Appendix — Barclays Bank PLC v. Franchise Tax Board of California

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92-212

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In the Supreme Court

OF THE

United States

OcTOBER TERM, 1992

BARCLAYS BANK PLC

Petitioner,

VS.

FRANCHISE TAX BOARD,

An Agency of the State of California

Respondent.

APPENDICES TO

PETITION FOR A WRIT OF CERTIORARI

TO THE SUPREME COURT OF

THE STATE OF CALIFORNIA

JOANNE M. GARVEY

Counsel of Record

JOAN K. IRION

TERESA A. MALONEY

HELLER, EHRMAN, WHITE &

MCAULIFFE

333 Bush Street

San Francisco, CA 94104-2878

(415) 772-6000

Attorneys for Petitioner

BOWNE OF SAN FRANCISCO, INC. « 180 NINTH ST. + &.F.. CA 84103 + (415) 864-2300

Appendix A:

Appendix B:

Appendix C:

Appendix D:

Appendix E:

Appendix F:

Appendix G:

TABLE OF CONTENTS

APPENDICES

Opinion of the Supreme Court of California

May 11, 1992.

Opinion of the Court of Appeal of the State of

California in and for the Third Appellate Dis-

trict, November 30, 1990.

Statement of Decision of the Superior Court of

California, County of Sacramento, August 20,

1987.

Constitutional and Statutory Provisions Involved.

Rule 29.1 List.

Brief of the United States as Amicus Curiae in

the Supreme Court of California.

Franchise Tax Board Notice No. 89-714,

November 17, 1989.

APPENDIX A

IN THE SUPREME COURT OF

THE STATE OF CALIFORNIA

BARCLAYS BANK INTERNATIONAL, LTD.,

Plaintiff and Respondeni,

Vv.

FRANCHISE TAX BOARD,

Defendant and Appellant.

BARCLAYS BANK OF CALIFORNIA,

Plaintiff’ and Respondent,

Vv.

FRANCHISE TAX BOARD,

Defendant and Appellant.

S019064

Ct. App. No. C003388

Sacto. Super. Ct.

Nos. 325059 and 352061

Supreme Court Filed May 11, 1992

Robert Wandruff Clerk

DEPUTY

We granted review to decide whether the use by the state

Franchise Tax Board of a three-factor formula to apportion the

income of a foreign-parent multicorporate unitary enterprise for

State tax purposes violates the foreign commerce clause of the

federal Constitution (art. I, § 8, cl. 3). We conclude that relevant

treaty and other materials manifest a federal intent not to prohibit

the states from employing formula apportionment in taxing the

income of such a multinational unitary business. We therefore

reverse the judgment of the Court of Appeal.

A-2

I

Plaintiff taxpayers, Barclays Bank of California and Barclays

Bank International, Ltd. (collectively, the Bank), brought this

refund action to recover assessments of $152,420 and $1,678

levied against them by the Franchise Tax Board (Board) for the

1977 tax year. The basis for the assessments was a finding by the

Board that, together with their United Kingdom-based corporate

parent and related worldwide subsidiaries, the Bank comprised a

unitary enterprise, thereby subjecting it to the three-factor mathe-

matical formula used by the Board to apportion the interjurisdic-

tional income of a unitary business for state corporate income tax

purposes.’ Although the Bank did not contest the Board’s predi-

cate finding of corporate unity, it did claim that application of

California’s apportionment formula to such a_ unitary

group — that is, one whose corporate parent is a foreign domicili-

ary — violates the foreign commerce clause of the federal

Constitution.

Following a bench tnal, the superior court ruled in favor of the

Bank; the Court of Appeal affirmed, holding that California’s

‘During 1977, the tax year at issue here, Revenue and Taxation Code

secuon 25101 provided in relevant part: “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 provisions of Article 2 (commencing with

Section 25120 of this chapter);...”

Section 25120 et seq. of the Revenue and Taxation Code is Califor-

nia’s version of the Uniform Division of Income for Tax Purposes Act

(UDITPA; see 7A West's U. Laws Ann. (1985) p. 331); as explained

more fully later in this opinion, the statute authorizes the use of a three-

factor formula to apportion the net income from a taxpayer's total

business activities in order to determine the net income attributable to

intrastate activities. (See post, p. __ et seq. [typed maj. opn. p. 5 et

seq.]; Rev. & Tax. Code, §§ 25120-25140.)

In this opinion, we sometimes use the term “formula apportionment”

as a shorthand description of this three-factor mathematical formula

employed by the Board to apportion for state tax purposes the interjuris-

dictional income of a worldwide or domestic unitary enterprise.

A-3

formula apportionment method was unconstitutional as applied to

foreign-based unitary groups. In the view of the Court of Appeal,

use of the Board’s method in such a case violated the foreign

commerce clause in two respects. First, its application to a so-

called “foreign parent” unitary business implicated foreign policy

issues that were constitutionally required to be left to the federal

government. Second, use of the formula apportionment method in

the Bank’s case was at odds with a clear federal directive

embodied in presidential and cabinet-level statements, letters, and

press releases, task force reports and the congressional testimony

of senior executive officials to the effect that American foreign

commercial policy supported the use of an alternative accounting

method to determine the taxable income of foreign-based corpo-

rations, one that is incompatible with formula apportionment.

As the Court of Appeal recognized, this suit is not the first

liugation challenging on foreign commerce clause grounds the

Board’s use of a three-factor formula to apportion the worldwide

income of a multinational enterprise. In Container Corp. v.

Franchise Tax Bd. (1983) 463 U.S. 159 (Container), the United

States Supreme Court sustained against foreign commerce clause

challenge the Board’s use of formula apportionment to determine

the taxable income of a domestic-based unitary business group

with foreign-domiciled subsidiaries. Despite the outcome in

Container, the Bank successfully contended before the Court of

Appeal that issues implicated by its foreign parentage are disposi-

tive of the constitutional question and compel the opposite result

in this case.

Although presented with a question left open in Container

(supra, 463 U.S. at p. 189, fns. 26 & 32), we approach its

resolution along a path illuminated by the high court’s analysis in

a series of recent opinions, Container among them, in the contem-

porary evolution of the “dormant foreign commerce clause”

doctrine. Our opinion has two parts. As a prelude to the constitu-

tional question, we first examine the extralegal issues raised by

competing methodologies used to distribute multijurisdictional

corporate income for state tax purposes; we then address the

Bank’s central contention that a dormant foreign commerce

clause analysis is appropriate here and that the Board’s applica-

A-4

tion of formula apportionment to the Bank’s unitary business does

not survive that analysis.

As we explain, neither of the two competing models used to

allocate interjurisdictional income for state tax purposes is de-

monstrably superior to the other, even in an international mul-

ticorporate setting. Both methods meet the constitutional

standard of avoiding “unreasonably” attributing extrastate value

to the taxing jurisdiction. Moreover, the high court’s recent

foreign commerce clause jurisprudence reflects a diminution in

the reach of dormant foreign commerce clause analysis in favor of

an expanded recognition that, under circumscribed conditions,

governmental silence may constitute a ratification of state taxa-

tion of foreign commerce, rendering a dormant analysis inappo-

site. In our view, this is such a case.

II

Background. State Taxation of International Income

A

Limitations on taxation by the states of the income of corpora-

tions doing business in more than one jurisdiction inevitably

implicate the sufficiency of quantitative measures used to identify

that portion of taxable value reasonably attributable to the tax-

payer's intrastate activities. This pivotal role of technique arises

from the stricture of the commerce and due process clauses of the

federal Constitution that “‘a State may not tax value earned

outside its borders.” (ASARCO Inc. v. Idaho State Tax Comm'n

(1982) 458 U.S. 307, 315 (ASARCO).) To meet this limitation,

State tax schemes must comply with multiple criteria designed to

produce a substantially accurate distribution of income so that

only “values created by business within its borders” are taxed.

(Butler Bros. v. McColgan (1942) 315 U.S. 502, 507 (Butler

Bros.).)

Two distinct models have long competed for supremacy in

identifying the required division of multijurisdictional income.

One model, known as the “arm’s length7separate accounting” or

“AL/SA” method, calculates income on a discrete and circum-

A-5

scribed basis, whether geographical, transactional, or functional.

In a multicorporate interjurisdictional setting, the AL/SA

method allocates income to a single taxing “sovereign” rather

than apportioning it among jurisdictions, and treats intercorporate

transfers of value between commonly held or related entities as if

they were “arm’s length” transactions between unaffiliated busi-

nesses. There seems little reason to doubt that, as an operauonal

matter, the AL/SA model is the dominant method employed by

corporations both in the United States and internationally; that is,

a majority of businesses use the AL/SA or a variant method for

their own internal accounting purposes.

The competing model for taxation purposes is the “unitary

business/formula apportionment” method. Founded on the per-

ception that “[i]n the case of a more-or-less integrated business

enterprise operating in more than one State . . . arriving at precise

territorial allocations of ‘value’ is often an elusive goal, both in

theory and in practice” (Container, supra, 463 U.S. at p. 164),

formula apportionment relies on mathematical generalization to

distribute an aliquot share of income or taxable value among

taxing jurisdictions. The dominant variation of formula apportion-

ment — the so-called “three-factor” model employed by the

Board in this case — defines the multijurisdictional scope of the

unitary enterprise of which the taxable intrastate activities are a

part, calculates the combined income of the components of the

unitary group, and distributes a portion of that result to the taxing

state using a mathematical formula based on an averaged ratio of

property, payroll, and sales in the taxing jurisdiction to that of the

unitary enterprise overall.? (See Container, supra, 463 U.S. at

p. 165.)-

? . es . . . . °

“Thus, the taxable income of a multjurisdictional unitary taxpayer in

a State using the three-factor variant of formula apportionment would be

calculated under the following equation:

In-state In-state In-state

Property + Payroll + Sales Total Income

Total Total Total X Corporate = Taxable by

Property Payroll Sales Income the state

3

A-6

So far as taxation of United States-derived income is con-

cerned, the use of formula apportionment is both established and

noncontroversial, being the preferred method of a majority of the

States; a substantially smaller number of American jurisdictions

— California among them — combine and apportion the world-

wide income of multinational corporate taxpayers, a variant some-

times referred to as the “worldwide combined reporting” or

“WWCR” method.’

_ Although AL/SA is the method of choice for corporate opera-

tional and internal accounting purposes, its recognized deficien-

cies in purpo. ing to locate and assign taxable value to a particular

jurisdiction reduce its appeal among state tax administrators, the

chief proponents of competing apportionment methods. These

critics cite several shortcomings in the AL/SA method: compara-

tive distortions in measuring income, and a resulting overtaxation

or undertaxation; administrative complexity generated by the

need to analyze thousands of intercorporate transactions; and the

common absence of uncontrolled comparable prices by which to

verify the value of intercorporate “‘arm’s length” transactions.‘

*(See Moorman Mfg. Co. v. Bair (1978) 437 U.S. 267, 283, fn. 1

(Powell, J., dis.) [45 of 50 states use some form of income apportion-

ment]; Trinova Corp. v. Michigan Dept. of Treasury (1991) ___ US.

___, ___ [111 S.Ct. 818, 831-832]; see also Chairman’s Rep. and

Supplemental Views, Final Rep. of the Worldwide Unitary Taxation

Working Group (Aug. 1984) (hereafter Chairman's Report) p. 1 [all 45

States that levy a corporate income tax use formula apportionment to

distnibute taxable income of single multijurisdictional corporations];

U.S. General Accounting Office, Key Issues Affecting State Taxation of

Multijurisdictional Corporate Income Need Resolving (July I, 1982)

GAO/GGD-82-38 (hereafter GAO Report), at appen. II, pp. 58-67

[tabular breakdown in use of apportionment variants among the

states ].)

“The critical literature assessing both methods is extensive. (For a

sampling, see Chairman's Rep., supra; GAO Rep., supra; Note, State

Worldwide Unitary Taxation: The Foreign Parent Case (1985) 23

Colum. J. Transnat’l L. 445; Comment, California's Corporate

Franchise Tax: Taxation of Foreign Source Income? (1980) 20 Santa

A-7

More fundamentally, critics of the AL/SA method have

pointed to a theoretical failure of the model to account for income

created by the effects of unitary interdependency. As the high

court has stated in the case of a unitary business enterprise,

“separate [geographical] accounting, while it purports to isolate

portions of income received in various States, may fail to account

for contributions to income resulting from functional integration,

centralization of management, and economies of scale. [Cita-

tion.] Because these factors of profitability arise from the opera-

tion of the business as a whole, it becomes misleading to

characterize the income of the business as having a single

identifiable ‘source.’” (Mobil Oil Corp. v. Commissioner of

Taxes (1980) 445 U.S. 425, 438 (Mobil Oil).)

Of course, formula apportionment has its critics, as well. They

too point to distortions in the measurement of taxable income,

especially in a multinational setting where a relatively larger

proportion of foreign to United States activities may result in

overtaxation of the income of foreign-based unitary businesses;

the substantial administrative burden of complying with income

reporting requirements in United States dollars and accessing

financial information that in some cases may be in the hands of

literally hundreds of worldwide corporate affiliates; and the ab-

sence of uniform standards among the states for defining a unitary

Clara L.Rev. 123; Rudy, The California Unitary Tax Concept as

Applied to the Worldwide Activities of Foreign Corporations: A Modern

Commerce Clause Analysis (1980-81) 15 U.S.F. L.Rev. 371; Note,

Multinational Corporations and Income Allocation under Section 482 of

the Internal Revenue Code (1975-1976) 89 Harv.L.Rev. 1202; Helier-

stein, State Income Taxation of Multijurisdictional Corporations: Re-

flections on Mobil, Exxon, and H.R. 5076 (1978) 79 Mich. L.Rev. 113;

Hellerstein, State Income Taxation of Multijurisdictional Corporations,

Part II: Reflections on ASARCO and Woolworth (1982) 81 Mich.

L.Rev. 157; Hellerstein, State Taxation Under the Commerce Clause:

An Historical Perspective (1976) 29 Vand. L.Rev. 335; Corrigan,

Interstate Corporate Income Taxation— Recent Revolutions and a

Modern Response (1976) 29 Vand. L.Rev. 423; Langbein, The Unitary

Method and the Myth of Arm's Length (1986) 30 Tax Notes 625; see

also Hearings Before the House Com. on Ways and Means on H.R. No.

5076, 96th Cong., 2d Sess. (1980).)

a

A-8

business.” Not surprisingly, partisans on both sides of the issue

contend that their method is the accepted standard — in the

international arena in the case of AL/SA, and in the taxation of

multijunisdictional unitary groups in the case of formula

apportionment.°

B

The United States Supreme Court first considered the suffi-

ciency of formula apportionment in the constitutional sense over

70 years ago, upholding Connecticut's use of a single-factor

formula to apportion the income of a Connecticut business

machine manufacturer whose products were marketed nationally.

The high court rejected the taxpayer's due process claim that the

formula taxed business conducted “beyond the boundaries of the

State.” As the Supreme Court explained, “|t]he profits of the

[company are] largely earned by a series of transactions begin-

ning with manufacture in Connecticut and ending with the sale in

other states.... The legislature in attempting to put on this

business its fair share of the burden of taxation was faced with the

impossibility of allocating specifically the profits earned by the

processes conducted within its borders.” (Underwood T'writer

Co. v. Chamberlain (1920) 254 U.S. 113, 120-121

(Underwood).)

Since Underwood, supra, 254 U.S. 113, the Supreme Court has

confronted recurrent claims of the comparative superiority of

each of these two theoretically irreconcilable techniques in re-

sponding to the distributive imperatives of the commerce clause.

Despite claims of the surpassing merit of the separate accounting

method, the court has refused to erect a “theoretical constitu-

tional preference for one method of taxation over another” by

mandating its use. (Mobil Oil, supra, 445 U.S. at p. 444.)

*(See, e.g., Chairman's Rep., supra, at pp. 1-8; GAO Rep., supra, at

pp. 32-40; and matenals cited ante, at fn. 4.)

The trial court found as a matter of fact that the AL/SA method was

the “international standard of accounting” and that “[n]o other system

is used internauonally.”

A-9

Likewise, it has rejected appeals to prescribe a variant of the

formula apportionment method as a uniform national standard for

interstate taxation. (Moorman Mfg. Co. v. Bair, supra, 437 U.S.

267, 278 (Moorman).)

Although the high court has refused to impose “national

uniform rules for the division of income” rooted in the commerce

clause (Moorman, supra, 437 U.S. at p. 279), it has repeatedly

validated the comparative empirical accuracy and constitutional

adequacy of formula apportionment. Thus, not long after uphold-

ing the due process sufficiency of formula apportionment in

Underwood, supra, 254 U.S. 113, the court authorized its use in a

multinational setting to apportion the combined income of a

United Kingdom-headquartered brewer whose separate account-

ing showed no United States net income for the tax years at issue.

Contending that the state was in effect taxing foreign income, the

taxpayer asserted violations of the foreign commerce and due

process clauses. (Bass, Etc., Lid. v. Tax Comm. (1924) 266 U.S

271 (Bass).)

