The California Franchise Tax Board released a legal ruling with guidance on the proper analysis for assigning gross receipts from sales of services under market-based sourcing rules.
On March 25, 2022, the California Franchise Tax Board (FTB) issued Legal Ruling 2022-01, concerning relevant considerations and the proper analysis for assigning gross receipts from sales of services under California’s current market-based sourcing rules.
To assign receipts from the sales of services under the cascading rules of Reg. section 25136-2, taxpayers must consider:
- Who is the customer?
- The value to the taxpayer’s customer that is analyzed, not the value provided to any other party
- While third parties may benefit from a taxpayer’s service, it is only the customer’s benefit that is relevant to the analysis, even though a third party might also benefit from the performance of the service.
- What is the service provided?
- The contract service agreement identifies specific service to be performed
- Absent a contract or description, the taxpayer identifies the activities engaged in for consideration
- What is the benefit being received?
- Value of the service is the direct effect of the action or function being performed
- The benefit, for example, of a service received by the taxpayer’s customer is potential sales and interest from the viewers of the advertisement
- Where is the benefit of the service received by the customer?
- When the value of the service is the direct effect of the action or function being performed, the location of the benefit will be where the direct effect impacts the taxpayer’s customer
- When the service provided by the taxpayer is directed at the customer’s customer(s), the benefit received by the customer is likely located at the customer’s customer(s)’ location
A taxpayer can use an assessment of these four questions to determine where the benefit of the service described in each scenario is received Cascading rules measure the location of where the benefit was received, per Reg. section 25136-2(C)(2)(E). Three scenarios are presented in the FTB Legal Ruling to illuminate the process of analysis.
The Takeaway
This assessment helps assign gross receipts for sourcing purposes thus providing insight as to how the Franchise Tax Board might approach a Taxpayer’s apportionment method under audit.
California Franchise Tax Board: Legal Ruling 2022-01
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