United States: Mofo New York Tax Insights - Fall 2013


By Eric J. Coffill

For decades, California utilized a mandatory corporate franchise tax equally-weighted three factor apportionment formula of payroll, property and sales, thus assigning a 33% weight to the sales factor. In 1993, California double-weighted sales in the three-factor formula, increasing the weight of the sales factor to 50%.1 Recently, following a number of unsuccessful attempts over the years by the California Legislature to change the apportionment formula to mandatory use of single-factor sales, the California voters passed Proposition 39 at the November 6, 2012 General Election requiring, for taxable years beginning on or after January 1, 2013, corporate taxpayers to apportion using single-factor sales.2 Accordingly, with three possible exceptions,3 current California law relegates payroll and property factor issues to obscurity. For example, a taxpayer with all of its manufacturing capacity (i.e., 100% property) and all of its employees (i.e., 100% payroll) outside of California, but with all of its sales assigned to California, will have a 100% California apportionment formula.4

Now, it is all about sales. If single-factor sales were not enough, for taxable years beginning on or after January 1, 2013, sales of other than tangible personal property are assigned for sales factor purposes based on a so-called "market" approach, instead of costs of performance.5 Also, recall that for taxable years beginning on or after January 1, 2011 California returned to a Finnigan approach under which all sales of a combined reporting group properly assigned to California will be included in the California sales factor, regardless of whether the member of the combined group making the sale is subject to California tax.6

The trend toward hyper-weighting the California sales factor—now to 100% sales beginning in 2013—continues to increase the tax value of that factor. There have been, and will continue to be, a wide variety of sales factor issues in California and all those issues now take on a heightened importance in terms of tax effect. One such issue, the inclusion in the sales factor of receipts from so-called "occasional sales," is the subject of this article. As more fully discussed below, California Franchise Tax Board ("FTB") Regulation 25137(c)(1)(A) generally provides that when substantial gross receipts arise from an occasional sale of a fixed asset or other property held or used in the regular course of the taxpayer's trade or business, those receipts must be excluded from the sales factor.7

Regulation 25137(c)(1)(A)

Regarding the preliminaries, the sales factor is a fraction, the numerator of which is the total sales of the taxpayer in California during the income year and the denominator of which is all gross receipts everywhere not allocated.8 Over the years, and often following in the footsteps of the Multistate Tax Commission, the FTB has promulgated a number of special regulations under the authority of California Revenue and Taxation Code9 Section 25137, which provides special rules for apportionment. Such special regulations are not to be taken lightly. If a relevant special formula is specifically provided in the FTB's Section 25137 regulations ("25137 Regulations") and the conditions and circumstances delineated in such a regulation are satisfied, the California State Board of Equalization ("SBE") has held that the method of apportionment prescribed in that regulation shall be "the standard" by which taxpayers and the FTB are to compute the taxpayer's apportionment formula.10 In other words, once found to be applicable to the particular situation, 25137 Regulations "will control."11

The FTB's special regulatory sales factor rules for so-called "occasional sales" are found in Regulation 25137(c)(1)(A),12 which provides in full:

(A) Where substantial amounts of gross receipts arise from an occasional sale of a fixed asset or other property held or used in the regular course of the taxpayer's trade or business, such gross receipts shall be excluded from the sales factor. For example, gross receipts from the sale of a factory, patent, or affiliate's stock will be excluded if substantial. For purposes of this subsection, sales of assets to the same purchaser in a single year will be aggregated to determine if the combined gross receipts are substantial.

1. For purposes of this subsection, a sale is substantial if its exclusion results in a five percent or greater decrease in the sales factor denominator of the taxpayer or, if the taxpayer is part of a combined reporting group, a five percent or greater decrease in the sales factor denominator of the group as a whole.

2. For purposes of this subsection, a sale is occasional if the transaction is outside of the taxpayer's normal course of business and occurs infrequently.

Accordingly, the key operative concepts under Regulation 25137(c)(1)(A) are: (1) substantial (vs. insubstantial) sales amounts; (2) from an occasional sale; (3) of a fixed asset or other property; (4) which is held or used in the regular course of the taxpayer's trade or business.

