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California Supreme Court issues decisions on Microsoft and General Motors

Apportioning corporations that have substantial treasury function gross receipts could find that their California sales apportionment factor is affected. The California Supreme Court issued two decisions on August 17, 2006, affecting apportioning corporations. The decisions relate to taxpayers' treasury function gross receipts, the apportionment sales factor of Revenue and Taxation Code (R&TC) Section 25136, and distortion analysis provided by R&TC Section 25137. On September 28, 2006, we issued FTB Notice 2006-3, explaining FTB's position on the application of the accuracy-related penalty under R&TC Section 19164 in gross receipts on intangible sales cases.

Although the California Supreme Court decisions are not final, we are evaluating the decisions issued on, and exploring guidance from the decisions (Microsoft Corp. v. FTB [California Supreme Court, Docket No. S133343], and General Motors Corp. v. Franchise Tax Board [California Supreme Court, Docket No. 127086]).

The California Supreme Court has indicated that the amount realized on redeeming marketable securities as part of a business's treasury function, qualifies as "gross receipts" for purposes of the sales factor, and therefore should be included in the sales factor. R&TC Section 25137 provides an exception that would take the gross receipts back out of the sales factor, if their inclusion would give a distorted picture of the taxpayer's activity in California.

We are analyzing the two court decisions, and exploring how to incorporate the guidance from these decisions in the audits of other taxpayers. Although the cases address the amount of gross receipts to be included in the sales factor denominator, taxpayers with treasury functions in California could potentially have sales factor numerator effects from the court's decisions.

As the California Supreme Court cited, with approval, the State Board of Equalization decision in the Appeal of Pacific Telephone & Telegraph (California State Board of Equalization, May 4, 1978, 78-DBE-028), we anticipate that we will need to apply the "Pac Tel" analysis in more audit cases. In addition to the long-standing "Pac Tel" analysis, FTB will be comparing the profit margins of the ancillary treasury functions with the profit margins of the core operations of the taxpayers, to determine if distortion exists.