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

Supreme Court brief1994

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In The

Supreme Court of the Unite

October Term, 1993

Barciays BANK PLC,

Petitioner,

FRANCHISE TAx BOARD,

AN AGENCY OF THE STATE OF CALIFORNIA,

Respondent.

COLGATE-PALMOLIVE COMPANY,

Petitioner,

FRANCHISE TAx BoaRD

AN AGENCY OF THE STATE OF CALIFORNIA,

Respondent.

On Writ Of Certiorari To The Court Of Appeals

Of The State Of California In And For The

Third Appellate District

AMICUS CURIAE BRIEF OF MULTISTATE TAX

COMMISSION IN SUPPORT OF RESPONDENT

FRANCHISE TAX BOARD

ALAN H. FrirepMaAn*

General Counsel

Pautt MInes

Counsel

Multistate Tax Commission

444 No. Capitol St., N.W. Suite 425

Washington, D.C. 20001

(202) 624-8699

*Counsel of Record

ok i ee as.

“BEST AVAILABLE COPY

iu ay! eae ~

Of Counsel:

Proressor RicHARD Pomp

University of Connecticut

School of Law

65 Elizabeth Street

Hartford, CT 06105-2290

(203) 241-4694

ProressoR OuiveR OLDMAN

Harvard Law School

1563 Massachusetts Avenue

Cambridge, MA 02138

(617) 495-4622

Proressor MicHaet McIntyre

Wayne State University Law School

468 West Ferry Mall

Detroit, MI 48202

(313) 577-3944

QUESTIONS PRESENTED

1. Whether California’s application of worldwide com-

bined reporting to determine the taxable income of domestic

corporations with foreign parents, or foreign corporations

with either foreign parents or foreign subsidiaries, is uncon-

stitutional under the foreign Commerce Clause.

2. Whether California’s application of worldwide com-

bined reporting to determine the taxable income of domestic

corporations with foreign parents, or foreign corporations

with either foreign parents or foreign subsidiaries, intrudes

into an inherently federal area and is pre-empted by the

United States Constitution.

3. Whether California’s application of worldwide com-

bined reporting to determine the taxable income of domestic

corporations with foreign parents, or foreign corporations

with either foreign parents or foreign subsidiaries, is uncon-

stitutional under the Commerce Clause where such applica-

tion imposes discriminatory compliance burdens on such

entities.

4. Whether California's system for compliance with

worldwide combined reporting violates the Due Process

Clause of the United States Constitution where compliance is

not possible without undue cost and the system, to function,

depends on discretionary relief provisions without constitu-

tionally sufficient standards to guide application and prevent

arbitrary enforcement.

QUESTIONS PRESENTED ~- Continued

In its Amicus Curiae Brief, the Multistate Tax Commis-

sion shall address only Questions | and 2 of the Questions

Presented. !

! The Multistate Tax Commission has received consent from ail

parties to file this brief and will file written confirmation of those

consents with the Clerk of the Court.

TABLE OF CONTENTS

Page

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WORD GP QIU UUN ED occ cc cn cccccccccsccuccesess ii

TABLE OF AUTOOORITIOS .... ccc ccc cccccccccce v

INTEREST OF AMICUS CURIAE................... 2

SUMMARY OF ARGUMENT ..................2000. 3

Es c40456Gudekda hed 4ehbbdesnnddetaeseds: 4

I. THE FOREIGN COMMERCE CLAUSE DOES NOT

PROHIBIT THE APPLICATION OF WORLDWIDE

COMBINED REPORTING METHOD TO DETER-

MINE THE CORPORATE INCOME TAX LIA-

BILITY OF EITHER DOMESTIC CORPORATIONS

WITH FOREIGN PARENTS OR OF FOREIGN

CORPORATIONS WITH EITHER FOREIGN PAR-

ENTS OR FOREIGN SUBSIDIARIES............ 4

A. The Dormant Foreign Commerce Clause Anal-

ysis Fashioned In Japan Line Is Reminiscent Of

The Discredited Cooley Doctrine And Is

Ee er ee ree 4

B. The Federal Government Does Not Speak With

One Voice On The Issue Of WWCR Nor Does

The Federal Government Consider Such Unifor-

RE MR bh centennccaemeeéuterdscuxences 7

|. No weight should be given to complaints of

foreign governments about worldwide com-

Se I tut denneuuséueeuesawes< 7

2. No weight should be given to the United

Kingdom's threat to violate international

Pe beneehennsedeceuseekiedetesécenceeens 11

TABLE OF CONTENTS -— Continued

Page

3. The Executive branch does not speak for the

CED bc cis bdic keneneseucess 13

C. No Unconstitutional Double Taxation Exists .. 17

D. The Court Should Clarify That Japan Line Does

Not Apply To Corporate Income Taxes....... 22

E. Jtel And Wardair Cast Doubt On The Continued

Vitality Of Japan Line..................2.4.. 23

Il. PROHIBITING WORLDWIDE COMBINED

REPORTING UNDER THE DORMANT FOREIGN

COMMERCE CLAUSE WOULD UNDERCUT THE

CONSTITUTIONAL PROTECTION OF FEDER-

TABLE OF AUTHORITIES

Page

Cases

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

ee es ee 6 ds ckneecvadasectacecdacsdéecexs )

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

Sis waes c0edeuesddsosenneduancobeusecenstenns 6, 24

Container Corp. of America v. Franchise Tax Board,

Ge es CU GU hone eneccnecvaccecescaseus passim

Cooley v. Board of Wardens, 53 U.S. (12 How.) 299

sshavaseuasibaes bas eeenbdessecnent 4, 5, 6, 7, 24

Garcia v. San Antonio Metropolitan Transit Authority,

Ge ae Be GU no be bce cesccvdevcnspesccedens 3, 26

Itel Containers International Corp. v. Huddleston, ___

a ee COD Wee. CEE CUUMEEs cccsceces 4, 13, 22, 23

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

fF, ., PPT evETT TTrrTiT Trrrrerrrrirrir ye passim

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

Pes eee Se ee COS ee Se GPE r cons cedees 25

Miller Bros. v. Maryland, 347 U.S. 340 (1954).......... 6

Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S.

Se Se vsccthcceusceanenaheocusesnseeavesas ses 17

New State Ice Co. v. Liebman, 286 U.S. 262 (1932).... 27

Quill Corporation v. North Dakota, | zs)

De PO UUEED oo bec cccnessutovctoceresetacoesese 15

TABLE OF AUTHORITIES — Continued

Page

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

Pe Gee CN 40 kb ek everdanveesiawectens 4, 23, 24

Youngstown Co. v. Sawyer, 343 U.S. 579 (1952)........ 14

Unirrep Stares ConstirutTionAL Provision

a ee, ee Oe. nc ces uh eens baeiseases 4

Treaties, StaruTes AND RULES

Convention for the Avoidance of Double Taxation,

Dec. 31, 1975 (U.S.-U.K. Tax Treaty).............3, Il

U.S. Model Tax Treaty, Aft. 23......0ccccccssceess 18, 20

Se ES SUD MI cee cccecccscssenepessesnss 18, 20

Section 54 to the Finance Act of 1985, reenacted as

§§ 812-815 of the Income and Corporations Taxes

Act, 1988 (United Kingdom) .............cscseeeees 11

ICTA of 1970, Sec. 498 (United Kingdom)............ 19

ITA, Sec. 126(7)(a),(b) (Camada)..................4.4.. 19

ee ey Th 6 wh dndehenkdoeenbvesseceesnpeaneeees 19

, SS Bet Pere TerrT Tr er TT TT 19

TREATISES AND ARTICLES

Robert Ackerman, et al., The Advance Pricing Agree-

ment (APA) Program: A Model Alternative Dispute

Resolution Process, 12 BNA Dany Report For

Executives L-! (January 19, 1994).................. 28

vil

TABLE OF AUTHORITIES — Continued

Page

Brian J. Arnold and Thomas E. McDonnell, Report on

the Invitational Conference on Transfer Pricing:

The Allocation of Income and Expenses Among

Countries, 61 Tax Notes 1377, at 1381 (December

ee aaa ks DEG ack ineae Cor eebeseebedeaereneess 28

Barser, Hoyt L., Tax Havens: How ro Bank, INvest,

AND Do Business — OrrsHore AND TAX Free (1993).... 10

British MPs United in Worldwide Unitary Method

Retaliation Efforts, 31 Tax Nores 439 (May 5,

PC TEeaNeehelees ude basibancenelckebieerLeeeeesee i]

