March 4, 2024

OTA Ruling Favors Microsoft: Opens Door for Taxpayer Refunds on Foreign Dividends

By Tri Hoang, Director, Tax & Business Services

OTA Ruling Favors Microsoft: Opens Door for Taxpayer Refunds on Foreign Dividends State & Local Tax

The California Office of Tax Appeals (OTA) recently denied the California Franchise Tax Board’s (FTB) request for rehearing in the Appeal of Microsoft Corporation and Subsidiaries (OTA Case # 21037336). For the tax years at issue, Microsoft filed a California Water’s Edge return and included 100% of the dividend income it received from foreign affiliates in its California sales factor denominator. Under Revenue & Taxation Code (R&TC) Section 24411, California generally authorizes a 75% dividend received deduction (DRD) for dividends received from a foreign affiliate, which Microsoft took advantage of. In Legal Ruling 2006-01, FTB concluded a corporation may only include activities related to income that is includible in the measure of taxable income in its apportionment factor. The ruling specifically provides an example where a corporation that eliminated income by operation of R&TC Section 24411 was required to exclude the corresponding elimination from its sales factor. FTB asserted that the ruling required Microsoft to exclude the 75% DRD it received from the California sales factor denominator. Microsoft contended that FTB’s Legal Ruling 2006-01 is not supported by statutory or regulatory authority and thus is invalid. OTA agreed with Microsoft and allowed 100% of foreign dividend income from affiliates to be included in the California sales factor, regardless of any DRD. This decision resulted in a large refund for Microsoft.

Taxpayers who are impacted by OTA’s decision should consider filing refund claims. Generally, California adopts a four-year statute of limitations so most affected calendar year-end taxpayers can request refunds beginning with the 2019 tax year. Impacted taxpayers will typically have the following:

  • Filed Form 100W – Corporation Franchise or Income Tax Return – Water’s Edge Filers
  • Received dividends from a foreign affiliate(s) (excluding deemed dividends, which are generally not taxed in California)
  • Claimed a DRD on California Schedule H(100W)

Additionally, certain corporate taxpayers who received intercompany dividends from non-unitary affiliates and claimed a deduction on Schedule H(100) may also be authorized to include such dividends in the California sales factor denominator.

If you have any questions, don’t hesitate to #AskMarcum and contact our State and Local Tax team.