By  on June 21, 1994

WASHINGTON -- The Supreme Court Monday upheld a California tax system that has sparked international calls of retaliation against U.S. business because it's based on a company's worldwide sales.

The state's unitary tax system for multinational companies was challenged by Colgate Palmolive Co. and the British-owned Barclays Bank of California and Barclays International. The court upheld the system in a 7-2 decision, which means California will not have to pay back $4 billion in taxes to multinational companies.

A unitary tax system treats a company and its foreign subsidiaries as one taxable entity, using a formula to calculate the state's taxable portion as part of a firm's worldwide sales. Six other states -- Idaho, Montana, North Dakota, Alaska, Tennessee and Utah -- have such a system. By contrast, the federal government and most foreign countries base their taxes on multinationals only on the companies' local subsidiaries. Nevertheless, the Clinton administration supported California's unitary system in a friend-of-the-court brief.

Under pressure from the European Union, Canada and Japan, California lawmakers last year made the state's unitary tax optional, starting in the 1994 tax year. A company can now choose to pay taxes under the so-called "water's edge" approach that bases a corporation's taxes on sales within the U.S.

The British government is ready to reinstate its call for retaliation if California or any other state makes the unitary system mandatory, in light of the Supreme Court's ruling.

"Any step backward will only deter foreign investment," said Kenneth Clarke, British Chancellor of the Exchequer, in a statement.

A statement from Colgate Palmolive read: "Colgate continues to believe the system improperly subjects multinational companies to unfair tax burdens and opens the door for potential international tax retaliation by foreign governments."

Officials with California's Franchise Tax Board could not be reached for comment about the possibility of reimposing the unitary tax.

In the opinion delivered by Justice Ruth Ginsburg, the court said the California tax doesn't violate the federal commerce or due process clauses. In addition, the court said it couldn't address Colgate's and Barclays' claims that the tax prevents the federal government from speaking with "one voice" in international trade.

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