan Line, 441 U.S. at 444-

446. The remaining two Foreign Commerce Clause tests,

set forth by this Court for the first time in Japan Line,

are that (5) the tax must not create a substantial risk of

international multiple taxation, and (6) the tax must not

prevent the Federal Government from speaking with one

voice when regulating commercial relations with foreign

governments. Jd. at 451.

The Government of the United Kingdom is aware of no

affirmative legislation enacted by Congress that authorizes

the imposition by individual States of worldwide unitary

taxation on foreign-owned multinational groups. Neverthe-

? The tests set out in (2), (2), and (4) are not considered in this brief

amicus curiae.

less, the California Supreme Court, while not disagreeing

with that proposition, concluded by process of “negative

implication” that Congress had in fact authorized the

States to utilize that method of taxation. As a result, the

California Supreme Court concluded that there was no

need to engage in Dormant Foreign Commerce Clause

analysis.

The Government of the United Kingdom believes that

the analysis of the California Supreme Court is subject to

“serious question” (see Brief for the United States as Ami-

cus Curiae, filed October 7, 1993, at 7). It wishes specif-

ically to address one of the points on which the court below

relied in finding its “negative implication.”’ That point in-

volves the developments relating to the approval and rat-

ification of the United Kingdom-United States Double

Taxation Treaty (the ‘U.K.-U.S. Treaty’) in the late

1970’s.

B. Ratification of the U.K.-U.S. Treaty

In both the decision of the California Supreme Court

and the brief of respondent Franchise Tax Board (‘‘FTB’’)

in opposition to certiorari, much has been made of the

reservation by the U.S. Senate to a portion of Article 9(4)

of the U.K.-U.S. Treaty and the subsequent approval of

the revised treaty by the U.K. Parliament.®

The Government of the United Kingdom does not now,

and did not either at the time of the reservation by the

U.S. Senate or at the time of ultimate approval by the

* As originally drafted, Article 9(4) would have expressly precluded

the States from imposing worldwide unitary taxation on members of

a U.K.-owned multinational group.

A majority of the Senate, but not the necessary two-thirds, approved

the Treaty with Article 94) in its original form. A reservation to

remove the prohibition on the States from the scope of Article 9/4)

failed on a separate vote. After parliamentary maneuvering, however,

the Senate then ratified the Treaty with the reservation attached.

U.K. Parliament, believe that the action of the Senate

constituted ‘‘Federal acquiescence’’ in California’s system

of worldwide unitary taxation. Furthermore, the Govern-

ment of the United Kingdom, in the strongest possible

terms, wishes to disabuse this Court of any impression

that the approval of the U.K.-U.S. Treaty by the U.K.

Parliament in any particular constituted acceptance by the

United Kingdom of California’s imposition of worldwide

unitary taxation on U.K.-owned groups.

1. The Senate Reservation

After reading this Court’s decision in Wardair as es-

tablishing ‘‘a kind of protocol for identifying those kinds

of governmental silences that give rise to ‘negative im-

plications’ supporting an inference of Federal acquiescence

in the state tax case under challenge,’’ App. at C-34* the

California Supreme Court completely misconstrued the sig-

nificance of the Senate’s reservation.

As described by that court, the reservation was “the

most explicit example of a persistent Congressional refusal

to enact curbs on the states’ use of worldwide formula

apportionment ....’’ App. at C-23. It is clear from all the

differing opinions expressed both in the Senate debate and

in committee, however, that there was no single Congres-

sional policy underlying the reservation. Moreover, only

one House of Congress considered the treaty in any event.

During the debates on the treaty in June 1978, three

distinct views on Article 94) emerged. There were those

who would vote for it, those who would vote against it

because they thought the states should have the unfettered

right to tax foreign-owned multinationals, and those who

would vote against it because they did not believe that a

‘ All references to pages A-__., B-___, and C-__ are to pages in

the Appendices to Petition for a Writ of Certiorari filed in the instant

case. All references to exhibits are to those numbered in the Joint

Stipulation of Facts on pages A-36 to A-73.

Pe a

FS a ne ON ee RE Oe tle i Rae Bt Sh Dect be rte

bw es

single bilateral tax treaty to be placed only before the

Senate was the proper vehicle for considering a measure

that should be acted on by both Houses as part of a uni-

form policy to be applied to all nations.