Calling Britain's Bluff, 300 Tue Economist 65 (August

Te Ps thé kh seeded edad sede seed bewee lies ekeseas 11

Chevron Not Required to Label 1.3 Million Pages

Turned Over to IRS, Tax MANAGEMENT TRANSFER

Pricinc Report 135 (July 7, 1993) ................4.. 9

Cunton, Governor Bit, Putting People First: A

National Economic Strategy for America, 4, 22

SN aRaud bUNRES kd Ghs PeKenededsesecheeeeeaews 16

Coffill, Eric J., Differences in Productivity and Prof-

itability: A Response to Allegations of the Misat-

tribution of Income in the Application of

California's Worldwide Unitary Method, 5 Inr't

, § Se S88, ee ee 21

Crump, Davin, et Ac., CAses AND Mareriats ON Consti-

I nn. i ccnnacedevesewesaucttes 5

DePARTMENT OF THE TREASURY, OpriCE OF THE SECRETARY,

Finat Report or THE Wortowimer Unirary TAXATION

Workinc Group, iii (August, 1984).................. 15

Vili

TABLE OF AUTHORITIES — Continued

Page

Di_not, ANDREW W. anp Kay, J.A., TAx REFORM IN THE

Unirep Kincpom: THe Recent Experience, in Wor-p

Tax Rerorm, eds. M. Boskin and C. McLure (1990),

Pedal ccnuwe cea tatwtadk eek eee eek 20

Fiamma, Stephen E., U.K. Retaliation Against Uni-

tary Taxation, 28 Tax Nores 1137 (September 2,

SE Oe er re fen er eR ee 1]

GinsperG, ANTHONY S., Tax Havens (1991) ............. 10

Grylls, Sir Michael, MP, UK Must Retaliate on CA

Tax, Financia. Times 16 SY Gs IS ss oh ones coin 11

GunTHER, GerALD, ConstirutionaL Law, 242 (1985)....... 6

Hevcerstein, Jerome R. ann Hevcersrein, Wacrer J...

Strate TAXATION I: Corporate INCOME AND FRANCHISE

I RU ree ee sie oe 18

Hellerstein, Jerome R., Federal Income Taxation of

Multinationals: Replacement of Separate Account-

ing with Formulary Apportionment, 60 Tax Nores

1131, at 1140-1141 (August 23, 1993) .............. 21

Holman, Clive, MPs Threaten Retaliation Against US

Unitary Tax, Financia Times 6 (June 19, 1986)...... 11

Kune, Joun M., Unrrep Stares’ FeperacisMm AND For-

EIGN Pouicy, IN STATES AND PROVINCES IN THE INTERNA-

TIONAL Economy, eds., Douglas M. Brown and Earl

ee I EE ree eer ee re 7

McIntyre, Micuaer J., Desicn or A NaTIonAL Formut-

ARY APPORTIONMENT TAX SysTEM, IN PROCEEDINGS OF

THE Nat’t. Tax Ass’N/TAx Inst. of Am. 841TH AN.

Conr. at 118 (November 1991) ...................... s

McIntyre, Micuaer J., THe INTERNATIONAL INCoME TAX

Rutes or tHE Unrrep Stares, ch.4 (1989).............. °)

TABLE OF AUTHORITIES —- Continued

McIntyre, Michael J., Harmonizing Direct Taxes in

the EEC, 2 Tax Nores Inr’t 131, 134 (1990).....

McIntyre and McIntyre, Using NAFTA to Introduce

Formulary Apportionment, 93 Tax Noves Int’ 64-9

EN ey eee pr rere eeaans

Munnell, Alicia H., Taxation of Capital Income in a

Global Economy: An Overview, New ENGLAND Eco-

NoMIc Review 33, at 46 (September/October 1992) ....

New Unitary Approaches Mulled in Wake of Treasury

Decision, 21 Tax Notes 69-70 (October 3, 1983)...

OECD Committee on Fiscal Affairs, Intercompany

Transfer Pricing Regulations Under U.S. Section

482 — Temporary and Proposed Regulations (1993) ...

OECD, TaxinGc Prorits in A Gtopat Economy: Domes-

TIC AND INTERNATIONAL Issues, 53 (1991)...........

Owens, EvizaperH, THe ForeiGn Tax Creprr 3 (1961) ....

Pomp, Richard, The Illogical Deduction for Income

Taxes Paid to Other States, 42 Tax Law Rev. 419

Si RS ee ee RE OLE Pe Eee re tne ae eae

Retaliatory Motion to Unitary Method Introduced in

Parliament, 38 Tax Nores 592 (February 8, 1988)...

Shea, Gerald C., APAs May Effectively Address

Income and Expense Allocation Problems Faced by

Global Trading Businesses, 4 Tax Nores Int’ 1022

eT te Oo ors ee Oe ne

Summers, Lawrence H., Taxation in a Small World. in

Herbert Stein, ed, Tax Pourcy In THE Twenty-First

Century 64, at 69, 70, 71 (1988)................

TABLE OF AUTHORITIES - Continued TABLE OF AUTHORITIES — Continued

Page Page

Summers Says Formula Apportionment System Would

Require Multilateral Move, 52 BNA Dany tax

Report G-6 (March 19, 1993) at G-7................ 27

Third Protocol to the 1975 Income Tax Convention

with the United Kingdom of Great Britain and

Northern Ireland, as Amended, Report of the Com-

mittee on Foreign Relations, United States Senate

Turro, John, /RS Grants Two APAs in Derivative on Executive Q, 96th Cong. Ist Sess., at 5, 46 47

Products Areas, 4 Tax Nores Inr’t 959 (May 11, nc ig Ng ae STEP PTET ETE PT Pry ny 12, 14

Ot crete weee es Cede Cw e rs eee eo on. 28

Turro, John, Clinton Administration Expected to Sup-

port California in Barclays Bank Unitary Case, 4 Be

Stare Tax Nores 717-718 (March 29, 1993) ......... 16 MisceLLansous

BarcLays INTERNATIONAL, A Wortp or BANKING List oF

Orrices Novemper 1977 (1977) 4-5.................. 10

CONGRESSIONAL PROCEEDINGS Letter from Barclays to British Inland Revenue of

; ps EDS Soteah cases en

Hearing on H.R. 5076 Before the House Comm. on Mgrs 59, USGS (Te, second, Ex. 31-¥) ”

Ways and Means, 96th Cong., 2d Session 2d Sess.

at 293-95 (statement of John S. Nolan, Counsel, on

Behalf of Confederation of British Industry and the

British National Comm. of the Int’! Chamber of

Commerce) (March 31, 1980)....................... 12

Hearing on Review of Unitary Method of Taxation,

Before the Subcomm. on Taxation and Debt Man-

agement, Senate Committee on Finance, 81 (State-

ment of J. Roger Mentz, Asst. Secretary, Tax

PE esas ks ils aa eae ee et 12, 16

Tax Underpayments by U.S. Subsidiaries of Foreign

Companies: Hearings before Subcomm. on Over-

sight of the House Comm. on Ways and Means,

100th Cong., 2d Sess., July 10, 12, 1990, pp. 72, 73

(Statement of Fred T. Goldberg, Commissioner of

the IRS) 262 (Statement of Rep. J.J. Pickle)......... 16

Nos. 92-1384 and 92-1839

In The

Supreme Court of the United States

October Term, 1993

No. 92-1384

Barciays Bank PLC,

Petitioner,

FRANCHISE TAx Boarp.

AN AGENCY OF THE STATE OF CALIFORNIA.

Respondent.

No. 92-1839

CoLGare-PALMOLive Company,

Petitioner,

FRANCHISE TAx Boarp

AN AGENCY OF THE STATE OF CALIFORNIA.

Respondent.

On Writ Of Certiorari To The Court Of Appeals

Of The State Of California In And For The

Third Appellate District

AMICUS CURIAE BRIEF OF MULTISTATE TAX

COMMISSION IN SUPPORT OF RESPONDENT

FRANCHISE TAX BOARD

STATEMENT OF INTEREST OF AMICUS CURIAE

MULTISTATE TAX COMMISSION

The Multistate Tax Commission (“MTC” or “Commis-

sion”) is the official administrative agency of the Multistate

Tax Compact (“Compact”). Currently, the Compact has been

entered into by 19 states and the District of Columbia as full

members; and 13 additional states have joined the Commission

as associate members.! The stated purposes of the Compact are

to:

1. Facilitate proper determination of State and local

tax liability of multistate taxpayers, including the

equitable apportionment of tax bases and settlement

of apportionment disputes.

2. Promote uniformity or compatibility in signifi-

cant components of tax systems.

3. Facilitate taxpayer convenience and compliance

in the filing of tax returns and in other phases of tax

administration.

4. Avoid duplicative taxation.

As reflected by these four basic principles, the Commis-

sion possesses vital and continuing interest in those state tax

issues that may radically affect the administration of state tax

systems. The pending cases have that potential. The issues

contained in these two cases strike close to the core of one of

the Commission’s overall responsibilities — to ensure that state

tax systems are allowed to innovate and develop more sophisti-

cated methods of taxing business activities conducted within

their jurisdictions, and to adapt those systems in response to

evolving social and economic conditions.

' The current full members are the states of Alabama, Alaska, Arkansas,

California, Colorado, District of Columbia, Hawaii, Idaho, Kansas, Minnesota.

Missouri, Michigan, Montana, New Mexico, North Dakota, Oregon, South Dakota,

Texas, Utah, and Washington. The associate members are the states of Arizona.

