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California Franchise Tax Board Issues Amended Market-Based Sourcing Regulations

Summary

On September 15, 2016, the California Office of Administrative Law approved the California Franchise Tax Board’s (“FTB”) amendments to the FTB’s current market-based sourcing regulations, 18 Cal. Code Regs. § 25136-2 (the “amended regulations”) and filed the amended regulations with the California Secretary of State. The amended regulations provide sourcing rules for dividends and interest, gross receipts from sales of goodwill, and definitions for marketable securities and sourcing rules for sales of marketable securities. The amended regulations are effective retroactively to taxable years beginning on or after January 1, 2015, and affected taxpayers will have to apply the amended regulations for their 2015 California return on or before October 17, 2016. In addition, and in tandem with California’s economic/factor presence nexus statute, the amended regulations could result in income tax nexus for corporations that are currently non-filers with California and other potential California income tax consequences.

Details

Background

For taxable years beginning on or after January 1, 2011, if the former single sales factor apportionment election was made, and for taxable years beginning on or after January 1, 2013, California has required market-based sourcing for gross receipts from sales of services and intangibles.[1] As a general rule under 18 Cal. Code Regs. § 25136-2, such gross receipts are sourced based on where the “benefit of a service is received” or to the extent an intangible is used in the state.

The FTB’s existing regulations were issued on March 27, 2012, and did not provide sourcing guidance with respect to dividends, interest, and receipts from sales of goodwill or marketable securities. The amended regulations attempt to provide this guidance.

Sourcing of Dividends, Interest, and Receipts from Sales of Goodwill
The amended regulations’ sourcing rule for dividends and receipts from sales of goodwill is the same as the existing rule applicable to sales of stock and pass-through entity interests in 18 Cal. Code Regs. § 25136-2(d)(1)(A).

Dividends and receipts from sales of goodwill are sourced, as follows:

  • If 50 percent or more of the amount of the assets of a corporation or pass-through entity sold are not intangibles (using the original cost basis of the assets), then dividends and goodwill are sourced based on the average of the corporation or pass-through entity’s property and payroll factors for the most recent 12 month taxable year, or the current taxable year if the sale occurs more than six months into the taxable year; or
  • If more than 50 percent or more of the amount of the assets of the corporation or pass-through entity sold are intangibles (using original cost basis), then the dividends and goodwill are sourced based on the sales factor of the corporation or pass-through entity’s most recent 12 month taxable year, or the current taxable year if the sale occurs more than six months into the taxable year.

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This article originally appeared in BDO USA, LLP’s State and Local Tax Alert – September 2016. Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com.

 

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