Effective on Jan. 1, 2019, California recently amended regulations sections 25137-1 and 17951-4 to address the apportionment and allocation of income from partnership interests owned by corporate partners. Section 25137-1 addresses unitary corporations included in a combined report that conduct business in and outside California, and which own interests in partnerships that also conduct business in and outside California. Section 17951-4 addresses nonresidents and part-year residents who own interests in partnerships that conduct business in and outside California.
Significant changes to the regulations are as follows:
- The amendments provide for the apportionment and allocation rules to include lower-tier partnerships that are held indirectly by a corporate partner, stating that the partner is subject to the rules when holding ownership of “a partnership that itself owns an interest, directly or indirectly, in one or more other partnerships”
- The determination of whether an item of income is apportionable business income or allocable nonbusiness income is made at the partnership level based on the trade or business of the partnership. Corporate partners conducting a business that is not considered unitary with the partnership must now treat the distributive share of business income from the partnership as from a separate trade or business of the corporate partner, not nonbusiness income
- Clarification that the term “interest in the partnership” is determined by the partner’s “interest in profits of the partnership”
- Nonresident partners conducting a unitary business with a partnership must apportion business income at the partner level
- Per a regulatory hearing on Dec. 18, 2017, the following language was deleted from the final version of Reg. 17951-4(d)(1): “Revenue and Taxation Code section 17952 is not applicable in determining the source of income allocated to the non-resident taxpayer by the partnership.” This language was a hot-button issue for tax practitioners at prior Interested Party Meetings (IPM) with tax practitioners objecting as the language was narrowing the application of the statute. The language was stricken since the FTB Hearing Officer concluded that that language was repetitive in that only nonbusiness income from a partnership is subject to the purview of section 17952 because business income from a partnership that conducts business within and without California is apportioned in all situations.
The initial statement of reasons provided the following background for changes to section 17951-4:
California Revenue and Taxation Code section 17952 provides that for purposes of determining income from sources within California from certain intangible property held by nonresidents or part-year residents, the certain intangible property must have a business situs in California. Some taxpayers have asserted that an interest in a partnership that conducts business within and without California comes under the purview of California Revenue and Taxation Code section 17952. The regulation is being revised to explicitly provide that California Revenue and Taxation Code section 17952 does not apply with respect to an interest in a partnership that conducts business within and without California. The regulation is further revised to provide that if the partner and the partnership that conducts business within and without California are engaged in a unitary enterprise, then the rules embedded in Regulation section 25137-1 apply for purposes of determining the income from the partnership from California sources attributable to the partner.
Takeaways
The proposed amendments were first discussed by FTB staff at an IPM on Aug. 21, 2008. Several IPMs later, and after various changes, the revised regulations were adopted effective Jan. 1, 2019. The amendments provide clarifications on how both a corporate partner and/or a nonresident partner should apportion and allocate income derived from a partnership interest. Although the previous language regarding section 17952 being not applicable has been stricken from the final amendments, a taxpayer that applies section 17952 to the distributive business income from a partnership is likely to be questioned by the FTB upon audit. Taxpayers should contact their state and local advisers to determine how the amended regulations will affect apportionment calculations.
