Opposition Brief — Citicorp North America, Inc. v. Franchise Tax Board

‘ Stiprame Court. U.S

22. 8D

MAY SO 200)

No. 00-1537

eee t ns.

In The A a en

Supreme Court of the United States

+--+ -—¢

CITICORP NORTH AMERICA, INC. & AFFILIATES,

Petitioners,

V.

FRANCHISE TAX BOARD,

Respondent.

+

On Petition For A Writ Of Certiorari

To The Court Of Appeal Of California

For The First Appellate District

¢

BRIEF IN OPPOSITION TO PETITION

FOR WRIT CF CERTIORARI

¢

Bint. LockYER

Attorney General

RANDALL P. BoORCHERDING

Supervising Deputy Attorney

General

Davip Lew

Deputy Attorney General

Counsel of Record

NorMAN Scort

Deputy Attorney General

1515 Clay Street, 20th Floor

Oakland, California 94612-1413

Telephone: (510) 622-2225

Counsel for Respendent

COCKLE LAW BRIEF PRINTING CO, (800) 225-9964

OR CALL COLLECT (402) 442-283)

QUESTION PRESENTED

California imposes a franchise tax on all corporations

doing business in the State. The measure of the franchise

tax is a corporation’s income attributable to California

sources. When a corporation doing business in California

is engaged in a unitary business enterprise with other

corporations, and the unitary business does business both

in and out of the State, California determines the income

attributable to California sources through the unitary

business formula apportionment method. This method

apportions income by applying a constitutionally-

approved three-factor apportionment formula to the busi-

ness income of the unitary business to arrive at the

amount of income of the unitary business attributable to

activities within the State. The apportionment factors

measure the income attributable to in-state activities by

comparing the portion of the group’s sales, property and

payroll in the State to the total sales, property and payroll

everywhere. Once the California-source income of the

unitary business has been determined, it is allocated

among the individual taxpayer members of the group

doing business in the State in proportion to their factors

in California. That amount is the measure of each corpo-

ration’s franchise tax liability. Against this background,

the following question is presented:

May California constitutionally determine

the California source income of the taxable

members of a unitary group by using an appor-

tionment formula that takes into account the

apportionment factors of all members of the

group, including the California factors of those

group members that are not themselves taxable

in the State?

il

LIST OF PARTIES

Respondent, Franchise Tax Board, accepts the List of

Parties as stated by petitioners Citicorp North America,

Inc. & Affiliates in the Petition for Writ of Certiorari.

ili

TABLE OF CONTENTS

Page

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RESPONDENT’S BRIEF IN OPPOSITION........... 1

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STATEMENT OF JURISDICTION. ...........000000- 1

CONSTITUTIONAL AND STATUTORY PROVI-

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ese pe ee 2 a | 2

A. California’s Method of Taxing Corporations

Engaged in a Multistate Unitary Enterprise... 2

B. California’s Method of Computing the Factors

of Its Apportionment Formula ............... 5

C. California’s Computation of Citicorp’s Califor-

nia Sales for Apportionment Purposes ....... 8

D. Adjudication of the Federal Questions in the

rey ete Tere eT eee Ere 9

REASONS FOR DENYING THE PETITION......... 11

I. THE ISSUE BEFORE THIS COURT LACKS SUF-

FICIENT IMPORTANCE TO WARRANT A

Se aa Oe OY Vine che nw bens bab eeaK dae ee 13

Il. THIS COURT SHOULD DENY REVIEW

BECAUSE THE CALIFORNIA COURT OF

APPEAL’S DECISION IS FULLY CONSISTENT

WITH THE WELL-SETTLED DECISIONS OF

Eas can Vas 4 hd kG oN UR ARE ONS 17

iv

TABLE OF CONTENTS - Continued

Page

A. California’s Method of Apportioning Uni-

tary Business Income to Its California

Source Does Not Implicate the State’s Juris-

diction to Tax Under the Due Process Clause

OR Re GG ok fle eek hess 17

B. California’s Apportionment Method Does

Not Violate the Commerce Clause by Favor-

ing In-State Over Out-Of-State Entities .... 21

C. California’s Apportionment Method Fairly

Approximates Citicorp’s Level of Unitary

Business Activity Within the State......... aa

RAR NE SALA Who 6s eres cu eee v ixi es peace end hs 25

APPENDIX

Appendix A: Relevant California Statutes ..... App. 1

Vv

TABLE OF AUTHORITIES

Page

CASES

Allied-Signal v. Director, Division of Taxation,

On I. FOS ERNE) bn re ndash Vandi eeeeeeeeereee 20

Appeal of Finnigan Corporation,

Cal. State Tax Rptr. (CCH) 1986-1990 transfer

binder J 401-797 (August 28, 1998)................ 7

Appeal of Finnigan Corporation on rehearing

Cal. State Tax Rptr. (CCH) 1986-1990 transfer

binder J 402-524 (January 24, 1990)................ 7

Appeal of the NutraSweet Company,

Cal. State Tax Rptr. (CCH) 1992-1993 (pt. 2)

