The California Franchise Tax Board (FTB) on May 20, 2025, issued a Second Notice of Modifications to Text of Proposed Regulation to adopt 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 (Proposed Regulation).¹ Notably, the FTB modified the applicable date of the Proposed Regulation, which now is intended to apply for tax years beginning on or after January 1, 2026.

In September 2024, the FTB released an "Initial Statement of Reasons" for the amendments, as well as draft language of the Proposed Regulation. (See Tax Alert 2024-1784.) After receiving public comments on the Proposed Regulation, the FTB in January 2025, issued modifications to the text of the Proposed Regulation and held a public hearing.

In addition to modifying the applicable date, the FTB also made clarifying edits based on public comments. Changes in the latest version of the draft language fix inconsistent references to "benefit of a service" and "benefit of the service" so that "benefit of the service" is consistently used. Clarifying edits were made to "reflect the proper application of the four presumption rules" in Section 25136-2(c)(1)(A) and how they interact with the other rules in Section 25136-2(c)(1). Changes also relocate certain provisions and update references to subsections.

Timeline of the Proposed Regulation

The FTB has one year from the date from which the Notice of Proposed Rulemaking was issued to adopt the Proposed Regulation and send it to the Office of Administrative Law (OAL) for review — i.e., by September 14, 2025.

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. The OAL will then either approve the rulemaking action and file the Proposed Regulation with the Secretary of State or disapprove the rulemaking action.

These steps in the formal rulemaking process would mean the Proposed Regulation could be finalized in the late Summer or Fall of 2025.

Asset management fees

As explained in previous Tax Alerts, the FTB's draft language proposes to source revenues for asset management services to the location of the "beneficial owner," essentially requiring a "look through" to the location of the investors that are invested in the funds, but adding a "value of interest" methodology and mathematical explanation with examples on how to source these fees to the location of the beneficial owners.

The FTB's draft language adds definitions for "asset management services," which would guide the application of the "look through" methodology. The definitions of administration services, distribution services, and management services are closely modeled after the corollary definitions in CCR Section 25137-14 (the special industry revenue-sourcing regulation for mutual fund service providers that provide services to regulated investment companies).

Implications

The change in applicable date to tax years beginning on or after January 1, 2026 provides additional time for companies to understand and adjust their California tax obligations in anticipation of the amendments to the regulation becoming final by September of 2025. Prior to the modification, asset managers were having to grapple with determining their California tax calculations for the 2025 tax year and consider making estimated payments under uncertain rules because the amendments to the regulation were not yet final.

Asset managers that want to apply look-through sourcing to asset management fees may be questioning the impact of moving the applicable date to 2026. However, because the FTB has already pushed back the applicable date a handful of times due to the long delay in this rulemaking process, companies may already have an approach for managing this uncertainty.

In this regard, while the applicable date has been moved to 2026 and the FTB has included an explanation that the change is in response to public comments asking for a prospective applicable date, companies have been experiencing the FTB currently applying look-through sourcing to asset management fees for historical tax periods during the audit process. Whether this retroactive application of the look-through sourcing rules continues after the proposed amendments are finalized is something to watch.

EY will continue to monitor developments as the Proposed Regulation makes its way through the formal rule-making process.