Challenge to California’s Combined Reporting Requirements May Result in Franchise Tax Refund Opportunities

A complaint recently filed in a California trial court spotlights a potential franchise tax refund opportunity for multistate corporate taxpayers who file combined franchise tax reports in California. Harley-Davidson, Inc. & Subsidiaries v. California Franchise Tax Board, No. 37-2011-00100846-CU-MC-CTL (Superior Court, San Diego County) (November 9, 2011).

In general, California law mandates that if a multistate taxpayer is engaged in a “unitary business,” and a part of that business is conducted in California, the taxpayer is required to compute its franchise tax using the combined reporting method. Under this method, the income from all activities of the unitary business group, including the income of group members not doing any business in California, is combined into a single report. The taxpayer’s share of the combined, unitary business income is then assigned to California using a statutory apportionment formula.

Combined reporting is strictly mandatory for taxpayers engaged in unitary businesses both inside and outside California. However, a taxpayer engaged in a unitary business exclusively inside California may elect to compute its franchise tax using either the separate-company or combined-reporting method. In its complaint, Harley-Davidson alleges that in withholding this option from taxpayers conducting any business outside the state, the election violates the Commerce Clause of the United States Constitution. The Franchise Tax Board has not yet responded.

The limitation period for claiming a franchise tax refund is the later of four years from the date the original return was filed, four years from the date the return was due (without regard to any extension), or one year after the date of overpayment. If the Franchise Tax Board does not notify the taxpayer of its refund claim denial within six months, the claim is deemed denied, allowing the taxpayer to invoke its appeal rights. When a claim is denied, the taxpayer may appeal to the State Board of Equalization or bring a refund action against the Franchise Tax Board in the superior court.

While it is impossible to predict the outcome of this case, given California’s precedent for seeking legislative fixes to pending litigation, it is imperative that taxpayers interested in this potential opportunity submit refund claims as soon as possible. Ryan’s team of State Income and Franchise Tax professionals can assist in performing the complex data analysis necessary for determining whether a taxpayer is a candidate for this initiative and can assist in all phases of the appeal process.