transfer binder J 402-524 (October 29, 1992)....... 7

Barclays Bank PLC v. Franchise Tax Bd. of Cal.,

DE I Ae PE 6 ic ios cue 14, 18

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

BGG LED. 272 CRI) sos iia pss cvssastiae 14, 18

Butler Brothers Stores v. McColgan,

Sha GIS. GRE (SE) oo ik owsnaneiayiensy ese 2, 14, 18

Container Corp. v. Franchise Tax Bad.,

St 8) a Ee (Oe 6b ec naeenea ecu passim

Exxon Corp. v. Wisconsin Dept. of Revenue,

‘4? US. 207 CASO 3s ess see ee 14, 16, 18

Fulton Corp. v. Faulkner,

720: UD. ae CGO 66x pci edaeenensnbeaeea 22

Hans Rees’ Sons v. North Carolina ex rel. Maxwell,

Zee US. 123 Hc cca See 14, 18

vi

TABLE OF AUTHORITIES - Continued

Page

Hunt-Wesson, Inc. v. Franchise Tax Board,

S36 U.S. 466 Cae vcs d0nucsndenns eoeesssense ee 15

International Harvester Co. v. Evatt,

529 US. G26 CRG) 26is cdadcwwsesstsieeione 14, 18

Mobil Oil Corp. v. Commissioner of Taxes,

445 US. G25 (IRR) sons oueeskuskeeeas 2, 14, 16, 18, 20

Moorman Mfg. Co. v. Bair,

437 US. 267 (AGF a xuscestaoencaeni ease 14, 18

Northwestern States Portland Cement Co. v. Minne-

seta, 3B US. 450 CiGOR é ccs vxencs cas iacteeus 14, 18

Shell Oil Co. v. Iowa Dep't of Revenue,

468 U.S... 19: CISED i ixvc vn o000000 sae 14, 15, 18

Underwood Typewriter Co. v. Chamberlain,

256 US. TES COO vo08t0dks5ssnsoa eee 14, 18

STATUTES

California Code of Regulations

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Tithe 16, § 25157434. oscccseesiea cee eee 6

California Revenue & Taxation Code

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TABLE OF AUTHORITIES - Continued

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RESPONDENT’S BRIEF IN OPPOSITION

Respondent Franchise Tax Board (“Board”) respect-

fully requests that this Court deny the Petition for Writ of

Certiorari (“Petition”) of petitioners Citicorp North

America, Inc. & Affiliates (collectively, “Citicorp”).

¢

OPINIONS BELOW

The Board accepts Citicorp’s statement of the Opin-

ions Below as contained in its Petition and as reproduced

at Appendix 1a-85a of the Petition.

+

STATEMENT OF JURISDICTION

The Board accepts Citicorp’s statement of Jurisdiction

as contained in its Petition.

CONSTITUTIONAL AND STATUTORY

PROVISIONS INVOLVED

The Board accepts Citicorp’s statement of the Consti-

tutional and Statutory Provisions Involved as contained

in its Petition and as reproduced at Appendix 92a-101a of

the Petition. Additional statutory provisions are con-

tained in Appendix A of the Board’s Brief in Opposition

to Petition for Writ of Certiorari.

STATEMENT OF THE CASE

This is an action for refund of California franchise

taxes brought by Citicorp, a Delaware corporation and its

affiliates located throughout the world, including Califor-

nia. Citicorp is part of a financial services organization

engaged in a worldwide unitary business consisting of

550 domestic corporations, 88 of which were California

taxpayers during the tax years ending December 31, 1985

through December 31, 1988 (“the years in issue”).}

A. California’s Method of Taxing Corporations

Engaged in a Multistate Unitary Enterprise

California imposes a franchise tax on every corpora-

tion doing business within the State. Cal. Rev. & Tax.

Code § 23151. The measure of that tax is the corporation’s

net income derived from or attributable to sources within

1 A unitary business is a functionally integrated economic

enterprise characterized by substantial mutual interdependence

and a flow of value among members of the unitary group.

Container Corp. v. Franchise Tax Bd., 463 U.S. 159, 178-179 (1983).

Flows of value are described as “some sharing or exchange of

value not capable of precise identification or sharing or

exchange of value not capable of precise identification or

measurement — beyond the mere flow of funds arising out of a

passive investment or a distinct business operation — which

renders formula apportionment a reasonable method of

taxation.” Jd. at 166. A business is unitary when sufficient flows

of value exist such that “contributions to income

[result] . . . from functional integration, centralization of

management, and economies of scale.” Mobil Oil Corp. v.

Commissioner of Taxes, 445 U.S. 425, 438 (1980), citing Butler

Brothers Stores v. McColgan, 315 U.S. 501, 508-509 (1942).

3

California. Cal. Rev. & Tax. Code § 25101. When a corpo-

ration conducts business with affiliated corporations as

part of a larger unitary business enterprise operating

both within and without California, it becomes necessary

to determine how much of the income of the unitary

business is attributable to sources within California as

_ opposed to another state. In other words, the income of

the enterprise must be apportioned between California

and other locations in which it conducts business. In

these circumstances, business income derived from or

attributable to California sources is determined on the

basis of the unitary business formula apportionment

method.? Container Corp. v. Franchise Tax Bd., 463 U.S. 159,

162-163 (1983).

Unitary business formula apportionment is a method

of apportioning income in which a business conducted by

related corporations as a single economic (unitary) enter-

prise and which earns income both in and out of Califor-

nia is treated as one unit for determining income

attributable to sources within the State. The proportion of

the business income of a unitary business attributable to

California sources is determined by applying a three-

factor apportionment formula, as outlined in the Uniform

* Business income is defined as “income arising from

transactions and activity in the regular course of the taxpayer’s

trade or business and includes income from tangible and

intangible property if the acquisition, management, and

disposition of the property constitute integral parts of the

‘axpayer’s regular trade or business operations.” Cal. Rev. &

Tax. Code § 25120(a). In contrast, nonbusiness income is defined

as all income other than business income. Cal. Rev. & Tax. Code

§ 25120(d).

