COLGATE–PALMOLIVE COMPANY, INC., Plaintiff and Respondent, v. FRANCHISE TAX BOARD, Defendant and Appellant.
The principal issue in this appeal is whether California's worldwide unitary method of taxation (based on Rev. & Tax.Code, §§ 25101, 25120–25139), as applied to domestic-parent unitary corporate groups, is unconstitutional under the foreign commerce clause of the United States Constitution. (U.S. Const., art. I, § 8, cl. 3.) 1 Using the legal framework set forth in Container Corp. v. Franchise Tax Bd. (1983) 463 U.S. 159, 103 S.Ct. 2933, 77 L.Ed.2d 545, we conclude the tax method does not violate that clause. We therefore reverse in part the trial court's judgment.
The Methods of Allocating Income
When a corporation, either on its own or through subsidiaries, conducts business across state or national boundaries, the allocation of income to each relevant jurisdiction becomes an issue. To resolve this issue, two methods of income allocation have been created: the arm's length/separate accounting method and the unitary business/formula apportionment method. In reality, these methods simply highlight a general distinction: there are many different ways of specifically applying either of them. (Container Corp. v. Franchise Tax Bd., supra, 463 U.S. at pp. 182, 191, 196, 103 S.Ct. at pp. 2949, 2954, 2956; Langbein, 23 Tax Notes (1986) 625, 626; Note, State Worldwide Unitary Taxation: The Foreign Parent Case (1985) 23 Columbia Journal of Transnational Law 445, 451, hereafter 23 Columbia Journal.)
Under separate accounting, the related corporations of a multijurisdictional enterprise are viewed as distinct from one another; taxable income is determined separately for each individual corporation by the jurisdiction in which that corporation actually conducts business or has a permanent establishment. Any improper shifting of value between the related corporations to avoid taxes is corrected by requiring “arm's length” pricing in related corporate transactions. In other words, the related corporations must act as if they were unrelated entities dealing at arm's length in the marketplace.
In contrast, under the unitary business/formula apportionment method of allocating income at issue in this case—the worldwide unitary method—the related 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.) 2 If a corporation doing business in California is deemed to be part of a unitary group, the total income for that group worldwide, including corporations operating wholly outside the United States, is apportioned to California by a three-factor formula. Under the formula, the property, payroll, and sales figures for the group in California are arithmetically compared to the property, payroll, and sales figures for the group worldwide. (See Rev. & Tax.Code, §§ 25128–25136.) This comparison results in a proportion that is multiplied against the unitary group's worldwide income, producing an apportioned amount of such income taxable by California.3 Simply put, if 25 percent of the property, payroll, and sales of the unitary group is located in California, then 25 percent of the group's worldwide income is apportioned to California. Under this method, it is unnecessary to make “arm's length” corrections because intercorporate transactions are disregarded.
Aside from a few minor exceptions, the income allocation method used by the United States and all of the other nations of the world is the separate accounting method, although, as noted, this method varies in practice. However, the United States has basically limited the application of its tax treaties to federal taxes. (Container Corp. v. Franchise Tax Bd., supra, 463 U.S. at p. 196, 103 S.Ct. at p. 2956.) 4
The present controversy involves Colgate–Palmolive Company, Inc. (Colgate), a domestic-parent unitary corporate group with approximately 75 foreign subsidiaries operating in about 54 foreign counties.5 Colgate was directed to pay additional taxes for the years 1970 through 1973 after California applied the worldwide unitary tax method to the group. Under protest, Colgate paid the additional taxes and this suit ensued.
The Issues on Appeal
At trial, Colgate challenged the federal constitutionality of these additional taxes on foreign commerce clause grounds. The thrust of Colgate's argument below was that the federal executive branch acted decisively after the Container decision to communicate its longstanding position that California's worldwide unitary tax method impermissibly interferes with American foreign policy; according to Colgate, this decisive action eliminated the factual ambiguity that resulted in the Container decision. The trial court agreed with this argument and determined that California's worldwide unitary tax method was unconstitutional on this ground. The Franchise Tax Board (the Board) appeals that decision here.
Colgate also argued at trial that California's three-factor unitary formula unlawfully “distorted” the amount of Colgate's income apportioned to California. The trial court found against Colgate on this issue, which Colgate again raises in its respondent's brief.6
Finally, two peripheral issues are raised by the Board in this appeal. First, the Board claims the trial court abused its discretion in denying the Board's motion for discovery sanctions. Secondly, the Board asserts the court below erroneously awarded certain costs to Colgate.
The Foreign Commerce Clause
Article I, section 8, clause 3 of the United States Constitution empowers Congress “To regulate commerce with foreign nations, and among the several states, and with the Indian tribes.” As the United States Supreme Court has long emphasized, this clause limits the power of the States even in the absence of Congressional legislation. (Boston Stock Exchange v. State Tax Comm'n. (1977) 429 U.S. 318, 328, 97 S.Ct. 599, 606, 50 L.Ed.2d 514, 523; Freeman v. Hewit (1946) 329 U.S. 249, 252, 67 S.Ct. 274, 276, 91 L.Ed. 265, 271.) In this respect, the commerce clause indirectly allocates the relative powers of states and the federal government. (Star–Kist Foods, Inc. v. County of Los Angeles (1986) 42 Cal.3d 1, 9, 227 Cal.Rptr. 391, 719 P.2d 987.)
As noted in Star–Kist, “[d]etermining whether a state tax exceeds the bounds of permissible state action under the [commerce] clause is often a difficult task.” (42 Cal.3d at p. 10, 227 Cal.Rptr. 391, 719 P.2d 987.) In the context of the foreign commerce clause, there are three United States Supreme Court decisions that have delineated the test under which this determination is made: Japan Line, Ltd. v. County of Los Angeles (1979) 441 U.S. 434, 99 S.Ct. 1813, 60 L.Ed.2d 336; Container Corp. v. Franchise Tax Bd., supra, 463 U.S. 159, 103 S.Ct. 2933; and Wardair Canada v. Florida Dept. of Revenue (1986) 477 U.S. 1, 106 S.Ct. 2369, 91 L.Ed.2d 1.
Applying the foreign commerce clause test it created, the court in Japan Line held that instrumentalities of commerce—in that case, seagoing cargo containers—which are foreign-owned, -based, and -registered and which are used solely in international commerce may not be subjected to a state's apportioned ad valorem property tax. (441 U.S. at pp. 436, 444, 99 S.Ct. at pp. 1815, 1819.)
In creating the foreign commerce clause test, the Japan Line court noted that the issue of taxation between nations is more complicated than the issue of taxation between American states. This increased complexity results from a number of factors, including the greater sensitivity to national as opposed to state sovereignty, the lack of an authoritative tribunal capable of resolving transnational disputes, and the fact that actions by individual states can work to the detriment of the whole country. (441 U.S. at pp. 447–451, 456, 99 S.Ct. at pp. 1820–1823, 1825.) In light of these circumstances, said Japan Line, the foreign commerce power of Congress is greater than its interstate commerce power and the need for one national voice in regulating commercial relations with foreign nations is paramount. (Id. at pp. 448–449, 99 S.Ct. at pp. 1821–1822.)
From this comparison of the interstate and the foreign contexts, the foreign commerce clause test was born. That test was engendered by adding two inquiries onto the already existing four-part test for interstate commerce clause review. (Japan Line, supra, 441 U.S. at pp. 444–445, 451, 99 S.Ct. at pp. 1819–1820, 1823.)
Under the four-part interstate test, a state tax will survive 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, 99 S.Ct. at pp. 1819–1820, 1822, 1824, quoting Complete Auto Transit, Inc. v. Brady (1977) 430 U.S. 274, 279, 97 S.Ct. 1076, 1079, 51 L.Ed.2d 326.)
The two additional inquiries prompted by the foreign context are: first, whether the tax creates a “substantial risk of international multiple taxation” (441 U.S. at p. 451, 99 S.Ct. at p. 1823); and, second, whether the tax “may impair federal uniformity in an area where federal uniformity is essential” (Id. at p. 448, 99 S.Ct. at p. 1821), and prevents “the Federal Government from ‘speaking with one voice when regulating commercial relations with foreign governments.’ ” (Id. at p. 451, 99 S.Ct. at p. 1823, quoting Michelin Tire Corp. v. Wages (1976) 423 U.S. 276, 285, 96 S.Ct. 535, 540, 46 L.Ed.2d 495; see also Container, supra, 463 U.S. at pp. 193–194, 103 S.Ct. at pp. 2954–2955.) If a state tax violates either of these precepts, it is unconstitutional under the foreign commerce clause. (Id. 441 U.S. at p. 451, 99 S.Ct. at p. 1823.)
