A Victory for Interstate Compacts

E-newsletter Issue #97 | August 2, 2012

A California court ruling is being hailed as a significant victory for states and the interstate compact mechanism.

At issue in the case of The Gillette Company v. The Franchise Tax Board was California’s method of collecting and allocating tax dollars from companies that do business across state lines. More broadly, however, the case brought into question a state’s ability to unilaterally amend the terms of a compact it has joined.

In a unanimous ruling issued last week, California’s First District Court of Appeals concluded, “the compact is a binding, enforceable agreement that overrides conflicting state laws. A state’s decision to withdraw must be expressly stated in a new statute—something the 1993 law failed to do—and must apply only to future tax years without attempting to increase past liability.”

Rick Masters, who serves as special counsel to CSG’s National Center for Interstate Compacts and legal counsel to three separate compact commissions affiliated with CSG, noted the ruling “reaffirms the power, durability and sustainability of interstate compacts.”

The terms of the Multistate Tax Compact require member states to equally consider a company's sales, property and payroll taxes when determining what percentage of the company’s income is taxable. The compact also allows companies to apportion their taxable income under state laws if those are more generous.

California, which joined the compact through legislative action in 1974, followed the compact’s formula until 1993, when the state legislature passed a bill that modified the existing formula, resulting in higher taxes for out-of-state companies. Gillette, Procter and Gamble and other multi-state companies that conduct business and pay taxes in California challenged the legality of this action in 2010.

“The opinion is significant for other interstate compacts because it represents an unequivocal decision by a state appeals court that an interstate compact, even one without Congressional consent, trumps conflicting state law based upon the Contract Clause of the U.S. Constitution,” Masters said.

The court’s ruling seems to preclude a state from unilaterally modifying the terms of a compact as long as it is part of existing state law. While California could appeal the appellate court’s ruling, the decision leaves little doubt about the contractual and binding nature of interstate compacts.

In response to the initial lawsuit filed by Gillette, California lawmakers decided to withdraw from the Multistate Tax Compact effective June 2012. In order to withdraw from the compact, the state had to amend existing statute through legislation.

Interstate compacts function, legally, as a contract between the states. More than 215 interstate compacts are in existence across the country, and most states belong to more than 20 different agreements. The Multistate Tax Compact was drafted in 1967 and currently has 19 fully participating member states.

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