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Microsoft Asks California: Are Repatriated Dividends Includible in the Sales Factor Denominator?

Tax Development May 02, 2023

Microsoft Asks California: Are Repatriated Dividends Includible in the Sales Factor Denominator?

On April 18, 2023, the California Office of Tax Appeals (OTA) held a hearing of the appeal of Microsoft1 to consider whether its foreign dividends deducted under Revenue and Taxation Code (R&TC) Section 24411 should be included in the sales factor.


For the 2017 tax year, Microsoft Corporation (“Microsoft”), a computer software and services company, filed a water’s-edge return and repatriated $108 billion in dividends from its unitary Controlled Foreign Corporations (CFC) as required for federal purposes under Internal Revenue Code (IRC) § 965. These CFCs are responsible for the majority of foreign sales and foreign earnings of its global business. On its original 2017 California return, Microsoft deducted the amount eligible for the 75% dividends-received deduction under Section 24411. The full amount of the dividends was included in the apportionable income base but was erroneously omitted from the sales factor denominator. Microsoft filed an amended 2017 return to include the dividends in the sales factor and correct the error. The resulting refund requested was more than $93 million that the Franchise Tax Board (FTB) denied. Microsoft appealed to the OTA.

Microsoft’s Position 

  • Gross foreign dividend is a “gross receipt” under Section 25120 and must be included in the sales factor under Section 25134.
  • FTB’s position to exclude these dividends from the sales factor creates gross distortion that vastly overstates income, and it violates the United States and California Constitutions. As such, alternative apportionment under Section 25137 should apply as an alternative position.

Franchise Tax Board’s Position

  • Foreign dividends are reportable net of deductions because the deducted amounts are not reflected in the tax base (i.e., 25% at most should be included in the sales factor).
  • Appellant’s distortion and constitutional arguments are procedurally barred by the doctrine of election because appellant affirmatively elected water’s-edge reporting.
  • Appellant’s constitutional arguments are outside the scope of an appeal before OTA.

The FTB’s position is reminiscent of its arguments against Microsoft made more than 15 years ago at the California Supreme Court. The issue was whether 100% of the gross receipts from selling securities, along with other treasury receipts, should be included in the sales factor. The Court rejected FTB’s position that only the net gains from selling securities should be included, thus providing clear guidance for taxpayers that the sales factor should include all gross amounts received.


During the hearing, the FTB emphasized its position that the inclusion of the dividends in the sales factor denominator was barred by statute as an occasional sale. Although Microsoft countered that the statute did not apply to intangibles, FTB cited the examples in the statute that included intangible assets. Because the inclusion of the dividends in the denominator resulted in more than a 5% decrease in the sales factor, the dividend would be considered substantial as an occasional, one-time sale. Microsoft contended that the receipts were not occasional, as they were earned regularly, but only repatriated during the year at issue because of requirements of the Tax Cuts and Jobs Act.2 Being required to take the accumulated dividends into income during the tax year, Microsoft decided to distribute the dividends as well. Because the dividends were received from outside of the water’s-edge group, they were not subject to intercompany elimination. Being properly included in the taxable base, Microsoft requested representation of this income within the sales factor. The FTB concluded by stating that even if the dividends would not be classified as an occasional sale, they should still be eliminated because inclusion results in distortion.

The matter is now in the OTA’s hands, and it is required to render its decision in this case within 100 days. Ryan will continue to monitor the developments in this matter and update our audience as to the results and any actions to be taken.

1 Microsoft Corporation & Subsidiaries, Case No. 21037336.

2 In 2017, a one-time deemed repatriation tax was imposed on foreign earnings accumulated after 1986 until the end of a company’s most recent fiscal year. Under this provision, accumulated foreign earnings were deemed repatriated whether or not they were actually repatriated. The tax rate was 15.5% on earnings held in cash and cash equivalents and 8% on earnings held in illiquid assets. Parent corporations could elect to pay this tax in prescribed installments over a period of eight years (Tax Cuts and Jobs Act of 2017).


Gina Rodriquez

Greg Rottjakob

Joseph Schmidt

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