Division of Income for Tax Purposes Act (“UDITPA”).?

Cal. Rev. & Tax. Code §§ 25120-25139.4

California’s three-factor apportionment formula is

comprised of the average of three “factors.” The sales

factor is a fraction, whose numerator is the sales of the

unitary group made in California during the year, and

whose denominator is the unitary group’s sales every-

where. Cal. Rev. & Tax. Code § 25134. The property factor

is also a fraction, whose numerator is the property

owned, rented or used by the unitary group in California

during the year, and whose denominator is the group’s

property everywhere. Cal. Rev. & Tax. Code § 25129. The

final factor is the payroll factor, whose numerator is the

compensation paid in California, and whose denominator

is compensation paid everywhere. Cal. Rev. & Tax. Code

§ 25132. The numerator of each of these three fractions or

“factors” represents the value of sales, property or pay-

roll of the unitary group within California, and the

denominator of each fraction represents the value of

sales, property or payroll of the group everywhere. For

the years in issue, the apportionment factor was deter-

mined by adding the sales, property, and payroll factors

and dividing by three. Cal. Rev. & Tax. Code § 25128.

3 UDITPA was enacted in California in 1966 and has been

adopted by over 20 states.

4 Under regulations promulgated under authority of Cal.

Rev. & Tax. Code § 25106.5, corporations engaged in a unitary

business are required to file a “combined report” for the

purpose of determining the amount of business income of the

unitary group attributable to California sources.

> Section 25128 was amended, effective for taxable years

beginning on or after January 1, 1994, to double-weight the sales

The apportionment factor is then applied to the world-

wide business income of the unitary group to determine

the amount of business income attributable to California

sources.

Once the business income of the unitary group is

apportioned by formula to California under combined

reporting principles, the tax status of each California

taxpayer member of the unitary group as a separate and

distinct legal entity is taken into account. The income

attributable to California sources is allocated among the

individual members of the unitary group that are Califor-

nia taxpayers in proportion to each corporation’s factors

in California. This process is required so that each tax-

payer’s income attributable to California sources can be

determined in arriving at its franchise tax liability.

This Court has observed that California’s three-factor

apportionment formula has not only “met our approval”

against constitutional challenge made under the Due Pro-

cess Clause and the Commerce Clause, but has become

“something of a benchmark against which other appor-

tionment formulas are judged.” Container Corp., 463 U.S.

at 1/0.

B. California’s Method of Computing the Factors

of Its Apportionment Formula

The dispute in this case involves the method by

which California determined Citicorp’s California sales

factor. Thus, the apportionment factor is currently determined

for most taxpayers by adding the sales factor twice, the property

factor and the payroli factor and dividing by four.

under the State’s three-factor apportionment formula

during the years in issue. Under California law, sales are

generally assigned for apportionment purposes to the

state of their destination if the “taxpayer” is subject to

taxation in that state. Cal. Rev. & Tax. Code § 25135.

However, if the “taxpayer” is not taxable in the state of

destination, the sales are “thrown back” to the state of

origin. Thus, if a “taxpayer” ships property from another

state to a purchaser in California, and the “taxpayer” is

taxable in California, the sale is considered to be a sale in

California and is included in the numerator of the sales

factor. On the other hand, if the “taxpayer” is not taxable

in California, the sale is “thrown back” to the state of

origin and deemed to be a sale outside California - and

thus excluded from the numerator of the sales factor — for

apportionment factor purposes. The throwback rule

arises from the fundamental premise of unitary business

formula apportionment that all, but not more than all, of

the income of a unitary business enterprise should be

subject to taxation in the jurisdictions in which it does

business.

For the years in issue, California determined that for

purposes of apportionment, the term “taxpayer,” as used

6 Cal. Rev. & Tax. Code § 25135 applies to the sale of

tangible property. Although intangible property is generally not

included in the sales factor, California regulations specially

provide that banks and other financial institutions such as

Citicorp are required to include intangible property, such as

credit card receivables, in both their sales and property factors

in accordance with statutory and regulatory provisions for the

assignment of tangible property. 18 Cal. Code of Regs. § 25137-4

(now renumbered 25137-4.1).

in Cal. Rev. & Tax. Code § 25135, referred not to the

individual member of the unitary group which made the

sale, but rather to the seller’s unitary group as a whole.

Appeal of Finnigan Corporation, Cal. State Tax Rptr. (CCH)

1986-1990 transfer binder, { 401-797 (August 28, 1988);

Appeal of Finnigan Corporation on rehearing, Cal. State Tax

Rptr. (CCH) 1986-1990 transfer binder { 402-524 (January

24, 1990). Accordingly, a sale made by a California seller

to a purchaser in another state (i.e., an “outbound sale”)

could not be thrown back to California if any other mem-

ber of the seller’s unitary group was taxable in the desti-

nation state, irrespective of whether the individual seller

corporation was itself taxable there. Rather, that sale was

treated as a sale in the state of its destination under

section 25135 and excluded from California’s sales factor

numerator. Conversely, a sale made by an out-of-state

seller into California (i.e., an “inbound sale”) could not be

thrown back to the state of origin, even if the individual

seller corporation was not taxable in California, if any

other member of the seller’s unitary group was taxable in

the State.” Appeal of the NutraSweet Company, Cal. State

Tax Rptr. (CCH) 1992-1993 (Pt. 2) transfer binder

4 402-524 (October 29, 1992).

