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The California Franchise Tax Board (FTB) on September 13, 2024, issued a Notice of Proposed Rulemaking to adopt amendments to its market-based sourcing rules for California corporate franchise and income tax purposes. The rules, which would be codified at California Code of Regulations, title 18, (CCR) Section 25136-2 (Proposed Regulations),¹ are intended to apply for tax years beginning on or after January 1, 2024.

The FTB released an "Initial Statement of Reasons" for the amendments, as well as draft language of the Proposed Regulations, which would affect asset managers, government contractors, research and development companies, and taxpayers in many other industries.

The latest version of the draft language includes no substantive changes from the draft language released in June of 2021. (see Tax Alert 2021-1167). One non-substantive change noted in the "Discussion of Necessity and Specific Purpose of the Proposed Regulations" in the Initial Statement of Reasons stated that Example 3 in Section 25136-2(c)(3), "Assignment Rule for Large Volume Professional Services," was deleted. The FTB explained that this deletion is "to ensure the examples do not unnecessarily complicate the correct application of the rule." However, Example 3 still appears in the September 13, 2024 version of the draft language, a matter that may need to be addressed by the FTB in order to align the draft language with the explanation in the Initial Statement of Reasons.

Written comments on the Proposed Regulations are due by October 31, 2024.²

Timeline of the Proposed Regulations

The FTB is currently about nine months behind its previous timeline for the Proposed Regulations to go through the formal rulemaking process. The current timeline will depend, in part, on whether a public hearing is scheduled. As of now, the FTB has not scheduled a public hearing, but indicated it would do so if it were to receive a written request for one no later than 15 days before the close of the comment period on October 31. After adoption by the FTB, which could happen at the FTB's December 2024 Board meeting, the Proposed Regulations will be sent to the Office of Administrative Law (OAL) for review.

The OAL will have 30 working days to conduct a review of the rulemaking record to ensure the agency satisfied the requirements of the California Administrative Procedure Act (APA) and OAL regulations. OAL will then either approve the rulemaking action and file the Proposed Regulations with the Secretary of State or disapprove the rulemaking action.

These steps in the formal rulemaking process would mean the Proposed Regulations would not be finalized until at least the first part of 2025.

Implications

The proposed applicability date for tax years beginning on or after January 1, 2024, could significantly impact affected taxpayers that may have previously taken, or are currently taking, a sourcing position at odds with what is outlined in the Proposed Regulations. The January 1, 2024 applicability date could also affect 2024 estimated tax payments, as well as signing positions on the 2024 returns. There is a possibility that the FTB could revise the applicability date to tax years beginning on or after January 1, 2025. (The FTB revised the applicability date of the changes over the course of the previous six interested parties meetings and subsequent revisions to the draft regulations.)

Interested parties should consider submitting written comments by the October 31, 2024 deadline. EY will continue to monitor developments as the Proposed Regulations makes its way through the formal rule-making process.