The California Franchise Tax Board (FTB) has proposed amendments to its regulations that govern how sales of services and intangibles are sourced for income tax purposes. The changes to this income tax apportionment regulation will apply to nearly every corporation that pays California tax. Comments regarding these proposed changes are due no later than February 5, 2025.
On January 30, 2025, the FTB held a public hearing to solicit comments on proposed amendments to California’s market sourcing regulation, Code of Regulations, Title 18, section 25136-2. This hearing represented the latest in FTB’s almost eight-year journey to amend the regulation. See our prior coverage (here, here, and here). The current draft of the proposed amended regulation is available here.
Several commentors raised concerns about the amendments at the hearing, including members of the Eversheds Sutherland SALT Team. We raised concerns about:
- the effective date of the amendments, which, as drafted, would apply to tax years beginning on or after January 1, 2025. Commentors noted, however, that auditors have already been applying the draft regulations to prior tax years under audit, and that it would be helpful to have more clarity on the significance of the effective date.
- whether the examples in the regulation that apply a “look-through” situsing approach are clarifying former law or constituted a change in law. FTB has published guidance, Legal Ruling 2022-01, applying a “look through” approach under the current (pre-amended) regulation—creating some confusion as to whether the proposed changes to the regulation are merely clarifying or embracing a new position.
- the changes to the cascading rules for sourcing receipts from sales of services. The first cascading rule provides that the location of the benefit of the service shall be presumed to be received in California “to the extent the taxpayer’s contracts or books and records kept in the normal course of business, indicate the benefit of the service is in this state.” The first cascading rule also provides a series of additional presumptions—before you even get to the second cascading rule—based on what the service “predominantly relates to,” including either (1) real property, (2) tangible personal property, (3) intangible property, or (4) individuals. We requested guidance on whether all services are expected to fit into one of the four categories of presumptions, or if the categories are merely examples. We also requested clarification on whether the new presumptions—contained under the first cascading rule—inform the application of the other cascading rules (e.g., reasonable approximation). For example, if the service “relates to individuals” would a reasonable approximation of those individuals’ locations be a reasonable approximation method?
In the context of this formal rulemaking process, FTB is required to respond to written comments under the California Government Code. The comment period remains open until 5:00 p.m. on Wednesday, February 5, 2025. Eversheds Sutherland will be submitting written comments.
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