California to revise partnership income apportionment regulations
Franchise Tax Board decision expected to apply prospectively
TAX ALERT |
After more than six years of interested party meetings and discussions with practitioners and taxpayers, the California Franchise Tax Board is on the verge of culminating the regulation-making process to amend California Reg. sections 25137-1 and 17951-4. Reg. section 25137-1 addresses the apportionment and allocation of partnership income when a partnership interest is owned by a corporation. Reg. section 17951-4 addresses a non-resident's income from a business, trade or profession and also provides guidance for non-residents with partnership interests. When the revised regulations are issued, the revisions are expected to apply prospectively as of the effective date of the changes.
Notable amendments to these regulations include:
1. Reg. section 25137-1(a):
- The sentence "The same principle applies when a taxpayer has an interest in a partnership that itself owns an interest, directly or indirectly, in one or more other partnerships" has been added to the first paragraph to clarify that the rules contained in this regulation apply not only to partnership interests held directly by corporate taxpayers, but also to lower-tier partnerships that are held indirectly by the corporate taxpayer.
- Previously, the determination of business or non-business partnership income was made at the corporate partner level. The second paragraph has been amended to clarify that the determination of business and non-business partnership income is made at the partnership level regardless of whether the partnership and the corporate partner are engaged in a unitary business. This change requires that the partnership be treated as a separate trade or business of the corporate partner and should remove any confusion regarding whether a corporate partner should make a determination as to the sourcing of partnership income based on its ownership of the intangible interest in the partnership. It should be noted that if the partner and the partnership are engaged in a unitary business, the corporate partner will be required to include its distributive shares of partnership income and apportionment factors in its business income and apportionment factors, as currently required under Reg. section 25137-1(f).
2. Reg. section 25137-1(f):
- The older "income year" nomenclature has been eliminated in favor of the more current "taxable year."
- Clarification has been added to indicate that intercompany sales within a unitary business are not includable in the sales factor, even if the sales are made to another member of the unitary business that is not the direct partner owner of the partnership interest itself. Intercompany eliminations to be removed from the sales factor include both:
- Sales by the taxpayer, or any member of the taxpayer's combined reporting group, to the partnership to the extent of the taxpayer's interest in the partnership, and
- Sales by the partnership to the taxpayer or any member of the taxpayer's combined reporting group, not to exceed the taxpayer's interest in all partnership sales.
- Under the amended regulation, sales made to non-partners, other than members of the partner taxpayer's combined reporting group, are to be included in the denominator of the taxpayer's sales factor in an amount equal to such taxpayer's interest in the partnership.
- Revisions have been made to provide greater clarity for the term "interest in the partnership," with the change providing that a partner's interest percentage in the partnership shall be determined by its interest in profits, as opposed to capital.
3. Reg. section 17951-4(d):
- Revisions consistent with Reg. section 25137-1(a) provide that the apportionment of income is determined at the partnership level and not at the partner level.
Taxpayers should work with their tax advisors to review their partnership apportionment and determine the impact of these amendments.