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Taxpayer Win: California Approves Apportionment Factor with Cooperative Members’ Income

Tax Development Aug 31, 2023

Taxpayer Win: California Approves Apportionment Factor with Cooperative Members’ Income

In the Appeal of Southern Minnesota Beet Sugar Cooperative and Subsidiary1 (SMBSC), the California Office of Tax Appeals (OTA) rejected the Franchise Tax Board’s (FTB’s) longstanding position that denied apportionment factor representation for business activities that generate deductible income.

SMBSC is an agricultural cooperative owned by farmer shareholders headquartered in Minnesota. In 2005, SMBSC acquired California-based Spreckels Sugar Company (“Spreckels”). Spreckels is not a cooperative and filed combined reports with SMBSC as a unitary business. As a cooperative business, SMBSC was allowed a deduction under California R&TC Section 24404 for income “resulting from or arising out of (its) business activities for or with (its) members.”

For the tax years at issue, SMBSC was required to compute its California apportionment using a three-factor formula, which was the sum of the property factor, payroll factor, and double-weighted sales factor divided by four. SMBSC included the factors for the cooperative business and the sugar business in its apportionment calculation, resulting in a small percentage as all of its property and payroll were outside California. Consistent with the FTB’s position in Legal Ruling 2006-01, the FTB sought to exclude the Minnesota factors from the apportionment calculation because those business activities generated deductible income.

Legal Ruling 2006-01, “Apportionment Factor Treatment of Exempt Income,” was issued on April 26, 2006 to address the factor representation for business activities generating income not subject to tax, such as exempt and deductible income. The Legal Ruling concludes that under the Uniform Division of Income for Tax Purposes Act (UDITPA) formula, net business income should be apportioned only based on the activities giving rise to that income.

The OTA disagreed with the FTB, noting that the FTB’s position conflicts with the basis for unitary determination that includes all members of a unitary group, regardless of whether it generates taxable income. The plain language of the statutes and regulations that determine net income, after any deductions for a cooperative member, is calculated before allocation and apportionment. The Opinion of the OTA stated that “there is no language in UDITPA to support the FTB’s position that unitary business activities are excluded from the apportionment formula if they relate to deductible income.”

The OTA sided with the taxpayer, despite the fact that the FTB requested deference in the ruling based partly on the Yamaha2 decision. The Yamaha decision provides that significant weight of an agency interpretation should be considered in a determination of taxability. The OTA noted the FTB’s expertise in multistate taxation but held that the position did not persuasively explain how the relevant statutes or regulations might be interpreted in the manner it proposes. The OTA concluded that the FTB’s interpretation would result in excluding unitary business activities that contribute to the production of apportionable business income from the apportionment formula without support in the UDITPA and without showing distortion.

The decision’s reluctance to defer to Legal Ruling 2006-01—and differentiate between factors attributable to deductible income as opposed to exempt income—bodes well for the increased inclusion of dividends in the sales factor at issue in Appeal of Microsoft.3

This opinion was released on August 2, 2023 as “Pending Precedential,” which indicates the start of a 30-day public comment period, after which the OTA determines precedential status. The FTB cannot appeal this decision.

Please contact one of the Ryan tax professionals listed below for additional information.

1 California Office of Tax Appeals, No. 19034447 (March 17, 2023, released as “Pending Precedential” August 2, 2023).

2 Yamaha Corp. of America v. State Board of Equalization (1998) 19th Cal 4th 1.

3 California Office of Tax Appeals, No. 21037336.


Josh Booth

Mary Bernard

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