California Court of Appeals, Fourth District, First Division
HARLEY-DAVIDSON, INC. et al., Plaintiffs and Appellants,
FRANCHISE TAX BOARD, Defendant and Respondent.
APPEALS from a judgment of the Superior Court of San Diego County No. 37-2011-00100846-CU-MC-CTL, Joel M. Pressman, Judge.
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Silverstein & Pomerantz, Amy L. Silverstein, Edwin P. Antolin, Johanna W. Roberts, Lindsay T. Braunig and Edward J. Beeby for Plaintiffs and Appellants.
Kamala D. Harris, Attorney General, Paul D. Gifford, Assistant Attorney General, W. Dean Freeman, Leslie Branman Smith and Tim Nader, Deputy Attorneys General, for Defendant and Respondent.
BENKE, ACTING P. J.
Harley-Davidson, Inc. and several of its subsidiaries (together, Harley-Davidson) sued the Franchise Tax Board (Board) for a tax refund. The trial court sustained the Board's demurrer to Harley-Davidson's commerce clause (U.S. Const., art. I, § 8, cl. 3) challenge to Revenue and Taxation Code provisions that allow intrastate unitary businesses to choose annually whether to compute their tax using the combined reporting method or the separate accounting method but require interstate unitary businesses to compute their tax using only the combined reporting method. We conclude the trial court erred in sustaining the demurrer because the statutory scheme facially discriminates on the basis of an interstate element in violation of the commerce clause. We will reverse the judgment in that respect and remand to the trial court to determine in the first instance whether the taxation scheme withstands strict scrutiny-that is, whether it " 'advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.' " (Oregon Waste Systems, Inc. v. Department of Environmental Quality of Ore. (1994) 511 U.S. 93, 101 [128 L.Ed.2d 13, 114 S.Ct. 1345] (Oregon Waste).)
On a separate issue, the trial court determined after a bench trial that two Harley-Davidson subsidiaries were taxable by California during the tax years 2000 through 2002 (Years at Issue). Harley-Davidson contends the trial court erred by finding those subsidiaries bore a sufficient nexus to this state to overcome due process and commerce clause limitations on taxing foreign entities. We disagree and affirm the judgment in this respect.
Because this appeal presents two factually and procedurally distinct issues that are subject to different standards of review, we will address each issue separately.
THE COMMERCE CLAUSE CHALLENGE TO CALIFORNIA'S STATUTORY SCHEME FOR COMPUTING TAX LIABILITY
Harley-Davidson contends the trial court erred by sustaining the Board's demurrer to its first cause of action, which challenged the constitutionality of California's statutory scheme for determining the method by which unitary business groups compute their California tax liability. Harley-Davidson contends that because the scheme treats taxpayers differently based solely on their geography, and because that differential treatment discriminates against interstate commerce by benefiting intrastate businesses at the expense of interstate businesses, the scheme violates the commerce clause. We conclude Harley-Davidson has alleged a commerce cause violation sufficiently to withstand the Board's demurrer.
A. Factual and Procedural Background
We begin with a brief overview of the relevant taxation scheme. A unitary business is an enterprise comprised of a number of commonly owned and controlled businesses, each of which is dependent on or contributes to the operation of the entire business enterprise of the group. (Edison California Stores v. McColgan (1947) 30 Cal.2d 472, 481 [183 P.2d 16]; Handlery v. Franchise Tax Board
(1972) 26 Cal.App.3d 970, 973 [103 Cal.Rptr. 465] (Handlery).) There are two possible methods for unitary corporate taxpayers to compute their California tax liability: the separate accounting method and the combined reporting method. "[S]eparate accounting treats each corporate entity discretely for the purpose of determining income tax liability." (Barclays Bank PLC v. Franchise Tax Bd. of Cal. (1994) 512 U.S. 298, 305 [129 L.Ed.2d 244, 114 S.Ct.
2268] (Barclays).) The combined reporting method aggregates the entire amount of business income of all corporations in the unitary group. (Cal. Franchise Tax Bd., Guidelines for Corporations Filing a Combined Report, Pub. No. 1061 (2000).)
Taxpayers engaged in a unitary business within and without California-interstate taxpayers-are required to use the combined reporting method. (§ 25101; Handlery, supra, 26 Cal.App.3d at p. 973 ["In the case of a 'unitary business' the enterprise files a combined report, and the income from its operations within the state is determined by a formula."].) Handlery confirmed that taxpayers engaged in a unitary business wholly within California-intrastate taxpayers-were required to use the separate accounting method. (Handlery, at p. 985.) In response to Handlery, the Legislature in 1980 enacted section 25101.15, which permits intrastate unitary groups to choose between the combined reporting and separate accounting methods. Thus, as the Board summarizes in its respondent's brief, "section 25101.15 provide[s] wholly in-state businesses... an election to file their returns on either a unitary combined reporting basis, or a separate-entity basis. [¶] Multistate unitary businesses have no corresponding election." (Fn. omitted.)
Harley-Davidson, through various subsidiaries, engages in two business lines: a motorcycle business and a financial services business. For the Years at Issue, Harley-Davidson reported the income of the motorcycle business but not the financial services business, reasoning the latter was not unitary with the former. Following an audit of Harley-Davidson's combined returns, the Board determined the financial services business was, in fact, unitary with the motorcycle business. Consequently, the Board notified Harley-Davidson that it intended to assess additional taxes for the Years at Issue. Harley-Davidson unsuccessfully protested the Board's determination and provisionally paid more than $1.8 million in additional taxes.
