Hunt-Wesson, Inc. v. Franchise Tax Bd. of Cal., 528 U.S. 458 (2000)

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certiorari to the court of appeal of california, first appellate district

No. 98-2043. Argued January 12, 2000—Decided February 22, 2000

A State may tax a proportionate share of the "unitary" income of a nondomiciliary corporation that carries out a particular business both inside and outside that State, Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U. S. 768, 772, but may not tax "nonunitary" income received by a nondomiciliary corporation from an "unrelated business activity" which constitutes a "discrete business enterprise," e. g., id., at 773. California's "unitary business" income-calculation system for determining that State's taxable share of a multistate corporation's business income authorizes a deduction for interest expense, but permits (with one adjustment) use of that deduction only to the extent that the amount exceeds certain out-of-state income arising from the unrelated business activity of a discrete business enterprise, i. e., nonunitary income that the State could not otherwise tax under this Court's decisions. Petitioner Hunt-Wesson, Inc., is a successor in interest to a nondomiciliary of California that incurred interest expense during the years at issue. California disallowed the deduction for that expense insofar as the nondomiciliary corporation had received relevant nonunitary dividend and interest income. Hunt-Wesson challenged the disallowance's constitutional validity. The State Court of Appeal found it constitutional, and the State Supreme Court denied review.

Held: Because California's interest deduction offset provision is not a reasonable allocation of expense deductions to the income that the expense generates, it constitutes impermissible taxation of income outside the State's jurisdictional reach in violation of the Federal Constitution's Due Process and Commerce Clauses. States may not tax income arising out of interstate activities—even on a proportional basis—unless there is a "minimal connection" or "nexus" between such activities and the taxing State, and a "rational relationship between the income attributed to the State and the intrastate values of the enterprise." Container Corp. of America v. Franchise Tax Bd., 463 U. S. 159, 165-166. Although California's statute does not directly impose a tax on nonunitary income, it measures the amount of additional unitary income that becomes subject to its taxation (through reducing the deduction) by precisely the amount of nonunitary income that the taxpayer has received. Thus, that which California calls a deduction limitation would seem, in fact, to

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