By Michael Penza and Andrew Appleby

The California Court of Appeal held that California’s disparate treatment of intrastate and interstate unitary businesses discriminated against interstate commerce. California requires taxpayers engaged in a unitary business within and without California to calculate their taxable income using combined reporting, but provides taxpayers engaged in a unitary business wholly within California an election to calculate their taxable income either on a combined reporting or a separate reporting basis (referred to as “separate accounting” by the Court of Appeal). Harley-Davidson argued that the separate reporting election favored intrastate taxpayers by reducing tax liabilities, lowering compliance costs, and increasing their ability to use credits and net operating losses. The court agreed that the tax regime discriminated against interstate commerce, but remanded the case to the trial court to determine whether there is a legitimate justification for the discrimination, which could allow the regime to stand.

The court next considered whether two of Harley-Davidson’s subsidiaries had nexus with California. The subsidiaries at issue were special purpose entities (SPEs) created to securitize consumer finance loans associated with Harley-Davidson motorcycle sales. The SPEs did not have any employees of their own but did have directors and officers that overlapped with another Harley-Davidson subsidiary, Harley-Davidson Credit Corporation (HDCC). HDCC administered the securitization process and serviced loans held by the SPEs, and conducted some of these activities in California. The court held that HDCC acted as an agent for the SPEs and that the agent’s visits to California created nexus for the SPEs. The court determined that due process concerns were satisfied because HDCC’s activities on behalf of the SPEtargeted California. Commerce clause nexus concerns were also satisfied because HDCC’s California activities were “integral and crucial” to the SPEs’ businesses. It should be noted that the “integral and crucial” test previously applied by California courts in Illinois Commercial Men’s Assn. v. State Bd. of Equalization, 34 Cal. 3d 839 (1983), predates the U.S. Supreme Court’s “establish and maintain” the in-state market standard contained in Tyler Pipe Industries v. Dept. of Revenue, 483 U.S. 232 (1987). In the latter case, the court held that nexus may be attributed where it “establishes and maintains” a party’s market. Harley-Davidson, Inc. v. Franchise Tax Board, 187 Cal. Rptr. 3d 672 (Cal. Ct. App. 2015).