This information is only of a general nature, intended simply as background material, omits many details and special rules and cannot be regarded as legal or tax advice.

The Franchise Tax Board ("FTB") recently proposed Regulation section 19141.6[fn. 1] (hereafter "Prop. Reg. § 19141.6" or "proposed regulation") which will dramatically change record-keeping requirements for California taxpayers if adopted. The proposed regulation includes significant monetary sanctions and, in the event of noncompliance, grants unprecedented discretion to the FTB to redetermine (1) the unitary business, (2) the apportionment factors, (3) the characterization of income as business or nonbusiness and (4) the transfer prices of "water's edge" taxpayers. The purpose of this article is to alert California taxpayers to the implications of the proposed regulation which is rapidly moving through the administrative review process, apparently toward adoption.[fn. 2]

Background

In issuing Prop. Reg. § 19141.6, the FTB stated that the regulation is needed to provide guidance concerning "how the statute will be implemented and administered . . . and to advise taxpayers of the procedural safeguards."[fn. 3] The "statute" referenced by the FTB is section 19141.6 of the California Revenue and Taxation Code ("section 19141.6"). Section 19141.6 is patterned after Section 6038A of the Internal Revenue Code.[fn. 4] In drafting the proposed regulation, the FTB "relied principally" upon the regulations adopted by the federal government to administer Section 6038A.[fn. 5]

I.R.C. § 6038A was enacted to address the frustration of the Internal Revenue Service ("Service") in conducting I.R.C. § 482 transfer pricing examinations of United States corporations controlled by foreign entities.[fn. 6] The legislative history[fn. 7] to I.R.C. § 6038A refers to litigation[fn. 8] involving enforcement of a summons served by the Service on Toyota Motor Sales USA, Inc. ("Toyota USA"). The summons was issued to obtain records needed to support an I.R.C. § 482 examination of transactions between Toyota USA and its Japanese parent ("Toyota Japan").

The Toyota litigation raised questions concerning whether service of process upon an officer of Toyota USA was sufficient to confer personal jurisdiction over Toyota Japan. Later Toyota litigation[fn. 9] raised other questions concerning record-maintenance policies. In the later litigation, the court denied enforcement of portions of the same summons because Toyota Japan had destroyed, in the ordinary course of its business, the requested documents. Congress included agent authorization and record-maintenance provisions in I.R.C. § 6038A to address the Service's experience in the Toyota litigation.[fn. 10]

The legislative history of I.R.C. § 6038A indicates that the Service's frustration in conducting section 482 examinations of transactions involving foreign-owned U.S. corporations persuaded Congress of the need for I.R.C. § 6038A. The FTB may contend that justification exists for adoption of a state version of the I.R.C. § 6038A regulations in anticipation of similar problems arising from transfer pricing examinations involving foreign-owned water's edge taxpayers. However, as discussed below, the draconian sanctions of Prop. Reg. § 19141.6 apply with equal force to taxpayers not making the water's edge election. There would appear to be little in the State's experience in examining unitary apportionment issues that would justify applying Prop. Reg. § 19141.6 to records relating to such issues, particularly as to U.S. unitary groups.[fn. 11] As discussed below, the legislative history of section 19141.6 indicates that the Legislature intended section 19141.6 to be a tool to aid the FTB in the examination of transactions between foreign related parties and "water's edge" taxpayers.

Legislative History of Section 19141.6

Section 19141.6 of the Revenue and Taxation Code was included in S.B. 671, which was signed by Governor Wilson on October 6, 1993. The legislative history to section 19141.6 began in 1986 when the Legislature, in response to complaints regarding application of the unitary tax to worldwide operations, enacted S.B. 85, which permitted a unitary group to make a "water's edge" election.[fn. 12] Under Senate Bill 85, a unitary group could elect to compute its California taxable income by reference to apportionment factors from within the "water's edge," i.e., including only U.S. payroll, property and sales amounts. Senate Bill 85 required companies making a water's edge election, among other things, to pay a fee and file a "domestic disclosure spreadsheet." Significantly, S.B. 85 also allowed the FTB to disregard a water's edge election if the FTB determined the taxpayer willfully refused to provide specific audit information.[fn. 13]

