Doug Andersen, Juan Acevedo

January 24, 2025

On January 6, 2025, the California Franchise Tax Board (FTB) proposed amendments to California Code of Regulations 25136-2. These changes, effective for tax years beginning on or after January 1, 2025, are intended to refine how businesses determine the sourcing of sales other than sales of tangible personal property under California’s market-based rules. Here’s what’s being proposed and how it might impact your business.

What Are the Proposed Changes?

1. New Presumption for Sourcing Location of Benefit of General Services: The FTB aims to clarify how businesses should determine the location where a service’s benefit is received.
   • The location of the benefit is based on the taxpayer’s books and records. This includes:

     • The location where services related to real property or tangible personal property are provided.

     • The location where intellectual property (IP) is used.

     • The location where individuals are working.

   • This presumption can be overcome with enough overwhelming evidence – Taxpayers need to consult all sources of information to approximate location before resorting to using customer’s billing address

2. Updated Rules for Sourcing of Management Fees: The sourcing is based on the domicile of investors in the assets, unless investor is holding title to the assets for a beneficial owner (in which case fees are sourced to domicile of beneficial owner).

   • Defining Domicile: Domicile is the investor billing address listed within books and records; unless investor’s primary place of business is at another address

   • Proportional Allocation: Fees must be apportioned based on the average value of the interest held by investors or beneficial owners in each state.

3. Modified Rules for Large Volume Professional Services: If a taxpayer is providing services to over 250 customers, then receipts from those services are sourced to the customer’s billing address.
   • Exception: If a single customer accounts for 5% or more of the total receipts, this rule does not apply
4. New Guidance for Sales of Marketable Securities: For receipts from the sale of marketable securities, the definition of “customer” has been updated to be the person who gains the greatest economic rights in the securities, regardless of intermediaries.

   • For Individuals: Sourcing is based on the customer’s billing address at year-end.

   • For Businesses: Sourcing is based on the customer’s commercial domicile, as indicated in the taxpayer’s books and records.

HCVT Observations and Key Takeaways:

1. General Services Sourcing
   • The FTB's clarified definition of general services includes management, consulting and marketing services not tied to specific tangible properties or transactions.
   • The updated regulations focus on where the customer receives the primary benefit of the service.
2. Management Fees Sourcing

   • These updates aim to establish a consistent methodology for sourcing asset management receipts to California.

   • Accurate sourcing is crucial for determining where a business has nexus and how much revenue is attributable to California.

   • The proposed rules address sourcing complexities like fees tied to multiple investments or jurisdictions.

3. Large Volume Professional Services
   • The simplified sourcing approach for businesses with over 250 customers aims to reduce administrative burdens and avoid double taxation or under-taxation.
4. Sales of Marketable Securities

   • The amended regulation departs from prior sourcing methods - where securities were sold or where underlying assets were located.

   • The shift focuses on sourcing receipts to where the economic rights are ultimately held, aligning more closely with federal tax rules and other states' methodologies.

Why These Changes Matter

These updates offer a significant opportunity for businesses to revisit and refine their tax practices. By understanding the new sourcing rules, you can ensure compliance while minimizing the risk of errors or disputes with the FTB.

Have Questions or Need Guidance?

A public hearing on these proposed changes will be held on January 30, 2025 at 10:00 AM in Sacramento. Stakeholders can join via telephone at 844-767-5651, using access code 8835965.

If you believe these changes may affect your business, now is the time to act. Contact your HCVT state and local tax partners for assistance in navigating these updates and evaluating potential impacts on your operations.