Opinion ID: 1353007
Heading Depth: 1
Heading Rank: 6

Heading: INCLUSION OF INTERCOMPANY DIVIDENDS IN THE SUBSECTION (b) COMPUTATION

Text: Let us now turn to the claim that dividends received from subsidiary corporations engaged in a unitary business (intercompany dividends) are not included in the quoted phrase of subsection (b). This claim has been made in a variety of ways. The primary basis of the claim is that such dividends are mere intercorporate transfers of funds and do not represent real income. It must be deemed settled that, at the time relevant here, our corporate franchise tax treated such dividends as real income subject to taxation where appropriate. ( Safeway Stores, Inc. v. Franchise Tax Board, supra, 3 Cal.3d 745, 749-753.) In Safeway, we determined that dividends received by a domiciliary corporation from subsidiary corporations engaged in a unitary business were includable in the computation of income for tax purposes. This was the starting point in the case. [8] The problem was phrased differently, namely, whether Safeway should be treated for tax purposes as a single corporation engaged in a unitary business or whether it should be treated as multi-corporations so that intercompany dividends of the corporations engaged in the unitary business would be taxed. In deciding that the latter was the proper treatment, we decided that Safeway, which is a domiciliary, would be taxed for dividends received from subsidiaries to the extent that those dividends were paid by the declaring corporation from portions of unitary income not allocated to California. [9] Let us return to the illustrations to point up the importance of Safeway and its effect. Assume now that the dividends received of $5 were intercompany dividends rather than dividends from unaffiliated corporations. As to domiciliary corporations, Tables I and II again express the possible results, and again Table II expresses the proper result, so that the net taxable income is $6 rather than $7.40. Under Safeway, we established as to domiciliaries that the intercompany dividends received from subsidiaries are to be treated substantially the same as dividends received from companies which were not part of the unitary group. [10] There is no reason to make a distinction between the two types of dividends because under Safeway they will both be taxed to an equal extent. In view of Safeway, every reason offered to accept Table II in the earlier part of this opinion dealing with dividends of nonaffiliated corporations applies with equal force to intercompany dividends received by a domiciliary. Actually, the argument is even stronger. In the domiciliary situation, if a distinction is to be made between intercompany and other dividends, it should be made in favor of inclusion of the intercompany dividends in the subsection (b) computation. The only reason to distinguish is that the intercompany dividends do not supposedly represent real income, and thus should result in lower taxes than dividends of unaffiliated corporations, which do represent so-called real income. The proper way, if this distinction is to be made, would be to provide that the interest expense may be offset against the intercompany dividends but not the unaffiliated corporation dividends because the use of the offset for a domiciliary corporation, as we have seen comparing Tables I and II, has the effect of reducing taxes. In other words, in order to reduce the taxes of domiciliary corporations receiving intercompany dividends in the light of the provisions of subsection (b), we must include those dividends in the phrase interest and dividend income ... not subject to allocation by formula. As to the domiciliary corporation, we are satisfied that the term interest and dividend income ... not subject to allocation by formula must include intercompany dividends. Otherwise, the taxes of such corporations are greatly and unreasonably increased. (2b) Once it is concluded that the term interest and dividend income ... not subject to allocation by formula includes intercompany dividends in the cases of domiciliary corporations and also includes nontaxable dividends, the same rule must apply to intercompany dividends paid to foreign corporations. There is no language in the section which permits a distinction between the different corporations or the different dividends. The logic underlying the section, to offset interest expense against investment income applies with equal force to all of the corporations and all of the dividends. [11]