The importance attached to this third factor was at-

tested to throughout the debates. The chief opponent of

the original Article 9(4), Senator Church, stated:

If accepted by the Senate, this provision could

serve as a precedent for fashioning internal tax

policy via agreements with foreign govern-

ments—a method that circumvents the tax writ-

ing committees of both the House and the Senate.

This is the first time the treaty power has been

used in such a manner, and, I believe, it repre-

sents an unwarranted extension of that power

which we will come to regret.

124 Cong. Rec. 16892 (1978).

Similarly, Senator Stevens stated: “I suggest that a tax

treaty is not the proper nor desirable medium for the

exercise of this [Federal] power.” (Jd: at 18427.)

If this were not clear enough, it is given added force

by the 1979 Senate Foreign Relations Committee report

on the Third Protocol to the U.K.-U.S. Treaty (not cited

by the California Supreme Court), which gave formal effect

to the Senate reservation. The Foreign Relations Com-

mittee stated that:

Even some supporters of Article 9(4), while not

questioning the propriety of the Article, indicated

their preference for Congressional consideration

through the legislative process of the issue. The

Foreign Relations Committee notes that Section

303 of S. 983, the Interstate Taxation bill intro-

duced by Senator Mathias, would accomplish for

all nations what Article 9(4) of the U.S.-U.K. Tax

Treaty sought to accomplish for the U.K.

10

The Committee urges the tax-writing Committees

of the Congress—the Finance and the Ways &

Means Committee—to hold hearings in the very

near future on S. 983 in order to permit all sides

of the issue to have their views known for the

record. In addition, such legislation will give the

Congress, which has the responsibility to resolve

on the federal level inconsistent state taxation

policies, the opportunity to take a position on the

merits of the case.

Exhibit 37b.

From this, it seems clear that the Senate Foreign Rela-

tions Committee—the Committee responsible for the rati-

fication process—in no way considered the Senate votes

on Article 9(4) as themselves somehow having been in-

tended to authorize state use of worldwide unitary taxa-

tion.

Yet, from the Senate’s action on this one bilateral

treaty—not 70 bilateral agreements and a 157-nation in-

ternational agreement as considered in Wardair—and from

the many motives expressed by Senators rather than one

consistent theme, the California Supreme Court somehow

discerned what it believed to be clear congressional intent.

The Government of the United Kingdom does not see how

the equivocal actions of the Senate with respect to a single

treaty (where a majority of the Senators actually voted in

favor of the original Article 9(4)) could be held to consti-

tute Congressional approval of the states’ use of worldwide

unitary taxation.

2. Approval by the U.K. Parliament

The California Supreme Court also suggested (citing

Wardair, 477 U.S. at 11) that the U.K.’s ratification of

the treaty “‘must be understood as representing a policy

Ot ee ll

eter a

Ce ie hae lea lig POE OMe Ne ND A i ee

Suber

11

choice by the contracting parties.’”> App. at C-30. Fur-

thermore, in its brief in opposition to certiorari, the FTB

stated “The government of the United Kingdom, while

regretting the defeat of the prohibition as preliminarily

negotiated in 1975, recognized that the US/UK Treaty as

finally negotiated and ratified was a ‘fair and balanced

agreement.’ ”’ FTB Opp. at 6.

The Government of the United Kingdom wishes firmly

to reject the impression conveyed by the California

Supreme Court and the FTB regarding its intentions in

approving the Treaty. The FTB extracted the quoted

phrase out of context from a demarche of March 25, 1980

sent to the State Department upon the exchange of in-

struments of ratification bringing the Treaty into force.

The penultimate paragraph of the demarche directly ad-

dressed the unitary tax issue:

Her Majesty’s Government has recognized, in rat-

ifying this Convention with the approval of the

United Kingdom Parliament, and in its accept-

ance of the United States Senate reservation

against Article 9(4) of the Convention, the dif-

* The court went on to buttress its argument by contending that the

“international business community” had somehow been on “notice” as

to worldwide unitary taxation for the last seventy years. App. at C-

32. The court’s reliance on the 1924 decision in Bass, Ratcliff & Gretton,

Ltd. v. State Tax Comm'n, 266 U.S. 271 (1924), in that regard is

misplaced: that case involved only formulary apportionment of a single

entity (combined reporting on a worldwide basis was not yet invented)

and it also preceded both the adoption of the international arm's length

standard and this Court’s modern Commerce Clause jurisprudence.

