California steps up for tax fairness

Picture the scene. It’s August in New York and international negotiators are meeting to continue moves to ensure that multinational companies are finally required to pay taxes according to where their real economic activity takes place.

Only one country is missing from around the table – the United States. Despite physically hosting the discussion, the Trump administration refuses to participate in the talks that will define the UN Framework Convention on International Tax Cooperation.

Trump support for tax abuse – at the expense of the US

This is part of a pattern. After coming to power in 2025, the administration upended everything that had been negotiated at the OECD since 2019. First they vetoed ‘pillar one’ of the agreement, and then they demanded an exemption from most of ‘pillar two’ – which was largely designed by the US to begin with. Now the negotiations have moved to the UN, and the US is being left behind.

When combined with the deeply damaging Tax Cuts and Jobs Act passed by the first Trump administration, the result is that US multinationals are now shifting twice as much profit out of the countries where they do business.

But don’t imagine that the US is benefiting. On the contrary, those multinationals are paying even less tax to the US than they did before. Don’t think that foreign multinationals are lining up to pay tax either – when in Rome, after all. Nor has the US gained any jobs from giving away the farm – so pretty much everyone is a loser.

That includes US states, who typically base their state-level corporate income tax on whatever the US administration accepts at federal level, adjusted for the state’s share of the multinational’s real (US) economic activity. So as the second Trump administration again lets multinationals, US and foreign, walk all over their tax obligations, that laxness deprives the states of revenue too.

And this is where California is stepping up.

Pay where you play

The US states, just like the provinces of Canada and the cantons of Switzerland, among others, use a taxing method known as formulary apportionment to determine their corporate taxes. A multinational’s total profits are added together and then distributed to states according to the share of its economic activity taking place there. Each state is then allowed to tax the share of profits that fits its share of the multinational’s employees, assets, or sales. For instance, if half of the employees and half of the sales are happening in California, California would be allowed to tax half of the profits.  

The key point is to make sure that companies pay where they play – rather than making their profits in one place, but declaring them somewhere else for tax purposes.

The reason to rely on this formulary apportionment method is that the basis of international corporate tax rules – the arm’s length principle – is unfit for purpose. This approach allows multinational groups to set ‘transfer prices’ for the exchange of goods and services between sister companies, as if they were operating independently (at arm’s length from one another). Inevitably, multinationals succumb to the temptation to manipulate these transfer prices in order to shift the group’s profit into entities in other jurisdictions where they will pay little or no tax. This allows companies to pay where they say the profits are, instead of where they actually arise.

The growing importance of intangible assets such as corporate brands and intellectual property, and the more recent phenomenon of digitalisation, has made it increasingly difficult for tax authorities to challenge abusive transfer prices. The result is that the scale of profit ‘misalignment’ – the share of multinationals’ profits that are declared where they say, instead of where they play – has rocketed. Back in the early 1990s, around only 5% of the global profits of US multinationals were misaligned in this way. That doubled within the decade and continued to rise ever since, reaching 20% by the 2010s and an average of 24% for 2016-2021 – supercharged by the Tax Cuts and (No) Jobs Act.

The current Trump administration’s recent changes, and undermining of even the limited OECD reforms, have further exacerbated the problem. Major US tech companies now pay tax at effective rates that are barely into double digits. Pharma companies and others channel vast profits through Switzerland, Ireland, Puerto Rico and Singapore.

That’s why the countries of the world, with the exception of the refusenik Trump administration, are now negotiating on a UN tax convention that would commit to allow all states to exert taxing rights over economic activity in their jurisdiction. This lays the base for the subsequent Conferences of the Parties to agree a formulary apportionment approach – an approach that may already be embedded in the protocol for taxing crossborder services which is being negotiated alongside the convention.

California points the way

The state of California is now pioneering the approach in the US. At present, and like a number of US states, California offers companies an election: for the apportionment of tax base that underpins their state tax liability, they can either be assessed on their declared US profit, or they can elect to be assessed on the appropriate share of their global profit. To the extent that the US share of profits has historically been less than its share of economic activity, it has almost always been cheaper for multinationals to pay state tax on the basis of their US profits – and so they elect for ‘water’s edge’ option, where the assessment stops at the US border.

California’s proposed legislation, AB 1790, would end this election and require companies to be assessed on the unitary basis – according, that is, to the global profits of the whole group, rather than the claimed US profits only. This would mandate ‘Worldwide Combined Reporting’ (WWCR). That is, companies would have to report the global activity and profits of their group.

