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Court of Appeals Affirms LLC Fee as Unconstitutional

 

February 15, 2008
By Phil Jelsma and Mark L. Mann

The First Appellate District of the Court of Appeals for the State of California affirmed the San Francisco Trial Court’s decision in Northwest Energetic Services, LLC v. California Franchise Tax Board, finding that the California gross receipts fee in existence before January 1, 2007, was unconstitutional because it was based on LLC’s total income, regardless of whether the income was attributable to California. As a result of this decision, the State will be required to commence processing refund claims for out of state LLCs whose only contact with California was registration with the Secretary of State.

Northwest Energetic Services, LLC was a Washington limited liability company with no operations, property, inventory, employees, agents, independent contractors or place of business in California. It sold construction explosives and explosive related services and did not solicit customers in California or make deliveries to customers in California. It paid the $800 minimum franchise tax and a graduated fee based on worldwide gross receipts and later filed a claim for refund arguing that the fee was unconstitutional because it was a tax that violated the Due Process or Commerce Clauses of the United States Constitution.

The Court of Appeals affirmed the trial court’s decision that the fee was a tax citing the legislative history of the fee and that the fee violated the Commerce Clause of the United States Constitution. In particular, the fee was not measured on the activities in the State of California or the benefits provided by the State. What is notable is footnote 16 which suggests that had Northwest Energetic Services, LLC actually conducted activities inside of California only a portion of the fee based on non-California activities would have been unconstitutional.

As a result of the decision in Northwest Energetic Services, LLC, it is anticipated that the State will start processing refund claims for taxpayers with the identical facts. There are two other cases currently being litigated, Ventus Finance I v. California Franchise Tax Board, concerning a Delaware LLC that had both business activities inside and outside the State and Bakersfield Mall, LLC v. California Franchise Tax Board, regarding an LLC whose activities were all within the State. It remains to be seen whether the decision in Northwest Energetic Services will lead to a settlement or quick resolution of those cases.