Partnering Perspectives | Winter 2016
Foreign corporations should keep a watchful eye on the attempts of
states, largely through legislative action, to expand their so-called
“water’s-edge” tax base.
By Eric Coffill
Traditionally, mandatory worldwide combined reporting was the
state corporate tax issue of most concern to entities engaged in
international business. Under worldwide combined reporting, a
substantial amount (perhaps all) of the activities of non-US
corporations were drawn into a state’s tax computational
compliance scheme. Indeed, decades ago, the Supreme
Court of the United States in Container1 and Barclays2 upheld
the ability of states to require worldwide combined reporting,
potentially forcing a taxpayer to include the income and
activities of all of its “unitary” companies throughout the
world in its state tax return.
Worldwide political pressure, however, subsequently resulted
in states moving toward a water’s-edge unitary combination
method for both US and foreign-based companies. As a
consequence, with a limited exception found in one state
(Alaska), no state currently forces a taxpayer to use a worldwide
combined reporting method. Except for Montana, there have
been no recent legislative efforts to return to mandatory
worldwide combined reporting.
1 Container Corp. of America v. Franchise Tax Board, 463 US 159 (1983).
2 Barclays Bank PLC v. Franchise Tax Board, 512 US 298 (1994).
Instead, foreign corporations should now keep a watchful eye
on the attempts of states, largely through legislative action, to
expand their so-called “water’s-edge” tax base through
various means. This article discusses four such trends.
Income tax treaties between nations typically limit taxation to
those jurisdictions in which a company maintains a “permanent
establishment.” However, in general, no current income tax
treaty to which the US is a party applies to subnational taxes, i.e.,
to state corporate income taxes. Accordingly, the permanent
establishment analysis typically does not apply to a state’s
jurisdiction to tax a non-US corporation.
The jurisdiction to tax at the state level involves a two-part
analysis. First, one must look at the law of a particular state
to discern its nexus standard under its state statutory and
administrative law. If a corporation cannot be taxed under a
state’s own law, the inquiry is over. The second and overriding
analysis is whether a state claiming jurisdiction to tax has the
ability to tax a corporation under the Due Process and
Commerce Clauses of the United States Constitution.
Expanding the Water’s Edge: Four
Trends to Watch in International
Issues in State Taxation