7 As will be discussed later, California has, since 1999,

returned prospectively to a previously-used method of

attributing unitary business income to the State which excludes

from the apportionment formula the California factors of group

members not taxable in the State.

C. California’s Computation of Citicorp’s Califor-

nia Sales for Apportionment Purposes

Citibank (South Dakota), N.A. (“Citibank South

Dakota”), a member of Citicorp’s unitary business during

the years in issue, issued Visa and MasterCard credit

cards. Citibank South Dakota had no physical presence

(i.e., tangible property or payroll) in California and was

not subject to California franchise tax. However, Citibank

South Dakota generated hundreds of millions of dollars

in California sales receipts and credit card receivables to

credit cards customers in California during each of the

years in issue.

For each of the years in issue, Citicorp originally filed

California franchise tax returns on a separate company

basis. Citicorp later filed amended returns for each of the

years in issue, taking the position that it engaged in a

worldwide unitary business. Consequently, Citicorp

determined its income attributable to California sources,

and ultimately, its franchise tax liability on the basis of

the California three-factor apportionment formula. The

amended returns, which constituted claims for refund,

sought tax refunds for each of the years in issue. Citicorp

took the position in its amended returns that the value of

the credit card sales and property generated by Citibank

South Dakota to California customers should be excluded

from the numerators (California factors) of the three-

factor apportionment formula because Citibank South

Dakota was not taxable in California.

The Board accepted Citicorp’s amended position that

it was engaged in a unitary business, but determined that

the California sales (credit card receipts) and property

(credit card receivables) of Citibank South Dakota should

be included in the numerators of the three-factor appor-

tionment formula. Accordingly, the Board increased the

numerator of Citicorp’s sales factor by adding Citibank

South Dakota’s sales receipts from California credit card

customers in the following amounts: $253,377,191 for

1985, $350,520,156 for 1986, $396,321,750 for 1987 and

$478,974,131 for 1988. The Board also increased the

numerator of Citicorp’s property factor by adding Citi-

bank South Dakota’s credit card receivables from Califor-

nia customers in the following amounts: $1,364,590,734

for 1985, $1,694,273,294 for 1986, $2,303,098,005 for 1987

and $3,187,824,161 for 1988. This resulted in an increase

in the apportionment of Citicorp’s unitary group income

to California by the following amounts: $12,826,406 for

1985, $11,558,073 for 1986, $9,083,509 for 1987 and

$14,705,509 for 1988.

As a consequence, Citicorp’s claims for refund were

only partially granted. The portion of the claims for

refund attributable to the exclusion of Citibank South

Dakota’s California sales and property from the appor-

tionment factor numerators was denied.

D. Adjudication of the Federal Questions in the

Proceedings Below

As a result of the Board’s actions, Citicorp filed suit

for a tax refund in the San Francisco County Superior

Court. Citicorp alleged, in part, that California’s method

of apportioning income resulted in the unconstitutional

taxation of the income of a nontaxable member (Citibank

South Dakota) of its unitary business, in violation of the

10

Due Process Clause and the Commerce Clause of the

United States Constitution. The trial court ruled that Cali-

fornia’s method of apportioning the sales of a corporation

engaged in a unitary business was constitutional and

rendered judgment in favor of the Board. Appendix

49a-84a of Petition.

Citicorp appealed. By unanimous decision, a three-

member panel of the California Court of Appeal affirmed

the judgment of the trial court. Appendix 1a-48a of Peti-

tion. The Court of Appeal rejected Citicorp’s claim that

California’s apportionment method resulted in the indi-

rect taxation of the income of Citibank South Dakota and

concluded that California was actually imposing taxes

“only on the corporations that are subject to California’s

taxing jurisdiction.” Appendix 14a of Petition.

Citibank (South Dakota) is not being sub-

‘ected to a tax in this case. The relevant stipu-

lated fact in this case is that Citicorp and its

affiliates, including Citibank (South Dakota)

“were conducting a worldwide unitary business

during the years in issue, and their combined

franchise tax liability must be computed on a

unitary basis.” The rule applied here results in

recognition that the unitary group benefitted

from sales in California.

Appendix 18a of Petition. Accordingly, the Court of

Appeal found California’s apportionment method to be

“consistent with accepted principles of taxation of a uni-

tary business.” Appendix 15a of Petition. Furthermore,

the Court of Appeal determined that Citicorp had failed

to carry its burden of demonstrating that California’s

approach to attributing sales to California under its

11

apportionment formula violated either the Due Process

Clause or the Commerce Clause. Appendix 29a-33a of

Petition.

There is nothing arbitrary or unconstitu-

tional about assigning Citibank’s (South Dakota)

credit card sales and transactions actually occur-

ring in California to California. Such an assign-

ment reasonably recognizes the contribution of

the state in producing the income of the unitary

group. Citicorp has not shown the allocation to

California is “ ‘out of all appropriate propor-

tions to the business transacted . . . in that

State. ...’” (Container Corp. v. Franchise Tax Bd.,

supra, 463 U.S. at p. 170.)

Appendix at 33a of Petition.

Citicorp sought review of the Court of Appeal’s deci-

sion in the California Supreme Court. Without comment,

the California Supreme Court denied Citicorp’s petition

for review. Appendix 85a of Petition.

*

REASONS FOR DENYING THE PETITION

This Court should deny review of the California

Court of Appeal’s decision affirming the validity of Cali-

fornia’s apportionment method for determining income

of the taxable members of a unitary business attributable

to California sources. Several reasons compel this conclu-

sion.