Because the foreign commerce clause is self-executing, the judiciary applies this test when Congress or the federal government has not acted or purported to act. (Merrion v. Jicarilla Apache Tribe (1982) 455 U.S. 130, 154–155, 102 S.Ct. 894, 910–911, 71 L.Ed.2d 21; Wardair, supra, 477 U.S. at pp. 7–8, 18, 106 S.Ct. at pp. 2372–2373, 2378.) In such “dormant” foreign commerce clause situations, the judiciary must determine whether a particular state action unduly threatens the purpose of the clause: to ensure a unified national voice in foreign commerce matters raising inherently national concerns and to ensure that individual states do not work to the detriment of the whole nation. (Ibid; see also Japan Line, supra, 441 U.S. at pp. 448–449, 99 S.Ct. at pp. 1821–1822.)
In Japan Line, the state tax at issue was found to violate both of the additional foreign commerce clause considerations. Multiple taxation resulted because the foreign country involved, Japan, taxed the cargo containers at full value. (441 U.S. at pp. 451–452, 99 S.Ct. at pp. 1823–1824.) The “one-voice” standard was violated because the United States and Japan had signed a convention reflecting a national policy to preclude such taxes. Furthermore, American-owned cargo containers were not taxed in Japan; this created an asymmetry in international taxation disadvantageous to Japan and, under such circumstances, the risk of Japanese retaliation against the whole nation was substantial. Finally, if other states enacted their own taxing schemes, taxation would vary port-by-port, making speaking with one voice impossible. (Id. at pp. 452–453, 99 S.Ct. at pp. 1823–1824.)
That brings us to the decision in Container Corp. v. Franchise Tax Bd., supra, 463 U.S. 159, 103 S.Ct. 2933. The importance of the Container decision to our analysis cannot be overstated. Container involved the precise issue presented here: the constitutionality under the foreign commerce clause of California's worldwide unitary tax method as applied to a domestic-parent unitary corporate group (hereafter, domestic-parent group) with foreign subsidiaries. (Id. at pp. 163, 171, 103 S.Ct. at pp. 2939, 2943.) Applying essentially the dormant foreign commerce clause test set forth in Japan Line, the court in Container held the tax method constitutional. (Id. at pp. 185–197, 103 S.Ct. at pp. 2950–2957.)
Initially, Container noted the similarities and differences between itself and Japan Line. Similar to Japan Line, in Container actual double taxation had occurred, such taxation resulted from a serious divergence between California and foreign taxing methods, and the foreign taxing methods accorded with the international practice of separate accounting. At this point, Container added: “․ 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 California.” (463 U.S. at p. 187, 103 S.Ct. at p. 2952.) Unlike Japan Line, the tax in Container was on income rather than on property, double taxation did not inevitably result from California's worldwide unitary method, and the tax fell on a corporation domiciled and headquartered in the United States rather than on foreign owners. (Id. at pp. 187–188, 103 S.Ct. at pp. 2951–2952.) At this point, Container noted “[w]e have no need to address in this opinion the constitutionality of [the worldwide unitary method] with respect to state taxation of domestic corporations with foreign parents or foreign corporations with either foreign parents or foreign subsidiaries.” (Id, at p. 189, fn. 26, 103 S.Ct. at p. 2952–2953, fn. 26.)
In applying Japan Line's first additional foreign commerce clause consideration—the enhanced risk of international multiple taxation—Container noted that separate accounting did not inevitably end double taxation and California's worldwide unitary method did not inevitably lead to it. Given this state of affairs, said Container, it would be perverse constitutionally to require one method of taxation over another when both could result in a double tax. (463 U.S. at pp. 189–193, 103 S.Ct. at pp. 2952–2953.)
Container refined Japan Line's second additional foreign commerce clause consideration—the “one voice” standard—by stating: “In conducting this inquiry, ․ we 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 treatment of foreign income at the federal level mandates identical treatment by the States.’ [Citations.] Thus, a state tax at variance 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 is, of course, essentially a species of pre-emption analysis.” (463 U.S. at p. 194, 103 S.Ct. at p. 2955, emphasis in original.)
According to Container, the most obvious foreign policy implication of a state tax is the threat it might pose of offending foreign trading partners, leading them to retaliate against the whole nation. The court in Container noted that the judiciary has little competence in making this determination and emphasized that the nuances of foreign policy “are much more the province of the Executive Branch and Congress than of this Court.” (463 U.S. at pp. 194, 196, 103 S.Ct. at pp. 2955, 2956.) The best a court can do, said Container, is try to develop objective standards reflecting general observations about international trade and relations. (Id. at p. 194, 103 S.Ct. at p. 2955.)
Doing just that, the court in Container set forth three reasons that weighed strongly against the possibility of justifiable and significant foreign retaliation. First, California's worldwide unitary tax method as applied to domestic-parent groups did not create an “automatic ‘asymmetry’ ” in international taxation disadvantageous to a foreign entity. (463 U.S. at pp. 194–195, 103 S.Ct. at pp. 2955–2956, emphasis in original.) Second, the tax method was applied to a domestic corporation rather than to a foreign entity. Here again, Container emphasized the domestic versus foreign construct, adding 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.” (Id. at p. 195, fn. 32, 103 S.Ct. at p. 2956.) Finally, stated Container, even if foreign nations have a legitimate interest in reducing the tax burden of domestic corporations, that burden results more from tax rate than allocation method, and California can simply raise its tax rate to achieve the same foreign economic effect. (Ibid.)
Of course, noted Container, the threat of retaliation is not the only foreign policy implication a state tax may have. However, the court also noted there was no amicus curiae brief from the executive branch opposing the tax at issue and setting forth other foreign policy implications. Although not conclusive on the issue, the lack of such a brief did suggest American foreign policy was not seriously threatened by California's worldwide unitary method as applied to domestic-parent groups with foreign subsidiaries. (463 U.S. at pp. 195–196, 103 S.Ct. at pp. 2955–2956.) The court did note the solicitor general had submitted a brief opposing state use of the worldwide unitary method in a domestic corporation case argued the previous term and carried over to the present term. Nevertheless, said the court, there was no indication that the position set forth in the solicitor general's brief still represented the government's view or that the solicitor general's brief should apply to the Container case. (Id. at p. 195, fn. 33, 103 S.Ct. at p. 2956, fn. 33.)
The court in Container then turned to specific indications of congressional intent in discussing the “clear federal directive” principle and found little there.
No federal statute provided the preemptive force. Although the federal government was bound by numerous tax treaties to use some form of separate accounting in taxing the domestic income of multinational enterprises, that requirement was generally waived regarding the taxes imposed by each of the contracting nations on its own domestic corporations. If nothing else, said the Container court, this fact “confirms our view that such taxation is in reality of local rather than international concern.” (Container, supra, 463 U.S. at p. 196, 103 S.Ct. at p. 2956.) The tax treaties, moreover, did not generally cover state taxes; none of them prohibited states from using non-separate accounting methods of taxation. 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 such methods. Finally, the court in Container noted that Congress had long debated but had not enacted legislation regulating state taxation of income. On this record, the court could not conclude that California's worldwide unitary method as applied to domestic-parent groups with foreign subsidiaries was preempted by federal law or fatally inconsistent with federal policy. (463 U.S. at pp. 196–197, 103 S.Ct. at pp. 2956–2957.)
The last of the three United States Supreme Court decisions critical to our dormant foreign commerce clause analysis is Wardair Canada v. Florida Dept. of Revenue, supra, 477 U.S. 1, 106 S.Ct. 2369. The court in Wardair, however, did not have occasion to apply the dormant foreign commerce clause test created in Japan Line and refined in Container. This was because the Wardair court found it “abundantly clear” that the federal government had affirmatively acted to permit the state tax at issue there. That tax was levied by Florida and applied to all airline aviation fuel sold within the state regardless of the airliner's destination or the amount of intrastate business the airliner did. (Id. at pp. 9, 12, 106 S.Ct. at pp. 2373, 2375.)
The foreign airliner and the United States as amicus curiae in Wardair argued there was a federal policy prohibiting Florida's unlimited tax. The policy was allegedly 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 International Civil Aviation Organization (1966 Resolution), an organization to which the United States belonged; and (3) more than 70 bilateral aviation agreements, including the 1974 U.S.–Canadian Aviation Agreement (Agreement). (Wardair was a Canadian airline.) The Wardair court viewed this evidence in a completely different light—in fact, as manifesting a federal policy permitting Florida's tax. Accordingly, the dormant foreign commerce clause test of Japan Line and Container did not come into play—the federal government had made its position clear in permitting such state action. (477 U.S. at pp. 8–12, 106 S.Ct. at pp. 2373–2375.)
