Legal ruling 366
STATE OF CALIFORNIA
Franchise Tax Board - Legal Division
December 03, 1973
Taxation of Income Generated by the Offshore Oil Operations of a Unitary Business
Advice has been requested as to the treatment to be accorded to the income earned by unitary businesses, taxable in California, from oil operations beyond the three mile continental limit. The operations considered are:
- The actual operations of an offshore oil well, beyond the three mile continental limit, conducted from a fixed drilling platform; and
- The exploring and drilling operations beyond the three mile continental limit conducted from floating drilling barges.
For California franchise tax purposes, what is to be included in the numerator and denominator of the apportionment formula with respect to:
- Activities conducted from fixed drilling platforms which are under federal jurisdiction by reason of the Outer Continental Shelf Lands Act?
- Activities conducted from fixed drilling platforms which are within the jurisdiction of a foreign country?
- Activities conducted from floating drilling barges?
- In 1953 the United States Congress passed the Outer Continental Shelf Lands Act (67 Stat. 462, 43 U.S.C.§§ 1,331 et. seq.) which extended the Constitution and laws of the United States to the Outer Continental Shelf; i.e., that property located beyond the three mile limit of state jurisdiction which was established by the Submerged Lands Act (43 U.S.C. §§ 1,301 et seq.). The outer limit of the continental shelf is not established with precision, but rather is marked only by a steep drop of the continental mass toward the ocean deeps. (1953 U.S. Code Congressional and Administrative News, p. 2,178). In some cases this may occur several hundred miles from shore.
Section 1333(a)(1) of the Outer Continental Shelf Lands Act extends federal jurisdiction to all artificial islands and fixed structures erected on the Outer Continental Shelf:
. . .to the same extent as if the Outer Continental Shelf were an area of exclusive Federal jurisdiction located within a State. . .
It is a matter of settled law that no state has jurisdiction to tax in an area of exclusive federal jurisdiction located within a state. Surplus Trading Co. v. Cook, 281 U.S. 647; Standard Oil Co. v. California, 291 U.S. 242; James v. Dravo, 302 U.S. 134. Since Congress extended federal jurisdiction to the Outer Continental Shelf "to the same extent" as if it were an area of exclusive federal jurisdiction within a state, this body of settled law applies with equal force to the Outer Continental Shelf and effectively prohibits the imposition of any state tax on revenues derived therefrom.
The lack of jurisdiction in a state to tax in areas of exclusive federal jurisdiction applies not only to direct taxes but to indirect taxes as well. In James v. Dravo, supra, the United States Supreme Court was faced with the question of whether "annual privilege taxes" measured by profits from "business and other activities" could be imposed by West Virginia on a contractor working on government-owned land. The Supreme Court stated that this depended upon, ".. . whether the United States has acquired exclusive jurisdiction over the respective sites. Wherever the United States has such jurisdiction [the Court added] the state would have no authority to lay the tax."
In the Buck Act, U.S.C.A., §§ 104-110, Congress did provide the states with jurisdiction to levy certain specified taxes within federal enclaves. The Buck Act cannot be construed, however, to apply to the Outer Continental Shelf. Section 1333 provides:
. . . State taxation laws shall not apply to the Outer Continental Shelf. . .
The provisions of this section for adoption of State law as the law of the United States shall never be interpreted as a basis for claiming any interest in or jurisdiction on behalf of any State for any purpose over the seabed and subsoil of the Outer Continental Shelf, or the property and natural resources thereof or the revenues therefrom. . . (Emphasis added.)
In view of the well settled law establishing the absence of state jurisdiction to tax in federal enclaves, the provisions of Section 1333(a)(1) extending federal jurisdiction to the Outer Continental Shelf by reference to such enclaves, the provisions of Section 1333 negating any possible application of the Buck Act to the are in question, it is clear that California tax laws cannot reach revenues derived from the Outer Continental Shelf.
Before considering the formula it should be mentioned that the income to be apportioned is the total business income including that derived from the Outer Continental Shelf. When a corporation doing business solely within California commences operations on the Outer Continental Shelf, outside California, it becomes subject to Section 25101 and its business income will be apportioned in a like manner with other unitary businesses as follows.
Property Factor: All real and tangible personal property owned by the taxpayer everywhere must be included in the denominator. But the numerator can include only those properties with sufficient California connections. In this situation, any such contacts appear to be minimal.
Although some suggestions have been made to exclude the property from both the numerator and the denominator, if such is done, there will be an indirect apportionment of additional income to California contrary to federal law.
