California rules foreign dividends includible in sales factor denominator

Taxpayer win provides opportunity for similarly situated taxpayers to consider refund claims

Mar 07, 2024
Income & franchise tax State & local tax

Executive summary: California Office of Tax Appeals denies rehearing in apportionment case

On Feb. 14, 2024, the California Office of Tax Appeals (OTA) issued an opinion denying a Petition for Rehearing (PFR) filed by the California Franchise Tax Board (FTB) in an appeal regarding whether Microsoft Corporation and Subsidiaries (Microsoft or Company) could include repatriated foreign earnings in its sales factor denominator. In the initial decision issued on July 27, 2023, the OTA held that the taxpayer could recompute its sales factor denominator to include the gross receipts from the repatriated foreign dividends. The FTB subsequently filed a PFR with the OTA arguing that the initial decision was contrary to law and should be overturned. The OTA held that the ruling in favor of the taxpayer was not contrary to law and the repatriated earnings were properly included in Microsoft’s California denominator. A summary of the case and what the decision means for taxpayers follow below.

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.


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.

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