Senate Bill 671 was enacted in response to the British government's threat of retaliation against states requiring multinationals to use the worldwide unitary method of income apportionment.[fn. 14] The British objected to S.B. 85--specifically to the election fee, to the "domestic disclosure spreadsheet," and to the FTB's authority to disregard the water's edge election.[fn. 15] In response, S.B. 671 repealed the election fee, eliminated the "domestic disclosure spreadsheet" requirement and eliminated the FTB's authority to disregard a water's edge election. The report of the Assembly Committee on Revenue and Taxation for S.B. 671 indicates that section 19141.6 was included in S.B. 671 as a sanction to replace the FTB's lost authority to disregard the water's edge election:

[S.B. 671] eliminates FTB's authority to "disregard" a water's-edge election. In place of the disregard authority, the bill requires taxpayers to provide specified audit information. Taxpayers failing to provide that information would be subject to a substantial penalty . . . [referring to section 19141.6]. [Emphasis added.][fn. 16]

This reading of the legislative history is confirmed by a reference in the committee report to the FTB's views concerning S.B. 671:

FTB indicates that these changes would have a minimal to non-existent revenue effect, and that the replacement disclosure and penalty provisions should provide the board with sufficient tools to enforce the bank and corporation tax on water's-edge electors. [Emphasis added.][fn. 17]

This language indicates that the Legislature intended section 19141.6 to address the concerns of the FTB in examining water's edge electors. There is a noticeable absence of any reference in the legislative history to a purpose of assisting the FTB in examining domestic unitary issues such as the determination of the unitary business, the apportionment factors or the character of income as business or nonbusiness for U.S. unitary groups.

Clearly, the State possesses sufficient information gathering tools to examine domestic unitary issues and therefore little justification exists for applying Prop. Reg. § 19141.6 other than in examinations of foreign-owned water's edge taxpayers. For example, California is a member of the Multistate Tax Compact. Article VIII of the Multistate Tax Compact authorizes the Multistate Tax Commission to seek compulsory process to enforce its audits in the courts of any member state. See, e.g., Multistate Tax Commission v. United States Steel Corp., 714 F.2d 925 (9th Cir. 1983) and Multistate Tax Commission v. International Harvester Corp., 639 F.2d 493, 494 (9th Cir. 1981). No similar authority exists at the international level. Moreover, the level of comity that exists among states seeking to obtain information to apply formulary apportionment factors does not exist in the international arena where bank secrecy laws may be confronted[fn. 18] and where serious differences exist as to the proper application of the arm's-length standard.[fn. 19]

It should be noted that the statute, section 19141.6, appears to permit application of the record-keeping and penalty provisions to domestic unitary issues, involving records located within the U.S.[fn. 20] Should the FTB attempt to apply the proposed regulation's record-keeping and penalty provisions to records located within the U.S., California taxpayers should consider appealing to the Legislature to unequivocally limit the scope of the statute, consistent with its legislative history, to records located outside of the U.S. relating to transfer pricing issues for water's edge taxpayers. Even if the regulation is to apply to non water's edge taxpayers, in no event should it apply to records located within the U.S.

Provisions of Prop. Reg. § 19141.6

The proposed regulation exceeds 50 pages in length and in parts is tedious reading as are the regulations under I.R.C. § 6038A which served as the blueprint for much of the proposed regulation. The principal provisions of the proposed regulation are summarized below. This summary is not a substitute for a careful reading of the proposed regulation which should be done by taxpayers facing application of the proposed regulation by the FTB. This summary reflects changes made by the FTB staff in response to the comments made in connection with the October 4, 1994 public hearing.

