The California Franchise Tax Board (FTB) announced it has initiated the formal rulemaking process to amend Regulation Section 25136-2, which governs the sourcing of receipts from services and intangible property. The proposed changes would apply to taxable years beginning on or after January 1, 2024.
The proposed amendments include several significant updates that could impact how taxpayers assign receipts for California apportionment purposes:
- New cascading rules for sourcing receipts from services, which eliminate the consideration of where an order was placed.
- Adding an example applying look-through sourcing for logistics services.
- Adding an example sourcing digital advertising revenue based on the circulation factor of the particular ad.
- Adding an example sourcing a pharmaceutical R&D milestone payment to the location where the drug is tested in clinical trials.
- New rules for asset management fees based on the average value of assets held by investors or beneficial owners.
- New rules for professional service providers with more than 250 customers.
- Guidance for reasonably approximating the location where an intangible is used after a complete transfer of all property rights.
- New rules for bundled services and intangibles, clarifying treatment when services and intangible property are sold together.
- Clarification that intermediaries are disregarded when identifying the customer of marketable securities.
- Modification to the use of foreign populations in sourcing rules, limiting the inclusion to “foreign jurisdictions or geographic areas” where sales are made, rather than the broader “foreign countries” when using population-based reasonable approximation. However, the amendments do not address whether California’s population can be limited to localities where sales are made.
The proposed changes could significantly impact taxpayers with substantial receipts from services or intangibles. Recent court decisions have emphasized the importance of analyzing proposed regulations in detail, as courts have held that when a regulation is more specific than the governing statute, the regulation can override a conflicting statutory provision. Thus, taxpayers should carefully review these changes and consider providing input.
Although the FTB has not scheduled a public hearing, it will hold one if requested by October 16, 2024. Taxpayers are encouraged to submit requests or comments on the proposed amendments by 5:00 PM PT on October 31, 2024. Submissions should be directed to Hanna Cho, Attorney (hanna.cho@ftb.ca.gov).