Harley-Davidson, Inc. v. Franchise Tax Board

Plaintiff Harley Davidson and its subsidiaries (Harley-Davidson) form a multistate

enterprise with numerous functionally integrated subsidiary corporations. It contends

that defendant California Franchise Tax Board's (Board) tax scheme violates the

commerce clause of the federal Constitution (U.S. Const., art. I, § 8, cl. 3), claiming that

it burdens interstate enterprises by providing a benefit to intrastate enterprises not

available to interstate enterprises. An intrastate unitary business may use either

combined or separate accounting to report its income to the Board, whereas HarleyDavidson

and other interstate unitary businesses must use the combined reporting

method, without the option of separate accounting for each related entity. The trial court

granted summary judgment for Harley-Davidson. It found that whether or not the state's

tax law unduly burdened interstate commerce, the state had a legitimate reason for

treating in-state and out-of-state unitary businesses differently that could not be served by

reasonable nondiscriminatory alternatives — to accurately measure, apportion and tax all

revenue acquired in California by an interstate unitary business.

After independent review, we also find that there is a legitimate state interest to

require combined reporting of taxable income of interstate unitary businesses, to

accurately measure and tax all income attributable to California, that outweighs any

possible discriminatory effect. We affirm the judgment of the trial court.

BACKGROUND

Harley-Davidson has a nation-wide business. The Harley-Davidson enterprise is

comprised of commonly owned and functionally integrated businesses, each of which is

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dependent on or contributes to the operation of the entire business enterprise of the group.

Such an enterprise is called a unitary business.

Harley-Davidson filed an action for a tax refund, raising several issues, including a

challenge under the commerce clause to the Board's requirement that interstate unitary

businesses must use the combined method of reporting income and apportioning taxes,

while intrastate unitary businesses may use either the combined method or the separate

accounting method. The sole remaining issue is Harley-Davidson's claim that this

differential treatment harms the flow of interstate commerce by providing a direct

commercial advantage to intrastate unitary companies. It asserts that the federal

commerce clause was violated by Revenue and Taxation Code provisions that allow

intrastate unitary businesses to choose 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.

In an earlier appeal, this court reversed an order sustaining the Board's demurrer to

this issue in the complaint. (Harley-Davidson (2015) 237 Cal.App.4th 193, 203–208,

(Harley I).) We found that this provision of California's tax system treats intrastate and

interstate unitary businesses differently, but we made no finding on whether that

differential treatment was discriminatory. (Id. at pp. 203, 206.) We found only that

Harley-Davidson adequately alleged that this differential treatment was discriminatory

because it benefitted intrastate unitary businesses and burdened interstate unitary

businesses. (Id. at p. 206.) A demurrer must be denied where the plaintiff has alleged

facts that, if true, would state a valid cause of action. (Evans v. City of Berkeley (2006)

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38 Cal.4th 1, 6 [alleged facts deemed true]; Perez v. Golden Empire Transit Dist. (2012)

209 Cal.App.4th 1228, 1235 (Perez) [standard of review of order sustaining demurrer].)

On remand, the Board and Harley-Davidson filed cross-motions for summary

judgment. The trial court granted summary judgment for the Board. The trial court

found that California tax law treats in-state and out-of-state unitary businesses differently

because it permits in-state businesses to choose between the separate entity or combined

reporting method, while out-of-state businesses have no choice but must use the

combined method of accounting. Differential treatment is discriminatory within the

commerce clause context, however, if the different treatment provides a direct benefit to

in-state entities or increases the tax burden on interstate entities. The trial court

concluded that there were triable issues of fact on whether a discriminatory effect exists.

It found that even if the law burdened interstate companies, the state had a legitimate

interest in "requiring this form of combined reporting to ensure that all business income

from interstate business is accurately accounted for [and] that it is fairly apportioned.

The state has a valid interest in preventing the manipulation and hiding of taxable

income. [Citation.] [¶] There does not appear to be a reasonable nondiscriminatory

alternative that would adequately serve the state's interest. The alternative of allowing

separate reporting for out of state business would potentially omit income of certain

entities doing business outside the state."

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We review this grant of summary judgment de novo and independently decide if

the findings of undisputed facts warrant judgment for the moving party as a matter of

law.1 (Aguilar v. Atlantic Richfield Co. (2001) 25 Cal.4th 826, 860 (Aguilar).)

