The questionable constitutionality of the California DRD and interest offset rules.

The California Bank and Corporation Tax Law currently provides dividends-received deductions (DRDs) modeled on those in Sec. 243 of the Internal Revenue Code. The California DRDs, however, are limited to dividends paid from earnings and profits (E&P) generated from California sources. This limitation creates a bias in favor of investing in California-based companies. In light of several U.S. Supreme Court decisions, such a geographically based DRD appears to violate the U.S. Constitution.

In addition, the California Bank and Corporation Tax Law contains another provision that tends to discriminate against non-California-source dividends. This second provision, known as the "interest offset rule," effectively disallows the deduction of interest expense in an amount equal to the nonbusiness income of corporations not headquartered in California. Since interest expense would only be offset against non-California-source dividends, this provision also creates a bias in favor of investing in California corporations. A California Superior Court recently found the interest offset rule to violate the Due Process, Commerce and Equal Protection Clauses of the U.S. Constitution.(1)

Treatment of California-Source and Non-California-Source Dividends

California Rev. & Tax. Code section 24402 provides that a corporation may deduct the percentage of a dividend received from another corporation if the dividend is paid from income that the payer corporation "included in the measure" of its California franchise tax or corporation income tax. The amount deductible depends on (1) the percentage of the recipient's ownership in the payer corporation and (2) the percentage of the payer's income derived from California sources. If the recipient owns more than 50% of the payer (by vote or value), the recipient may receive up to a 100% deduction; if it owns from 20% to 50% of the payer (by vote or value), the recipient may receive up to an 80% deduction; and if it owns less than 20% of the payer (by vote or value), the recipient may receive up to a 70% deduction (Rev. & Tax. Code section 24402(b)).

The second limitation restricts the DRD by the payer's activity in California. The percentage deductible equals the income of the payer corporation included in California taxable income over the payer corporation's total income (Rev. & Tax. Code section 24402; Regs. section 24402). The following example illustrates the application of both restrictions.

Example 1: Recipient corporation C owns 40% of the payer; 70% of the payer's income is from California sources. C can exclude 56% of the dividend: The 40% ownership limits the deduction to 80% of the dividend, and the payer's activities in California further limit the deduction to 56% (70% of the 80%). If C owned 15% of the payer, the amount deductible would be 49%: 70% deduction based on ownership, further reduced by 70% due to the payer's activities in California.

The DRD issue would not affect dividends received from corporations that are members of the same unitary business group as the dividend recipient. These intercompany dividends are fully excluded from the recipient's taxable income under Rev. & Tax. Code: section 25106, without regard to their geographic source. Often, when a taxpayer has more than 50% ownership of the voting stock of another entity, a unitary business relationship exists. However, because a unitary relationship requires the presence of other factors as well as ownership,(2) the DRD can easily apply to dividends received from a subsidiary when those other factors are not present.(3) Furthermore, Rev. & Tax. Code section 24402 provides the only basis for deducting dividends taxable in California received from payers in which the recipient owns 50% or less of the voting stock.

While a dividend recipient not domiciled in California may claim that dividends from nonunitary subsidiaries and minority stockholdings are nonbusiness income allocable entirely outside of California, application of the "interest offset rule" tends to negate such a claim. Under this rule, the dividend recipient is required to allocate its net interest expense (the excess of interest expense over business interest income) against nonbusiness dividend (and interest) income. The allocation of interest expense outside of California is effectively the equivalent of denying that portion of interest expense as a deduction for California tax purposes. The interest offset rule, however, does not apply to dividends from California sources excluded from California taxable income under the DRD provisions (Rev. & Tax. Code section 24344(b)). As a result, only non-California-source dividends are subject to the interest offset rule.

