On November 2, 2018, the Chief Counsel of the California Franchise Tax Board issued Chief Counsel Ruling No. 2018-01, determining: (1) that a taxpayer servicing mortgages was not a financial corporation for purposes of the corporation franchise tax; and (2) gains from interest rate hedging contracts are general income, not money or moneyed capital. Although the taxpayer earned origination income, interest income and net gains from sales of mortgages, its primary revenue was from servicing the mortgage loans.

Among other differences, California taxes financial corporations at a higher corporation franchise tax rate than general corporations.

First, the Chief Counsel determined that the taxpayer was not a financial corporation because it derives more than 50% of its total gross income from servicing mortgages. A financial corporation is a corporation that predominantly deals in money or moneyed capital in substantial competition with the business of national banks. While originating and selling mortgage loans constitutes dealing in moneyed capital, servicing loans does not. Rather, servicing loans generates income from a service activity. Because the taxpayer predominantly engaged in service activities instead of dealing in money or moneyed capital, it was not a financial corporation.

Second, the Chief Counsel determined that gains from interest rate hedging contracts are general income, not money or moneyed capital. The hedging contracts are not specifically listed as money or moneyed capital, nor are they similar to the listed examples. Thus, the hedging contracts would not qualify the taxpayer as a financial corporation.


Chief Counsel Ruling No. 2018-01, California Franchise Tax Board (Nov. 2, 2018).

The California Court of Appeals affirmed a trial court’s holding that the California Franchise Tax Board can require interstate unitary businesses to use combined reporting, even though combined reporting is optional for intrastate unitary businesses. The taxpayer, a motorcycle retailer, argued that the differential treatment of interstate and intrastate business gave a direct commercial advantage to intrastate unitary companies and therefore discriminated against interstate commerce in violation of the Commerce Clause of the United States Constitution. The appellate court rejected the taxpayer’s argument and held that the legitimate state interest to accurately measure and tax all income attributable to California outweighed any possible discriminatory effect.


Harley-Davidson, Inc. v. California Franchise Tax Bd., Dkt. No. D071669 (Cal. Ct. App. Aug. 22, 2018).

By Charles Capouet and Jeff Friedman

In a 4-4 decision, the U.S. Supreme Court affirmed the Nevada courts’ exercise of jurisdiction over the California Franchise Tax Board (FTB), but held, by a majority of the justices, that the taxpayer could only receive the damages Nevada provides for suits by private citizens against Nevada agencies. The taxpayer, Gilbert Hyatt, sued the FTB in Nevada for abusive audit and investigation practices. The Nevada Supreme Court rejected the FTB’s claims that the U.S. Constitution’s Full Faith and Credit Clause required Nevada to apply California’s sovereign immunity law, holding that Nevada courts, as a matter of comity, would immunize California where Nevada law would similarly immunize its own agencies and officials. The Nevada Supreme Court, however, set aside much of the nearly $500 million in damages awarded by the jury after trial and only affirmed $1 million of the award. Nevada statutes would impose a $50,000 limit in a similar suit against its own officials. The Court held that the Full Faith and Credit Clause does not permit Nevada to award damages against California agencies under Nevada law that are greater than it could award against Nevada agencies in similar circumstances. As a result, the Court held that the taxpayer’s award for damages could not exceed Nevada’s $50,000 limit. Franchise Tax Bd. of California v. Hyatt, No. 14-1175 (U.S. Apr. 19, 2016).

