March 14, 2024

California OTA Ruling Favors Microsoft on Foreign Dividend Sales Factor Treatment

Holland & Knight Alert
John Wertz | Emily Marie Earnshaw

The California Office of Tax Appeals (OTA) denied a request for rehearing of a July 2023 OTA opinion favorable to Microsoft Corp. that could have wide-ranging impacts for a water's edge filer in California, particularly one that has been including only 25 percent of foreign dividends in its sales factor denominator.

Case Background

Primarily at issue was whether Microsoft – a multinational, water's edge filer – could include 100 percent of its foreign dividends in its sales factor denominator while excluding 75 percent of the dividends from its tax base. The California Franchise Tax Board (FTB) argued that because Microsoft included only 25 percent of dividends received from its foreign affiliates – repatriated income under the federal 2017 Tax Cuts and Jobs Act (TCJA) – in its California tax base, it should be allowed to include only 25 percent of the dividends as its sales factor denominator.

The OTA ultimately held that the FTB lacks authority to treat deducted income the same as excluded or exempt income and that Microsoft can include 100 percent of its foreign dividends in its sales factor denominator, resulting in a multimillion-dollar refund. Though the OTA has yet to decide whether to propose the opinions be precedential – and applicable to taxpayers other than Microsoft – that decision should be known soon.

Importance of the Decision

The OTA's inclusion of gross foreign dividends vs. net foreign dividends in the sales factor denominator reduces the overall California tax owed by a taxpayer in similar circumstances to Microsoft.

Refund Opportunity

Companies that are water's edge filers in California and have been excluding 75 percent of their foreign dividends from their California sales factor denominators should evaluate whether to file a claim for refund.

If you have questions about how the decision may impact your business, please contact the authors or another member of Holland & Knight's Tax Practice.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.

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