"Substantial Amounts"

While "substantial amounts" is a key term long found in Regulation 25137(c)(1)(A), it was only defined therein by the FTB's amendments to the regulation filed on January 30, 2001 and operative as of January 1, 2001.13 The 2001 amendments added the definition, now found in Regulation 25137(c)(1)(A)(1), that a sale is "substantial" if its exclusion results in a 5% or greater decrease in the taxpayer's sales factor denominator or, if the taxpayer is part of a combined reporting group (i.e., is unitary), a 5% or greater decrease in the sales factor denominator of the group as a whole. The FTB staff's explanation for the creation of this 5% standard is that "this number reflects staff's belief that a five percent change in the sales factor denominator is large enough to skew the sales factor in favor of the location of the occasional sale."14 The FTB staff went on to explain the 5% calculation "recognizes that it is the clear reflection of the income of the entire unitary group that is in issue and therefore only a substantial change in the apportionment formula of the group as a whole should trigger the occasional sale throwout."15 This intersection of apportionment and unitary theory means a unitary analysis is an essential component of an occasional sale analysis under the regulation.16

Aside from the FTB "staff's belief," nothing in the regulatory history shows a reasoned basis for the arbitrary, bright-line 5% figure compared to, say, a 4%, a 6%, a 10% or a 20% figure. The FTB staff freely admits that even if the 5% threshold in the regulation is called into play, a taxpayer (or the FTB) still can show the regulation does not properly reflect its activities in California under Section 25137.17 This admission is consistent with the SBE's decision in Fluor Corporation, which stated that any party wishing to deviate from the method prescribed in one of the 25137 Regulations, when found to be applicable, may do so upon establishing by clear and convincing evidence the regulation "does not fairly represent the extent of the taxpayer's business activities" in California.18 Query, is it now easier or harder to demonstrate such fair/unfair representation when the sales factor is the only (i.e., 100%) "business activity" used for apportionment, compared to when the regulation was first written at the time of an equally-weighted (i.e., 33%) three-factor formula or compared to when the regulation was amended to include the 5% threshold at the time of a double-weighted (i.e., 50%) sales factor? Another amendment the FTB made in 2001 was adding language to Regulation 25137(c)(1)(A) stating that sales of assets to the "same purchaser" in a single year will be aggregated to determine if the combined gross receipts is "substantial." During the regulatory process, the FTB staff explained this additional language is meant to address transactions that are completed in several steps rather than as one transaction. Although the FTB stated the language is not meant to aggregate unrelated transactions and the reference to the "same purchaser" intentionally "is left without reference to either the single entity or a unitary group context," the FTB also stated "it is proper to conclude that 'purchaser' should be construed to mean individual entity rather than a unitary group."19 However, the FTB staff noted that if it appears that what otherwise would be a single sale has been intentionally spread by a taxpayer into multiple sales to multiple members of a purchaser's unitary group "without a business purpose, the transactions could still be aggregated using a tax avoidance theory."20

"Occasional Sale"

Another key component of Regulation 25137(c)(1)(A) is that, for it to apply, the gross receipts must be from an "occasional sale." Prior to the FTB's 2001 amendments, the precise language of Regulation 25137(c)(1)(A) read "an incidental or occasional sale." The amendment struck "incidental" from the regulation. The FTB's explanation for removing the term "incidental" during the regulatory process is that:

[S]taff feels the term is not in accord with the regulation's requirement of substantiality. The term implies that a sale is thrown out if it is merely an afterthought of another transaction. Staff believes that such afterthought types of sale will never rise to the level of substantiality required to trigger the regulation.21

Regarding the meaning of "occasional" in the regulation, the 2001 amendments added Regulation 25137(c)(1)(A)(2), which provides that "[f]or purposes of this subsection, a sale is occasional if the transaction is outside of the taxpayer's normal course of business and occurs infrequently."