Connecticut, Georgia, Louisiana, Maine, Maryland, Massachusetts, New Hamp-

shire, New Jersey, Ohio, Pennsylvania, Tennessee and West Virginia. To the extent

that any member state of the Commission files a separate brief in this case, this

amicus curiae brief does not represent the position of said state or states in this case.

SUMMARY OF ARGUMENT

Petitioners seek to elevate the “squeaking” of foreign

multinationals, the “bullying shouts” of a few foreign govern-

ments, and the occasional “whining” of a few ex-officials of

the Executive branch to the federal government's “one voice”.

The Court is being asked to follow these voices, as if they were

the calls of the Pied Piper. However, when all of the self-

serving noise and clutter are filtered out, one clear message

emerges: worldwide combined reporting (hereafter “WWCR”)

is Consistent with and not in opposition to policies adopted by

the federal government with respect to the state taxation of

foreign commerce.

No need for a dormant foreign commerce clause analysis

exists in the cases before the Court because the circumstances

surrounding the Senate ratification of the U.S.-U.K. Tax Treaty

demonstrate that both countries acquiesced to the states’ uses

of WWCR. In particular, the Senate’s reservation to proposed

Article 9(4) of the-Treaty clearly establishes that California's

WWCR does not violate the “one voice” prong of Japan Line,

Ltd. v. County of Los Angeles, 441 U.S. 434 (1979). Since this

aspect of the “one voice” issue has been extensively addressed

in the Brief of Respondent, the Commission will not repeat it

here, but will deal primarily with the dormant federal com-

merce clause issue that is reached if the Court hears voices

other than those expressed by Respondent and its amici.

Worldwide combined reporting for state tax purposes

greatly reduces the opportunity for tax planning and tax avoid-

ance with regard to international business activities conducted

by domestic or foreign-based taxpayers. WWCR addresses

more effectively than any arm's length or separate accounting

method the taxation of income derived by a unitary business

from international transactions, regardless of their Operating in

or through the various tax havens. This method of accounting

(which its detractors often intentionally mislabel a “tax”) is a

product of our federal system. It was conceived, developed and

advanced by the states to maturity over the past 40 years or so.

The teaching of Garcia v. San Antonio Metropolitan Transit

Authority, 469 U.S. 528 (1985) suggests that it be left to

Congress to advance or limit the states’ sovereignty in this

area.

Even applying the test in Japan Line, WWCR should be

upheld. More fundamentally, the Japan Line analysis is not

appropriate in a global economy. To the extent that Japan

Line’s rationale has survived subsequent decisions of the

Court, it is clearly not properly applied outside the context of a

tax, such as a property tax, for which no existing pattern or

practice of eliminating double taxation exists. The Court’s

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

477 U.S. 1 (1986) and /tel Containers International C orp. v.

Huddleston, __ U.S. __, 113 S.Ct. 1095 (1993) have all but

overruled key holdings of Japan Line.

At issue in both cases is the use of the same type of

accounting method, worldwide combined reporting. While all

of the arguments that are set forth by the Commission are

specifically addressed to Petitioner Barclays, with no specific

mention of Petitioner Colgate-Palmolive Co.. a very critical

relationship exists between the issues in the two pending cases.

If this Court were to prohibit WWCR in the case of Barclays,

then, as a political matter, state legislatures will find it nearly

impossible to apply WWCR to U.S.-based multinationals. A

decision in favor of Petitioner Barclays under the foreign

commerce clause (U.S. Const. Arr. I, § 8, cl. 3) will be

tantamount to overruling the result in Container Corp. of

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

ARGUMENT

1. THE DORMANT FOREIGN COMMERCE CLAUSE

DOES NOT PROHIBIT WORLDWIDE COMBINED

REPORTING

A. The Dormant Foreign Commerce Clause Analysis

Fashioned in Japan Line is Reminiscent of the

Discredited Cooley Doctrine and is Unworkable.

The Court's dormant foreign clause analysis as formulated

in Japan Line is reminiscent of the so-called Cooley doctrine,

set forth in Cooley v. Board of Wardens, 53 US. (12 How.) 299

(1851). This similarity is not surprising because in both cases

the Court was struggling with the same issue: when does a

State's action unconstitutionally impact on multijurisdictional

economic activity. In Cooley, the Court held that the states

could not regulate those aspects of interstate commerce that

were so national in character that a single, uniform rule was

necessary. /d. at 319. To paraphrase Cooley using the language

of Japan Line, state regulations would be unconstitutional if

they would “impair federal uniformity in an area where federal

uniformity is essential.” Japan Line, 441 U.S. at 448.

Over time, the Cooley doctrine proved unworkable for

reasons that do not augur well for the Court’s current formula-

tion of dormant foreign commerce clause analysis. In the

comparatively undeveloped U.S. economy of 1851, with a

primitive transportation and communication infrastructure.

there was less interdependency between the local and national

economy. In this relatively uncomplicated era, the Cooley

doctrine must have seemed manageable. As the country devel-

oped, however, the frequency of cross-border activities

increased exponentially, and the line between local and inter-

state commerce became less distinct. Almost any state regula-

tion had some impact on interstate commerce. The courts found

it difficult, if not impossible, to determine which areas were.

by their nature, inherently national.

According to a leading constitutional casebook, “the Court

is not particularly well-suited for determining whether a given

problem ‘requires’ a national solution as opposed to treatment

tailored to local conditions,”? a sentiment that the Court itself

has expressed in the context of the dormant foreign commerce

clause. See Container Corp. of America, 463 U.S. 159. 194.

196. Because of the difficulty of identifying inherently national

areas of interstate commerce, a subsequent doctrine, related to

the Cooley doctrine developed. This doctrine required the

Courts to distinguish between the constitutional “indirect” reg-

ulation of commerce and unconstitutional “direct” regulation.

2 Daviw Crump, er at.. Cases anp Mareriats on Constrrutionar Law 195

(1989)

That distinction was also criticized as being too mechanical

and conclusory.’

Eventually, the earlier doctrines were discarded and “the

tangled underbrush of past cases” was cleared. Miller Bros. vy.

State of Maryland, 347 U.S. 340, 344 (1954). The modern

domestic dormant commerce clause analysis is now embodied

in the four tests set forth in Complete Auto Transit v. Brady,

430 U.S. 274 (1974). In the domestic situation, a tax will be

upheld if it: is applied to an activity with a substantial nexus

with the taxing state; is fairly apportioned; does not discrimi-

nate against interstate commerce; and is fairly related to the

services provided by the taxing state. /d. at 279. For purposes

of the interstate commerce clause, Complete Auto abandoned

any attempt to determine the need for federal uniformity or the

need for the government to speak with one voice.

The same economic forces that undermined the Cooley

doctrine and its progeny domestically are still at work interna-

tionally, undermining Japan Line. As the world’s economies

become more interdependent, state regulations and taxes now

increasingly impact foreign commerce as well as interstate

commerce. State corporate takeover legislation, plant closing

laws, right to work laws, policies on resource extraction, gov-

ernmental procurement preferences, environmental, product

liability, and antitrust regulations have a global impact through

interlinked trade and investment ties. Environmental issues

such as acid rain or global warming demonstrate that the

economic and social welfare of individuals in any political

jurisdiction are inextricably linked to the actions and interests

of individuals living elsewhere. For example, a state such as

California that has adopted pollution control and automobile

emission standards more stringent than federal law has an

impact on cars manufactured all around the globe.

As the world of Cooley evolved into the global mar-

ketplace, the role of state and local government has also

evolved. “[SJubnational governments have traditionally served

as valuable innovators and incubators of policy ideas in many

* Greaco Guetuer, Constrrutionat Law 242 (1985).

different fields. The central difference now is the extension of

this function to the foreign policy arena. . . . "4 National

borders have now become as porous as state borders. All of the

examples noted above raise possible violations of the dormant

foreign commerce clause. To sort through the panoply of state

laws to decide which ones impact on the need for national

uniformity is to sink into the Cooley quagmire.

B. The Federal Government Does Not Speak with

One Voice on the Issue of WWCR Nor Does the

Federal Government Consider Such Uniformity

Essential

1. No Weight Should be Given to Complaints of

Foreign Governments About WWCR

Japan Line takes the position that a state taxing scheme

violates the dormant foreign commerce clause if it impairs

federal uniformity in an area where federal uniformity is essen-

tial and if it prevents the federal government from speaking

with one voice in international trade. Container, 463 US. at

193. In support of their assertion that WWCR runs afoul of the

“one voice” metaphor, Petitioners cite the complaints of other

countries against WWCR. These complaints are simply evi-

dence of the success of WWCR in controlling tax avoidance by

foreign-based multinationals and should be given no weight in

assessing the constitutionality of WWCR.

