SeeSALT Blog
Following its February 26, 2026 Proposed Statement of Decision, the California Superior Court issued a final Statement of Decision in Smithfield Packaged Meats Corp. v. California Franchise Tax Board directly rebuking the Franchise Tax Board’s (“FTB”) reflexive application of the single-sales factor apportionment formula and its narrow construction of “agricultural business activity.” The Court’s final decision reached two significant conclusions.
First, the Court held that the FTB erred in concluding that the taxpayer did not qualify as an agricultural business under California Revenue and Taxation Code section 25128. As a result of this finding, the taxpayer was entitled to apply the three-factor apportionment formula, which considers property, payroll, and sales, rather than being limited to the single-sales factor method.
Second, the Court held that the taxpayer successfully demonstrated that the application of the single-sales factor apportionment formula did not fairly represent the extent of its business activities in California. Therefore, the taxpayer was permitted to use the three-factor apportionment formula for this reason as well.
Section 25128 requires businesses that derive more than 50 percent of their gross receipts from “agricultural business activity” to use a three‑factor formula consisting of property, payroll, and sales, rather than a formula based entirely on sales.
Smithfield argued that more than 50 percent of its gross receipts were derived from agricultural business activity because its core business involves raising and harvesting hogs. It contended that Section 25128 focuses on business activities, e.g., the raising and harvesting of hogs, not on the character of the final product sold, e.g., bacon. Downstream processing, the taxpayer argued, does not change the agricultural nature of the underlying activity generating the receipts. In the alternative, even if it did not qualify as an agricultural business, Smithfield argued that the single-sales factor materially overstated its California business activity and alternative apportionment, in the form of a three-factor formula, was warranted to cure distortion.
The FTB defended its assessment by recasting Section 25128 as a product-based test and insisting that the taxpayer’s receipts were predominantly from sales of processed foods such as bacon, sausage, and other products, rather than “agricultural business activity.” Relying on California Code of Regulations (“Regulation”) 25128-2, the FTB argued that once an agricultural product has been “processed,” the resulting receipts from that product are categorically treated as non-agricultural, even if the taxpayer raised and harvested the animals itself.
The Court rejected the FTB’s substantive arguments. The Court held the statute governing agricultural businesses focuses on what the taxpayer does, not on whether the final product is processed. Based on expert evidence presented at trial, the Court held that more than 50 percent of the taxpayer’s gross receipts were derived from agricultural business activity and therefore it was required to use the three-factor formula based on property, payroll, and sales. In doing so, the Court held Regulation 25128-2 was invalid because it narrowed the scope of the statute by focusing on the taxpayer’s products, whereas the statute looked to the taxpayer’s activities.
The Court further held that even if the taxpayer did not qualify as an agricultural business, the standard single-sales factor formula did not fairly represent the taxpayer’s California business activity. Only 1.02 percent of the taxpayer’s income-generating activities occurred in California, yet the sales factor produced an apportionment percentage of over 6.6 percent (a disparity of more than 600 percent). The Court held this mismatch justified using the three-factor formula, which better reflected where Smithfield’s business operations actually took place.
The Court also rejected the FTB’s procedural defenses, which argued the taxpayer failed to exhaust administrative remedies, failed to raise certain arguments during the administrative process, and should be limited to the evidentiary record developed at audit. The Court held that California tax refund suits are tried de novo, meaning a court is not limited to the audit record. A taxpayer need only state the statutory grounds for refund in its administrative refund claim and is not required to present all evidence or fully develop legal theories during audit. The Court declined to fix the evidentiary record at the audit level, noting that such a rule would effectively convert audits into full trials.
Following the Court’s Proposed Statement of Decision, the FTB raised multiple objections regarding the Court’s use of an activity-based approach, its interpretation of Regulation 25128-2, its method for calculating the agricultural sales threshold and corresponding refund, as well as its treatment of procedural defenses related to the matter. In response, the taxpayer characterized the FTB’s objections as improperly rearguing the merits of the case but expressed willingness to address any or all of the FTB’s objections. On April 28, 2026, the Court overruled the FTB’s objections, agreeing with the taxpayer and concluding that the FTB’s arguments were “largely … improper attempts to reargue the matter and/or … an effort to force the Court to explain the reasons for its findings in a more granular way than is required.”
The Court then issued a clarified and refined Statement of Decision, dated April 28, 2026. This decision added language making it clear that the FTB’s interpretation and application of Section 25128 “ignores the plain language of the statute” and that the evidence presented at trial proved that the FTB “was not open to an evaluation of the distortion issue to the extent it varied from the single sales factor analysis.” The Court added that it had reviewed all FTB testimony, which confirmed the FTB understood the taxpayer’s arguments. The Court also emphasized its decision was based not on a lack of evidence by the FTB, but on the taxpayer’s evidence being more persuasive. Finally, the Court dismissed any assertion of unfair surprise, stating that any issues arising at trial that were new to the FTB resulted from its own failure to pursue available information in a timely manner, rather than from improper litigation tactics by the taxpayer.
Although it is not certain whether the FTB will choose to appeal, this case stands out as an uncommon instance in which a taxpayer demonstrated that the standard single-sales factor apportionment formula was distortive and that the three-factor formula offered a reasonable alternative. In addition, the case illustrates a successful challenge to the validity of an FTB regulation on the grounds that it conflicted with the scope of the underlying statute.
