California court finds for taxpayer in industry apportionment case

Executive summary

A recent decision by the California Superior Court for Los Angeles County provides important guidance on the application of California’s apportionment rules to agricultural and other capital‑intensive businesses. In Smithfield Packaged Meats Corp. v. California Franchise Tax Board, the court held that Smithfield qualified as an agricultural business required to use a three‑factor apportionment formula. The court also concluded that California’s single‑sales factor formula did not fairly represent Smithfield’s business activity in the state. The decision, issued as a ‘proposed statement of decision’ on Feb. 26, 2026, may have significant implications for taxpayers in agriculture and other industries with substantial out‑of‑state property and payroll.

Court finds Smithfield is an agricultural business under California law

California generally requires multistate taxpayers to apportion business income using a single‑sales factor formula. However, Cal. Rev. & Tax. Code section 25128(b) provides a statutory exception for qualifying agricultural businesses, which must instead apportion income using an equally weighted three‑factor formula based on property, payroll and sales. Smithfield originally filed its return using California’s standard single‑sales factor apportionment formula, but subsequently filed a refund claim asserting that it should have apportioned income using an equally weighted three‑factor formula because it derived more than 50% of its gross receipts from agricultural business activities. In the alternative, Smithfield contended that the single‑sales factor did not fairly represent the extent of its business activity in California and that alternative apportionment was required. The California Franchise Tax Board (FTB) denied the refund claim, applying a product‑focused approach that looked only to the sale of processed and packaged meat products and ignored Smithfield’s farming and hog‑harvesting activities that generated those sales.

Finding in favor of the taxpayer, the court concluded that Smithfield met the statutory definition of an agricultural business because it derived more than 50% of its gross receipts from agricultural business activities. Those activities included the raising, feeding, managing and harvesting of hogs. In reaching this conclusion, the court emphasized that the statute focuses on gross receipts derived from business activities, rather than the character of the final products sold. The court rejected the FTB’s reliance on a product‑based approach that treated receipts from processed meat products as entirely non‑agricultural. According to the court, the governing statute contains no language permitting the FTB to disregard agricultural production and harvesting activities simply because those activities culminate in the sale of processed products.

Based on extensive factual findings, the court determined that approximately 61% of Smithfield’s gross receipts were attributable to agricultural business activities. As a result, Smithfield was required to use the statutory three‑factor apportionment formula rather than California’s single‑sales factor method.

Regulation conflicts with statute as applied

The court further held that the FTB’s regulation interpreting section 25128 was invalid as applied to Smithfield because it conflicted with the plain language and purpose of the statute. While the statute requires an examination of a taxpayer’s activities, the regulation focuses almost exclusively on the nature of the final product sold. The court concluded that this approach impermissibly narrows the scope of the statute and disregards substantial agricultural activities that generate income. Processing of the harvested hogs into a packaged product, standing alone, does not eliminate the agricultural character of underlying receipts derived from raising and harvesting livestock.

Court grants alternative apportionment relief in independent holding

Even if Smithfield had not qualified as an agricultural business, the court stated that relief was warranted under California’s alternative apportionment statute, section 25137. That provision permits a departure from the standard apportionment formula when it does not fairly represent the extent of a taxpayer’s business activity in the state. Smithfield demonstrated by clear and convincing evidence that the single‑sales factor formula produced a distortive result. The court found that Smithfield operates a highly capital‑intensive business with the vast majority of its property, payroll and income‑generating activities located outside California. Only a small fraction of Smithfield’s overall activities occurred in the state.

Under these facts, the court concluded that relying solely on the sales factor significantly overstated Smithfield’s California business activity. The court therefore held that use of a three‑factor apportionment formula was a reasonable and appropriate alternative method. Notably, the court stated that it would have ruled in Smithfield’s favor on alternative apportionment grounds, even absent the statutory agricultural holding.

Procedural considerations and next steps

Requests for alternative apportionment generally must be made before filing a return, making advance planning critical. In certain circumstances, taxpayers may also be able to assert alternative apportionment positions during audit as an offset. Although the decision currently is a ‘proposed statement of decision’–a non-final procedural step that ultimately may be appealed–it provides meaningful guidance that taxpayers can evaluate now when considering refund claims, prospective filing positions and audit strategies.

Taxpayers with California operations—particularly those in agriculture, manufacturing or other capital‑intensive industries—should consider whether the Smithfield decision may affect their apportionment methodology.