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June 11, 2021

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

On June 4, 2021, the California Franchise Tax Board (FTB) held a sixth Interested Parties Meeting (6th IPM, preceding IPMs referred to sequentially as described later), continuing discussions with the public on additional proposed amendments to its market-based sourcing rules for California corporate franchise and income tax purposes (to be codified at California Code of Regulations, title 18, (CCR) section 25136-2 (Regulation)).

In anticipation of the 6th IPM, the FTB released draft regulatory language and explanations of the proposed amendments to the Regulation, including language that would 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 July 5, 2021 deadline.1

For a recap of what was discussed at the fifth IPM held on July 21, 2020 (5th IPM), see Tax Alert 2020-1926.

Due to limitations on public gatherings implemented in response to the COVID-19 emergency, the 6th IPM was hosted via teleconference, which created technical difficulties that may have potentially limited the level of discussion that may have ordinarily occurred at other IPMs conducted in person.

Retained rules for assignment of sales of services

Simplifying rules

The proposed language presented at the 6th IPM was the same as that at the 5th IPM, which would revise the simplifying rules proposed to be implemented in the 3rd and 4th IPMs. In the 5th IPM, the FTB had again proposed revamping its rules for assigning sales of services to businesses and government entities by proposing further changes to the FTB-denominated "simplifying rules."

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 to 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 under the "simplifying rules":

  1. Services that relate to real property would be sourced to the location of the real property.
  2. Services that relate 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 TPP's delivery location.
  3. Services that relate to intangible property would be sourced to the location where the customer uses the intangible property.
  4. Services related to individuals would be sourced to the individual's location at the time the services are performed.

Professional services safe harbor

In response to requests from representatives and taxpayers during prior IPMs, the FTB included a safe harbor for large-volume providers of professional services to provide greater certainty and administrability for these taxpayers.

Under the language presented for the 6th IPM, if a taxpayer provides substantially similar professional services to more than 250 customers, gross receipts from those services would be assigned to each customer's billing address. If more than 5% of the taxpayer's receipts from sales of that service are derived from a single customer, the receipts from that particular customer would not fall under the safe harbor rule.

The definition of "professional services" for these purposes would be limited to management services, tax services, payroll and accounting services, audit and attest services, actuarial services, legal services, business advisory consulting services, technology consulting services, services relating to brokering securities that generate commission income, investment advisory services (other than asset management services) 2 and services related to the underwriting of debt or equity securities.

The proposed safe-harbor rule would align with uniformity principles and similar model rules promoted by the Multistate Tax Commission.

Commenters during the 6th IPM expressed concerns about applying these rules to smaller businesses, including a request for an expansive definition of "substantially similar" for purposes of applying the test.

Modification of examples

In 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 in the 6th IPM applying its proposed updated rules.

Because FTB staff is proposing a new rule for enumerated professional services (as discussed previously), including legal services, the most recent proposed language modified the Law Corp. example to reference Architecture Corp. This proposed modification demonstrates how the simplifying rules apply to the sourcing of professional services that fall outside the new safe harbor provision. In this proposed example, architecture services provided for a manufacturing plant expansion are sourced to the location of the manufacturing plant, as opposed to the location where the Architecture Corp. employees may be providing the services. This result is based on the reasoning that the customer receives the benefit of the service at the location where the manufacturing plant is being expanded (not where the Architecture Corp. employees may be located).

During the 6th IPM, no comments were made regarding this proposed modification to the example.

Asset management fees

The language presented at the 6th IPM proposed definitions for "asset management services" that would guide application of the "look through" methodology from prior IPMs. This methodology remained unchanged from the 5th IPM, but the proposed definitions provide guidelines for defining services as "asset management services" for purposes of the Regulation. These proposed definitions appear to be modeled after the existing definitions of "administration services," "distribution services," and "management services," which are corollary definitions in the existing special industry revenue-sourcing regulation governing mutual fund service providers that provide services to regulated investment companies (See CCR Section 25137-14(a)(1), (2) and (3)).

The FTB's language for the 6th IPM continues to source revenues for asset management services to the location of the "beneficial owner. This essentially requires a "look through" to the location of the fund's investors but adds a "value of interest" methodology and mathematical explanation with examples to source these fees to the location of the beneficial owners.

Effective date of proposed changes

The most recent proposed language would also revise the Regulation's applicable date. The proposed language stated the changes made to the Regulation would apply for tax years beginning on or after January 1, 2023, instead of January 1, 2019, as proposed in the 5th IPM.

During the 6th IPM, no comments were made about the revised applicable date.

Removal of retroactive election

The FTB would remove proposed CCR 25136-2(j)(4), which had given taxpayers the option to elect to apply the Regulation's new sourcing provisions to tax years beginning on or after January 1, 2018.

A commenter asked why the FTB removed the retroactive election. The FTB responded that it intentionally removed the election, and that FTB staff no longer wanted to include it in the Regulation. The commenter further questioned whether FTB staff had considered that taxpayers may have relied on the inclusion of the election and FTB staff noted that the election had only been included in draft language.


The draft Regulation on California's market-based sourcing rules discussed at the 6th 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. Similar to the 5th IPM, with public dialogue restricted by the COVID-19 precautions, little was clarified in the discussions with the FTB during the 6th IPM.

The inclusion of the proposed safe harbor provision to assign revenues based on customer billing address for large-volume professional services was a welcome addition for many professional services businesses. There continues to be, however, uncertainty around how broadly this proposed assignment rule would apply.

Pushing back the applicable date to tax years beginning on or after January 1, 2023, as opposed to the previously suggested tax years on or after January 1, 2019, would give taxpayers more time to prepare for the sourcing changes. That being said, pushing back the applicable date, as well as removing the retroactivity election, still creates considerable uncertainty for taxpayers looking to utilize provisions in the proposed changes before 2023. In addition, the later applicability date also raises questions on how FTB auditors will proceed, as some FTB auditors already appear to be looking to portions of the proposed market-based sourcing rules in the draft Regulation when examining taxpayers' market-based sourcing methodologies.

At the conclusion of the 6th 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.

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 Taxpayers may submit written comments via email to

2 The draft language of the Regulation presented for purposes of the 6th IPM specifies that "professional services" include "asset management services as defined in this regulation" (emphasis added).