The high court rejected the challenge. The taxpayer’s business,

the court explained, was a unitary enterprise conducted transna-

tionally, “in which its profits were earned by a series of transac-

tions beginning with the manufacture in England and ending in

sales in New York and other places — the process of manufactur-

ing resulting in no profits until it ends in sales. . . ." The state was

thus justified “in attributing to [itself] a just proportion of the

profits earned by the Company from such [a] unitary business.”

Moreover, since the taxpayer had failed, as in Underwood, supra,

254 U.S. 113, to show that formula apportionment “produced an

unreasonable result,” its use was not unconstitutional. (Bass,

supra, 266 U.S. at pp. 282, 283.) |

In Butler Bros., supra, 315 U.S. 502, the taxpayer also chal-

lenged the state’s use of formula apportionment on the ground

that separate accounting showed its sales office in the taxing

jurisdiction had no net income for the tax year at issue and that

apportionment thus resulted in the taxation of extraterritonal

value. The court rejected this showing as insufficient, explaining

that it “need not impeach the integrity of [the separate] account-

ing system to say that it does not prove [taxpayer's] assertion that

A-10

extraterritorial values are being taxed. ... A particular accounting

system, though useful or necessary as a business aid, may not fit

the different requirements when a State seeks to tax values

created by business within its borders.”’ (/d., at p. 507.)

And in Exxon Corp. v. Wisconsin Dept. of Revenue (1980) 447

U.S. 207, the court rejected the attempt of a vertically integrated,

multistate petroleum company to demonstrate, based on its iater-

nal use of the separate accounting method applied to distinct

operating divisions, that income was allocable to extrastate com-

ponents and thus constitutionally was not subject to apportion-

ment. “[A] company’s internal accounting techniques are not

binding on a State for tax purposes,” the court wrote. ““Exxon’s

use of separate functional accounting . . . does not defeat the clear

and sufficient nexus between [its] interstate activities and the

taxing State’’ upon which the finding of corporate unity was

based. [/d., at pp. 221, 225.)

Again, in Mobil Oil, supra, 445 U.S. 425, a nondomiciliary

corporate taxpayer challenged the state’s inclusion in its appor-

uonment formula of foreign source dividend income received by

the taxpayer from subsidiaries and affiliates, on the ground that its

foreign ongin made it constitutionally unapportionable. Although

the taxpayer was able to isolate its foreign dividend income using

separate accounting, the court observed that “the linchpin of

apportionability in the field of state income taxation is the unitary

business principle.” (/d., at p. 439.) The divisibility of income

produced by a ‘separate accounting treatment, the court said,

“may fail to account for contributions to income resulting from

functional integration, centralization of management, and econo-

mies of scale.... Although separate geographical accounting

may be useful for internal auditing, for purposes of state taxation

it is not constitutionally required.” (/d., at p. 438.) (See also

ASARCO, supra, 458 U.S. 307; F. W. Woolworth Co. v. Taxation

& Revenue Dept. (1982) 458 U.S. 354; and Amerada Hess Corp.

v. N. J. Taxation Div. (1989) 490 U.S. 66, 74.)

in a slightly different context, the high court recently re-

affirmed its views of both the theoretical problems inherent in

locating the “source” of multijurisdictional income, and the

validity for commerce clause purposes of the formula apportion-

eS mm

A-ll

ment method. Last term, in upholding Michigan's “value added”

tax against commerce clause challenge, the court wrote that “the

discrete components of a state income tax may appear in isolation

susceptible of geographic designation. Nevertheless, since Under-

wood ... we have recognized the impracticability of assuming

that all income can be assigned to a single source.” (7rinova

Corp. v. Michigan Dept. of Treasury, supra, US.

[111 S.Ct. 818, 831].)

The court went on to reiterate its statement in Container,

supra, 463 U.S. at page 170, that the three-factor formula “has

become something of a benchmark against which other appor-

tionment formulas are judged,” noted its incorporation into

UDITPA, adopted by almost half of the states, and acknowledged

its accuracy in reflecting “the activities by which [taxable] value

is generated.” “The same factors,” the court wrote, “that prevent

determination of the geographic location where income is gener-

ated, factors such as functional integration, centralization of

management, and economies of scale, make it impossible to

determine the location of value added with exact precision.”

(Trinova Corp. v. Michigan Dept. of Treasury, supra, US.

=n (545 SAX, OO. Been

Thus, the rule that has emerged from this series of high court

encounters — spanning over 70 years — with the contending mer-

its of two “theoretically incommensurate” systems (Mobil Oil,

supra, 445 US. at p. 444) is that, for state tax purposes, neither

the commerce clause nor the due process clause of the federal

Constitution mandates the use of a particular methodology to

allocate or distribute multijurisdictional income. Either of the two

principal methods and their variants is constitutionally permissi-

ble, as long as the one chosen does not operate “‘unreasonably and

arbitrarily” to attribute to the taxing state a percentage of total

income “out of all appropriate proportion to the business trans-

acted by the [taxpayer] in that State.” (Hans Rees’ Sons v. No.

Carolina (1931) 283 U.S. 123, 135.) Or, as the high court stated

in Moorman, supra, 437 U.S. 267, 274, “the States have wide

latitude in the selection of apportionment formulas and...a

formula-produced assessment will only be disturbed when the

taxpayer has proved by clear and cogent evidence that the income

A-12

attnbuted to the State is in fact out of all appropriate proportion

to the business transacted... in that State.” (Internal quotation

marks omitted. )

We present this extended account of the competing division-of-

income methods and their treatment at the hands of the high

court in order to meet at the outset the Bank’s unpersuasive

contenuon that formula apportionment is an inherently inequita-

ble method, at least when applied to foreign-based unitary groups

such as the Bank and its affiliates.’ In substance, this argument is

no different from the one explicitly rejected by the court in

Container, supra, 463 U.S. 159. There the taxpayer presented

related challenges to California’s use of the three-factor formula

to apportion the global income of a domestic-based unitary

enterprise. Specifically, the taxpayer claimed that its foreign

affiliates were significantly more profitable, and that by ignoring

underlying economic realities such as lower wage and production

costs among its foreign subsidiaries, three-factor formula appor-

tionment systematically distorted the “true” allocation of income

between unitary components, unfairly inflating the income appor-

tioned to California.

“The problem with this argument,” the court said, “is...

[that] the profit figures relied on by [the taxpayer] are based on

precisely the sort of formal geographical accounting whose basic

theoretical weaknesses justify resort to formula apportionment in

the first place.” And the difficulty with the taxpayer’s evidence of

differing costs, the court said, “is that it does not by itself come

’To forestall any conceptual misunderstanding, we note that one of

the two elements of the dormant foreign commerce clause analysis

developed by the high court in Japan Line, Lid. v. County of Los

Angeles (1979) 441 U.S. 434 and subsequent cases (see post, p. — et

seq. [typed maj. opn. p. 19 et seq.]) is the risk of multiple taxation

posed by the challenged state taxation method. Although the high

court's assessment of the principal division of income methods speaks to

that risk, the foregoing summary is undertaken for the limited purpose of

gauging the comparative technical or “accounting” merits of the two

models, not as part of a dormant commerce clause analysis. (See post,

p. — et seq. [typed maj. opn. p. 33 et seq.].)

A-13

close to impeaching the basic rationale behind the three-factor

formula. ...[{{]] Both geographical accounting and formula ap-

portionment are imperfect proxies for an ideal which is not only

difficult to achieve in practice, but also difficult to describe in

theory....” (Container, supra, 463 U.S. at p. 182.) “Of course,

even the three-factor formula is necessarily imperfect,” the court

continued, “‘[b]ut we have seen no evidence demonstrating that

the margin of error (systematic or not) inherent in the three-

factor formula is greater than the margin of error (systematic or

not) inherent in the sort of separate accounting urged upon us by

[taxpayer].” (/d., at pp. 183-184.)

In light of this analysis and the precedents summarized above,

we conclude that, in considering the Bank’s case for relief, neither

of the two methods can lay claim to a decisive technical superior-

ity or greater constitutional stature than the other.* We turn, then,

to the merits of the Bank’s contention that a dormant foreign

commerce clause analysis renders unconstitutional the Board’s

application of the three-factor apportionment formula to the

Bank’s unitary enterprise.

*The Bank argues that the conclusion in the Container opinion

(supra, 463 U.S. at p. 184) that three-factor formula apportionment is a

“proper and fair method of taxation” does not mean that its application

to foreign-based multinationals produces an accurate determination of

their intrastate income. The Container characterizations, the Bank

contends, are merely the outcome of the four-part dormant interstate

commerce clause analysis developed in Complete Auto Transit, Inc. v.

Brady (1977) 430 U.S. 274. This argument stnkes us as semantical at

best.

The court made clear in Trinova Corp. v. Michigan Dept. of Treasury,

supra, US. [111 S.Ct. 881, 835], that if a state tax

complies with the requirement of fair apportionment, constitutonal

demands are exhausted. Moreover, even under a dormant foreign

commerce clause analysis, both the trial court and the Court of Appeal

concluded — largely under the compulsion of the identical holding in

Container, supra, 463 U.S. 159 — that the Board’s use of worldwide

formula apportionment in this case did not offend the nsk-of-multiple-

taxation leg of the dormant analysis.

III

The Dormant Foreign Commerce Clause Doctrine

Despite the framers’ explicit commitment to Congress of the

power to “regulate commerce with foreign nations, and among the

several states” (U.S. Const., art. I, § 8, cl. 3), by far the bulk of

commerce clause jurisprudence has been developed by the high

court itself under the judicially created doctrine of the “‘unexer-

cised,” “negative,” or “dormant” commerce clause. From its

origin early in the nation’s constitutional history with the opinion

of Chief Justice Marshall in Gibbons v. Ogden (1824) 22 US.

(9 Wheat.) 1, 209, through its reformulation at the hands of

Justice Curtis in Cooley v. Board of Wardens of Port of Philadel-

phia et al. (1852) 53 U.S. (12 How.) 298, the high court has

posited irreducible and self-executing constitutional minima that

limit state action affecting interstate and foreign commerce, even

where Congress has failed to exert its plenary commerce clause

power. “[T]he Commerce Clause was not merely an authoriza-

tion to Congress to enact laws for the protection and encourage-

ment of commerce among the States, but by its own force created

an area of trade free from interference by the States. In short, the

Commerce Clause even without implementing legislation by

Congress is a limitation upon the power of the States....”

(Freeman v. Hewit (1946) 329 U.S. 249, 252; see also Southern

Pacific Co. v. Arizona (1945) 325 U.S. 761, 769 [“For a hundred

years it has been accepted constitutional doctrine that the com-

merce clause, without the aid of Congressional legislation...

affords some protection from state legislation inimical to the

national commerce, and that in such cases, where Congress has

not acted, this Court, and not the state legislature, is under the

commerce clause the final arbiter of the competing demands of

state and national interests. [Citations.]"”]; Hood & Sons v. Du

Mond (1949) 336 U.S. 525, 534; Northwestern Cement Co. v.

Minn. (1959) 358 U.S. 450, 458; Hughes v. Oklahoma (1979)

441 U.S. 322, 326, fns. 2 & 3; Wyoming v. Oklahoma (Jan. 22,

SPE) consensus : [60 U.S.L. Week 4119, 4124].)

In the modern era, the consolidative work of the court led it to

recast the interstate dimension of the dormant commerce clause

doctrine as it applies to state taxation. In Complete Auto Transit,

eS

A-15

Inc. v. Brady, supra, 430 U.S. 274, the court adopted a four-part

test to evaluate state tax schemes to ensure compliance with the

inherent demands of the “unexercised”’ commerce clause. If a tax

“is applied to an activity with a substantial nexus with the taxing

State, is fairly apportioned, does not discriminate against inter-

state commerce, and is fairly related to the services provided by

the State,” it does not burden impermissibly interstate commerce.

(/d., at p. 279.)

This four-part test is not adequate, however, to subserve the

additional policies underlying the foreign commerce clause. In

Japan Line, Lid. v. County of Los Angeles, supra, 441 U.S. 434

(Japan Line), the court held that “[w]hen construing Congress’

power to ‘regulate Commerce with foreign Nations,’ a more

extensive constitutional inquiry is required.” (Jd., at p. 446.)

Specifically, “two additional considerations, beyond those articu-

lated in Complete Auto, come into play.” (Jbid.) “In addition to

answering the nexus, apportionment, and nondiscrimination ques-

tions posed in Complete Auto, a court must also inquire, first,

whether the tax, notwithstanding apportionment, creates a sub-

stantial risk of international multiple taxation, and second,

whether the tax prevents the Federal Government from ‘speaking

with one voice when regulating commercial relations with foreign

governments.’ If a state tax contravenes either of these precepts, it

is unconstitutional under the [foreign] Commerce Clause.” (/d.,

at p. 451, emphasis added.)

Although the court’s opinion in Japan Line, supra, 441

U.S. 434, stressed the paramount national need for and plenary

nature of congressional power over foreign commerce — greater,

perhaps, than Congress’s textually parallel power over interstate

commerce (id., at p. 448 & fns. 12-13) — as one of the funda-

mental policies animating the framers, it had little to say concern-

ing the preemptive role of Congress in defining the contours of

permissible state taxation of foreign commerce. The court illumi-

nated that question a year later when it decided Mobil Oil, supra,

445 U.S. 425, a challenge by Mobil to Vermont’s tax on foreign

dividend income. Rejecting what it termed Mobil’s “forced”

analogy to California’s tax on Japanese shipping containers at

issue in Japan Line, the court said that the real issue before it was

0

A-16

not one of multiple taxation at the international level, as in Japan

Line, but of multiple taxation at the state level.

“Concurrent federal and state taxation of income, of course, is

a well-established norm,” the court wrote. “Absent some explicit

directive from Congress, we cannot infer that treatment of foreign

income at the federal level mandates identical treatment by the

States. The absence of any explicit directive to that effect is

attested by the fact that Congress has long debated, but has not

enacted, legislation designed to regulate state taxation of income.

[Citations.]” (Mobil Oil, supra, 445 U.S. at p. 448, emphasis

added.)

The view taken in Mobil Oil, supra, 445 U.S. 425, that

Congress, under its “ ‘exclusive and absolute’ power . . . over for-

eign commerce” (Japan Line, supra, 441 U.S. at p. 448, fn. 13,

quoting Buttfield v. Stranahan (1904) 192 U.S. 470, 492), is the

source of “explicit directive[s]” preempting state taxation of

foreign commerce, was amplified in the court’s treatment of the

issue in Container, supra, 463 U.S. 159. The court first noted that

“allocating income among various jurisdictions bears some resem-

blance. . . to slicing a shadow,” and concluded that “it would be

perverse, simply for the sake of avoiding double taxation, to

require California to give up one allocation method that some-

times results in double taxation [i.e., formula apportionment] in

favor of another allocation method [i.e.. AL/SA] that also

sometimes results in double taxation.” (Jd., at pp. 192-193.) It

then turned to the “second inquiry suggested by Japan Line,”

namely, whether California’s use of formula apportionment in an

international context might “ ‘impair federal uniformity in an area

where federal uniformity is essential,’ ’’ and “ ‘prevent the Federal

Government from “speaking with one voice” in international

trade.” ” (Ibid.)

In examining the “one voice” branch of the dormant commerce

clause doctrine, the court in Container was careful to distinguish

between state tax schemes that are unconstitutional because they

implicate foreign affairs and those that, although they may have

“foreign resonances,” are void because they “‘violate[] a clear

federal directive.” While either infirmity will offend the “one

voice” standard, the latter does so, the court said, not as a result

of a dormant commerce clause analysis, but because of “some

explicit directive from Congress.” This latter analysis, the court

noted, “‘is, of course, essentially a species of pre-emption... .”

(Container, supra, 463 U.S. at p. 194, emphasis added.)

Applying the “explicit directive from Congress” language of

Mobil Oil, supra, 445 U.S. 425, and canvassing “specific indica-

tions of congressional intent,” the Container opinion found

neither statutory preemption by Congress nor any requirement

that the AL/SA method be applied to the states in any of the

many bilateral tax treaties to which the United States was a

signatory. Indeed, the court pointed out, “the Senate has on at

least one occasion, in considering a proposed treaty, attached a

reservation declining to give its consent to a provision in the treaty

that would have extended [an AL/SA] restriction to the States.”

(Container, supra, 463 U.S. at pp. 196-197.) “[I]t remains true,”

the court concluded, “as we said in Mobil, that ‘Congress has long

debated, but has not enacted, legislation designed to regulate state

taxation of income.’ ” (/bid.)

Although the court concluded in Container that the Board’s use

of formula apportionment did not violate the foreign commerce

clause under a dormant analysis, it is important for our purposes

to observe that the opinion carefully separates the analytical

thread of congressional preemption from what the court termed a

“more relaxed standard which takes into account our residual

concern about the foreign policy implications of California’s tax.”

(Container, supra, 463 U.S. at p. 197.) In the former case, there

obviously is no need for resort to a dormant analysis since

Congress has explicitly exerted its plenary authority under the

commerce power to preempt a state tax scheme that, far from

“implicating foreign affairs,” has only “foreign resonances.”’ As

*Compare the court's statement in Merrion v. Jicarilla Apache Tribe

(1982) 455 U.S. 130, 154-155, that “we only engage in [dormant

analysis] review when Congress has not acted or purported to act.