California also has a specific DRD provision for dividends received from insurance companies (Rev. & Tax. Code section 24410).(4) If the recipient corporation is commercially domiciled in California, it may deduct dividends received from a California subsidiary insurance company if the recipient owns at least 80% of each class of the insurance company's stock and the dividends are paid from California-source income. The amount of the insurance company's California-source income equals the dividends received multiplied by the ratio of gross income from California sources to all gross income.(5) A company not commercially domiciled in California is not eligible for the DRD, under Rev. & Tax. Code section 24410. This lack of a DRD tends to be problematic when the dividend is treated as apportionable business income by the California Franchise Tax Board (FTB).(6)

Constitutional Standards

The U.S. Supreme Court has held on numerous occasions that state tax statutes that facially discriminate against interstate and foreign commerce violate the Commerce Clause of the U.S. Constitution.(7) In Kraft General Foods, Inc. v. Iowa Dept. of Rev. and Fin.,(8) the Supreme Court made it clear that a state's favorable tax treatment of dividends based on their geographical source is not allowed.

For the tax years in dispute in Kraft, Iowa adopted the Federal DRD provisions of Sec. 243. Under Sec. 243, dividends from U.S. domestic corporations are eligible for full or partial DRDs, while dividends from foreign corporations paid from E&P not effectively connected with a U.S. trade or business are not eligible for the DRD. To prevent double taxation of the foreign-source dividends at the Federal level, the Internal Revenue Code contains foreign tax credit provisions; the Iowa tax law, however, did not provide for similar credits. The Supreme Court found that the Iowa regime of taxing dividends generated from non-U.S. business activities of foreign corporations discriminated against foreign commerce in violation of the Commerce Clause.

Iowa raised several arguments in its defense. The taxpayer could have avoided taxation of its foreign dividends through use of a holding company incorporated and domiciled in a tax haven state. This holding company would have received the foreign dividends and, in turn, paid a dividend to the taxpayer. Since the holding company's dividend would have been from a U.S. corporation, the taxpayer would have been entitled to a DRD for Iowa tax purposes. The Supreme Court stated that Iowa could not force a taxpayer to reorganize its business as a condition for avoiding discriminatory taxation.

Next, Iowa argued that coupling its tax law with Sec. 243 provided administrative convenience to both the taxpayer and to Iowa. The Supreme Court rejected this argument. It noted that Iowa could have provided a subtraction modification for dividends (which several other states had adopted) that would not have substantially increased Iowa's administrative burdens.

Finally, Iowa argued that dividends from U.S. corporations could actually be subject to a higher state and Federal tax burden than that suffered by foreign corporations in their respective countries. While the Court acknowledged this possibility, it concluded that the Iowa tax law nevertheless imposed a burden on foreign dividends that was not imposed on domestic dividends.

In light of Kraft, discriminatory DRDs of other states have been found by their respective courts to be unconstitutional. In Dart Industries v. Clark,(9) the Rhode Island Supreme Court upheld the decision of a lower court that Rhode Island's DRD rules violated the Commerce Clause. For the tax years in dispute, Rhode Island provided two DRDs. The first referred to Sec. 243; the second provided that dividends from corporations having nexus with Rhode Island were excluded from the recipient's Rhode Island taxable income.(10) Since the differential tax treatment of both provisions was based on the location of the business activities of the dividend payer, they were in conflict with Kraft.

In Conoco, Inc. v. Taxation and Rev. Dept. of New Mexico,(11) the New Mexico Supreme Court held that its state tax law discriminated against foreign source dividends. Similar to Iowa and Rhode Island, New Mexico used the Sec. 243 DRD rules. New Mexico, however, adjusted the taxpayer's business apportionment ratios to reflect the property, payroll and sales of the taxpayer's foreign subsidiaries (a method known as "factor representation"). The New Mexico Supreme Court determined that factor representation for foreign dividends did not provide the same treatment as the DRD for domestic dividends; a portion of the foreign dividends remained taxable by New Mexico, while none of the domestic-source dividends were taxed.

In Smith v. New Hampshire Dept. of Rev. Admin.,(12) a taxpayer challenged provisions that exempted interest and dividends received from New Hampshire banks, but taxed interest and dividends received from non-New Hampshire banks. The New Hampshire Supreme Court held that the exempt ions were unconstitutional; they discriminated against interstate commerce to the direct competitive advantage of New Hampshire banks. A New Hampshire depositor's decision to invest in a local or foreign bank was not tax-neutral; the exemptions violated the principle that state statutes may not constitutionally encourage the development of local industry by means of taxing measures that impose greater burdens on economic activities taking place outside the state than would be placed on similar activities within the state.

