Harley-Davidson thumps California’s Franchise Tax Board

June 4, 2015

By STEW JENKINS

A California appeals court ruled last week, in a lawsuit brought by the Harley-Davidson Motorcycle Company against the California Franchise Tax Board, that part of California’s statutory income tax scheme is unconstitutional because it discriminates against out of state businesses, such as Harley-Davidson.

The ruling forbids California’s tax policy from discriminating against out of state businesses. As a result, the cost of purchasing out of state products such as Harley-Davidson motorcycles in California could be reduced.

This discrimination violates the United State Constitution’s commerce clause, unless the different treatment “advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives,” the justices determined.”

The court explained that levying a higher tax on out of state businesses as a way to favor California industry was illegitimate under the U.S. Constitution.

Based in Milwaukee, Harley-Davidson owns and operates a collection of subsidiaries which operated together in the motorcycle business making and selling the company’s quintessentially American motorcycles.  Harley-Davidson also operates a financing business based outside of California.

Harley-Davidson had properly reported the income from their California sales of motorcycles between 2000 and 2002 and paid the California income taxes due.  However, the out of state financing company’s income had not been reported with the manufacturing and sales companies.

California’s Revenue and Taxation Code required out of state businesses to report the income of both the motorcycle and the financing businesses on a combined tax return as a “unitary business.”  Similar California businesses, working together, are allowed by California statute and Franchise Tax Board regulations to file tax returns separately for each separate business as a way to reduce the overall income tax liability from these business consortiums.

After auditing Harley-Davidson, the Franchise Tax Board sent the company a demand that a unitary tax return be filed for all their businesses combined, with a bill for an additional $1.8 million. Harley-Davidson paid the $1.8 million under protest, but promptly sued the Franchise Tax Board for a refund, claiming that its different treatment violated the U.S. Constitution’s commerce clause.

The Court of Appeal reversed the trial judge who had thrown out Harley-Davidson’s suit after on the motion of Attorney General Kamala Harris.

The Court of Appeal sent the case back to the Superior Court, directing the lower court to apply “strict scrutiny” to California’s income tax scheme discrimination against out of state businesses, and to hold California’s income tax discrimination unconstitutional unless some new evidence demonstrated a “legitimate purpose” that could not be served by some reasonable alternative.  Favoring California businesses over businesses in other parts of the United States was held not to be a legitimate purpose.

The unanimous opinion of Harley-Davidson, Inc. v. Franchise Tax Board was issued by Justice Benke on May 28, and unless appealed to the California Supreme Court, will be final at the end of June.

Stewart Jenkins is an Attorney practicing in San Luis Obispo since 1978.  Mr. Jenkins’ handles Tax Payer Suits, Municipal Law, Estate Planning and Family Law.  You can contact Stewart Jenkins at (805) 541-5763.