By Evan Hamme and Timothy Gustafson

The California State Board of Equalization (Board) unanimously rejected Craigslist, Inc.’s (Craigslist) argument that California’s adoption of a factor-presence nexus regime in 2009 reflected pre-existing federal constitutional nexus standards pursuant to which Craigslist would be “subject to tax” in jurisdictions where it did not have a physical presence, and would not be required to throw out sales made in such jurisdictions. Pursuant to a written agreement, the California Franchise Tax Board (FTB) had granted Craigslist alternative apportionment for the 2007-2010 tax years, which required Craigslist to exclude from its sales factor sales made in states where Craigslist was not subject to tax under “United States constitutional standards for nexus.” At the time, California law, as interpreted by the Board and the FTB, required taxpayers to have a physical presence in a jurisdiction to be taxable in that jurisdiction. But 2009 legislation changed California’s nexus rules to include a market-based definition, effective January 1, 2011, which established a bright-line, $500,000 threshold for sales in a state to establish nexus. Craigslist filed an amended return in 2011 for the 2007 tax year, and included in its sales factor sales in any jurisdiction where Craigslist had more than $500,000 in sales for 2007 even if Craigslist had never had a physical presence there, arguing that if economic nexus satisfied U.S. constitutional standards in 2009 when expressly adopted by the California Legislature, it necessarily satisfied those same standards two years prior. The FTB argued that the constitutional standards must be determined through the lens of California decisional law, that the 2011 legislation applied prospectively to adapt to changes in the economy, and that a Board ruling in favor of Craigslist would cause significant uncertainty for other taxpayers regarding pre-2011 tax and filing obligations. The Board unanimously agreed with the FTB and denied Craigslist’s appeal, stating at the hearing it would be an “injustice” to allow the “change in law” effective in 2011 to apply to earlier years. Because the amount in controversy exceeds $500,000, the Board will have 120 days from when the appeal becomes final to issue a written decision. Appeal of Craigslist, Inc., Cal. Bd. of Equalization, No. 725838, appeal denied, Dec. 16, 2015.

By Evan Hamme and Tim Gustafson

In a rare Chief Counsel Ruling (the first of 2015), the California Franchise Tax Board (FTB) held that the sale of an entire line of business qualified as an “occasional sale” for corporate franchise tax purposes, thus requiring the selling taxpayer to exclude the resulting gross receipts from its California sales factor. The taxpayer operated two lines of business and, through the transaction at issue, sold one to an unrelated party in order to focus on the other. California Code of Regulations, title 18, section 25137(c)(1)(A) requires taxpayers to exclude from the sales factor gross receipts resulting from a transaction that is both: (1) “substantial” (i.e., a 5% or greater decrease to the sales factor denominator would result from excluding the gross receipts); and (2) “occasional” (i.e., “is outside the taxpayer’s normal course of business and occurs infrequently”). The FTB found the transaction was “substantial” because excluding the gross receipts decreased the taxpayer’s denominator by approximately 33%. Adopting and applying an analysis from case law interpreting California’s transactional test for business income, the FTB also found the transaction was “occasional” because (1) the taxpayer’s disposition of an entire line of business was “an extraordinary corporate occurrence” that did not occur in the taxpayer’s regular course of business; and (2) the sale was infrequent since this was the only time the taxpayer had disposed of an entire line of business. Cal. FTB Chief Counsel Ruling No. 2015-01 (Jul. 31, 2015).

By Robert P. Merten III and Timothy A. Gustafson

The California State Board of Equalization (BOE) has issued a rare ruling on residency topics, finding in favor of individual taxpayers on two issues. First, the BOE found that the taxpayers established domicile in Washington three months earlier than the Franchise Tax Board claimed, because they purchased a fully furnished $2.8 million home, registered to vote, registered automobiles and obtained driver’s licenses in the state. Although the taxpayers only spent six days in Washington and 64 days in California during the pertinent time frame, they sufficiently established that their time spent in California was only for a “temporary or transitory purpose” between post-retirement trips. Second, the BOE concluded that the taxpayers were not liable for $3.7 million in California income tax on payments from a California partnership made to liquidate the newly retired taxpayer’s partnership interest because such payments were non-taxable distributions as opposed to taxable distributive shares or guaranteed payments with a California source. Because the amount at issue was more than $500,000, the BOE must follow its ruling with a written decision. The BOE is currently considering whether the written opinion should take the form of a precedential formal memorandum or a non-precedential summary decision. If the former, then taxpayers will be provided with official BOE California residency guidance for the first time in years. Appeal of Michael J. and Mary E. Bills, Cal. St. Bd. of Equal. (heard May 28, 2015)

By Michael Penza and Timothy Gustafson

The California Franchise Tax Board (FTB) issued an information letter explaining that a trust is taxable in California if any of the following three conditions are met: (1) the trust has income from California sources; (2) a trustee is a resident of California; or (3) a non-contingent beneficiary is a resident of California. The letter elaborated that where a trust accumulates income from both California and foreign sources, California taxes 100% of the California source income, plus a percentage of the foreign source income reflecting the proportion of trustees and beneficiaries residing in California to trustees and beneficiaries residing outside of California. California FTB Information Letter No. 2015-02 (April 21, 2015).

