Elective Separate Corporate Filings – Has Harley-Davidson Paved the Road in California?

On May 28, 2015, Harley-Davidson’s unmistakable rumble enveloped the California Court of Appeal. The Court ruled in Harley-Davidson, Inc., et al. v. Franchise Tax Board, Cal. Ct. App., Dkt. No. D064241, (05/28/2015) that the California Revenue and Taxation Code may violate the Commerce Clause of the U.S. Constitution by requiring multistate unitary corporations to file one combined corporation tax return while allowing wholly in-state corporate unitary corporations an election to file combined or separate tax returns, as noted. The Court found the statute facially discriminatory because wholly intrastate corporate taxpayers benefit from a choice that could impact the tax liability that interstate taxpayers do not enjoy. While the Court stopped short of finding that the statute is a violation of federal law, the Court’s holding places the statute under a strict scrutiny test. Accordingly, the Court remanded the case back to the trial court where the State will bear the burden to articulate a legitimate local purpose that the State cannot advance using reasonable nondiscriminatory alternatives. Note that the Court of Appeal agreed with the trial court on a separate issue that certain related financial special purposes entities (SPEs) of Harley-Davidson had nexus with California for the years at issue by virtue of related-party agents acting on behalf of the SPEs.

The "Ride-"Away?

While the litigation continues and the outcome is not certain, strict scrutiny is a high hurdle for the Franchise Tax Board. Nevertheless, the road to an ultimate disposition may be lengthy. In addition, Harley-Davidson is contending that multistate taxpayers must be afforded an election to filed separate corporate tax returns to cure the Constitutional defect. However, the question of an appropriate remedy is not yet at issue. 

Should the ultimate disposition provide a similar election for multistate corporate taxpayers to use a separate reporting method, every multistate corporate taxpayer with more than one corporate member in a combined return should compare the tax liability isolating each entity as a separate filer. Separate reporting may yield a lower tax liability where entities with high California apportionment generate losses or lower margins than their unitary affiliates.

The statute of limitation for filing refund claims in California is generally four years from the original due date of the tax return or four years from the date filed if extended. Multistate corporate taxpayers that are included in combined reporting groups should consider filing protective claims for refund should separate reporting be advantageous.