06/08/2011 01:17:00 PM EST
"All or Nothing" Approach to Attributing Sales: A California Tax Practice Insights Commentary
For tax years beginning prior to 2011, California took an "all or nothing" approach to sourcing sales, other than sales of tangible personal property (i.e., sales of intangible personal property and sales from performance of personal services), where "income-producing activity" was in more than one state. If the income-producting activity was exclusively in California, sales, other than sales of tangible property, were considered to be "in this state" for purposes of the sales factor formula for apportionment. Cal. Rev. & Tax. Code Section 25136 Assuming the appropriate records are kept, and assuming the activity producing the income does not have to be conducted in a particular state, a taxpayer was best advised to conduct more than 50 percent of the activity (based on dollar costs) in a low tax or no tax state in order to lower a corporate taxpayer's franchise (income) tax liability.
For taxable years beginning on or after January 1, 2011, the sales factor rules for sourcing sales of nontangible personal property have been repealed and replaced. California's sourcing rules are now based on the Multistate Tax Commission's model regulation (MTC Reg. IV.17, available on the MTC's website at: http://www.mtc.gov/).
Former Section 25136 provided that sales, other than sales of tangible personal property, were considered to be "in th[e] state" if: (a) the income-producing activity was performed in this state; or (b) the income-producing-activity was performed both in and outside this state and a greater proportion of the income-producing activity was performed in this state than any other state, based on costs of performance.
Cal. Code Regs. tit. 18, Section 25136(a) provided, in part, "gross receipts [we]re attributed to this state if, with respect to a particular item of income, the income-producing activity is performed within and without this state but the greater proportion of the income-producing activity is performed in this state, based on costs of performance."
Thus, all that was previously needed to attribute a sale of intangible personal property or a sale from performance of personal services to a particular state, was that the "greater proportion" (i.e., more than 50 percent) of the income-producing activity take place in that state. Despite the obvious extraterritorial taxation constitutional issue, this was the law for tax years beginning prior to 2011. This clearly afforded a taxpayer a tax planning opportunity if the income-producing activity did not have to be performed in any particular state.
Example: Taxpayer X performs personal services in various states. Taxpayer X contracts to perform a personal service for a company located in State A. State A is a high franchise (income) tax rate state. State B is a low or no franchise (income) tax rate state. The nature of the personal service is such that much of the work can be performed in State B. If Taxpayer X performs more than 50 percent of the personal service work (based on dollar costs) on the deliverables in State B before the project is completed in State A, the gross receipts from the performance of the personal service will be attributed to State B. See former Cal. Rev. & Tax. Code § 25136. Planning to execute the personal service contract in this manner will reduce the sales factor of Taxpayer X in State A, reducing its franchise (income) tax liability.
Beginning with the 2011 taxable year, sales are sourced under new rules.
For taxable years beginning on or after January 1, 2011, the "all or nothing" approach to sales no longer applies. Sales, other than sales of tangible personal property are now sourced in the following manner under revised Cal. Rev. & Tax. Code § 25136(a):
- sales from services are in California to the extent the purchaser of the services received the benefit of the service in California;
- sales from intangibles are in California to the extent the intangible property is used in this state. With respect to marketable securities, sales are considered in this state if the customer is in California;
- sales from the sale, lease, rental, or licensing of real property are in the state if the property is located in California; and
- sales from the rental, lease, or licensing of tangible personal property are in this state if the property is located in California.
It is also worth noting for planning purposes that effective July 17, 2010, activities performed by an independent contractor are treated the same as activities performed by the taxpayer for purposes of the apportionment sales factor income-producing activity test. See Cal. Code Regs. tit. 18, Section 25136. This is retroactive for tax years beginning after 2007.
These materials are published solely as reference materials for use by attorneys and other tax professionals. They do not constitute an opinion or written advice concerning federal or state tax issues and are not written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or other applicable tax laws.
RELATED LINKS: For more information about sourcing sales for California tax purposes, see:
For additional insight on principles governing the sourcing of sales, LEXIS users can view:
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