California Adopts Single-Sales Factor Election Regulation

The California Franchise Tax Board (“FTB”), recently adopted a corporation franchise and income tax regulation regarding single-sales factor apportionment elections.  See Cal. Code Regs. tit. 18, § 25128.5.  The regulation, which is effective as of October 22, 2011 and applies to taxable years beginning on or after January 1, 2011, provides definitions, procedures, and examples for making the single-sales factor election, ass well as special rules for situations involving changes in affiliation, partnerships, and nonresidents.  Highlights include:

• Timely Election. A taxpayer must make the election on a timely filed (including extensions) original return for the year of the election.  A taxpayer that is engaged in more than one apportioning trade or business may make a separate election for each apportioning trade or business.  Timely filings that only supplement a previously filed return, or correct mathematical or other errors, are treated as incorporating the previously filed return (to the extent the return is not inconsistent), and are treated as timely filed.  Any timely filings that clearly reflect an intent to withdraw an election made on a previously filed return also are treated as a timely filed original return.


• Valid Election.  An election is valid if: (1) the tax is computed in a manner consistent with the single-sales factor formula election; and (2) a written notification of election is made on Part B of schedule R-1 that is attached to the taxpayer’s return.  An apportioning trade or business may make the election even if it includes one or more qualified business activities, such as financial or extractive activities that are required to use the standard apportionment formula, so long as the apportioning trade or business does not derive more than 50% of its gross business receipts from qualified business activities.


• Combined Reporting Groups.  All California taxpayer members of a combined reporting group must make the election for the election to be valid.  An election made on a group return is an election by each taxpayer member included in that group return.  The election made on the group return will not, however, have any effect if a taxpayer member of the combined reporting group files a separate return in which no election is made unless the business assets held by the electing group members are greater than the business assets held by the non-electing members.


• Forced Combination.  Corporations that are non-electing taxpayers that are subsequently found to be members of a combined reporting group as the result of an FTB audit determination are deemed to have made the election if the value of the total business assets of the electing taxpayer(s) is greater than those of the non-electing taxpayer(s).  Business assets of members who are not California taxpayers are not included.  Conversely, if the value of total business assets of the electing taxpayers does not exceed the value of total business assets of the non-electing taxpayers, the single-sales factor formula election of each electing taxpayer is terminated as of the date the non-electing taxpayers are properly included in the same combined reporting group as the electing taxpayers pursuant to the audit determination.  The deemed election will not, however, apply if the FTB audit determination is withdrawn or otherwise overturned.


• Forced Decombination.  A taxpayer that subsequently is found not to be a member of the combined reporting group during an FTB audit may make the election on an amended return within 60 days (180 days for reasonable cause) after the date of the applicable FTB notice.  Separate elections may be made for each taxable year included in the audit.  In the case of a refund claim made by the entity that was erroneously included in the combined reporting group, a request to make the election must be made in the claim itself or presented before issuance of the notice of action on the claim.


• Changes in Affiliations.  Elections are made at the end of each taxable year when changes in affiliation are known. When a corporation is acquired by a combined reporting group and becomes unitary mid-year, the taxpayer members of the combined reporting group have the option of electing to use the single-sales factor formula at the end of that taxable year. The income and factors of the acquired entity are not included in the combined report for the portion of the year before acquisition, and the acquired entity must file a return reflecting its income from California sources and may make its own separate election for that time period. When a combined reporting group sells a corporation, at the end of the year the taxpayer members of the combined reporting group may make a group election; however, the divested entity's income and factors are not included for the time period after the sale. The divested entity must file its own tax return for the post-sale time period and may make its own election for that portion of the year.


• Partnerships Owned by Corporations.  Corporations that make the election must use the single-sales factor formula for distributive share items of income and factors from unitary partnerships.  A partnership may make a single-sales factor formula election on Part B of Schedule R-1 of Form 565 or Form 568 to determine California-source income for its nonunitary partners.


• Nonresident Business Owners.  A nonresident individual who is a sole proprietor of a business that engages in activities both inside and outside California also may determine California-source income using the single-sales factor formula.  Similarly, a non-resident individual who is a partner in a partnership that engages in activities inside and outside California may determine California-source income using the single-sales factor formula on Part B of schedule R-1 of Form 565. If the partnership elects to use the single-sales factor formula, the partnership must use the single-sales factor formula to determine California-source income for all non-unitary non-resident partners.

If you have any questions regarding the contents of this newsletter, please contact the following attorneys in the firm’s State and Local Tax Practice Group.

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