Cite as: 528 U. S. 458 (2000)
Opinion of the Court
No other taxing jurisdiction, whether federal or state, has taken so absolute an approach to the tax arbitrage problem that California presents. Federal law in comparable circumstances (allocating interest expense between domestic and foreign source income) uses a ratio of assets and gross income to allocate a corporation's total interest expense. See 26 CFR §§ 1.861-9T(f), (g) (1999). In a similar, but much more limited, set of circumstances, the federal rules use a kind of modified tracing approach—requiring that a certain amount of interest expense be allocated to foreign income in situations where a United States business group's loans to foreign subsidiaries and the group's total borrowing have increased relative to recent years (subject to a number of adjustments), and both loans and borrowing exceed certain amounts relative to total assets. See § 1.861-10. Some States other than California follow a tracing approach. See, e. g., D. C. Mun. Regs., Tit. 9, § 123.4 (1998); Ga. Rules and Regs. § 560-7-7.03(3) (1999). Some use a set of ratio-based formulas to allocate borrowing between the generation of unitary and nonunitary income. See, e. g., Ala. Code § 40-18-35(a)(2) (1998); La. Reg. § 1130(B)(1) (1988). And some use a combination of the two approaches. See, e. g., N. M. Admin. Code, Tit. 3, § 5.5.8 (1999); Utah Code Ann. § 59-7-101 (19) (1999). No other jurisdiction uses a rule like California's.
Ratio-based rules like the one used by the Federal Government and those used by many States recognize that borrowing, even if supposedly undertaken for the unitary business, may also (as California argues) support the generation of nonunitary income. However, unlike the California rule, ratio-based rules do not assume that all borrowing first supports nonunitary investment. Rather, they allocate each borrowing between the two types of income. Although they may not reflect every firm's specific actions in any given year, it is reasonable to expect that, over some period of
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