When multinational firms began operating extensively in

California during the 1960's and early 1970's, the state faced

* Joun M. Kune, Unrrep States’ FEDERALISM AND Foreign Powicy, ww

STATES AND Provinces IN THE INTERNATIONAL Economy, eds., Douglas M. Brown

and Earl H. Fry (1993), 225. As a another illustration of the world’s linked destinies.

the European Community was particularly concerned with California’s 1990 debate

over Proposition 128, which would have imposed limits on the pesticide content of

food that differed from federal standards. The EEC sem an “aide memoire” to the

US. State Department, expressing concer that Proposition 128 could be “a means

of arbitrary discrimination or a disguised restriction on trade, thereby unjustifiably

increasing fragmentation of the US. market and adversely affecting international

trade.” Id. 2149-20.

two policy options. It could continue to apply formulary appor-

tionment and combined reporting to unitary businesses operat-

ing domestically but switch to the federal system of separate

entity accounting and source rules for unitary businesses oper-

ating internationally. Or it could apply its formula apportion-

ment statute (including combined reporting for unitary

businesses of multiple corporations) to California members of

all unitary businesses, regardless of whether those businesses

operated internationally and regardless of where they were

incorporated. California chose the second option. As more

worldwide businesses were attracted to California, the state’s

application of what became known as worldwide combined

reporting naturally occurred more often and created more

notice.

The second option was fully consistent with California’s

domestic approach. The same reasons that led California and

many states to use formulary apportionment and combined

reporting for unitary businesses operating domestically applied

equally, if not more strongly, in an international setting. For-

mulary apportionment and combined reporting eliminate the

opportunities to avoid tax through the use of transfer prices and

tax havens — opportunities that are particularly serious in an

international setting. One of the premises of the California

approach in the domestic setting was that the tax paid by a

unitary business should not be a function of the way it is

organized on paper; California had no good reason to reject

that premise just because part of the unitary business was

conducted abroad or just because a corporation filed its incor-

poration papers abroad. WWCR merely extends California's

domestic approach, based on substance over form. across

national boundaries.

To implement its system internationally in a world marked

by tax havens and zreat diversity in taxing rules, the federal

5 Micnaer J. Mcinryee, Design oF a NarionaL Formutary Appor moONMENT

Tax System, in Procempincs or rue Nat's. Tax Ass’ x/Tax Ine. or Am. 84rn An.

Conr. at 118 (November 1991).

government has had to develop source rules,® police transfer

prices, and adopt anti-tax haven measures. The difficulties the

IRS had, and continues to have, in policing transfer prices were

well-known and it was doubtful that a state could indepen-

dently administer an arm's length standard.’ Subsequent events

have borne out these fears.

Faced with these two choices, it is entirely understandable

why California opted for WWCR. WWCR eliminates the need

to police transfer prices, generally does away with source of

income rules, and undercuts the use of tax havens. Tax plan-

ning that minimizes the federal income tax is typically useless

under WWCR. Consequently, after WWCR was adopted, cor-

porations able to pay no federal income tax now found them-

selves paying California tax, a situation that a foreign

corporation or country not familiar with the federalist structure

of the United States might not fully understand or appreciate.*

Certainly banks such as Barclays, with offices in some of

the best-known tax havens of the world — Bahamas. Barbados,

Bermuda, Cayman Islands, Channel Islands, Gibraltar. Hong

purpose in that foreigners are generally taxed on only U.S. source income. Second,

they determine how much of a credit a U.S. taxpayer will receive for foreign

income taxes imposed on foreign source income. For an exhaustive treatment, see

Micnart J. Mcinryver, Tae Inreenarionat. Income Tax Retes on re Uniren

Starrs, ch. 4( 1989).

All the attention focused on transfer pricing problems has overshadowed a

mayor weakness in the federal system: the need to develop a set of workable source

rules that can be easily administered, that can not be manipulated by the taxpayer.

that reflect some acceptable notion about economic nexus. and that assign income

fo countries inclined to tax it. See id. at 3-66 - 3-70. Formulary apportionment

greatly reduces the need for source rules.

’ The practical impossibility for even the federal government of enforcing the

arm’s-length system is well illustrated by the LLR.S.’s recent loss of an effort to

compel Chevron Corporation to label 1.3 million pages of documents it turned over

to the government in a transfer pricing case. Chevron Not Required to Label |.3

Million Pages Turned Over to IRS, 2 BNA Tax Mawacement TRANSFER Pricina

Rerort 135 (July 7, 1993).

* For an early example of where a UK. corporation was able to pay no

federal tax but nonetheless had to pay a state tax under formulary apportionment.

see Bass, Ratcliff & Gretton, Lid. v. State Tax Comm'n. 266 US 271 (1924)

Kong, Isle of Man, Nauru, Netherlands Antilles, New

Hebrides, Singapore, Turks and Caicos, Virgin Islands? — have

much of their international tax planning nullified under

WWCR. Complaints about WWCR may be nothing more than a

protest against an approach that minimizes the benefits of

orthodox tax avoidance techniques such as the use of transfer

pricing and tax havens and results in the payment of a state tax

even where no federal tax is due. For example, Barclays Bank

International, Ltd. owed a California tax even though its Cali-

fornia Operations were conducted at a loss under the taxpayer's

arm’s length calculations.!°

Complaints from foreign countries are neither unprece-

dented in the tax area nor limited to state taxation. Some

foreign countries have also complained about the new transfer

pricing regulations promulgated by the I.R.S.'! Just as the lack

of complaints about a state tax department may suggest a

passive administration that is not aggressively countering tax

avoidance, the existence of complaints may simply be a

healthy sign of a well functioning tax system. A fact-intensive

inquiry into the nature and motivation underlying the com-

plaints paraded by the Petitioners is necessary before the Court

can give them any significance for purposes of a dormant

foreign commerce clause analysis.

% See Barcrays INTERNATIONAL, A Wortp or Bankinc — List oF Orrices

Novemper 1977 (1977) 4-5.

These countries are all described as tax havens in either Anrnony S. Gin-

sperG, Tax Havens (1991), or Hover L. Barner, Tax Havens: How ro Bank,

Invest, AND Do Business — Orrsuorr AND Tax Free (1993),

'0 See Letter from Barclays to British Inland Revenue of April 14, 1986 (Tr.

record, Ex. 51-¥V).

'! See OECD Committee on Fiscal Affairs, Intercompany Transfer Pricing

Regulations Under U.S. Section 482 ~ Temporary and Proposed Regulations

(1993). Complaints by foreign governments may be raised as a courtesy to major

taxpayers or industries or they may be initiated by the country itself. Most devel-

oped countries provide a credit to their taxpayers for income taxes paid to other

jurisdictions. A country providing a credit has a financial stake in minimizing the

tax burden imposed by other countries, especially if these other countries are not

viewed as competing with it for investment.

2. No Weight Should be Given to the United

Kingdom’s Threats to Violate International

Law

Complaints by the United Kingdom against WWCR are

mentioned prominently by Petitioner Barclays because of the

form in which they are embodied. The United Kingdom has

threatened to deny certain benefits (the advance corporation

tax, “ACT”, credit) to corporations that have significant activ-

ity in a state using WWCR. The United Kingdom adopted

enabling legislation in 1985,'? but the Parliament had to give

its specific approval before the retaliatory legislation could be

triggered.

In 1986, British officials stated that they had not triggered

the retaliatory legislation on the understanding that the United

States would enact legislation abolishing WWCR before the

end of the year.'* The threat of “retaliation” was repeated two

more times in 1986.'4 The threat was made agai in 1988!5 and

in 1993.'© With the passage of California's legislation in 1993,

discussed below, the threat has substantially been withdrawn.

These threats are the height of lawlessness and hypocrisy. In

Article 10 of the U.S.-U.K. Tax Treaty, the United Kingdom agreed

to provide the very ACT credits that it subsequently turned around

and threatened to hold hostage in the political battle over WWCR.

'2 Section 54 of the Finance Act of 1985, reenacted as §§ 812-815 of the

Income and Corporations Taxes Act, 1988 (United Kingdom); Stephen E. Fiamma,

U.K. Retaliation Against Unitary Taxation, 28 Tax Noves 1137 (September 2,

1985).

13 British MPs United in Worldwide Unitary Method Retaliation Efforts, 3\

Tax Norrs 439 (May 5, 1986).

'4 Clive Holman, MPs Threaten Retaliation Against US Unitary Tax, Finan-

cit Times 6 (June 19, 1986): Calling Britain's Bluff, 300 Tue Economist 65

(August 2, 1986).

'S Retaliatory Motion to Unitary Method Introduced in Parliament, 38 Tax

Norrs 592 (February 8, 1988).

'© Sir Michael Grylls, MP, UK Must Retaliate on CA Tax, Financia. Times

16 (May 6, 1993).

Further, its threats to violate international law!’ are in protest of

WWCR, the very issue over which it received concessions during

the negotiations over the treaty.'* Such lawless action cannot be

the type of justifiable retaliation by a foreign government that the

Court was concerned about in Container. Id. at 194.

Apparently, the Congress agrees. The Congress has shown no

interest either in counting the noses of those who have chimed in

against WWCR or in genuflecting in the face of threats to violate

international law.'” Perhaps the Congress appreciates that as the

economies of the world become more interlinked, state actions will

inevitably raise some foreign protests. Some complaints are to be

taken more seriously than others. As Container recognized, the

nuances of U.S. foreign policy are much more the province of the

Executive Branch and Congress than of this Court. /d. at 196.

