By Mark Muntean
Excerpt: 2011 Emerging Issues 5996
Repatriation of Dividends from a Wholly Owned Foreign Subsidiary Taxable
under California State Law
SUMMARY: This Emerging Issues Analysis discusses the
repatriation of earnings from controlled foreign corporation and the
application of the earnings to current and prior year earnings. A secondary
issue is also addressed concerning the allocation of interest expense between
taxable and nontaxable expenditures.
ARTICLE: The California Court of Appeal recently held that the
repatriation of earnings from a controlled foreign corporation, in this case a
wholly owned foreign subsidiary, were applied to current year earning first
before applying the dividends to prior year earnings on a LIFO basis. Apple,
Inc. v. Franchise Tax Board, Nos. A128091 and A129090 Court of Appeals, 1st
Dist., Div. 5 (9/12/11), Apple, Inc. v. Franchise Tax Bd., 199 Cal. App. 4th 1
(Cal. App. 1st Dist. 2011). In the same case, the court decided a second issue
that, with respect to an interest expense deduction, in allocating the interest
expense between taxable and nontaxable expenditures, the taxpayer must
demonstrate its dominant purpose in borrowing the funds generating the interest
expense deduction and allocate the interest expense to that purpose. Id.
A. Background. Apple, Inc. (Apple) is incorporated and has its principal
place of business in California. Apple operates its global operations through a
number of wholly owned foreign subsidiary corporations. Apple paid the tax and
sued the California Franchise Tax Board (FTB) seeking a refund of taxes. The
issue before the court related to the California tax treatment of repatriated
dividends paid to Apple from its subsidiaries. The court focused on the
appropriate method used to account for the source from which repatriated dividends
are paid.
B. Worldwide and Water's Edge. Apple filed its California tax returns on
a worldwide basis prior to 1989. According, Apple's foreign subsidiaries
earning were added into its worldwide tax calculation, and were taxed.
Normally, dividends paid from previously taxed earnings are eliminated from the
tax calculation in the year of the dividend.
Apple made a water's-edge election in 1989. Also, in 1989 it recognized only a
small part of its worldwide foreign subsidiary earnings in its water's-edge tax
return subject to tax. Apple received a dividend (dividending its repatriated
foreign earnings) from its wholly owned foreign subsidiaries in 1989. In
claiming its foreign earnings were previously taxed, Apple applied preferential
ordering approach as provided in Fujitsu
IT Holdings, Inc. v. Franchise Tax Board., 120 Cal. App. 4th 459 (Cal. Ct.
App. 2004).
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ABOUT THE AUTHOR(S):
Mark Muntean, J.D., LL.M. Taxation (Georgetown), is a business and tax lawyer
in the San Francisco/Bay Area of California with over 25 years of experience in
federal, state, and international tax matters. He represents clients in
connection with corporate, real estate, mergers and acquisitions, private
equity, business law and criminal tax issues.