Chaos resulting from the California budget crisis reached a crescendo in recent weeks because of a new budget agreement, a bevy of voter referendums addressing tax legislation, and new regulations addressing corporate income tax apportionment issues. In the aftermath of the chaos, California has again significantly modified its corporate income tax apportionment provisions, for the second time in the last two years.
The first major event occurred on October 8, when the California Legislature approved a set of budget bills that were signed by Governor Schwarzenegger. The budget bills included SB 858, which made two significant changes to California’s corporate income tax regime:
- Enacted modifications to California’s sales apportionment factor sourcing provisions; and
- Imposed a two-year suspension on utilization of Net Operating Losses (NOL) for the 2010 and 2011 tax years.
By way of background, California’s costs-of-performance methodology had been repealed (and replaced with market type sourcing provisions) through legislation passed in February 2009; however, the repeal was not set to become effective until January 1, 2011. This change from costs-of-performance to market-based apportionment was made along with the enactment of an election available to most taxpayers to annually choose to use a single sales factor (rather than a formula comprised of property, payroll, and double-weighted sales). SB 858 changes this regime and provides that effective January 1, 2011:
- Taxpayers that do not elect single sales factor apportionment (either because the election is not available or the election is not made) are required to use California’s costs-of-performance methodology to source receipts from “other than sales of tangible personal property” (e.g., receipts from intangibles and services).
- Taxpayers that elect to apportion income via a single sales factor apportionment formula are required to source receipts from “other than tangible personal property” via California’s market sourcing provisions.
At the time of enactment of SB 858, the fate of California’s single sales factor election—which was not set to become effective until January 1, 2011—was left to California voters through Proposition 24, which would have repealed the election. Proposition 24 was defeated, and therefore the annual single sales factor election survives.
At the same time that California’s legislature enacted legislation that modified California’s corporate income tax sourcing regime, the California Franchise Tax Board (FTB) issued new proposed regulations for applying its market-based apportionment rules to the sourcing “of sales other than sales of tangible personal property in the state.” Under the FTB’s proposed Regulation Section 25136, sales of services are generally assigned to California “to the extent the customer of the taxpayer receives the benefit of the service” in the state. However, the proposed regulations provide for a cascading set of rules that considers other differing factors for individual customers and business customers to the extent the location where the “benefit of the service” is received is not determinable. The other factors are more complex rules for business customers. For receipts from intangible property, Reg. 25136 provides for varying rules depending on the type of intangible generating receipts, whether there is a complete transfer of the rights in the intangible, and whether there is exclusive use of the intangible in California or use in multiple states. These receipts may be sourced to California if any of the criteria are satisfied under a tiered methodology.