The information letter is consistent with the California Supreme Court’s ruling in McCulloch v. Franchise Tax Board, 390 P.2d 412 (Cal. 1964), which held that California could tax a foreign trust’s undistributed income based on a beneficiary’s California residence without violating the federal Constitution. A North Carolina Superior Court, however, reached the opposite conclusion in The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue. In Kaestner, the trust’s only connection to the state was through its beneficiary, a North Carolina resident. The trust did not hold any real or personal property in North Carolina; it did not generate any income from direct investments in North Carolina; it did not maintain any records in North Carolina; and its sole trustee did not reside in North Carolina. Accordingly, the court held that the federal Due Process Clause prevented North Carolina from taxing the trust’s undistributed income because: (1) the trust did not have a physical presence in the state, or derive any income from sources within the state; and (2) the trust did not receive any benefits from the state that could justify the tax imposed. Similarly, the court held that the Commerce Clause prevented the state from taxing the trust because: (1) the trust did not have substantial nexus with the state; and (2) the tax was not fairly related to the services provided by the state. The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue, Docket No. 12 CVS 8740 (N.C. Super. Ct., April 23, 2015).

By Evan Hamme and Timothy Gustafson
A California Superior Court held that passive membership in a limited liability company (LLC) is insufficient to meet California’s statutory “doing business” standard. In Swart Enterprises, Inc. v. California Franchise Tax Board, an Iowa corporation with no business activities or physical presence in California invested in a fund organized as a California LLC. Despite its previous Technical Advice Memorandum (TAM) finding that passive investment in an LLC did not create nexus with California, the Franchise Tax Board (FTB) asserted that Swart Enterprises, Inc. was “doing business” in the state by virtue of having previously purchased an interest in the fund two years prior to the tax year in question. Because the LLC had elected under federal and California law to be treated as a partnership for tax purposes, the FTB argued that “partnership” must be interpreted to mean a general partnership, and that each LLC member, like a general partner in a partnership, would presumptively have control over the management of the business. The court disagreed. Under California law, the fund was organized as a “manager-managed LLC” rather than a “member-managed LLC”; thus, Swart had no control over the management of the fund. Nor did Swart have a sufficient percentage interest to indirectly control its management, because Swart’s investment gave it only 0.2% ownership of the fund. Accordingly, the court held that Swart was not doing business in California. Notably, while the litigation was pending, the FTB issued a TAM effectively changing the position espoused in its earlier TAM and asserting that passive LLC members were subject to tax in California. After analyzing the California case law relating to limited partnership interests, the court stated there was “no legal authority” for the conclusions drawn by the FTB under the new the TAM. The court did not reach Swart’s contentions that subjecting Swart to California’s corporate franchise tax would violate the due process clauses of the California and United States Constitutions. Also, the court did not address the FTB’s constitutional and standing arguments. Swart Enterprises, Inc. v. California Franchise Tax Board, Case No. 13CECG02171 (Cal. Super. Ct. Nov. 13, 2014).

