California Court of Appeal Upholds FTB's Disallowance Of Dividends Received Deduction, Imposition of Amnesty Penalty

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

In 2004, the California Court of Appeal ruled, in Farmer Brothers v. California Franch. Tax Bd., that California could not restrict its dividends received deduction (DRD) to dividends paid from income subject to tax in the state. Such a practice, the court held, was discriminatory under the U.S. Commerce Clause. Rather than authorize refunds to taxpayers that had been denied the deduction, the FTB determined that the proper remedy was to disallow the DRD for all taxpayers, regardless of the source of the income. This remedy was itself challenged as unconstitutional, in River Garden Retirement Home v. California Franch. Tax Bd. On July 15, 2010, the court of appeal issued its decision in River Garden, upholding the FTB's disallowance of the DRDs and affirming the imposition of an amnesty penalty on the taxpayer. In this article, authors Valerie C. Dickerson and Shirley Wei, of Deloitte Tax LLP, review this latest decision and assess its implications for other taxpayers.