Important Tax Cases: Container Corp. v. Franchise Tax Board and the Constitutionality of Combined Reporting

June 14, 2005

Some states employ something called the “unitary business” principle when determining corporate taxable income (also called combined reporting). This principle basically says that a unitary business has to report all its worldwide income to the state, even if the unitary business is divided into numerous subdivisions and affiliates located all over the world. This practice was upheld by the U.S. Supreme Court in the case of Container Corp. v. Franchise Tax Board.

Container Corp., a Delaware corporation headquartered in Illinois, omitted income from its foreign subsidiaries when reporting its income to California, where it did business and was required to pay tax. California, which uses the “unitary business” principle, required Container to include the income from its foreign affiliates, and litigation ensued. Container claimed that the U.S. Constitution restricted California from taxing value earned outside its borders.

Writing for the Court, Justice William Brennan upheld the unitary business principle. California’s combined reporting scheme, Brennan argued, did not run afoul of the Constitution because it was a reasonable approximation of the activity of Container Corp.’s activity inside California and did not seek to tax more than California’s fair share of Container Corp’s income.

In dissent, Justice Powell wrote that the unitary business principle ran afoul of the Foreign Commerce Clause, which requires the U.S. to speak with “one voice” on issues relating to international relations. Since California’s unitary business principle differed from federal tax rules, it created confusion for international dealings and threatened to expose companies like Container to double taxation overseas.

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