The court's analysis was as follows. The 1944 Convention prohibited only state taxation of aviation fuel “ ‘on board an aircraft ․ on arrival ․ and retained on board on leaving.’ ” (Wardair, supra, 477 U.S. at p. 10, 106 S.Ct. at p. 2374.) Consequently, according to the court, the international community had considered the issue of state taxation of aviation fuel and had decided to limit only certain state taxes while implicitly preserving the right of states to tax in nonprohibited ways. Although the 1966 Resolution indisputably sought to exempt airline fuel tax from all foreign national and subnational customs and duties, neither the executive branch nor Congress had acted in any way to make the Resolution legally binding. Furthermore, after the 1944 Convention came into force, the United States entered into more than 70 bilateral aviation agreements; not one of these agreements prohibited states from imposing a Florida-like tax. The 1974 U.S.–Canadian Agreement was limited to “ ‘national duties and charges.’ ” This limitation was particularly significant, reasoned the Wardair court, because the Agreement was entered into eight years after the 1966 Resolution—which addressed the concern of foreign subnational taxation—and because both parties to the Agreement were federalist nations. Finally, during the Agreement, other American states and some Canadian provinces had imposed Florida-like fuel taxes without challenge; this evidenced a course of conduct by the Agreement parties that such taxation was permissible. (Id. at pp. 10–12, 106 S.Ct. at pp. 2374–2375.)
According to the court in Wardair, “all of this makes abundantly clear” that the federal government has affirmatively acted to permit the states to impose these sales taxes on aviation fuel. (477 U.S. at p. 12, 106 S.Ct. at p. 2375.) Consequently, the foreign commerce clause test of Japan Line and Container was inapplicable. (Ibid.)
With this background in mind, we turn to the foreign commerce clause issue presented here.
1. Does Wardair Apply Here To Preclude A Dormant Foreign Commerce Clause Analysis?
The first issue we must consider is whether the Board is correct that this case is akin to Wardair and that there is an affirmative federal policy permitting California to apply the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries. If the Board is correct, such affirmative action by the federal government will end our constitutional analysis because there will be no need to apply the dormant foreign commerce clause test of Japan Line and Container. As we explain, however, the Board is not correct.
The Board finds such an affirmative federal policy in the following five matters: (1) The United States income tax treaties with foreign countries bind the federal government to use some form of separate accounting but do not similarly bind the states; (2) The executive branch has adopted a Model Income Tax Treaty that does not apply to state taxation and has reserved its position on the Organization of Economic Cooperation and Development (OECD) Model Convention's application to subnational taxes; (3) The United States Friendship, Commerce, and Navigation (FCN) treaties with foreign countries do not contain any state taxation restrictions; (4) Congress has not enacted any legislation prohibiting or restricting state use of the worldwide unitary method; and (5) The United States Senate rejected article 9(4) in the United States–United Kingdom Tax Treaty, which would have prohibited states from applying the worldwide unitary method to U.K.-parent unitary corporate groups.
The treaties and treaty actions set forth in (1) through (3) above do not support the Board's Wardair position. This is because those treaties and actions, aside from the U.S.–U.K. Tax Treaty which we discuss shortly, either do not consider state taxation at all or do so in only the most general way. Not one of the treaties or actions, with the exception noted, specifically addresses state use of the worldwide unitary method. The affirmative federal policy expressed in these treaties and actions is the general principle of preserving state sovereignty rather than the specific principle of permitting states to use the worldwide unitary method.
The Board argues that since the bilateral income tax treaties bind only the federal government, and not the states, to use some form of separate accounting, that constitutes, under Wardair, “an omission which must be understood as representing a policy choice ․” permitting state use of the worldwide unitary method. (477 U.S. at p. 11, 106 S.Ct. at p. 2374.) This argument fails for two reasons. First, as noted previously, these tax treaties either do not consider the issue of state taxation at all or do so in only the most general fashion. It cannot be argued seriously that policy choices regarding methods of state taxation are being made in this climate. Second, and more specifically, there are many different separate accounting methods and many different unitary accounting methods. (Container, supra, 463 U.S. at pp. 182, 191, 196, 103 S.Ct. at pp. 2949, 2954, 2956; Langbein, 23 Tax Notes, supra, at p. 626; 23 Columbia Journal at p. 451.) Accordingly, just because an income tax treaty commits the federal government to a particular form of separate accounting does not automatically mean the states can use the worldwide unitary method. Again, the limitation to the federal government, in this context, is a general limitation to preserve state sovereignty and not a specific affirmation of state use of the worldwide unitary method.
Nor can much affirmative action be discerned from the absence of congressional legislation prohibiting or restricting state use of the worldwide unitary method. Under the Board's argument, we are to presume that Congress has affirmatively stated its position through silence. We are unpersuaded. It is just as easy to say that the absence of congressional legislation allowing the states to use the worldwide unitary method affirmatively indicates that Congress does not want the states to use that method. Furthermore, how is a court to construe legislative silence? In this context, affirmative legislative silence is an oxymoronic concept which sheds no light on the issue.
That leaves the fifth factor—the United States Senate action on the U.S.–U.K. Tax Treaty.
This treaty was signed by the executive branch in 1975 and contained a provision—article 9(4)—that would have prohibited states from applying the worldwide unitary method to U.K.-parent groups. The United States Senate ratified the treaty only after article 9(4) was in effect deleted through a reservation by Senator Church.
The problem for the Board regarding this matter is that Senator Church's reservation was defeated in committee and on the senate floor, and the treaty with article 9(4) included was voted upon favorably by a margin of 49 to 32. True, the treaty fell 5 votes short of the two-thirds majority needed for ratification and was ratified only after the Church reservation was exhumed without a vote. But, three Senate majorities approving article 9(4) hardly argue for the proposition that Congress has affirmatively acted to permit the states to use the worldwide unitary method.
In its opening brief, the Board argues the Senate action on article 9(4) indicated a congressional policy permitting states to use the worldwide unitary method because the executive branch has never again negotiated an income tax treaty—ratified by the Senate—which either restricted or prohibited state use of the worldwide unitary method. However, the answer to this argument is found on the very next page of the Board's brief, where the Board acknowledges that “[t]he Senate debate ․ on article 9(4) shows the preferred method to deal with the issue of the states' use of the worldwide unitary method was on a comprehensive legislative basis.” In other words, the Senate and the executive—the two entities responsible for making treaties—have acknowledged that the treaty process is not the preferred way to resolve this issue. (U.S. Const., art. II, § 2, cl. 2.)
In marked contrast to the factors relied upon here by the Board stand the factors relied upon by the court in Wardair. In Wardair, the 1944 Convention specified which state taxes on aviation fuel could not be imposed, thereby strongly implying that other state taxes on aviation fuel could be imposed. Moreover, the 1966 Resolution specifically addressed the concern of subnational taxation. It was in the context of these two foundational documents that the American government and foreign governments negotiated many of their bilateral aviation agreements. In other words, the aviation agreements were being negotiated with an awareness of the type of tax involved in Wardair and the agreements did not prohibit such a tax. In fact, the relevant agreement in Wardair—the 1974 U.S.–Canadian Agreement—was limited to national taxes, was signed by two federalist nations long after the 1944 Convention and the 1966 Resolution, and was performed in a manner indicating the tax involved in Wardair was permitted. These factors in Wardair 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 p. 12, 106 S.Ct. at p. 2375.) The same cannot be said for the factors cited here by the Board.
Our conclusion that Wardair is inapplicable is buttressed by the fact that the Container court had before it all of the significant factors upon which the Board relies and nevertheless engaged in a dormant foreign commerce clause analysis. (463 U.S. at pp. 196–197, 103 S.Ct. at pp. 2956–2957.) Obviously, the Container court did not think the Board's factors made it “abundantly clear” that the federal government had affirmatively acted to permit the states to apply the worldwide unitary method to domestic-parent groups with foreign subsidiaries. Accordingly, we proceed to a foreign dormant commerce clause analysis and apply the corresponding test created in Japan Line and refined in Container.
2. The Applicable Test and Standard of Review
Under the dormant foreign commerce clause test created in Japan Line, a state taxation method is unconstitutional if it either creates a “substantial risk of international multiple taxation” or “may impair federal uniformity in an area where federal uniformity is essential” and prevents “the Federal Government from ‘speaking with one voice when regulating commercial relations with foreign governments.’ ” (441 U.S. at pp. 448, 451, 99 S.Ct. at pp. 1821–1823.) In refining Japan Line 's “one voice” standard, Container stated: “․ we 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 treatment of foreign income at the federal level mandates identical treatment by the States.’ [Citations.] Thus, a state tax at variance 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 species of preemption analysis].” (463 U.S. at p. 194, 103 S.Ct. at p. 2955, emphasis in original.)
As for the standard of review, Colgate asserts we must use a two-step procedure. First, we are to determine whether substantial evidence supports the trial court's factual finding that California's use of the worldwide unitary method interferes with American foreign policy. Secondly, we are to apply the constitutional “one voice” standard to that supported factual finding. Colgate's position is not without constitutional analogy—it is similar to the constitutional appellate inquiry conducted in Fourth Amendment cases. (See People v. Leyba (1981) 29 Cal.3d 591, 596–597, 174 Cal.Rptr. 867, 629 P.2d 961.) Nevertheless, the Board correctly sets forth the simpler standard of review we use here.