Records Required to be Maintained

The proposed regulation specifies the records that must be maintained as including:

[R]ecords that are sufficient to determine the correct amount of any liability imposed by Part 10.2 and Part 11 of the Revenue and Taxation Code . . . including records to the extent they may be relevant to determine the combined report of any unitary business of which the taxpayer is a member, including the determination of the components of the unitary business, the apportionment factors of such business, and the classification of an item of income or loss as business or nonbusiness, for the taxpayer and any related party[[fn. 21]] which is a part of the unitary business . . . In addition, the taxpayer must keep records that are sufficient to determine the attribution of income to the United States or foreign jurisdictions under section 882, Subpart F, or other similar sections of the Internal Revenue Code for the taxpayer and any related party which is part of the unitary business.[fn. 22]

Note that this language requires taxpayers to anticipate what records will be "sufficient" to determine the correct amount of tax. The proposed regulation includes additional record maintenance provisions requiring taxpayers to keep such records as will "enable the Franchise Tax Board to determine the correct liability . . ."[fn. 23] Of course, a taxpayer cannot know in advance what records will be "sufficient," or will "enable" the FTB to determine the taxpayer's correct tax liability.

The broad record-maintenance requirements of Prop. Reg. § 19141.6 parallel those of Treas. Reg. § 1.6038A-3, which also generated significant critical comment when proposed.[fn. 24]

"Indirectly Related" Records

The proposed regulation requires taxpayers to maintain "indirectly related records." Prop. Reg. § 19141.6(c)(2)(A) provides that taxpayers must maintain records that are directly or "indirectly" related to transactions between the unitary business of which the taxpayer is a part and any "excluded entity."[fn. 25] Further, the proposed regulation requires taxpayers to maintain records possessed by an affiliate of an excluded entity that might be relevant to a transaction between the unitary group and the excluded entity. The proposed regulation, as revised, provides that records required under I.R.C. § 6038A shall satisfy the requirements of section 19141.6 "to the extent they relate to equivalent transfer pricing issues." The reference to "equivalent transfer pricing issues" leaves considerable discretion with the FTB in applying this limitation.

Prop. Reg. § 19141.6(c)(2)(A) includes an example of an excluded entity purchasing a product from a foreign subsidiary of the excluded entity for resale to the unitary business. The regulation states that the raw material and component cost records of the foreign subsidiary must be maintained, presumably so that a profit split analysis of transactions between the excluded entity and the unitary business could be prepared.

It is unlikely that such a foreign affiliate of an excluded entity would have any nexus with California. Thus, foreign affiliated groups could argue that the burdensome record-maintenance requirements and the agent authorization requirements (discussed below) of Prop. Reg. § 19141.6 discriminate against foreign commerce because of the inordinate compliance burden. Prop. Reg. § 19141.6 does not allow for "reasonable approximations" in complying with its record-maintenance provisions.[fn. 26] Thus, there may be grounds for distinguishing the Supreme Court's holding in Barclays[fn. 27] that California's unitary apportionment system does not impose inordinate compliance burdens because "reasonable approximations" are permitted.

Record Maintenance Safe Harbor

The proposed regulation describes categories of documents that, if maintained, will result in the taxpayer being deemed to have met the record maintenance requirements of the proposed regulation. As a preface to a description of the safe harbor, the proposed regulation states that the record maintenance requirements do not require the "original creation" of records except for: (1) basic accounting records sufficient to document the California tax effects of transactions between related parties; and (2) records sufficient to produce "material profit and loss statements" relevant in determining the California tax treatment of transactions between the unitary business and an excluded entity.[fn. 28]

A brief description of the safe harbor categories follows. The proposed regulation descriptions are considerably more detailed.

• Financial and Tax Data, § 19141.6(c)(3)(B)1. This category includes financial statements and books and records of all types and descriptions. Notably, this category includes "tax accrual workpapers" which are requested at the federal level only after several levels of review have occurred.[fn. 29] This category also includes federal tax filings and financial statements of partnerships in which the taxpayer or any related party is a partner.