First, Citicorp’s arguments raise issues which have no

ongoing legal significance in California. As of April 22,

1999, California has reverted prospectively to using a

12

previously-used apportionment method in which the Cal-

ifornia sales, property and payroll of nontaxable mem-

bers of a unitary business, including Citicorp, are no

longer attributed to California for purposes of computing

the numerators of the group’s sales, property and payroll

factors.

Second, Citicorp’s claim is a thinly-disguised attempt

to undermine decades of authority from this Court per-

mitting a taxing state to look beyond its borders to arrive

at a fair allocation of its share of the taxable values of a

taxpayer's activities within the state. Citicorp is undis-

putedly engaged in a unitary business. This Court has

repeatedly and consistently rejected the contention that a

state that takes into consideration for apportionment pur-

poses the activities of nontaxable members of the unitary

group is engaged in extraterritorial taxation. Citicorp’s

petition reflects a fundamental misapprehension between

two distinct and separate concepts: a state’s right to

apportion the income of a unitary business to determine

the proper state source of that income and a state’s juris-

diction to tax individual corporations.

Third, Citicorp’s position is based on the false prem-

ise that the separate identity (and thus, the separate

income) of the individual members of a unitary group,

such as Citibank South Dakota, should ultimately deter-

mine the group’s collective tax liability. This premise is

contrary to the fundamental unitary business principle

that, for purposes of apportioning the appropriate share

of the group’s unitary business income to a state, the

separate identity of the individual members of the uni-

tary group may be ignored, because separate accounting

13

does not and cannot adequately reflect the many contri-

butions to income and flows of value among members of

a unitary group. Combined reporting operates on the

constitutionally-approved principle that the income of

the entire unitary group of corporations, and the group’s

factors, may be considered when apportioning income to

the taxing state.

I. THE ISSUE BEFORE THIS COURT LACKS SUFFI-

CIENT IMPORTANCE TO WARRANT A GRANT

OF REVIEW

At the outset, certiorari should be denied because the

issues raised in the Petition have no ongoing legal signifi-

cance in California. As of April 22, 1999, California

administratively changed, on a prospective basis, its

method of assigning sales to the State by returning to a

previously-used apportionment method, one in which the

California sales, property and payroll of nontaxable uni-

tary members are no longer attributed to California in

computing the numerators of the group’s sales, property

and payroll factors. 18 Cal. Code of Regs.

§ 25106.5(c)(7)(B). Thus, for corporations doing business

in the State, including Citicorp, the implications of the

California Court of Appeal’s decision have little, if any,

ongoing impact. Citicorp’s petition raises questions appli-

cable only to the years in issue, already resolved twice in

favor of California, and with little significance outside the

limits of this case Therefore, certiorari should be denied.

In any case, Citicorp misstates the significance of the

California Court of Appeal’s decision by characterizing it

as “a serious threat to constitutional restraints on state

14

taxation.” Petition at 22. In reality, what Citicorp seeks is

to significantly erode many decades of decisional author-

ity from this Court permitting a taxing state to look

beyond its borders to arrive at a fair allocation to the state

of a fair share of the taxable values of the taxpayer’s

activities within the state. See, e.g., Barclays Bank PLC v.

Franchise Tax Bd. of Cal., 512 U.S. 298, 311-12 n. 10 (1994);

Shell Oil Co. v. Iowa Dep't of Revenue, 488 U.S. 19, 30-31

(1988); Container Corp., supra, 463 U.S. at 165; Exxon Corp.

v. Wisconsin Dept. of Revenue, 447 U.S. 207, 219 (1980);

Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 436

(1980); Moorman Mfg. Co. v. Bair, 437 U.S. 267, 273 (1978);

Northwestern States Portland Cement Co. v. Minnesota, 358

U.S. 450, 460 (1959). See generally International Harvester

Co. v. Evatt, 329 U.S. 416 (1947); Butler Brothers Stores v.

McColgan, 315 U.S. 501 (1942); Hans Rees’ Sons v. North

Carolina ex rel. Maxwell, 283 U.S. 123 (1931); Bass, Ratcliff

& Gretton, Ltd. v. State Tax Comm'n, 266 U.S. 271 (1924);

Underwood Typewriter Co. v. Chamberlain, 254 U.S. 113

(1920).

Never before in the history of state apportionment of

income cases before this Court has a taxpayer suc-

cessfully contended that a state’s inclusion of the nontax-

able income of a unitary group member, generated as part

of the unitary business, in the apportionable income base

of a unitary group member resulted in extraterritorial

taxation. None of the cases cited by Citicorp that invali-

dated state exactions of extraterritorial income involved

the apportionment of income of a unitary business or,

more specifically, the prohibitions agairist a state consid-

ering, in the apportionment process, the activity and

income of corporations whose connection to the taxing

i

state was that they were part of a unitary business oper-

ating there. This Court has uniformly rejected such a

notion on the ground that the apportionment of income is

not tantamount to the taxation of income.