The foreign commerce clause issue in this case was submitted solely on exhibits that were not materially disputed by either of the parties. The issue, therefore, reduces to the applicability of the foreign commerce clause to uncontradicted facts. This presents a question of law and we are not bound by the trial court's findings. (Western Contracting Corp. v. State Board of Equalization (1968) 265 Cal.App.2d 568, 575, 71 Cal.Rptr. 472; C.R. Fedrick, Inc. v. State Bd. of Equalization (1988) 204 Cal.App.3d 252, 258, 251 Cal.Rptr. 305.) Accordingly, we independently analyze the foreign commerce clause issue presented here. With these general guidelines in mind, we apply the relevant constitutional tests.
A. The Enhanced Risk of Multiple Taxation
On this issue, there is no distinction between this case and Container. Having nothing distinctive to say, we simply reiterate Container 's conclusion that California's application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries is not unconstitutional on this ground.
B. Whether California's Application Of The Worldwide Unitary Method To Domestic–Parent Groups With Foreign Subsidiaries May Impair Federal Uniformity In An Area Where Federal Uniformity Is Essential And Prevents The Federal Government From Speaking With One Voice In Regulating Commercial Relations With Foreign Governments
In the context of the case before us, the “foreign policy implications” and the “clear federal directive” strands of Container 's “one voice” refinement become somewhat muddled. Essentially, the position of Colgate—and of the trial court below—is that after Container the federal executive branch acted to communicate clearly its longstanding policy that states are not to apply the worldwide unitary tax method to any multinational corporation—be it domestic-parent or foreign-parent—because such application interferes with the federal government's conduct of foreign policy and foreign affairs. For this position, Colgate and the trial court relied on (1) a 1985 statement issued by President Ronald Reagan, (2) a 1986 letter from Secretary of State George Shultz to California Governor George Deukmejian, (3) a 1986 letter from Treasury Secretary James Baker to Senator Bob Packwood, chairman of the Senate Finance Committee (an identical letter was sent by Secretary Baker to Representative Dan Rostenkowski, chairman of the House Ways and Means Committee), (4) an amicus trial brief from the United States filed in another case this court reviewed (Barclays Bank v. Franchise Tax Bd., 225 Cal.App.3d 1342, 275 Cal.Rptr. 626 (1990) (ptn. for review granted 2/28/91), and (5) statements by two attorneys from the United States Department of Justice that the views expressed in that amicus brief remained unchanged at the time of trial in this case.
Before we analyze the substance of this issue, we must address the Board's contention that the statements and letters noted above do not constitute evidence we can consider. We reject the Board's contention for three reasons. First, statements and letters from executive branch officials have been recognized as evidence by both the United States Supreme Court and the California courts. (Zschernig v. Miller (1968) 389 U.S. 429, 437, fn. 7, 88 S.Ct. 664, 669, fn. 7, 19 L.Ed.2d 683; Spindulys v. Los Angeles Olympic Organizing Com. (1985) 175 Cal.App.3d 206, 210, fn. 3, 220 Cal.Rptr. 565.) Second, in Container, diplomatic letters and notes from foreign governments were admitted into the record. (463 U.S. at p. 203, fn. 4, 103 S.Ct. at p. 2960, fn. 4.) Finally, the Board concedes the authenticity of these statements and letters. Under these circumstances, we conclude the statements and letters constitute evidence we can consider.
To analyze this evidence adequately, however, some background is required. The distinction between a domestic-parent and a foreign-parent group was deemed significant by the Container court. That court explicitly reserved the issue of “the constitutionality of [the worldwide unitary method] with respect to state taxation of domestic corporations with foreign parents or foreign corporations with either foreign parents or foreign subsidiaries.” (463 U.S. at p. 189, fn. 26, 103 S.Ct. at p. 2953, fn. 26.) That court also carefully noted the tax there was imposed on a domestic-parent group, “not on a foreign entity as was the case in Japan Line; ” and that “[a]lthough California ‘counts' income arguably attributable to foreign corporations [i.e., foreign subsidiaries] in calculating the taxable income of that domestic corporation, the legal incidence of the tax falls on the domestic corporation.” (Id. at p. 195, 103 S.Ct. at p. 2956.) Finally, Container 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.” (Id. at p. 195, fn. 32, 103 S.Ct. at p. 2956, fn. 32.)
In response to complaints about the Container decision raised by the domestic and the foreign business communities and by foreign governments, President Reagan in 1983 asked then Treasury Secretary Donald Regan to establish and chair a Worldwide Unitary Taxation Working Group (Working Group). The Working Group was comprised of representatives of the federal government, the state governments, and the business community, and was to provide recommendations on the worldwide unitary issue. No foreign government representative was appointed.
At its final meeting in May 1984, the Working Group agreed on three principles to guide state taxation of multinational corporations: (1) “Water's edge” unitary combination for both domestic-parent and foreign-parent groups (i.e., essentially an allocation method with the United States as the relevant jurisdiction); (2) Increased federal administrative assistance and cooperation with the states to promote full taxpayer disclosure and accountability; and (3) Competitive balance for domestic-parent groups, foreign-parent groups, and purely domestic businesses. In transmitting the Working Group's report to the President, Secretary Regan indicated he would recommend restrictive federal legislation if the states had not made substantial voluntary progress on the worldwide unitary issue by the end of July 1985.
It was against this backdrop that President Reagan issued the (November) 1985 statement involved here. In that statement, the President said in pertinent part: “Since early in this Administration, we have been working with the states, the business community, and foreign governments in an effort to resolve issues related to state use of the worldwide unitary method of taxation. At this time I believe it appropriate for the Federal Government to state its support for the concept of legislation that would: [¶] 1. Effect a requirement that multinationals be taxed by states only on income derived from the territory of the United States (‘the water's edge requirement’); and [¶] 2. Address the question of equitable taxation of foreign source dividends. [¶] We hoped that by this time these principles would have been enacted by the various states that have unitary taxation. Since states have not universally accepted these principles, I am instructing the Secretary of the Treasury to initiate the process of crafting Federal legislation to incorporate these principles into law and to work with the Congress for passage, and also, where appropriate, to enter into negotiations to amend double taxation agreements․ [¶] Further, I am instructing the Attorney General to ensure that the United States' interests are represented in appropriate controversies and cases consistent with this approach.”
Our task is to analyze this statement as well as the other statements, letters, and briefs noted above from executive branch officials to determine if they either constitute an authoritative expression of the federal government that state application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries implicates foreign policy issues which must be left to the federal government or constitute a clear federal directive violated by California here. (Container, supra, 463 U.S. at p. 194, 103 S.Ct. at p. 2955.) 7 For the reasons set forth below, we conclude that California's application of the worldwide unitary tax method to Colgate does not offend the foreign commerce clause.
President Reagan issued his 1985 statement against the backdrop of the Container decision and the recommendations of the Working Group. In line with those recommendations, President Reagan stated the federal government's support for legislation that would effect a requirement that multinationals be taxed by states only on income derived from the territory of the United States (the “water's edge” requirement). The President's statement did not distinguish between domestic-parent and foreign-parent multinationals. From this, it reasonably can be inferred that the executive branch—at least when President Reagan was at the helm—did not want states applying the worldwide unitary method to domestic-parent groups.
Nevertheless, when we examine the other parts of President Reagan's statement in the context of the foreign commerce clause issue presented here, this reasonable inference starts to erode.
Pursuant to the President's statement, the Attorney General was instructed “to ensure that the United States' interests are represented in appropriate controversies and cases consistent with this approach.” In the context of the case before us, this instruction is most troubling. This is because the executive branch has neither filed an amicus brief here nor indicated in any way its position on the issue presented in this case: California's application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries.
We can conceive of no more appropriate a case than this one for the executive branch to make its post-Container position clear. The factual context of this case is identical to Container. Container noted the absence of an executive branch amicus brief and noted that foreign policy nuances are much more the province of the executive branch and Congress than of the judiciary. (463 U.S. at pp. 195–196, 103 S.Ct. at pp. 2955–2956.) As one commentator on the Container decision has noted, “[g]iven the unusual attention paid to his absence, the Solicitor General's position in future appeals is certain to be a focus of attention.” (WhiteNack, 20 Tax Notes (1983) 771, 780.) As we have seen, Container emphasized repeatedly the distinction between domestic-parent and foreign-parent corporations. And, likeContainer, this case arises from California's application of the worldwide unitary method, indisputably the most important state applying the method. (Langbein, 23 Tax Notes, supra, at p. 626.)