DISCUSSION

I. Combined Reporting Aggregates the Income of an Interstate Unitary Business and

Permits California to Tax a Proportionate Amount of the Income Attributable to

California

A state may tax the value that a corporation earns within its state borders. But in

an enterprise such as Harley-Davidson, that consists of a number of commonly owned

and functionally controlled entities, it is difficult to assess the value earned throughout

the entire interconnected enterprise that is attributable to the state. The unitary business

principle was developed to permit the states "to tax a corporation on an apportionable

share of the multistate business carried on in part in the taxing [s]tate." (Allied-Signal v.

Director, Div. of Taxation (1992) 504 U.S. 768, 778 (Allied-Signal) [history of unitary

business principle].) It protects an enterprise from being taxed for value not attributable

to the state, while allowing the state to collect its fair share of taxes attributable to the



1 In a motion filed December 1, 2017, the Board requested we take judicial notice of

the Judgment and Statement of Decision after trial in Abercrombie & Fitch v. Franchise

Tax Board, Fresno Superior Court No. 12CECG03408, now on appeal in the Fifth

District Court of Appeal, case No. F074873. That court's ruling was not before the trial

court when it rendered its decision in this case. It is not part of the record on appeal.

That case involved a different plaintiff, and the decision came after a trial of the facts.

The record before the Fresno Superior Court was different from the record that is before

us in this appeal.

The decision of the Fresno Superior Court in a different case is not relevant to our

appellate review of the summary judgment before us. The Board's request for judicial

notice is therefore denied.

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enterprise's connection to the state. (Ibid.) Under this system, the interstate unitary

business must calculate the income of all of its functionally integrated components, and

apportion to the state that income proportionate to the business conducted within the

state. (Container Corp. of America v. Franchise Tax Board (1983) 463 U.S. 159, 165

(Container Corp.).) A proportionate share of the income that is attributable to California

activities is determined by an apportionment formula that uses objective measures of the

corporation's activity within California — payroll, property, and sales. (Id. at p. 170.)

The United States Supreme Court has long upheld the constitutionality of this combined

reporting/formula apportionment method under the commerce and due process clauses.

(Id. at p. 165, and cases cited therein, dating back to 1920; Allied-Signal, supra, 504 U.S.

at pp. 778–779 [history of unitary business principle].)

California's combined reporting method has been found constitutional under the

commerce and due process clauses for interstate unitary companies and for foreign

unitary companies. (Barclays Bank PLC v. Franchise Tax Bd. of Cal. (1994) 512 U.S.

298, 311–312 (Barclays); Container Corp., supra, 463 U.S. at pp. 164–165; Butler

Brothers v. McColgan (1942) 315 U.S. 501, 506–507 [no due process violation].)

In Barclays, a foreign international corporation claimed that California's

worldwide combined reporting scheme was discriminatory, due to the compliance costs

and administrative burdens it imposed on foreign unitary enterprises. (Barclays, supra,

512 U.S. at pp. 312–313.) The Supreme Court found that California's tax scheme did not

systematically overtax foreign corporations. (Id. at p. 314.) Barclays complained of the

compliance and administrative burdens it bore in preparing the combined accounting and

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reporting required by California. (Id. at pp. 312–314.) But regulations that have only

incidental effects on interstate commerce are valid. (Oregon Waste Systems v. Dept. of

Environmental Quality (1994) 511 U.S. 93, 98 (Oregon Waste).) Compliance burdens

are generally incidental, although they can violate the commerce clause if

disproportionately imposed on out-of-state enterprises. The compliance and

administrative burdens were not excessive in Barclays. (Barclays, at p. 313.)

Some unitary businesses conduct business solely within California. All income is

earned within California and all is subject to California tax. These intrastate unitary

businesses have the option of computing their California tax liability by either 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.' " (Harley I, supra, 237 Cal.App.4th at p. 199, quoting Barclays, supra, 512

U.S. at p. 305.) The combined method of reporting aggregates the entire amount of

business income of all corporations in the unitary group. While intrastate businesses

would not have to apportion value earned in California, as all value is earned in

California, combined reporting may permit the enterprise to offset the tax gains of one

entity by the losses of another entity, and to shift tax liability, and other assorted benefits.

