How California levies taxes on foreign-based companies doing business in-state
A professional baseball pitcher with a multimillion-dollar contract may well have a million-dollar arm, figuratively speaking. But his tax accountant would be hard-pressed to say the pitcher's arm alone was worth the total of his multimillion-dollar pitching ability.
The baseball player, the accountant would concede, is a multifaceted unit of pitching ability.
So goes a favorite and simplified analogy of state unitary tax laws. These laws are being adopted by revenue-hungry states who want to tax corporations and their subsidiaries as if they were a single moneymaking entity - like a baseball player who makes money with the diverse but related abilities to throw a ball over home plate with his arm, or to run across home plate with his legs.
A series of United States Supreme Court decisions have upheld the states' right to levy taxes on US-based corporations in proportion to their earnings worldwide. And on Jan. 9, a high court decision left intact a lower court ruling that allows California to tax foreign-based multinational corporations with US subsidiaries.
Questions about unitary tax are raised in the following example in California , where unitary tax has been most aggressively applied:
The Shell Oil Company is a US-based subsidiary of Dutch Shell Petroleum. Shell does business in California and contributes to the profits of its parent company in the Netherlands.
Now, should Shell Oil pay state taxes on a portion of the total profits the parent makes? What if Shell Oil loses money in California, but its parent company makes a profit - is Shell still liable in California for a tax on those worldwide profits?
An increasing number of revenue-hungry states say yes. And predictably, the corporate community disagrees.
In June, the unitary tax got the judicial green light, prompting several revenue-hungry states to examine the possibility of unitary tax applications. Immediately after the Supreme Court upheld California's right to tax US-based corporations and their subsidiaries, Florida passed a unitary tax package expected to raise $95 million in revenue for the sagging education budget there. And since the June decision three other states have been quietly preparing to dust off their long-dormant unitary-tax formulas, says Eugene Corrigan, executive director of the Multistate Tax Commission, a group that helps develop uniformity of state tax laws.
The flurry of interest in the unitary tax raises several issues:
* Unitary taxes fly in the face of decades-old international standards. They have become a ''major offense'' to some of America's biggest trading partners (Japan, the Netherlands, and the United Kingdom, for example), says Gary Huffbauer, a senior fellow on trade policy at the Institute for International Economics. Further, he says, the US can expect foreign countries to use the unitary-tax issue as a bargaining chip in tax treaty negotiations and to follow suit with their own unitary taxes on US-based corporations.
* The Reagan administration has set up a task force of state governors, legislators, and business executives to study the tax. The panel has been appointed to decide if a national standard should be applied, to determine if the tax amounts to double taxation, to find alternatives to the tax, and to determine its effect on trade.
* In California, Gov. George Deukmejian has ordered an informal review of the unitary tax to determine its impact on business growth in the state. One-third of the state's corporate tax revenue comes from the unitary tax.
Some business leaders contend that banning the unitary tax would encourage business growth in the state - providing enough taxable profits to make up for lost state revenues.
States generally apply the unitary tax in the same way as California. The apportionment formula here involves finding the individual percentages of a company's property, payroll, and sales in California, says Jim Hamilton, assistant chief counsel for the California State Franchise Tax Board. These percentages are added and then divided by three. The result is considered to be the company's share of business done in California - which is taxed at 9.6 percent.
Business's objections to the unitary law range from complaints that it may constitute double taxation to the sheer impossibility of translating diverse worldwide assets into a taxable US figure, says David Milton, general tax counsel for Shell Oil. Further, he says, it's a fine line to determine how much the profits of scattered subsidiaries are dependent on each other. For example, if a California subsidiary manufactures doors at a modest profit, or even a loss , does the parent company in New York owe higher California taxes because another subsidiary has made a bonanza of profits in insurance?
About 22 states already have some form of the unitary tax, according to tax experts, and all states have heard threats that business will leave their boundaries if the tax is more stringently applied.
But, ''business remains in this country because there is a good market here - a good, educated work force, raw materials, good transportaion, and a good climate,'' says Tom Field, publisher of a trade magazine called Tax Notes. ''If taxes were the main deciding point in where to locate, then states like Wyoming, Mississippi, and Alaska would be getting all the business.'' Further, admits a Shell executive, you can't move an oil field because of taxes.