A Supreme Court ruling in June has revived a furious debate and Washington lobbying contest that matches the states against this country's major trading partners, with the Reagan administration caught in the middle.
The court decision confirmed the right of the states to take into account the overseas earnings of multinational corporations in calculating their state tax liability.
Japan and European nations led by Britain are asking the administration to support legislation that would undo the high court's ruling. They fear that other states will adopt the California corporate tax system that the court upheld, and attempt to tax a share of the cumulative worldwide earnings of multinational companies, including foreign corporations with U.S. subsidiaries. These fears were exacerbated when Florida moved within a few days of the court's ruling to adopt a new tax system similar to California's.
Aligned against Britain, Japan, and the countries of the European Common Market are state governors and tax commissioners and a powerful bloc of members of Congress who oppose federal intervention in state tax policies, and who say enactment of the legislation would cost the states more than $700 million a year in corporate tax revenue.
The Reagan administration, in a friend of the court brief filed in a separate Supreme Court case that the justices eventually declined to decide, opposed the California system as an obstacle to international tax treaties and an infringement on the federal government's constitutional power to regulate foreign commerce. But the administration has taken no position on the legislation, and opponents of the bill have been reminding Reagan that he, as governor of California in 1967, said that "federal intervention in state tax matters is objectionable in principle."
At issue is a method of tax assessment known as worldwide combined reporting of the income of unitary, or integrated, corporations. States that use this system generally levy tax on a pro-rata share of all income of a corporation and its "unitary" subsidiaries, such as an oil company with separate production, refining and marketing units.
California is one of 12 states that use the worldwide combined assessment system, taking into account overseas as well as domestic income. The others are Alaska, Colorado, Idaho, Indiana, Massachusetts, Montana, New Hampshire, North Dakota, Oregon, Utah and, since last month, Florida.
Most states, and most countries, including the United States, use a different method known as "arm's-length" accounting, in which subsidiaries are treated as if they were in fact separate corporations with their own tax liability.
Container Corp. of America, which like many multinational corporations would have lower state taxes under this method, challenged the California system when the state counted the income of Container's overseas subsidiaries in computing its income.
The Supreme Court, by a 5-to-3 vote, said that California and the other states have the right to use the worldwide combined system. But the court limited its ruling to multinational corporations with U.S. parents, such as Container, and left open the question of whether the states could use this tax system on foreign-parent corporations.
California already does so, though it is facing court challenges from such foreign-based giants as Alcan Aluminum, Royal Dutch Shell and Beecham Ltd., and tax experts predict that other states will, too.
"Clearly, the states that have the worldwide system or adopt it are going to use it on foreign-parent corporations until they're told not to. No question about it," said Ruurd Leegstra, director of state and local taxation for the accounting firm of Coopers & Lybrand.
This probability has led Britain and the other countries to redouble their efforts on behalf of a bill that would prevent it. The legislation, sponsored in the House by Rep. Barber Conable (R-N.Y.) and in the Senate by Sen. Charles McC. Mathias (R-Md.), was introduced before the Supreme Court ruled because, according to Conable, even if the California system was found to be "marginally constitutional," Congress still must decide whether it is "consistent with the national interest in the free flow of national and international commerce."
The High Court ruling intensified lobbying on the bill. Britain's chancellor of the exchequer, Nigel Lawson, said in a starchy letter to Treasury Secretary Donald T. Regan there is "strong pressure in Parliament" to protect British interests, and asked that "the matter be resolved as soon as possible before possible harm is done to the good relations between our two countries."
Harry Evans, economic counselor at the British Embassy here, put it more bluntly. "The ruling was unsatisfactory," he said. "We want action" from the administration to promote the legislation, he said, because it will probably be years before any of the court challenges to the constitutionality of inclusion of foreign-parent corporations is decided by the Supreme Court.
Administration officials say the question of whether to support the Conable-Mathias bill is being studied by the Cabinet Council on Economic Affairs. Even if the administration should throw its weight behind the bill, however, its chances of enactment appear to be slim because there is widespread, bipartisan opposition to it.
As long ago as January, senators from states that would be affected--including Budget Committee chairman Pete Domenici (R-N.M.), Majority Whip Ted Stevens (R-Alaska), Commerce Committee Chairman Bob Packwood (R-Ore.) and Edward M. Kennedy (D-Mass.), wrote to Regan in support of the worldwide unitary system, saying that "the fairness of the unitary method has repeatedly been affirmed by federal courts at all levels."
One of the most outspoken opponents of the bill is Rep. Byron Dorgan (D-N.D.), a member of the tax-writing Ways and Means Committee and a former North Dakota tax commissioner.
"This legislation has no merit," he said in an interview. "It is without any redeeming features." Opponents of the combined worldwide system, Dorgan noted, say it exposes them to double taxation, by the states and by foreign countries, but "I have challenged those trying to handcuff the states to get any dozen corporate entities to disclose their tax returns and we will sit around the table here and examine them and we will find massive underreporting of taxable income."
The administration, in its court brief opposing the worldwide combined method, said it undercut the federal government's authority to negotiate tax treaties with foreign nations, most of which want to be shielded from this type of state taxation. But if federal negotiators include such a provision in tax treaties, Dorgan said, "they are negotiating with the states' chips."
The arguments against allowing the states to use the worldwide combined method were summarized by the administration in its legal brief filed with the Supreme Court in a case involving Caterpillar Tractor Co., which, unlike most large corporations, favors this tax system and defended it in an Illinois case.
State tax on the "apportioned combined worldwide business income of a unitary group of related corporations, including foreign corporations, impairs federal uniformity in an area where such uniformity is essential," limits the government's ability to "speak with one voice" in negotiating with foreign governments, and can result in international double taxation, the brief said.
The Supreme Court, in deciding the California case, refused to consider the government's position because the brief was filed in another case that the court dismissed without deciding, but the brief nonetheless constitutes a concise statement of the arguments against the California system.
Tax authorities in the states that use this method are emphatic in rejecting these arguments, and say that if the worldwide combined system is applied to domestic-parent corporations it should also be applied to foreign-parent corporations.
"We see no basis for a state to not to apply it to any corporation, whether domestic parent or foreign parent," said Jerry Goldberg, director of the California Franchise Tax Board. "We feel we don't have a choice--we have a duty under the equal protection clause and the commerce clause of the Constitution to treat every taxpayer equally."
Kent Conrad, tax commissioner of North Dakota and chairman of the Multistate Tax Commission, said he and other commission members met recently with representatives of the European Economic Community at the Greek Embassy in Washington for "a little state-to-country diplomacy."
He said the state officials sought to convince the EEC delegates that the worldwide combined method is both fair and practical, and that if it carries a potential for double taxation, as the Supreme Court noted, that risk could theoretically occur under the arm's-length method as well.
"If a company will come forward and lay out their tax returns and demonstrate they are being taxed on more than 100 percent of their federal tax base," he said, "the states will be glad to take administrative action to remedy it. In fact, though, there is not full accountability. There are substantial amounts of 'nowhere income,' not taxed in any state."
In general, tax experts agree, the worldwide combined income method favors the states at the expense of the corporations, but they reject the argument that use of this tax system inhibits business investment. As a congressional staff expert put it, "the Japanese aren't exactly screaming to get out of California."