Reference no: EM131139998

TAX RESEARCH PROBLEM:

You work for the state and local tax department of Grayling Company, a very large company engaged in multistate taxation issues and with extensive activity in the state of California. Due to extensions of statute of limitations, many prior years are open and large amounts of taxable income and tax refunds are at stake on open audit issues. Your Manager has asked you to assess the likelihood of success and prepare a research memo on the status of refund claims for earlier years in California pertaining to a key multistate issue.

Grayling Company originally filed tax refunds for tax years 1993 through 2005 and apportioned its business income in the standard 3-factor formula for apportioning business income (sales, payroll, and property, equally weighted). This was a fair representation for apportionment to the state based on its multistate activities. The standard 3-factor formula was set forth in the Multistate Tax Compact and adopted by the California legislature through enactment of the former California Rev. & Tax Code Section 38006, which included the entire texts of the Uniform Division of Income for Tax Purposes Act (UDIPTA), and made California a member state of the Compact.

However, in 1993, California amended its apportionment formula by amending California Rev. & Tax Code Section 25128(a), that provided in part, "Notwithstanding Section 38006 (the provisions of the Multistate Compact), all business income will be apportioned to California by using a double-weighted sales factor formula.

Between 1993 and 2005, Grayling Company paid income tax using the new law (double weighted sales apportionment factor), then sought a refund claim arguing that the Compact gave the Company the right to choose between the new double weighted-sales formula imposed by the California Legislature under Ca. Rev. & Tax Code Section 25128(a), or the UDIPTA approach from the Multistate Compact, adopted under former Ca. Rev. & Tax Code Section 38006.

The refund claims were filed under the UDIPTA standard 3-factor formula and are now under dispute in audit. You are asked to research the tax issue so the Company can decide whether to settle the audit dispute or take the issue to court and tax litigation. At stake is a $10 million dollar refund claim due to the large size of the Company. Your tax manager has told you that other states have addressed this same issue, naming Michigan, Minnesota, Oregon and Texas. In doing your research, write your opinion about the likelihood of success in California and also address how the issue was addressed by at least one of these other states.