[ Citation.] Once Congress acts, courts are not free to review state taxes

or other regulations under the dormant Commerce Clause. When

Congress has struck the balance it deems appropriate, the courts are no

slate tinier

A-18

the Container opinion makes clear, however, the court will not

lightly overturn the historic prerogatives of the states to adminis-

ter their own tax systems. Before being declared nullified by

Congress under this “species of pre-emption,” the “federal direc-

tive” that a state tax scheme allegedly violates must be “‘clear.”

(463 U.S. at p. 194.)

The “more relaxed standard” of a dormant analysis — based on

“residual concern[s]” about the “foreign policy implications” of a

given state tax scheme — is appropriate only “in the absence of

explicit action by Congress” preempting a given state taxation

method. It is undertaken by a judiciary with “little competence in

determining precisely when foreign nations will be offended by

particular acts, and even less competence in deciding how to

balance a particular risk of retaliation against the sovereign right

of the United States as a whole to let the States tax as they

please.” (Container, supra, 463 U.S. at p. 194.) Thus, it is for

reasons of its limited foreign policy expertise that, in conducting a

dormant “one voice” inquiry, the “best that [a court] can do, in

the absence of explicit action by Congress [preempting a chal-

lenged state tax scheme], is to attempt to develop objective

standards that reflect very general observations about the impera-

tives of international trade and international relations.” (Jbid.)

Where they apply, the development of such standards is informed

significantly by the views of executive officials charged with

implementing the nation’s foreign policy — including its foreign

commercial policy — “whose nuances ... are much more the

province of the Executive Branch and Congress than of this

Court.” (/d., at p. 196.)

As might be expected, the Bank argues at length that the

Board’s application of formula apportionment to the unitary

business of which it is a part offends the foreign commerce clause

longer needed to prevent States from burdening commerce, and it

matters not that the courts would invalidate the state tax or regulation

under the Commerce Clause in the absence of congressional action.

[ Citation.] Courts are final arbiters under the Commerce Clause only

when Congress ha: not acted.”

A-19

precisely because it violates a “clear federal directive.” That

directive, the Bank tells us, is embodied in an impressive array of

federal executive communications — presidential statements and

press releases; official letters from cabinet officers charged with

overseeing national monetary, trade, and foreign policies; the

testimony of senior Treasury Department officials; and the “white

paper” of an executive task force established to study and present

recommendations on the issues surrounding state use of formula

apportionment to foreign-based unitary groups. Without excep-

tion, the Bank argues, these executive sources vigorously and

explicitly support the exclusive use of the AL/SA method in such

circumstances and condemn the use of formula apportionment by

the states.

The Court of Appeal essentially agreed with the Bank’s under-

lying premise that executive pronouncements of what national

foreign commercial policy should be qualifies as a source of the

“clear federal directive.” It reasoned that because the Container

opinion (supra, 463 U.S. 159) subsumed the search for specific

indications of congressional intent within the “‘one voice” stan-

dard, congressional intent must therefore be an integral compo-

nent of the dormant commerce clause test. From that analytical

keystone, it had little difficultly in concluding on the basis of a

substantial executive-compiled record that the federal directive

was clear and explicit: according to executive branch officials,

formula apportionment, in the words of the Court of Appeal, “‘is

not to be applied to foreign-based corporate groups — those

groups are to be taxed by the states only on income derived from

the United States.”

Were we confronted with the Bank’s argument in the immedi-

ate aftermath of the Container decision, it might carry some

force, although given the absence of textual support for the

claim — both in the Container opinion and the commerce clause

itself — it is by no means facially convincing. The fact is, how-

ever, that dormant foreign commerce clause jurisprudence has

evolved in the nine years since Container, supra, 463 U.S. 159,

was decided, an evolution that, as we parse the cases, has

reoriented the doctrine. That development has reduced the scope

A-20

for a dormant analysis and makes its invocation here particularly

inappropmiate. .

IV

Wardair: A “Governmental Silence” of a Different Kind.

Three years after its opinion in Container, supra, 463 U.S. 159,

upholding California’s use of formula apportionment in calculat-

ing the intrastate tax liability of a domestic-based unitary busi-

ness, the high court decided Wardair Canada v. Florida Dept. of

Revenue (1986) 477 U.S. 1 (Wardair). At issue was a Canadian-

, based international air carrier’s challenge to an excise tax assessed

by Florida on intrastate fuel purchases by common carriers,

including airlines. The tax was levied at the rate of 5 percent on a

deemed fuel price of $1.148 per gallon; air carriers were liable for

the full amount of the tax whether the fuel was consumed in

flights within or outside the state, regardless of the amount of

intrastate business transacted by the taxpayer. (/d., at p. 4.)

In attacking application of the tax to its Florida fuel purchases

on foreign commerce clause grounds, the carrier — joined by the

United States as amicus curiae — conceded that the tax, being

assessed on discrete intrastate transactions, presented no risk of

multiple international taxation. It relied instead entirely on the

“one voice” element of the dormant foreign commerce clause

analysis, the last of the six factors identified by the court in Japan

Line, supra, 441 U.S. 434.

Specifically, the carrier contended that a patchwork of recipro-

cal tax exemptions, embodied in a network of multilateral agree-

ments and conventions to which the United States was a party,

manifested a national policy to exempt from state taxation the

instrumentalities of international air commerce, including avia-

tion gasoline. Florida’s excise on aviation fuel purchased by a

foreign carrier engaged in international air commerce, the carrier

claimed, was inconsistent with that univocal national policy, thus

threatening “the ability of the Federal Government to ‘speak with

one voice.” (Wardair, supra, 477 US. at p. 9.)

A-21

The high court rejected the claim. Not only did the matrix of

international conventions, resolutions and air commerce agree-

ments relied on by the carrier and the United States fail to sustain

a federal policy pretermiting Florida’s excise on aviation fuel, the

high court said, “but, even more fundamentally, [it] shows also

that in the context of this case we do not confront federal

governmental silence of the sort that triggers dormant Commerce

Clause analysis.” In point of fact, the court continued, “the

international agreements cited demonstrate that the Federal Gov-

ernment has affirmatively acted, rather than remained silent, with

respect to the power of the States to tax aviation fuel, and thus

that the case does not call for dormant Commerce Clause analysis

at all.” (Wardair, supra, 477 U.S. at p. 9.)

As we explain below, the court’s opinion in Wardair, supra, 477

U.S. 1, establishes an interpretive framework for educing from a

compilation of legislative materials a species of governmental

silence that forecloses resort to a dormant foreign commerce

clause analysis. In some cases where Congress affirmatively

declines to adopt certain measures, the resulting governmental

“silence” is not the sort that triggers use of a dormant foreign

commerce clause analysis. Properly applied under the appropriate

conditions, the Wardair methodology interdicts judicial resort to

executive branch opinions as to the international commercial

effect of a challenged state taxation practice because Congress

has “acquiesced in” the contested practice, thereby validating it.

(/d., at p. 12.) Where appropriate, Wardair supplants what the

court has termed the “quagmire” of dormant commerce clause

analysis (Northwestern Cement Co. v. Minn., supra, 358 U.S.

450, 458) with a heightened judicial attentiveness to expressions

of congressional foreign commerce policy. Because it delimits use

of dormant foreign commerce clause analysis in important ways,

it is useful to lay out the analytical lines of the Wardair paradigm

in some detail before applying it to the case before us.

The foreign carrier in Wardair, supra, 477 US. 1, relied on a

hierarchy of multinational agreements to support its thesis that

federal policy precluded state taxation of intrastate aviation fuel

purchases by international carriers: the Chicago Convention on

International Civil Aviation (Convention), signed in 1944 by the

A-22

United States, Canada, and 155 other nations; a resolution

adopted in 1966 by the International Civil Aviation Organization,

of which the United States was a member by virtue of being a

signatory to the Convention; and more than 70 bilateral-interna-

tional aviation agreements between the United States and foreign

nations, including a United States-Canadian aviation agreement.

(Wardair, supra, at p. 10.) But it was these very texts, the high

court concluded, that in combination impeached the existence of

a national policy to exempt international air commerce from state

taxation and, by their “negative implications,” supported an

inference that “the United States has at least acquiesced in state

taxation of fuel used by foreign carriers in international travel.”

(/d., at p. 12.)

First, a provision of the Convention explicitly prohibited taxa-

tion by both national and subnational governmental units of fuel

“on board” arriving international aircraft. The Convention failed,

however, to reach the issue of taxing intrastate fuel purchases by

foreign aircraft following their arrival. This omission, the court

reasoned, demonstrated by “negative implication” the “interna-

tional community’s awareness of the problem of state and locai

taxation of international air travel... and represent[ed] a deci-

sion by the parties to [the] Convention to address the problem by

curtailing... only some of the localities’ power to tax, while

implicitly preserving other aspects of that authority.” ( Wardair,

supra, 477 U.S. at p. 10.)

Second, the resolution relied on by the carrier, although en-

dorsing an international regime prohibiting duties of any kind by

any taxing authority on international air travel, had “not been

specifically endorsed, let alone signed, entered into, agreed upon,

approved, or passed by either the Executive or Legislative Branch

of the Federal Government. In other words, no action has been

taken to give the Resolution the force of law.” (Wardair, supra,

477 U.S. at p. 11.) It thus could not tenably represent, the court

concluded, “a policy of the United States, as opposed to a policy

of an organization of which the United States is one of many

members.” (/bid., emphasis in original.)

Third, in the years following the Convention, the United States

entered into more than 70 bilateral international civil aviation

A-23

agreements, “in not one of [which] has the United States agreed

to deny the States the power asserted by Florida in this case.”

Significantly, most of these agreements “explicitly commit the

United States to refrain from imposing national taxes on aviation

fuel used by airlines of the other contracting party... but...

none... explicitly interdicts state or local taxes on aviation fuel

used by foreign airlines in international traffic.” (Wardair, supra,

477 U.S. at p. 11, emphasis in original internal quotation marks

omitted.) Reenforcing this view, the United States-Canadian

agreement also limited tax exemptions granted foreign air carriers

to “national duties and charges,” an “omission [to reach subna-

tional duties] which must be understood as representing a policy

choice by the contracting parties....” (/bid.)

Summing up the implications of this mosaic of texts for a

dormant commerce clause attack on Florida’s tax, the court

concluded that “[w]hat all of this makes abundantly clear is that

the Federal Government has not remained silent with regard to

the question whether States should have the power to impose

taxes on aviation fuel used by foreign carriers in international

travel.” (Wardair, supra, 477 U.S. at p. 12.) “It would tum

dormant commerce Clause analysis entirely upside down,” the

court continued, “to apply it where the Federal Government has

acted, and to apply it in such a way as to reverse the policy that

the Federal Government has elected to follow. For the dormant

Commerce Clause, in both its interstate and foreign incarnations,

only operates where the Federal Government has not spo-

ken....” (Jbid., first emphasis in original, second emphasis

added.)

For our purposes, the high court’s analysis of the textual

materials in Wardaiz, supra, 477 U.S. 1, can be abstracted into a

kind of protocol for identifying those kinds of governmental

silences that give rise to “negative implications” supporting an

inference of federal acquiescence in the state tax under challenge.

Thus, in Wardair the court found that bilateral recognition of an

international taxation issue and its specific treatment at the

national level (numerous international aviation agreements ex-

empting foreign air carriers from national duties), impliedly

supported a finding that the failure to address the correlative issue

A-24

at the subnational level represented ‘“‘a policy choice by the

contracting parties.” (/d., at p. 11.)

By a kind of parity of reasoning, Wardair found that the explicit

treatment of some subnational aspects of an international taxation

issue (Convention -prohibition on state taxation of fuel aboard

arniving foreign aircraft) supported an inference of international

“awareness of the problem” at the state level and a “deci-

sion ...to address the problem by [limited curtailment of the

subnational power] ... while implicitly preserving other aspects

of [subnational] authority.” (477 U.S. at p. 10.) Last, the court

found that notwithstanding an international aspiration to erect a

particular tax regime (the resolution’s endorsement of the com-

plete eradication of national and subnational duties on interna-

tional air travel), the fact that domestic “/aw as it presently stands

acquiesces in taxation... by political subdivisions” was decisive

of the commerce clause issue. (/bid., emphasis in original.)

Before considering the history of congressional consideration of

curbs on the states’ application of formula apportionment to

foreign-based multinationals in light of the court’s analysis in

Wardair, we first consider the treatment of Wardair at the hands

of the Court of Appeal.

V

The Wardair Canon and Congressional Refusal to Prohibit

State Use of Formula Apportionment

A

As noted ante, the Court of Appeal declined to accept the view

that Wardair, supra, 477 U.S. 1, represents, if not a change of

course in the high court’s dormant foreign commerce clause

jurisprudence, at least a retrenchment in its scope. It also con-

cluded that statements of executive branch officials as to United

States foreign commercial policy could constitute the “clear

federal directive’ component to the “one voice” analysis of Japan

Line, supra, 441 U.S. 434, Mobil Oil, supra, 445 U.S. 425, and

Container, supra, 463 U.S. 159.

———————————

A-25

In our view, both of these conclusions are born of the root error

of failing to grasp the conceptual impact of Wardair, supra, 477

U.S. 1, on dormant foreign commerce clause doctrine. As we

explain, the failure of the Court of Appeal to appreciate

Wardair’s limitations on dormant commerce clause analysis is

cognate to its erroneous view that executive branch aspirations as

to what national foreign commercial policy ought to be can

constitute a “clear federal directive,” at least where, under a

Wardair analysis, Congress has decreed otherwise.

The Court of Appeal rejected the Board’s argument that Japan

Line, Container, and Wardair demonstrate a trend in foreign

commerce clause jurisprudence toward a heightened attention to

governmental expressions of United States foreign commercial

policy. Instead, it concluded that “the theoretical underpinning

has remained intact through these cases.” What was different in

them, it thought, “was the degree to which foreign affairs and

international commercial relations where implicated” by the chal-

lenged state tax scheme.

It may-be that the application of such a theme to these three

cases would produce a coherent alternative explanation of the

results reached by the high court. To contend, however, that

Wardair, supra, 477 U.S. 1, turns on “the degree of which foreign

affairs and international commercial relations were implicated,” is

to misread fundamentally the court’s opinion. Such a view ignores

the high court’s explicit statement that in Wardair it “[did] not

confront federal governmental silence of the sort that tnggers

dormant Commerce Clause analysis,” that the case “does not call

for dormant Commerce Clause analysis at all,” and that “[iJt

would turn dormant Commerce Clause analysis entirely upside

down to apply it where the Federal Government has acted.” (/d.,

at pp. 9, 12.) We are confident that the overarching significance

of Wardair lies in its explicit limitation on when a dormant

foreign commerce clause analysis is appropriate, its affirmation

that the analysis “only operates where the Federal Government

has not spoken,” and its statement that the court “[has] never

suggested... that the Foreign Commerce Clause insists that the

Federal Government speak with amy particular voice.” (/d., at

pp. 12, 13, emphasis in original.)

———————————

A-26

The Court of Appeal’s misapprehension of this central meaning

of Wardair, supra, 477 U.S. 1, led it to a related error — the

conclusion, against the backdrop of an explicit congressional

refusal to adopt curbs on state use of formula apportionment, that

a tnal of letters, press releases, task force reports, transcripts of

congressional testimony of Treasury Department officials, and like

communications orchestrated by the executive branch could con-

stitute a “clear federal directive” condemning state use of formula

apportionment in foreign parent cases. As we have indicated,

however, the “clear federal directive” formulation in Container,

supra, 463 U.S. 159, has no role to play in a dormant foreign

commerce clause analysis; rather, it confirms the preemptive

power of Congress to interdict state tax schemes that would, had

Congress not chosen to act, survive challenge under a dormant

foreign commerce clause analysis because they present only

“foreign resonances.” (/d., at p. 194.)

Whether, in the absence of a congressionally enacted “clear

federal directive,” the executive branch can itself assume a

preemptive role and in effect nullify state tax schemes as they

affect foreign-based businesses is a distinctly different question.

The Court of Appeal, relying principally on the concurring opin-

ion of Justice Jackson in Youngstown Co. v. Sawyer (1952) 343

U.S. 579, 634— the famous “steel seizure case” — concluded

that such a nower inhered in the President’s authority to conduct

foreign affairs and that the executive had spoken with sufficient

clarity to prohibit state application of formula apportionment to

foreign parent unitary groups such as the Bank.

In light of Wardair, supra, 447 U.S. 1, we need not and do not

reach this issue. For in the debate over state use of worldwide

formula apportionment — a controversy waged on multiple fronts

by foreign governments, multinationals and their domestic and

foreign affiliates, state tax authorities, senior Treasury and State

Department officials, the White House and Congress — we hear

the din of a “governmental silence” that cannot be ignored. In our

view, Congress, after being repeatedly pushed and pulled in bot?

directions, at least for the present has decided not to prohibit state

use of formula apportionment in cases of this kind. To paraphrase

the Wardair opinion, international agreements demonstrate that

<n pneneeeedeeams ei amen een

A-27

the federal governmental has affirmatively acted, rather than

remained silent, with respect to the power of the states to employ

formula apportionment in so-called foreign parent cases, as a

result, this case does not call for dormant foreign commerce

clause analysis at all. (477 U.S. at p. 9.)