Moreover, Bass, Ratcliff was not an income tax case. It involved a

franchise tax imposed for the privilege of doing business in New York.

The measure of the tax was net income for the prior year, computed

on an apportionment basis. The taxpayer, a U.K. corporation, manu-

factured ale in England and sold it in New York and elsewhere. Even

though the taxpayer suffered a loss on its New York operations in the

prior year, this Court upheld application of the tax for the privilege

of doing business in the current year.

12

ficult issues raised within the United States in

seeking to limit State taxing powers through the

double taxation conventions of the United States.

It has also recognized the importance of the Con-

vention in its many other aspects for the two

Governments and for the business and invest-

ment communities on each side. Jt must be em-

phasized however that the acceptance of the Senate

reservation in no way implies approval of the

unitary basis and it is the urgent request of Her

Majesty’s Government for the reasons given in

this Note that the Government of the United

States should use its best endeavours to eliminate

the international application of the unitary basis

of taxation. (emphasis added.)

Exhibit 32c.

For the reasons set forth above, as well as those set

forth by petitioner in its brief, the Government of the

United Kingdom strongly urges this Court to reject the

analysis of the court below and acknowledge that the in-

stant case presents a question for decision under the Dor-

mant Foreign Commerce Clause.

II. Issues Under the Dormant Foreign Commerce Clause

Moving first to the two tests that this Court has fash-

ioned peculiarly for Dormant Foreign Commerce Clause

analysis, the Government of the United Kingdom believes

that California’s worldwide unitary tax fails both tests. As

will be shown below, California’s taxing scheme ‘“‘creates

a substantial risk of international multiple taxation” Japan

Line, 441 U.S. at 451, and, in this case, actual double

taxation. It also interferes with the ability of the Federal

Government to speak with one voice in its regulation of

commercial relations with foreign governments.

a -

we een te Oe bee

13

A. Substantial Risk of International Multiple Tax-

Because there was in fact inevitable actual double tax-

ation in Japan Line, this Court specifically reserved the

issue whether the “mere risk’ of such taxation would

result in unconstitutionality.

Because California’s tax in this case creates mul-

tiple taxation in fact, we have no occasion here

to decide under what circumstances the mere risk

of multiple taxation would invalidate a state tax,

or whether this risk would be evaluated differ-

ently in foreign, as opposed to interstate, com-

merce.

Japan Line, 441 U.S. at 452 n.17 (emphasis in original)

(citations omitted).

Since actual double taxation of income may not be inev-

itable under worldwide unitary taxation, the Government

of the United Kingdom believes that the instant case pre-

sents the proper occasion for this Court to resolve the

issue left open in Japan Line.

In Container, this Court declined a similar opportunity.

The majority apparently believed that Japan Line required

a showing of actual double taxation in every instance be-

fore the California unitary tax could be found to violate

the “multiple taxation” test. In any event, the majority

identified two inquiries to be undertaken in applying the

multiple taxation test:

Although double taxation in the foreign com-

merce context deserves to receive close scrutiny,

that scrutiny must take into account the context

in which the double taxation takes place and the

— reasonably available to the taxing

Container, 463 U.S. at 189.

14

The “context’’ on which the majority focused in Con-

tainer was the fact that an income tax, rather than a

property tax, was involved. The difficulties identified in

dividing income among taxing jurisdictions apparently

caused the majority to be unsympathetic to the taxpayer’s

double taxation claim. The “alternatives’”’ which the ma-

jority said were available to California were either to re-

frain from taxing income altogether or to adopt the arm's

length method of taxation. Neither alternative was found

acceptable as applied to a domestic-owned group.

1. Context Revisited

The tax here involved is also an income tax—indeed,

the same tax that was involved in Container. However,

the group bearing the burden of the tax here is foreign-

owned rather than domestic-owned as in Container. As

will be shown, foreign-owned groups considering doing

business in California are inevitably exposed to a substan-

tial risk of international double taxation under the Cali-

fornia taxing scheme. For the reasons noted below, that

fact should be sufficient to render California’s tax uncon-

stitutional when applied to foreign-owned groups.

