The state of California has enacted a highly controversial corporate tax system, that treats as a single enterprise all the affiliates worldwide of multinational business groups engaged in a so-called “unitary” business. The worldwide income is then allocated between California and the rest of the world using a three-factor apportionment formula based on property, payroll, and sales; California corporate tax is then charged against the California portion. The law was modified in 1988 to permit a multi-national corporate taxpayer to compute its California franchise tax liability on the basis of its U.S., as opposed to worldwide, business operations; the business in the U.S. is known as that falling within “the waters’ edge.” The U.S. taxpaying entity must include any other U.S. subsidiaries in its unitary business if those subsidiaries can be included in its U.S. federal consolidated tax return; certain foreign subsidiaries must be included if more than twenty percent of their average property, payroll, and sales are generated within the United States. However, for a foreign corporation to avail of this exception, the foreign parent company must take care to avoid substantial activity in California, i.e., activity should be by the U.S./California operating subsidiary. In practice this means that when a non-U.S. company has business activities in California, it should seek high quality tax advice; moreover, if it sets up a California subsidiary, it will need to closely monitor activities by the parent company in California, for example board meetings, management visits, and presence, etc.