Key Takeaways:
- California’s market-based sourcing rules to change for tax years from Jan 1, 2024.
- Public hearing for feedback scheduled on January 29th, 2025.
- New rules aim to clarify and update service and intangible sales sourcing.
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On January 6, the California Franchise Tax Board (FTB) issued a formal notice (and modified text) setting a public hearing for January 30 to discuss proposed amendments to California’s market-based sourcing regulations.
On September 13, the FTB published a notice of proposed rulemaking inviting the public to submit written comments on the proposed changes, which the board has been drafting for the past seven years. Comments were due October 31.
In response to the comments it received, the FTB set a tentative public hearing for January 25, denoted in its 2025 rulemaking calendar, which was approved at the FTB’s December 10 meeting.
The FTB has projected that it will adopt the proposed regulations by March 25, 2025, and that the rulemaking action will be transmitted for review and approval by the California Office of Administrative Law on July 25, 2025.
- The proposed regulations, which would apply to tax years beginning on or after January 1, 2024, would amend several market-based sourcing rules. For sales of services, they would create:
- Presumptions that apply to such sales (regardless of whether the customer is an individual or business entity) based on whether the service predominantly relates to real property, tangible personal property, intangible property, or individuals;
- A rule permitting use of all other sources of information to substantiate the location when the benefit of the service is derived under specific circumstances;
- Rules that apply to asset management services, generally using a new “average value of interest” test and applying a look-through approach to the location of the investors or beneficial owners; and
- A large volume professional services rule for taxpayers providing services to more than 250 customers.
The proposed changes would also:
- Create rules for sales of intangibles that apply to sales of corporate stock/pass-through entity interest, dividends, and goodwill, providing guidance on how to address the 50% asset test when the taxpayer lacks the necessary information to properly apply the test;
- Create rules that apply when mixed sales are from the provision of a service, tangible property, or intangible property;
- Update the rules for sales of marketable securities; and
- Require that a taxpayer’s reasonable approximation method be used unless the FTB shows by a preponderance of the evidence that the taxpayer’s method is not reasonable. Taxpayers that want to change their reasonable approximation method must submit notification and a brief description for prior approval by the FTB.
Insights
- As proposed, the amendments would significantly change California’s market-based sourcing rules, especially how sales of services are sourced in California. The state’s existing rules do not use presumptions to source those kinds of sales.
- Many of the remaining rules are intended to provide additional clarification to taxpayers on how to apply California’s market-based sourcing rules to various revenue streams. Notably, California has added a favorable rule that places the burden of proof on the FTB to show that a taxpayer’s reasonable approximation method is unreasonable before it can reject the taxpayer’s method.
- As proposed, the regulations apply to tax years beginning on or after January 1, 2024. However, the FTB has received comments on the proposed regulations, so the final language could change. Pending the final version, taxpayers should consider whether and how the proposed changes might affect their California tax liabilities.
- Taxpayers interested in providing feedback on the proposed regulations should participate in the FTB’s January 30 hearing. Typically, the FTB issues a notice of public hearing on its website 30 days before the meeting and provides details on how to participate in the hearing.
How MGO Can Help
MGO can help businesses and individuals navigate the proposed changes to California’s market-based sourcing rules by providing tax consulting and compliance services. We can offer guidance on how to apply the new regulations, assist with preparing for the public hearing, and help ensure that your tax liabilities are accurately calculated under the new rules.
Stay ahead of California’s evolving tax regulations by joining the California FTB’s public hearing on January 30, 2025. Review the proposed market-based sourcing changes and participate to confirm your voice is heard. Our tax consultants are here to guide you through these changes, helping you understand the impact on your tax liabilities and compliance. Contact us today to schedule a consultation and make informed decisions about your taxes.
Written by Shirley Wei, Raymund Dagarag and Jacob Shin. Copyright © 2024 BDO USA, P.C. All rights reserved. www.bdo.com