California’s system of worldwide combined reporting re-

quires a taxpayer in a foreign-owned group to include in

its California tax base the entire worldwide income earned

by the group as a whole. That is the essence of the unitary

business concept—flows of value within the group justify

treating it as if it were essentially a single entity. Yet all

but the U.S. portion of that income would have been sub-

ject to tax in other countries under the arm’s length-sep-

arate accounting method that is the international norm.

iring the non-U.S. portion of the income, as so com-

puted, to be included in the California tax base thus guar-

antees not only that it will be exposed to a second tax,

but to a second tax computed on a different and incon-

sistent basis (i.e., formulary apportionment).

15

There is, in short, a conceptual clash between the arm’s

length method and worldwide unitary taxation—the former

being fact-specific and applied on a transaction-by-trans-

action basis, the latter being entirely formulaic and com-

puted by reference to global figures accumulated on an

annual basis. There is simply no harmony between the two

systems. Whether actual double taxation in fact will result

in any given case where the two systems are applied be-

comes a matter of pure chance.* It is hard to imagine a

clearer example of a tax giving rise to a “substantial risk

of international multiple taxation’’ than a worldwide uni-

tary tax imposed on a tax base that includes income that

has also been subject to tax in another jurisdiction under

the arm’s length method.

While the same substantial risk of double taxation the-

oretically exists in the case of a domestic-owned group

with foreign subsidiaries, it does not necessarily lead to a

comparable indication of constitutional infirmity. In the

context of business conducted within the United States,

i.e., interstate commerce, this Court has allowed the States

a certain amount of flexibility in applying apportionment

formulae to the income of a unitary business. Moorman

Mfg. Co. v. Bair, 437 U.S. 267 (1978) (lowa single sales

factor formula upheld even though neighboring Illinois used

*If the apportionment formula produces a result that is less than

the U.S. portion of the group’s worldwide income, computed on an

arm's length basis, no double taxation of income wil] occur. If the

formula produces a greater result, double taxation of some portion of

the group’s non-U.S. source income will occur.

It is no answer to suggest that California is only taxing that portion

of the group's income fairly attributable to it, not a portion of world-

wide income per se. If the business is unitary, all of the income goes

into a single pool. The rationale for apportionment is that all] members

of the group have contributed to the total amount in the pool, and the

states where they operate may each tax some portion of the whole.

That is why under unitary taxation even a loss company may find itself

paying tax on apportioned income. California cannot have it both ways.

16

three-factor formula). Possible overlaps in formulae among

the States may in fact result in some domestic double

taxation. Yet this Court has concluded that because it does

not sit as the legislature of last resort, it will uphold any

domestic apportionment formula that is reasonable in ap-

plication, notwithstanding possible overlaps and resulting

double taxation.

Since Container involved a domestic parent company

doing business in California, the fact that the income of

its foreign subsidiaries was included in California's tax

base for apportionment purposes and that the formula ap-

plied by California produced actual double taxation in that

case (463 U.S. at 187 n. 22) essentially reflected an ex-

tension of the principles set down in Moorman. See Con-

tainer, citing Moorman, 463 U.S. at 192-193. The possibility

of an overlap of this sort is simply one of the accepted

hazards under which domestic-owned businesses know they

must operate. The principles of Moorman have never been

applied to foreign-owned groups, however.

The reason why a substantial risk of double taxation is

of greater constitutional significance in the case of foreign-

owned, as contrasted with domestic-owned, groups is the

adverse impact that the risk has on inbound international

investment. The international commitment to use of the

arm’s length-separate accounting method for dividing in-

come is designed to provide assurances to international

investors that they should not suffer inappropriate double

taxation on the profits from their investments. If a State

is allowed to apply worldwide unitary taxation to inter-

national income, no such assurances can be given. That,

in turn, plainly serves to discourage international invest-

ment in unitary states and, as a result, adversely affects

the United States as a whole.

Presumably for these very reasons, the Secretary of

State, the Honorable George P. Shultz, wrote to the Gov-

ernors of California and other unitary tax States in 1986

17

to express the foreign policy concerns of the United States

in relation to the imposition of worldwide unitary taxation

and its effect on international investment.

In an environment in which separate accounti

is the federal policy and the generally sonnel

international rule, state taxation on a worldwide

unitary basis creates a clear risk of double tax-

ation. . . . This risk of double taxation may distort

investment decisions, thereby reducing the over-

all flow of investment into the United States.

Exhibit 46h.

