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Tax ruling will hurt state
Verdict rejecting part of the corporate tax code may cost more
than $1.5 billion.
By Michael Doyle -- Bee Washington Bureau - (Published February
24, 2004)
WASHINGTON - California's already bleak budget outlook took another
blow Monday as the U.S. Supreme Court let stand an opinion striking
down part of the state's corporate tax code.
The action eventually could cost the state upward of $1.5 billion,
by some estimates. In the short run, the state likely will face
demands for hundreds of millions of dollars in corporate tax refunds.
"Not the way you want to start your workweek," said H.D. Palmer,
deputy director of the California Department of Finance. "It's going
to be a substantial hit, there's no question about it."
Losing the case involving the deductibility of corporate dividends
"will have a major negative revenue impact on the general fund
budget," California Legislative Analyst Elizabeth Hill agreed.
In a recent report, Hill pegged the potential tax refunds at
between $500 million and $1.5 billion. "The exact magnitude and timing
of such refunds is not clear at this time," Hill noted, but "in
addition, the state could face ongoing annual revenue reductions of
$180 million under a worst-case scenario."
For many corporations, though, the Supreme Court's decision means
an opportunity to recoup tax payments they've maintained violate the
Constitution. The court's decision not to hear California's appeal
tracks closely with other recent decisions eliminating certain state
tax provisions as interfering with interstate commerce.
"I think it was, frankly, to be expected," said Thomas Steele, the
San Francisco-based attorney who challenged California's state
corporate tax provision. "We were very much expecting the court to
deny (California's appeal), and I think most tax experts were as
well."
The case known as Franchise Tax Board v. Farmer Bros. was one of
dozens that the Supreme Court announced Monday it would not take up
for full consideration. California needed to get the votes of at least
four of the court's nine justices for the case to be considered.
Steele, a University of California, Davis, law school graduate
who's now with the firm Morrison & Foerster, represents Farmer Bros.
Starting administratively, and working its way through the courts,
the company challenged the dividends-received deduction in the state's
tax code.
This provision permits corporations a deduction for dividends
received from income that's already been taxed in California. In the
case of Farmer Bros., for instance, the company received a Pacific Gas
and Electric Co. dividend of $17,550 in 1992. Essentially all of this
dividend was deductible, because PG&E already had been taxed for the
income upon which the dividend was based.
On the other hand, Farmer Bros. also reported a dividend of $4,800
from Merrill Lynch, and very little of that was deductible.
The provision has been part of California's Revenue and Tax Code
since 1929, with officials describing it as a way to avoid double
taxation - at least, with regard to California-based income.
"I don't think they saw the unintended consequence of
disadvantaging interstate commerce," Steele said.
The Constitution's all-important commerce clause gives Congress the
power to regulate interstate commerce. By extension, through what's
called the dormant commerce clause, this provision blocks states from
erecting barriers against one another. In May 2002, the Los
Angeles-based 2nd District Court of Appeal concluded that California's
dividend provision amounted to just such an economic barrier.
"(It) is discriminatory on its face," the state appellate court
ruled, because "the dividends-received deduction scheme favors
dividend-paying corporations doing business in California over
dividend-paying corporations which do not do business in California
and pay no taxes in California."
In a somewhat similar 1996 case involving North Carolina, the
Supreme Court unanimously struck down that state's provision that
essentially levied higher taxes on income from out-of-state companies.
About the Writer
--------------------------- The Bee's Michael Doyle can be reached
at (202) 383-0006 or
mdoyle@mcclatchydc.com.
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