• Profit and Loss Statements, § 19141.6(c)(3)(B)2. This category includes records from which the taxpayer can compile "material profit or loss statements" of the taxpayer and related parties attributable to U.S.-connected products or services. The regulation provides that the records should be kept under U.S. GAAP if ordinarily maintained in that manner. If not, an explanation for material differences must be made available. The regulation further requires an explanation of methods used to allocate a related party's costs to the revenues generated by the sales of the U.S.-connected products. Note, this requires that records of foreign related parties be maintained if needed to compile a profit and loss statement for the U.S. transactions. The proposed regulation, as revised, includes language for this safe harbor category, similar to that discussed above, stating that records satisfying the requirements of I.R.C. § 6038A shall satisfy the requirements of section 19141.6 to the extent of "equivalent transfer pricing issues."

• Apportionment Factor Records, § 19141.6(c)(3)(B)3. This category includes records from which the apportionment factor numerators and denominators are determined for each entity in the combined report group. Examples listed include appraisals, fixed asset ledgers, inventory records, payroll records and records documenting fair market value of property.

• Foreign Country and Third-Party Filings, § 19141.6(c)(3)(B)4. This category includes financial and other documents filed with, or prepared for, U.S. or foreign jurisdiction government entities, independent commissions or financial institutions. Examples listed include SEC filings, employment tax filings, PUC and FAA filings and records maintained pursuant to the Hart, Scott and Rodino Act.

• Ownership and Capital Structure Records, § 19141.6(c)(3)(B)5. This category includes records or charts showing the relationship between the taxpayer and all related entities, including world-wide organization charts describing the "status" of each entity, e.g., joint venture, partnership, branch or division.

• Management Structure, § 19141.6(c)(3)(B)6. This category includes records showing, for each year and for each related entity, corporate officers and directors, including charts showing the management structure and job descriptions, personnel files detailing transfers and correspondence files of directors and officers, including all E-mail reduced to a written form.

• Records of Sales Transactions, § 19141.6(c)(3)(B)7. This category includes records relevant to establishing the appropriate price for transactions between the combined reporting group and an excluded entity to the extent relevant to determine the components of the unitary business and the attribution of income between the U.S. and foreign jurisdictions. The regulation includes as examples shipping and export documents, commission agreements, manuals, specifications, intercompany correspondence and similar documents describing the functions performed or the value and ownership of intangibles used or developed. The proposed regulation, as revised, includes language for this safe harbor category, similar to that discussed above, stating that records satisfying the requirements of I.R.C. § 6038A shall satisfy the requirements of section 19141.6 to the extent of "equivalent transfer pricing issues."

• Records of Loans, Services and Other Non-Sales Transactions, § 19141.6(c)(3)(B)8. This category includes records of loans to excluded entities or loans through a member of a combined group to an excluded entity and service and other agreements between an excluded entity and any member of the combined reporting group.

Material Profit and Loss Statements

Prop. Reg. § 19141.6(c)(3)(C) describes "material profit and loss statements." The proposed regulation requires that taxpayers be able to prepare such statements within a reasonable time from records required to be maintained by Prop. Reg. § 19141.6(c)(3)(B)2. The proposed regulation states that a taxpayer may reach an agreement with the FTB concerning what constitutes a "material profit and loss statement." Absent such an agreement, a profit and loss statement will be material if it meets either the "existing records test" or the "significant industry segment test."

The "existing records test" essentially requires that existing profit and loss statements reflecting profit or loss for U.S.-connected products or services be maintained, regardless of whether the profit or loss is shown separately or included with aggregate figures.

The "significant industry segment test" applies where: (1) there is profit or loss attributable to U.S.-connected products or services within a single industry segment; (2) the world-wide gross revenue attributable to the industry segment is 10% or more of the world-wide gross revenue attributable to all industry segments; and (3) the amount of gross revenue earned by the related party group from U.S.-connected products or services within the industry segment is $25 million or more.

Record Maintenance Agreements

Prop. Reg. § 19141.6(c)(4) provides for agreements between taxpayers and the FTB concerning records required to be maintained. The proposed regulation states that generally records required under a negotiated agreement will be less than the broad range of records described in the safe harbor provision. The proposed regulation states that the FTB will generally enter into an agreement upon written request by the taxpayer when the FTB believes it can obtain sufficient knowledge of the business or industry to limit the record maintenance requirement to particular documents.

