Brief of Tax Executives Institute, Inc. as amicus curie in support of petitioner

Tax Executive, The, Nov, 1999

On November 10, 1999, Tax Executives Institute filed the following brief with the Supreme Court of the United States concerning the constitutionality of the State of California's interest-offset rule, pursuant to which a nondomiciliary company's interest deduction is reduced dollar-for-dollar by the amount of dividend income received from non-unitary subsidiaries. The brief was prepared under the aegis of TEI's State and Local Tax Committee, whose chair is Amy J. Eisenstadt of General Electric Company. An earlier TEI brief, successfully urging the Supreme Court to review the lower court decision in Hunt-Wesson, is reprinted in the July-August issue of The Tax Executive.

Interest of Amicus Curiae

Pursuant to Rule 37 of the Rules of the Supreme Court, Tax Executives Institute, Inc. respectfully submits this brief as amicus curiae in support of Petitioner.(1) Tax Executives Institute (hereinafter "TEI" or "the Institute") is a voluntary, nonprofit association of corporate and other business executives, managers, and administrators who are responsible for the tax affairs of their employers. The Institute was organized in 1944 and currently has approximately 5,000 members who represent nearly 2,800 of the leading businesses in the United States and Canada, nearly all of which are engaged in interstate commerce.

The members of the Institute represent a cross-section of the business community in North America. The Institute is dedicated to promoting the uniform and equitable enforcement of the tax laws throughout the Nation, to reducing the costs and burdens of administration and compliance to the benefit of both the government and taxpayers, and to vindicating the due process and Commerce Clause rights of business taxpayers.

Tax Executives Institute's members have a vital interest in this case, which involves the unconstitutional effect of the so-called interest-offset rule in section 24344 of the California Revenue and Taxation Code. Many of the companies represented by TEI are directly and adversely affected by the interest-offset rule, which reduces a company's interest expense deduction for each dollar of dividends received from non-unitary subsidiaries. Even those TEI members whose companies are not doing business in California are, almost without exception, engaged in interstate commerce. Consequently, they benefit from, and are entitled to, the positive business environment ensured by the Commerce Clause and Due Process Clause of the United States Constitution.

Because TEI members and the businesses by which they are employed will be materially affected by the Court's decision in this case, the Institute has a special interest in the outcome of this case.

Summary of Argument

The question presented in this case is whether the State of California's system of taxation for out-of-state companies violates the Commerce Clause and Due Process Clause of the Constitution. It is well settled that a State may not tax value outside its borders. Such taxation is proscribed because the "fundamental purpose of the [Commerce] Clause is to assure that there be free trade among the several States," Boston Stock Exchange v. State Tax Comm'n, 429 U.S. 318, 335 (1977), and because extraterritorial taxation offends fundamental notions of due process and constitutes an "unreasonable clog on the mobility of commerce," Baldwin v. G.A.F. Seelig, Inc., 294 U.S. 511, 527 (1935).

Like many states, California imposes a corporate franchise tax for the privilege of doing business in the State, using an apportionment formula in respect of corporations with income from sources within and without the State. In calculating a taxpayer's net taxable income, business interest expense is generally deducted from business income. Under section 24344 of the California Revenue and Taxation Code, however, taxpayers must offset their business interest expense -- on a dollar-for-dollar basis -- with non-business income not allocable to the State. Thus, out-of-state corporations (such as Petitioner Hunt-Wesson) are compelled to reduce their interest deduction by the amount of their nontaxable income, without regard to whether the interest expense is related to the nontaxable income. It is this statute that is at issue here.

In this case, the trial court concluded that section 24344 violates the Due Process, Commerce, and Equal Protection Clauses of the Constitution. This latter decision was reversed by the Court of Appeal, First Appellate District, largely on the force of the Supreme Court of California's 1972 decision in Pacific Tel. & Tel. Co. v. Franchise Tax Board, 7 Cal. 3d 544 (1972). Subsequent decisions of this Court, however, unequivocally demonstrate that the State's 1972 decision cannot stand. South Central Bell Tel. Co. v. Alabama, 119 S. Ct. 1180 (1999); Fulton Corp. v. Faulkner, 516 U.S. 325 (1996); Oregon Waste Systems, Inc. v. Department of Environmental Quality, 511 U.S. 93 (1994).

In Pacific Telephone, the taxpayer challenged the California interest-offset statute as it applied to nondomiciliary corporations. In reviewing the rule, the California Supreme Court conceded that "when viewed in the light of a domiciliary corporation," the rule "does not deprive the taxpayer of any of its interest deduction, but is merely an attempt to provide how the interest expense shall be allocated as between income from operations and income from investments." 7 Cal. 3d at 551 (emphasis in original). The court also commented that the allocation of interest expense is "very favorable" to the domiciliary corporation. Id. As applied to out-of-state companies, however, the allocation is manifestly not favorable. Hence, on its face, the rule violates the overarching principle of the Commerce and Due Process Clauses that an apportionment formula must, first and foremost, be fair. Container Corp. v. Franchise Tax Board, 463 U.S. 159, 169 (1983).