Now, it might be argued, the federal Justice Department attorneys are busy people and they cannot be aware of all the relevant cases being litigated across the land. There are several problems with this argument, however. The number of relevant cases is relatively small given the small number of states that have employed the worldwide unitary method. (In fact, California apparently is the only state currently using the method; of course, it too has now adopted a “water's edge” election. (See fn. 4, ante.) As noted previously, no one would dispute that California is the pivotal state on this issue given the sheer size of its economy and its more comprehensive application of the method. (See Langbein, 23 Tax Notes, supra, at p. 626; Comment, California's Corporate Franchise Tax: Taxation of Foreign Source Income? (1980) 20 Santa Clara L.Rev. 123, 134.) And, of course, the “appropriate” nature of the present case cannot be denied. But most significantly, the United States Department of Justice was twice notified about this case by letters from Colgate's counsel. Two high-ranking Justice Department attorneys responded to those letters by stating that the position taken by the United States in Barclays Bank of California v. Franchise Tax Board—then pending in the Superior Court of California for Sacramento County (Nos. 325061, 325059)—and the position taken in Alcan Aluminum v. Franchise Tax Board and Imperial Chemical Industries PLC v. Franchise Tax Board—then pending in the United States District Court for the Northern District of Illinois (Nos. 84–C–6932, 84–C–8906, respectively)—remained the position of the United States.
These two letters from the Justice Department attorneys are the same two letters Colgate relies upon here to argue that the federal executive has indeed made its views known in this case and that an executive amicus brief or other statement of position is unnecessary. The problem for Colgate is that the Barclays, Alcan and Imperial Chemical cases all involved the application of the worldwide unitary method to foreign-parent groups. (See Franchise Tax Bd. v. Alcan (1990) 493 U.S. 331, ––––, 110 S.Ct. 661, 664, 107 L.Ed.2d 696, 702.) According to the Justice Department letters, the three cases “involved the appropriateness of taxation of the plaintiffs [i.e., foreign-parent multinationals] on a worldwide unitary basis under California law prior to the September, 1986, amendment thereto [i.e., the “water's edge” election]. [¶] In those cases the United States filed briefs amicus curiae wherein it stated its position on the above-stated issue.” (Emphasis added.)
A matter we can judicially notice supports our conclusion. We filed a decision in the Barclays case on November 30, 1990. (225 Cal.App.3d 1342, 275 Cal.Rptr. 626; ptn. for review granted 2/28/91.) In that action, the United States filed an amicus brief with this court. (Evid.Code, §§ 452, subd. (d), 459, subd. (a).) 8 That amicus brief was authored under the supervision of one of the Justice Department attorneys who responded by correspondence to Colgate's counsel here. That brief stated in part: “It is the position of the United States Government, as reflected in the letter of ․ Secretary of State [Shultz] to ․ Governor [Deukmejian] [the same letter Colgate relies upon here], that the unitary tax is at odds with the ‘arm's length’ accounting method which is the international rule and standard, and that adherence to the ‘arm's length’ method of taxing corporations with foreign parents is essential to avoid adverse consequences for the foreign relations of the United States. (Letter.) ․ Container Corp. involved the application of California's tax to a domestically controlled group of corporations and it was that issue on which the Federal Executive expressed no view. The Supreme Court in Container Corp., as stated before, expressly reserved judgment on the issue sub judice in this case, and with respect to this issue the Federal Executive is filing a brief amicus curiae and is expressing its policy and position. In the instant case therefore, this Court should have no difficulty in determining the Federal Executive's views. The statements of the Secretary of State (Letter) and the President of the United States, (Statement) [the same statements Colgate relies upon here] demonstrate that the Federal Government has a clearly articulated policy in favor of ‘arm's length’ accounting in the conduct of foreign affairs, and that California's worldwide combined unitary business concept method is in conflict with the internationally accepted standard and policies, and custom, and this in turn has caused serious disputes and difficulties for the United States in the conduct of foreign affairs. Finally, precisely because of these foreign policy considerations and because of their gravity, the Department of Justice, at the direction of the President, is filing this amicus curiae brief.” (Barclays C003388 U.S. Amicus App. Brief, pp. 31, 33–35.) As noted, we do not have any statement from the executive in the present litigation.
It also might be argued that the executive branch need not continually have to set forth its position. The President has issued an authoritative statement; the matter is settled; how many more times does something have to be said? Of course, the problem with this argument is that in the President's statement, the President instructs the Attorney General to ensure that the United States' interests are represented in appropriate cases consistent with the statement. The President's statement arguably covers domestic-parent groups and the executive branch was notified about this significant and appropriate case. Nevertheless, the executive branch here, as in Container, has chosen to remain silent.
In sum, the executive branch was twice explicitly notified about this case. This case could not have provided a more appropriate context for the executive branch to express its views regarding the application of the worldwide unitary method to domestic-parent groups with foreign subsidiaries. The President's statement instructed the Attorney General to ensure that the United States' interests were represented in appropriate cases. Nevertheless, the executive branch has done nothing here to make its position known. Under these circumstances, we cannot say that President Reagan's statement either constitutes an authoritative expression of the federal government that application of the worldwide unitary method to domestic-parent groups with foreign subsidiaries implicates foreign policy issues which must be left to the federal government or constitutes a clear federal directive which California has violated here.
We now examine Secretary of State Shultz's 1986 letter to Governor Deukmejian. The purpose of this letter was to note that the Reagan Administration had proposed federal legislation prohibiting worldwide unitary taxation, but that similar action at the state level would be welcomed. Apparently this legislation would have prohibited the application of the worldwide unitary method to all multinational corporations, be they domestic-parent or foreign-parent. Nevertheless, Secretary Shultz's 1986 letter provides no stronger support for Colgate's foreign commerce clause position than did President Reagan's 1985 statement.
In that letter, Secretary Shultz states that “[t]he longstanding policy of the federal government has been to follow the separate accounting method. The United States has advocated and adopted the position that the ‘arm's-length’ adjustment method of allocating income among commonly controlled corporations doing business in various national jurisdictions is the appropriate method to be employed. This view is embodied in the Internal Revenue Code and is a central feature in our bilateral tax treaties.”
There is an important passage in Container, however, which calls into question the Secretary's statement in the domestic-parent context. As noted in Container: “[A]lthough the United States is a party to a great number of tax treaties that require the Federal Government to adopt some form of arm's-length analysis in taxing the domestic income of multinational enterprises, that requirement is generally waived with respect to the taxes imposed by each of the contracting nations on its own domestic corporations. This fact, if nothing else, confirms our view that such taxation is in reality of local rather than international concern.” (463 U.S. at p. 196, 103 S.Ct. at p. 2956.) Thus, the longstanding policy and position expressed by Secretary Shultz—embodied in the Internal Revenue Code and a central feature in American bilateral tax treaties—apparently does not apply to the taxation of domestic-parent groups by their home countries but applies only to the taxation of foreign-parent groups.
The Secretary of State's letter further specifies 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”; that continued state use of the worldwide unitary method “will greatly impair the ability of the federal government to carry out its tax and investment policy in the international arena and to manage the sensitive issue of international double taxation”; and finally that “[t]he worldwide unitary issue has seriously complicated our economic relations with many of our closest allies.”
In making these observations, however, Secretary Shultz relies primarily on factors illustrating that the foreign commerce problem is limited to foreign-parent groups and does not encompass their domestic-parent counterparts. For example, the Secretary notes the worldwide unitary method can impede foreign entry into the United States market. He discusses the administrative burdens of compliance, particularly for foreign-controlled entities. He cites to the diplomatic notes received from many countries complaining about state use of the worldwide unitary tax method. Although the specific contents of these notes are not set forth, similar protests in Container were discussed in the exclusive context of the foreign-parent group. (463 U.S. at pp. 202–203, fn. 4, 103 S.Ct. at pp. 2959–2960, fn. 4.) Finally, the Secretary notes that British “anti-unitary retaliatory legislation” has been adopted denying U.S.-parent corporations operating in worldwide unitary states a very valuable benefit under the U.S.–U.K. Tax Treaty. From all of this, it is difficult to discern genuine executive branch concern—arising from issues germane to the foreign commerce clause—regarding state application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries.
That brings us to Treasury Secretary James Baker's 1986 letter to Senator Bob Packwood, chairman of the Senate Finance Committee. (An identical letter was sent by Secretary Baker to Representative Dan Rostenkowski, chairman of the House Ways and Means Committee.) This letter was sent “to describe the serious concerns that have led the [Reagan] Administration to propose and support [the] legislation” (alluded to in Secretary Shultz's letter to Governor Deukmejian).9
Those “serious concerns”, however, are largely the same concerns noted in Secretary Shultz's letter: the longstanding policy of separate accounting embodied in the Internal Revenue Code and a central feature in the bilateral tax treaties; the diplomatic notes from countries around the globe complaining about state use of the worldwide unitary method; the British anti-unitary retaliatory legislation aimed at U.S.-parent multinational corporations; the administrative burdens of compliance, particularly for foreign-owned companies; and the barrier to foreign entry into the United States market. As we have seen, these matters illustrate that the foreign commerce problem involves foreign-parent groups rather than their domestic-parent counterparts. Consequently, these matters do not support Colgate's argument that California's application of the worldwide unitary method to domestic-parent groups with foreign subsidiaries is unconstitutional under the foreign commerce clause because it interferes with the conduct of American foreign policy.