The I.R.C. § 6038A regulations similarly provide for record maintenance agreements.[fn. 30] However, to date apparently few record maintenance agreements have been entered into because of the general reluctance of Service district directors to limit the scope of future document requests.

General Rule That Records Must Be Maintained in the U.S.

Prop. Reg. § 19141.6(c)(5) generally provides that the records required to be maintained must be maintained in the U.S. An exception allows taxpayers to maintain records outside of the U.S., but taxpayers must, within 60 days of an FTB request: (1) deliver the documents to the FTB; or (2) move the documents to the U.S. and provide an index of the documents, including the name and address of a U.S. custodian having control of the records. The regulation allows 120 days in lieu of 60 days for records that must be created in order to prepare material profit and loss statements.

Period of Retention of Records

Prop. Reg. § 19141.6(d)1 states that the records required to be maintained must be retained for the period during which the taxpayer's tax liability may be subject to adjustment, including all periods within which additional taxes may be assessed. The regulation states that the period may not exceed eight years from the due date or extended due date of the return or, if longer, the period during which a protest or an appeal to the State Board of Equalization is pending or the period during which a suit for refund is pending. The regulation includes examples of the application of the records retention requirement.

Monetary Penalty

Prop. Reg. § 19141.6(e) provides for a monetary penalty of $10,000 for each year for which a taxpayer fails to maintain, or cause another to maintain, records as required in the regulation. If the taxpayer fails to maintain records as required relating to related-party transactions, a separate penalty may be imposed for each related party, but only one $10,000 penalty may be applied for each related party for each year.

Reasonable Cause

Prop. Reg. § 19141.6(e)(2) provides that certain failures to maintain records may be excused by reasonable cause. To show that reasonable cause exists, the taxpayer must file a written statement under penalty of perjury containing the facts alleged as reasonable cause.[fn. 31] Circumstances that may indicate reasonable cause include an honest misunderstanding of fact or law that is reasonable in light of the experience and knowledge of the taxpayer.[fn. 32] Reliance on facts that, unknown to the taxpayer, are inaccurate does not necessarily constitute reasonable cause.[fn. 33] Reliance on professional advice may, but not necessarily, constitute reasonable cause.[fn. 34]

Additional Monetary Penalty for Failure to Maintain Records After Notification

Prop. Reg. § 19141.6(e)(4) provides for an additional $10,000 monetary penalty for a failure to maintain records more than 90 days after the FTB notifies the taxpayer of the failure. The additional penalty is $10,000 for each 30-day period for each related party[fn. 35] which fails to maintain records. For income tax years beginning before the first day of the month following the month the proposed regulation is adopted, or before December 31, 1995, if earlier, the additional penalty is capped at $50,000.

Consequence of Failure to Produce Documents in Response to Subpoena Duces Tecum

Prop. Reg. § 19141.6(f) provides that the "noncompliance" sanction of 19141.6(g) (discussed below) may be applied when the taxpayer fails to produce documents in response to a subpoena duces tecum requesting records to determine the correct treatment of: (1) the components of the unitary business; (2) the apportionment factors; (3) the classification of income as business or nonbusiness; or (4) the attribution of income under section 882, Subpart F or other "similar" sections of the Internal Revenue Code.[fn. 36]

This provision is very broadly worded, placing almost no limitation on the FTB in determining the scope of the subpoena duces tecum which could trigger the noncompliance sanction. The noncompliance sanction will apply if: (1) the subpoena is not quashed and the taxpayer fails to substantially and timely comply with the subpoena after notification of such noncompliance by the FTB; or (2) the subpoena is quashed because the taxpayer failed to maintain the records required to be maintained by the proposed regulation. The FTB is not required to bring enforcement proceedings to impose the noncompliance penalty. Thus, only by succeeding in quashing the subpoena for reasons other than failure to maintain the requested records will a taxpayer avoid the noncompliance sanction. Finally, the proposed regulation provides that the statute of limitations will be suspended while the taxpayer brings an action to quash the subpoena.[fn. 37]

