Sales Factor Gross Receipts Cases Addressed By The California Supreme Court

After years of litigation and speculation, the California Supreme Court issued its decisions in Microsoft Corp. v. Franchise Tax Board, 139 P.3d 1169 (Cal. 2006) ("Microsoft") and General Motors Corp. v. Franchise Tax Board, 139 P.3d 1183 (Cal. 2006) ("General Motors"). Both cases presented the Revenue and Taxation Code section ("section") 25120 "gross receipts" issue and the section 25137 "distortion" issue. The decisions will unquestionably have varied and widespread effects on many taxpayers doing business in California.

The court treated Microsoft as the lead opinion on the gross receipts and distortion issues. The court framed the two issues as follows: (1) whether the redemption of marketable securities at maturity generates "gross receipts" (or, alternatively, the net price difference) includible in the sales factor; and (2) if so, whether the FTB met its burden of showing section 25137 should be applied. In General Motors, the court addressed another gross receipts issue not present in Microsoft: how repurchase agreements ("repos") are to be treated for sales factor purposes.

In short, the court ruled in Microsoft that: (1) the redemption of marketable securities at maturity does generate gross receipts for sales factor purposes; and (2) the FTB did meet its burden under section 25137, and an alternative apportionment formula should be used. In General Motors, the court ruled repos have the characteristics of loans and therefore only the interest received is a gross receipt for purposes of section 25120.

The Court's Section 25120 "Gross Receipts" Analysis

Microsoft and General Motors separately argued the entire gross proceeds from certain treasury function transactions must be included in their respective sales factor as "gross receipts" under section 25120. Microsoft's transactions mainly included marketable securities held to maturity, while General Motors' transactions included both marketable securities held to maturity and repurchase agreements. The Supreme Court concluded in both cases the entire gross receipts from marketable securities held to maturity are to be included in the sales factor, but that only interest from repurchase agreements is to be included in the sales factor.

Microsoft addressed the issue in the context of marketable securities. First, the court in Microsoft stated that the meaning of "gross receipts" in section 25120 "more naturally includes the entire redemption price of marketable securities." Microsoft, 139 P.3d at 1174. The court stated that inclusion of only the net difference as gross receipts "is an awkward fit with the statutory language, at best." Id. Second, the court stated the legislative history behind section 25120 supports inclusion of marketable securities held to maturity as gross receipts. Section 25120 is part of the Uniform Division of Income for Tax Purposes Act ("UDITPA"), which a number of states, including California, have adopted to determine multistate taxpayers' apportioned income. The court noted that an early version of the UDITPA defined "sales" as "all...