If the legislation passes, California will cut through the abuses of the arm’s length principle and simply tax multinationals according to California’s fair share of each group’s global economic activity. This will not only point the way for other US states to follow, but also aligns with the direction of travel for negotiators at the UN: away from the obsolete arm’s length principle, and towards a system of taxing rights based on the location of real economic activity.

As this new future of corporate taxation comes ever more closely into view, California’s policymakers are weighing up their opportunity to end the loophole of the water’s edge election and mount a powerful defence of their tax base. 

Thinking of the questions that policymakers might have, we’ve put together a Q&A based on close engagement with expert allies. The full text is below, or you can download a pdf.

Q&A on California’s proposed legislation on Worldwide Combined Reporting (WWCR)

Q1. How do multinational companies use profit shifting to avoid US state taxes?

In US states, a corporation’s income tax base essentially begins with its federal tax base. That means that the offshore profit shifting that drains the federal tax base drains the state tax base as well. Profit shifting schemes take different forms, many incredibly complex and intentionally opaque. Often, they are engineered by creating paper transactions among artificially manipulated legal entities, typically in the types of jurisdictions that top our Corporate Tax Haven Index – while the real economic activity that produced those profits never moves at all.

Q2. Do traditional anti-abuse rules eliminate state tax avoidance?

No. Traditional anti-abuse rules still rest on the legal fiction that the prices for internal transactions in a multinational group, including of subsidiaries transacting with their controlling parent, can be set as if they were independent equals operating at ‘arm’s length’ from each other in a free market. This absurdity allows multinationals great leeway in practice to manipulate these transfer prices in order to make sure the profit from economic activity in one place, is declared in a much lower-tax jurisdiction elsewhere.

Q3. How does WWCR end multinational state tax avoidance?

Worldwide Combined Reporting (WWCR) ends multinationals’ state tax avoidance by taxing them based on economic reality instead of on embarrassing fictions. When a commonly controlled group of affiliates are functionally integrated and mutually interdependent, as virtually all multinationals are, then WWCR treats them all as a single taxpayer. It requires complete reporting of the entire group’s profits, everywhere. Then, to determine what portion of those profits the state may fairly tax, it uses a standard “apportionment formula” (for example, the group’s in-state share of its worldwide sales and employment).

Under WWCR, the entire group’s worldwide profits are in the tax base, so shifting profits around the group achieves nothing. And corporate state-tax avoidance disappears.

Q4. Does WWCR have any impact on corporate location decisions?

Under WWCR, corporate relocation threats are hollow. The cost and disruption of relocating significant operations out of state can be enormous. Such decisions are based not on marginal increases in tax costs but on access to infrastructure, resources, trained workers, and customers. And, in the majority of states that apportion taxable profits by sales alone, relocation would not avoid a single dollar of tax.

Furthermore, no executive could credibly justify, to shareholders, the decision to abandon a profitable market over the end of an unfair tax advantage. If anything, WWCR improves the business climate: it levels the playing field for local small and medium-sized businesses that do not have shell companies in offshore tax havens. And this is crucial: by ending the unfair tax advantage that multinationals have over the smaller, local businesses that typically provide the bulk of employment and economic dynamism, WWCR is a fundamentally pro-business measure.

Q5. Why will corporate owners, not customers, be impacted by WWCR?

WWCR’s economic incidence falls on those who actually pocket the profits — shareholders and senior executives — not consumers. The multinationals that will pay more under WWCR are not businesses competing on thin margins; they are the giants whose profits flow from market dominance, valuable intangibles, pricing power… and tax avoidance. Economic research consistently finds that this windfall — what economists call “supernormal profits” or “excess rents” — accrues to corporate owners, not customers. In fact, some research shows that where multinationals have engineered lower effective tax rates, even shareholders do not gain – they appear to receive no higher return, but they do end up taking on greater risk because the shares of aggressive tax-avoiders become more volatile. Customers never share the upside when these corporations book outsized profits. They will not bear the downside when WWCR captures part of those profits as state tax.

Q6. What ensures that WWCR taxes only those profits attributable to each state?

Two long-established principles ensure that each state taxes only its fair share. The “unitary business principle” treats an integrated and interdependent multinational corporate group as the single enterprise that it is in the eyes of management and financial regulators. “Formulary apportionment” then calculates the state’s fair share by an objective formula — for example, its share of the group’s worldwide sales, employment, etc. Picture the group’s worldwide profits as a pie: if 2 per cent of the group’s worldwide sales are to in-state customers, and 2 per cent of the group’s employees work there, the state’s slice is 2 per cent of the pie. That slice reflects in-state economic activity, not foreign profits. There is no double taxation.

