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

Tax Executive, The, Nov, 1999

In calculating a taxpayer's net taxable income, business interest expense is generally deducted from business income. CAL. REV. & TAX CODE [sections] 24344(a) (West 1992) (App. at 35a). Under California law, however, taxpayers must offset their business interest expense -- on a dollar- for-dollar basis -- with non-business income not allocable to the State. CAL. REV. & TAX CODE [sections] 24344(b) (West 1992) (App. at 35a). 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 -- which increases Petitioner's California tax liability -- that is at issue here.

In this case, the trial court concluded on the merits 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 decision in Pacific Tel. & Tel. Co. v. Franchise Tax Board, 7 Cal. 3d 544 (1972). As explained by the Court of Appeal:

   Hunt-Wesson contends that the interest offset provision of section 24344
   impermissibly taxes dividends which are constitutionally immune from
   taxation by California, and therefore violates the federal Due Process
   Clause. The Due Process Clause limits a state's power to impose a tax on an
   activity which is not connected with the taxing state. Thus, a state may
   not constitutionally tax income [from] dividends which a nondomiciliary
   corporation receives from subsidiary corporations having no other
   connection with the state.

   Hunt-Wesson argues that the interest offset provision of section 24344
   constitutes an indirect tax on immune income, increasing a nondomiciliary
   corporation's tax liability solely because it receives nontaxable
   dividends. Hunt-Wesson also argues that the interest offset [rule] is
   overbroad, because it fails to apportion interest expense, but creates a
   dollar-for-dollar offset. If we were writing on a clean slate, these
   arguments might appear persuasive. In Pacific Telephone, however, the
   California Supreme Court explicitly held that inclusion of nontaxable
   dividends in the statutory offset computation under section 24344 does not
   constitute taxation of the dividends themselves.

(App. at 7a-8a (citations omitted).) The Court of Appeal reached a similar conclusion in respect of Petitioner's argument that the interest-offset rule violates the Commerce Clause, but essentially held that the Pacific Telephone decision compelled it to sustain the statute. (App. at 9a-10a.) The California Supreme Court subsequently refused to review the case. (App. at 43a.)

The Court of Appeal's decision flows from the principle of stare decisis -- unquestioned reliance on the Pacific Telephone decision. Subsequent decisions of this Court, however, unequivocally demonstrate that the 1972 decision of the California Supreme Court cannot stand. South Central Bell Tel. Co. v. Alabama, 119 S. Ct. 1180, 1185 (1999); Fulton Corp., 516 U.S. at 327; Oregon Waste Systems, Inc. v. Department of Environmental Quality, 511 U.S. 93, 99 (1994). See United States v. Gaudin, 515 U.S. 506, 521 (1995) ("stare decisis cannot possibly be controlling when ... the decision has been proved manifestly erroneous, and its underpinnings eroded, by subsequent decisions of this Court.").