NCR v. Wisconsin Dept. of Rev.(13) addressed a statute that closely follows California's DRD provisions. For the years in issue, Wisconsin allowed a deduction for dividends if the payer filed Wisconsin income tax returns and was subject to the Wisconsin income tax, and more than 50% of the payer's business was in Wisconsin.(14) The court held that the provision was facially discriminatory because a parent corporation locating a subsidiary in Wisconsin receives a tax benefit denied to a subsidiary located in another state.

In a similar vein, the Massachusetts Supreme Judicial Court found in Perini Corp. v. Massachusetts Commissioner of Rev.(15) that the Massachusetts excise tax facially discriminated against interstate commerce. The excise tax (as it then existed) permitted a Massachusetts intangible property corporation(16) to deduct from its net worth the value of a subsidiary incorporated in Massachusetts, while a foreign intangible property corporation could deduct from its taxable net worth the value of a subsidiary incorporated outside Massachusetts (provided the subsidiary did not do any business in Massachusetts). The provision had the effect of discouraging Massachusetts corporations from owning non-Massachusetts corporations. In addition, foreign corporations were discouraged from owning subsidiaries that did business in Massachusetts. The Massachusetts Supreme Judicial Court determined that the overall effect of the excise tax was to discriminate against investments in foreign subsidiaries in violation of the principles enunciated in Kraft. Thus, the Massachusetts Supreme Judicial Court ordered the net worth deduction to be extended to the value of investments in all subsidiaries for all corporate taxpayers.

The U.S. Supreme Court, however, has stated that a tax that is discriminatory on its face may survive constitutional challenge if, under a strict scrutiny test, the provision "advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives."(17) The classic example of this is a compensatory use tax typically used by a state in conjunction with its sales tax.(18) The use tax would appear to be facially discriminatory against interstate commerce, since the effect is to tax purchases made outside (but not inside) of the taxing state (to the extent that those items were not subject to sales tax in the state of purchase).(19) Use taxes, though, are constitutionally valid; in the context of the overall sales tax scheme, items purchased outside the state are not taxed more heavily than items purchased inside the state.(20)

In Fulton Corp. v. Faulkner,(21) North Carolina argued that its intangibles tax was a compensating tax in relation to its corporate income tax. In general, the intangibles tax was imposed on the fair market value (FMV) of corporate stock, but taxpayers could deduct from the FMV of each stock the portion of the value related to business conducted by the corporation in North Carolina. The deductible portion was based on the ratio of the corporation's income subject to North Carolina income taxation over the corporation's total taxable income. If a corporation paid North Carolina corporate income tax on 100% of its income, the corporation's stockholders did not pay an intangibles tax. Conversely, if the corporation did no business in North Carolina, the total FMV of its stock was subject to the intangibles tax imposed against the corporation's shareholders. The Supreme Court first concluded that the intangibles tax was facially discriminatory against interstate commerce and then analyzed the intangibles tax to determine whether it was a compensatory tax.

The Court stated that for a tax to be a valid compensatory tax, it must satisfy a three-prong test. First, the state must identify the intrastate tax burden for which the state is attempting to compensate. Second, the tax on interstate commerce must be shown roughly to approximate--but not exceed--the amount of the tax on intrastate commerce. Third, the events on which the interstate and intrastate taxes are imposed must be "substantially equivalent."

For the first prong, North Carolina argued that it was enticed to compensation for maintaining its capital markets. The state received compensation for this service from in-state corporations through the corporate income tax, and the intangibles tax served merely to compensate the state for use of the North Carolina capital markets by out-of-state corporations. The Supreme Court, however, noted that the corporate income tax was a general tax levy and not a charge tied specifically to the regulation of capital markets in North Carolina.(22) The danger in permitting a state to justify a discriminatory tax as compensation for charges purportedly including a general tax levy is that states would have a loophole through which any discriminatory levy could be justified.