What is intriguing about this added language in Regulation 25137(c)(1)(A)(2) is the FTB made no attempt to quantify the term "occasional" when revising the regulation. One might argue any such attempt at quantification would be futile as it would be unnecessarily arbitrary (e.g., to create a brightline that less than "X" number of sales within a tax year is "occasional"), but that same objection could be raised equally to the FTB's addition of a 5% bright-line test of "substantial" receipts in Regulation 25137(c)(1)(A)(1). While sales/use tax is generally more a slave to rules than is the law regarding multistate corporate income tax apportionment, California sales tax law has long functioned on the general principle that less than three sales within a period of 12 months is "occasional."22 Instead of quantifying what is an "occasional" sale, the 2001 amendments provide that an occasional sale is one that "occurs infrequently." The 2001 regulatory history is essentially silent as to the rationale for adding the term "infrequently" or the meaning of that term. Thus, as with the "substantial" language in the regulation, the "occasional" standard requires a thoughtful analysis, on a case-by-case basis, taking into account a wide range of facts and circumstances.23

Another significant component of the "occasional sale" analysis under the regulation is the language added in 2001 to Regulation 25137(c)(1)(A)(2) providing that "a sale is occasional if the transaction is outside of the taxpayer's normal course of business . . . ." The FTB explains that the definition of "occasional" in the regulation "is premised upon the regulation only applying to sales of property which are outside of the taxpayer's normal course of business, but, when sold, still give rise to business income" and explains that this concept "is also a reflection of the so-called 'functional test' for business income contained in Revenue and Taxation Code section 25120 . . . ."24 The functional test is one of two alternative tests found in Section 25120 for business income and includes income from tangible and intangible property if the acquisition, management and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations.25 What of the alternative transactional test, whose omission is conspicuous? While only explaining the language in terms of the functional test, the FTB's position likely would be that a sale typically would not be an occasional sale if the gain from the sale was business income under the transactional test.

"Fixed Assets or Other Property"

The last key issue presented under Regulation 25137(c)(1)(A) is what type of property is subject to the regulation. Prior to the amendments in 2001, the regulation expressly applied by its terms only to the sale "of a fixed asset," which necessarily excluded sales of intangibles (e.g., stock or goodwill). However, in 1997, FTB Legal Ruling 97-1 ("Ruling") addressed the scope of the regulation and concluded that notwithstanding the fact the language referred only to a "fixed asset," the regulation similarly also should apply to sales of intangible property because "there is no logical basis for distinguishing between fixed assets and intangibles."26 However, in apparent recognition of the fact this conclusion expanded the regulation beyond its express language, the Ruling did not purport to amend the regulation itself. Instead, the Ruling reached its conclusion to include intangibles "under authority of [Revenue and Taxation Code] section 25137 . . . ."27 In other words, the FTB looked to Section 25137 to impliedly write intangible property into the regulation.28

As part of the 2001 amendments, the FTB modified the relevant language of Regulation 25137(c)(1)(A) from sale of a "fixed asset" to "fixed asset or other property" to conform to the conclusion reached in the Ruling. Indeed, while a number of other changes also were made at the time, it appears the driving purpose behind the 2001 amendments was to change the regulation to add the FTB's position on including intangibles consistent with the Ruling.29 In the same vein, the regulation was amended at that time to expand the examples of sales from "a factory" to "a factory, patent, or affiliate's stock." The FTB's rationale for expanding the regulation to include sales of "other property" was the change reflected the FTB's position set forth in the Ruling and "[t]here isn't any logical basis for distinguishing between fixed assets and intangibles in the instant context."30 The FTB elaborated this same potential for distortion involving "other property" is "especially true if you're talking about the growth of built-in appreciation, which occurs over a substantial period of time, because taking the gross receipt into account in the year of the recognition event does not reflect the gradual effects of appreciation over several years."31

Interplay Between Section 25137 and Regulation 25137(c)(1)(A)

