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

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.