Historically, the individual entities of a unified business that operated solely

within California were required to separately account for their taxable income, because

there was no need for aggregation and apportionment. Some of these intrastate

interdependent corporations sued the Board, contending that they were discriminated

against under the equal protection clause because the intrastate businesses were not

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permitted to file under the combined method of reporting used by interstate unitary

businesses. (Handlery v. Franchise Tax Board (1972) 26 Cal.App.3d 970, 982–983

(Handlery).) The intrastate taxpayers contended that they were denied the benefits of

combined reporting that were available to interstate unitary businesses. Specifically, the

intrastate taxpayers alleged that they were denied the benefits of offsetting losses against

gains between different entities. (Id. at p. 984.) The appellate court found no violation of

equal protection because the state tax laws had a reasonable basis. (Id. at p. 983.) It

explained, "the 'formula' apportionment of unitary business income has not only been

found to be constitutionally permissible, but that it is often the only reasonable and

practical manner in which a state may levy and collect taxes to which it is constitutionally

entitled. It might be described as a sort of rule of necessity, having its origin in the

accommodation of a state's constitutional right to tax income derived from within the

state, to constitutional due process of law and interstate commerce provisions." (Id. at

p. 974.) It found no violation of equal protection, because "the formula-unitary business

reporting method has but one purpose—determination of the income from interstate

operations properly allocable to California. Where intrastate operations only are

concerned such intrastate income is readily discernible from the books of the enterprise,

without resort to any formula or other device." (Id. at p. 979.) Interstate and intrastate

unitary businesses were not similarly situated for purposes of the equal protection law.

(Id. at p. 983.)

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In response to Handlery, the Legislature in 1980 amended the Revenue and

Taxation Code to permit intrastate unitary groups to choose either the combined reporting

or the separate accounting methods. (Harley I, supra, 237 Cal.App.4th at p. 200.)

Interstate unitary groups do not have that choice. Harley-Davidson contends that this

differential treatment of interstate and intrastate unitary enterprises violates the commerce

clause.

II. The Commerce Clause Prohibits Economic Protectionism and Interference with

Interstate Commerce

We provided an overview of the commerce clause in Harley I:

"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

(Fulton); Bacchus Imports, LTD v. Dias (1984) 468 U.S. 263, 268

['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' " '].) . . .

" '[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

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"the burden imposed on such commerce is clearly excessive in

relation to the putative local benefits. . . ." '

" '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; see South Central Bell Telephone

Co. v. Alabama (1999) 526 U.S. 160, 169 (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.)"

(Harley I, supra, 237 Cal.App.4th at pp. 201–202, fns. omitted.)

III. Harley I Did Not Rule on the Discriminatory Effect of California's Reporting

Requirements

Harley-Davidson contends that we held in Harley I that the difference in

permissible methods of reporting facially discriminated against interstate unitary

enterprises. We could not have made such a decision on the bare allegations of the

complaint, without determining the veracity of the allegations. We held only that

"Harley-Davidson has sufficiently alleged for purposes of surviving the Board's demurrer

that the differential treatment of intrastate and interstate unitary businesses is

discriminatory within the meaning ascribed by commerce clause precedent." (Harley I,

supra, 237 Cal.App.4th at p. 207.) Harley-Davidson's complaint alleged that the option

to use the separate reporting method benefitted intrastate unitary taxpayers by allowing

"the ability to more efficiently use credits and net operating losses, reduced tax burden,

increased administrative ease and lower compliance costs in preparing returns. . . ."

(Harley I, at pp. 200–201.) In Harley I, we reversed the order sustaining the demurrer

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because if these facts were true, they stated a valid cause of action to be determined in the

trial court. (See Perez, supra, 209 Cal.App.4th at p. 1235.)

IV. Because Harley-Davidson Has Made a Facial Challenge, It Need Not Specify the

Amount of the Excess Burden on It

We reject the Board's contention that Harley-Davidson must show the amount of

taxes it overpaid as a result of the alleged discriminatory statutes. We agree with HarleyDavidson

that it need not show that Harley-Davidson, itself, was burdened, because it

raises a facial challenge to the statutes. (Tobe v. Santa Ana (1995) 9 Cal.4th 1069, 1084.)

But it must show that the different choice of reporting methods has an actual

discriminatory effect on interstate commerce. "To support a determination of facial

unconstitutionality, voiding the statute as a whole, petitioners cannot prevail by

suggesting that in some future hypothetical situation constitutional problems may

possibly arise as to the particular application of the statute . . . . Rather, petitioners must

demonstrate that the act's provisions inevitably pose a present total and fatal conflict with

applicable constitutional prohibitions." (Ibid., citations and internal quotation marks

omitted.) It is disputed here whether the reporting requirements of California's tax law

facially show a factual dispute about an inevitable, present, total and fatal conflict with

the commerce clause.