While actual double taxation may not be inevitable under

California's taxing scheme (although petitioner did suffer

such double taxation here), that fact should not relieve the

California tax of its infirmity. The question reserved in

Japan Line was whether the “mere risk” of multiple tax-

ation was sufficient to invalidate a state tax, particularly

in the case of foreign commerce. That question should now

be answered in the affirmative. Any state tax that inev-

itably exposes foreign-owned groups to a substantial risk

of multiple taxation directly interferes with inbound in-

vestment decisions. As a result, it places an undue burden

on foreign commerce and should be invalidated under the

Foreign Commerce Clause.

2. Alternative Taxing Methods

The majority in Container appears to have believed that

there were only two alternatives to worldwide unitary tax-

ation that were open to the State of California: the arm’s

length method or no tax at all. 463 U.S. at 190. As the

minority pointed out, however, there is a third alternative:

the so-called ‘“‘water’s edge’ method. Jd. at 198-199 n.1.

The “water’s edge” method is designed to

é . apply uni

taxation and formulary apportionment only to income 4

ing within the United States. Under a water’s edge ap-

proach, therefore, domestic source income could continue

18

to be apportioned among the states in time-honored fash-

ion. But the tax could also be applied on a basis consistent

with the Federal treatment of international income because

the tax base would not include income determined under

the arm’s length method to have had its source in other

countries.

The water’s edge method is clearly an alternative “rea-

sonably available to the taxing state’. California recently

adopted a new elective variation of the water’s edge

method in the amendatory legislation it enacted in October

1993. The availability of the water’s edge alternative per-

mits the conclusion that the inevitable risk of double tax-

ation should itself be sufficient to invalidate worldwide

unitary taxation when imposed on foreign-owned groups.

B. Speaking with One Voice

1. In General

Under the Constitution, the Federal Government is

charged with responsibility for the policies of the United

States regarding all matters involving foreign commerce.

That is one proposition on which the Framers were most

insistent when they agreed upon the distribution of powers

between the Federal and State governments. See Japan

Line, 441 U.S. at 449; Michelin Tire Corp. v. Wages, 423

U.S. 276, 283-286 (1976).

The States, therefore, may not conduct their affairs in

a manner that interferes with the foreign policy of the

Nation. The question presented here is whether Califor-

nia’s imposition of worldwide unitary taxation on foreign-

owned groups impermissibly interferes with the Federal

Government’s conduct of its commercial relations with for-

eign nations.

In both Japan Line and Container, one of the principal

concerns of this Court in considering the ‘‘one voice’’ test

was whether the nature and scope of the state tax in

question created a significant prospect of retaliation against

19

the United States as a whole by the affected foreign gov-

ernment(s). A state tax that could provoke such retaliation

would obviously represent a serious interference with the

conduct of foreign commercial relations. There can be no

clearer illustration of how an inappropriate state taxing

scheme can spark the type of foreign government reaction

that jeopardizes the conduct of foreign commercial rela-

tions than the response to California’s imposition of its

worldwide unitary tax on foreign-owned groups.

2. Retaliation and the United Kingdom

The Government of the United Kingdom wishes to rei-

terate to this Court that its acceptance of the U.K.-U.S.

Treaty with the Article 94) reservation did not constitute

acceptance of the California system of worldwide unitary

taxation. It also did not quiet the strong demands for

action on the issue in the U.K. Parliament that ultimately

resulted in the enactment of specific retaliatory legislation.

The foundation for that legislation can be traced to a

December 17, 1981 letter from the then Chancellor of the

Exchequer, the Rt. Hon. Sir Geoffrey Howe, Q.C., M.P.,

to the U.S. Secretary of the Treasury, the Honorable Don-

ald T. Regan. (The letter was appended to the Adminis-

tration’s brief amicus curiae filed in this Court in support

of the petitioner in Chicago Bridge & Iron Co. v. Cater-

pillar Tractor Co., 454 U.S. 1029 (1981), appeal dismissed,

463 U.S. 1220 (1983)). In that letter, the Chancellor stated

that worldwide unitary taxation:

. introduces an undesirably asymmetric ele-

ment into the tax relationship between our two

countries, since the unitary basis of taxation with

worldwide combined reporting is not used by the

U.K. at any level of government. This imbalance

is causing increasing concern, not only on the

part of British companies which have made rep-

20

resentations about it, but in Parliament where

Questions have been asked.’