This view is bolstered by Senator Pete Wilson's comments in the Congressional Record made during his introduction of the subject legislation in the Senate. Senator Wilson stated: “While the principal foreign commerce issues raised by State worldwide unitary taxation would be resolved if States were to agree that they would not impose worldwide unitary tax on foreign controlled entities, such [a] limited resolution would cause other serious problems. If a ‘foreign only’ solution were adopted, domestically controlled businesses would thereby be disadvantaged.”
Secretary Baker's letter to Senator Packwood does note the Working Group's principle of “water's edge” (allocation methods restricted to United States boundaries) for both domestic-parent and foreign-parent companies in line with the Working Group's principle of competitive balance for all companies, whether domestic or foreign. The problem for Colgate in this appeal is that domestic-parent groups are included in the proposed restrictive legislation on “competitive balance” grounds rather than on the foreign commerce clause grounds set forth in Japan Line and Container. “Competitive balance” for domestic corporations is not an issue under the dormant foreign commerce clause “one voice” test created in Japan Line and refined in Container. (Japan Line, supra, 441 U.S. at pp. 456–457, 99 S.Ct. at pp. 1825–1826; see Container, supra, 463 U.S. at pp. 188–189, 195, fns. 26, 103 S.Ct. at pp. 2952–2953, 2956, fns. 26.) 10
Under the “foreign policy implications” precept of Container 's “one voice” refinement, we must determine whether California's application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries “implicates foreign policy issues which must be left to the Federal Government.” (463 U.S. at p. 194, 103 S.Ct. at p. 2955.) As we have seen, the President's statement, the two Secretary letters, and the two letters from the Justice Department attorneys show that the foreign commerce problem is essentially limited to foreign-parent groups and does not materially involve their domestic-parent counterparts. “Competitive balance” for domestic corporations is not part of the “foreign policy implications” issue. Therefore, the statement and letters from the executive branch officials do not constitute, either individually or collectively, an authoritative expression of the federal government that state application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries implicates foreign policy issues which must be left to the federal government.
Of course, our analysis is not confined merely to foreign policy implications. We must also consider whether the President's statement, the Secretarys' letters, and the Justice Department attorneys' letters constitute, individually or cumulatively, a clear federal directive violated by California here. The “clear federal directive” envisioned in Container does not exist in a vacuum, but is part of the foreign commerce clause “one voice” standard enunciated in that case. (463 U.S. at p. 194, 103 S.Ct. at p. 2955.) Arguably, then, the directive is in some way linked to issues of foreign commerce or foreign affairs. In the statement and letters at issue here, however, the state application of the worldwide unitary tax method to domestic-parent groups is not linked to issues of foreign commerce or foreign affairs. To the contrary, the statement and letters relegate those issues to the foreign-parent context. Moreover, the statement and letters, as analyzed above, are ambiguous regarding the domestic-parent context. Such ambiguity is inconsistent with a clear directive.
Nevertheless, one could also argue persuasively that Container 's “clear federal directive” precept need not be linked to foreign policy. This is because a genuine and authoritative clear federal directive must always be acknowledged, regardless of whether it was promulgated in the context of foreign policy or domestic policy. (U.S. Const., art. VI, cl. 2; Tribe, Amer.Const.Law, supra, Limits on State and Local Power, pp. 479–511.) But conceding this point does not help Colgate.
In Container, the court did not find any “clear federal directive” from Congress. (463 U.S. at pp. 196–197, 103 S.Ct. at pp. 2956–2957.) That situation has not changed since Container. (See fn. 9, ante.) We therefore are left with the executive branch as the source of the directive, assuming that branch can be the source. (See fn. 7, ante.) Our analysis has shown that this case, like Container, presents an essentially domestic issue. However, in the domestic policy arena—in contrast to the foreign policy sphere—the executive's powers and its ability to formulate policy are much more limited. (Tribe, Amer.Const.Law, supra, Federal Executive Power, §§ 4–2, 4–4, pp. 210–213, 219–225.) If the executive branch indeed has a clear federal directive on the domestic issue involved here, why has that branch not presented this court with an amicus brief or other affirmation of that directive? As we have seen, this is especially troubling given that the executive branch was twice notified about this case, given that this case presents an extremely appropriate context for the executive to make its post-Container views known (be they domestic-oriented or foreign-oriented), and given that President Reagan's 1985 statement instructed the Attorney General to ensure that federal interests were represented in appropriate cases. The executive's failure here to assert any directive evidences either the lack of such a directive or the ambiguity of one, if one exists. When these circumstances are aligned against the fundamental concept of state sovereignty and the broad power of a state to tax (see Hines v. Davidowitz (1940) 312 U.S. 52, 68, 61 S.Ct. 399, 404, 85 L.Ed. 581, 587–588), the argument for a clear federal directive in this case evaporates.
Finally, in addition to its principal evidence analyzed above, Colgate relies on a federal district court case in Alaska filed in 1987 by the United States against the state of Alaska. Colgate alleges this case demonstrates the federal government's commitment to eradicate state use of the worldwide unitary method. Again, however, the Alaska suit involved the application of the worldwide unitary tax method to a foreign-parent group and it was on that basis the United States sought a judgment declaring the method unconstitutional. Rather than support Colgate's foreign commerce clause argument, the Alaska case undermines it.11
Because we conclude that the evidence relied upon by Colgate does not show any foreign policy implications or clear federal directives which alter the Container “one voice” analysis, that analysis remains valid in the context of this case. A few general observations buttress our position.
In marked contrast to the record presented to this court in the Barclays case (Barclays Bank v. Franchise Tax Bd., 225 Cal.App.3d 1342, 275 Cal.Rptr. 626 (ptn. for review granted 2/28/91)), the record presented here contains no statements, protests, or amici briefs from foreign governments or representatives of foreign interests. (Evid.Code, §§ 452, subd. (d), 459, subd. (a); see fn. 8, ante.) This is not really surprising, however. The difference between applying the worldwide unitary tax method to a domestic-parent group and applying it to a foreign-parent group is a distinction of significance in the context of foreign commercial relations and the “custom of nations.” (See Japan Line, supra, 441 U.S. at p. 454, 99 S.Ct. at p. 1824.) This is because the worldwide nature of the tax method at issue falls ultimately on the parent corporation. It is the parent's worldwide income that is apportioned. It is the parent's worldwide operations that are scrutinized. It is the parent upon whom the worldwide administrative burden of compliance falls. By definition, the worldwide unitary method seeks the ultimate source of corporate responsibility and that source is the global parent. Unlike the domestic parent, the foreign parent is likely versed only in the separate accounting tradition, is likely unfamiliar with the concepts of federalism and genuine subnational sovereignty, and is often intimidated by the complexities of our multi-level system of government. In this context, foreign resentment of the worldwide unitary method is understandable. In contrast, the foreign subsidiary of a domestic-parent is merely a cog in the unitary wheel; the parent is the hub. Put simply, the foreign subsidiary of a domestic-parent is akin to a child who is not saddled with parental responsibilities.
Furthermore, although we are increasingly entering a global economy where national boundaries are less significant, there is still a nationalistic dignity associated with the “home base” of a multinational corporation. There is nothing unnatural about the assertion of this dignity. (See Japan Line, supra, 441 U.S. at p. 456, 99 S.Ct. at p. 1826.)
Presented in this case is the very line of federalism. On one side of the line is the federal government's rightful power to conduct foreign affairs without interference from the states. (See Japan Line, supra, 441 U.S. at pp. 448–457, 99 S.Ct. at pp. 1821–1826.) On the other side is the states' rightful power to tax as a separate sovereign. (Hines v. Davidowitz, supra, 312 U.S. at p. 68, 61 S.Ct. at p. 404.) In this fundamental clash of political power, we look to the two political branches of our national government to specify if a state's activity is jeopardizing foreign policy positions that are inherently national in character. (Container, supra, 463 U.S. at pp. 194–196, 103 S.Ct. at pp. 2955–2956.) Neither branch has specified foreign policy implications here. And the length of our “clear federal directive” discussion illustrates perhaps better than the discussion itself the lack of such a directive on the issue presented in this case. Nor can the federal government, as we have seen, plead ignorance about this case or claim the case presents an inappropriate context in which to state its views. In fact, here the federal executive did not see fit to follow its own pronouncement to make sure federal interests were represented in appropriate cases. In this posture, we cannot say that California's application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries is unconstitutional under the foreign commerce clause because it either impermissibly interferes with the conduct of foreign policy or violates a clear federal directive. In this light, Container 's conclusion remains valid that such “taxation is in reality of local rather than international concern.” (463 U.S. at p. 196, 103 S.Ct. at p. 2956.)
Based on the uncontradicted evidence presented here, we hold that California's application of the worldwide unitary tax method to domestic-parent groups with foreign subsidiaries is not unconstitutional under the foreign commerce clause of the Federal Constitution.12
3. Did California Unlawfully “Distort” the Amount of Colgate's Income Apportioned to California?
Although Colgate did not file a cross-appeal, it argues the trial court erroneously determined that California's application of the worldwide unitary tax method to Colgate did not unlawfully “distort” the amount of Colgate's income apportioned to California. We denied the Board's motion to strike this argument from Colgate's respondent's brief. Accordingly, we consider the issue.