Despite complaints, Congress has refused for over twenty-five

years to prohibit WWCR.°° The Court should not now substitute

its voice for that of the Congress.

'? There is no doubt that if the United Kingdom were to deny the ACT

credits, the treaty would be violated. In describing the retahatory legislation,

Assistant Secretary (Tax Policy), J. Roger Mentz stated “its actual implementation

would be a clear violation of the treaty.” Hearing on Review of Unitury Method ot

Taxation, Betore the Subcomm. on Taxation and Debt Manager at, Senate Com-

mittee on Finance, 81 (Statement of J. Roger Mentz, Asst. Secretary, Tax Policy)

(September 29, 1986).

'S Third Protocol to the 1975 Income Tax Convention with the United

Kingdom of Great Britain and Northern Ireland, as Amended, Report of the

Committee on Foreign Relations, United States Senate on Executive Q. 96th Cong

Ist Sess. at 46-7 (June 15, 1979)

19 The United States could respond to a violation by the British of Article 10

ot the treaty in numerous ways. The President could terminate the treaty; or, under

domestic law, the President could double the U.S. tax rate on U.K. companies up to

a maximum of 80%, or increase the effective tax rates on U.K. companies to

equalize them with the UK. tax rate on US. companies. See IRC §§ 891 and 896

All of these options are serious, which may explain why the U.K. has never

implemented its threat.

20 See Hearing on H.R. 5076 Betore the House Comm. on Ways and Means,

96th Cong., 2d Session. at 293-95 (statement of John S. Nolan, Counsel, on Behalt

ot Contederation of British Industry and the British National Comm. of the Int’!

Chamber of Commerce) {March 31, 1980) tor a detailed history (through 1980) of

congressional consideration of, hearings on, and non-enactment of legislation that

would have preempted WWCR and/or state taxation of foreign source income as it

3. The Executive Branch Does Not Speak for the

Legislative Branch

Turning from international complaints about WWCR to

domestic complaints, Petitioners remind us that former offi-

cials of the Executive branch of the federal government have

been upset with the elimination of the antic WWCR clause from

the U.S.-U.K. treaty almost from the day that it was signed.

Both Petitioners cite actions and statements from former Exec-

utive branch officials expressing their hostility to WWCR. But

the federal government is not monolithic.2! The issue of

WWCR is not one in which the Constitution has given the

President exclusive power. Power over foreign commerce is

shared. The Legislative branch has the Constitutional power to

regulate foreign commerce, the President has the Constitutional

power to sign or veto legislation passed by the Congress, and

the Congress has the Constitutional power to override a Presi-

dential veto. The President has the Constitutional power to

enter into treaties with foreign nations that might regulate

foreign commerce, and the Senate has the Constitutional power

to advice and consent on such treaties. This Constitutional

distribution of powers does not give the President the power to

preempt a state tax provision through press releases or letters.

is defined by the federal government. Legislation to prohibit WWCR was intro-

duced continuously through the 1980s in both houses and hearings were held at

regular intervals. See Hearing, supra note ‘7. Preemptive legislation has been

introduced at least as recently as late 1991. See $.1775, H.R. 2913, 102d Cong. Ist

Sess.

2! The Court has never suggested that the views of the Executive branch

were to carry more weight than the views of the Legislative branch. In its dormant

foreign commerce clause discussion in Container, the Court consistently refers to

the “federal government,” “federal policy,” “the Executive Branch and Congress”

and so forth. See Container, 463 U.S. at 193-196. The disproportionate emphasis

placed by the Petitioners on the views of the Executive branch may reflect the

Court's reference in Container to the lack of an amicus curiae bnef from the

Executive branch. The failure of the Executive branch to file an amicus curiae bnef

would undercut a claim that WWCR interferes with federal uniformity. The filing of

such a brief, however, is merely one factor to be considered by the Court in

applying a dormant foreign commerce clause analysis. Compare Itel, 113 S.Ct.

1095 with Container, 463 U.S. 159.

Otherwise, the constitutionality of WWCR could change every

four years and would “emphasize transient results upon poll-

cles . . . and lose sight of enduring consequences upon the

balanced power structure of our Republic.” Youngstown Co. v:

Sawyer, 343 U.S. 579, 634 (Jackson, J., concurring) (1952),

Such a result would be contrary to our deeply held tradition of

being a country that ascribes to the “rule of law.” Fortunately,

the foreign dormant commerce clause does not require that

absurdity.

Understandably, the Petitioners would like to ignore the

posture of the Legislative branch, which has always refused to

interfere with WWCR. The Senate made its position clear at

the time of the U.S.-U_K. tax treaty: “political subdivisions and

local authorities of either country are free to use formula

methods to apportion income, deductions, and other items

among related enterprises in determining income subject to

their taxes, so long as such methods do not violate the pro-

posed treaty’s nondiscrimination provisions (Article 24)."22

The House has also expressed its position by refusing to adopt

for the past 20 years bills that have been introduced that would

affect WWCR.?3

After more than two decades of debate. the Legislative

branch has still refused to curtail the use of WWCR. Unifor-

mity can hardly be characterized as “essential” if it is still

lacking after all this time. Accordingly, California’s use of

WWCR cannot “impair federal uniformity in an area where

federal uniformity is essential.” Container, 463 U.S. at 193

(citing Japan Line, 441 U.S. at 448).

Finally, even a decision for Petitioners would not result in

the government speaking with one voice because the Congress

has indicated not only that federal uniformity is not essential

but also that WWCR is permitted. The Court has, in similar

contexts, recognized its limitations in imposing solutions on

22 Report, supra note 18, at §.

** See Brief for Petitioner Barclays at 9.

issues best left to the political process.24 “It may be that ‘the better

part of both wisdom and valor is to respect the judgment of the

other branches of the Government.’ ”?*

Furthermore, California’s use of WWCR is not necessarily at

odds with the actions of the Reagan administration, which ts the

last administration to articulate a comprehensive position on

WWCR. In 1983, the Reagan administration appointed a Cabinet

level working group, consisting of government officials, business

representatives, tag “remnap samara governments, to

study the issue.2° The Working Group recomme ded that the States

voluntarily adopt a water's edge limitation on combined reporting.

Secretary of the Treasury Regan’s final report indicated that the

Group would support restrictive federal legislation if the issue was

not solved within a year of the report. But if the “states enact

legislation . . . agreed upon by the Working Group, the United

States will be able to speak with one voice in dealing with its

foreign trading partners .. . “?’

California enacted water's edge legislation, but made it elec-

tive and imposed an election fee. This action appeased the Execu-

tive branch, which stated that “state legislative

developments . . . go a long way toward resolving the difficult

unitary tax issue” and “illustrate the successful operation of the

24 “The underlying [commerce clause issue] is not only one that Congress

may be better qualified to resolve, but also one that Congress has the ultimate power

to resolve.” Quill Corporation vy. North Dakota, 112 S. Ct. 1904, 1916 ( 1992). Quail

involved another long-standing problem of state taxation: the sales taxation of mail

order sales. Despite Congress’ unwillingness to adopt a federal solution to this

problem, the Court refused to impose its own solution, recognizing that “Congress

has the power to protect interstate commerce from intolerable or even undesirable

burdens.” [citations omitted]. /d.

25 Quill, 112 S.Ct. at 1916 (citing Commonwealth Edison Co. v. Montana,

453 U.S. 609, 638 (1981) (White, J.. concurring)).

26 New Unitary Approaches Mulled in Wake of Treasury Decision, 2\ Tax

Norrs 69-70 (October 3, 1983).

27 DeparTMENT OF THE TREASURY, Orrick oF THE SecreTARY, Finar Report

or THE Wortpwipe Unrrary Taxation Workinc Group, tit (August, 1984).

Federal system.”?* The Executive branch pronounced “that restric-

tive Federal legislation is not warranted at this time.”2? Most

recently, in 1993 California further amended its legislation, remov-

ing the election fee. California’s current law satisfies the expecta-

tions of the Reagan administration.

With the election of President Clinton, the Executive branch

may have shifted its voice. During the 1992 presidential campaign

Governor Clinton stated “ . . . a Clinton Administration will be pro-

California in [the Barclay’s} litigation.”° Consistent with this

position, the Solicitor General opposed the grant of certiorari in

Barclays, citing California’s recent legislative changes modifying

WWCR for concluding that “[a] decision by this Court on the

constitutional question posed in this case is . . . unnecessary to

achieve adequate consistency in the Nation's regulation of foreign

commerce, which California has striven to accomplish through its

voluntary action.” Brief of Solicitor General on Petition for Writ of

Certiorari at 10. The Solicitor General also made it clear that

federal uniformity is no longer essential. There has now been an

“accommodation of state, national, and international interests,” id.

at 10. As of 1994, it appears that the voice of the Executive branch

is More in harmony with the voice of the Legislative branch than at

°8 See Hearing, supra note 17 at 71.