As we explain in some detail below, over the past 25 years,

senior tax and foreign policy officials of the executive branch have

sought to respond to the demands of foreign governments that the

states be barred from applying formula apportionment to deter-

mine the tax liability of foreign-based multinationals. For much of

this period, the chief forum for resulting executive branch initia-

tives was the Senate, where successive administrations sought to

win ratification of a treaty provision barring state use of formula

apportionment. But in 1978, with explicit recognition of the

“negative implications” of its act, the Senate rejected an income

tax convention negotiated by the executive branch with the

United Kingdom whose centerpiece was a provision — art-

cle 9(4) — prohibiting the states from using formula apportion-

ment in determining the intrastate tax liability of United

Kingdom-based multinationals. Only after the ban on state use of

formula apportionment was stricken was the administration able

to muster the two-thirds majority required for Senate ratification

under the treaty clause.

In addition, numerous bilateral tax treaties between the United

States and other nations, although precluding use of formula

apportionment by the signatory national governments, do not

include within that prohibition political subdivisions such as the

states. And while such tax treaties do include subnational govern-

ments within the scope of nondiscrimination provisions, they are

not included within the prescription that the signatory govern-

ments employ an AL/SA methodology in taxing local branches of

foreign corporations. Similarly, so-called “Friendship, Commerce

and Navigation” treaties — a common form of commercial agree-

ment between the United States and its trading partners —

typically require both the federal and state governments to tax

foreign enterprises within their jurisdictions on a “reasonably

allocable or apportionable” basis, a standard which United States

drafters viewed as “intended to cover all the various methods,

i lalallala

A-28

proportionate or otherwise, by which a reasonable tax base might

be determined.” (U.S. State Dept., Standard Draft Treaty of

Friendship, Commerce and Navigation, prepared by Charles H.

Sullivan (Aug. 1980) pp. 202, 203.)

Finally, in the wake of Senate rejection of article 9(4) and the

decision in Container, supra, 463 U.S. 159, upholding California’s

use of worldwide unitary methods in taxing domestic-parent

multinationals, the executive branch scuttled its effort to achieve

treaty-imposed curbs on the states’ use of worldwide formula

apportionment. Instead, the administration proceeded on other

fronts, first seeking the voluntary cooperation of the states in

mitigating the internationally effects of formula apportionment

and, in a new tack, presenting its views in selected litigation

through amicus curiae participation, before again renewing its call

for Congress to enact restrictive legislation.

It is in the course of this undertaking that the executive branch

has produced what the Bank insists is the “clear federal directive”

that sustains its dormant foreign commerce clause case. We

think, however, that rather than qualifying as a “clear federal

directive,” these materials, in the context of Congress’s persistent

refusal to regulate state taxation of multinationals and the Sen-

ate’s explicit rejection of article 9(4) of the United States-United

Kingdom treaty, embody nothing more than executive aspirations

of what the federal government’s policy in this area ought to be.

B

In 1975, the Ford administration concluded a bilateral income

tax convention with the United Kingdom, a central feature of

which was the following provision, article 9(4):

“Except as specifically provided in this Article, in determining

the tax liability of an enterprise doing business in a Contracting

State, or in a political subdivision or local authority of a Con-

tracting State, such Contracting State, political subdivision or

local authority shall not take into account the income, deductions,

receipts, or outgoings of a related enterprise of the other Con-

A-29

tracting State or of an enterprise of any third State related to an

enterprise of the other Contracting State.”'®

When the succeeding Carter administration sought Senate

ratification of the convention, state tax authorities attacked article

9(4) as an infringement on state powers of taxation, reached by

executive branch negotiators without prior consultation with the

states. They vigorously lobbied for its excision. Following a series

of committee and floor votes, the Senate ultimately ratified the

treaty, subject to the telling reservation “that the provisions of

paragraph (4) of Article 9...shall not apply to any political

subdivision or local authority of the United States.” (124 Cong.

Rec. 18416 (1978).)

Explaining one of the motivations behind the reservation,

which in effect struck article 9(4) from the treaty, its chief

proponent objected to executive branch use of “the device of a tax

treaty” to “impose major changes in internal tax policy” by

circumventing congressional consideration of the states’ use of

formula apportionment. (Remarks of Sen. Church, 124 Cong.

Rec. 18416 (1978).) “For some 10 years,” the sponsor of the

reservation stated, “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.” (/bid.) Imme-

diately following ratification of the United States-United King-

dom tax convention as amended by the so-called “Church

reservation,” Senator Javits, a chief sponsor of the treaty, includ-

ing article 9(4), noted that “what we [the Senate] have done is

very serious... We have for all practical purposes eliminated a

very important provision of this treaty [article 9(4)] for which

the United Kingdom believed it had entered into the treaty.”

(Remarks of Sen. Javits, 124 Cong. Rec. 19077 (1978).)

The parallels between this evidence of “governmental silence”

or refusal to act and that regarded as decisive in Wardair, supra,

‘(Convention Between United States and United Kingdom for

Avoidance of Double Taxation, Dec. 31, 1975, 31 U.S.T. 5670, 5677,

T.I.A.S. 9682.)

A-30

477 U.S. 1, seem to us both evident and compelling. As in

Wardair, an international agreement (here the bilateral income

tax treaty between the United States and the United Kingdom)

demonstrates that while federal executive branch officials aspired

to eliminate a state tax practice (here the use of formula appor-

tionment to calculate the tax liability of foreign-based multina-

tionals), “the /aw as it presently stands acquiesces” in the states’

continued use of that practice. As in Wardair, “the negative

implications” of international agreements (here the tax treaty as

ratified by the Senate) support recognition of a federal policy that

acquiesces in the states’ tax practice. And certainly, in the

circumstances of Senate consideration detailed above, the ex-

' plicit removal of “political subdivisions” from the scope of article

9(4) effected by the Church reservation, like the omission of

restrictions on taxation by political subdivisions in the interna-

tional agreements considered in Wardair, “must be understood as

representing a policy choice by the contracting parties.”

(Wardair, supra, 477 U.S. at p. 11.)"

: The Court of Appeal rejected the analogy to Wardair, supra,

477 U.S. 1, on the ground that, in both a committee vote and on

the Senate floor, the Church reservation failed to command a

plurality, and the vote for the treaty with article 9(4) was only five

votes short of the needed two-thirds majority. In light of these

tallies, it reasoned that it was difficult to see a congressional policy

permitting the states to use formula apportionment. In our view,

however, the focus on preliminary votes misses the mark.

Preliminary voting tallies lack meaning precisely because they

are not definitive, may be cast for any number of tactical parlia-

mentary reasons, and thus do not reliably reflect legislative policy.

The sole constitutional mechanism for congressional considera-

tion of executive-negotiated treaties is Senate ratification by a

two-thirds majonty (U.S. Const., art. II, § 2); to that defining

vote, institutional significance sensibly can and should be

''Parliament eventually acceded to Congress's demands, ratifying the

income tax convention without article 9(4). (See 31 U.S.T., supra,

5709-5710.)

A-31

ascribed. In any case, the method enjoined upon us by Wardair,

supra, 477 U.S. 1, requires that we ponder the significance of “the

law as it stands,” not count noses.

The Senate’s action with respect to article 9(4) is only the

most explicit example of a persistent congressional refusal to

enact curbs on the states’ use of worldwide formula apportion-

ment reaching back well before 1977, the tax year at issue in this

case. The parties agreed in a pretrial stipulation that “various

proposed Legislative bills have been introduced in the United

States Congress that would, among other things, affect the states’

use of worldwide combined reporting.” The stipulation identifies

twenty such House and Senate bills spanning twenty years. These

range from House Resolution No. 11798 introduced in the House

in 1965 (an ambitious “Interstate Taxation Act” that would have

required the states to adopt a two-factor apportionment formula

in taxing unitary groups) to 1985 legislation sponsored by the

Treasury Department that would have limited state use of world-

wide formula apportionment to members of foreign-based corpo-

rate groups actually doing business in the United States, that is,

so-called “water's edge” legislation. (See post, p. _— [typed maj.

opn. pp. 52-54].) None of these measures was enacted into law

by Congress.

We likewise part company with the Court of Appeal in its view

of the significance to be drawn from the web of bilateral tax

conventions into which the United States has entered both before

and after the Senate’s rejection of article 9(4). As noted, these

conventions typically require use of the separate accounting

method by the national signatory governments in their tax treat-

ment of domestic branches of foreign-based businesses.'* This

'2Representative treaty language appears, for example, in article VII,

section 2 of the United States-Canadian treaty of 1984, providing for tax

treatment of domestic branches of foreign-domiciled corporations as “if

it were a distinct and separate person engaged in the same or similar

activities under the same or similar conditions and dealing wholly

independently” with the rest of the corporation. (Convention Between

LS

A-32

restriction, however, does not encompass division of income

methods used by political subdivisions of the contracting states.

Again, the Court of Appeal found the analogy to Wardair,

supra, 477 U.S. 1, inapt because, unlike that case — in which

subsequent air commerce agreements rested on the foundational

understanding of the Convention — many of the agreements

relied on by the Board in this case predate an international

awareness of formula apportionment issues that did not arise until

the 1970's. Thus, according to the Court of Appeal, affirmative

prescriptions of national division of income methods in interna-

tional treaties would not support Wardair’s “negative implica-

tions” that the parties were aware of competing methods and

made the conscious decision to acquiesce in their use by the

states.

Despite the facial plausibility of this reasoning, we cannot

accept the supposition underlying it that formula apportionment

as a division of income alternative to separate accounting for

taxation purposes did not penetrate the international financial and

diplomatic consciousness until the multinational corporate boom

of the 1970's. The high court’s 1924 decision in Bass, supra, 266

U.S. 271, upholding the constitutionality of state use of formula

apportionment to a United Kingdom-based taxpayer, suggests at a

minimum notice to the international business community of the

valid use of an alternative to separate accounting by political

subdivisions of the United States.

Although the Court of Appeal also rejected this argument on

the ground that “awareness of a particular tax theory is one thing;

to be subjected to that theory in practice is quite another,” we

think that this reasoning requires greater proof than that de-

manded by Wardair, supra, 477 U.S. 1. The dramatic growth of

multinationals during the 1960’s and 1970’s may well have served

to sharpen corporate concern over the international effects of the

states’ use of formula apportionment, but that increased appre-

hension does not demonstrate a prior lack of awareness of its

United States and Canada with Respect to Taxes on Income and

Capital, Aug. 16, 1984.)

A-33

potential applicability or negate the sensible decision of United

States treaty negotiators — operating with an awareness of a

federalist-based tax practice —to include a standard provision

limiting only national governments to the AL/SA method.'?

There is evidence suggesting a basis for just such an interna-

tional recognition of formula apportionment as a competing

taxation method, at least from the mid-1950’s on. The Container

case itself dealt with California’s use of formula apportionment

for the 1963 to 1965 tax years (463 U.S. at p. 171) and a prior

decision of our Court of Appeal (Anaconda Co. v. Franchise Tax

Board (1982) 130 Cal.App.3d 15) dealt with the tax years 1955

through 1969.'* Moreover, in enacting the Internal Revenue Act

of 1956, Congress authorized the Secretary of the Treasury to

“distribute, apportion, or allocate gross income... between or

among” multicorporate enterprises, including those with foreign

‘Thus, one of the leading spokesmen of executive branch opposition

to state use of the worldwide unitary method, Donald Lubick, Assistant

Secretary of the Treasury for Tax Policy, explained why, except for the

nondiscrimination clause, subnational taxes were not included in the

United States Model Income Tax Treaty by noting that “local U.S.

taxes are not covered because it is unlikely that the United States would

consent to the ratification of any treaty provision that restricted the

rights of the... states to impose their own taxes.” (See International

Tax Treaties: Hearing Before the Sen. Com. on Foreign Relations, 96th

Cong., Ist. Sess., at p. 112.)

The United States (together with two other federalist nations, Canada

and Australia) likewise reserved its position “‘on that part of paragraph |

{of article 1 of the Organization for Econamic Co-operation and

Development [OECD] Model Taxation Convention] which states that

the Convention [which requires use of a separate accounting method]

should apply to taxes of political subdivisions or local authorities.”

(Model Double Taxation Convention on Income and on Capital (1977),

at p. 50.)

'SA key 1984 Treasury Department document notes that debate on

state use of the worldwide version of formula apportionment “spans at

least two decades.” (Chairman's Rep., supra, at p. 3, emphasis added.)

A-34

domiciles, “in order...clearly to reflect [their] income” (26

U.S.C. § 482, emphasis added), a formulation that reflects at

least an awareness of apportionment methodologies.'* Similarly,

as early as the late 1940’s, United States negotiators of “Freedom,

Commerce and Navigation” agreements incorporated standards

to preserve the states’ freedom to employ methods that produced

a tax “reasonably allocable or apportionable” to the taxing juris-

diction, a formulation American drafters described as limiting

state levies to “‘a fair portion of a global income derived from dual

or multiple territorial sources.” (U.S. State Dept., Anno. Draft

Treaty of Friendship, Commerce and Navigation for Portugal,

prepared by Herman Walker (1947-1948) pp. 14a, 15.)

In addition, bilateral income tax treaties negotiated by the

United States with many of its trading partners typically prescribe

use of the AL/SA method by the signatory governments; they do

not, however, impose such a requirement on taxation by subna-

tional levels of government. Moreover, despite this methodologi-

cal exemption, subnational organs of government are included for

purposes of nondiscrimination treaty provisions. We think this

latter evidence substantially parallels the Wardair paradigm,

where the high court concluded that the “negative implications”

arising from the Convention’s limited ban on state taxation of fuel

“on board” arriving foreign aircraft demonstrated an awareness of

subnational taxation issues and represented “a decision by the

parties... to address the problem by curtailing and limiting only

some of the localities’ power to tax, while implicitly preserving

other aspects of that authority.” (Wardair, supra, 477 U.S. at

p. 10.) In short, an extensive pattern of executive branch-

negotiated diplomatic texts parallels, in our view, Congress’s own

unwillingness to disallow legislatively the states’ application of

formula apportionment methods to foreign-controlled multina-

tonal taxpayers, and bespeaks a coordinate “‘acquiescence.”

'*The 1954 version, as well as the current version of 26 United States

Code section 482, derives from section 45 of the Revenue Act of 1928.

(See H.R. Rep. No. 2, 70th Cong., Ist Sess., p. 16 (1928).)

A-35

Finally, the strategy pursued by the executive branch in the

wake of the high court’s opinion in Container, supra, 463 U.S.

159, underlines the aspirational character of its insistence on an

end to state use of formula apportionment in foreign-parent cases.

Although in the immediate aftermath of the decision, the admin-

istration rejected appeals by the business community and major

trading partners to seek amicus curiae status in Container and

support a rehearing, the White House soon announced an alterna-

tive plan.'°

President Reagan directed the Secretary of the Treasury to

establish a “working group” composed of representatives of the

federal and state governments and the business community

“charged with producing recommendations... that will be con-

ducive to harmonious international economic relations, while also

respecting the fiscal rights and privileges of the individual states.”

(Chairman’s Rep., supra, at p. ii; see also 48 Fed.Reg. 208,

p. 49570 (Oct. 26, 1983).) The final report of the working group,

released in 1984 as the Chairman’s Report, ante, footnote 3,

recommended efforts by the states to mitigate the international

effects of formula apportionment, including limiting its use to the

“water’s edge,” (that is, excluding from the unitary tax base

members of foreign-controlled groups not doing business in the

United States). Although these state efforts at reform were to be

“voluntary,” in his transmittal letter to the President, Treasury

Secretary Regan stated that “If there are not sufficient signs of

appreciable progress by the states in this area by... next

year,...I will recommend to you that the Administration pro-

pose federal legislation that would give effect to a water’s edge

limitation patterned after that in [the report].” (Chairman’s

Rep., supra, at p. iii.)

Eighteen months later, the administration followed up on its

threat to seek congressional action. In a November 1985 state-

ment, the President called for federal legislation that would

‘Pleas for administration support for a rehearing and for congres-

sional legislation and the administrations’ reaction are detailed in the

Chairman's Report, supra, at pages 2-3.

—————

A-36

require the states to adopt “water's edge” restrictions on the use

of worldwide formula apportionment and directed the Treasury

Secretary to “work with the Congress for [its] passage.” At the

same time, the President directed the Attorney General “to

ensure that the United States’ interests are represented in appro-

priate controversies and cases consistent with [the] approach”

outlined in the President’s statement. (45 Weekly Compilation of

Pres. Documents 1368.) In January 1986, Secretary of State

Shultz wrote to then-Governor Deukmejian informing him that

legislation had been introduced before Congress “‘at the express

direction of the President” that “‘would prohibit states from taxing

corporations under the worldwide unitary method.” (Letter of

Jan. 30, 1986, from Sect. of State Shultz to Governor

Deukmejian.)'”