Colgate's argument is premised on what Container described as the “external consistency” requirement of fairness in an apportionment formula. Under that requirement, the application of a tax apportionment formula, such as California's worldwide unitary tax method, must be fair to pass constitutional scrutiny under both the due process and the commerce clauses; stated another way, the formula must actually reflect a reasonable sense of how income is generated. (Container, supra, 463 U.S. at pp. 169–170, 103 S.Ct. at pp. 2942–2943; Trinova Corp. v. Michigan Dept. of Treasury (1991) 498 U.S. 358, 111 S.Ct. 818, 112 L.Ed.2d 884.) Under this constitutional edict, an apportionment formula will be invalidated if the taxpayer can prove by clear and cogent evidence that the income attributed to the state is “ ‘out of all appropriate proportion to the business transacted by the [taxpayer] in that State’ ” or has “ ‘led to a grossly distorted result.’ ” (Container, supra, 463 U.S. at pp. 170, 181, 103 S.Ct. at pp. 2942, 2948; Trinova, supra, 498 U.S. at p. ––––, 111 S.Ct. at p. 832–833, 112 L.Ed.2d at pp. 908–909.)
In addition to the constitutional “external consistency” requirement, there is a statute in California on the subject. Revenue and Taxation Code section 25137 provides: “If the allocation and apportionment provisions of this act do not fairly represent the extent of the taxpayer's business activity in this state, the taxpayer may petition for or the Franchise Tax Board may require, in respect to all or any part of the taxpayer's business activity, if reasonable: [¶] (a) Separate accounting; [¶] (b) The exclusion of any one or more of the factors; [¶] (c) The inclusion of one or more additional factors which will fairly represent the taxpayer's business activity in this state; or [¶] (d) The employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer's income.”
Colgate argues that California's worldwide unitary tax method apportioned 70 percent more income to California in comparison to separate accounting and that such apportionment contravenes both the constitutional and the statutory distortion principles. We disagree.
As noted by one commentator in reviewing Container's discussion of the constitutional distortion principle of “external consistency,” the taxpayer's burden of proof on this issue is “steep if not insurmountable.” (23 Columbia Journal at p. 457.) This is an accurate comment. In Container, the court noted that the three-factor formula used by California has not only “met our approval” but has become “something of a benchmark against which other apportionment formulas are judged.” (463 U.S. at p. 170, 103 S.Ct. at p. 2942.)
Container also noted the distortion figures in that case were based essentially on separate accounting methods that failed to account for the flow of value between the parts of the unitary business. (Id. at pp. 181–184, 103 S.Ct. at pp. 2948–2950.) The same can be said here.
Colgate argues the distortion arises here because Colgate's foreign subsidiaries are substantially more profitable than its California operations. That is, the foreign subsidiaries' lower property, payroll, and sale figures for the same level of productivity result in a distorted apportionment to California under the three-factor formula. In Container, the taxpayer made the same argument. The court in Container rejected this argument, stating: “The problem with this argument is obvious: 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.” (463 U.S. at p. 181, 103 S.Ct. at p. 2948.)
Apparently, there is only one United States Supreme Court decision that has invalidated a state tax apportionment formula applied to a corporate income tax or a franchise tax of a manufacturing or mercantile company like Colgate. (23 Columbia Journal at pp. 450–451; see also Container, supra, 463 U.S. at pp. 182–184, 103 S.Ct. at pp. 2949–2950.) That decision is from 1931 and is entitled Hans Rees' Sons Inc. v. North Carolina ex rel. Maxwell 283 U.S. 123, 51 S.Ct. 385, 75 L.Ed. 879 (1931). In that case, a one-factor unitary tax method was applied to a domestic company. Although the company's income in Hans Rees' was derived from a variety of far-flung activities—including buying, selling and manufacturing—North Carolina's statutory formula allocated the entire wholesale profit to North Carolina, where the manufacturing occurred. This allocation resulted in 250 percent more income attributed to the state. (283 U.S. at pp. 126–128, 51 S.Ct. at pp. 386–387; see 23 Columbia Journal at p. 450; Container, supra, 463 U.S. at pp. 183–184, 103 S.Ct. at pp. 2949–2950.)
Colgate's 70 percent figure—which does not account for the flow of value between the parts of Colgate's unitary business—is not comparable to the 250 percent tally in Hans Rees'. Colgate has not met the steep burden imposed by the constitutional distortion principle of “external consistency.” 13
Colgate realizes this and pins its hopes on Revenue and Taxation Code section 25137. Colgate faces an uphill battle here as well. Under section 25137 and California case law, the Franchise Tax Board is given discretion to select the factors to be used in a tax formula. (McDonnell Douglas Corp. v. Franchise Tax Bd. (1968) 69 Cal.2d 506, 512, 72 Cal.Rptr. 465, 446 P.2d 313.) Where a taxpayer petitions for an alternative formula under section 25137, the taxpayer bears the burden of establishing by clear and convincing evidence that the formula used by the Franchise Tax Board reaches an unreasonable result in his or her case. (Ibid.; Rev. & Tax.Code, § 25137; Communications Satellite Corp. v. Franchise Tax Bd. (1984) 156 Cal.App.3d 726, 746–749, 203 Cal.Rptr. 779; see e.g., Firestone Tire & Rubber Co. v. County of Monterey (1990) 223 Cal.App.3d 382, 387–388, 272 Cal.Rptr. 745.)
Colgate argues that the trial court used the constitutional “out of all proportion” test to dismiss Colgate's statutory assertion under section 25137. Additionally, Colgate argues that testimony from the Board's counsel for multi-state tax affairs establishes that the Board unlawfully fails to consider separate accounting as an alternative for unitary companies under section 25137. Neither of these arguments has merit.
As noted by the Board, the trial court did not apply the constitutional “out of all proportion” test to the statutory issue. In reviewing the Board's denial of Colgate's section 25137 petition, the trial court cited Container 's “flow of value” concept and upheld the Board's determination that Colgate had not demonstrated by clear and convincing evidence that California's apportionment formula unfairly represented the extent of Colgate's business activity in California. (Container, supra, 463 U.S. at pp. 181–184, 103 S.Ct. at pp. 2948–2950.) This constituted a correct application of the statutory standard set forth in section 25137. (McDonnell Douglas Corp. v. Franchise Tax Bd., supra, 69 Cal.2d at p. 512, 72 Cal.Rptr. 465, 446 P.2d 313; see Amoco Production Company v. Arnold (1974) 213 Kan. 636, 518 P.2d 453, 463–465.)
Citing Hunt–Wesson Foods, Inc. v. County of Alameda (1974) 41 Cal.App.3d 163, 176, 116 Cal.Rptr. 160, Colgate contends the right to recover taxes paid under protest is a fundamental vested right; therefore, the trial court was obligated to exercise its independent judgment on the section 25137 evidence. We disagree with Colgate for two reasons. First, the Hunt–Wesson court did not hold that the right to recover taxes paid under protest is a fundamental vested right. That court said the argument could be made. (41 Cal.App.3d at p. 176, 116 Cal.Rptr. 160.) Second, and more importantly, the precise issue involved here concerns the application of a particular tax method that is within the discretion of the Franchise Tax Board under statutory directive. (McDonnell Douglas Corp. v. Franchise Tax Bd., supra, 69 Cal.2d at p. 512, 72 Cal.Rptr. 465, 446 P.2d 313; Rev. & Tax.Code, §§ 25120–25139; Cal.Code Regs., tit. 18, § 25137–6; see Amoco Production Company v. Arnold, supra, 518 P.2d at pp. 463–465; see e.g., Firestone Tire & Rubber Co. v. County of Monterey, supra, 223 Cal.App.3d at pp. 387–388, 272 Cal.Rptr. 745.) Colgate can hardly ascribe an individually “vested” status to this process. (See Hunt–Wesson, supra, 41 Cal.App.3d at p. 174, 116 Cal.Rptr. 160.) As noted, McDonnell Douglas is the relevant decision on this limited issue. (69 Cal.2d at p. 512, 72 Cal.Rptr. 465, 446 P.2d 313.)
Our resolution of the statutory distortion issue renders irrelevant Colgate's argument that the Board unlawfully fails to consider separate accounting as an alternative for unitary companies under section 25137. Colgate has not shown that California's apportionment formula unfairly represented the extent of Colgate's business activity in California. The alternatives set forth in section 25137 are invoked only if the taxpayer makes that showing. Consequently, we do not address this argument.
4. The Sanctions and Costs Issues
The Board claims the trial court abused its discretion in denying the Board's motion for sanctions against Colgate. In that motion, the Board argued that Colgate unduly delayed in producing certain documents evidencing the unitary nature of Colgate's operations.