Note here, again, the continuing issue of the interplay between Section 25137 and Regulation 25137(c)(1)(A) addressing "occasional sales." As explained above, the SBE's decision in Fluor Corporation states the 25137 Regulations create "the standard," yet any party remains free to challenge the application of such a regulation under Section 25137. The FTB relied upon this principle and Section 25137 in issuing the Ruling. As also discussed above, the FTB recognizes taxpayers are entitled to take the same approach (i.e., to challenge under Section 25137 the application of a 25137 Regulation). In taking such an approach (and one should always at least consider such an approach based upon the application of the regulation to a specific set of facts and circumstances), bear in mind the legal standards for obtaining relief under Section 25137. California law currently states that for a party (taxpayer or FTB) to invoke Section 25137, that party must satisfy a two-part burden of proving by "clear and convincing evidence" that (1) the approximation provided by the standard formula is not a fair representation and (2) the party's proposed alternative is "reasonable."32 California law also appears to currently state that Section 25137 only applies "where the particular function or activity is qualitatively different from the taxpayer's principal business and the quantitative distortion from inclusion of the receipts of that function or activity . . . is substantial."33 However, it is important to bear in mind that the judicial decisional law setting forth these so-called "quantitative and qualitative" approaches all involved application of Section 25137 in the context of gross versus net receipts from various treasury operations. How the language of those decisions impact the application of Section 25137 in other contexts, such as challenging the application of the FTB's "occasional sale" 25137(c)(1)(A) regulation, and how the merits of showing distortion are to be calculated outside the context of these treasury operation cases are interesting questions and are definitely a fruitful area for innovative thinking.


Regulation 25137(c)(1)(A) is just one of many possible examples of issues long lurking in the sales factor computation and just one of many examples of such issues that now take on a heightened importance in terms of their growing potential tax effect under California's new singlefactor sales apportionment formula. Here, one must work through the vagaries of regulatory terms such as "occasional" and "infrequent," as well as assess the composition of the unitary group. Then, one must consider whether the regulation should not apply in any event under the controlling statutory authority of Section 25137. As with many of such California sales factor issues, careful situational application of this regulation, looking to the specific facts and circumstances of each case, is a sound and recommended practice.


1 Cal. Rev. & Tax. Code § 25128, as amended by Ch. 946, Laws 1993. There were a number of statutory exceptions to double-weighted sales (e.g., taxpayers that derived more than 50% of their gross business receipts from agriculture, extractive business activity, savings and loan activity or banking or financial activity).

2 Proposition 39, entitled the "California Clean Energy Jobs Act," was approved by 61.1% of the voters in the General Election. California Secretary of State, Statewide Summary by County for State Ballot Measures, available at http://www.sos.ca.gov/elections/sov/2012-general/ssov/ballot-measuressummary- by-county.pdf, last accessed October 18, 2013. Proposition 39 also ended a brief period where, for taxable years beginning on or after January 1, 2010, a taxpayer could make an annual irrevocable election on an original return to apportion income using a single sales factor. See 2009 Budget Trailer Bills, SBX3 15, ABX3 15, Laws 2009. The election only was available to taxpayers otherwise subject to double-weighted sales. See Cal. Rev. & Tax. Code §§ 25128, as amended by Ch. 544, Laws 2009; 25128.5, as added by Ch. 17, Laws 2009.

3 The first exception continues to be that certain businesses by statute—taxpayers deriving more than 50% of their gross receipts from agriculture, extractive business activity, savings and loan activity or banking or financial activity—must continue to use an equally-weighted three-factor formula. Cal. Rev. & Tax. Code § 25128. The second exception is that taxpayers are always free to petition the FTB to use an alternative apportionment formula if use of a single sales factor does not "fairly represent the extent of the taxpayer's business activity in this state . . . ." Cal. Rev. & Tax. Code § 25137. The third exception involves the pending litigation over a taxpayer's ability to elect to use the equally-weighted three factor formula under the Multistate Tax Compact ("Compact") as incorporated into California law. In The Gillette Company and Subsidiaries v. Franchise Tax Board, review granted January 16, 2013, S206587, the taxpayer contends the Compact (former Cal. Rev. & Tax. Code § 28008 et seq.) was a binding interstate compact and California is bound by its terms unless and until it withdraws from the Compact. Senate Bill No. 1015, enacted on July 27, 2012, purports to repeal the Compact in full on a prospective basis, but the validity of that repeal likely will be the subject of future litigation on the issue of whether such repeal required a two-thirds vote of the California Legislature.