North Carolina attempted to satisfy the second prong of the compensatory tax test by comparing the rate of the corporation income tax with that of the intangibles tax. Based on the respective tax rates, North Carolina asserted that the intangibles tax on the stock of any corporation with a price/earnings ratio of 31 or less would be less than the income tax imposed on that corporation had it been doing all of its business in North Carolina. The Supreme Court found this analysis to be insufficient because it compared a tax (the corporate income tax) collected to fund a wide variety of activities with a tax (the intangibles tax) a alleged-collected to fund maintenance of the North Carolina capital markets. The Supreme Court stated that North Carolina would have to identify specifically the portion of the income tax used to maintain North Carolina's capita markets and then compare that portion of the income tax to the intangibles tax rate. Because North Carolina failed to make this comparison, its intangibles tax did not satisfy the second prong of the compensatory tax analysis.

As to the third prong, the Supreme Court noted that the intangibles tax and the corporate income tax were imposed on different taxpayers (the stockholder and the corporation, respectively). This undermined North Carolina's claim that the two taxes fell on substantially equivalent events.

It is difficult to see how the California DRD provisions can be successfully reconciled with the principles of Kraft and Fulton. Both Rev. & Tax. Code sections 24402 and 24410 base the grant of a deduction on where the dividend payer conducted its business.(23) If Iowa and the other states listed could not base their respective DRD provisions on where the dividend payer conducted its business, it is questionable whether California can base its DRD on a similar basis. California must demonstrate that its taxation of non-California-source dividends is a compensatory tax scheme under the three-prong test of Fulton, a test California would appear to be hard-pressed to satisfy.

Under the first prong, there appears to be no service for which California is entitled to compensation. California does not tax the income of a foreign corporation because California does not provide services (such as police and fire protection, infrastructure, etc.) to the foreign corporation for which the state could ask for something in return (taxes). In contrast, California taxes the income of a domestic dividend payer because California does provide services to that corporation, entitling the state to ask for a payment of tax. Similarly, a foreign dividend recipient does not receive additional services in California that require it to pay a higher tax than that imposed on a domestic dividend recipient.

California appears to fail the second prong because the tax on interstate commerce would exceed the tax on intrastate commerce. As shown, a taxpayer investing in corporations not doing business in California pays a higher tax than one investing in corporations doing business in California. California should also fail the third prong of the test, which requires that the interstate and intrastate taxes must be imposed on "substantially equivalent" events. As the Supreme Court stated in Fulton, the alleged compensatory tax falls on a different taxpayer from that of the first tax: The taxation of the foreign dividends is imposed on the recipient, while the taxation of the earnings used to pay the dividends is on the corporate dividend payer.

California may try to justify the DRD provisions as an attempt to avoid double intrastate taxation. Under Rev. & Tax. Code section 24402, California may argue that it only taxes the income once. If the corporation earns the income from doing business in the state, the income is taxed at that level and not again when paid as a dividend to its corporate recipients. If the payer does not pay tax to California on the income, the tax is collected when the recipient receives the dividend.

While the Supreme Court did not specifically address the double intrastate taxation issue in the cases discussed above, the issue seems foreclosed by the Supreme Court's decision in Tyler Pipe; Industries, Inc. v. Washington Dept. of Rev.(24) Tyler Pipe involved the validity of Washington State's business and occupation tax (B&O tax). Under that tax, local manufacturers were taxed on the value of their manufactured goods (measured by gross receipts), but were exempt from a gross receipts tax imposed on sales made in Washington by wholesalers. In contrast, out-of-state manufacturers selling in Washington were subject to the gross receipts tax imposed on wholesalers. For the tax years in dispute, the B&O tax did not provide a credit for gross receipt taxes imposed on out-of-state manufacturers by other states.

The state had argued that exempting local manufacturers from the wholesale tax was necessary to prevent the double taxation of goods made and sold in Washington. The Supreme Court noted, however, that the protection against double taxation applied only to taxpayers that both manufactured and sold their goods in Washington. If another state imposed a tax on the value of the manufactured goods, the out-of-state manufacturer would suffer that tax as well as the Washington wholesale tax when selling goods in Washington. The Supreme Court determined that the local manufacturers' exemption discriminated against interstate commerce.

