Regulation 25136-2 provides some new rules for determining the amount of sales to be included in the sales factor numerator for sales, other than sales of tangible personal property. These sales include sales from services; sales from intangible property; sales from the sale, lease, rental, or license of real property; and sales from the rental, lease, or license of tangible personal property.
Change in the default rules and presumptions (§§ 25136-2(c)(1)(A) – (1)(F))
The proposed regulation establishes a new framework of presumptions for determining the location of the benefit of the service as follows:
- The proposed regulation begins with the same initial presumption that the location of the benefit of the service is presumed to the extent that the location is indicated by the taxpayer’s contracts or books and records kept in the normal course of business.
- However, the proposed regulation departs from the current regulation by establishing further presumptions regarding the location of the service receipt to the extent the service predominantly relates to real property in the state, services related to tangible personal property used or delivered into the state, intangible property used in the state, and individuals in the state when the service is delivered.
- The presumption may be overcome by showing based on a preponderance of the evidence that the benefit of the service is received at a different location after first considering information from the contracts or books and records.
- If the initial presumption does not apply or has been overcome, all other sources of information may be used to substantiate the location of the benefit.
- If location still cannot be determined, the location must be reasonably approximated.
- If a presumption does not apply or has been overcome, and cannot be reasonably approximated, then the location of the benefit of the service is determined using the customer’s billing address as indicated by the taxpayer’s books and records.
- If a sale is for services provided under US government contracts and the location of the benefit cannot be assigned based on presumptions or reasonable approximation, such as when a contract cannot be disclosed and no relevant information is publicly available, then the benefit is deemed to be received by the 50 states based on relative population.
The proposed regulation provides new or revised examples illustrating how the new framework should be applied to services relating to real property, government contracts, logistics and delivery operations, milestone payments for research and development, internet advertising, call centers, and personal property.
Observation: By establishing presumptions based on specific factual scenarios, e.g., the location of services related to real property, the proposed regulation may answer ongoing taxpayer questions at least regarding the areas covered by the specific presumptions.
Further, under the proposed regulation, when the presumptions may not apply, taxpayers and the agency are free to consider “all other sources of information” to determine the location of the benefit of a service.
Observation: Notably, this condition applies before considering the billing address of the customer as the location of the benefit of the service. The change reflects an inherent mistrust of the billing address but may allow taxpayers broader means to determine the true market for their services.
In addition, the specific rule for government service contracts now allows for specific delivery information, when available, to be used for apportionment purposes.
Observation: In the past, such a departure would require a taxpayer to request to apply the distortion provisions of Cal. Rev. & Tax. Code section 25137.
New rules for receipts from asset management services (§§ 25136-2(b) and (2)(c)(2))
The proposed regulation provides a new definitional framework for receipts from asset management services, defined as the “direct or indirect provisions of management distribution or administrative services to funds.” The proposed regulation also defines administrative services, distributions services, management services, and fund. It also includes a definition for the “beneficial owner” as one who makes independent decisions to invest. The definition excludes decision-makers for pooled or corporate investments and who participate in a defined benefit plan.
The proposed regulation establishes specific rules for determining the location of gross receipts from asset management services based on the domicile of the investors in the assets unless the investor is holding title to the assets for a beneficial owner, in which case the benefit of the service is received at the domicile of the beneficial owner. Location of domicile is presumed to be the investor’s billing address as reflected in the taxpayer’s books and records, unless the taxpayer has actual knowledge that the investor’s principal place of business is at a different location. Location of domicile of a beneficial owner is presumed to be the billing address of the beneficial owner as reflected on the records of the entity for whom the asset management services are rendered unless there is evidence that the primary residence or principal place of business is different.
Receipts from asset management services are assigned in proportion to the average value of the interest in the assets held by investors or beneficial owners domiciled in the state. If a taxpayer does not know the average value of the interests held by investors or beneficial owners in the state, receipts are assigned based on a reasonable estimation.
Observation: This proposed change brings the broader asset management community under the same rules previously only applied to mutual fund service providers under Regulation Section 25137-14. By defining the provision of asset management services broadly, the FTB is indicating that investor-based sourcing is the appropriate means for service providers earning income from the provision of investment-related services to funds, regardless of the nature of those funds.
New rule for large volume professional services (§§ 25136-2(b)(9) and (2)(c)(3))
The proposed regulation adds a definition for professional services to include management services, tax services, payroll and accounting services, audit and attest services, actuary services, legal services, business advisory consulting services, technology consulting services, services related to brokering securities that generate commission income, investment advisory services other than asset management services as defined in this regulation, and services related to the underwriting of debt or equity securities.
The proposed regulation provides a new rule and an example for assignment of receipts from “large volume professional services.” If a taxpayer provides any single professional service to more than 250 customers, then receipts from that service are assigned based on the customer’s billing address. If more than 5% of the receipts from the sale of a specific service are derived from a single customer, then receipts from that customer do not fall under this rule.
Observation: The proposed regulation would apply to large national service providers and recognizes the difficulty inherent in providing the detailed information necessary to determine the location of the benefit of the service on a customer-by-customer basis. Rather, the proposed regulation essentially allows for sourcing based on billing address in recognition that the billing address for the customers of large volume service providers will be relatively easy to obtain and provide a serviceable estimate of the location of the benefit of the services.
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