29 Id.

’ ) . . . . . e

Barclays Bank Unitary Case. 4 Siar Tax Noves 717-718 (March 29, 1993). This

position was consistent with the President's promise to collect $45 billion of

additional tax revenue over four years by “cracking down on foreign companies that

prosper here and manipulate tax laws to their advantage.” Governor Bill Clinton,

Putting People First: A National Economic Strategy for America, 4, 22 (1992). It

was widely believed that this revenue loss was attributed to transfer pricing abuses.

For example, a former Commissioner of the Internal Revenue Service testified that

“foreign controlled companies have adopted transfer pricing and other practices that

may significantly understate their U.S. income tax liabilities,” and that the IRS

believes “the shortfall is substantial,” with the “U.S. Government . . . being short-

changed billions of dollars annually.” Tax Underpayments by U.S. Subsidiaries of

Foreign Companies: Hearings before Subcomm. on Oversight of the House Comm

on Ways and Means, 100th Cong., 2d Sess., July 10, 12, 1990, pp. 72, 73 (Statement

of Fred T. Goldberg, Commissioner of the IRS). Estimates of the annual federal

revenue loss from transfer pricing abuses is as high as $30 billion. Jd. at 262

(Statement of Rep. J. J. Pickle).

any other time in the debate over WWCR. Also, the retaliatory

threat of the United Kingdom to deny treaty benefits to U.S.

corporations has subsided.*!

C. No Unconstitutional Double Taxation Exists

Under Japan Line, a tax is constitutionally suspect if it

inevitably results in double taxation. In Japan Line, the same

property was taxed by both Japan and California, with no estab-

lished means of mitigating the overlapping assertions of taxing

jurisdiction. The meaning of objectionable double taxation was

obvious in Japan Line: two taxes on the same property with no

relief mechanism. In a world in which both national and subna-

tional governments impose income taxes, and where a long-stand-

ing custom and pattern of relief mechanisms exist internationally,

the concept of objectionable double taxation is less evident. The

Court in Container appreciated the difference between property

taxes and income taxes and properly dismissed the double taxation

argument in that case. Because Petitioner Barclays attempts to

reopen that argument, it is worthwhile to expand on why there is

no objectionable double taxation in the present case.

As this Court has recognized, double taxation already exists in

the purely domestic U.S. situation. In Mobil Oil v. Vermont, 445

U.S. 425, 448 (1980), the Court recognized that

“{[cloncurrent federal and state taxation of income, of

course, is a well-established norm. Absent some explicit

directive from Congress, we cannot infer that treatment

of foreign income at the federal level mandates identical

treatment by the States.” (Emphasis added).

A corporation’s income is taxed by both the federal government

and the states.*? This type of double taxation is above constitu-

tional challenge. In other federalist countries, such as Canada, this

‘t See Brief of the Government of the United Kingdom as Amicus Curiae in

Support of Petitioner at 21-22.

52 The double taxation from the concurrent taxation by the United States and

the states is mitigated because state income taxes are deductible in calculating the

federal income tax. A few states even allow a deduction for the federal income tax

in calculating the state income tax. See Richard Pomp, The /llogical Deduction for

Income Taxes Paid to Other States, 42 Tax Law Rey. 419 (1987); Jerome R.

Es)

same pattern of unobjyectionable double taxation exists between the

national government and the subnational governments.

When a corporation resident in one country (the country of

residence) earns income from another country (the source country),

problems of double taxation can arise if no relief mechanism is

provided. But in the case of income taxes, that problem tends not

to occur. The custom and international practice ts that the country

of residence assumes the responsibility for eliminating the double

taxation.‘' Most countries discharge this responsibility by either

exempting foreign income (or categories thereof) or by providing a

credit for income taxes paid to the source country.“

“The effect of the foreign tax credit ts that when the

foreign tax rate 1s lower than the United States rate . . . a

tax is paid to the United States at a rate equal to the

excess of the United States rate over the foreign rate.

When the foreign rate equals or exceeds the United

States rate, the credit cancels United States tax liability.

In short, the credit generally operates to reduce the

effective over-all rate of tax to the higher of the foreign

or the United States rate and double taxation is elimi-

nated because, in effect, only one tax is paid at the

higher of the two rates.” *

The credit does not eliminate the double taxation that results

from the concurrent taxation by a national government and its

subnational governments. This type of double taxation ts the norm

and outside the goal of the credit, regardless of whether a subna-

tional government is taxing more or less income than what the

national government ts taxing.

For example, suppose P, a corporation, earns $100 in the

source country and pays an income tax to the source country of

Hriteesmiw ann Warren J. Hecieesreis, Stare Taxarton Fk Comporare Incoae

ant) Prancurse Taxes (1993), 7-10

** See U.S. Model Tax Treaty, Art. 23: OBCD Model Tax Treaty, Art. 23

* Nearly one-third of the OECD countries exempt foreign dividends

received from other OECD countries. The remainder provide a foreign tax credit

See OECD, Taxiwe Proerrs wa Gropat Economy: Domestic anv INTRRNATIONAL

Isstes at 63 (1991)

* Euizasere Owens, Tar Fortian Tax Cerner 3 (1961) (emphasis added)

FEE EE EEE

$20. Assume the country of residence also imposes a tax of $30 on

this same income. Without the credit (or some other relief mea-

sure), double taxation would result because P would be paying two

taxes on the same item of income. If the country of residence

chooses to discharge its responsibility for relieving double taxation

through the use of a credit, it would reduce the $30 of tax

otherwise owed to it by the $20 paid by P to the country of source,

for a net tax of $10. P pays the same amount of tax that it would

have paid if all of the income had been earned in the country of

residence. Any subnational income tax in the country of residence

would be in addition to the national taxes — the same result that

occurs in a purely domestic situation.

Double taxation might occur if a subnational government in

the country of residence ts taxing income that 1s also subject to tax

by a subnational government in the source country. Without any

relief, there would be one level of national tax, as in the preceding

example, and two levels of subnational taxes. One way of dealing

with this problem of double taxation by subnational governments,

if it occurs, would be for the subnational government in the

country of residence to provide a credit for the income tax of the

subnational government in the country of source. The respon-

sibility of relieving subnational double taxation, however, has been

viewed as the proper responsibility of the national government,

which can easily address the problem by simply extending its tax

credit to include foreign subnational income taxes. *°

Some countries, such as the United States, Canada, and the

United Kingdom, have unilaterally adopted foreign tax credits that

extend to subnational income taxes.*’ Other countries that might

not have done so unilaterally might do so by treaty. The OECD

Model Tax Treaty, for example, provides that if the country of

residence chooses to relieve double taxation by a credit rather than

‘7 In the United States, see IRC Sec. 901(b) and Treas. Reg. § 1.901-2(g)2):

in Canada, see ITA, Sec. | 267 )(a).(b), in the United Kingdom, see ICTA of 1970,

Sec. 498

by exempting foreign income, the credit extends to subnational

income taxes. **

Barclays is not disputing California's right to impose some

kind of income tax. Barclays is therefore conceding that two

legitimate levels of taxes can exist: the federal income tax and the

State taxes. An objectionable double tax would occur only if

California and a subnational U.K. government taxed the same

income. But such double taxation cannot occur because subnational

governments in the United Kingdom do not levy income taxes.*”

Even if such double taxation occurred, the responsibility for alle-

viating it would fall on the United Kingdom as the country of

residence. The essence of Barclays’ objections to WWCR reduces

to the fact that it may pay more under that system than under the

arm's length method. But that objection may speak more to weak-

nesses im the arm’s length method than to defects in WWCR.*°

Moreover, it is not inevitable that WWCR produces a higher

tax than would arm's length or some alternative form of taxation.

There are at least two situations in which a taxpayer will be better

off under WWCR than under the U.S. rules. The first involves

corporations operating at a loss. WWCR allows a taxpayer to

include loss corporations that have no nexus with California to be

included in the combined report of the unitary business. These

losses will offset income of the other corporations. The result can

be that less income enters the pre-apportionment tax base than

would be true if California followed the federal rules.*!

‘8 OECD Model Tax Treaty, Arts. 23B, 2(1).

” Anprew W. Dunor & JA. Kay, Tax Rerorm ww o rue Unrrep

Kincpom: THe Recent Expertence, in Wortp Tax Rerorm, eds. M.

Boskin and C. McLure (1990), 149-176.

*° Residence countries that have chosen to address double taxation through

the use of foreign tax credit often have complicated rules to prevent abuse or to

further political goals. Complaints that Barclays might have about the British

foreign tax credit are properly addressed to the British Inland Revenue and not this

Court.

