California Court Opens the Door to Three-Factor Apportionment for Capital-Intensive Businesses

In a decision that could reshape how multistate companies apportion income to California, the Los Angeles County Superior Court ruled in Smithfield Packaged Meats Corp. v. California Franchise Tax Board (No. 21STCV39637) that the taxpayer was entitled to use a three-factor apportionment formula (based on property, payroll, and sales) rather than California’s standard single-sales factor method. The statement of decision, originally issued as a proposed statement of decision on February 26, 2026 and entered as a final statement of decision on April 28, 2026, has drawn significant attention from the state and local tax community for its potential implications well beyond the agricultural industry. Although the decision remains subject to potential appeal, it provides meaningful support that taxpayers should be evaluating now when considering refund claims, prospective filing positions, and audit strategies.

Smithfield v. FTB: What the Case Was About

Smithfield, the world’s largest hog producer, operates a vertically integrated business spanning hog farming, harvesting, and packaged meat production. Virtually all of its thousands of farms, harvest facilities, and processing plants are located outside California; its only in-state presence was a small processing facility accounting for less than half a percent of total product volume. Despite this minimal California footprint, the company’s use of a single-sales factor formula attributed over 6.6% of its income to the state, which is more than six times the percentage that Smithfield’s expert calculated based on the company’s actual business activities in California.

Smithfield filed a refund claim arguing it should have used the equally weighted three-factor formula available to agricultural businesses under California Revenue and Taxation Code (CRTC) § 25128(b), or, alternatively, that the single-sales factor produced a distortive result warranting relief under CRTC § 25137.

How the Court Ruled: Three Independent Grounds for Relief

The court ruled in Smithfield’s favor on three independent grounds.

Ground 1: Smithfield Qualified as an Agricultural Business

The court held that Smithfield qualified as an agricultural business because more than 50% of its gross receipts were derived from agricultural activities, including raising, feeding, managing, and harvesting hogs. Critically, the court focused on the nature of the taxpayer’s activities rather than the character of the final products sold, and rejected the Franchise Tax Board’s (FTB) product-based approach that treated all receipts from processed meat as non-agricultural.

Ground 2: FTB Regulation 25128-2 Invalidated as Exceeding Statutory Authority

The court found that the FTB’s interpretive regulation conflicted with the plain statutory language of Section 25128. Where the statute looks to a taxpayer’s agricultural activities, the regulation focused almost exclusively on the end product. The court concluded the regulation impermissibly narrowed the statute’s scope and was invalid as applied to Smithfield.

Ground 3: Alternative Apportionment Available Even Without Agricultural Classification

Lastly, the court held that even if Smithfield did not qualify as an agricultural business, it would still be entitled to use a three-factor formula. The court gave a broad reading to ‘business activity’ under § 25137, concluding that it captures all activities that generate income for the taxpayer, not only those reflected in the sales factor but also those measured by the property and payroll factors. Because the single-sales factor ignored Smithfield’s substantial out-of-state workforce and facilities, it did not fairly represent the company’s California business activity. The court found the standard UDITPA three-factor formula to be a reasonable alternative, noting its longstanding use as a benchmark by both the U.S. and California Supreme Courts.

Which California Taxpayers Should Act on the Smithfield Decision

The Smithfield decision carries implications that extend well beyond hog farming or even the agricultural sector. Several categories of taxpayers should take note.

Capital-intensive and manufacturing businesses

Companies with significant property and payroll concentrated outside California may now have stronger grounds to argue that the single-sales factor overstates their in-state activity. The court’s broad reading of “business activity” under § 25137 means that payroll and property, and not just sales, are relevant measures when evaluating whether the standard formula produces distortive results. Any business whose California sales percentage materially exceeds its share of in-state property and payroll may have a viable claim for alternative apportionment.

Agricultural Businesses Selling Processed Products

Taxpayers in the agricultural space that were previously denied three-factor treatment because their end products were deemed “processed” should reconsider their positions. The court’s activity-based approach to § 25128 and its rejection of the FTB’s product-focused regulation could change the calculus for many agribusinesses.

Taxpayers Challenging FTB Regulatory Overreach

The invalidation of Regulation 25128-2 provides useful support for taxpayers who believe FTB regulations have gone beyond what the underlying statute authorizes. This holding has potential relevance in a variety of contexts where taxpayers believe regulatory interpretations have strayed from legislative intent.

Life sciences and pre-revenue companies

The decision may be particularly relevant for life sciences companies, many of which have no sales at all during early-stage development or experience highly inconsistent revenue streams driven by one-off licensing transactions, milestone payments, option payments or other collaboration/license agreement transactions. The FTB has historically been willing to grant alternative apportionment petitions allowing a two-factor payroll and property formula when a taxpayer has no sales to include in the denominator, which can be critical for California-headquartered companies seeking to generate usable California NOLs during pre-revenue years. Smithfield reinforces the conceptual underpinning of those petitions by recognizing that “business activity” under § 25137 captures property and payroll, not just sales.

A more challenging scenario arises when a company does have a sale which is a one-off or irregular transaction that may not fit neatly within the framework of the substantial and occasional sale rules under Regulation 25137(C). In those situations, a single large transaction can dramatically skew the sales factor in ways that bear no relationship to the company’s ongoing business activity in California. Smithfield’s recognition that a 600%+ disparity between in-state activity and sales-based apportionment was distortive offers a useful reference point. Life sciences taxpayers whose facts approach or exceed that level of mismatch, whether driven by an anomalous transaction, by a heavy out-of-state licensee base, or by other features of their revenue profile, now have a recent, on-point articulation of why a single-sales factor can fail to fairly represent California operations. For these companies, a petition for alternative apportionment using a two-factor or three-factor formula may now warrant fresh consideration. Alternatively, where a single transaction is at risk of exclusion under Regulation 25137(c) but the taxpayer’s facts suggest exclusion itself would be distortive, a petition for inclusion of the specific transaction may be worth evaluating.

Multistate Applicability: Implications Beyond California

Because the court’s alternative apportionment analysis rests on UDITPA § 18 principles, language which specifically appears in many states’ tax codes, the reasoning may support similar challenges in other single-sales factor jurisdictions. Commentators have already noted potential relevance in states such as Pennsylvania and New Jersey, where similar cases are reportedly pending.

What to Do Now: Statute of Limitations and Filing Strategies

Taxpayers evaluating their options in light of Smithfield should keep several things in mind. California’s statute of limitations for refund claims is generally four years, so companies that may benefit from three-factor apportionment should assess their open tax years promptly. Requests for alternative apportionment generally must be made and approved before filing a return in order to avoid penalties, making advance planning essential for prospective positions. Additionally, taxpayers may also be able to raise alternative apportionment arguments during an audit as an offset.

It is worth noting again that the decision remains subject to potential appeal. Nonetheless, it provides meaningful guidance that taxpayers can use today when evaluating refund opportunities, future filing strategies, and audit defense positions.

If you have any questions on how this applies to your business, contact our state and local tax team here.