Butler Bros. v. McColgan, Franchise Tax Commissioner

Background

An Illinois wholesale dry-goods company that ran seven separate distributing houses, including one in San Francisco, challenged a California franchise tax. California’s Bank and Corporation Franchise Tax Act imposed an annual tax on a corporation’s net income, with a four percent rate and a $25 minimum. The company said its San Francisco house lost $82,851 in 1935 and paid only the $25 minimum, but the tax commissioner assessed an additional $3,798.43, which the company paid under protest and then sued to recover.

Reasoning

The main question was whether California’s method for dividing up a multistate company’s income fairly assigned to California the share reasonably connected to business done there. The state used an average of three factors — property value, payroll, and sales — to allocate income. The Court accepted that the company’s branches formed a single, unitary business and that centralized buying and other shared functions could produce savings benefiting all branches. The Court said a challenger must show clearly that the formula taxed income actually earned outside the state, and that a separate internal accounting system alone did not prove extraterritorial taxation. Because the company did not meet that burden, the California assessment stood.

Real world impact

States may rely on practical allocation formulas using property, payroll, and sales to tax part of a multistate company’s profits when branches work as a unit. Companies must present clear, convincing evidence that such an allocation unfairly reaches income from other states. The Court affirmed the state court’s judgment upholding the tax assessment.