As a result of executive branch initiatives, some states agreed

to cease using the formula apportionment method in the case of

foreign-parent multinationals.'* Others, California among them,

adopted meliorative measures designed to pacify critics. In 1986,

our Legislature enacted “water's edge” legislation,'? prompting

senior Treasury Department officials to retreat from their previous

‘Neither the Senate nor the companion House versions of the

Treasury Department-drafted legislation were enacted. (See Remarks of

Sen. Wilson on Sen. No. 1974, 131 Cong. Rec. S17975, daily ed.

Dec. 18, 1985; remarks of Representative Duncan on H.R. No. 3980,

131 Cong. Rec. E574, daily ed. Dec. 19, 1985.)

On the legal front, the Solicitor General filed a brief amicus curiae in

Wardair, supra, 477 U.S. 1, supporting the foreign-air carrier in its

unsuccessful contention that Florida's tax on aviation fuel was unconsti-

tutional under a dormant foreign commerce clause analysis. (/d., at

p. 9.} ;

'§(See, e.g., Langbein, The Unitary Method and the Myth of Arm's

Length, supra, 30 Tax Notes at p. 674, fn. 1. [by early 1986, four of the

twelve states using worldwide unitary methods, “including all of the

commercially significant states except California,” had repealed them ].)

''(See Rev. & Tax. Code, § 25110 et seq.)

+ aceite iat aia aaa iil ial

A-37

insistence that Congress prohibit state use of worldwide formula

apportionment. For the time being, the administration told Con-

gress, neither prohibitory congressional legislation nor treaty re-

strictions on state use of worldwide unitary methods was

appropriate.”

As this account rather pointedly makes clear, the struggle for

supremacy between the major interests with a stake in the fate of

worldwide formula apportionment — states using that method

and their federalist allies, on the one hand, and aggrieved mul-

tinationals and their supporters in the business community and

the executive branch, on the other — has a long history. For

much of this history, executive officials have sought unsuccess-

fully to impose their solution on the states through Senate

ratification of a treaty provision embodying curbs and, failing that,

legislation enacted under Congress's foreign commerce clause

power.

Only late in the campaign have the partisans of separate

accounting changed the locus of attack by seeking to have the

worldwide use of formula apportionment by the states judicially

invalidated on dormant foreign commerce clause grounds. In

pressing that challenge, opponents of the worldwide unitary

method have marshalled executive branch arguments designed to

persuade Congress and the states to legislate curbs, and have

attempted to transmute them into the “clear federal directive” of

°(Statement of J. Roger Mentz, Asst. Sect. of the Treas. for Tax

Policy, before the Subcom. on Taxation and Debt Management, Sen.

Finance Com. (Sept. 29, 1986), at pp. 2-3.) The Assistant Secretary's

comments, stating the administration's position on Senate Bill No. 1974

— the Treasury Department-sponsored legislation drawn up at President

Reagan's direction — included the view that “Congressional action on

S. 1974 should be deferred until the remaining worldwide unitary states

have a full opportunity to act...” and that “a treaty resolution of the

unitary issue is [not] necessary or appropriate at this time.” (Jbid.)

A-38

Container, supra, 463 U.S. 159.' As explained above, however,

that doctrine underlines the plenary power of Congress to preempt

State taxation methods with “foreign resonances”; it does not give

executive Officials carte blanche to declare state tax methods null

when they irritate our trading partners.”

Conclusion

It is clear that federal limitations on the states’ use of world-

wide formula apportionment is a controversial political and eco-

nomic issue of which Congress has long been aware. In light of

that history, we cannot turn away from the substantial evidence of

Congress’s repeated refusal to intervene in the regulation of state

division of income methods for tax purposes, even one that

provokes continuing international complaint. Under the compul-

sions of established constitutional doctrine, the courts sometimes

are required to divine what foreign commerce policy Congress

*'These materials consist largely of numerous diplomatic notes of

complaint (“demarches”) filed with the United States by its trading

partners objecting to the states’ use of worldwide formula apportion-

ment, presidential statements, statements and letters from cabinet of-

ficers and other senior Treasury and State Department officials to the

same effect, and official documents such as the Chairman's Report,

supra. As noted, there is no doubt that many foreign governments object

strenuously to the practice and that executive branch officials charged

with conducting American foreign commercial policy agree with them.

~We thus reject the claim of the United States Department of

Justice, appearing as amicus cunae in support of the Bank, that

California's use of formula apportionment in this case is “an egregious

interference with the Federal Executive's conduct of foreign affairs and

is thus patently unconstitutional.” Although we accept the Justice

Department's argument that the views of the executive branch on the

internauonal effect of state taxation practices are entitled to “great

weight” under a foreign dormant commerce clause analysis (cf.

Container, supra, 463 U.S. at p. 196), our conclusion that such an

analysis is not triggered here forecloses resort to those views. (Compare

Wardair, surpa, 477 U.S. at p. 9 [rejecting views of United States as

amicus cunae].)

A-39

would pursue in the absence of any indication that it has thought

about the subject; it is a quite different matter, however, for a

court to ignore a pattern of congressional action that evidences

both an awareness of an issue and a refusal to adopt the remedy

urged upon it by executive officials and resisted by its state

constituencies. The latter, we believe, viewed in context alongside

additional treaty materials, is a governmental silence that is

eloquent.

In light of Congress’s awareness of antagonistic state taxation

and international business interests, the path taken by the high

court in Wardair, supra, 477 U.S. 1, seems the constitutionally

correct one here. To invest a paper trail of executive aspiration

with the dignity of a “clear federal directive” would, in the

language of Wardair, “turn dormant Commerce Clause analysis

entirely upside down.” (/d., at p. 12.) Taking our lead from the

high court, we decline to adjudicate on dormant foreign com-

merce clause grounds a debate between the political branches of

the federal government over what is, in both its international and

federalist dimensions, a sharply contested issue of national tax

policy that has been repeatedly aired before Congress. We adhere

to the central meaning of the high court’s opinion in Wardair in

holding that Congress’s refusal to legislate restrictions on state

use of worldwide formula apportionment is not the sort of govern-

mental silence that triggers a dormant foreign commerce clause

analysis.

_ Our holding does not end the matter, however. The trial court

held that the cost to a foreign-based unitary enterprise of furnish-

ing financial data required by the Board's use-of the worldwide

formula apportionment method — the so-called “compliance bur-

den” — violated due process. In addition, it held that same

burden violated the nondiscrimination requirement of the four-

part dormant interstate commerce clause analysis under Complete

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

The Court of Appeal explicitly declined to decide the due

process issue and does not appear to have passed directly on the

nondiscrimination issue. The due process issue is a fact-depen-

dent question that should be decided by the Court of Appeal in

the first instance; moreover, we think its examination of the issue

A-40

would profit from a consideration of its merit free of the view that

a dormant foreign commerce clause analysis is appropriate in the

circumstances present here.

Accordingly, the judgment of the Court of Appeal is reversed

and the cause is remanded to that court for further proceedings

consistent with this opinion.

ARABIAN, J.

WE CONCUR:

LUCAS, C. J.

MOSK, J.

PANELLI, J.

KENNARD, J.

BAXTER, J.

GEORGE, J.

A-41

BARCLAYS BANK INTERNATIONAL, LTD. v.

FRANCHISE TAX BOARD

S019064

Counsel Who Argued For The Parties

FOR APPELLANT: Mr. Timothy G. Laddish

Office of the Attorney General

2101 Webster Street, 12th Floor

Oakland, California 94612

(510) 464-0364

FOR RESPONDENT: Ms. Joanne M. Garvey

Heller, Ehrman, White &

McAuliffe

333 Bush Street, 32nd Floor

San Francisco, California 94101

TRIAL COURT: Sacramento County Supenor

Court

TRIAL COURT #: 325059

The information provided here is not intended to reflect that

which will appear in official reports.

APPENDIX B

CERTIFIED FOR PUBLICATION

IN THE COURT OF APPEAL OF

THE STATE OF CALIFORNIA IN AND FOR

THE THIRD APPELLATE DISTRICT

(Sacramento)

BARCLAYS BANK INTERNATIONAL, LTD.,

Plaintiff and Respondent,

Vv.

FRANCHISE TAX BOARD,

Defendant and Appellant.

BARCLAYS BANK OF CALIFORNIA,

Plaintiff and Respondent,

Vv.

FRANCHISE TAX BOARD,

Defendant and Appellant.

C003388

o (Super. Ct. Nos. 325059 & 325061)

Filed November 30, 1990

COURT OF APPEAL - THIRD DISTRICT

BY _ Robert L. Liston, Clerk

DEPUTY

APPEAL from judgments of the Superior Court of Sacra-

mento County, George E. Paras, Retired Associate Justice of the

Court of Appeal, sitting under assignment by the Chairperson of

the Judicial Council. Affirmed.

John K. Van de Kamp, Attorney General, Timothy G. Lad-

dish, Assistant Attorney General, Robert F. Tyler, Supervising

Deputy Attorney General, and Robert D. Milam, Deputy Attor-

ney General, for Defendant and Appellant.

B-2

Joanne M. Garvey, Joan K. Irion, Teresa A. Maloney, and

Heller, Ehrman, White & McAuliffe, for Plaintiffs and

Respondeuts.

Lawrence V. Brookes and Valentine Brookes as Amici Cunae

for Thorn-EMI PLC and EMI Limited, on behalf of Plaintiffs

and Respondents.

Jane H. Barrett, Lawler, Felix & Hall, and F. Eugene Wirwahn

as Amici Curiae for the Government of the United Kingdom and

the Government of Canada, on behalf of Plaintiffs and

Respondents.

David F. Levi, United States Attorney, William S. Rose, Jr.,

Assistant Attorney General, and Gary R. Allen, David English

Carmack, John J. McCarthy, and Richard A. Correa, Attorneys,

Department of Justice, as Amicus Cunae for the United States of

America, on behalf of Plaintiffs and Respondents.

In this appeal we hold that California’s unitary tax method of

worldwide combined reporting (based on Rev. & Tax. Code,

§§ 25101, 25120-25138), as applied to foreign-based unitary

groups, is unconstitutional under the foreign commerce clause of

the United States Constitution. (U.S. Corft., art. I, § 8, cl. 3.)'

‘During the tax year at issue (1977), section 25101 of the Revenue

and Taxation Code provided in pertinent part as follows: ““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 shal] be measured by the net income derived from or attributable

to sources within this state in accordance with the provisions of Article 2

(commencing with Section 25120 of this chapter); .. .”

Article 2 contains the California enactment of the Uniform Division

of Income for Tax Purposes Act (UDITPA), which provides for

formula apporuonment of the net income from business activities both

within and outside California in order to reach the net income attributa-

ble to California activities. (Rev. & Tax. Code, §§ 25120-25138.)

In 1982, section 25101 was amended in an insignificant fashion for our

purposes. ( Stats. 1982, ch. 466, § 104, p. 2055.)

Bile Mio

B-3

BACKGROUND

When a corporation conducts business in more than one juris-

diction, either through branches or subsidiaries, the proper alloca-

tion of income for tax purposes becomes an issue. Essentially, two

methods of allocating income have evolved to resolve this issue:

the arm’s length/separate accounting method (AL/SA) and the

unitary business/formula apportionment method. As to multina-

tional corporations, California employs a common variant of the

unitary method called worldwide combined reporting (WWCR).

Under the separate accounting method, the various affiliated

corporations of a multijurisdictional enterprise are viewed as

separate from one another and the income attributable to any

particular jurisdiction is determined on the basis of internal

accounting records reflecting the activity of the affiliate within

that jurisdiction. To preclude tax-manipulative intercorporate

transfers of goods, services or other value, this accounting method_

requires that the tax reporting entity deal at “arm’s length”’ with

its affiliated businesses as if they were simply unrelated entities

dealing in the marketplace.

In contrast, under the unitary business/ formula apportionment

method of accounting employed by California (WWCR), the

affiliated corporations of a multijurisdictional enterprise are

treated as units of a single business — that is, as a “unitary

group.” (Cal. Code Regs., tit. 18, § 25137-6.) If a corporation

doing business in California is deemed to be part of a unitary

group, the total income for that group, including corporations or

affiliates operating wholly outside California or the United States

for that matter, is apportioned to California by a three-factor

formula. The formula takes into account property, payroll, and

sales (revenue in this case) for the group in California, as a

fraction of total worldwide property, payroll, and sales. (See Rev.

& Tax. Code, §§ 25128-25136; Notes, State Worldwide Unitary

Taxation: The Foreign Parent Case (1985) 23 Columbia Journal

of Transnational Law 445, fn. 2; hereafter 23 Columbia Journal. )

The fraction is then multiplied against the unitary group's total

income, producing an apportioned amount of such income taxable

by California. Because intercorporate transactions are disre-

garded, it is unnecessary to make “arm's length” adjustments.

B-4

The income allocation method used by the United States and

all of the other nations of the world, with a couple of minor and

limited exceptions, is the AL/SA method, although this method

varies in practice. However, the United States has essentially

limited the application of its tax treaties to federal taxes. Appar-

ently no nation in the world uses WWCR in any meaningful

fashion. |

The present controversy involves challenges to additional tax

assessments for the year 1977 resulting from California’s use of

WWCR.’ Those additional assessments were levied after the

"In 1986, California passed legislation, operative January 1, 1988,

permitting taxpayers to make a “water's-edge election” notwithstanding

secuon 25101 (Rev. & Tax. Code, § 25110 et seq.).

The “water'’s-edge” method is essentially an AL/SA method, and

offers an alternative to the WWCR method for determining taxable

income. (See Rev. & Tax. Code, §§ 25101, 25110.) Instead of account-

ing for the income and apportionment factors (property, payroll, and

_..-Sajes) of all the members of its worldwide unitary group, a corporate —

taxpayer making such an election accounts for the income and appor-

uionment factors of the following entities affiliated with it, subject to

some technical exceptions: corporations incorporated in the United

States; any corporation, wherever incorporated, if the average of its

apportionment factors within the United States is 20 percent or more;

affiliated corporations which are eligible to be included in a federal

consolidated tax return; domestic international sales corporations and

foreign salés corporations engaged in sales in the United States; export

trade corporations; any corporation not set forth previously but only to

the extent of its income derived from or attributable to sources within

the United States; and any affiliated corporation which is a controlled

foreign corporation as defined in the Internal Revenue Code. Any

Corporation not subjected to WWCR under Revenue and Taxation Code

Section 25101 need not be included in this “water's-edge” accounting.

(Rev. & Tax. Code, § 25110, subd. (a).)

In general, this election permits a taxpayer corporation to exclude the

income and apportionment factors of foreign incorporated affiliates from

the corporation's California tax base. In the context of state taxation of

Tulunational corporations, an accounting restriction to the water's edge

Of the United States means that a state tax authority relies only on

B-5

defendant California Franchise Tax Board (Board) determined

that the plaintiff taxpayers, Barclays Bank of California (Barcal)

and Barclays Bank International (BBI), and their ultimate corpo-

rate parent, Barclays Bank Limited (BBL), as well as the

significant subsidiaries of BBI and BBL, constituted a unitary

group.’ Barcal was directed to pay an additional $152,420 and

BBI an additional $1,678. Under protest Barcal and BBI (hereaf-

ter referred to collectively as either plaintiffs or Barclays) paid the

additional taxes and this suit ensued.

Plaintiffs challenge the federal constitutionality of these addi-

tional tax assessments on foreign commerce clause and due

income derived from permanent establishments of the corporation in the

United States, and not on income derived from wholly foreign interests,

to calculate the corporation's franchise tax. Essentially, then, Califor-

nia’s “‘water's-edge election” is a separate accounting method with the

United States as the jurisdictional boundary.

Only “qualified taxpayers” can make a water’s-edge election. To

qualify, the corporate taxpayer must (1) consent to the taking of

depositions from key corporate personnel and to the production of

documents to ensure the Franchise Tax Board has the information

necessary to make genuine arm's length adjustments and unitary busi-

ness investigations, and (2) agree that dividends received by any

affiliated entity from corporations significantly related to the unitary

business constitute business income of the taxpayer. (Rev. & Tax. Code,

§ 25110, subd. (b) (2).) Additionally, to make the election the corpo-

rate taxpayer must enter into a five-year contract with the Franchise Tax

Board, pay an annual fee, and subject itself to various conditions. (Rev.

& Tax. Code, §§ 25111-25115.)

A foreign-based multinational corporation that does not make this

election is subjected essentially to the 1977 taxation method at issue

here. (See fn. 1, ante, pp. 2-3.) We emphasize, however, that the issue

we confront is the ¢onstitutionality of California's unitary tax method of

WWCR as applied to foreign-based unitary groups (Rev. & Tax. Code,

§ 25101 et seq.). Because California's “water's-edge election” is not

involved in this case, we express no view regarding it. (Rev. & Tax.

Code, § 25110 et seq.)

3Barcal and BBI do not challenge the determination that they are part

of a unitary group.

B-6

process grounds. For us, the critical issue concerns the foreign

commerce clause.

