Unitary Taxation

Summary of Unitary Taxation

A form of corporate taxation adopted by some U.S. states whereby state income tax is assessed on a pro rata portion of the company's worldwide profits, rather than on locally earned profits only. Unitary taxation emerged in the United States in 1926; at that time it was applied to interstate railroads to permit a fair apportionment of the railroad's earnings among the states in which the company operated. At least eleven states use the unitary tax system, although unitary taxation is most closely identified with California, which has applied it aggressively and has become the object of litigation to overturn the principle on constitutional and other grounds.

In 1983 the United States Supreme Court, by refusing to hear an appeal from a lower court, tacitly admitted the legality of applying the unitary method to the income of American firms with foreign subsidiaries. The application of the tax to foreign corporations is somewhat more complicated because of tax treaties and other international agreements. Nevertheless, the Supreme Court in December 1983 rejected an appeal from Shell Petroleum of the Netherlands (and supported by eight European governments and Japan) that challenged the authority of local tax officials to include the worldwide profits of a foreign corporation in taxing a subsidiary in their state. The Federal government has taken no official position on the issue of unitary taxation, but there is strong pressure from foreign governments to abolish it.

In computing the taxable profits of a local firm, tax officials in states employing the unitary method do not look merely to transactions performed by the local firm. Because that firm is viewed as part of a larger “global entity,”the tax burden of the local firm is derived by utilizing three ratios: local sales to worldwide sales, local assets to worldwide assets, and local payroll to worldwide payroll. The average of the three reflects that portion of a multijurisdiction entity's profits subject to tax by the unitary state.

(Main Author: William J. Miller)