TAX NEWS - 2010

California Amends sales factor cost of performance rules for services and intangibles to include payments made to agents and independent contractors

Approval was granted recently for the California Franchise Tax Board's adoption of amendments to its corporate franchise tax sales factor "cost of performance" regulation (Regulation 25136) applicable to sales of services and intangibles.

Although the change becomes effective on July 19, 2010, the amended regulation applies retroactively to taxable years beginning on or after January 1, 2008. As amended, California's cost of performance regulation includes consideration of transactions and activities performed "on behalf of" a taxpayer by an agent or independent contractor in determining the state to which receipts from sales, other than sales of tangible personal property, should be assigned.

Because California's general cost of performance provision utilizes an "all or nothing" approach in assigning receipts to the numerator of the sales factor, application of the new regulation could alter the analysis of the location in which costs are incurred and, ultimately, change the state to which sales are assigned. In addition, because the application of the amended regulation is retroactive to taxable year 2008, taxpayers should review closely the effect of this change. Those taxpayers that potentially benefit from the amended regulation may wish to consider filing claims for refund, while those impacted unfavorably should consider the effect on their California franchise tax liability, including the potential application of penalties and interest accruing beginning in 2008.