Similarly, while the California DRD prevents the double taxation of income earned in California distributed to a California corporate shareholder, it does not prevent double taxation when the income is earned outside California and distributed to a shareholder taxable in California. Thus, a defense based on the avoidance of intrastate double taxation when the statute does not provide a mechanism to avoid double interstate taxation would have the same defects as the B&O tax in Tyler Pipe.

Interest Offset Provision

When a taxpayer's holding of stock of another corporation is not an integral part of that taxpayer's trade or business, the dividends from the other corporation are classified as nonbusiness income and are allocated to the taxpayer's commercial domicile. A taxpayer not commercially domiciled in California excludes nonbusiness dividends from its California taxable income.

A taxpayer with nonbusiness dividends, however, must determine how much of its interest expense deduction will be applied against the nonbusiness dividends under the "interest offset rule" (Rev. & Tax. Code section 24344(b)). For taxpayers commercially domiciled outside of California, the interest offset rule prevents the deduction of a portion of the taxpayer's interest expense up to the amount of nonbusiness dividends (and interest) claimed by the taxpayer. California's rationale for the disallowance is that the disallowance prevents taxpayers not commercially domiciled in the state from receiving a double tax benefit--one from the exclusion of nonbusiness dividends from taxable income and a second from deducting interest on debt used to finance the acquisition of the stocks paying the nonbusiness dividends.(25)

While this rationale appears reasonable, the interest offset rule does not contain any means for testing whether some or all the taxpayer's debt is related to the taxpayer's stockholdings. Instead, the interest offset rule operates in a very mechanical fashion. First, interest expense is applied against the taxpayer's business (apportionable) interest income. The excess interest expense is then applied against the taxpayer's non-business dividends and interest (exclusive of dividends deductible from California taxable income under Rev. & Tax. Code sections 24102 and 24410). Any remaining interest expense is applied against the taxpayer's operating income. The effect of the interest offset rule, when coupled with the DRD provision of Rev. & Tax. Code section 24402, is that dividends generated from business activities conducted outside of California remain taxable by California.

The interest offset provision was upheld by the California Supreme Court in Pacific Tel. & Tel. Co. v. FTB.(26) In light of recent U.S. Supreme Court decisions with respect to dividends, taxpayers have renewed the challenge against the interest offset provision.

Currently, there are two California Superior Court decisions(27) in which taxpayers have challenged the constitutionality of the interest offset rule.(28) The FTB was victorious in F.W. Woolworth Co. v. FTB,(29) now on appeal, because the trial court felt constrained by Pacific Tel. & Tel. The trial court in Hunt-Wesson, Inc. v. FTB,(30) however,; determined that Pacific Tel. & Tel. did not address the constitutionality of the interest offset rule and, therefore, was not a barrier to finding the interest offset rule constitutionally invalid.

Freed from this constraint, the Hunt-Wesson court found that the interest offset rule's automatic attribution of interest expense against nonbusiness dividends violated the Due Process, Equal Protection and Commerce Clauses of the U.S. Constitution. The interest offset rule violated the Due Process Clause because no regard was given to whether the disallowed interest expense was related to the dividend income. In effect, California was taxing income (the nonbusiness dividends) without showing that there was a sufficient nexus between the state and the income it sought to tax. The court also concluded that the interest offset rule violated the Commerce and Equal Protection Clauses because a corporation not domiciled in California must pay more tax than a corporation commercially domiciled in the state.

With respect to the Commerce Clause, California argued that the interest offset rule did not discriminate against a nondomiciliary corporation because the amount of tax imposed on that corporation would be no greater than the tax imposed on a similarly situated California-domiciled corporation (see Example 2, below).