This matter arose when Colgate, during the first two days of trial, belatedly produced to the Board's counsel five boxes of documents pursuant to the Board's requests for production of documents and a court order based on those requests. Included in this belated production were documents relevant to the operation of Colgate's Danish subsidiary and therefore relevant to the issue of whether Colgate's subsidiaries operated in a unitary fashion with the domestic parent corporation. This production occurred in mid-July 1988. It was not until mid-February 1989, however, that the Board moved for sanctions on this matter; this was after the trial was over and after the Board had won on the unitary issue. On these facts, the trial court declined to award sanctions because the motion was untimely and failed to evidence prejudice against the Board.
The trial court has broad discretion in imposing discovery sanctions, subject to reversal only for arbitrary, capricious or whimsical action. (See Sauer v. Superior Court (1987) 195 Cal.App.3d 213, 228, 240 Cal.Rptr. 489; Kahn v. Kahn (1977) 68 Cal.App.3d 372, 380–381, 137 Cal.Rptr. 332 [although these cases were not decided under the current discovery statutes, the general principle of review they enunciate remains valid. (See former Code Civ.Proc., § 2034.) ].) Code of Civil Procedure section 2023, subdivision (b)(1), upon which the Board relies, does not alter this well-settled principle and the Board concedes as much. That section and subdivision provides in pertinent part that “[i]f a monetary sanction is authorized by any provision of this article, the court shall impose that sanction unless it finds that the one subject to the sanction acted with substantial justification or that other circumstances make the imposition of the sanction unjust.”
The Board argues that the trial court's finding of no prejudice conveys the message that it is acceptable to abuse discovery and conceal evidence, so long as the party seeking discovery cannot prove how those actions prejudiced its case. Of course, prejudice is difficult to prove in the face of victory. The Board's real concern is that such discovery abuse will go unpunished. The Board can rest assured that the trial court possesses an array of weapons to counter parties abusing the discovery process. These weapons include a “Monetary sanction,” an “Issue sanction,” an “Evidence sanction,” a “Terminating Sanction,” and a “Contempt Sanction.” (Code Civ.Proc., § 2023, subd. (b)(1)(2)(3)(4)(5).) The problem for the Board here is that a timely motion for sanctions is required to make these sanctions effective. The Board made its motion after the trial was over and after it had won on the issue for which it sought sanctions. And the Board cannot claim it did not know about the discovery abuse until it made its motion in February 1989. The Board admits it uncovered the abuse in July 1988 during the first days of trial.
The Board argues it was prejudiced because it could have moved for summary judgment on the unitary issue had the documents been timely produced, and the trial could have been shortened if not eliminated. We doubt seriously that operational documents concerning one of Colgate's 75 foreign subsidiaries were the only evidence standing in the way of a summary judgment motion on the unitary issue. In any event, the nature of the unitary issue is essentially factual and particular to the corporate enterprise being examined. For that reason, the issue would not usually be amenable to summary adjudication resolution.14 We also doubt that Colgate's timely production could have eliminated or significantly shortened the trial. The testimony part of the trial also encompassed the distortion issues, and the heart of the lawsuit concerned the foreign commerce clause issue.
The trial court did not abuse its discretion in denying the Board's motion for discovery sanctions.
Our partial reversal of the judgment renders moot the issue of costs awarded below to Colgate. Under our decision, Colgate is no longer the prevailing party.
The judgment on the foreign commerce clause issue is reversed. The judgment on the constitutional and statutory distortion issues and on the matter of sanctions is affirmed. The Board is awarded its costs on appeal.
1. During the tax years at issue (1970–1973), Revenue and Taxation Code section 25101 provided in pertinent 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); ․”California's version of the Uniform Division of Income for Tax Purposes Act (UDITPA), is contained in Article 2. That Act provides for formula apportionment of the net income from business activities both within and outside California in order to reach the net income attributable to California activities. (Rev. & Tax.Code, §§ 25120–25139.)In 1982, section 25101 was amended in a manner insignificant to our purposes. (Stats.1982, ch. 466, § 104, p. 2055.)
2. Generally, a corporation is included within the unitary group if its activities outside California are dependent upon or contribute to the business of a related corporation within California. (See Edison California Stores v. McColgan (1947) 30 Cal.2d 472, 183 P.2d 16.)
3. The amount of the unitary group's income taxable by California is calculated as follows:In–State Property+In–State Payroll+In–State SalesUnitaryTotal PropertyTotal PayrollTotal SalesXGroup'sC1–53 TotalR7IncomeR7Worldwide=Income Taxable by California. (Rev. & Tax.Code, §§ 25128–25137; 23 Columbia Journal at p. 445, fn. 2.)
4. California in 1986 passed legislation, effective January 1, 1988, permitting taxpayers to make a “water's-edge election” notwithstanding Revenue and Taxation Code section 25101 (Rev. & Tax.Code, § 25110 et seq.).This “water's-edge” method restricts tax allocation methods to the United States as the jurisdictional boundary, and offers an alternative to the worldwide unitary method for determining taxable income. (See Rev. & Tax.Code, §§ 25101, 25110.) Rather than accounting for the income and apportionment factors (property, payroll, and sales) of all the corporations of its worldwide unitary group, a corporate taxpayer making such an election accounts for the income and apportionment factors of the following entities affiliated with it, subject to some minor 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 sales corporations engaged in sales in the United States; export trade corporations; any corporation not mentioned above but only to the extent of 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 the worldwide unitary method 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 subsidiaries from the corporation's California tax base. An accounting restriction to the water's edge of the United States in the present context would mean that California could rely only on income derived from permanent establishments of Colgate in the United States, and not on income derived from wholly foreign interests, to calculate Colgate's franchise tax.To qualify for the “water's-edge” election, 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 business 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 qualify the corporate 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 domestic-parent multinational corporation that does not make this election is subjected essentially to the 1970–1973 taxation method at issue here. (See fn. 1, ante.) We emphasize, however, that the principal issue in this case is the foreign commerce clause constitutionality of California's worldwide unitary tax method as applied to domestic-parent unitary corporate groups with foreign subsidiaries (Rev. & Tax.Code, § 25101 et seq.). Because California's “water's-edge election” is not involved in this case, we do not express any views regarding it. (Rev. & Tax.Code, § 25110 et seq.)
5. Reversing its position below, Colgate on appeal does not dispute that it is a domestic-parent unitary corporate group.
6. The Board moved to strike this argument on appeal, contending it was improperly raised in these proceedings. We denied the Board's motion.
7. We assume without deciding that the “clear federal directive” precept set forth in Container applies to a directive from the federal executive branch. (Container, supra, 463 U.S. at pp. 194–197, 103 S.Ct. at pp. 2955–2957; see also Tribe, American Constitutional Law (2d ed. 1988) Federal Executive Power, §§ 4–4, 4–6, pp. 219–225, 230.)
8. Compliance with Evidence Code section 455, subdivision (a) is unnecessary (Evid.Code, § 459, subd. (c)) because Colgate has relied on the United States' amicus trial brief in the Barclays case and has introduced and had admitted various parts of the Barclays record as part of the record here.
9. Congress never enacted this proposed legislation.
10. In arguing for mandatory equal tax treatment for domestic-parent and foreign-parent groups, Colgate relies on Star–Kist Foods, Inc. v. County of Los Angeles, supra, 42 Cal.3d 1, 227 Cal.Rptr. 391, 719 P.2d 987. Star–Kist, however, recognizes Japan Line 's sanction of inequality if necessary to preserve the values embodied in the dormant foreign commerce clause. (42 Cal.3d at pp. 12–14, 227 Cal.Rptr. 391, 719 P.2d 987; see fn. 13, post.)
11. The Board asks that we take judicial notice of a stipulation of dismissal in the Alaska action, based on a settlement. We do so. (Evid.Code, §§ 452, 459.)
12. On constitutional grounds involving equal protection and the commerce clause, Colgate also argues that foreign-parent groups and their domestic-parent counterparts must be treated identically for tax purposes. We are not aware of any final decision holding that state application of the worldwide unitary tax method to foreign-parent groups is unconstitutional under the foreign commerce clause. Until such decision, this issue of equality is premature. There is a well-settled principle that courts do not consider constitutional issues that are not ripe for determination. (Regional Rail Reorganization Act Cases (1974) 419 U.S. 102, 138, 95 S.Ct. 335, 356, 42 L.Ed.2d 320, 350.) We adhere to that principle in this case and do not express any views on this issue. (See fn. 10, ante.) We do note that this issue was not litigated below in any meaningful fashion, was not part of the trial court's decision, and consequently has not been briefed adequately here.
13. In a recent decision, the United States Supreme Court relied on Container 's flow of value concept to uphold the application of the three-factor formula involved here to a value added tax on a unitary business. (Trinova, supra, 498 U.S. 358, 111 S.Ct. 818, 112 L.Ed.2d 884.)
14. We note that Code of Civil Procedure section 437c was amended in 1990 to eliminate motions for summary adjudication of issue(s).
DAVIS, Associate Justice.
PUGLIA, P.J., and CARR, J., concur.