For instance, in Shell Oil Co., 488 U.S. at 30-31, this

Court upheld the inclusion in the State of Iowa’s tax base

of income generated from the Outer Continental Shelf.

and rejected an argument - that the inclusion of nontax-

able income in the apportionable base of a state’s tax

results in the taxation of extraterritorial values - similar

to that presented here:

Shell’s argument hinges on the mistaken

premise that including OCS-derived income in

the preapportionment tax base is tantamount to

the direct taxation of OCS production. But

income that is included in the preapportionment

tax base is not, by virtue of that inclusion, taxed

by the state. Only the fraction of total income

that the apportionment formula determines (by

multiplying the income tax base by the appor-

tionment fraction) to be attributable to lowa’s

8 For example, in this Court’s recent decision in Hunt-

Wesson, Inc. v. Franchise Tax Board, 528 U.S. 458 (2000), the issue

presented did not involve the proper apportionment of income

of a unitary busines. “sing business in California. Rather, the

case involved the constitutionality of California’s “interest

offset deduction,” (Cal. Rev. & Tax. Code § 24344), which, after

the apportionment of income to individual taxpayers, operated to

assign the interest expense deduction of a corporation as a

deduction against nonbusiness income. This Court held that this

assignment, as applied to out-of-state taxpayers whose

nonbusiness income was not taxable in California, caused

extraterritorial income to be taxed indirectly by the State in

violation of the Due Process Clause.

16

taxing jurisdiction is taxed by Iowa. As our

Commerce Clause analysis of apportionment

formulas has made clear, the inclusion of

income in the preapportioned tax base of a state

apportionment formula does not amount to

extraterritorial taxation. This court has repeat-

edly emphasized that the function of an appor-

tionment formula is to determine the portion of

a unitary business’ income that can be fairly

attributed to instate activities. Exxon Corp. v.

Wisconsin Dept. of Revenue, 447 U.S. 207, 219

(1980); Mobil Oil Corp. v. Commissioner of Taxes of

Vermont, 445 U.S. 425, 440 (1980).

It follows implicitly from these decisions that where, as

here, income apportioned to the State is increased by

consideration of the income and factors (such as sales to

California customers) of the nontaxable members of the

group, any increase in the tax base is properly borne by

the taxable corporations. The combined reporting process

utilized by California reflects the values in the State of

the integration and interdependence of the taxable and

nontaxable members of Citicorp’s unitary business.

Granting certiorari to affirm, yet again, what has long

been a fundamental principle of state taxation law is

unwarranted.

17

Il. THIS COURT SHOULD DENY REVIEW BECAUSE

THE CALIFORNIA COURT OF APPEAL’S DECI-

SION IS FULLY CONSISTENT WITH THE WELL-

SETTLED DECISIONS OF THIS COURT

A. California’s Method of Apportioning Unitary

Business Income to Its California Source Does

Not Implicate the State’s Jurisdiction to Tax

Under the Due Process Clause or Commerce

Clause

Citicorp attempts to make the case that California’s

apportionment method - which attributed to the State the

credit card sales to California customers of a nontaxable

member of Citicorp’s unitary business, thereby increasing

the tax base of Citicorp’s members taxable in California —

resulted in extraterritorial taxation. To the contrary, Cali-

fornia’s method of apportionment is fully consistent with

constitutionally-approved principles of apportioning

income for the purposes of taxation of the members of a

unitary business.

aS

Citicorp’s attack on California’s apportionment

method suffers from two critical misconceptions.

First, it confuses a state’s jurisdiction to tax with

apportionment of income. Citicorp’s contention that Cali-

fornia’s apportionment of income to its taxable members

results in extraterritorial taxation solely because sales to

California customers are made by a nontaxable member

of the unitary business is contrary to the long line of well-

established precedents of this Court approving the appor-

tionment of income of unitary business enterprises. These

decisions have consistently affirmed the fundamental

unitary business principle that in apportioning the com-

bined income of a unitary group of corporations, a state is

18

not constitutionally barred from taking into account the

income and factors of all the members of the group,

without regard to whether the members are subject to tax

by the state.

This method [unitary business formula appor-

tionment], unlike separate accounting, does not

purport to identify the precise geographical

source of a corporation’s profits; rather, it is

employed as a rough approximation of a corpo-

ration’s income that is reasonably related to the

activities conducted within the taxing State.

Moorman Mfg. Co., 437 U.S. at 273. See also Barclays Bank,

512 at 311-12 n. 10; Shell Oil Co., 488 U.S. at 30-31; Con-

tainer Corp., 463 U.S. at 165; Exxon Corp., 447 U.S. at 219;

Mobil Oil Corp., 445 U.S. at 436; Northwestern States Port-

land Cement Co., 358 U.S. at 460. See generally Butler Bros.,

315 U.S. 501; Hans Rees’ Sons, 283 U.S. 123; Underwood

Typewriter Co., 254 U.S. 113. In so holding, this Court has

declared that a “state’s tax law is not to be nullified

merely because the result is achieved through a formula

which includes consideration of interstate and out-of-

state transactions in their relation to the intrastate privi-

lege,” (International Harvester Co., 329 U.S. at 423), and

that in imposing an apportioned tax on doing business, a

state may look “to the property of such corporations

beyond its borders. ...” Bass, Ratcliff & Gretton, Ltd., 266

U.S. at 282.

The decision of the California Court of Appeal is

fully consistent with these well-established decisions. In

rejecting Citicorp’s claim that California’s attribution of

Citibank South Dakota’s sales to California in the appor-

tionment formula results in extraterritorial taxation, the

19

Court of Appeal held that the State “is not taxing, but is

apportioning income attributable to California. (Edison

California Stores v. McColgan, supra, 30 Cal.2d 472,

474-475.) Taxes are actually imposed only on the corpora-

tions that are subject to California’s taxing jurisdiction.”

Appendix 14a of Petition. California’s attribution of Citi-

bank South Dakota’s credit card sales to California cus-

tomers to the State “results in recognition that the unitary

group benefitted from sales in California.” Appendix 18a

of Petition.