Example 2: Corporation X is commercially domiciled in California; corporation Y is domiciled in another state. Each has $30 of nonbusiness dividends, $70 of net business income (before interest expense), $50 of interest expense and a California business apportionment percentage of 40%. X's and Y's California taxable income would be:

                                   California-   Non-California-
                                   domiciled X   domiciled Y

Nonbusiness dividends                 $30           $30
Less: Interest attributed to
  nonbusiness dividends
  under the interest offset rule      (30)          (30)
Net nonbusiness income (A)              0             0
Business income                        70            70
Less: Remaining interest
  expense ($50 - $30)                 (20)          (20)
Net business income                    50            50
Business apportionment
  percentage                           40%           40%
Apportioned business
  income (B)                           20            20
California taxable income
  (A + B)                             $20           $20

While it may be true that the interest offset rule does not discriminate against a nondomiciliary corporation, the Commerce Clause requires that there be some nexus between the activities in the taxing state and the income that the state seeks to tax. In Allied Signal Inc. v. Director, Div. of Taxation,(31) the U.S. Supreme Court rejected New Jersey's argument that it should be able to subject all dividends of a nondomiciliary corporation to apportionment without establishing any link between the taxpayer's in-state activities and the dividend income. The only difference between what New Jersey attempted in Allied Signal and what California is attempting under its interest offset rule is that the latter is using the denial of a deduction to effect what it cannot do directly. The court in Hunt-Wesson recognized this ploy and refused to grant this result to California.

The FTB is expected to file an appeal in Hunt-Wesson. Based on the mechanical application of the interest offset rule, it is anticipated that the Superior Court's decision will be upheld.

Expenses Related to Tax-Exempt Income

Under Rev. & Tax. Code section 24425, expenses related to the production of tax-exempt income are not deductible in determining California taxable income. Dividends deducted from taxable income under Rev. & Tax. Code sections 24402 and 24410 are considered to be tax-exempt income for purposes of section 24425.(32) In determining expenses related to excluded dividends, the FTB will first determine what expenses are directly traceable to particular items of income; any remaining expenses are apportioned to tax-exempt income by; means of a ratio consisting of the amount of tax-exempt income over total income.

If the existing California DRD sections are found to be unconstitutional, the courts may order the expansion of the DRDs to encompass all dividends as a possible remedy. In that case, the FTB would likely use Rev. & Tax. Code section 24425 to attribute expenses against the excluded dividend income to reduce any refund claims. Taxpayers should consider this potential action when determining the economics of challenging California's DRDs.

Conclusion

For the reasons discussed, California's treatment of dividend income is likely to be found unconstitutional over the coming years. Any taxpayer suffering a substantial California tax on its dividend income should consider mounting a challenge to those provisions.

Editor's note: Ms. Manos-McHenry chairs the AICPA Tax Division's State and Local Taxation Committee. Mr. Banigan is a member of the committee.

If you would like more information about this article, contact Ms. Manos-McHenry at [phone], Mr. Rosen at [phone], or Mr. Banigan at [phone].

(1) Hunt-Wesson, Inc. u. Franchise Tax Board (FTB), No. 976628 (Sup. Ct., San Francisco Cty., 6/6/97).

(2) Container Corp. v. FTB, 463 US 159 (1983); Butler Bros. v. McColgan, 315 US 501 (1942); and Edison California Stores v. McColgan, 30 Cal2d 472, 183 P2d 16 (1947).

(3) The DRD might conceivably apply between members of a combined group if the dividends are paid from E&P that was not part of the corporations' unitary business. For example, California has a doctrine that corporations are not instantaneously unitary once they meet the ownership requirements. The corporations must establish an interrelationship of operations, management or functions, which may take up to a year (Willamette Industries v. FTB, 33 CA4th 1242, 33 CalRptr2d 757 (1995)). Income earned by the payer during this period would not come from the companies' unitary business and, therefore, would not be eligible for exclusion under Rev. & Tax. Code section 25106.

(4) Rev. & Tax. Code section 24402 is not applicable to dividends received from insurance companies because such companies are not subject to the Bank and Corporation Tax (Appeal of Saks & Cc)., No. 95R-0023 (3/19/97)).

