Oral arguments had gone very poorly for the taxpayer, Marty Dakessian, a partner in the Los Angeles office of Reed Smith, told Bloomberg BNA when asked predict the outcome of  Gillette vs. California Franchise Tax Board. The California Supreme Court had its mind made up in favor of the state going into oral arguments, Dakessian added. (The full interview appears in the Nov. 13 issue of the Weekly State Tax Report).

This grim prognosis by an attorney who filed an amicus brief in favor of Gillette signals that much more is at stake than the election to apportion income under the Multistate Tax Commission Compact. A ruling for the state--and against requiring them to adhere to compact provisions--could doom the prospects for greater uniformity among the states on market-based sourcing. 

Gillette , Market-Based Sourcing and the MTC

Dakessian noted that “the whole reason for [the MTC’s] existence was to [provide] some semblance of uniformity among the many states.” How that can be furthered, at this point, is questionable, at best.

As Tripp Baltz reported in October in the Daily Tax Report, the MTC will soon issue its proposed market-based sourcing regulations for consideration before the December meeting of the MTC’s Uniformity Committee. The MTC regulations are expected to be based in no small part on Massachusetts’s recently adopted and voluminously complex regulations.

With the MTC arguing in Gillette that the legislatures of its member states are free to unilaterally alter the terms of the Compact at any point pre- or post-enactment, the MTC’s statutes and regulations are transformed from ‘uniform’ into ‘model’.

Why does this matter? Well, for one reason, many states’ arguments in moving away from the cost-of-performance methodology originally employed by the UDITPA, and by extension the MTC, was that it was too difficult to administer. That market-based sourcing rules would simplify multistate tax compliance for both administrators and taxpayers.

The exact opposite has, in fact, occurred. States have diverged with what are increasingly notorious, and often cascading, sets of rules and look-through provisions for evaluating a taxpayer’s market in a state. The result is genuine confusion with a compliance burden never remotely approached by the cost-of-performance sourcing method.

In light of its arguments in Gillette, the MTC’s place and role in guiding states through a transition to market-based sourcing are largely rendered irrelevant. Why would an ever increasingly smaller group of states pay to support an institution that, at best, provides model statutes and regulations that will be ignored, discarded or modified by state legislature’s and administrators?

With so few states even Compact members at this point, how important will the regulations that the MTC issues in December be?

The Unresolved Interstate Compact Issue

Dakessian explained in our interview that the California Supreme Court had ‘punted’ on the compact issue, instead choosing to focus on a, largely unbriefed, separation of powers issue.

There had been extensive briefing by both parties in the run up to oral arguments on U.S. Supreme Court precedent on interstate compacts and the Multistate Tax Compact, specifically. Gillette cited extensively to the Supreme Court’s decision in U.S. Steel while the parties went back and forth on several other leading compact cases involving water rights, kidnapping and environmental and energy regulation.

Taxpayers are adamant that the MTC was a binding, interstate compact whose terms could not be subsequently modified. All of the MTC member or former member states, by way of an amicus brief, argued that each had always been free to modify the terms of the Compact and that the MTC was distinguishable by its terms and history from other interstate compacts.

With the public policy and hit to the state’s fiscal health looming should these cases go against the states, there is increasingly a sentiment that no state supreme court will side with taxpayers.

The question is, then, whether the U.S. Supreme Court will find the compact issue, itself, compelling when there is no disagreement amongst state courts. Or, potentially in the case of Gillette, where these courts have found different bases on which to rule against taxpayers.

Whether taxpayers will get there day in in the U.S. Supreme Court won’t be known for a while but will make for a topic of much discussion 2016.

Bloomberg BNA will have extensive coverage of the Gillette decision and its implication for other Compact litigation in the coming months.

By Christopher Bailey

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Do you think that that California Supreme Court’s forthcoming Gillette decision is the beginning or the end for Compact litigation? What does it mean for the Multistate Tax Commission and is uniformity still an important consideration for states and taxpayers going forward?

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