Foreign Commerce Clause

Before beginning our analysis, we note that plaintiffs also

contend th’ WWCR unitary method is unconstitutional because

it impropertly interferes with the power of the executive branch of

the federal government to conduct foreign affairs. (See United

States v. Curtiss-Wright Export Corp. (1936) 299 U.S. 304 [81

L.Ed 255].) The Board argues here, as it did below, that

plaintiffs’ failure to raise the latter issue in their claim for refund

precludes their assertion on appeal. The trial court rejected the

argument, reasoning that the protest proceedings provided ade-

quate notice of the issue and, more importantly, the Board lacked

the authonty to address constitutional issues. There is substantial

evidence supporting the trial court’s determination of adequate

notice; it would have been a futile exercise to raise this constitu-

tional issue involving sensitive matters of international relations

before the Board. (See Park’N Fly of San Francisco, Inc, v. City

of South San Francisco (1987)188 Cal.App.3d 1201, 1208-1209,

1215-1216.) Moreover, as we shall explain, the dispute is irrele-

vant as the foreign commerce clause issue inextricably involves

foreign affairs, the subject of foreign affairs inextricably involves

the two political branches of our national government, and the

foreign commerce clause issue was undeniably raised in a timely

fashion. With these prefatory remarks in mind, we address the

substance of the matter.

Article I, section 8, clause 3 of the United States Constitution

gives Congress the power “To regulate commerce with foreign

nations, and among the several states, .. .”

As noted by the tral court, three United States Supreme Court

decisions that have construed this provision in the last decade are

vital to the positions of each of the parties to this litigation. Those

cases are: Japan Line, Ltd. v. County of Los Angeles (1979) 441

U.S. 434 [60 L.Ed.2d 336]; Container Corp. v. Franchise Tax

Bd. (1983) 463 U.S. 159 [77 L.Ed 7d 545]; and Wardair Canada

v. Florida Dept. of Revenue (1986) 477 U.S. | [91 L.Ed.2d 1].

B-7

In Japan Line, the high court held that instrumentaliues of

commerce (in that case, cargo containers in seagoing ships) that

are owned, based, and registered abroad and that are used

exclusively in international commerce may not be subjected to an

apportioned ad valorem property tax by a state. (441 US. at

pp. 436, 444 [60 L.Ed.2d at pp. 340, 345).)

Through Japan Line, the so-called “dormant” foreign com-

merce clause test of constitutional review came into being. The

judiciary engages in dormant commerce clause analysis when the

Congress has not acted or purported to act; in such situations, it is

the judiciary’s responsibility to determine whether an action taken

by a state unduly threatens the underlying purpose of the clause:

to ensure a free flow of commerce and that individual states do

not work to the detriment of the nation as a whole. (Mernon v.

Jicarilla Apache Tribe (1982) 455 U.S. 130, 154-155 [71

L.Ed.2d 21, 40]; Wardair, supra, 477 U.S. at pp. 7-8 [91 L.Ed.2d

at pp. 9-10].)

This dormant foreign commerce clause test was engendered

through the engrafting of two additional inquiries onto the already

existing four-part test for dormant Interstate commerce clause

review. (Japan Line, supra, 441 U.S. at pp. 444-445, 451

[60 L.Ed.2d at pp. 345-346, 349].)

That four-part test upholds a state tax against an interstate

commerce clause challenge if the tax “‘[i] is applied to an

activity with a substantial nexus with the taxing State, [ii] is

fairly apportioned, [iii] does not discriminate against interstate

commerce, and [iv] is fairly related to the services provided by

the State.” (Japan Line, supra, 441 U.S. at pp. 444-445, 449,

454 [60 L.Ed.2d at pp. 345, 34%, 351], quoting Complete Auto

Transit, Inc. v. Brady (1977) 430 U.S. 274, 279 [51 L.Ed.2d 326,

331].) The two additional inquiries prompted by the foreign

context are first, whether the tax creates a “substantial msk of

international multiple taxation” (441 U.S. at p. 451 [60 L.Ed.2d

at p. 349]), and, second, whether the tax “may impair federal

uniformity in an area where federal uniformity is essential”

(Id., at p. 448 [60 L.Ed.2d at p. 347]), and prevents “the Federal

Government from ‘speaking with one voice when regulating

commercial relations with foreign governments.’ If a state tax

-

B-8

contravenes either of these precepts, it is unconstitutional under

the Commerce Clause.” (/d., at p. 451 [60 L.Ed.2d at p. 349},

quoting Michelin Tire Corp. v. Wages (1976) 423 U.S. 276, 285

[46 L.Ed.2d 495, 503]; Container, supra, 463 U.S. at pp. 193-194

[77 L.Ed.2d at p. 571].)

The court in Japan Line assumed, without deciding, that the

tax at issue passed constitutional muster under the four-part

interstate test, and proceeded to ask the two new questions.

(441 U.S. at p. 451 [60 L.Ed.2d at p. 349].)

The court had little difficulty in determining that California's

property tax failed the first additional test: since the facts showed

that Japan taxed the cargo containers at full value, California’s

tax created more than the nsk of multiple taxation; it in fact

produced such taxation. (Japan Line, supra, 441 US. at

pp. 451-452 [60 L.Ed.2d at pp. 349-350].)

The court decided rather easily that California's tax prevented

the nation from “speaking with one voice” in regulating foreign

trade. (Japan Line, supra, 441 U.S. at pp. 452-453 [60 L.Ed.2d

at pp. 350-351].) The court cited the Customs Convention on

Containers, which both the United States and Japan had signed,

and stated it reflected a national policy to remove all duties and

taxes as to temporanily-imported containers in international traf-

fic. (/d., at pp. 452-453 [60 L.Ed.2d at pp. 350-351].) Since

American-owned containers are not taxed in Japan, California’s

tax creates an asymmetry in international taxation operating to

Japan’s disadvantage; under such circumstances, the risk of

retaliation by Japan is acute, a retaliation that of necessity would

be borne by the entire nation. Finally, if other states were to

follow California’s example, taxation would vary port-by-port,

making speaking with one voice impossible. (/d., at p. 453

[60 L.Ed.2d at pp. 350-351 ]}.)

The relative ease with which these constitutional! invalidations

were made is grounded in the Japan Line court’s sensitivity to

intrusions by individual states into the realm of foreign affairs.

(See also Hines v. Davidowitz (1941) 312 U.S. 52, 63 [85 L.Ed.

581, 584-585]; United States v. Belmont (1937) 301 U.S. 324,

330-331 [81 L.Ed. 1134, 1139].) As to the first inquiry, the court

B-9

noted that “[e]ven a slight overlapping of tax — a problem that

might be deemed de minimis in a domestic context — assumes

importance when sensitive matters of foreign relations and na-

tional sovereignty are concerned.” (Fn. omitted; Japan Line,

supra, 441 U.S. at p. 456 [60 L.Ed.2d at p. 352].) When

confronted with the assertion that it was Japan’s levy rather than

California’s which created the double tax, the court responded,

“California’s tax, however, must be evaluated in the realistic

framework of the custom of nations... .” (Emphasis added, id.,

at p. 454 [60 L.Ed.2d at p. 351].)

Regarding the second inquiry, the court stressed that the

foreign commerce power of Congress is greater than its interstate

commerce power, and emphasized not only the aeed for uniform-

ity in dealing with other nations but “the Framers’ overriding

concern that ‘the Federal Government must speak with one voice

when regulating commercial relations with foreign govern-

ments.”” (Japan Line, supra, 441 U.S. at pp. 448-449 [60

L.Ed.2d at pp. 347-348].) Of course Japan Line involved a

property tax on a foreign cargo container, not a particular method

of income tax allocation applied to a foreign-based unitary group.

The case of Container Corp. v. Franchise Tax Bd. supra, 463

U.S. 159 [77 L.Ed.2d 545], to which we turn now, involved not

only a particular income tax method but the one at issue here.

Container held in part that California’s application of WWCR

to domestic-based unitary groups was constitutional under the

dormant foreign commerce clause test enunciated in Japan Line.

(463 U.S. at pp. 185-197 [77 L.Ed.2d at pp. 566-573].)

Container Corporation was a business entity incorporated in

Delaware and headquartered in Illinois with 20 subsidiaries in 4

European and 4 Latin American countries. (/d., at pp. 163, 171

(77 L.Ed.2d at pp. 551, 557].)

At the outset of its foreign commerce clause discussion, the

court in Container stated that “[t]he case most relevant to our

inquiry is Japan Line.” (463 U.S. at p. 185 [77 L.Ed.2d at

p. 566].) Following Japan Line, Container applied the two

additional foreign commerce clause considerations there set forth.

(463 U.S. at pp. 185-186 [77 L.Ed.2d at pp. 566-567].)

ee |

B-10

Before applying those two additional considerations, Container

noted the similarities and differences between the two cases.

Similarities included the fact that actual double taxation had

resulted, that such taxation stemmed from a serious divergence

between California and foreign taxing methods, that the foreign

taxing method was consistent with international practice (i.e.,

AL/SA), and that “our own Federal Government, to the degree

it has spoken, seems to prefer the taxing method adopted by the

international community to the taxing method adopted by Cali-

fornia.” (Fn. omitted, 463 U.S. at pp. 184, 187 [77 L.Ed.2d at

pp. 565, 567].)

Three differences were noted. First, the tax in Container was on

income rather than on property, and the court noted the ease with

which income traverses boundaries. Second, the double taxation,

although real, was not the “ ‘invevitabl[e]’ result of the California

taxing scheme.” Finally, the tax in Container fell, not on the

foreign owners of an instrumentality of foreign commerce, but on

a corporation domiciled and headquartered in the United States.

(463 U.S. at pp. 187-188 [77 L.Ed.2d at pp. 567-568].) After

essentially analogizing a corporation and an instrumentality of

commerce, Container carefully noted “[w]e have no need to

address in this opinion the constitutionality of combined appor-

tionment with respect to state taxation of domestic corporations

with foreign parents or foreign corporations with either foreign

parents or foreign subsidiaries.” (/d., at p. 189, including fn. 26

[77 L.Ed.2d at p. 568].) It is important to note at this juncture

that those issues are the crux of the matter presented here.

In applying the first additional test set forth in Japan Line,

Container noted Japan Line’s concern that even slight overlap-

ping of tax assumes importance in the sensitive area of foreign

relations, but further noted that this concern did not express an

absolute prohibition on stated-induced double taxation. While

such taxation deserves close scrutiny, said Container, that scru-

tiny must take into account the context in which the double

taxation takes place ar:' the alternatives reasonably available to

the taxing state. (463 U.S. at p. 189, [77 L.Ed.2d at

pp. 568-569].) Taking into account the context of the tax, the

distinction between an income tax and a property tax, and the fact

B-11

that even implementing AL/SA would not guarantee an end to

double taxation, Container concluded that since California's tax-

ing method did not “inevitably” lead to double taxation, it would

be perverse to constitutionally require one method of taxation

over another when both could result in a double tax. (/d., at

pp. 189-193 [77 L.Ed.2d at pp. 568-571 ].)

Proceeding to Japan Line’s second inquiry — that is, the “‘one-

voice” standard — Container stated: “In conducting this inquiry,

... Wwe must keep in mind that if a state tax merely has foreign

resonances, but does not implicate foreign affairs, we cannot infer,

‘[a]bsent some explicit directive from Congress, ... that treat-

ment of foreign income at the federal level mandates identical

treatment by the States.” [Citations.] Thus, a state tax at vamance

with federal policy will violate the ‘one voice’ standard if it either

implicates foreign policy issues which must be left to the Federal

Government or violates a clear federal directive [the second of

these considerations being essentially a preemption analysis].”

(Emphasis in original, 463 U.S. at p. 194 [77 L.Ed.2d at

pp. 571-572].)

In applying this refinement of the one-voice standard,

Container noted that the most obvious foreign policy implication

of a state tax is the threat it might pose of offending foreign

trading partners and leading them to retaliate against the nation

as a whole. Coniainer, however, said the judiciary has little

competence in making these determinations on a theoretical

basis, and even less competence in deciding how to balance a

particular risk of retaliation against the sovereign right of the

United States as a whole to let the states tax as they please.

(463 U.S. at p. 194 [77 L.Ed.2d at p. 572].) The Container court

emphasized that the nuances of foreign policy “are much more

the province of the Executive Branch and Congress than of this

Court.” (/d., at p. 196 [77 L.Ed.2d at p. 573].) According to

Container, the best a court can do is try to develop objective

standards that reflect general observations about international

trade and relations. (/d., at p. 194 [77 L.Ed.2d at p. 572].)

Container provided three reasons that weighed strongly against

the possibility of justifiable and significant foreign retaliation.

First, California’s taxing method as applied to domestic-based

av

B-12

unitary groups did not create an “automatic ‘asymmetry’”’ in

international taxation operating to a foreign entity’s disadvantage.

(Emphasis in original, 463 U.S. at pp. 194-195 [77 L.Ed.2d at

p. 572].) Second, the method was imposed not on a foreign

entity, as was the case in Japan Line, but on a domestic corpora-

tion. At this point, the Container court noted that a tax falling on

a domestic corporation “might be less significant in the case of a

domestic corporation that was owned by foreign interests,” that is,

the court again noted it was not dealing with the issue presented

here. (/d., at p. 195, including fn. 32 [77 L.Ed.2d at p. 572].)

Third, even if foreign nations had a legitimate interest in reducing

the tax burden of domestic corporations, that burden is more the

function of tax rate than of allocation method, and California can

simply raise its rate to achieve the same foreign economic effect.

(Ibid. )

After stating that the threat of retaliation was not the only

foreign policy implication a state tax may have, the Container

court noted there was no amicus curiae brief from the executive

branch opposing the tax (463 U.S. at p. 195 [77 L.Ed.2d at

pp. 572-573]), and indicated that although the lack of such a

brief was not dispositive, it did suggest that United States foreign

policy was not seriously threatened by California’s application of

WWCR to domestic-based corporate groups. (/d., at pp. 195-196

[77 L.Ed.2d at p. 573].)

After concluding that foreign affairs were not implicated by

California’s unitary tax in a domestic-based multinational con-

text, the Container court inquired whether the tax violated a

“clear federal directive.” For the following reasons, no such

directive was found.

There was no federal statute on point. While there were

numerous tax treaties that committed the federal government to

use an arm’s length method in taxing the domestic income of

multinational enterprises, that requirement was generally waived

as to contracting nations taxing their own domestic corporations.

This fact, if nothing else said the Container court, “confirms our

view that such taxation is in reality of local rather than interna-

tional concern.” (463 U.S. at p. 196 [77 L.Ed.2d at p. 573].)

Those tax treaties did not generally cover the taxing activities of

B-13

states, and in none of them did the requirement of arm’s length

accounting apply to the states. Moreover, the United States

Senate had on one occasion declined to give its two-thirds consent

to a treaty provision that would have prohibited the states from

using WWCR. Finally, the court noted that Congress had long

debated but not enacted legislation designed to regulate state

taxation of income. In light of these circumstances, the court in

Container could not conclude that California’s unitary tax

method, as applied to domestic-based unitary groups, was pre-

empted by federal law or fatally inconsistent with federal policy.

(463 U.S. at pp. 196-197 [77 L.Ed.2d at p. 573].)

Unlike Japan Line and Container, the United States Supreme

Court in Wardair Canada v. Florida Dept. of Revenue, supra, 477

U.S. 1 [91 L.Ed.2d 1], did not engage in a dormant commerce

clause analysis, finding it “abundantly clear” that the federal

government had affirmatively acted rather than remained silent

with respect to the issue there: the power of a state to tax all

airline aviation fuel sold within the state regardless of the air-

liner’s destination or the amount of intrastate business it did.

(Pp. 9, 12 [91 L.Ed.2d at pp. 10, 12].)

In Wardair, the airliner and the United States as amicus curiae

argued there was a federal policy prohibiting such an unlimited

tax, a policy manifested by (1) the 1944 Chicago Convention on

International Civil Aviation (1944 Convention), which the

United States had signed; (2) a 1966 Resolution of the Interna-

tional Civil Aviation Organization (1966 Resolution), an organi-

zation to which the United States belonged; and (3) more than

70 bilateral aviation agreements, including the 1974 US-Cana-

dian Aviation Agreement (Agreement). (Wardair was a Cana-

dian airline.) The court in Wardair saw things much differently.

Not only did this evidence fail to reveal any such policy, said the

court, but showed the federal government had affirmatively acted

to permit the tax at issue, thus precluding application of the

dormant foreign commerce clause test enunciated in Japan Line.

(477 U.S. at pp. 8-12 [91 L.Ed.2d at pp. 9-12].)

Wardair’s analysis proceeded as follows. The 1944 Convention

only prohibited the local taxation of aviation fuel “‘on board an

aircraft...on arrival...and retained on board on leaving.’”

