Departments of Revenue (and many taxpayers) treat the concept of a unitary business as an automatic decision when there are related entities involved. However, the linchpin of apportionability – a unitary business – is not a throwaway determination, and mere ownership of another entity does not establish the requisite connection. The California Office of Tax Appeals recently released a decision confirming just that. Appeals of Watts, 2026-OTA-423 (Cal. Off. Tax Appeals, Feb. 28, 2025) (Nonprecedential).
In Appeals of Watts, at issue was whether a holding company and one of its operating subsidiaries were a unitary business. The subsidiary was sold to a third party as part of a staged acquisition, with the sale of the remaining interest (less than 50 percent) being sold in 2012. The gain from the sale was treated as nonunitary on the 2012 California returns. On audit, the Franchise Tax Board (the “FTB”) determined that the businesses were unitary.
On review, the Office of Tax Appeals (the “OTA”) stated there are two tests in California to determine whether businesses are unitary – the dependency or contribution test and the three unities test. To satisfy the first test, the business done in the State must depend upon or contribute to the business done outside of the State. When dealing with a holding company and an operating subsidiary, there may be dependence or contribution if there is intercompany financing, shared tax benefits, or improved creditworthiness. In this case, those factors did not exist, which made for a “less than compelling argument” by the FTB. While there were some intercompany transactions, they were not meaningful, and the overlap of officers between the entities was not complete.
In analyzing the three unities test, the OTA stated that there needed to be “significant integration between the day-to-day administrative operations” of the entities in order to be considered unitary (along with other elements). The FTB made no allegation that there was any overlap in such functions. Instead, the FTB pointed to the overlap in officers. However, the OTA quickly noted that such overlap in officers was insufficient to meet the burden under the three unities test.
The FTB also argued that the entities had filed as a unitary business in prior years. However, each year stands on its own. A business can be unitary in one year and not in another. Therefore, pointing to years prior to 2012 was not compelling.
While many companies operate as a unitary business, it is not a one size fits all. Just because they are related entities is not sufficient to meet the burden to establish that they are unitary. Instead, the facts in each tax year need to be analyzed to determine whether the necessary connections and interactions exist between them to be treated as a unitary business.
This update is one in a series of updates written for the October 2026 edition of The BR State + Local Tax Spotlight.
© 2026 Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.