The US Supreme Court has confirmed that WWCR, operating this way, does not tax “extraterritorial values.” And that makes sense, because if every state and every country took this same approach, the tax base would be precisely defined and apportioned among the different jurisdictions. No profits would be taxed in two different places; and no profits would be left entirely untaxed.

Q7. Is the legality of WWCR firmly settled?

Yes — and twice over. The US Supreme Court has upheld WWCR in Container Corp. v. Franchise Tax Board (1983), as applied to a US-based multinational, and again a decade later in Barclays Bank PLC v. Franchise Tax Board (1994), as applied to foreign-parent multinationals. Both decisions rest on principles of state taxing power and federalism that have remained stable across changes in the Court’s composition.

Q8. Is WWCR consistent with current global aims to stop tax avoidance?

Fully consistent. Article 5 of the draft United Nations Framework Convention on International Tax Cooperation being negotiated today shares the goals of WWCR, indicating that each countries’ taxing rights should be tied to the economic activity that they host. Also, for more than a decade, foreign governments have worked with the OECD on the Base Erosion and Profit Shifting (BEPS) initiative and its successor framework, Pillar One and Pillar Two. Both efforts expressly recognize the serious harm aggressive corporate profit shifting causes to public revenues worldwide.

The multilateral convention to implement Pillar One has been vetoed for now by the Trump administration, but the US was a party to the agreement and the process by which Pillar One developed the technical basis to apply unitary taxation for the first time within OECD rules. Pillar Two was intended to apply a minimum rate of tax on the profits of multinationals, in whichever country they were declared. The Trump administration has also undermined this by insisting on exemptions from key elements for US multinationals – freeing them of any constraint on profit shifting. Nonetheless, the expressed intentions to ensure multinationals pay fair tax rates, and are taxed in the places where they carry out their economic activities, are well established. No foreign government can credibly retaliate against a US state for adopting a policy aligned with the international consensus that government itself helped build.

Q9. Do powerful global corporations have the resources to comply with WWCR?

Yes — abundantly. Under the WWCR Model Statute, only corporate groups with $1 billion or more in annual revenues are required to use WWCR. These huge multinational corporations already maintain comprehensive worldwide financial data for consolidated reporting under securities laws, federal corporate minimum-tax obligations, and a growing set of international transparency standards. They already devote enormous resources to designing the complex schemes by which they shift profits in the first place; the additional work to comply with WWCR is modest by comparison.

Q10. Will revenue department enforcement of WWCR ultimately be easier?

Yes — after a reasonable start-up period. WWCR replaces the never-ending chase to identify and untangle complex profit shifting schemes with a combined report and an objective apportionment formula. There is one corporate group, one set of worldwide books, and no transfer-pricing dispute to relitigate year after year. State revenue departments can build the necessary expertise within a normal lead-in period — typically a year — by training auditors, hiring international-tax specialists, and updating systems. The expertise is widespread: Alaska has mandated WWCR for oil-and-gas corporations for decades, and a number of other states already audit elective WWCR filings with success.

Q11. How is WWCR’s modern revival grounded in history?

Solidly. By the early 1980s, twelve US states had adopted mandatory WWCR and successfully defended it in the US Supreme Court. This closed the profit shifting loophole for large multinational tax avoiders, who reacted by pressuring the UK’s Thatcher administration to press the Reagan administration to demand that the states retreat. WWCR was abandoned not because it failed, but because Washington forced the states’ hand.

No such pressure campaign could work today, when the problem of profit shifting by aggressive global corporations is widely understood and condemned – including by the UK public. States revisiting WWCR are returning to a tested, court-affirmed framework on far stronger ground than four decades ago.

Q12. Why is California the heart of WWCR’s revival?

California is the birthplace of Worldwide Combined Reporting. The unitary business principle on which WWCR rests was forged largely in the state’s tax cases before the US Supreme Court. In the early 1980s, California became the first state to mandate WWCR. Four decades later, in 2026, the state again leads: a bill based on the widely respected WWCR Model Statute passed favourably out of the Assembly Revenue and Taxation Committee — the first WWCR bill to clear any California legislative committee in more than 40 years, and a development closely watched in other state capitols. With the global momentum to ensure taxing countries’ rights are aligned with their share of multinationals’ economic activity, California is set to lead nationally on an issue where the US administration has simply vacated its role.