On March 25, 2022, the California Franchise Tax Board (FTB) issued Legal Ruling 2022-01, on the subject “Numerator Assignment of Gross Receipts from Sales of Services to Business Entities.” The ruling sets forth the FTB’s position regarding the “relevant considerations and proper analysis” for sourcing sales of services under California’s current market-based sourcing rules. It also poses four questions as “guidelines” to assist in the sourcing analysis:
- Who is the customer?
- What is the service provided?
- What is the benefit being received?
- Where is the benefit of the service received by the customer?
Using these four questions, the ruling walks through three different scenarios and applies the rules found in FTB’s market-sourcing regulation, 18 California Code of Regulations section 25136 (FTB Regulation 25136), to determine where the benefit of the service described in each scenario is received.
Notably, the benefit is determined to be received at the location of the taxpayer’s customer’s customer in two of the scenarios. Previously, the FTB had issued two Chief Counsel Rulings (“CCR”), CCR 2015-03 and CCR 2017-01, which interpreted FTB Regulation 25136 in situations where the benefit of a service potentially was received at the location of the taxpayer’s customer’s customer. These two rulings provided support for sourcing certain sales to the location of the business operations of a taxpayer’s direct customer. Legal Ruling 2022-01 revokes both CCRs.
Also of note is the timing of this particular ruling. The FTB has been in the process of amending FTB Regulation 25136 for over five years, with the project moving to formal proceedings in late 2021. See our discussion of California’s current market-sourcing provisions along with an overview of the regulation project here. How the position laid out in Legal Ruling 2022-01 will apply under an amended regulation remains to be seen. We will continue to follow the regulation process and provide updates on the status of the proposed amendments.