B-14

(477 U.S. at p. 10 [91 L.Ed.2d at p. 11].) That provision, said

the court, demonstrated the international community’s awareness

of the problem of state taxation of aviation fuel, and represented a

decision by the Convention parties to address the problem by

limiting only some of the localities’ power to tax while implicitly

preserving other aspects of that authority. (/bid.) While the 1966

Resolution undeniably endorsed an international scheme to ex-

empt fuel tax “*‘ “from all customs and other duties, neither

the executive nor the legislative branch had acted in any way to

give the Resolution the force of law. (/d., at pp. 10-11 [91

L.Ed.2d at p. 11].) And after the Convention came into force, the

United States entered more than 70 bilateral aviation agreements,

not one of which prohibited the states from imposing a tax like

Florida’s. (/d., at p. 11 [91 L.Ed.2d at pp. 11-12].) The US-

Canadian Agreement itself was limited to “ ‘national duties and

charges,’ ’’ an especially striking feature given that (1) the Agree-

ment was completed eight years after the 1966 Resolution specifi-

cally addressed the concern of subnational taxation, and (2) both

signatories were federalist nations. (/d., at pp. 11-12 [91 L.Ed.2d

at pp. 12].) Moreover, throughout the duration of the Agreement,

other American states and some Canadian provinces had imposed

fuel taxes similar to Florida’s without challenge, a course of

conduct suggesting that the parties to the Agreement and those

most immediately affected by it understood it to permit this

taxation. (477 US. at p. 12 [91 L.Ed.2d at pp. 12].)

“What all of this makes abundantly clear,” said the court in

Wardair, is that the federal government has not remained silent

but “[b]y negative implication” “has at least acquiesced” in the

state taxation at issue. (477 U.S. at p. 12 [91 L.Ed.2d at pp. 12].)

The dormant commerce clause test of Japan Line was deemed

inapplicable because “the Federal Government ha[d] affirma-

tively decided to permit the States to impose these sales taxes on

aviation fuel.” (Jbid.)

Notable is the fact that the Wardair court continually reaf-

firmed the foreign dormant commerce clause test created in

Japan Line, bui failed to find an opportunity to employ it. Also

notable is Wardair’s recognition of the basic value underlying that

clause: to “‘ensure that the essential attributes of nationhood will

9 9 09

B-15

not be jeopardized by States acting as independent economic

actors.” (477 U.S. at p. 12; see also pp. 7-8 [91 L.Ed.2d at

p. 12].) And the heightened importance of this value in the

context of foreign commerce was recognized by Wardair when it

stated: “In the unique context of ... foreign commerce, we have

alluded to the special need for federal uniformity: * “In interna-

tional relations and with respect to foreign intercourse and trade

the people of the United States act through a single government

with unified and adequate national power” ’ [quoting Japan Line,

supra, 441 US. at p. 448 [60 L.Ed.2d 336], quoting Board of

Trustees v. United States (1933) 289 U.S. 48, 59 [77 L.Ed.

1025].” (477 US. at p. 8 [91 L.Ed.2d at p. 9].)

With the various holdings and analysis of the problems decided

in Japan Line, Container, and Wardair in mind, we turn to the

present context. The first issue to be resolved is whether the

Board is correct that our case tracks Wardair, rendering a

dormant commerce clause analysis unnecessary. For the reasons

that follow, we think the Board is incorrect in its conclusion.

Preliminary, we reject the Board’s suggestion that the three

decisions, Japan Line, Container, and Wardair, together manifest

a significant retrenchment in the sensitivity shown to foreign

relations. Both Container and Wardair reaffirmed Japan Line's

sensitivity to the unique context of foreign commerce and the

special need for federal uniformity in international relations. To

us, the theoretical underpinning has remained intact through

these cases. What was different in them was the degree to which

foreign affairs and international commercial relations were impli-

cated. In Japan Line, the factual context presented an interna-

tional asymmetry, an acute risk of retaliation, and varying degrees

of international multiple taxation. By contrast, in Container, there

was a minimal risk of retaliation, a largely domestic context, and

executive branch silence; and in Wardair, both the American

government and the Canadian government (the foreign country

involved) had essentially agreed to permit the subnational taxa-

tion at issue. Far from demonstrating any significant retrench-

ment in the sensitivity shown to foreign relations, the three cases

demonstrate how that sensitivity is aligned with the degree to

which such relations are implicated.

ee aE Tee eo eee

B-16

Relying upon five perceived indications of executive and con-

gressional acquiescence in light of the principles of Wardair, the

Board contends an affirmative federal policy permitted Califor-

nia’s use of WWCR. Those five factors are (1) the failure to

consider state taxes in United States income tax treaties with

foreign countries, except in nondiscrimination clauses; (2) the

actions by the executive branch in adopting a Model Income Tax

Treaty and in reserving its posjtion on the Organization of

Economic Cooperation and Development (OECD) Model Con-

vention’s application to subnational taxes; (3) Friendship, Com-

merce, and Navigation (FCN) Treaties to which the United

_ States is a party do not require the states to use any particular

method of tax accounting; (4) the absence of enacted congres-

sional legislation prohibiting or restricting the states’ use of

WWCR; and (5) the rejection by the United States Senate of

article 9(4) in the United States-United Kingdom Tax Treaty,

the only attempt by the executive branch to alter federal acquies-

cence in the states’ use of WWCR.

In analyzing the treaties and treaty actions encompassed in

facior (1) through (3), we find little, if any, support for the

Board’s position. True, these treaties and actions reflect a general

policy at the federal level of noninterference in state taxation, but

they do so to preserve the general principle of state sovereignty.

Not one of the treaties or actions, except for the U.S.-U.K. Tax

Treaty to which we shall come, specifically addresses the unitary

tax method or the use of WWCR by subnational units. The

treaties either state in general terms that they apply to national

taxes, or contain general provisions regarding subnational taxes.

The reservations were made to model treaty provisions that state

generally that the treaties should apply to subnational taxes.

Moreover, it was not until the 1970’s when use of WWCR in an

international context essentially began that a problem of interna-

tional dimension arose. (Cal. Code Regs., tit. 18, § 25137-6; see

Comment, California's Corporate Franchise Tax: Taxation of

Foreign Source Income? (1980) 20 Santa Clara L. Rev. 123,

131-136; hereafter 20 Santa Clara L.Rev.) Many of the treaties

B-17

predate the existence of the problem and therefore do not discuss

“hy

“The Board chides the trial court for determining that pre-1978 tax

treaties were largely irrelevant to this case. To support its position, the

Board cites the 1924 United States Supreme Court decision in Bass,

Ratcliff & Gretton v. State Tax Commission, 266 U.S. 271 [69 L.Ed.

282]. In Bass, the court constitutionally validated New York’s applica-

tion of a unitary business/formula apportionmentymethod to the overall

income of a British brewing company that imported a portion of its

product through branch offices in New York and Chicago. Because of

Bass, says the Board, the international community has been well aware

since 1924 of this income allocation alternative to the AL/SA method.

Rather than support the Board’s argument, we think Bass undermines

it. Awareness of a particular tax theory is one thing; to be subjected to

that theory in practice is quite another. Though Bass and its foreign-

based unitary tax concept have been around since 1924, it was not until

the early 1970’s when the concept began to be noticeably applied that

the problem of unitary taxation in the international arena arose. That

history supports the idea that such a tax, though known as a concept,

was little applied in internationai practice and thus largely irrelevant

beyond our borders. (See Mobil Oil Corp. v. Commissioner of Taxes

(1980) 445 U.S. 425, 438-439, 446-448 [63 L.Ed.2d 510]; Container,

supra, 463 U.S. at pp. 163-165, 168-169, including fn. 7, 185-197 [77

L.Ed.2d 545].) Ali of this supports the trial court’s eminently sensible

determination that a tax treaty cannot be relevant to a tax problem that

did not exist and was not foreseeable at the time the treaty was

negotiated. Like judicial decisions, the older tax treaties here cannot

sensibly be considered authority for propositions not considered.

In a somewhat related vein, the Board also cites Bass as constitution-

ally validating the unitary tax method as applied to foreign-based

corporations. For a number of reasons, we disagree. First, Bass was

decided before the United States developed its network of international

tax treaties. (See 23 Columbia Journal at p. 450, fn. 32.) Second, Bass

did not discuss foreign policy implications. Third, Bass obviously did not

have the opportunity to apply the foreign dormant commerce clause test

as enunciated in Japan Line. Finally and most importantly, Container

cited Bass three times in passing yet twice explicitly reserved determin-

ing the constitutionality of the unitary tax method as applied to foreign-

based corporate groups. (Container, supra, 463 U.S. at pp. 164-166, 189,

fn. 26, 195, fn. 32 [77 L.Ed.2d 545].) Bass’s importance fades consider-

B-18

Contrast the treaty analysis in Wardair. There, the specific

subject matter encompassing the tax at issue, as well as inextrica-

bly related taxes, had been discussed in the 1944 international

Convention well before the aviation agreements were negotiated.

Many of these agreements also postdated the 1966 international

Resolution which specifically discussed the subject matter en-

compassing the tax. The American government and the interna-

tional community were therefore negotiating these agreements

with a keen awareness of the tax involved in Wardair. In fac‘,

Wardair involved an issue of subnational taxation and the most

relevant agreement in that case — the United States-Canadian

Agreement — was signed by two federalist nations 30 years after

the 1944 Convention and 8 years after the 1966 Resolution;

furthermore, the course of conduct under this agreement indi-

cated the tax at issue was permitted.

The Board’s approach is simply too general and ignores histori-

cal context in essentially arguing that when a treaty is limited to

national taxes or fails to discuss a particular taxation method, a

conscious decision has been made to allow states to tax in any

manner they please. Common sense charts a different course

while respecting the broad power of a state to tax. (See Hines v.

Davidowitz, supra, 312 U.S. at p. 68 [85 L.Ed. at pp. 587-588]}.)

In an attempt to be more specific, the Board does note that

many of the bilateral tax treaties contain nondiscrimination

clauses applicable to the states. The Board argues that these

clauses give rise to a Wardair-like “negative implication” of a

decision by the treaty parties to resolve the problem of state

taxation by curtailing only some of the states’ power to tax, while

implicitly preserving other aspects of that authority. (Wardair.

supra, 477 U.S. at pp. 10, 12 [91 L.Ed.2d at pp. 11, 12].) Again,

we disagree.

In Wardair, the negative implication arose because foundation

agreements had addressed not only the specific subject matter

encompassing the tax at issue but specific taxes within that

subject, without addressing the tax at issue. Subsequent agree-

ably in light of these factors. (See 20 Santa Clara L.Rev. at

pp. 126-128.)

B-19

ments were negotiated and conducted in the atmosphere of these

foundational ones. The nondiscrimination clauses do not provide a

similar parallel here. Those clauses are simply reflections of a

general principle that a state shall not tax a foreign company more

than it taxes its own companies. A Wardair-like negative implica-

tion concerning WWCR which arises from this generality is

impossible.°

Also cloaked in generality is the Board’s fourth factor that the

Board asserts would preclude a dormant commerce clause analy-

sis: the absence of enacted congressional legislation prohibiting or

restricting the use of WWCR to foreign-based multinationals.

Apparently the Board concedes the trial court’s finding that

there was no evidence there has ever been a vote in a congres-

sional committee or in Congress itself on legislation prohibiting

the use of WWCR. And the senior career official in the Depart-

ment of Treasury for WWCR matters during much of the 1970's

and 1980's, George N. Carlson, testified that none of the proposed

legislation dealt solely with WWCR as to foreign-based enter-

prises. It is also true, as reiterated in Container, that “ ‘Congress

has long debated, but has not enacted, legislation designed to

regulate state taxation of income.’ ” (463 U.S. at pp. 196-197 [77

L.Ed.2d at p. 573], quoting Mobil Oil Corp. v. Commissioner of

Taxes, supra, 445 U.S. at p. 448 [63 L.Ed.2d at p. 528].)

The problem with this factor is that in trying to assign a specific

reason to legislative inaction, we must enter the realm of pure

speculation. It is difficult enough trying to ascertain legislative

intent when a statute has been enacted, but trying to find meaning

in legislative silence is about as difficult as hearing sound in a

vacuum.

That brings us to the Board’s fifth factor and the only one that

specifically concerns the application of WWCR to foreign-based

enterprises.

‘Our determination is supported by the fact that less tax-specific

treaties such as the FCN Treaties contain a comparable nondiscrimina-

uon clause. (23 Columbia Journal at p. 471.)

B-20

In 1975 the executive branch negotiated an income tax treaty

with the United Kingdom containing a provision — article 9(4)

— that would have prohibited the states’ aprl‘cation of WWCR

to U.K.-based corporate groups. The Unitec tates Senate rati-

fied the treaty only after article 9(4) was effectively removed

through a reservation by Senator Church. The Board contends

this senatoria! action “was a significant indication of federal policy

to let the states continue to use WWCR.” Again, the Board

simply reads too much into too little.

The Church reservation to article 9(4) was defeated in the

Senate Foreign Relations Committee and again on the Senate

floor. However, the treaty with article 9(4) included received a

favorable full Senate vote of only 49 to 32, falling 5 votes short of

the two-thirds majority needed for ratification. When the Church

reservation was resurrected without a vote and the controversial

article was effectively removed, the Senate then provided its

constitutional imprimatur.

In light of these Senate tallies, it is difficult to see a congres-

sional policy permitting states to use WWCR. Moreover, it

appears that some of the senatorial opposition to article 9(4) was

rooted not in the substance of the article but in the procedural

wariness of addressing the problem through patchwork treaties

rather than through comprehensive legislation.

The Board asks reasonably why no tax treaty subsequent to the

U.S.-U.K. Tax Treaty has included a provision similar to arti-

cle 9(4). The Board’s answer is that the Senate action on 9(4)

indicated a congressional policy permitting states to use WWCR.

Our answer is that the constitutional high hurdle of treaty

ratification and a treaty’s piecemeal approach to the problem

render a resolution via the treaty process ineffectual. We simply

fail to see how three majority votes in the Senate essentially

approving article 9(4) can be transmogrified into a congressional

policy of disapproval.

Whether the Board’s five factors are analyzed individually or

collectively, they fall far short of establishing under Wardair an

affirmative federal policy permitting California's use of WWCR.

To the court in Wardair the factors there — an international

B-21

Convention, an international Resolution, and more than 70 post-

Convention agreements, including the U.S.-Canadian Agreement

and the course of conduct thereunder by its two federalist signato-

ries — made it “abundantly clear” that the federal government

had “affirmatively decided to permit the States to impose these

sales taxes on aviation fuel.” (477 U.S. at pp. 9-12 [91 L.Ed.2d at

pp. 10-12].) That clarity was grounded in the close connection

between those factors and the tax at issue, as the factors specifi-

cally discussed the subject matter of and taxes inextricably related

to the tax at issue, or actually encompassed the type of tax at

issue.

As we have seen, there is no similar connection between the

factors cited by the Board and the WWCR taxation method at

issue here. Only one of the Board’s factors specifically addresses

WWCR, and it does so in a manner that is at best neutral in

respect to the Board’s position. Interestingly, the court in

Container had before it many of the same factors upon which the

Board relies including the Senate action on the U.S.-U.K Treaty,

and nevertheless engaged in a dormant commerce clause analysis.

(463 U.S. at pp. 185-197 [77 L.Ed.2d at pp. 566-573}.) Put most

succinctly, while the court in Wardair was dealing with hard and

specific evidence, we have been dealt “Five Easy Pieces.” We

proceed to a foreign dormant commerce clause analysis, applying

the foreign dormant commerce clause test of Japan Line and

Container.

1. The Enhanced Risk of Multiple Taxation.

This consideration need not detain us long. All of the elements

of double taxation involved in Container are also involved here.

(463 U.S. at pp. 189-193 [77 L.Ed.2d at pp. 568-571].) But

Container rejected those elements, reasoning that they were not

“inevitable” and that resorting to the AL/SA method would not

guarantee their demise. (/bid.) We can discern no constitution-

ally significant differences between domestic-based and foreign-

based multinational corporations concerning the enhanced risk of

multiple taxation: in neither case is double taxation inevitable.

Following the precedent of Container, we find California’s use of

as

B-22

WWCR as to foreign-based multinationals is not unconstitutional

on this ground.

2. Whether California's Application of WWCR to Foreign-Based

Unitary Groups May Impair Federal Uniformity in an Area

Where Federal Uniformity Is Essential and Prevents the Fed-

eral Government From Speaking With One Voice in Interna-

tional Trade.

A. FOREIGN POLicy IMPLICATIONS

The first issue to consider is whether California’s application of

WWCR to foreign-based unitary groups implicates foreign policy

issues which must be left to the federal government. (Container,

supra, 463 U.S. at p. 194 [77 L.Ed.2d at pp. 571-572]; see also

Japan Line, supra, 441 U.S. at pp. 448, 453 [60 L.Ed.2d at

pp. 347, 350].) We think that it does.

According to Container, “[t]he most obvious foreign policy

implication of a state tax is the threat it might pose of offending

our foreign trading partners and leading them to retaliate against

the Nation as a whole.” (Emphasis added, 463 U.S. at p. 194 [77

L.Ed.2d at p. 572].) Every single nation in the industrialized

western world has sent letters to the United States government

protesting the use of WWCR by American states. Many of these

protests have also been directed to California. Among the most

vigorous of these remonstrators has been Canada, by far the

United States’s largest trading partner, and Britain, this country’s

largest foreign investor. These protests have been sharp, frequent,

and incessant over a number of years. There was also evidence

that no other taxation issue had ever led foreign governments to

deal directly with American states. Even high-placed officials of

the Board acknowledged awareness of this international outcry.