Second, Citicorp’s attack on California’s apportion-

ment method is fatally flawed because it is based on the

premise that the separate identity (and thus, the separate

income) of individual members of its unitary group, such

as Citibank South Dakota, should ultimately control the

determination of the group’s collective tax liability. In

order to repeatedly complain that California’s apportion-

ment method results in the “shifting” of income from a

nontaxable corporation to taxable corporations, Citicorp

must necessarily segregate the income of its unitary busi-

ness enterprise into the separate income of each of the

individual member corporations. This segregation can

only be accomplished through the mechanism of separate

accounting, which this Court has held “is subject to

manipulation and imprecision, and often ignores or cap-

tures inadequately the many subtle and largely unquanti-

fiable transfers of value that take place among the

components of a single enterprise.” Container Corp, 463

U.S. at 164-165. Thus, Citicorp’s argument disregards the

undisputed fact that each of its unitary members,

whether taxable or nontaxable in the State, constitutes an

integrated part of a single unitary enterprise.

20

The premise of Citicorp’s argument is fundamentally

at odds with the underlying theory of unitary business

formula apportionment as reflected in California’s system

of combined reporting: the separate identity of the indi-

vidual members of the unitary group is disregarded for

the purpose of determining the appropriate amount of

the unitary group’s combined income to apportion to the

taxing state. See Mobil Oil, 445 U.S. at 439 [“the linchpin

of apportionability in the field of state income taxation is

the unitary business principle”]. Under combined report-

ing principles, the income and factors of the entire uni-

tary group, not solely its taxable members, are properly

considered in making that determination, because a state

may tax a proportionate share of the “unitary” income of

a nondomiciliary corporation that carries out a particular

business both in and out of that state. Allied-Signal v.

Director, Division of Taxation, 504 U.S. 762, 778 (1992).

Thus, as the California Court of Appeal correctly

observed in this case, the attribution of Citibank South

Dakota’s “credit card sales and transactions actually

occurring in California to California ... reasonably recog-

nizes the contribution of the state in producing the

income of the unitary group.” Appendix 33a of Petition.

Simply put, California’s apportionment method nei-

ther “shifts” nor “assigns” anything to or from one corpo-

ration to another or from one state to another. It merely

apportions to the State a portion of Citicorp’s unitary

business income which reasonably approximates the level

of business conducted by the unitary group in the State,

i.e., determines the income of the unitary group attributa-

ble to California sources. Income attributable to Califor-

nia sources, which is the measure of a corporation’s tax

ah ra

21

liability under California statutes, is then assigned to the

members of Citicorp’s unitary business taxable in the

State.

Citicorp is undisputedly engaged in a unitary busi-

ness. Because its business i. not truly separate and dis-

tinct from the operations of the unitary group in

California, its income may not be segregated clearly and

accurately from its California operations. Thus, as the

California Court of Appeal properly concluded, Citi-

corp’s credit card sales to its California customers,

regardless of the taxable or nontaxable status of the indi-

vidual member of the unitary group that carries it out,

may be appropriately considered in determining the

appropriate amount of Citicorp’s income that is attributa-

ble to California sources.

B. California’s Apportionment Method Does Not

Violate the Commerce Clause by Favoring In-

State Over Out-Of-State Entities

Citicorp’s allegation that California’s apportionment

method discriminates against interstate commerce is con-

structed on the same faulty premise as its allegation of

extraterritorial taxation. By inappropriately ascribing its

unitary business income to individual members of its

unitary group, such as Citibank South Dakota, in an

apportionment setting, Citicorp once again ignores fun-

damental principles of combined reporting and reverts to

the separate accounting principles which this Court has

previously rejected. Container Corp., 463 U.S. at 164-165.

Little, if anything, needs to be added to the Board’s

22

previous response: the tax liability of a group of corpora-

tions engaged in a unitary business both within and

without the state is appropriately measured not by refer-

ence only to the taxable status of individual members of

the unitary business, but rather, by reference to the activ-

ities of the entire unitary group through the use of an

objective three-factor apportionment formula that “has

become . . . something of a benchmark against which

other apportionment formulas are judged.” Id. at 170.

California’s method of apportionment does not dis-

criminate against interstate commerce, because the mea-

sure of the State’s franchise tax does not depend on the

state where a corporation is domiciled or conducts its

business. To illustrate, during the years in issue, Califor-

nia treated “inbound sales” to the State in exactly the

Same manner as “outbound sales” from the State, i.e.,

sales were not “thrown back,” or attributed to their state

of origin when any member of the unitary group was

taxable in the state of destination. Consequently, when

this apportionment method was applied to “outbound

sales,” it actually had the effect of reducing the income

base of the taxable members of the group taxable in

California.

Citicorp’s reliance on Fulton Corp. v. Faulkner, 516

U.S. 325 (1996) is misplaced. The state taxing scheme

condemned in that case did not arise in the context of the

apportionment of income of a unitary business doing

business in the state. Moreover, the attribution to Califor-

nia of the credit card sales to California customers made

by Citibank South Dakota was not the result of its non-

taxable status. Under California’s apportionment method,

23

the credit card sales would have been included in Citi-

corp’s California sales numerator regardless of the tax-

able or nontaxable status of Citibank South Dakota.

This Court has observed that “[a]t least in the inter-

state commerce context . . . the anti-discrimination princi-

ple has not in practice required much in addition to the

requirement of fair apportionment.” Container Corp., 463

U.S. at 171. No “penalty” of nontaxable members of a

unitary business is inherent in California’s methodology.