(5) Gross income from California sources equals total gross income less dividends from other insurance companies multiplied by the three-factor formula (receipts, property and payroll) with the gross receipts factor modified as follows: the denominator includes all receipts (other than dividends from another insurance company), regardless of their nature or source. The numerator includes all gross receipts (other than dividends from another insurance company) derived from or attributable to California; see Rev. & Tax. Code section 24410(c).

(6) Appeal of Dial Financial Company of California, State Board of Equalization, No. 93-SBE-004 (2/10/93).

(7) See, e.g., Oregon Waste Systems, Inc. v. Department of Environmental Quality of Oregon, 511 US 93 (1994).

(8) Kraft General Foods, Inc. v. Iowa Dept. of Rev. and Fin., 505 US 71 (1992).

(9) Dart Industries v. Clark, 657 A2d 1062 (1995).

(10) R.I. Tax Law section 44-11-12.

(11) Conoco, Inc. v. Taxation and Rev. Dept. of New Mexico, 122 NM 736 (1997).

(12) Smith v. New Hampshire Dept. of Rev. Admin., NH Sup. Ct., No. 95-852 (4/3/97).

(13) NCR v. Wisconsin Dept. of Rev., Wisc. Cir. Ct., Dane Cty., Nos. 92 CV 1516 & 92 CV 1525 (1993).

(14) Section 71.04(4).

(15) Perini Corp. v. Massachusetts Commissioner of Rev., 419 Mass 763 (1995) and C.A. No. 93-393, SJC 06657 (1996).

(16) An "intangible property corporation" is defined in Mass. G.L. Chapter 63, section 30, as a corporation whose tangible property situated in Massachusetts that is not subject to local taxation is less than 10% of its total assets. Generally, intangible property companies tend to be holding companies.

(17) Oregon Waste Systems, note 7, p. 101.

(18) Henneford v. Silas Mason Co., 300 US 577 (1937).

(19) To be constitutionally valid, a complementary use tax must provide a credit for sales or use taxes paid to other states. Thus, the total tax imposed on the buyer by both the state of purchase and the state of use will not exceed the sales tax that would have been imposed had the taxable item been purchased and used in the same state.

(20) In Fulton Corp. v. Faulkner, 116 Sup. Ct. 848 (1996) (quoting Associated Industries of Mo. v. Lohman, 511 US 641, 646 647 (1994)), the Supreme Court stated that a "truly `compensatory tax designed simply to make interstate commerce bear a burden already borne by intrastate commerce'" would be constitutionally valid.

(21) Fulton Corp., id.

(22) In fact, the Supreme Court stated that maintenance of the North Carolina capital markets was more a function of North Carolina's "Blue Sky" securities laws, regulations and fees than it is of the corporate income tax. This served to further undermine North Carolina's claimed activity for which it sought compensation.

(23) Rev. & Tax. Code section 24410 is even more discriminatory than section 24402 because the former deduction is only available to dividend recipients commercially domiciled in California.

(24) Tyler Pipe Industries, Inc. v. Washington Dept. of Rev., 483 US 232 (1987).

(25) Pacific Tel. & Tel. Co. v. FTB, 7 Cal3d 544, 498 P2d 1030 (1972).

(26) Id.

(27) California Superior Court decisions do not serve as precedent.

(28) Taxpayers have also raised the constitutionality of the offset rules before the State Board of Equalization, but the Board has refused to hear the issue. Sierra Pacific Industries, 94-SBE-002 (1/5/94).

(29) F.W. Woolworth Co. v. FTB, No. 962405 (Sup. Ct., San Francisco Cty., 3/11/96).

(30) See note 1.

(31) Allied Signal Inc. v. Director, Div. of Taxation, 504 US 768 (1992).

(32) See Great Western Financial Corp. v. FTB, 4 Cal3d 1, 479P2d 993 (1971); Sierra Pacific Industries, note 28; Mission Equities Corp., 75-SBE-002 (1/7/75).

From Jay M. Rosen, J.D., LL.M., Senior Manager, Multistate Tax Services Group, and Russell W. Banigan, CPA, National Director, Multistate Tax Services Group, Deloitte & Touche LLP, New York, N.Y.