Following the 1983 decision of this Court in Container,

President Reagan formed a Working Group on Worldwide

Unitary Taxation that was charged with studying the issue

and making recommendations for action. The Working

Group recommended a water’s edge solution, but no con-

crete action resulted.

Concerned about the progress being made on the subject

in the United States, Parliament proceeded to enact leg-

islation in 1985 that gave the United Kingdom power to

retaliate against national and subnational authorities that

imposed worldwide unitary taxation on U.K.-owned com-

panies. The legislation authorized, in respect of any U.S.

corporation having a ‘‘qualifying presence’’ in a ‘unitary

state,” the withdrawal of the right to claim the partial

tax credit given by the U.K. under the U.K.-U.S. Treaty

in respect of dividends paid by a U.K. subsidiary. (The

legislation is now contained in sections 812-815 of the In-

come and Corporation Taxes Act 1988.)

After Parliament’s passage of the retaliatory legislation,

California enacted its own legislation in 1986. For the first

time, it provided a water's edge election for multinational

groups, beginning in 1988. The change was generally con-

sidered unacceptable to the multinational community be-

cause of its conditionality, including the imposition of a

substantial fee and the retention by the State of a right

to impose unitary tax notwithstanding the election. Never-

theless, the fact that California had taken some steps,

coupled with the commencement of the instant litigation

in the California courts as a test case for foreign-owned

* Brief Amicus Curiae of the United States, in Chicago Bridge &

Iron Co. v. Caterpillar Tractor Co., App. at 3a, Docket No. 81-349.

“Questions” in Parliament are the traditional means whereby M.P.'s

express concern to the Government.

21

groups, caused the Government of the United Kingdom to

defer implementation of its retaliatory legislation at that

time.

Eventually, faced with the prospect of no immediate

solution to the problem, the then Chancellor of the Ex-

chequer, the Rt. Hon. Norman Lamont, M.P., announced

in May 1993 that the Government of the United Kingdom

would have to take retaliatory measures in respect of Cal-

ifornia’s worldwide unitary tax if the matter were not

satisfactorily resolved by the end of the year.

... I have informed [the U.S. Secretary of the

Treasury} that the Government will have to take

retaliatory measures in relation to United States

based companies if there is not a satisfactory

resolution of the problem of the internationally-

opposed unitary tax on foreign-owned companies

in California by the end of this year."

Following this announcement, the U.K. Board of Inland

Revenue notified 900 major U.S. corporations with U.K.

subsidiaries of the various retaliatory options available to

it under the 1985 U.K. legislation.

In response to the 1993 developments, the California

legislature adopted certain further modifications to its

water's edge election, effective in 1994. This action

prompted the Chancellor of the Exchequer, the Rt. Hon.

Kenneth Clarke, Q.C., M.P., to inform the U.S. Secretary

of the Treasury, the Honorable Lloyd Bentsen, that the

United Kingdom would defer the implementation of any

retaliatory measures in 1993 and would retaliate only if

it became clear that the new legislation was being applied

* Statement of the Chancellor of the Exchequer, the Rt. Hon. Norman

Lamont, M.P., May 13, 1993.

in a way that damaged U.K.-owned companies.’ This po-

sition was expanded upon in the Chancellor’s public state-

ment of September 15, 1993:

While the legislation in California is a significant

step forward, on its own it does not provide a

complete solution to the unitary tax problem. For

a complete solution it will be necessary to have

the internationally accepted arm’s length princi-

ple endorsed, on a permanent basis, as the only

valid method of taxing foreign companies in any

State. Success for the Barclays case in the

Supreme Court would achieve this. The Govern-

ment will continue strongly to support Barclays’

case. I hope it will succeed. If it does not, the

UK will have to retain its retaliatory powers in

reserve as a barrier against the possibility that

States might damage UK owned companies by

the imposition of unitary taxation at some tim

in the future.” ;

In Container, the majority concluded that because the

legal incidence of the California tax fell on a domestic

corporation (albeit one with foreign subsidiaries), foreign

governments would not be justified in engaging in signif-

icant retaliation. 463 U.S. at 194-195. In so concluding,

the majority expressly acknowledged that the result might

well be different if the tax fell on a domestic corporation

that was owned by foreign interests. Jd. at 195 n.32. Here,

the legal incidence of the tax fell on Barcal (a domestic

subsidiary) and BBI (a U.K. subsidiary doing business in

California) when both were owned by foreign interests (i.e.,

* Letter of Chancellor of the Exchequer, the Rt. Hon. Kenneth Clarke,

Q.C., M.P. to U.S. Secretary of the Treasury, the Honorable Lloyd

Bentsen, September 14, 1993.

