Did the section 24402 dividend exception in California's historical interest-offset computation apply to a foreign-domiciled recipient corporation?

Plain-English summary

California Legal Ruling 379 held that dividends qualifying for the former section 24402 deduction were excluded from the section 24344(b) interest-offset computation regardless of the recipient corporation's commercial domicile.

A foreign-domiciled corporation therefore could reduce the relevant dividend income by the section 24402 deduction before using that income to offset interest expense.

The ruling rejected the contrary situs-based approach in Legal Ruling 128 to the extent of inconsistency.

How the historical interest offset worked

For a taxpayer using formula apportionment, former section 24344(b) first allowed interest income subject to formula allocation and then compared the remaining interest expense with interest and dividend income outside the formula.

The statute's parenthetical phrase excluded "dividends deductible under the provisions of Section 24402" from the dividend income used in that offset.

The question was whether that exclusion applied when the corporation receiving the dividend was commercially domiciled outside California.

Why FTB rejected a domicile limit

Legal Ruling 128 had concluded that foreign-situs dividends were not eligible for the predecessor dividend deduction and therefore had to be used in full when measuring disallowed interest.

That earlier ruling relied partly on former Regulation 24121(b), which imposed a situs requirement. By 1974, that regulation had been repealed, and the replacement Regulation 24344(a)(2) did not contain the same requirement.

FTB also relied on a California Supreme Court decision discussing foreign-domiciled corporations and stating that the statutory parenthetical excluded dividends declared from California-taxed income.

The operative rule

The phrase "dividends deductible under the provisions of Section 24402" referred to the type of dividend allowed as a deduction, not the commercial domicile of the recipient.

Accordingly:

1. Determine whether the dividend qualified for the former section 24402 deduction.
2. Reduce dividend income by that deductible amount.
3. Use the remaining interest and dividend income in the section 24344(b) offset computation.

The same treatment applied to a foreign-domiciled recipient corporation.

Effect on Legal Ruling 128

Legal Ruling 379 expressly prevailed over Legal Ruling 128 wherever the two were inconsistent.

The change reflected the repeal of the earlier situs regulation, the wording and purpose of section 24402, and the cited court's interpretation of the parenthetical exception.

What this means for you

Multistate and foreign-domiciled corporations

Under the historical ruling, commercial domicile did not by itself prevent the dividend deduction from reducing the income used to offset interest expense.

Corporate tax departments

The classification of the dividend under section 24402 came before the interest-offset calculation. The entire dividend was not automatically included merely because the recipient was domiciled elsewhere.

Accountants and tax professionals

This ruling applies repealed or superseded provisions. Confirm the current dividend deduction, interest limitation, apportionment, and sourcing rules rather than reusing the historical computation.

Common questions

Q: Did the recipient have to be commercially domiciled in California?

A: No. The ruling applied the dividend exception regardless of commercial domicile.

Q: Was the entire dividend used to reduce deductible interest?

A: No. Dividend income first was reduced by the amount deductible under former section 24402.

Q: Why did FTB depart from Legal Ruling 128?

A: The earlier situs regulation had been repealed, the newer regulation omitted that restriction, and the cited court interpreted the statute differently.

Q: Which ruling controlled if the two conflicted?

A: Legal Ruling 379.

Q: Is this the current interest-deduction rule?

A: No. It explains a 1974 computation under former statutes and regulations.

Citations and references

• Former Cal. Rev. & Tax. Code §§ 24344(b) and 24402
• Cal. Rev. & Tax. Code § 25101
• Former 18 Cal. Code Regs. §§ 24121(b) and 24344(a)(2)
• 7 Cal. 3d 544 (1972)
• Legal Ruling 128 (overridden to the extent inconsistent)

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 379

Original ruling text

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Legal Ruling 379

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division

November 14, 1974

Franchise Tax - Interest Equivalent Offset Computation Under Section 24344(b)

The parenthetical phrase, "except dividends deductible under the provisions of Section 24402," in Revenue and Taxation Code Section 24344(b), refers to dividends of the type allowed as a deduction by § 24402, irrespective of the commercial domicile of the recipient corporation.

Section 24344(b) of the Revenue and Taxation Code provides:

(b) If income of the taxpayer is determined by the allocation formula contained in Section 25101, the interest deductible shall be an amount equal to interest income subject to allocation by formula, plus the amount, if any, by which the balance of interest expense exceeds interest and dividend income (except dividends deductible under the provisions of Section 24402) not subject to allocation by formula. Interest expense not included in the preceding sentence shall be directly offset against interest and dividend income (except dividends deductible under the provisions of Section 24402) not subject to allocation by formula.

In determining the interest allowable under the second step, the section provides that interest paid shall be reduced by dividend and interest income received. It is further provided by way of the parenthetical phrase that dividend income shall first be reduced by the § 24402 deduction.

The question at issue is whether the parenthetical phrase refers to dividends received by a foreign domiciliary corporation. In December of 1958 the department published Legal Ruling No. 128. The legal ruling provides in part:

. . . Since dividends with a situs outside the State were not included in income in the first instance, no part of such dividends are deductible under Section 24121j, therefore, the entire amount must be used to measure the amount of interest expense to be disallowed under alternative computation No. 1. The regulation specifically sets forth that the exception as to Section 24121j dividends was not applicable to dividends with a situs outside the State.

This ruling was based in part on Cal. Admin. Code, tit. 18, Reg. 24121(b). Regulation 24121(b) has since been repealed. Regulation 24344(a)(2) issued in April of 1972 does not contain the situs requirement of Regulation 24121(b).

The most recent case considering the § 24344(b) interest offset was Pacific Telephone and Telegraph v. Franchise Tax Board, 7 Cal. 3d 544 (1972). At page 555 of that decision, the court, in referring to a foreign domiciliary corporation, stated:

. . . At the outset it must be pointed out that the fact that the corporation declaring the dividend does no business in the state points in the direction of tax consequences in California rather than away from such consequences. Under Section 24402, dividends declared from income due to California activities are deductible, and subsection (b) in the parenthetical phrase expressly excludes those dividends from the subsection computation. Thus, the dividends which have tax consequences under the franchise tax are those which are not declared from income due to California activities. . . . (Emphasis added.)

By virtue of this statement, the court indicates that dividends declared out of California taxed income will be allowed as a deduction to foreign domiciliary corporations in computing the interest offset. This interpretation follows the original explanation of the parenthetical phrase given at the time of its enactment in 1937. The allowance of a § 24402 deduction on foreign situs dividends in the interest offset computation is also consistent with the purpose of § 24402.

The Revenue and Taxation Code § 24344(b) parenthetical phrase shall include dividends of the type allowed as a deduction by § 24402, regardless of the commercial domicile of the recipient corporation, and to the extent of any inconsistency with Legal Ruling No. 128, this ruling shall prevail.

Last updated: 09/24/2025