By Evan Hamme and Timothy Gustafson

A California Superior Court held that passive membership in a limited liability company (LLC) is insufficient to meet California’s statutory “doing business” standard. In Swart Enterprises, Inc. v. California Franchise Tax Board, an Iowa corporation with no business activities or physical presence in California invested in a fund organized as a California LLC. Despite its previous Technical Advice Memorandum (TAM) finding that passive investment in an LLC did not create nexus with California, the Franchise Tax Board (FTB) asserted that Swart Enterprises, Inc. was “doing business” in the state by virtue of having previously purchased an interest in the fund two years prior to the tax year in question. Because the LLC had elected under federal and California law to be treated as a partnership for tax purposes, the FTB argued that “partnership” must be interpreted to mean a general partnership, and that each LLC member, like a general partner in a partnership, would presumptively have control over the management of the business. The court disagreed. Under California law, the fund was organized as a “manager-managed LLC” rather than a “member-managed LLC”; thus, Swart had no control over the management of the fund. Nor did Swart have a sufficient percentage interest to indirectly control its management, because Swart’s investment gave it only 0.2% ownership of the fund. Accordingly, the court held that Swart was not doing business in California. Notably, while the litigation was pending, the FTB issued a TAM effectively changing the position espoused in its earlier TAM and asserting that passive LLC members were subject to tax in California. After analyzing the California case law relating to limited partnership interests, the court stated there was “no legal authority” for the conclusions drawn by the FTB under the new the TAM. The court did not reach Swart’s contentions that subjecting Swart to California’s corporate franchise tax would violate the due process clauses of the California and United States Constitutions. Also, the court did not address the FTB’s constitutional and standing arguments. Swart Enterprises, Inc. v. California Franchise Tax Board, Case No. 13CECG02171 (Cal. Super. Ct. Nov. 13, 2014).

By Todd Betor and Timothy Gustafson

A California Franchise Tax Board (FTB) Chief Counsel Ruling concluded that a taxpayer’s sales of assets pursuant to a plan of reorganization under Chapter 11 of the U.S. Bankruptcy Code were not “occasional sales” within the meaning of 18 Cal. Code Regs. § 25137(c)(1)(A)2. Instead, the sales of assets were deemed to be part of the taxpayer’s normal course of business and occurred frequently. As a result, the taxpayer’s gross receipts from the asset sales were includable in its sales factor for apportionment purposes. Under 18 Cal. Code Regs. § 25137(c)(1)(A), receipts are excluded from the sales factor when a substantial amount of gross receipts arise from an occasional sale of assets used in that taxpayer’s trade or business. A sale is an “occasional sale” if the transaction is outside of a taxpayer’s normal course of business and occurs infrequently. The taxpayer at issue filed for Chapter 11 bankruptcy, which lead to a number of creditors cashing out to investors for amounts less than face value of the debt. In order to monetize their investments, and as part of the taxpayer’s plan of reorganization, the new owners directed the taxpayer’s management to sell the taxpayer’s assets, resulting in a series of asset sales over a two-year period. The FTB concluded that “[t]o accomplish the goal of the Plan of Reorganization, negotiation and implementation of asset sale transactions became part of [the] Taxpayer’s normal course of business.” Consequently, the asset sales were found not to be “occasional sales.” California FTB Chief Counsel Ruling No. 2014-2 (June 3, 2014).

By Shane Lord and Andrew Appleby

The California Superior Court ruled that certain special purpose entities (SPEs) owned by Harley-Davidson, Inc. had nexus in California. The taxpayer formed the SPEs as securitization subsidiaries, which the court held were subject to California income taxation because the SPEs: (1) were “financial corporations” under California law; and (2) had substantial nexus with California because the SPEs had agents in the state. The court determined that independent dealerships and the SPEs’ parent and sister corporations were agents of the SPEs. The taxpayer argued that the SPEs were not “financial corporations” because the SPEs were bankruptcy remote subsidiaries of the taxpayer and were not in substantial competition with national banks, as required by Cal. Code Regs. tit. 18, § 23183. The court did not address the implications of the SPEs constituting bankruptcy remote subsidiaries. The court ultimately held that the SPEs were in substantial competition with national banks because the SPEs and national banks conducted the same activities of bundling loans and selling securities backed by those loans. In addition to the above issues, the court sustained a demurrer early in the case, dismissing the taxpayer’s two other causes of actions: (1) the Franchise Tax Board discriminated against the taxpayer by not allowing it to file separate returns; and (2) the taxpayer was entitled to use an equal-weighted three-factor apportionment formula (see Gillette Co. v. Franchise Tax Bd., 147 Cal. Rptr. 3d 603 (Cal. Ct. App. Oct. 2, 2012)). Harley-Davidson, Inc. & Subs. v. Franchise Tax Bd., No. 37-2011-00100846-CU-MC-CTL (San Diego Super. Ct. May 1, 2013).