Revamping Tax Rules: California Updates Alternative Apportionment Procedures

The California Office of Administrative Law (“OLA”) approved amendments to the California Code of Regulations, Title 18, Section 25137, concerning alternative apportionment method petition procedures. These amendments were filed with the Secretary of State on November 3, 2023 and became effective from that date.

What is Alternative Apportionment?

Generally, alternative apportionment is a provision under state tax law that allows the state taxing authority to disregard the standard apportionment and allocation provisions if it determines that those provisions do not accurately represent the extent of a taxpayer’s business activity in the taxing state.

In other words, in the present context, the alternative apportionment rules generally allow the California Franchise Tax Board (“FTB”) to use a different method to determine how much of a multistate business’s income is subject to California tax if the standard method does not fairly represent the amount of business the taxpayer is actually conducting in California. This provision is typically when the standard formula results in an unfair or distorted income representation.

Under current tax law, the standard apportionment formula applicable to most general businesses typically involves a single-sales factor formula based on the proportion of a taxpayer’s sales within the state compared to total sales everywhere.

Both the FTB and Taxpayers may, respectively, assert or petition for the use of an alternative apportionment methodology. The FTB generally has the burden of proving by clear and convincing evidence that an alternative apportionment method is necessary. However, a taxpayer may also petition the FTB for consent to use an alternative method.

Amended Cal. Code Reg. § 25137

As discussed above, Cal. Code Reg. § 25137 allows taxpayers to request an alternative apportionment method if the standard method does not accurately represent their business activity in California. The FTB may choose to hear and decide petitions in cases deemed appropriate rather than delegating this task to the staff, typically considered in an open session by the Board at regularly scheduled meetings.

The recently adopted amendments to Cal. Code Reg. § 25137, specifically subsection (d), aims to provide taxpayers with certainty by offering guidelines for petitions filed with the Board. The amendments provide clear rules, conditions, and deadlines for filing petitions, clarify the briefing process, and outline the procedures related to hearings. The new rules also address the application of ex-parte communications. The new procedural guidance aims to streamline the petition process and ensure consistent application of procedures.

Businesses that should consider alternative apportionment as part of their comprehensive state income tax planning typically include:

• Multistate Businesses: Businesses that operate in multiple states should consider the application of the standard apportionment rules in light of their general business activities and whether such activities correlate with the overall tax burden based on the extent of their business activity in each state.
• Complex Business Structures: Businesses with complex structures or operations, such as those with multiple lines of business, those that engage in significant intercompany transactions, or those with substantial intangible assets, may find that the standard apportionment method does not accurately reflect their business activity.
• Businesses with Significant Non-Business Income: The standard apportionment method may not accurately reflect the business activity of companies with significant non-business income.
• Businesses with Substantial Changes in Operations: If a business has undergone significant changes in its operations, such as a major expansion or contraction, the standard apportionment method may no longer accurately reflect its business activity.
• Businesses Subject to Special Industry Apportionment Rules: Certain industries (e.g., transportation, agricultural, media and entertainment, etc.) may have special apportionment rules. If a business is in one of these industries, it may need to consider alternative apportionment.

It is important to note that alternative apportionment is a fact-intensive analysis, and the specifics may be complex and vary depending on a multitude of factors, including the nature of the taxpayer’s business activities.

If you have any questions regarding California’s new rules or are interested in learning more about alternative apportionment opportunities available to your business, please reach out to our Marcum State and Local Tax team.