Toys “R” Us operates in California and, of course, pays California taxes. California uses a three-part allocation formula based on unitary taxation to determine how much a corporation operating in multiple states must pay. Toys “R” Us came to the conclusion that if the sales portion of the formula included the principal amount of short-term notes, that their California tax would go down. So they filed an appeal, and took their case to court.
Toys ‘R Us lost in district court, and they appealed their claim for $4.8 million plus interest to the Court of Appeals (Third Circuit, CA). In FTB v Toys “R” Us, the main issue was whether the California rule results in an equitable apportionment formula. The Franchise Tax Board (FTB) successfully argued that if Toys “R” Us could include the principal, they could move between 11% and 28% of their annual sales to a different state by just relocating their Treasury Department.
The FTB tends go too far in its regulatory tactics and enforcement actvities; however, I completely agree with them and the Court’s decision. Perhaps principal could be included for a business that’s a financial services corporation. For a retailer, though, this doesn’t make sense.