*! To take a simple, straightforward example, consider a U.S. parent operat-

ing in Califorma owning 100% of a foreign corporation, which operates abroad at a

loss. Assume the US. parent has $100 of income and that the foreign subsidiary has

$100 of losses. If the US. parent files a conibined report with its foreign subsidiary,

Second, under WWCR the apportionment percentage of the

California taxpayer will reflect the payroll, property, and sales of

all the members of the unitary business. The apportionment per-

centage of a unitary business that includes foreign corporations will

likely he lower than under a water's edge approach where only

U.S. corporations could be included in the combined report. The

lower percentage may more than offset the increase in the pre-

apportionment tax base resulting from including profitable foreign

corporations.*? Accordingly, there is no systemic bias in WWCR

one way or the other.**

the $100 loss will offset the $100 gain and there will be no taxable income. By

contrast under the federal rules, U.S. corporations cannot file consolidated returns

with foreign corporations. The parent would be taxable by the United States on

$100. If, however, the U.S. corporation were to operate abroad in the form of a

branch, the foreign loss would be offset against its U.S. profits. Consequently, the

choice between operating abroad as a branch or as a subsidiary has U.S. tax

consequences. Under California's approach, however, the same amount of Califor-

mia tax would be due regardless of whether a branch or a subsidiary were used. The

California method has the advantage of not making the tax a function of how a

business is organized on paper. Put differently, the California fisc will not be

affected by the form in which a business chooses to operate.

+2 To illustrate, consider a U.S. parent that owns 100% of a foreign corpora-

tion. Assume the U.S. parent has $100 of taxable income and that its subsidiary also

has $100 of taxable income. If only the parent is taxable by California under a

water's edge approach, assume its apportionment factor is 25%, so that it would

apportion $25 to California (25% X $100). Assume further that if the foreign

subsidiary were included in a combined report. the apportionment factor would

decline to 5%. In a combined report, the corporation would apportion $10 to

California (5% X $200). The increase in taxable income from $100 to $200 is more

than offset by the decline in the apportionment percentage from 25% to 5%.

** Petitioner Barclays’ assertion that the “underlying economic assumption

lof WWCR is] that the activity of the worldwide unitary business is equally

profitable in all jurisdictions,” Petitioner Barclays’ Brief at 24, has been rejected by

this Court, as well as by scholars. See Container, 463 U.S. at 182-83; Jerome R.

Hellerstein, Federal Income Taxation of Multinationals: Replacement of Separate

Accounting with Formulary Apportionment, 60 Tax Nores 1131, at 1140-1141

(August 23, 1993); and Eric J. Coffill, Differences in Productivity and Profitability:

A Response to Allegations of the Misattribution of Income in the Application of

California's Worldwide Unitary Method, § Iwr't. Tax & Bus. Law. 246 (1987).

D. The Court Should Clarify that Japan Line does

not Apply to Corporate Income Taxes

The globalization of the marketplace means that state tax

systems will inevitably reach activities having international

connections. As this case demonstrates, Japan Line invites

endless quarrels between the states and the multinationals. If

the Petitioners were to have their way, every complaint by a

foreign country about a state tax can become a federal Consti-

tutional issue. And such complaints can easily be orches-

trated.

A principled distinction exists, however, between prop-

erty taxes and income taxes. Unlike income taxes, there is no

international custom or pattern requiring the country of resi-

dence to provide a credit for property taxes levied by other

countries. Moreover, Japan actually levied a property tax on

the same containers that were taxed by California and did not

provide a credit for foreign property taxes. Japan Line, 44]

U.S. at 452. Consequently, double taxation existed in fact.

The recent decision in /tel suggests that the Court itself

recognizes that Japan Line should not be applied if measures

exist for relieving double taxation. In upholding Tennessee's

sales tax on the proceeds from the lease of containers used in

foreign commerce, the Court stated,

“{flurthermore, the foreign commerce clause cannot

be interpreted to demand that a state refrain from

taxing any business transaction that ts also poten-

tially subject to taxation by a foreign sover-

eign . . . [the Tennessee credit] reduces, if not

eliminates, the risk of multiple international taxa-

tion. .. Absent a conflict with a ‘consistent interna-

tional practice [or] . . . federal policy,’ Container

Corp., 463 U.S., ut 190, the careful apportionment

of a state tax on business transactions conducted

44 The lack of a custom of relieving double taxation in the case of property

taxes Is not surprising; under the discarded “home port doctrine” there would not be

multiple property taxes. Although the Court in Japan Line retused to rehabilitate the

home port doctrine, 441 U.S. at 443, the result of the case ts consistent with that

doctrine.

within state borders does not create the substantial

risk of international multiple taxation that impli-

cates foreign commerce clause concerns... . ”

rel, 113 S.Ct. at 1104.

The concerns the Court expressed about multiple taxation

in Japan Line have long been addressed and remedied in the

case of income taxes. At a minimum, Japan Line should be

limited to situations of multiple taxation that the international

community has not addressed.

E. Jtel and Wardair Cast Doubt on the Continued

Vitality of Japan Line

The reasoning of /tel and Wardair would have required a

different outcome in Japan Line. Japan Line involved the

Customs Convention on Containers, signed by both Japan and

the United States. The relevant part of the Convention pro-

vided that “ . . . containers temporarily imported are admitted

free of ‘all duties and taxes whatsoever chargeable by reason

of importation. ” Japan Line, 441 U.S. at 452. In interpreting

the same Convention, /tel makes it clear that the relevant

inquiry is the reason a state imposes a tax and not the reason

why the subject of the tax — the containers — are in the

jurisdiction. /te/, 113 S. Ct. at 1100. The /te/ Court held that

the Convention prohibits only those taxes based on the act of

importation itself. The Los Angeles property tax in Japan

Line would presumably be upheld under this standard because

it is Not imposed on the act of importation nor ts it any kind of

import duty or custom duty.

Japan Line is aiso inconsistent with Wardair. In Wardair,

the Court examined the Chicago Convention on International

Civil Aviation, a Resolution by the International Civil Avia-

tion Organization, and other bilateral agreements dealing with

international aviation. None of these prohibited taxation of

aviation fuel by political subdivisions, “an omission which

must be understood as representing a policy choice by the

contracting parties.” Wardair, 477 U.S. at 11.

“What all of this makes abundantly clear is that

the federal government has not remained silent with

regard to the question of whether states should have

the power to impose taxes on aviation fuel used by

foreign carriers in international travel. By negative

implication arising out of more than 70 agreements

entered into since the Chicago convention, the

United States has at least acquiesced in state taxa-

tion of fuel used by foreign carriers in international

travel... . ” Id. at 12.

By contrast, in Japan Line the Court characterized a

convention authorizing an exemption only from duties and

taxes chargeable by reason of importation, as “reflect[ing] a

national policy to remove impediments to the use of con-

tainers .. . ” Japan Line, 441 U.S. at 452. Wardair suggests

that the Court in Japan Line should have inferred that the

signatories had acquiesced in a property tax on containers.

From a broader perspective, Japan Line is an aberration.

Japan Line was decided in 1979, just two years after the

Court made clear in Complete Auto that it had abandoned any

attempt at determining when a state tax interfered with

national uniformity or imposed a direct burden on interstate

commerce. Without much experience with the four tests in

Complete Auto, perhaps the Japan Line Court was unwilling

to abandon the old Cooley-type inquiries in the case of for-

eign commerce. The difficulty with that type of inquiry

seemed to be recognized by 1983 when the Court in Con-

tainer went to great lengths — properly so — to remove state

income taxes from the Japan Line orbit. Container showed

great sensitivity to the complexities that are resolved by the

rational workings of WWCR. Dormant foreign commerce

clause analysis is not rigorous enough to be used to annul

basic taxing schemes such as WWCR. Subsequent experience

with the Complete Auto tests should reassure the Court that

the additional Japan Line tests are unnecessary in the case of

income taxes.

Il. PROHIBITING WWCR UNDER THE DORMANT

FOREIGN COMMERCE CLAUSE WOULD UNDER-

CUT THE CONSTITUTIONAL PROTECTION OF

FEDERALISM

This case presents a weak setting for the application of

the dormant foreign commerce clause. The Court is not writ-

ing on a clean slate, as it has in other situations. See, e.g.,

Kraft v. lowa, 112 S. Ct. 2365 (1992). The issue of WWCR

comes to the Court with 25 years of history. In 1978, in the

debate over the U.S.-U.K. tax treaty, Senator Church stated

that “[f]or some ten years, Congress has been rejecting the

type of limitation on the power of our State governments to

tax which is incorporated in article 9(4) of the pending

treaty.”4° He noted that “[t}he original purpose for the Sen-

ate’s role in the treaty process was to protect the interests of

the several States in treaty matters. The framers feared that to

give the executive branch of the Federal Government free rein

in the treaty process would enable the President to ride

roughshod over the States. We may have waited a while to see

that fear confirmed, but that is exactly what article 9(4) of

this treaty does. It demonstrates that the fears of the framers

of our Constitution were well founded.”46

Senator Church’s understanding of the constitutional

structure of the government was expanded upon by the Court

a few years later:

“Apart from the limitation on federal authority

inherent in the delegated nature of Congress’ Arti-

cle I powers, the principal means chosen by the

Framers to ensure the role of the States in the

federal system lies in the structure of the Federal

Government itself. It is no novelty to observe that

the composition of the Federal Government was

designed in large part to protect the States from

overreaching by Congress. [footnote omitted]... . ”

In short, the Framers chose to rely on a federal

system in which special restraints on federal power

45 124 Conc. Rec. Part 14, Senate pp. 18416. (June 22, 1978).

over the States inhered principally in the workings

of the National Government itself, rather than in

discrete limitations on the objects of federal author-

ity. State sovereign interests, then, are more prop-

erly protected by procedural safeguards inherent in

the structure of the federal system than by judicially

created limitations on federal power. . . . we are

convinced that the fundamental limitation that the

constitutional scheme imposes on the Commerce

Clause to protect the ‘States as States’ is one of

process rather than one of result. . . . the principal

and basic limit on the federal commerce power Is

that inherent in all congressional action — the built-

in restraints that our system provides through state

participation in federal government action. The

political process ensures that laws that unduly bur-

den the States will not be promulgated.