‘° Statement of the Chancellor of the Exchequer, the Rt. Hon. Ken-

neth Clarke, Q.C., M.P., September 15, 1993.

23

petitioner’s predecessor). The circumstances are thus quite

different than in Container.

There can be no doubt about the overwhelmingly hostile

reaction in the U.K. (and elsewhere) to California’s world-

wide unitary taxation as imposed on foreign-owned groups.

There can also be no doubt that the tax has had an ex-

tremely adverse effect upon the foreign commercial rela-

tions of the United States. For its own part, the

Government of the United Kingdom considers that it has

not before come so close to retaliating economically against

another sovereign nation over an issue of taxation, and

certainly has never previously come so close to economic

retaliation against a sovereign nation over the taxation

activities of a political subdivision thereof.

3. Reaction of Other Governments

That California’s taxing scheme interferes with the abil-

ity of the Federal Government to conduct its foreign com-

mercial relations indisputable. If further proof is needed,

it can be found in the reaction to California’s tax by many

of the other major trading partners of the United States.

In the last fifteen years, more than twenty diplomatic

notes and other formal communications have been sent to

the State Department objecting to worldwide unitary tax-

ation. Those demarches have spelled out the attitude of

numerous foreign governments to the California tax. In

addition, twenty OECD nations wishing to make their

views even more clearly known to this Court have joined

in the filing of a separate brief amici curiae in support

of petitioner in the instant case. The Government of the

United Kingdom knows of no other state tax that has ever

engendered such a powerful reaction from foreign gov-

ernments.

Given the extraterritorial reach of the California tax and

the fact that both the legal incidence and the economic

burden of the tax fall on foreign interests in the instant

case, coupled with the inevitable exposure of such foreign-

24

owned groups to the substantial risk of double taxation,

actual retaliation by a foreign government would clearly

be justifiable even under Container’s standards. Indeed,

the residence country of a foreign-owned group can find

itself facing an unacceptable choice: either to allow its

multinational companies to be double taxed under world-

wide unitary taxation or to forego part of its own tax

revenue by providing relief through tax credits (or oth-

erwise) for a second tax that is imposed under a system

incompatible with its own. The circumstances here pres-

ent—in sharp contrast to those in Container—clearly justify

retaliation and, therefore, require a holding of unconsti-

tutionality under the Foreign Commerce Clause.

C. Substantial Nexus

The remaining Dormant Commerce Clause test which

the Government of the United Kingdom wishes to address

in this brief amicus curiae is the nexus test. It requires

that the tax in question must be applied ‘‘to activities with

a substantial nexus with the taxing State.’ Japan Line,

411 U.S. at 444.

Prior to this Court’s decision in Quill v. North Dakota,

112 S.Ct. 1904 (1992), it had been assumed that some form

of ‘‘minimum contact’”’ between the activity and the taxing

state satisfied both the Due Process and Commerce Clause

requirements for ‘‘nexus.’’ In Container, for example, this

Court considered the ‘“‘nexus’’ issue solely in those terms.

463 U.S. at 165-166.

Quill involved the question whether companies selling

goods into a state by mail order could be required to collect

the state’s use tax. This Court held that they could not

unless they satisfied the more stringent Commerce Clause

‘“‘nexus’’ requirement by maintaining a physical presence

in the state. In its decision in Quill, this Court made it

clear that the “nexus” standard under the Commerce

Clause is a higher standard than under the Due Process

Clause because the Commerce Clause is concerned with

25

the extent of the actual burden being imposed on com-

merce by the tax in question. Due Process, by contrast,

is concerned only with whether the taxpayer was suffi-

ciently connected with the state to be a proper subject of

taxation.

As was stated in Quill, the ‘‘substantial nexus’’ test

imposed under the Commerce Clause serves to “‘limit the

reach of State taxing authority so as to ensure that State

taxation does not unduly burden interstate commerce.”

Quill, 112 S.Ct. at 1913 (emphasis added). (While Quill

was an interstate commerce case, the same principles un-

derlie the ‘‘substantial nexus’’ test in the foreign commerce

area. Japan Line, 441 U.S. at 444-445.)

