Why only seek an alternative formula when you can win under the normal formula? A corporate taxpayer won under a special-industry normal apportionment formula, and it won the right to use an alternative apportionment formula in California (even if the special-industry normal apportionment formula did not apply). Smithfield Packaged Meats Corp. v. California Franchise Tax Board, Case No. 21STCV39637 (CA Sup. Ct. LA Cty. Feb. 26, 2026). A taxpayer may assert two main arguments to make for a one trial on the same set of facts. A taxpayer does not typically bear the burden of proof for the normal formula, though a taxpayer typically bears the burden of proof to use an alternative formula. This makes a win on the normal formula a potentially lighter lift, and therefore, the normal formula should always be argument number one.
The company, here, is in animal production and harvesting, specifically as to hogs, with business segments focusing separately on Hog Production, Fresh Pork, and Packaged Meats. A special-industry three-factor formula was established in recognition of very capital-intensive and labor-intensive businesses in agriculture (one need have only more than 50% of gross business receipts from “qualified business activities”). Rev. & Tax. Code § 25128(b). California regulations limited the use of the statutory agricultural business three-factor formula of property, payroll, and sales, to only agricultural businesses that do not have a final product that has undergone processing. 18 Cal. Code of Regs. 25128-2. That is, the regulations applied a “final product” test, notwithstanding the “50% of gross receipts” test expressly stated in the statute. The company protected its position by also claiming a right to the three-factor formula by asserting that the single sales factor formula unfairly reflects and distorts its actual income and activity attributable to California under Rev. & Tax. Code § 25137 (statutory alternative apportionment).
California started requiring use of a single sales-factor formula in 2013 as the catch-all: “all business income of an apportioning trade or business, other than an apportioning trade or business described in subdivision (b) of Section 25128, shall be apportioned to this state by multiplying the business income by the sales factor.” Rev. & Tax. Code § 25128.7. California auditors asserted that the company was not an agricultural business under the Section 25128(b) regulations. Further, California asserted that the company had not demonstrated distortion and, therefore, it forced the taxpayer into the single sales factor formula notwithstanding clear legislative expression for a three-factor formula for businesses such as the company’s business.
During the trial, the company presented in-depth testimony from the three different segments of the business. Included in the testimony was how and where the business segments conducted their businesses, how the later-in-time segments relied on each segment that completed the step ahead of it (i.e., the Fresh Pork segment relied on the Hog Production segment and the Packaged Meats segment relied on the Fresh Pork segment), and economics-based testimony regarding attribution/sources of receipts and profits. That is, the packaged-meat products did not just happen out of thin air and were part of the business. Further, the packaged meat products were not the only reason for the business. The company also sold pork products at various stages of the production and harvesting process.
The Court found the testimony was credible and proved that the company was entitled to use the three-factor apportionment formula as a demonstrated agricultural business and ruled that the regulation was contrary to, and exceeded the scope of, the statute. The company also presented testimony from an expert in state tax policy, who the Court expressly stated: “was credible and helpful to the Court in providing context for the issues at bar[]” and was accepted by the Court as an expert in state tax policy. Slip Op. at 12, n. 11. This is no surprise because it is rarely error to admit expert testimony and give it weight it is due, but it is often error to exclude expert testimony – even more so because the typical standard for admission of expert testimony is that the witness be credible and the testimony be helpful to the Court. Since judges do not know everything, one could ask how it is that a judge could ever not find a tax specialist’s testimony to be helpful.
It is interesting to note that on the same set of facts, the company also proved unfair reflection of activities giving rise to its income and distortion arising from use of the single sales-factor formula. We caution that the company won alternative apportionment (though by successfully arguing for application of the agriculture business formula, it did not need an alternative) because it did more than simply complain about math (i.e., it did not merely assert to the Court that if it agreed with the company, then the company would pay less tax). It proved the facts, including the location, attribution, and economics of the company’s income that was subject to apportionment by California. See, e.g. Moorman v. Bair (Iowa Department of Revenue), 437 U.S. 267 (1978).
We won this formula-entitlement issue in 2022 in the Virginia Supreme Court where a taxpayer had the right to exclude property from the numerator of the property fraction under the express language in the Virginia apportionment statute by demonstrating the facts of the business and the location, attribution, and economics of the business (whether property was “used” in Virginia, not just “owned” in Virginia). The taxpayer did not need to prove unfair reflection or distortion.
The Takeaway: Words matter! Don’t skip the normal apportionment formulas. Start with the specific language of the statute as drafted by the legislature, knock out department regulations that are contrary to the statute, and also assert alternative arguments such as fair reflection or unconstitutional distortion for the win!
