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California’s 2011 Corporate Income Tax Law Changes
Given the state’s financial straits of the past several years, California has seen several changes in its tax laws as policymakers ride the tides of a severely strained budget. With the beginning of the new year, many of the tax law changes implemented since 2009 are now in full effect, and represent significant changes in the way domestic and out-of-state companies do business. The new legislation, effective January 1, 2011: • • • • Readopts the Finnigan approach to assigning receipts from combined groups to California Changed the nexus standards for companies doing business in the state Will allow corporate taxpayers to elect to use a single sales factor apportionment formula And transition to a market-based approach for sourcing receipts from sales of other than tangible personal property
Finnigan Takes the Field
For taxable years beginning on or after January 1, 2011, the state has enacted legislation adopting the Finnigan rule, which provides that the sales factor numerator of a combined group include all corporations in the unitary group that have California sales, regardless of whether the corporation has nexus or is protected under Public Law (P 86-272. .L.) The state has teetered back and forth between Joyce (adopted for tax years prior to January 1, 2011) and Finnigan since the rule was first adopted in the mid-1960’s. Under Joyce, the sales factor numerator of the combined group consists of sales by those corporations that have nexus in California and are required to file a California corporate income tax return. Finnigan’s significance lies in the new law’s impact on out of state businesses. Taxpayers engaged in the sale of tangible personal property to California customers and are protected under P 86-272 will see an increase in their California corporate income tax .L. liability due to the inclusion of sales of tangible personal property in the numerator of the sales factor notwithstanding the P 86.L. 272 protection. The constitutionality of this method of sourcing receipts from sales of tangible personal property has been generally upheld, as the inclusion of the sales do not amount to a tax on entities without nexus, but instead is considered a method of calculating the tax imposed on a combined unitary group.
“Doing Business” Defined – New Nexus Standards for Presence
For taxable years beginning on or after January 1, 2011, a taxpayer is deemed to be “doing business” in this state if it is organized or commercially domiciled (i.e., the principal place from which taxpayer’s trade or business is directed or managed) in California or it has:
Sales in the state that exceed the lesser of $500,000 or 25-percent of the taxpayer’s total sales (including sales by an agent or independent contractor) 2. Real property and tangible personal property in the state that exceed the lesser of $50,000 or 25-percent of the taxpayer’s total real property and tangible personal property 3. Payroll in the state that exceeds the lesser of $50,000 or 25-percent of the total compensation paid by the taxpayer For tax years beginning prior to January 1, 2011, a taxpayer was considered to be doing business in the state if it was actively engaged in any transaction for the purpose of financial or economic gain or profit. 1.
Single Sales Factor (“SSF”) Election
The February 2009 state budget agreement, passed under Governor Arnold Schwarzenegger, changed the apportionment formula used to determine California taxable income for businesses with multi-state operations. Beginning January 1, 2011, businesses subject to the California Corporate Income or Franchise Tax may make an annual irrevocable election to apportion income using a single sales factor (“SSF”) apportionment formula. The election is irrevocable only for the tax year to which the election is applied. As such, taxpayers have the ability to choose the apportionment option that would yield the least amount of tax on an annual basis. Under prior law, businesses with activities or income derived from sources both within and outside of California, were required to calculate their California income tax using the three-factor apportionment method (i.e., property, payroll, and sales) with doubleweighted sales (i.e., the sales factor is used twice in the apportionment formula). Taxpayers not making the SSF election would continue to use the three-factor, double-weighted sales apportionment formula. The move to an elective SSF was meant as a business development incentive to attract businesses into the state. The absence of a property and payroll factor for income tax apportionment purposes would encourage businesses to establish operations in California, given the tax costs of such a move would be nil. Moreover, given the trend by most states move to a SSF method of apportionment, California-established business would be given equal footing when competing with out-of-state competitors who have the ability to manipulate their sales activities and source such sales to SSF states. The election to use a SSF must be made on an original, timely-filed return, including extensions, and is an irrevocable annual election. Presumably, many California corporations will choose to make the SSF election and benefit form a decrease in California income tax. However, out-of-state corporations will likely choose to continue to utilize the three-factor, double-weighted sales formula described above. Businesses that derive more than 50% of its gross business receipts from agricultural, extractive, savings and loan, and banking and financial activities, are excepted from the SSF election, and must use an evenly-weighted three factor apportionment formula. The Franchise Tax Board (“FTB”) is currently drafting regulations that would clarify the implementation and the proper method of electing the use of a SSF apportionment method. On January 10, 2011, Governor Jerry Brown revealed his proposed state budget for the 2011-2012 fiscal year, which would remove the election from the statutory language, and make the SSF mandatory for all businesses.
For tax years beginning on or after January 1, 2011, receipts from sales, other than sales of tangible personal property, will be sourced based on the following:
Receipts from services are in the state to the extent the purchaser of the service received the benefit of the service in the state 2. Receipts from intangible property are in the state if the property is used in the state. For marketable securities, if the taxpayer’s customers are in the state, the receipts are also in the state 3. Receipts from the sale, lease, rental or licensing of real and tangible property are in the state if the property is located in the state Prior to this new approach, California adopted the Cost of Performance rule, whereby a taxpayer would evaluate its incomeproducing activities, and if an activity was performed solely in California, then all receipts from that activity would be included in the California sales factor numerator. If the income producing activity was performed both within and without California, then the receipts were included in the sales factor numerator only if a greater proportion of the costs (i.e., greater than 50-percent) were in California. The elimination of the Cost of Performance sourcing rule, along with the enactment of an elective single sales factor apportionment formula (as discussed above), may potentially benefit California-based service companies that have a significant out-of-state customer base. Please contact our tax professionals if you are a business owner and would like to learn more about how the new tax law changes may impact your business. ________________________________________________________________________________________________________________ Thank you for your time and continued support of the Enterprise Zone program As always, please call if you would like to discuss any of these items further. 1.
Your Tax Partners, Mark G. Cook, Partner Steven J. Cupingood, Partner John A. Eckweiler, Partner Dan B. Faulk, Partner Andrew L. Gantman, Partner Richard A. Linder, Partner David Neighbors, Partner Todd Northrup, Partner Javier Ramirez, Partner Thomas E. Wendler, Partner Jon Widdowson, Partner Michael Wu, Partner Don Leve, Partner
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