It seems clear from Quill wnat the extent of nexus re-

quired under the Commerce Clause is influenced by the

nature of the burden imposed on commerce. Since foreign

commerce is involved here, the issue would seem to be

particularly sensitive because of the various ways in which

a state tax might interfere with the conduct by the United

States of its foreign commercial relations.

Under worldwide unitary taxation, the California tax

base consists of the combined net incomes of all the cor-

porations in the Barclays group, i.e., more than 220 sep-

arate corporations doing over 98 percent of their business

outside the United States. App. at B-26. The question pre-

sented under the Foreign Commerce Clause is whether

the. » is sufficient nexus between California and the activ-

ities of those corporations in the countries where they

operate to justify including the income derived from those

activities in the California tax base. The answer must be

in the negative for at least two reasons.

First, there is no indication of any meaningful contact

between the State of California and the activities of the

various corporations in the Barclays group that operate in

the 59 countries other than the United States. To find

26

Commerce Clause nexus in the absence of any meaningful

contact is clearly inconsistent with Quill.

Second, the extraterritorial reach of California’s tax has

placed a severe burden on foreign commerce. Not only

does it generally interfere with inbound international in-

vestment decisions because of the inevitable exposure of

such investment to double taxation, but it also has created

an international reaction of major proportions. (The United

Kingdom, the largest foreign direct investor in the United

States, reached the brink of economic retaliation before

California amended its taxing scheme in 1993.) In the view

of the Government of the United Kingdom, California

should be denied the ability to include the worldwide in-

come of foreign-owned groups in its tax base because of

the extraordinarily heavy burden its unitary tax has placed

on foreign commerce.'!

The only possible basis upon which a claim of sufficient

nexus could rest here would derive from the fact that,

under California law, the Barclays group conducts a “‘un-

itary business.’”’ The theory underlying the unitary method

of taxation is that certain intangible ‘flows of value”’ within

the unitary group serve to link the various members to-

gether as if they were essentially a single entity. That

linkage may have caused the trial court below to conclude

'' This analysis need not apply with respect to domestic-owned groups

with foreign subsidiaries. In those situations, it can be assumed that

all the income earned by the group will be remitted to, or realized by,

the domestic parent at some point in time. The burden placed on com-

merce by worldwide unitary taxation is thus much less severe in such

a case, because it is only a matter of timing as to when the state

would be able to reach—and tax—the income in any event.

The same cannot be said of foreign-owned groups with domestic

subsidiaries. The income of such a group will flow away from the

unitary tax state, not toward it. Under those circumstances, therefore,

the state is seeking to tax income which it would not be able to reach

either then or at a later time.

27

that California had the requisite nexus with every member

of the Barclays group."

While such intangible flows of value may be the ration-

ale for treating a multinational group as a unitary busi-

ness, their rather speculative ‘‘subtle and largely

unquantifiable” nature (Container, 463 U.S. at 164-165)

make them too insubstantial to provide the requisite lin-

kage for Commerce Clause nexus. Quill suggests that

something far more tangible is required.

In the view of the Government of the United Kingdom,

California’s system of mandatory worldwide unitary tax-

ation as applied to foreign-owned groups goes beyond what

is contemplated by the U.S. Constitution because of (1)

the inevitable exposure of foreign-owned groups to the

substantial risk of double taxation, (2) the manner in which

the tax interferes with inbound investment decisio’ s and

thereby impacts on the conduct of U.S. foreign co: 1ercial

relations, and (3) the extraterritorial reach that sweeps

into the tax base income earned from international activ-

ities with which the state has insufficient contact to pro-

vide substantial nexus.

* That is not entirely clear, however. The trial court actually ap-

peared to accept the nexus analysis adopted in Container, which, as

noted, was a “minimum connection"’ analysis. See App. at A-30 - A.

31.

28

CONCLUSION

For all the foregoing reasons, the decisions of the courts

below should be reversed and California’s mandatory

worldwide unitary taxing scheme should be held uncon-

stitutional.

Respectfully submitted,

JEROME B. LIBIN

(Counsel of Record)

WILLIAM H. Morris

1275 Pennsylvania Avenue, N.W.

Washington, D.C. 20004

(202) 383-0100

SUTHERLAND, ASBILL & BRENNAN |

Counsel for the Government of |

the United Kingdom |

December 16, 1993