Harley-Davidson then sued the Board to recover a refund in the amount of its additional provisional payment. In the first cause of action of its operative first amended verified complaint (complaint), Harley-Davidson alleged the differential treatment afforded to intrastate and interstate unitary businesses regarding the available methods for computing tax liability violates the commerce clause of the United States Constitution because it "confers benefits on intrastate unitary taxpayers that are not available to... interstate unitary taxpayers and that operate as burdens on... interstate unitary taxpayers." The complaint cited (among others) the following benefits and burdens: "[t]he option to file on the basis of the separate reporting method allows intrastate unitary taxpayers... the ability to more efficiently use
credits and net operating losses, reduced tax burden, increased administrative ease and lower compliance costs in preparing returns...."
The Board demurred to the first cause of action and the trial court sustained the demurrer without leave to amend. Harley-Davidson timely appealed.
B. Standard of Review
The constitutionality of California's corporate taxation scheme at issue is a question of law that we review de novo. (Cutler v. Franchise Tax Bd.
(2012) 208 Cal.App.4th 1247, 1253 [146 Cal.Rptr.3d 244] (Cutler).) Additionally, "[o]n review from an order sustaining a demurrer, 'we examine the complaint de novo to determine whether it alleges facts sufficient to state a cause of action under any legal theory....' " (Committee for Green Foothills v. Santa Clara County Bd. of Supervisors (2010) 48 Cal.4th 32, 42 [105 Cal.Rptr.3d 181, 224 P.3d 920].)
C. Commerce Clause Overview
The commerce clause provides that "[t]he Congress shall have Power... [¶] [t]o regulate Commerce... among the several States." (U.S. Const., art. I, § 8, cl. 3.) "Though phrased as a grant of regulatory power to Congress, the [c]lause has long been understood to have a 'negative' aspect that denies the [s]tates the power unjustifiably to discriminate against or burden the interstate flow of articles of commerce." (Oregon Waste, supra, 511 U.S. at p. 98.) In this negative, or dormant, aspect, "the [c]ommerce [c]lause 'prohibits economic protectionism -- that is, "regulatory measures designed to benefit in[-]state economic interests by burdening out-of-state competitors." ' " (Fulton Corp. v. Faulkner (1996) 516 U.S. 325, 330 [133 L.Ed.2d 796, 116 S.Ct. 848] (Fulton); Bacchus Imports, Ltd. v. Dias (1984) 468 U.S. 263, 268 [82 L.Ed.2d 200, 104 S.Ct. 3049] ["A cardinal rule of [c]ommerce [c]lause jurisprudence is that '[no] [s]tate, consistent with the [c]ommerce [c]lause, may "impose a tax which discriminates against interstate commerce... by providing a direct commercial advantage to local business." ' "].) "This reading effectuates the Framers' purpose to 'prevent a [s]tate from retreating into economic isolation or jeopardizing the welfare of the Nation as a whole, as it would do if it were free to place burdens on the flow of commerce across its borders that commerce wholly within those borders would not bear.' " (Fulton, at pp. 330-331.)
"[T]he first step in analyzing any law subject to judicial scrutiny under the negative [c]ommerce [c]lause is to determine whether it 'regulates evenhandedly with only "incidental" effects on interstate commerce, or
discriminates against interstate commerce.' " (Oregon Waste, supra, 511 U.S. at p. 99.) In this context, " 'discrimination' simply means differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter." (Ibid.) "By contrast, nondiscriminatory regulations that have only incidental effects on interstate commerce are valid unless 'the burden imposed on such commerce is clearly excessive in relation to the putative local benefits.' " (Ibid.) Whether the "discrimination comes in the form of a deprivation of a generally available tax benefit, rather than a specific penalty on the [interstate] activity itself, is of no moment." (Camps Newfound/Owatonna, Inc. v. Town of Harrison (1997) 520 U.S. 564. 578-579 [137 L.Ed.2d 852, 117 S.Ct. 1590].)
"If a restriction on commerce is discriminatory, it is virtually per se invalid, " (Oregon Waste, supra, 511 U.S. at p. 99) unless the "justifications for discriminatory restrictions on commerce pass the 'strictest scrutiny' " (id. at p. 101; South Central Bell Telephone Co. v. Alabama (1999) 526 U.S. 160, 169 [143 L.Ed.2d 258, 119 S.Ct. 1180] (South Central Bell)). Accordingly, a discriminatory regulation must be invalidated unless its proponent can " 'show that it advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.' " (Oregon Waste, at pp. 100-101.)
In applying the commerce clause precedents just discussed, we must determine whether (1) the relevant aspect of California's tax scheme treats intrastate and interstate unitary businesses differently, (2) any differential treatment discriminates against interstate commerce either by benefiting intrastate businesses or burdening interstate businesses, and (3) any discriminatory differential treatment withstands strict scrutiny. (Oregon Waste, supra, 511 U.S. at pp. 99-101.)
1. Differential Treatment
The Board effectively concedes in its briefing that the differential-treatment prong is satisfied, acknowledging that "section 25101.15 provides[s] wholly in-state businesses... an election to file their returns on either a unitary combined reporting basis, or a separate-entity basis, " while ...