Microsoft has won a significant case against California that will recover millions of dollars for thousands of companies that do business in California. The California Office of Tax Appeals (OTA) has declined the Franchise Tax Board’s (FTB) request for a rehearing of its 2023 defense against Microsoft. The OTA’s decision cannot be appealed and Microsoft claim of a $94 million refund in the case was upheld.
Water’s Edge Election
Multi-state and multi-national companies use apportionment formulas to parse their incomes and expenses between their divisions and subsidiaries when determining the taxes owed to the various jurisdictions where they operate.
California permits corporations to make a water’s-edge election that provides tax savings to multinational companies through its unique apportionment formula that reduces worldwide income. The election is valid for a seven-year period.
Deductions, Exclusions, and Eliminations
Microsoft filed a 2017 tax-year California amended return which claimed a $94 million refund was due. The FTB denied the refund, stating that the calculation was not done correctly. According to water’s-edge rules, filers are required to both take a 75% deduction for dividends received from foreign affiliates and to exclude all deductions, exclusions and eliminations from the formula’s total sales denominator. Microsoft included 100% of their foreign dividends in the denominator of their amended calculation.
The California Franchise Board argued that including the deductions in full in the denominator created qualitative distortion and didn’t fairly reflect the taxable income of the company to California. They also cited procedural errors and new material evidence when seeking their appeal. The OTA did not feel there was sufficient reason to justify taking additional action. The final ruling is that the FTB did not have statutory authority to require the exclusion of repatriated dividends from its apportionment calculations.
Impact and assistance
The California Office of Tax Appeals’ final decision—by not rehearing the case—permits filers to amended California tax returns and claim refunds.
All companies that do business in California should make themselves familiar with this case whether they repatriate income or not. More than 15,000 tax returns are filed annually in California using the water’s edge method and significant funds will be recovered but others may also benefit and determine that they are due refunds. Filers in other states should also review repatriated dividend treatment to determine if taking action may be beneficial.
Microsoft’s ability to see this case through has earned them a $94 million refund plus interest for the 2017 tax year alone that was the center of this case.
Staying plugged in to tax regulations is what we do. The State and Local Tax (SALT) experts at REDW help you file amended returns and recover tax overpayments for prior years, ensuring that you stay compliant while not paying more than your share. Contact us today to learn more.
