Tax News

CCH (cch.taxgroup.com) reports:

California Governor Arnold Schwarzenegger vetoed legislation that would have repealed the interest offset provision under California corporation franchise and income tax law. The proposed repeal was intended to reflect the U.S. Supreme Court's decision in Hunt-Wesson, Inc. v. Franchise Tax Board , 528 U.S. 458 (2000), and to remove grounds for constitutional challenges to the provision as discriminatory in favor of corporations domiciled in California. However, the Governor claimed that the bill went beyond the holding in Hunt-Wesson , which applied to non-California domiciliary corporations, and would have negatively impacted California-based corporations.
In Hunt-Wesson, the U.S. Supreme Court held that the interest offset provision was unconstitutional as applied to a non-California domiciliary corporation because the provision unreasonably assigned interest expense on a dollar-for-dollar basis to nonbusiness interest and dividends, resulting in the taxation of extraterritorial income in violation of both the Commerce Clause and the Due Process Clause of the U.S. Constitution. Under the interest offset provision, interest expense was deducted in the following order:
(1) interest expense was deducted from business interest income;
(2) interest expense in excess of business interest income was deducted from nonbusiness interest and dividend income; and
(3) any remaining interest expense was allowed as a deduction in computing net business income.
The FTB has adopted a narrow interpretation of the Hunt-Wesson
decision and continues to apply the interest offset provision to corporations domiciled in California, but uses a direct tracing or proration method for assigning interest expense to business income and nonbusiness income for corporations domiciled outside California. However, the California Legislative Counsel offered an opinion that the portion of the interest offset provision that was invalidated by the U.S. Supreme Court was not severable and, therefore, the entire provision was void and could not be applied to California domiciled corporations or corporations domiciled outside of California.
A.B. 1618, as returned to the California General Assembly by Governor Schwarzenegger; Veto Message , Governor Arnold Schwarzenegger, October 11, 2007; Bill Analysis , Senate Floor, July 12, 2007; Analysis of Original Bill , California Franchise Tax Board, May 1, 2007.