California Court Finds Securitization Entities Subject to California Income Tax

by Reed Smith

A California Superior Court has issued a decision with significant impact on financial services. In the case, Harley-Davidson, Inc. v. Franchise Tax Board,1 San Diego Superior Court Judge Joel Pressman held that bankruptcy-remote entities formed to hold financial assets in connection with securitization transactions had nexus with California and can be taxed as financial corporations, notwithstanding the fact that the entities had no physical presence in California.

Harley-Davidson, through financing subsidiaries, originated loans in all 50 states, including in California. The Harley-Davidson group included two special purpose entities (SPEs), which were bankruptcy-remote subsidiaries. The SPEs bundled and securitized the loans originated by the financing subsidiaries and sold the related securities. The SPEs did not have a physical presence in California and, therefore, Harley-Davidson sought to exclude the SPEs’ California-sourced sales from the combined reporting group’s sales factor.2

The court held that the SPEs did in fact have nexus with California--not because they had any California activities themselves—but, rather, because the Court deemed the SPEs to have been inextricably intertwined with the California activities of Harley-Davidson’s financing subsidiaries. The court stated, "The SPEs were not doing business for themselves," and were instead doing business for the financing subsidiaries that conducted activities in the state. The court emphasized the financing subsidiaries’ right to exercise control over the SPEs and the fact the SPEs only did business for the related Harley-Davidson financing entities.

In addition to holding that the SPEs had nexus in California, the court determined that the SPEs were financial corporations. For California income tax purposes, a financial corporation is taxed at a rate of 2 percent higher than a general corporation. Additionally, a financial corporation must include gains from the sale of loans and income from investment assets and activities and trading assets and activities in its sales factor. A corporation is a financial corporation if it "predominantly deals in money or moneyed capital in substantial competition with the business of national banks."3 The court determined, based on one of the types of loans the SPEs dealt with and the fact that national banks could legally securitize vehicle loans, that the Harley-Davidson SPEs met this definition.

If sustained by the Court of Appeal, the Harley-Davidson decision would set a troubling precedent for any California taxpayer that has formed an affiliated SPE to securitize financial assets. The number of taxpayers impacted by the Harley-Davidson decision is expected to be large because of the increasing usage of securitization to finance various sorts of consumer lending in recent years. Up until the Harley-Davidson case, this nexus issue was an issue that the FTB would settle. For example, the AmeriCredit case that had been appealed to the State Board of Equalization was settled on favorable terms in 2012.4 It is now unclear whether the FTB will continue to settle the issue—and if so, on what terms.

Harley-Davidson may now appeal the decision to the California Court of Appeal.

If you have questions about the Harley-Davidson case or its application to your company’s facts, please contact the authors of this alert, or the Reed Smith lawyer with whom you usually work. For more information on Reed Smith's California tax practice, visit

About Reed Smith State Tax

Reed Smith’s state and local tax practice is comprised of more than 30 lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues. Click here to view our State Tax team.

1. Docket No. CASD-37-2011-00100846-CU-MC-CTL.
2. Under the Joyce rule, which was applicable during the years at issue, an entity without California nexus would exclude its California-sourced sales from the combined reporting group’s sales factor.
3. Cal. Code Regs. Tit. 18, § 23183(b)(2).
4. In re AmeriCredit Financial Services, Inc. SBE No. 5712431 (filed May 9, 2011; settled 2012).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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