California Court Lays Groundwork for Wider Use of Three-Factor Apportionment

A California superior court recently held that a hog farming company was entitled to use a three-factor formula to apportion its income to California (Smithfield Packaged Meats Corp. v. California Franchise Board, No. 21STCV39637 (Cal. Sup. Ct. 2026)).

Smithfield Packaged Meats Corp. raises and processes hogs for sale as final pork products, with most of its business operations being agricultural hog production and harvesting activities. In assessing Smithfield’s California corporate tax responsibility for tax year 2014, the Franchise Tax Board (FTB) focused solely on the character of the final products rather than the agricultural nature of the company’s hog production and harvesting activities. 

First, Smithfield argued that it improperly apportioned its 2014 income on its originally filed return because it used the single-sales factor apportionment formula. It filed a refund claim arguing that it was entitled to a three-factor apportionment formula (payroll, property, and sales) reserved for agricultural businesses. Smithfield argued that it derived more than 50% of its gross business receipts from agricultural activities, so the statute required it to use three-factor apportionment rather than the statutory single-sales formula. 

The Los Angeles County Superior Court agreed, saying that by focusing on the character of the final product, the FTB’s interpretation of California Rev. & Tax. Code (CRTC) §25128 disregarded nearly all of Smithfield’s agricultural activities, which made up the majority of the company’s operations.

The court also held that the FTB’s interpretive Reg. 25128-2, which resulted in the FTB disregarding nearly all of Smithfield’s agricultural business activities, was inconsistent with CRTC §25128, which looks expressly and exclusively to receipts of a taxpayer’s agricultural activities and not to receipts from the final products. Therefore, as applied to Smithfield, the court found the FTB regulation inconsistent with the governing statute and thus invalid.

Finally, the court found that even if Smithfield was not an agricultural business required to use three-factor apportionment under CRTC §25128, the use of a single sales factor was distortive enough to warrant alternative apportionment under CRTC §25137 and that a three-factor formula was a reasonable alternative. It concluded that because Smithfield’s business activity from all income-generating activities was also represented by its property and payroll factors, which were largely located outside California, it was entitled to include those factors when determining its business income in California.