The Fifth Appellate District of the California Court of Appeal has struck another blow to taxpayers claiming California unconstitutionally discriminates against interstate commerce by permitting intrastate unitary businesses to file using either a combined reporting method or separate accounting method, while requiring interstate unitary businesses to file under the combined reporting method.
The Court of Appeal affirmed the underlying trial court judgment against interstate unitary business taxpayer appellant Abercrombie & Fitch (Abercrombie), but did not directly address all arguments on appeal. Instead, the Court of Appeal expressly “assumed” without affirmatively determining or thoroughly addressing, both (1) the sufficiency of Abercrombie’s prima facie showing that California’s statutes call for differential treatment of intrastate and interstate unitary businesses in benefit of intrastate unitary businesses, and (2) the state’s failure to carry its burden of showing these discriminatory measures advanced a legitimate local purpose that could not be adequately served by reasonable nondiscriminatory alternatives. Notwithstanding these assumed conclusions in the taxpayer’s favor, the Court of Appeal jumped straight to holding the trial court did not err in determining Abercrombie failed to carry its burden of proof as to damages and causation.
When looking at the damages issue, the Court of Appeal turned Abercrombie’s plea for equal treatment against it, concluding that Abercrombie was not actually seeking to obtain equal treatment in response to a reporting scheme detrimental to interstate unitary businesses but was rather seeking to obtain preferential treatment over intrastate unitary businesses. Specifically, the Court of Appeal interpreted Abercrombie’s evidence and argument as an attempt to capitalize on using the separate accounting method to avoid needing to report certain income derived from or attributable to sources within California that intrastate businesses could not possibly avoid reporting. The Court goes on to state, at the end of the opinion: “This technique of not reporting income properly apportioned to California creates, rather than eliminates, disparate treatment.”
Side Note Evidentiary Takeaway: The Court of Appeal’s analysis partially relied on Abercrombie’s expert witness testimony, noting that while this testimony covered hypothetical situations where a unitary business might benefit from choosing to file on a separate accounting basis as opposed to a combined reporting basis (primarily due to differing applications of tax credits and loss carryovers), the testimony failed to show Abercrombie actually suffered damages as a result of the state’s different reporting requirements. Regardless of whether this determination was merited or not, it is a reminder to take extra efforts when presenting evidence to clearly connect all the dots between law and facts, or between theory and practical application.
When looking at this opinion from a trend perspective, regardless of whether you are selling motorcycles or branded t-shirts, California courts aren’t buying the argument that California’s tax reporting scheme is discriminatory.