Noncompliance Sanction

Prop. Reg. § 19141.6(g) provides that where the taxpayer fails to produce records in response to a subpoena duces tecum as discussed above, or fails to maintain records as discussed below,[fn. 38] the FTB may determine, using its sole discretion: (1) the components of the unitary business; (2) the apportionment factors; (3) the amounts attributable to business or nonbusiness income; and (4) the income attributable under section 882, Subpart F or similar sections of the Internal Revenue Code. The proposed regulation provides that the FTB may not exercise this discretion to disregard a water's edge election by including in the unitary group an entity or entities properly excluded through such an election.[fn. 39]

The proposed regulation gives the FTB "sole discretion" to make these determinations, providing that information submitted by the taxpayer shall be considered, but may be disregarded, if deemed to be "insufficiently probative of the relevant facts."[fn. 40] The proposed regulation states that to overcome an FTB determination in applying the noncompliance sanction, the taxpayer must demonstrate that the FTB determination is "arbitrary and capricious."[fn. 41]

This is an exceedingly deferential review standard, particularly in light of the significant consequence of the FTB's determinations. This almost unbridled discretion, particularly as it applies to unitary issues of the U.S. unitary group, is surprising in view of the absence of any reference to a need for such discretion in the legislative history of section 19141.6, as discussed above.

FTB Authority to Require That Specified Records Be Maintained

Prop. Reg. § 19141.6(h) provides that where a taxpayer has failed to maintain records as evidenced by the assessment of a monetary penalty, the FTB may require the taxpayer to maintain records in the "form, manner and location as specifically described . . . by the FTB."[fn. 42] This provision apparently empowers the FTB to require taxpayers to maintain records other than the records described in the record- maintenance section (Prop. Reg. § 19141.6(c)) of the proposed regulation. A taxpayer will be required to maintain the specified records for the first taxable year beginning after the date of the letter of notification, and continuing until notified that the records need no longer be maintained.

The proposed regulation limits the records which the FTB can require a taxpayer to maintain to records which are "ordinarily created in the normal course of business, including the filing of tax returns."[fn. 43] A taxpayer that fails to maintain the records specified by the FTB will be subject to the monetary penalty, but may be excused from the penalty upon a showing of reasonable cause by "clear and convincing evidence."[fn. 44] A taxpayer may seek review by the three-member FTB Board of the reasonableness of the records specified by the FTB or such other review "as may be provided by law."[fn. 45]

Authorization of Agent for Service of Process

Prop. Reg. § 19141.6(i) provides that the noncompliance sanction discussed above will also apply unless each related party authorizes the taxpayer to act as its limited agent for purposes of a Regulation § 19504 request to examine books and records or obtain testimony, or for service of a subpoena or subpoena duces tecum issued by the FTB for books and records. The regulation provides that a single authorization may be made on behalf of a foreign-affiliated group by an entity with legal authority to authorize the taxpayer to act as an agent on behalf of the foreign-affiliated group.

The FTB included a new provision in the revised proposed regulation permitting "deemed compliance" with the agent authorization requirement in "exceptional circumstances" where the FTB may deem that an agent authorization exists without actual appointment.[fn. 46] To qualify for "deemed compliance, taxpayers must show that neither the taxpayer nor the related party knew, or had reason to know, that the parties were related and that the transactions between the taxpayer and related party were arm's length.[fn. 47]

Conclusion

The proposed regulation could dramatically change the conduct of California corporation franchise tax examinations if adopted. Apart from the practical problems and expense of attempting to comply with the broadly worded record-maintenance requirements, the dynamics of the audit process may be changed because of the almost unfettered discretion given to the FTB to enforce the sanctions included in the proposed regulation. Taxpayers who are unable to correctly anticipate what records the FTB will deem to be "sufficient" to determine their tax liability, or who fail to be appointed as an agent for all related parties, may be subject to the sledgehammer noncompliance sanction. The noncompliance sanction would give the FTB almost unfettered discretion to determine a taxpayer's tax liability under the highly deferential arbitrary and capricious standard.

