A landmark agreement forged 45 years ago to make corporate taxation more uniform among U.S. states is at the center of a court fight between California and Gillette Co, potentially leading to more tax conflict between states and big businesses.
Gillette, the razor giant owned by Ohio-based Procter & Gamble Co, wants to be able to use the 1967 Multistate Tax Compact (MTC) to determine how much tax it owes California. This would cut Gillette's 1997-2004 tax bill by more than $4 million. The company is seeking a rebate of taxes already paid.
California wants Gillette to abide by more recent tax rules the state has written and, as a result of the dispute, has withdrawn from the MTC, reducing its membership to 18 states and raising questions about the compact's future.
At a time of tight state budgets, the case is being closely watched across the country. Early next year, the California Supreme Court will decide whether to take the case under review. Whether or not it does, more litigation is expected.
A victory for Gillette in California - which has by far the largest economy among the 50 states - could unleash $750 million in new California tax rebate claims, according to the state.
Similar disputes involving other companies are pending in Michigan, Oregon and Texas. Experts expect more states to become involved next year.
PATH THROUGH COURTS
The case dates to January 2010. That was when Gillette and other companies filed claims saying California, as an MTC member, must honor the MTC formula for apportioning state taxes, and not impose its own formula. The claims were consolidated.
The other companies were Kimberly-Clark Corp, Sigma-Aldrich Corp, RB Holdings, Jones Apparel Group and Procter & Gamble, Gillette's parent since 2005. They argued that under the MTC, their tax bills, with interest, would be $34 million less than under California's math.
The state went to court and prevailed at trial in San Francisco Superior Court, but then lost before the State Court of Appeals in July. In November, the state's Franchise Tax Board appealed to the California Supreme Court to hear the case.
In finding for Gillette, the appeals court ruled that the compact was a binding obligation on California which subsequent legislation did not erase. Only California's withdrawal from the compact would do that, the court said.
The state dropped out of the MTC in June, an action that could protect it from future claims. But if other states follow California's lead, seeking to avoid trouble from companies testing the Gillette approach, MTC membership would shrink, potentially ushering in a newly fragmented system pitting states against corporate taxpayers a case at a time.
Joe Huddleston, executive director of the Washington-based Multistate Tax Commission, an interstate group created 45 years ago to administer the compact, said the principles of state tax cooperation remain strong. But he predicted the Gillette case would have broad implications.
Forged to promote equitable apportionment of tax dollars among states, the MTC represented an effort by states to ensure that companies operating in multiple states not pay tax on the same income to more than one state.
Tax consistency was seen as a benefit both to states, which used the compact to fight off federal intervention on the topic, and to multistate companies seeking fair taxation. The MTC includes a formula whereby companies place equal weight on their property, payroll and sales in a given state when calculating how much tax they owe there.
In the years since 1967, many states, including California, have moved away from the MTC formula. To favor and attract businesses within their borders, these states have rearranged the way they tax business income so that in-state businesses pay less and out-of-state businesses pay more, explained University of Connecticut Law School Professor Richard Pomp.
Annette Nellen, professor of accounting and finance at San Jose State University, said the change is an example of how the state has used the tax code as an economic development tool.
In California, the state's recent rules added up to millions of dollars in additional costs for the companies involved in the Gillette case. All of them are based outside of California.
The California Franchise Tax Board declined to answer questions about the case or the claim that its formula benefits local companies. It cited a policy of not discussing pending litigation.
Gillette and Procter & Gamble both declined comment on the litigation, as well.
The MTC is one of more than 200 compacts in force among the 50 states. The tax compact takes in nearly every state in one form or another. With California's withdrawal in June, the compact now includes 18 states and the District of Columbia as full members. Another 23 states are associate members and attend meetings and in some cases take part in other programs, such as joint taxpayer audits. Six other states support the MTC's purpose, but are not participating members.
The case is Gillette Co & Subsidiaries v. California Franchise Tax Board, Supreme Court of the State of California Case No. S206587.