Microsoft decision in detail
Case facts
Microsoft received repatriated dividends from certain unitary controlled foreign corporations (CFCs) during fiscal year ending June 30, 2018. In computing California net income, the Company deducted 75% of the repatriated dividends from its tax base as ‘qualifying dividends,’ and therefore 25% of the dividends were included in its income subject to apportionment. On its originally filed water’s edge return, the Company included 25% of the dividends in its sales factor denominator because that was the portion of the qualifying dividends represented in its net income. However, the Company subsequently filed a refund claim with the FTB asserting that the gross amount of the repatriated dividends should be included in the denominator, which would result in a significant reduction to the Company’s California apportionment factor. The FTB denied the refund claim and the Company subsequently appealed to the OTA.
The initial decision
After oral argument, the OTA unanimously agreed with Microsoft and reversed the FTB’s decision to deny the refund claim. The OTA determined that 1) the gross amount of qualifying dividends should be included in the denominator notwithstanding the fact that the dividends are partially deducted from the tax base, and 2) that the dividends should not be excluded from the denominator pursuant to California’s ‘occasional sale’ rule. The OTA reasoned that the plain language of the statutory definition of ‘gross receipts’ identifies certain items of income not included as a gross receipt, but does not specifically address the qualifying dividends subject to a dividend received deduction. Thus, because the language of the statute did not specifically exclude the repatriated dividends, they clearly fell within the definition of gross receipt (under Cal. Rev. & Tax Code section 25120(f)(2)) such that they should be included in the Company’s sales factor denominator. The OTA also disagreed with the FTB’s position that the sales factor had an inherent “matching principle” which required exclusion of receipts that were not included in Microsoft’s apportionable income. The FTB then filed the PFR with the OTA, asserting that the decision was contrary to law and the case should be reconsidered.
The petition for rehearing
On Feb. 14, 2024, the OTA denied the FTB’s petition for rehearing and upheld the decision in favor of Microsoft. The OTA concluded that the initial decision was not contrary to law, there were no irregularities in the appeal proceedings, and there was not any newly discovered, material evidence. Accordingly, the FTB had not established the statutory grounds for a rehearing. With the OTA’s decision to deny the PFR, the OTA’s initial decision becomes final and the FTB is unable to further appeal.
Takeaways
While the OTA has not indicated whether the opinion will become precedential (neither opinion has been published to the OTA as of the date of this article), the decision gives support for other similarly situated taxpayers to take the same approach to calculating the California sales factor. Taxpayers with repatriated foreign earnings subject to the qualifying dividends deduction may have a position to file refund claims to include the gross amount in the sales factor denominator on prior year returns.
Taxpayers with questions about Microsoft, or California apportionment generally should speak to their California state tax advisers for more information.