Clearly, as discussed above, the Legislature did not intend to dramatically increase the record-keeping burden of California taxpayers for records relating to domestic, as opposed to foreign, transactions and entities. The FTB should therefore limit the application of the proposed regulation to records located outside of the U.S. relating to transfer pricing issues for water's edge taxpayers. Otherwise, the proposed regulation will exceed the scope of the regulations under I.R.C. § 6038A and thereby adversely affect California business by saddling California taxpayers with significantly greater record-keeping burdens than taxpayers located in other states.

If it is determined that the proposed regulation should apply to non water's edge taxpayers, the record-keeping and penalty provisions should apply only as to records located outside the U.S. Even with such a limitation, applying the record-keeping and penalty provisions to non water's edge taxpayers would place such taxpayers at a disadvantage relative to taxpayers in other states because such an application would exceed the scope of the regulations under I.R.C. § 6038A. A reasonable compromise would be to apply the proposed regulation to non water's edge taxpayers only as to records that would be required to be maintained under the federal regulations.

Notes

1. Proposed Regulation section 19141.6, if adopted, would be effective for taxable years beginning on or after January 1, 1994. [return to text]

2. Public hearings were held concerning the adoption of Prop. Reg. § 1.19141.6 on October 6, 1994. Taxpayer groups presented comments during the hearing concerning the potential adverse impact on California business from the record-keeping burdens imposed by the proposed regulation. See the "Notice of Hearing" for the January 18, 1995 hearing. The FTB held a follow-up hearing on January 18, 1995. [return to text]

3. "Initial Statement of Reasons for the Adoption of Regulations 19141.6 and 25111.1" at 1. [return to text]

4. Id. [return to text]

5. Id. [return to text]

6. See Patton & Levey, Reporting Rules Made Tougher for Multinationals, 1 J. Int'l Tax. 19 (May/June 1990). [return to text]

7. H. Rep. 101-247, 101st Cong., 1st Sess. 1295 (1989). [return to text]

8. United States vs. Toyota Motor Corp., 569 F. Supp. 354 (C.D. Cal. 1983). [return to text]

9. United States vs. Toyota Motor Corp., 569 F. Supp. 1158 (C.D. Cal. 1983). [return to text]

10. Patton, supra note 6, at 20. [return to text]

11. That is, issues such as determining the unitary business, the apportionment factors and the characterization of income as business or nonbusiness for U.S. unitary groups. [return to text]

12. Comm. on Rev. & Tax. (Sept. 3, 1993), California Committee Analysis, Information for Public Affairs, Inc., LEXIS, Cal Library, CABILL file at 1. [return to text]

13. Former Rev. & Tax. Code § 25111(c). [return to text]

14. Comm. on Rev. & Tax., supra note 21, at 4. [return to text]

15. Id. at 5. [return to text]

16. Id. at 4. [return to text]

17. Id. at 7. [return to text]

18. See, e.g., United States v. Vetco, 644 F.2d 1324 (9th Cir. 1981), cert. denied, 462 U.S. 1098 (1981). [return to text]

19. See, e.g., Organization for Economic Cooperation and Development, Transfer Pricing Guidelines for Multinational Enterprises, Discussion Draft of Part I (July 8, 1994) at para. 160 where the OECD expresses "substantial concern" with the use of the final I.R.C. § 482 "comparable profits method" (Treas. Reg. 1.482-5). [return to text]

20. See Section 19141.6(a)(1), (2) and (3) of the Revenue and Taxation Code. It is noteworthy that the statute grants discretion to the FTB to prescribe regulations that are "appropriate" to determine the unitary business, the apportionment factors and the characterization of income as business or nonbusiness. It is submitted that in view of the legislative history it is not "appropriate" to apply the statute's record-keeping and penalty provisions as to records located within the U.S. [return to text]

21. Prop. Reg. § 19141.6(b)(5) states that "related party" means:

    banks and corporations that are related because one owns or controls directly or indirectly more than 50 percent of the voting stock of the other or because more than 50 percent of the voting stock of each is owned or controlled, directly or indirectly, by the same interests. A bank or corporation need not be a taxpayer as defined in section 23037 of the Revenue and Taxation Code, and need not be include din any combined report filed pursuant to section 25101 or 25110 of the Revenue and Taxation Code, in order to be considered a related party. Banks and corporations are considered related for purpose of this section if the over-50-percent-ownership or control standard is met at any time during the taxpayers's income year. [return to text]