Garcia, 469 U.S. at 550-52, 554, 556 (1985).

To date, the political process has ensured that the federal

government would not impose constraints on WWCR, thereby

recognizing that the power of taxation is an essential and

indisputable attribute of state sovereignty. The curtailment of

WWCR has come from the voluntary action of the States at

the encouragement of the Executive Branch. As the Solicitor

General stated, an “accommodation of state, national, and

international interests”4”? has now been reached. That accom-

modation was over two decades in the making and should not

be upset by this Court under a dormant foreign commerce

clause analysis. |

Considerations of federalism also caution against

destroying the diversity of experimentation in the field of

state taxation. As Justice Brandeis wrote,

“There must be power in the States and the Nation

to remould, through experimentation, our economic

practices and institutions to meet changing social

and economic needs. . . . It is one of the happy

incidents of the federal system that a single coura-

geous State may, if its citizens choose, serve as a

47 Brief of Solicitor General on Petition for Writ of Certiorari at 10.

laboratory; and try novel social and economic

experiments without risk to the rest of the country.”

New State Ice Co. v. Liebman, 285 U.S. 262, 311 (1932)

(Brandeis, J., dissenting). WWCR well illustrates Justice

Brandeis’ wisdom.

The states were forced early in this century to cope with

the problem of taxing multijurisdictional activities: in

response to this challenge, they designed formulary appor-

tionment and combined reporting. As federal officials and

their counterparts around the world are becoming increasingly

disillusioned with the arm’s length method, they are begin-

ning to extol the virtues of WWCR. For example, at his

confirmation hearings, the Undersecretary of the Treasury for

International Affairs referred to formulary apportionment as

the direction in which the world will have to move.48 Indeed.

WWCR has already been suggested for use by the United

States, Canada, and Mexico in the taxation of corporations

operating within the North American Free Trade Zone.4?

Examining the issue of formulary apportionment for use by

the European Community, a person who would become Assis-

tant Secretary of the Treasury wrote: “Formula apportionment

provides a useful and fair approximation of geographic

allocation of income. This approach helps to curb tax avoid-

ance by making it difficult to shift income away from high-

tax jurisdictions. Furthermore, if a Community-wide formula

were adopted, then the potential for double taxation would be

mitigated. Additionally, formula apportionment simplifies tax

administration, because authorities no longer need to verify

48 Summers Says Formula Apportionment System Would Require Multi-

lateral Move, 52 BNA Daiy Tax Report G-6 (March 19, 1993) at G-7. Summers

earlier wrote that under the federal rules, multinational firms can move profits

across borders by manipulating transfer prices and by altering their means of

financing. “An alternative approach is to rely on formula apportionment, which

obviates the need to locate a multinational’s home country and eliminates the

incentive to use transfer prices to manipulate tax liabilities.” See Lawrence H.

Summers, Taxation in a Small World, in Herbert Stein, ed, Tax Poucy ww THE

Twenty-First Century 64, at 69, 70, 71 (1988).

49 McIntyre and McIntyre, Using NAFTA to Introduce Formulary Appor-

tionment, 93 Tax Notes INTERNATIONAL 64-9 (April 5, 1993).

the transfer prices involved in separate accounting, a time-

consuming and difficult process.”%°

At a recent international conference involving tax offi-

cials, academics, lawyers and OECD representatives, formul-

ary apportionment was acknowledged as having a bad

reputation, largely because of political reasons.°! This same

group of tax experts concluded that the “ arm’s length ptinci-

ple and formulary apportionment should not be seen as polar

extremes .. . it is not clear where the arm’s length principle

ceases and formulary apportionment begins.”5? Indeed, in one

of the ultimate ironies in this case, it has been reported that

Barclays negotiated a transfer pricing agreement with the IRS

based on formulary apportionment.>* IRS officials have con-

firmed that they have completed an “advanced pricing agree-

ment” with a foreign bank based on a three-factor formulary

apportionment method employed on a worldwide basis.*4

Paradoxically, at a time when federal officials are looking to

50 Alicia H. Munnell, Taxation of Capital Income in a Global Economy: An

Overview, New ENGLAND Economic Review 33, at 46 (September/October 1992).

This article was written when Assistant Secretary of the Treasury for Economic

Affairs Alicia H. Munnell was Senior Vice President and Director of Research for

the Federal Reserve Bank of Boston. Her views are consistent with other scholars.

See, for example, McIntyre, Harmonizing Direct Taxes in the EEC, 2 Tax Norrs

Int’ 131 (1990); McIntyre, Harmonizing Direct Taxes on Business within the

EEC, 2 Tax Nores Int’t 341 (1990).

5! Brian J. Arnold and Thomas E. McDonnell, Report on the Invitational

Conference on Transfer Pricing: The Allocation of Income and Expenses Among

Countries, 61 Tax Nores 1377, at 1381(December 13, 1993).

52 Id.

53 John Turro, IRS Grants Two APAs in Derivative Products Areas, 4 Tax

Notes Int’ 959 (May 11, 1992); Gerald C. Shea, APAs May Effectively Address

Income and Expense Allocation Problems Faced by Global Trading Businesses, 4

Tax Notes Int’: 1022 (May 18, 1992).

54 Case example 2 in an Internal Revenue Service report on the Advanced

Pricing Agreement program is “a U.S. branch of a foreign bank. The APA applied a

formulary allocation of the net trading profits of the participants from their trading

of derivative products on an integrated worldwide basis. The APA used a methodol-

ogy with a weighted three factor approach.” See: Robert Ackerman, et al., The

Advance Pricing Agreement (APA) Program: A Model Alternative Dispute Resolu-

tion Process, 12 BNA Dany Report ror Executives L-1 (January 19, 1994), at L-4

nas te deemed oo

WWCR as part of a solution to the dilemma of arm’s length

pricing, the states have succumbed to political pressures and

have retrenched.

The current emphasis on reinventing government has led

to a new appreciation of the contributions and impact the

States have had on federal policies. The experience of the

States with WWCR has helped expose the practical inefficien-

cies and limitations with the arm’s length approach and has

irrevocably altered the debate over transfer pricing issues.

Out of necessity, the states have built a better mousetrap

than the federal government. This mousetrap cannot be

avoided by mergers and acquisitions, reorganizations, by how

a business is organized on paper, or by where incorporation

papers are filed, or by the setting of artificial prices in

transactions between related parties. The mousetrap catches

those who would use tax havens, such as Bermuda, the Cay-

man Islands, the Isle of Man, Nauru, the Turks and Caicos, or

the Virgin Islands. The mice that get caught will squeak — ond

they may even get their friends to squeak and make empty

threats. But these complaints cannot rise to the level of

Constitutional significance without the anomalous result that

the better the mousetrap, the greater the chance that the courts

will release the mice.

The multinational community has led a relentless politi-

cal campaign against WWCR. These efforts have forced the

States to adopt voluntary limits on WWCR. Not content with

this political victory, Petitioners are asking this Court to seal

the laboratory doors shut so that no state could ever resurrect

the method again. In an era of diminishing resources, the

states need the freedom to deal with ever more complex

international transactions. If the state laboratories are to be

permanently closed, there should be more compelling reasons

than those presented by the Petitioners.

(emphasis added). (The authors are identified as staff members of the APA Program

in the IRS Office of the Associate Chief Counsel (International)). /d., at L-1.

CONCLUSION

For the reasons stated above, Amicus Multistate Tax

Commission urges the Court to affirm the decisions below.

Respectfully submitted,

ALAN H. FriepMAN*

PauLL MINES

Multistate Tax Commission

444 No. Capitol St., N.W.

Suite 425

Washington, D.C. 20001

(202) 624-8699

*Counsel of Record for Amicus

Multistate Tax Commission

Of Counsel:

Proressor RicHARD Pomp

University of Connecticut ;

School of Law |

65 Elizabeth Street

Hartford, CT 06105-2290 )

(203) 241-4694

Proressor OLIver OLDMAN

Harvard Law School

1563 Massachusetts Avenue

Cambridge, MA 02138

(617) 495-4622

Proressor Micuaet McIntyre

Wayne State University Law School

468 West Ferry Mall

Detroit, MI 48202

(313) 577-3944

January 19, 1994

ORS Ae he ee et ee et ee -

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.