(See 20 Santa Clara L.Rev. at pp. 125-126.)

And it is not just talk. The ultimate test of diplomatic sincer-

ity — watch what they do, not what they say — has been met

here. In 1985, Britain passed retaliatory legislation withdrawing a

tax advantage for U.S.-based corporations doing business in both

Britain and a unitary tax state. Though Britain stopped short of

pulling the procedural trigger to fully implement this legislation,

B-23

the law had a retroactive provision that impelled many American

companies into preimplementation compliance. Moreover, Bnit-

ain cancelled a trade mission to Florida because that state applied

WWCR to foreign-based multinationals. And there were other

similar cancellations. There was also evidence the United States

has had problems in negotiating treaties because of objections to

WWCR.

The Board claims Britain has orchestrated the international

outcry and passed a disingenuous piece of “retaliatory” legislation

that does not retaliate. However, some nation has to take the lead

and the often-noted “special relationship” between Britain and

the United States makes Britain the obvious choice for conductor.

We doubt that every industrialized country in the western world

would have joined the symphony if there were not truly a

significant problem. In fact, a committed leader is more likely, not

less likely, to be genuinely devoted. As to the allegedly devious

legislation, Britain, the largest foreign investor in the United

States, stood to lose disproportionately if America deemed that

legislation completely unfounded. Many American companies

operating in Britain did not believe such legislation was merely for

show. Moreover, the legislation was introduced “back-bench,”

that is, by the opposition party, and nevertheless passed unani-

mously — extraordinary legislative feats according to the bill’s

author.

Our views are buttressed by analyzing the three general factors

identified in Container that “might justifiably lead to significant .

toreign retaliation.” (463 U.S. at pp. 194-195 [77 L.Ed.2d at

p. 572].) The first factor is whether California’s use of WWCR

creates an automatic asymmetry in international taxation operat-

ing to the foreign-based multinational’s disadvantage. Because no

other country in the world uses WWCR, domestic-based multina-

tionals do not face this taxation method abroad. And while both

domestic and foreign-based multinationals are subjected to the

method if they do business in an American jurisdiction that

employs it, the administrative burdens of compliance, as we shall

see, fall much harder on the foreigner.

The second general factor identified in Container inquires

whether the legal incidence of the tax falls on a domestic

——————————w

B-24

corporation or a foreign one. (463 U.S. at p. 195 [77 L.Ed.2d at

p. 572].) This factor was of significant importance in Container,

being noted at four places in the opinion. (/d., at pp. 188-189,

195, including fns. 26, 32 [77 L.Ed.2d at pp. 568-569, 572].) We

face here the precise issue reserved ir Container: “the constitu-

tionality of combined apportionment with respect to state taxation

of domestic corporations with foreign parents or foreign corpora-

tions with either foreign parents or foreign subsidiaries.” (/d., at

p. 189, fn. 26 [77 L.Ed.2d at p. 568].) Container carefully noted

that the tax there was imposed on a domestic corporation, “not on

a foreign entity as was the case in Japan Line,” and that

“[a]lthough, California ‘counts’ income arguably attributable to

foreign corporations in calculating the taxable income of that

domestic corporation, the legal incidence of the tax falls on the

domestic corporation.” (/d., at p. 195 [77 L.Ed.2d at p. 572].)

Container also recognized “that the fact that the legal incidence

of a tax falls on a corporation whose formal corporate domicile is

domestic might be less significant in the case of a domestic

corporation that was owned by foreign interests.” (463 U.S. at

p. 195, fn. 32 [77 L.Ed.2d at p. 572].)

Here, California’s taxation method of WWCR falls directly on

a domestic corporation with a foreign parent (Barcal) and. di-

rectly on a foreign corporation with a foreign parent and foreign

subsidianes (BBI). As we have seen, foreign governments are

none too happy about this state of affairs. The governments of

Britain and Canada have expressed their displeasure to this court

through their amici cunae briefs.

Proponents of the worldwide unitary tax method cannot dispel

foreigners’ concerns by arguing that it is really the United States

subsidiary or operation that bears the tax burden. The premise of

the unitary tax system is that it is unrealistic geographically to

isolate income derived from the intangible flow of value among

the parts of a unitary business. Similarly, then, it is unrealistic to

isolate the tax payments necessitated by that system: the inci-

dence of taxation falls on the entire business, including the foreign

parent. (See 23 Columbia Journal at p. 466.)

That brings us to the third general factor identified in Container

as bearing on the misk of foreign retaliation: whether the tax

B-25

burden is more a function of California’s WWCR tax rate or its

allocation method. (463 U.S. at p. 195 [77 L.Ed.2d at p. 572].)

Foreign-based corporate groups incur significantly greater ad-

ministrative costs to comply with Californiass WWCR system

than do their domestic-based counterparts; in fact, all of the trial

witnesses agreed that literal compliance with the system was cost-

prohibitive for the foreign groups.° (See Comptroller General

Report, Key Issues Affecting State Taxation of Multijurisdictional

Corporate Income Need Resolving, 3, GAO/GGD-82-38 (1982)

[ hereafter, GAO Report].)

In a nutshell, this distinction between domestic and foreign-

based multinationals is a result of the following: while domestic-

based multinationals keep most of their records in English, in

United States currency and in accord with United States account-

ing principles, the same cannot be said for multinationals based

abroad. (GAO Report at p. 39.) For the foreign parent, some of

the information may not be available because different nations

use different accounting methods. Obviously, the information that

does exist is not always in the language, in the currency, and in

accord with the principles just noted. Substantial costs are in-

curred in obtaining the necessary information and translating and

transforming it to these modes. (See 20 Santa Clara L.Rev. at

pp. 143-144; 23 Columbia Journal at p. 471.)

The administrative nightmare for the foreign-based multina-

tional is aptly demonstrated here. In 1977, BBI, a Britain-based

company, was engaged in business directly or through subsidiaries

in approximately 55 countnes. During this time, BBI had an

interest sufficient for California unitary group purposes, in more

than 70 subsidianes operating in approximately 34 countnes

outside Bntain. Two of those subsidianes were organized and

°The Board contends the trial court should have excluded all evidence

on cost of compliance because plaintiffs failed to adequately raise the

issue in administrative proceedings. We disagree. Plaintiffs’ original and

supplemental protests raise the compliance issue as part of their overall

constitutional challenge. Moreover, the Board was apprised of this issue

in correspondence during the administrative process.

a

B-26

operated in the United States: Barcal and Barclays Bank of New

York (BBNY). In addition to owning BBI and BBI’s subsidiaries,

BBL, the Britain-based ultimate corporate parent, owned a suff-

cient interest for California unitary purposes in over 140 subsidi-

aries that operated outside the United States. All told then, the

Barclays unitary group consisted of over 220 subsidiaries (includ-

ing subsidiaries of subsidianies)operating in some 60 countries,

but of these only BBI, Barcal, and BBNY, did business in the

United States.

Using the Board’s own figures, only 1.5 percent of the income

generated by the Barclays group worldwide in 1977 can be

attributed to California. Even accounting for the BBNY activity,

this means that over 98 percent of the Barclays group’s income in

1977 had its source outside the United States. According to

witnesses at tnal, it would cost millions of dollars for Barclays to

establish and maintain the global system necessary to literally

comply with California’ss WWCR tax method. (The figures

ranged from $6.4 million to $7.7 million to establish the system,

and from $2 million to $3.8 million a year to maintain it.) And

note that Barclays, unlike many other foreign multinationals, at

least speaks the same language as the California taxing

authorities.

That it is California’s allocation method rather than its tax rate

that is the primary source of difficulty becomes readily apparent

when these kinds of circumstances are viewed by foreign entities

steeped in the AL/SA tradition. Foreign anger is even more

understandable in light of the critical role the United States has

played in attempting to construct a coherent and nondiscrimina-

tory tax policy for all nations based on the AL/SA method. (See

23 Columbia Journal at pp. 459-462; 20 Santa Clara L.Rev. at

pp. 153-154.)

The trial court deemed these costs of compliance sufficient to

invalidate WWCR as an unconstitutional discrimination against

foreign commerce — i.e., as a breach of one of the onginal four

tests set forth in Complete Auto (430 U.S. 274 [51 L.Ed.2d

326]). While we do not here use costs alone to constitutionally

invalidate the use of WWCR (see Bibb v. Navajo Freight Lines

(1959) 359 U.S. 520, 526 [3 L.Ed.2d 1003, 1008]), this legal

B-27

analysis by the tral court — based upon a factual foundation of

substantial evidence — demonstrates just how serious the admin-

istrative burden can be for the foreign entity.

The Board argues that literal compliance is a nonissue because

regulations have been adopted by which a foreign-based multina-

tional can use reasonable approximations to figure its California

tax. (Cal. Code Regs., tit. 18, § 25137-6; Rev. & Tax Code,

§ 25137.) These approximations, according to the Board, can be

derived from annual reports and other data that are already

publicly available. (See 23 Columbia Journal at p. 472.)

There are several problems with the Board’s argument. The

Board decides whether to allow a foreign entity the route provided

by regulation 25137-6, and such discretion is a powerful instru-

ment in light of the cost-prohibitive alternative of literal compli-

ance. Moreover, California state tax authorities have at least once

threatened to impose penalties for failure to produce detailed

information needed to apportion income, even though the Bnitish-

based company involved claimed the information was confidential

under Britain’s national security laws. (See EM/ Lid. v. Benneti

(N.D.Cal. 1982) 560 F.Supp. 134; Capitol Industries — EMI,

Inc. v. Bennett (9th Cir. 1982) 681 F.2d 1107, 1110-1111; 23

Columbia Journal at p. 472.) These tax authorities cannot main-

tain on the one hand that reasonable approximations derived from

already publicly available data are sufficient, and on the other

hand demand under sanction more detailed information that is

not readily available or even producible. Logically, detailed infor-

mation on payroll, property, and sales is needed to apply the

WWCR formula in an uncapricious manner. But more funda-

mental is why a state which has so little faith in the AL/SA

method would so willingly embrace another method that is based

On approximations derived from very general data? In light of

these observations, the practical availability of the reasonable

approximation approach is seriously open to question.

In contrast to Container then, we do not have to speculate on

whether the taxation method at issue may offend our foreign

trading partners and lead them to retaliate against the nation as a

whole. (463 U.S. at p. 194 [77 L.Ed.2d at p. 572].) They are

offended; they have retaliated. And the three general factors

a

‘

B-28

identified in Container that might justifiably lead to significant

retaliation — asymmetry, upon whom the tax falls, and tax rate

versus allocation method — are all present in this case. (/d., at

pp. 194-195 [77 L.Ed.2d at p. 572].)

Also in marked contrast to Container stands the amicus cunae

brief from the federal executive branch opposing California’s

application of WWCR to foreign-based corporate groups. That

brief reiterates many of the points noted above and delineates an

executive branch policy we will discuss below. We are mindful of

Container’s observation that in the context of the foreign com-

merce clause the foreign policy nuances of the United States are

much more the province of the executive and the Legislature than

of the judiciary. (463 U.S. at pp. 195-196 [77 L.Ed.2d at

pp. 572-573].)

B. CLEAR FEDERAL DIRECTIVE

That brings us to the other avenue identified in Container by

which a state tax will violate the “one-voice” standard: if the tax

violates a clear federal directive. (463 U.S. at p. 194 [77 L.Ed.2d

at pp. 571-572].) As this consideration is an integral component

of the dormant commerce clause test, obviously such a directive is

not synonymous with an affirmative federal policy precluding

dormant commerce clause analysis. (/d., at pp. 193-194

[77 L.Ed.2d at p. 571].)

In dealing with this issue, the court in Container looked for

specific indications of congressional intent after noting that no

amicus bref from the executive branch had been filed. (463 U.S.

at pp. 195-196 [77 L.Ed.2d at pp. 572-573].) Examining much of

the same evidence relied on by the Board here to preclude a

dormant commerce clause analysis, Container did not find any

such indications and concluded that California’s application of

WWCR to domestic-based corporate groups was not preempted

by federal law or fatally inconsistent with federal policy. (Jd., at

pp. 196-197 [77 L.Ed.2d at p. 573].)

Like the court in Container, the tnal court in this instance

found “no Congressional expression either way on this subject.”

B-29

Our earlier discussion as to why Wardair does not preclude a

dormant commerce clause analysis supports this finding.

However, the trial court found the evidence unequivocal “that

the executive branch all along, under three administrations since

the WWCR problem in the present context became known, has

steadfastly adhered to a policy of use of the arms length/separate

accounting (AL/SA) method and not WWCR, both as to the

States and the Federal Government.” In the context presented

here, we agree with the trial court.

George Carlson, who was the Treasury Department’s (the

executive department charged with formulating tax policy) senior

career official for WWCR issues during most of the 1970’s and

1980’s, testified regarding the executive branch’s policy on

WWCR application to foreign-based corporate groups. That pol-

icy was Officially pronounced in 1975 when the U.S.-U.K. Tax

Treaty was signed, and essentially proscribed such an application

while advocating an accounting restriction to the “water’s-edge”’

of the United States. The genesis of the policy can be found in

Treasury Department studies confirming complaints from foreign

governments about increased risks of double taxation, dispropor-

tionate administrative burdens, and possible retaliation. Addition-

ally, those studies found that WWCR in a foreign context was

interfering with the federal government’s foreign commercial

policy and its ability to negotiate bilateral tax treaties. In short,

the Treasury Department — again, the executive department

charged with formulating the executive branch’s tax policy —

concluded that WWCR was an irritant in our foreign commerce

relations.

This executive policy remained constant through four presiden-

tial administrations, starting when negotiations on the U.S.-U.K.

Tax Treaty began, to the point when this case was litigated. And

though there was a change in political party of the executive

during this time, there was no change in policy: the executive

branch did not want WWCR applied to foreign-based corporate

groups.

Negotiations on the U.S.-U.K. Tax Treaty began during Presi-

dent Nixon’s administration.

—————————————aaEeEeEee——————ee

B-30

That treaty, with article 9(4) included, was signed during

President Ford’s tenure.

President Carter’s Secretary of the Treasury, Michael Blumen-

thal, in a 1977 letter to Martin Huff, then the executive director

of the Board, stated: “The unitary apportionment system is

inconsistent with accepted tax treaty policy which prohibits one

country from taxing the business profits of an enterprise of the

other unless that enterprise is engaged in business through a

permanent establishment in the first country....[{]]...The

arm’s length standard is the internationally accepted approach.”

And President Carter’s Assistant Secretary of the Treasury for

Tax Policy, Donald Lubick, explained the administration’s posi-

tion to both houses of Congress in March and June of 1980.

Lubick emphasized that WWCR application to foreign-based

corporate groups was the preeminent concern, citing the firmly-

documented problems of foreign policy interference, double taxa-

tion, administrative burdens, and possible retaliation.

Faced with a deluge of complaints from all of our major trading

_ partners and his patience exhausted by the failure of the states to

resolve the WWCR problem voluntarily, President Reagan in

1985 publicly issued a directive on the matter. He instructed the

Attorney General to pursue through litigation and the Secretary

of the Treasury to pursue through legislation and where appropri-

ate, through treaty amendment, the federal policy that multina-

tional corporations be taxed by states only on income derived

from the United States and not on income derived from foreign

subsidiaries. Under the aegis of that directive, Secretary of State

Schultz in early 1986 wrote to Governor Deukmejian urging him

to support efforts to end California’s use of WWCR. Not only did

this letter explain that it was the long-standing policy of the

United States to follow the AL/SA method, which was also the

international standard, but that, “[y]our state’s employment of

the worldwide unitary method of tax accounting is at odds with

the position of the United States and has become a source of

conflict with foreign states;” furthermore, the letter pointed out

that “[t]he worldwide unitary issue has seriously complicated our

economic relations with many of our closest allies.” California

passed the “water’s-edge”’ legislation a few months later.

B-31

On this record we feel confident in saying that the executive

branch has spoken clearly. Through that branch, the policy of the

United States since the WWCR problem in the present context

arose in the 1970’s has been established: WWCR is not to be

applied to foreign-based corporate groups — those groups are to

be taxed by the states only on income derived from the United

States.

Naturally, the question arises as to whether the executive

branch alone can establish national policy in the field of foreign

commerce or does it need the concurrence of the legislative

branch?

Undoubtedly, the legislative branch can establish national pol-

icy in the field of foreign commerce without the concurrence of

the executive branch. Specifically, the federal Constitution grants

Congress this power (U.S. Const., art. I, § 8, cl. 3).

Does the same obtain for the executive branch? In the steel

industry seizure case of Youngstown Sheet & Tube Co. v. Sawyer

(1952) 343 U.S. 579 [96 L.Ed. 1153], Justice Jackson wrote a

concurring opinion analyzing the scope of presidential power.

(343 U.S. at pp. 634-656 [96 L.Ed. at pp. 1198-1210].) It has

been said that Jackson’s opinion “b

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