22. Prop. Reg. § 19141.6(c)(1)(A)1. [return to text]

23. Prop. Reg. § 19141.6(c)(1)(A)3. [return to text]

24. See, e.g., the numerous references in March of 1991 to comments, most of them critical, concerning the proposed I.R.C. § 6038A regulations. Tax Notes Today, LEXIS, Fedtax Library, TNT file. [return to text]

25. An "excluded entity" is defined in Prop. Reg. § 19141.6(b)(2) as a related party which is "not properly included" in the combined report used to determine the taxpayer's tax liability. [return to text]

26. The Prop. Reg. § 19141.6 record-maintenance provisions relating to profit and loss statements of related party groups permit the use of "reasonable" allocation methods. Prop. Reg. § 19141.6(e)(2). However, the proposed regulation states that GAAP principles should be used, or that an explanation of differences between GAAP and the accounting principles used must be provided. Id. Moreover, the proposed regulation requires that an explanation of the allocation method used be provided. Id. Finally, the proposed regulation requires that the explanation of the accounting principles and allocation methods used be sufficient to permit a comparison of the profitability of the related party group and the profitability of the combined reporting group attributable to the U.S. product or services provided by the related party group. Id. Needless to say, an extensive cost accounting analysis will be required. [return to text]

27. Barclays Bank PLC v. Franchise Tax Board of California, 129 L. Ed. 2d 244, 62 U.S.L.W. 4552 (June 20, 1994). [return to text]

28. Prop. Reg. §§ 19141.6(c)(3)(A)2 and 3. [return to text]

29. See Internal Revenue Manual, Part IV, § 4024.4. [return to text]

30. Treas. Reg. § 1.6038A-3(e). [return to text]

31. Prop. Reg. § 19141.6(e)(2)(B)1. [return to text]

32. Prop. Reg. § 19141.6(e)(2)(B)3. [return to text]

33. Id. [return to text]

34. Id. [return to text]

35. As presently written, Prop. Reg. § 19141.6(e)(4)(A) appears to apply the additional monetary penalty only to failures by a related party, not the taxpayer, to maintain records after notification.. [return to text]

36. Prop. Reg. § 19141.6(f)(1). [return to text]

37. Prop. Reg. § 19141.6(f)(4). [return to text]

38. The proposed regulation permits the noncompliance sanction to be applied for a failure to maintain records that does not result in a subpoena duces tecum being quashed. In this regard, the proposed regulation exceeds the scope of the regulations under I.R.C. § 6038A. The regulations under I.R.C. § 6038A permit the noncompliance sanction to be applied as to a failure to maintain records only where the failure results in a subpoena duces tecum being quashed. See Treas. Reg. § 1.6038A-6(a)(2). The FTB should revise the proposed regulations to be consistent in this respect with the Section 6038A regulations, upon which the FTB " relied principally" in drafting the proposed regulations. See the text at footnote 3, supra. [return to text]

39. Prop. Reg. § 19141.6(g)(2). [return to text]

40. Prop. Reg. § 19141.6(g)(3). [return to text]

41. Prop. Reg. § 19141.6(g)(5). The FTB substituted the "arbitrary and capricious" standard for a "beyond a reasonable doubt" standard included in the initial version of the proposed regulation, apparently acknowledging that such a standard was inappropriate for a civil regulation. [return to text]

42. Prop. Reg. § 19141.6(h)(1). [return to text]

43. Prop. Reg. § 19141.6(h)(5). [return to text]

44. Prop. Reg. § 19141.6(h)(6). [return to text]

45. Prop. Reg. § 19141.6(h)(7)(A) and (B). [return to text]

46. Prop. Reg. § 19141.6(i)(6)(A). [return to text]

47. Prop. Reg. § 19141.6(i)(6)(A)(1) and (2). [return to text]

© 1995, 2001, 2005