However, it may be noted that, under the rule set forth in Montgomery Ward & Co., Inc. v. Franchise Tax Board, 6 Cal.App.3d 149 (1970), that oil in transit to a California location would be considered California property includible in the numerator of the property factor.
Payroll Factor: Regulation 25132 provides that the payroll factor shall include the total amount paid by the taxpayer in the regular course of its trade or business for compensation during the tax period. Subdivision (b) further provides that the denominator of the payroll factor is the total compensation paid everywhere during the income year. Accordingly, compensation paid to employees whose services are performed entirely in a state where the taxpayer is exempt from taxation, for example by Public Law 86-272, is included in the denominator of the payroll factor. In other words, there is no throwback of the payroll to the California numerator even though the taxpayer is exempt from taxation in the state in which the services are performed. Where the services are performed partially within California and without California, the tests set forth under Regulations 25132(c) and 25133 apply. Payroll shall be included in the California numerator in accordance with the provisions of Section 25133 and the regulations thereunder.
Sales Factor: In view of the express federal ban against any state taxation of revenues derived from the Outer Continental Shelf, none of the sales, if any, which take place in the Outer Continental Shelf area will be includible in the sales factor numerator. Furthermore, in order that there be no indirect taxation of income from such sales, the sales factor denominator must include these sales. And, of course, if the natural resource is placed on the driller's own ships, no sale has occurred. On the other hand, if the natural resource is piped or brought into California, then the sale can be included in the numerator thereafter (assuming that it is subsequently sold in California).
It should be recognized that there are two fundamental considerations involved in this question. There is first the mandate that, under California law, the income of a unitary business must be apportioned by formula. Edison California Stores v. McColgan, 30 Cal.2d 472 (1947). John Deere Plow Co. v. Franchise Tax Board,38 Cal.2d 214 (1951). Secondly, there is the federal prohibition against state taxation of revenue derived from the Outer Continental Shelf.
It is established that while formula apportionment is inherently incapable of attaining exactitude, so long as the formula employed produces a reasonable result its use will be sustained. El Dorado Oil Works v. McColgan, 34 Cal.2d 731 (1950). It is submitted that the formula factors set forth above take into account both fundamental considerations. They provide formula apportionment to California of the income reasonably attributable to California sources, and by including the Continental Shelf factors only in the denominator, they do not apportion income to California, thereby giving effect to the federal law.
- Section 25120(f) of the California Revenue and Taxation Code provides that the definition of "state" includes a foreign country. A basic purpose of the Uniform Division of Income for Tax Purposes Act (UDITPA), which is codified in Sections 25120-25139, is to insure that 100 percent of income, no more or no less, would be subject to tax. See Pierce, the Uniform Division of Income for Tax Purposes Act, 35 Taxes 747.
It therefore seems clear that where another state has jurisdiction to tax and the taxable activity has no connection whatever to California, the factors associated with the activity may not be reflected in the California numerator. These factors, however, are income producing and must be included in the denominator. McDonnell Douglas Corporation v. Franchise Tax Board, 69 Cal.2d 506 (1968).
- The Outer Continental Shelf Lands Act extends federal jurisdiction (and prohibits state taxation) "To the subsoil and seabed of the Outer Continental Shelf and to all artificial islands and fixed structures which may be erected thereon. . ." (43 U.S.C. § 1333).
It has been established by a number of decisions that a drilling barge or rig is neither an artificial island nor a fixed structure within the contemplation of the Act, but rather is properly classified as a vessel.
Offshore Company v. Robison, 266 Fed.2d 769 (1959); Producers Drilling Co. v. Gray, 361 Fed.2d 432 (1966); Marine Drilling Company v. Autin, 363 Fed.2d 579 (1966). Although the cited cases arose in the context of wrongful death or injury under the Jones Act (46 U.S.C. § 688), rather than a tax contest, they hold squarely that drilling barges or rigs are vessels and not within the ambit of the Outer Continental Shelf Lands Act. It therefore follows that the Act likewise does not exempt the activities of such barges or rigs from state taxation and California can apply its usual rules to tax the income earned from the operations of the barges.
Under the Submerged Lands Act (43 U.S.C. §§ 1301 et seq.) California's jurisdiction to tax extends offshore for three miles. There can therefore be no question that, to the extent that the drilling barges are within the three mile limit their presence and activities must be reflected in the California numerators of the apportionment formula. Similarly, the activities of drilling barges not present within California's jurisdiction will only be reflected in the denominator of the factors of the apportionment formula.
When, during a taxable year, the drilling barge is both within and without California waters, its operations and presence shall be reflected in the California numerator in accordance with the rules set forth in Cal. Adm. Code, tit. 18, Regs. 25128 to 25136, inclusive.