A recent decision out of the Los Angeles County Superior Court marks a significant win for taxpayers involving the use of alternative apportionment and successful challenges to the Franchise Tax Board’s (“FTB”) regulations, which the court found to be inconsistent with the statute as applied.
On February 26, 2026, the court in Smithfield Packaged Meats Corp. v. California Franchise Tax Board ordered the FTB (in a Proposed Statement of Decision, which becomes final after an objection period closes and any objections are resolved) to grant a refund on the basis that Smithfield was entitled to apportion its income using a three‑factor apportionment formula applicable to agricultural businesses (or, alternatively, under California’s alternative apportionment statute), rather than California’s general sales factor only apportionment formula.
Smithfield is the world’s largest hog producer and operates a vertically integrated business that includes hog production, harvesting, and packaged meats operations. In 2014, Smithfield raised and harvested millions of hogs through a nationwide network of farms, feed mills, and harvesting facilities, almost all of which were located outside California. None of Smithfield’s hog farms, breeding stock operations, or harvesting facilities were located in California, and only one small packaged meats facility operated in the state. Smithfield demonstrated that approximately 1% of its income‑generating activities occurred in California, yet California’s general sales factor only apportionment formula attributed more than 6.6% of Smithfield’s income to the state.
Smithfield & FTB Arguments
Smithfield filed a refund claim asserting two arguments:
- First, Smithfield asserted that it derived more than 50% of its gross receipts from “agricultural business activity” and therefore was statutorily required under California Revenue and Taxation Code (“CRTC”) section 25128(b) (the “Statute”) to use a three‑factor apportionment formula based on property, payroll, and sales.
- Second, Smithfield asserted that even if it were not an agricultural business, it was entitled to alternative apportionment under CRTC section 25137 because the sales factor only apportionment formula did not fairly represent its business activity in California.
The FTB denied the refund by relying on California Code of Regulations, title 18, section 25128‑2 (the “Regulation”). Unlike the Statute, the Regulation applied a “product‑based” approach to determine whether a taxpayer was primarily an agricultural business and entitled to the special apportionment formula. The product-based approach looked at the character of the final product sold by the taxpayer, and because the final product was all “processed” none of Smithfield’s activities generated receipts from agricultural activities. Consequently, Smithfield was not entitled to use the special apportionment formula.
Decision
The court rejected the FTB’s approach and held that the Regulation is invalid as applied. The court emphasized that the Statute looks exclusively to a taxpayer’s business activities, not to the character of the final product sold. By focusing solely on whether the final product had been “processed,” the Regulation disregarded nearly all of Smithfield’s agricultural hog production and harvesting activities, which comprised the majority of its business operations. The court further found that nothing in the Statute authorizes a product‑based test, and that the Regulation impermissibly narrowed the Statute and conflicted with its purpose “to prevent penalizing businesses which have no choice as to their ‘manufacturing’ location.” Notably, in reviewing and invaliding the regulation as applied to Smithfield, the court emphasized that it does not defer to an agency’s interpretation of an ambiguous statute and followed the general principle that any ambiguity in a tax apportionment statute should be interpreted in the taxpayer’s favor.
Alternatively, the court agreed that Smithfield was entitled to alternative apportionment under CRTC section 25137 because the disparity between the location of Smithfield’s income‑generating activities and the income attributed to California under the sales factor only formula was extreme. The court noted that attributing more than 6.6% of its income to California when only about 1% of the relevant activities occurred there constituted distortion of more than 600%. That difference justified the application of alternative apportionment pursuant to the alternative apportionment cases of Microsoft Corp. v. Franchise Tax Bd., 39 Cal. 4th 750 (2006) and General Mills, Inc. v. Franchise Tax Bd., 208 Cal. App.4th (2012). The court held that the traditional three‑factor formula was a reasonable alternative to the sales factor only formula applicable if Smithfield was determined to not be an agricultural business under the Statute. The court referred to the traditional three factor apportionment formula as “the ‘benchmark’ formula [used] by the United States Supreme Court and the California Supreme Court” citing Container Corp. of Am. v. Franchise Tax Bd. 463 U.S. 159 (1983).
The court also rejected all of the FTB’s procedural defenses, including arguments that Smithfield lacked standing, failed to exhaust administrative remedies, and was barred from introducing evidence at trial that had not been provided during audit. In particular, the court rejected the FTB’s position that the record is fixed at audit, noting that such a rule would effectively “turn every audit into a full‑blown trial” and is inconsistent with both FTB practice and well‑established law governing refund actions, which are tried de novo.
This case marks a significant win for taxpayers because of its use of alternative apportionment and the invalidation of an FTB regulation as applied to a taxpayer. While Superior Court cases are not precedential, and this case is likely to be appealed, the judge’s reasoning provides a roadmap to qualify for alternative apportionment in the context of distortion caused by the application of a sales factor only apportionment formula. Taxpayers should examine whether the reasoning in Smithfield creates avenues to argue for application of a three-factor apportionment formula.
Contact the Authors: Kent Strader, Dmitrii Gabrielov, Matt Musano
