What is California’s unitary method of taxation across borders and how does it affect multi-state and multi-national corporations? The “unitary method” of taxation was developed to replace the “source method” strategy of taxation which would tax income based upon the geographic location where income was actually realized. California understood the source method of taxation failed to take into consideration the impact of a multi-state or multi-national corporation’s entire operational activity upon the actual earnings the company realized in California. California is always concerned that large corporations operating across borders have the internal capacity to manipulate the geographical location of realized income in an attempt to shift income from higher tax authorities (such as California) to a state or nation with a lower (or zero) tax rate.
California bases its taxation upon the “unitary method” which combines the total corporate income of a multi-state or multi-national corporation, then applies a formula designed to determine the total amount of income the corporation realized within California. California applies this to individual corporations as well as groups of companies who operate as a “unit.” When California determines a group of companies are a “unit” they are considered to be a single entity under California’s tax law.
The complications which arise from California’s unitary method of taxation across borders is far too complex to address directly in a pithy blog post. The legal questions surrounding the grounds required to designate a group of companies as a “unit” would fill volumes, and continues to expand to this day. Generally speaking there are three broad tests to determine a corporate “unit”:
- Three Unities
- Contributions and Dependency
- Functional Integration
The “Three Unities” test evaluates the “unity of ownership,” the “unity of operation” and the “unity of use.” Complex formulas are applied to determine how a group fits the “unity of ownership” based upon the voting power of common interests. Unity of operation is generally characterized by shared business functionality such as the managerial structure, purchasing, supply chain management, accounting, marketing and advertising. Unity of use is characterized by a centralized executive force and operational systems.
Allen Barron is uniquely positioned to advise national and international corporations who face California’s unitary method of taxation across borders and to provide legal, tax and business strategies designed to increase profitability and reduce tax exposure. Our integrated disciplines provide a much broader perspective to all issues of business formation, executive and operational management, domestic and international tax planning, supply chain management, transfer pricing, and accounting. If you are a multistate or multinational corporation conducting business in California we invite you to contact us or call 866-631-3470 to learn more about Allen Barron’s integrated services and how you can leverage economy of scale while providing a deeper insight and more accurate advice regarding the impact of decisions across your corporation or the constellation of corporations you own.