The California Franchise Tax Board has released new draft amendments to the state's market-based sourcing regulations for sales of services and intangibles.
The FTB held an interested parties meeting July 19 on the latest draft of proposed changes, which would be the second round of amendments to the state's 2013 market-based sourcing rules. The meeting was the fourth in the years-long effort to vet and finalize the changes; the last interested parties meeting was in May 2018.
The latest proposed amendments include a rewritten version of a section from the 2018 draft containing simplifying rules that establish where benefits of services sold to business or governmental customers are presumed to be received, based on what the services relate to. The location where the benefit of a service is received is used to assign the sale.
For services relating to intangible property, “the benefit of the service is presumed to be received at the location the intangible property is used by the customer,” whereas for services relating to individuals, “the benefit of the service is presumed to be received where those individuals are physically present at the time the service is received,” according to the draft. It also lays out the presumed location where the benefit of services relating to real property are received, and modifies the presumption for services relating to tangible personal property from the previous draft. The draft also addresses how to determine the presumed benefit-of-the-service location for mixed services that don’t fall into a single category.
Notably, a 2018 draft provision on the presumed location of the benefit from services related to in-state businesses has been eliminated because it was unnecessary and confusing, according to an explanation of the draft regs.
The section on sales of asset management services has also been modified and includes new language clarifying that a taxpayer’s gross receipts from managing assets are assigned to California “in proportion to the average value of interest in the asset(s) held by the asset's investors or beneficial owners domiciled in this state,” along with the calculation for determining “average value of interest.”
Another notable change to that section is the elimination of a rule in the 2018 draft that if a taxpayer didn’t know and couldn’t reasonably approximate the location of shareholders, beneficial owners, and investors for whom it manages assets, sales would be allocated to California “based upon the ratio of the population in this state compared to the population of the United States.”
The draft amendments also clarify rules for assigning gross receipts from sales of corporate stocks and ownership in passthrough entities, and dividends and goodwill. Depending on whether the majority of the assets of the corporation, passthrough entity, or dividend payor are real and/or tangible personal property or intangible property, a different method is used for assigning receipts to California. According to the newest draft, “cash, cash equivalents, prepaid items, and similar items are excluded from the asset calculation.”
That section also contains definitions of California’s payroll and property factors, which are used to assign receipts.
Safe Harbor Provision
An item that was discussed at the July 19 meeting but wasn’t included in the draft rules was a possible safe harbor provision for taxpayers providing “a high volume of identical services to business customers” that would allow them to “source such sales to the billing addresses or commercial domiciles of their customers,” to ease both administration and compliance.
Eric Coffill of Eversheds Sutherland (US) LLP told Tax Notes on July 25 that the safe harbor provision generated significant interest from the meeting attendees and that he “would not be surprised to see draft language on that item in the next draft,” predicting at least one more interested parties meeting for the amendments.
Coffill also noted that the asset management provisions were significantly altered from those in the 2018 draft. “FTB made many changes to the prior draft from the third [meeting] back in May 2018, and many of them are very significant. There is still work to be done, but FTB is making great progress,” he said.
However, Nikki Dobay of the Council On State Taxation told Tax Notes that COST still has concerns regarding the latest version of the draft amendments, arguing that the section containing the simplification rules is still potentially confusing and that the rules might create too great an onus on taxpayers to track all of their customers’ activities.
“Determining the precise location of your customer seems . . . particularly challenging,” Dobay said.
“There was also some language [that] talked about the FTB being able to look to the taxpayer’s resources to determine if they’ve done enough” to comply with the market-sourcing regulations, Dobay said. "For COST members, the fear is that for big companies,” the tax board might consider their resources sufficient to impose burdensome expectations, she added.
“We appreciate the FTB’s efforts on this, and they’ve been open to working with us,” Dobay said. “But the members are really just trying to figure out how to comply, and . . . these [rules] seem more vague in many ways.”
Comments for the draft amendments are due by August 19.