Container Corp. of America v. Franchise Tax Board
463 US 159, 77 L. Ed. 2d 545, 1983 U.S. LEXIS 89 (1983)
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Rule of Law:
California's application of the unitary business principle and three-factor apportionment formula to include the income of a domestic parent corporation's foreign subsidiaries for franchise tax purposes does not violate the Due Process Clause, Commerce Clause, or Foreign Commerce Clause, particularly when the subsidiaries constitute a functionally integrated enterprise and the tax does not inevitably result in double taxation or fatally undermine federal foreign policy.
Facts:
- Container Corporation of America, a Delaware corporation headquartered in Illinois, manufactured custom-ordered paperboard packaging through a vertically integrated operation.
- During the tax years 1963-1965, Container Corporation controlled 20 foreign subsidiaries located in four Latin American and four European countries, with ownership stakes ranging from 66.7% to 100%.
- Most of these subsidiaries engaged in essentially the same business as Container Corporation in their respective local markets and were largely autonomous with respect to personnel and day-to-day management, which was handled by local executives.
- Approximately half of the subsidiaries’ long-term debt was either held directly or guaranteed by Container Corporation.
- Container Corporation provided advice and consultation to its subsidiaries regarding manufacturing techniques, engineering, design, architecture, insurance, and cost accounting, either through technical service agreements or informal arrangements.
- Container Corporation occasionally assisted its subsidiaries in procuring equipment, either by selling them used equipment or by using its own purchasing department as an agent.
- High officials of Container Corporation oversaw subsidiary operations, establishing general standards for professionalism, profitability, and ethical practices, and dealing with major problems and long-term decisions.
- Container Corporation's sales representatives sometimes referred its customers with overseas needs to its foreign subsidiaries, and in at least one instance, assisted in contract negotiation between a customer and a foreign subsidiary.
Procedural Posture:
- Container Corporation of America filed California franchise tax returns for 1963, 1964, and 1965, excluding income from its foreign subsidiaries.
- In 1969, the California Franchise Tax Board (appellee) conducted an audit of Container Corporation's returns and issued notices of additional assessments for each of those years, contending that the foreign subsidiaries should have been treated as part of Container Corporation's unitary business.
- Container Corporation paid the additional amounts under protest.
- Container Corporation sued the Franchise Tax Board in California Superior Court for a refund.
- The Superior Court, after a trial on stipulated facts, upheld the Franchise Tax Board’s assessments.
- On appeal, the California Court of Appeal affirmed the Superior Court's decision.
- The California Supreme Court refused to exercise discretionary review.
- The U.S. Supreme Court noted probable jurisdiction to review the case.
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Issue:
1. Does California's application of the "unitary business" principle to include a domestic corporation and its overseas subsidiaries, despite their separate incorporation and day-to-day autonomy, violate the Due Process and Commerce Clauses? 2. Does California's standard three-factor apportionment formula (payroll, property, sales), when applied to a multinational enterprise with foreign subsidiaries, result in an unfair apportionment of income in violation of the Due Process and Commerce Clauses? 3. Does the Foreign Commerce Clause require California to use the "arm's-length" method, rather than worldwide formula apportionment, for taxing a domestic parent corporation and its foreign subsidiaries, especially when actual double taxation occurs and other nations employ the arm's-length method?
Opinions:
Majority - Justice Brennan
No, California's tax scheme is constitutional. First, the state courts' finding that Container Corporation and its overseas subsidiaries constituted a "unitary business" was proper. The Court defers to state court judgments if they are "within the realm of permissible judgment" and apply correct legal standards. This case presented a "functionally integrated enterprise" demonstrating "substantial mutual interdependence" and a "flow of value," unlike ASARCO and F. W. Woolworth. Key factors included Container Corporation's significant financial backing (loan guarantees), substantial technical assistance, assistance with equipment and personnel, and managerial oversight in setting general standards and approving major decisions, despite decentralized day-to-day management. The Court rejected a bright-line "flow of goods" requirement, emphasizing that "flow of value" is the prerequisite for a unitary business finding. Second, California's standard three-factor apportionment formula was fair. The Court rejected arguments that the formula distorted income by ignoring higher foreign subsidiary profitability or lower foreign wage rates, as these rely on separate geographical accounting, whose inherent weaknesses justify formula apportionment. The three-factor formula is a widely approved benchmark that avoids extreme distortions. Container Corporation failed to meet its burden of showing "clear and cogent evidence" that the income attributed to California was "out of all appropriate proportions" or "grossly distorted," noting the approximate 14% increase in tax liability was well within the margin of error and not comparable to distortions previously found unconstitutional. Third, California was not obligated to employ the "arm's-length" analysis under the Foreign Commerce Clause. While acknowledging actual double taxation and a divergence from international practice, the Court distinguished this case from Japan Line, Ltd. because it involved a tax on income (not property, which has a single situs), the double taxation was not "inevitable" (as both "arm's-length" and formula apportionment can lead to double taxation depending on application), and the tax was imposed on a domestic corporation, not a foreign entity. The tax does not create an automatic "asymmetry," its legal incidence falls on a domestic corporation, and the amount of tax is more a function of California’s tax rate than its allocation method. Furthermore, the Executive Branch did not file an amicus curiae brief opposing the state tax, and congressional intent does not explicitly pre-empt state application of worldwide unitary apportionment, with tax treaties generally not covering subnational entities and Congress having debated but not enacted legislation to restrict state taxation methods.
Dissenting - Justice Powell
Yes, California's tax scheme does violate the Foreign Commerce Clause. Justice Powell argued that the California tax clearly violates the Foreign Commerce Clause, as dictated by Japan Line, Ltd. The dissent emphasized the majority's concession of actual double taxation and the inconsistency with the internationally accepted "arm's-length" method. The "close scrutiny" standard from Japan Line requires a state tax to be unconstitutional if it creates a substantial risk of international multiple taxation or prevents the Federal Government from "speaking with one voice." The double taxation here is inherent because California's formula, which relies on factors like wage rates, property values, and sales prices, systematically allocates a higher proportion of income to jurisdictions like California where these factors are higher. This inevitably leads to double taxation for income already taxed in lower-cost foreign jurisdictions. While acknowledging the risk of double taxation under the "arm's-length" method due to differing applications, the dissent distinguished this from the current situation where double taxation is inevitable due to fundamentally different systems. Regarding federal uniformity, the dissent contended that the tax does prevent the federal government from speaking with one voice by being fundamentally inconsistent with international practice. Even though the taxpayer is a domestic corporation, California is effectively taxing the income of foreign subsidiaries, which offends foreign governments and discourages U.S. investment abroad. The dissent criticized the majority for dismissing the Solicitor General's amicus brief in Chicago Bridge & Iron Co., which directly opposed worldwide unitary apportionment, arguing it clearly represents the Executive Branch's view that such state taxes "impair federal uniformity."
Analysis:
This case significantly clarified the permissible scope of state taxation for multinational corporations, particularly regarding the "unitary business" principle and the application of the Foreign Commerce Clause. It affirmed that states can apply worldwide formula apportionment to the income of domestic parent corporations and their foreign subsidiaries, even if it results in some double taxation, provided the business is functionally integrated and the double taxation is not "inevitable." The Court's distinction of Japan Line (focusing on property vs. income tax, inevitable vs. non-inevitable double taxation, and foreign vs. domestic taxpayer) is a critical precedent for future Foreign Commerce Clause challenges, establishing a higher bar for invalidating state income taxes on domestic corporations' foreign-source income. The ruling generally reinforces state power in tax matters unless there is a clear federal preemption or an overwhelming, demonstrable foreign policy implication.
