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Oregon Bars Use of Three Factor Apportionment Formula

In Health Net Inc. v. Dep’t of Revenue, Docket No. S063625 (Apr. 12, 2018), the Oregon Supreme Court rejected a business taxpayer’s constitutional challenges to a 1993 Oregon statute that eliminated the right to utilize a three-factor apportionment formula in calculating Oregon income tax. The Oregon Supreme Court joined courts in Texas, Minnesota, California and Michigan in rejecting taxpayer arguments that states which have enacted Article IV of the Multistate Tax Compact, thereby incorporating the UDITPA three-factor (payroll, property and sales) formula, have entered into a binding contractual obligation which may not be overridden.

Oregon enacted UDITPA in 1965 (ORS 314.605 – 314.675) and the Multistate Tax Compact (including Article IV) (ORS 305.655), in 1967. In 1993, however, following a series of amendments to the apportionment formula in Oregon’s version of UDITPA, which moved the state to a single sales factor formula, the Oregon legislature eliminated taxpayers’ ability to elect the three factor apportionment formula incorporated via ORS 305.655.

In Health Net, the taxpayer argued that when Oregon enacted the MTC in 1967, it had entered into a binding contract with other states that was violated by the state’s 1993 elimination of the three factor apportionment formula, in violation of the Contract Clause of the state and US constitutions. In Oregon, a statute is considered “a contractual promise only if the legislature has clearly and unmistakably expressed its intent to create a contract.”  The Oregon Supreme Court determined that the text, context, and legislative history of ORS 305.655 did not “clearly and unmistakably” establish that the Oregon legislature intended to execute a binding contract with other states. The court found ORS 305.655 to have only created statutory obligations—according to the majority, it was a uniform law, not a compact—and, thus, there was no Contract Clause violation.

The Oregon Supreme Court also rejected the taxpayer’s argument that the 1993 legislation violated Article IV, Section 22 of the Oregon state constitution because it did not set out the text of ORS 305.655. The court stated that Article IV, Section 22 was intended to apply to statutory amendments where “a textual fragment… was being added to or omitted from an existing statute.” The court found that the 1993 legislation was not a textual amendment to an existing statute but rather a “complete and perfect legislative choice to replace one set of apportionment formulas with another” and, thus, Article IV, Section 22 of the state constitution did not apply.

Oregon Supreme Court Justice Nakamoto issued a concurring opinion disputing the majority’s conclusion that Oregon did not enter into an interstate compact—a contract among states—in enacting the MTC. However, Judge Nakamoto concurred with the majority’s ultimate result because, in the court’s view, the taxpayer did not establish that the three-factor apportionment formula was “unmistakably immutable” absent complete withdrawal from the MTC, and also failed to demonstrate that the taxpayer was an intended “third-party beneficiary” of the original three factor formula.

Practice Note: This is the last of the widely publicized state court lawsuits challenging taxpayer’s ability to use the three factor apportionment formula based on a state’s enactment of Article IV of the MTC. The US Supreme Court already has rejected taxpayer requests for review of this issue, arising out of Minnesota, California and Michigan. See, e.g., Graphic Packaging Corp. v. Hegar, 538 S.W.3d 89 (Tex. App. 2017)); Kimberly-Clark Corp. v. Comm’r of Revenue, 880 N.W.2d 844 (Minn. 2016), cert den. 12-12-16; Gillette Co. v. Franchise Tax Bd., 62 Cal. 4th 468 (Cal. 2015), cert den. 10-11-16; and Gillette Commercial Operations v. Dept. of Treasury, 878 N.W.2d 891 (Mich. Ct. App. 2015), appeal den. 880 N.W.2d 230 (Mich. 2016), cert den. 5-22-17.

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About this Author

Mary Kay McCalla Martire, McDermott, local tax disputes lawyer, Internal Audits Attorney

Mary Kay McCalla Martire focuses her practice on state and local tax disputes. She helps clients with audits, tax-related litigation, letter rulings and settlement conferences. Mary Kay has experience resolving disputes involving income, sales and use, utility and telecommunications taxes, as well as premium and retaliatory tax.

Mary Kay has an extensive litigation background in state and federal court, as well as administrative tribunals. She has particular experience in the defense of qui tam (whistleblower) claims filed in the state...

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Kathleen Quinn, McDermott Will, State Tax Matters Lawyer, Corporate Development Attorney

Kathleen Quinn focuses her practice on state and local tax matters. She has represented corporations and individuals in New York State and New York City income tax controversies. She also has advised clients on the state and local consequences of corporate restructurings and other business transactions.

Previously, Kathleen worked at a Big Four accounting firm, where her practice focused exclusively on state and local tax.

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