V. There Are Triable Issues of Fact About the Existence of Discriminatory Effect

The gravamen of discriminatory action is "differential treatment of in-state and

out-of-state economic interests that benefits the former and burdens the latter." (Oregon

Waste, supra, 511 U.S. at p. 99.) Discrimination that puts a higher tax burden on in-state

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businesses than on interstate businesses does not violate the commerce clause because it

does not discourage commerce among the states. (See Direct Marketing Association v.

Brohl (10th Cir. 2016) 814 F.3d 1129, 1143 [complementary tax].) Negative incidental

effects such as compliance costs and administrative burdens are not generally

discriminatory. (Barclays, supra, 512 U.S. at pp. 313–314.)

The trial court made no factual finding here about the discriminatory effect of the

different reporting requirements of California's tax law. The trial court concluded that

there were triable issues of fact on this question. We decline the Board's invitation to

make a factual determination on direct appeal of the possibility of discriminatory effect

from the disparate reporting choices.

VI. Legitimate State Interests Justify the Disparate Reporting Rule

A tax scheme that burdens the flow of interstate commerce must generally be

invalidated unless "it advances a legitimate local purpose that cannot be adequately

served by reasonable nondiscriminatory alternatives." (Oregon Waste, supra, 511 U.S. at

pp. 100–101.)

The trial court found that the state had a legitimate interest in requiring combined

reporting for interstate unitary businesses in order to accurately measure and fairly

apportion the income from all functionally integrated entities, and to prevent the

manipulation and hiding of taxable income. (Barclays, supra, 512 U.S. at p. 303; see

also Container Corp., supra, 463 U.S. at p. 164.) The court in Container Corp. explained

that separate accounting "often ignores or captures inadequately the many subtle and

largely unquantifiable transfers of value that take place among the components of a single

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enterprise." (Container Corp., at pp. 164–165.) While these compelling reasons were

stated in the context of a due process claim, they provide the same rational basis for

supporting the state's legitimate interest in requiring combined reporting when it is

challenged as discriminatory under the commerce clause. Harley-Davidson has, in any

event, agreed that these are "worthy goals."

Harley-Davidson contends, however, that there are reasonable nondiscriminatory

alternatives to the disparate reporting system. But separate accounting cannot be

extended to interstate corporations because it "ignores or captures inadequately" the

transfers of value that take place among the many entities that that can make up a unitary

enterprise, and can lead to "the manipulation and hiding of taxable income." (Barclays,

supra, 512 U.S. at p. 303; Container Corp., supra, 463 U.S. at p. 164.) Harley-Davidson

has not pointed us to facts in the record that cast doubt on these findings. (See Lewis v.

County of Sacramento (2001) 93 Cal.App.4th 107, 116 (Lewis) [appellants bear burden to

support claims by citations to record and to authority].) Harley-Davidson argues that the

Board has "tools at [its] disposal" to seek out all the "subtle and largely unquantifiable

transfers of value" among the entities of a unitary business (Container Corp., at pp. 164–

165) and to prevent manipulation. This basic ability to capture fraud is not broadly

effective in the way that the combined reporting method prevents and limits the potential

fraud and manipulation facing the Board. As the Supreme Court has repeatedly held, the

combined reporting / apportionment method is a rule of necessity that conforms to and

fulfills "two imperatives: the States' wide authority to devise formulae for an accurate

assessment of a corporation's intrastate value or income; and the necessary limit on the

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States' authority to tax value or income that cannot in fairness be attributed to the

taxpayer's activities within the State." (Allied Signal, supra, 504 U.S. at p. 780; see also

Handlery, supra, 26 Cal.App.3d at p. 974 ["[T]he 'formula' apportionment of unitary

business income has not only been found to be constitutionally permissible, but . . . it is

often the only reasonable and practical manner in which a state may levy and collect

taxes to which it is constitutionally entitled"].)

Nor has Harley-Davidson convinced us that prohibiting intrastate unitary

companies from choosing either the solitary accounting or the combined method would

be a reasonable alternative. There are no undisputed facts to support this suggestion. (See

Lewis, supra, 93 Cal.App.4th at p. 116.) All income earned by an intrastate unitary

business is taxed by California, without apportionment. Intrastate unitary businesses

have less opportunity for hiding and manipulating taxable income among separate

entities, because all of their income is earned and value added within the state's borders,

subject to general state corporate regulation. Intrastate entities are not similarly situated

to interstate entities for purposes of filing taxes. Harley-Davidson has given us no facts

supporting its claim that requiring intrastate unitary businesses to always file by the

combined reporting method would be a reasonable nondiscriminatory alternative.

We affirm the judgment of the trial court.