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July 29, 2020

California FTB holds fifth interested parties meeting to discuss next round of proposed amendments to its market-based sourcing rules

On July 21, 2020, the California Franchise Tax Board (FTB) held its fifth Interested Parties Meeting (5th IPM, preceding IPMs referred to sequentially as described later), continuing ongoing discussions between the FTB and the public for the next round of proposed amendments to its market-based sourcing rules for California income tax purposes (to be codified at California Code of Regulations, title 18, (CCR) section 25136-2 (Regulation)).

In anticipation of the 5th IPM, the FTB released draft regulatory language and explanations of the proposed amendments, including language that will affect asset managers, government contractors, research and development companies, and taxpayers (including corporations, individuals and pass-through entities) in many other industries.

Affected taxpayers should consider submitting written comments by the August 18, 2020 deadline.1

For a recap of what was discussed at the fourth IPM held on July 19, 2019 (4th IPM), see Tax Alert 2019-1389.

Due to limitations on public gatherings implemented in response to the COVID-19 emergency, the 5th IPM was hosted via teleconference, which affected the level of commentary and response from both the FTB and the public. The newly implemented forum created technical difficulties that may have potentially limited the level of discussion that may have ordinarily prevailed at other IPMs conducted in person. FTB officials suggested that written comments would be the preferred method of comment to allow for more thorough consideration of the Regulation.

Discussion topics

Modifying rules for assignment of sales of services

Simplifying rules

In the latest iteration of the Regulation, the FTB again revamped its rules for assigning sales of services to businesses and government entities by proposing further changes to the FTB-denominated "simplifying rules." In the 5th IPM draft of the Regulation, the FTB truncated the simplifying rules while retaining the essence of the methodology prescribed in the previous draft Regulation.

The "simplifying rules" first appeared in the FTB's draft Regulation submitted in connection with the 3rd IPM. In the 4th and 5th IPMs, the FTB further modified these rules, which would provide a rebuttable presumption as to the manner in which various kinds of service revenues should be sourced.

The following are the proposed four presumptive methods for the sourcing of services:

  1. Services that are related to real property would be sourced to the location of the real property.
  2. Services that are related to tangible personal property (TPP) would be sourced to the location of the TPP at the time the service was performed, unless the TPP is directly or indirectly delivered to the customer after the service, in which case the service would be sourced to the location of delivery.
  3. Services that are related to intangible property would be sourced to the location where the intangible property is used by the customer.
  4. Services related to individuals would be sourced to the location of the individual at the time the services are performed.

Safe harbor exclusions including services for individuals

Since its original proposal, the Regulation differentiated sourcing of services between those to individuals and those to businesses. These proposals included a presumption that services to individuals could use a billing address as a sourcing method, effectively creating a safe harbor for taxpayers providing services to individuals.

In the language for the 5th IPM, the FTB proposes to remove this differentiation between services to individuals and business entities, stating that this change is necessary to better conform to the statute itself (Cal. Rev. & Tax Code Section 25136 (Statute)), which differentiates revenues from services provided to different kinds of consumers. Thus, under this new language, the business sourcing provisions are also intended to apply to revenues derived from providing services to individuals, removing the billing-address safe-harbor presumption for individuals entirely.

Commenters took issue with the FTB's removal of this safe-harbor provision for individuals, challenging the FTB's assertion that the individual safe harbor was not supported by the Statute. Commenters argued that the billing address location is likely the appropriate location of the benefit of the service for individual customers and the ability to rely on that presumption is important for taxpayers that are rendering services to individuals and looking to file based on the information they routinely and customarily have available.

The explanations offered for the 4th IPM discussed the inclusion of an additional safe harbor for taxpayers providing services to a large volume of customers, which garnered taxpayer support. Neither the draft Regulation for the 4th IPM nor the 5th IPM included draft language for this additional safe harbor. Moreover, this proposed safe harbor was not included in the discussion topics for the 5th IPM. Commenters asked whether this indicated that the FTB was no longer entertaining its inclusion. The FTB responded that its exclusion had not been solidified but did not clarify further. Commenters again stated that, in addition to providing greater certainty and administrability for taxpayers at filing, a safe-harbor rule would align with uniformity principles and similar model rules promoted by the Multistate Tax Commission.

Modification of examples

In the language for the 4th and 5th IPMs, the FTB removed several examples that applied the market-based sourcing rules to specific factual circumstances. These examples included sourcing for accounting firms and online advertisers. In their stead, the FTB added several examples applying its updated rules.

Most significantly, the FTB added an example for broker/dealers. In the new example, Broker Corp. provides brokerage services to Capitol Tours Corp. for investment purposes. Broker Corp. can determine from "all information reasonably available" that Capitol Tours only has business locations and activities within California, so Broker Corp's commission fees should be sourced to California. Commenters expressed concern that it is not realistic to require a broker to develop information outside of its books and records in order to assign the commission earned from a customer, because the large volume of transactions makes this highly burdensome.

