PacBell’s recent victory in California illustrates how international matters can impact state-level taxation. 

In Appeal of Pacific Bell Telephone Company and Affiliates (Case No. 521312), California sought tax a larger portion of the income of PacBell (a Texas taxpayer) by arguing that PacBell’s income from certain foreign investments constituted “business income.”  If upheld, such foreign income would have been subject to PacBell’s multistage apportionment and would have generated a higher California tax bill.

Got that?  California tried tax a Texas taxpayer on investment income earned in Belgium,  Denmark, Switzerland, Taiwan, Canada, and Mexico.  

According to the state, PacBell’s  investments were acquired in the course of, and so related to, its overall global telecommunications business that the dividends and capital gains arising from these investments constituted business income.   PacBell countered that income from foreign investments is nonbusiness income unless the investments “are so interwoven into the fabric of its business operations that the foreign investments become ‘indivisible’ or inseparable” from its domestic telecommunications business and both receive operating value from the relationship.  According to PacBell it was merely a regional domestic provider during the audit years and the foreign investments did not materially contribute to its domestic business. 

Unfortunately, the Board’s sparse decision does not divulge which particular fact or law ultimately persuaded the panel to side with PacBell.  A comprehensive issue briefing can be found at this link.  

http://www.boe.ca.gov/meetings/pdf/hearingsummaries/B_Pacific_Bell_Telephone_Co_521312_Sum.pdf

Nevertheless, clients with investments abroad in related industries (particularly those with influential positions) should take care when structuring these relationships.  It’s all too easy for a state taxing authority to saddle a passive investor with the responsibilities of an owner/operator.