C. California’s Apportionment Method Fairly

Approximates Citicorp’s Level of Unitary Busi-

ness Activity Within the State

California’s apportionment method does not violate

the Commerce Clause requirement of fair apportionment

by “shifting” the income of a nontaxable corporation to a

taxable corporation. Once again, by attempting to attach

income and apportionment factors to individual members

of an integrated unitary business enterprise, Citicorp

inappropriately injects separate accounting principles

into the apportionment process. In so doing, Citicorp

ignores the basic purpose and rationale of apportion-

ment.

On the most fundamental level, there is nothing arbi-

trary or unfair about attributing Citicorp’s credit card

sales made in California and to California customers to

California. Including such sales in the California based

numerators of the apportionment formula reasonably

reflects how income is generated in the State. Citicorp’s

contention that the unitary business income apportioned

to California was out of all appropriate proportion to its

24

activities in California is demonstrably false: although

credit card sales receipts to Citibank South Dakota from

California customers during the years in issue ranged

from over $253 million to in excess of $478 million and

credit card receivables from California customers ranged

from over $1.3 billion to over $3.1 billion, the additional

unitary income apportioned to the State increased only

by amounts ranging from approximately $9 million to

less than $15 million. The California Court of Appeal

properly found that Citicorp had failed to present any

evidence at trial to support its allegation that California’s

apportionment scheme grossly distorted the amount of

unitary business income allocable to California. Appen-

dix 31a of Petition. On the contrary, the Court of Appeal

concluded, “the evidence reflected the reasonable appor-

tionment of sales generated in California.” Appendix 31a

of Petition.

Including sales in California’s apportionable tax base

notwithstanding that the individual seller (Citibank

South Dakota) in Citicorp’s unitary group was not itself

taxable in California is the apportionment method that is

most consistent with the fundamental theory of unitary

business formula apportionment. While a state is per-

fectly free to exclude consideration of such sales in the

determination of its apportionable income base, as Cali-

fornia has done prospectively, there is no provision in the

Constitution that requires it to do so. If the sales of

Citibank South Dakota must be excluded from the appor-

tionable income base under the Constitution, it would

follow that all sales of goods to a state by a member of a

unitary group that is nontaxable in the destination state

would have to be excluded from the numerator of the

25

State’s sales factor. Such a result would hardly reflect a

reasonable apportionment of income among the jurisdic-

tions in which the unitary business conducts its activities

which, after all, is the ultimate goal of formula apportion-

ment. Indeed, it would have just the opposite effect. More

importantly, Citicorp has failed to cite a single authority

interpreting the limitation on the states’ powers of taxa-

tion in this manner.

CONCLUSION

For all of the foregoing reasons, the petition for writ

of certiorari should be denied.

Respectfully submitted,

Bitt Lockyer

Attorney General

RANDALL P. BORCHERDING

Supervising Deputy Attorney

General

Davip Lew

Deputy Attorney General

Counsel of Record

NorMan Scott

Deputy Attorney General

1515 Clay Street, 20th Floor

Oakland, California 94612-1413

Telephone: (510) 622-2225

Counsel for Respondent

App. 1

APPENDIX A

RELEVANT CALIFORNIA STATUTES

Cal. Rev. & Tax Code § 23151 (1997)

§ 23151. Imposition and rate of tax

(a)With the exception of banks and financial corpora-

tions, every corporation doing business within the limits

of this state and not expressly exempted from taxation by

the provisions of the Constitution of this state or by this

part, shall annually pay to the state, for the privilege of

exer sing its corporate franchises within this state, a tax

according to or measured by its net income, to be com-

puted at the rate of 7.6 percent upon the basis of its net

income for the next preceding income year, or if greater,

the minimum tax specified in Section 23153.

(b) For calendar Or fiscal years ending after June 30,

1973, the rate of tax shall be 9 percent instead of 7.6

percent as provided by subdivision (a).

(c) For calendar or fiscal years ending in 1980 to

1986, inclusive, the rate of tax shall be 9.6 percent.

(d) For calendar or fiscal years ending in 1987 to

1996, inclusive, and for any income year beginning before

January 1, 1997, the tax rate shall be 9.3 percent.

(e) For any income year beginning on or after Janu-

ary 1, 1997, the tax rate shall be 8.84 percent. The change

in rate provided in this subdivision shall be made with-

out proration otherwise required by Section 24251.

App. 2

Cal. Rev. & Tax Code § 25101 (1982)

§ 25101. Basis of Allocation

When the income of a taxpayer subject to the tax

imposed under this part is derived from or attributable to

sources both within and without the state the tax shall be

measured by the net income derived from or attributable

to sources within this state in accordance with the provi-

sions of Article 2 (commencing with Section 25120). How-

ever, any method of apportionment shall take into

account as income derived from or attributable to sources

without the state, income derived from or attributable to

transportation by sea or air without the state, whether or

not the transportation is located in or subject to the

jurisdiction of any other state, the United States or any

foreign country.

If the Franchise Tax Board reapportions net income

upon its examination of any return, it shall, upon the

written request of the taxpayer, disclose to it the basis

upon which its reapportionment has been made.

Cal. Rev. & Tax Code § 25135 (1966)

§ 25135. Determination of sales in this state of tangible

personal property for inclusion in sales factor

Sales of tangible personal property are in this state if:

(a) The property is delivered or shipped to a pur-

chaser, other than the United States government, within

this state regardless of the f.o.b. point or other conditions

of the sale; or

App. 3

(b) The property is shipped from am office, store,

warehouse, factory, or other place of storage in this state

and (1) the purchaser is the United States government or

(2) the taxpayer is not taxable in the state of the pur-

chaser.