Commenters continued to take issue with the Fly Fishing Corp. example added for the 3rd IPM. In this example, a company provided call center services to Fly Fishing Corp. as a subcontractor. The company sourced its sales to the individual customers of Fly Fishing Corp., rather than to Fly Fishing Corp. itself. Commenters saw the example as a "look-through," saying the FTB is expecting taxpayers to look to the location of their customer's customer, potentially requiring approximations or overly burdensome taxpayer obligations to require more information from customers than has been collected in the past.

Asset management fees

In its language for the 3rd IPM, the FTB deleted its previously proposed asset management examples entirely and instead determined that a new set of assignment rules, specific to asset managers, would be more appropriate. The new assignment rules were patterned after the rules in CCR Section 25137-14 (the special industry revenue-sourcing regulation for mutual fund service providers that provide services to regulated investment companies). This methodology was further clarified in the 4th IPM.

The FTB's language for the 5th IPM continues to source revenues for asset management services to the location of the "beneficial owner," essentially requiring a "look through" to the location of assets that are invested in the funds, but adding a "value of interest" methodology and mathematical explanation with examples to source these fees to the location of the beneficial owners.

Commenters continued to take issue with whether this method effectively requires a taxpayer to source such revenues based on the location of the taxpayer's customer (the managed entity) or instead to the location of the taxpayer's "customer's customer" in a manner that was not intended by the Statute.

Reasonable approximation method standard

The language of the 5th IPM requires a taxpayer using either the reasonable approximation method or the customer location for marketable securities as a sourcing method to request a change of method from the FTB before using a different method. The 4th IPM language added that the taxpayer shall notify the FTB of its new method and provided a brief description of the method in the manner prescribed by the FTB.

In the 5th IPM language, the FTB added that the taxpayer's methods of reasonable approximation would be presumed acceptable unless the FTB establishes by a preponderance of the evidence that the methodology is not reasonable.

In the explanations provided with the 5th IPM, the FTB acknowledges that the taxpayer's method of reasonable approximation controls, even when the FTB prefers an alternative reasonable approximation method. The addition of this language should give taxpayers added security for relying on a sourcing methodology, despite potential scrutiny upon audit.

Effective date of proposed changes

For the first time, the FTB has proposed an applicable date for the Regulation. The changes made to the Regulation would apply for tax years beginning on or after January 1, 2019. The FTB also proposed an option for taxpayers to elect to apply the new sourcing provisions in the Regulation to tax years beginning on or after January 1, 2018. In addition, the FTB clarified the distinction between (1) an "effective date," which carries more statutory implications and (2) an "applicable date," which merely gives a date on which taxpayers may rely on the methods described in the Regulation.

Some commenters wanted the applicability date to be prospective only and disagreed with the proposed language requiring the sourcing rules to apply retroactively to tax years beginning on or after January 1, 2019. The FTB responded that it intended to apply the Regulation to tax years beginning in 2019 unless there were strong positions against this date, and that taxpayers should not rely on the proposed draft Regulation language for market sourcing years before 2018 because the Regulation has not yet been finalized.


The draft Regulation on California's market-based sourcing rules discussed at the 5th IPM still contains some of the most sweeping changes to California's market-sourcing rules to date. The latest modifications did little to lighten the burdensome reporting expectations on taxpayers, and, if approved, would affect taxpayers in almost every industry. With public dialogue restricted by the COVID-19 precautions, little was clarified in the discussions with the FTB during the 5th IPM.

While a presumption of reasonableness in taxpayer approximations gives some comfort, pulling away from the proposed safe harbors offered in earlier Regulation drafts suggests that the Regulation would complicate taxpayer compliance. The continued inclusion of the proposed presumptions and the complexity of applying these rules look to be areas of focus for the FTB as it considers the comments received from interested parties.

The clarification of the applicability date for the proposed changes still looms over the process, in part because FTB auditors already appear to be looking to portions of the proposed market-based sourcing rules in the draft Regulation as they examine taxpayers' market-based sourcing methodologies during current audits. As the FTB continues to offer language changes to the draft Regulation, taxpayers will likely to struggle to find any concrete guidance or methodology to rely on as they try to apply market-based sourcing methods when preparing and filing their tax year 2019 California returns, particularly because of the continued uncertainty around the timing of the applicable and effective dates for the market-based sourcing rule amendments.

At the conclusion of the 5th IPM, the FTB stated that it would review comments it receives and would release a summary of those comments and its responses on its website. The FTB stated that it would move forward with moving the amendments to the next step in the regulatory process once comments have been addressed. To that end, the FTB did not affirmatively state when or if it would schedule yet another IPM on the market-based sourcing rules.

We will continue to monitor the discussions and send Alerts as the regulatory process continues.


Contact Information
For additional information concerning this Alert, please contact:
State and Local Taxation Group
   • Carl Joseph (
   • Jenica Wilkins (
   • Chris Berkness (
   • Josh Booth (


1 The FTB's initial notice states that the deadline for submitting comments is August 18, 2020.