4 One reasonably might question the constitutionality under Due Process and Commerce Clause grounds of an apportionment formula that gives no recognition to any value-generating activity of a taxpayer other than sales. The U.S. Supreme Court in Container Corp. v. Franchise Tax Board spoke of the need for fairness in the apportionment formula and how the traditional three-factor formula "has gained wide approval precisely because payroll, property, and sales appear in combination to reflect a very large share of the activities by which value is generated." 463 U.S. 159, 183 (1983). Can it be said that the value of a business always, in all conceivable facts and circumstances, fairly can be measured by looking exclusively at sales activity? See Hans Rees' Son, Inc. v. North Carolina, 283 U.S. 123 (1931). On the other hand, a single sales factor has passed Constitutional muster on at least one prior occasion. See Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978). Further thoughts on this topic will be the subject of a future article.

5 Cal. Rev. & Tax. Code § 25136.

6 Cal. Rev. & Tax. Code § 25135; see also Appeal of Finnigan Corp., 88-SBE-022-A (Cal. State Bd. of Equal. Jan. 24, 1990). The impact of returning to a Finnigan approach is somewhat complicated by the fact that California, for taxable years beginning on or after January 1, 2011, adopted a so-called "factor presence test," under which, for example, a corporation is doing business in California and taxable simply by having more than $500,000 of California sales, even if it has no other connection to California and has no physical presence in California. Cal. Rev. & Tax. Code § 23101.

7 Cal. Code Regs. tit. 18 § 25137(c)(1)(A).

8 The statutory definition of "gross receipts" has changed significantly for taxable years ending on or after January 1, 2011 with respect to a variety of treasury functions, activities and investments. See Cal. Rev. & Tax. Code § 25120, as amended by Ch. 17 (SB 15), Laws 2009, 3d Extra. Sess.

9 Unless otherwise indicated, all statutory references herein are to the California Revenue and Taxation Code.

10 Appeal of Fluor Corp., 95-SBE-016 (Cal. State Bd. of Equal. Dec. 12, 1995). To the author's knowledge, there is no precedential California court decision on this issue.

11 Id.

12 Cal. Code Regs. tit. 18 § 25137(c)(1)(A).

13 Amendment of Cal. Code Regs. tit. 18 § 25137(c)(1)(A), filed Jan. 30, 2001 (Register 2001, No. 5).

14 Cal. Franchise Tax Bd., Staff Report and Recommendation on Proposed Amendments to Regulation 25137(c)(1)(A), Att. D, p. 1 (FTB Staff Report and Recommendation, Definitions For Regulation 25137(c)(1)(A) Text).

15 Id.

16 California courts have generally used two tests to determine whether related business entities are engaged in a unitary business. The first is the "Three Unities Test." Butler Bros. v. McColgan, 17 Cal. 2d 664 (1941), aff'd, 315 U.S. 501 (1942). The second is the "Contribution or Dependency Test." Edison California Stores v. McColgan, 30 Cal. 2d 472 (1947). These two tests are alternative methods for determining unity. A.M. Castle & Co. v. Franchise Tax Bd., 36 Cal. App. 4th 1794, 1805 (1st Dist. 1995).

17 Cal. Franchise Tax Bd., Staff Report and Recommendation on Proposed Amendments to Regulation 25137(c)(1)(A), Att. D, pp. 1-2 (FTB Staff Report and Recommendation, Definitions For Regulation 25137(c)(1)(A) Text).

18 Appeal of Fluor Corp., 95-SBE-016.

19 Cal. Franchise Tax Bd., Staff Report and Recommendation on Proposed Amendments to Regulation 25137(c)(1)(A), Att. A, p. 4 (Synopsis of Comments Received During the Regulation Hearing and Staff Responses and Recommendations).

20 Id.

21 Cal. Franchise Tax Bd., Staff Report and Recommendation on Proposed Amendments to Regulation 25137(c)(1)(A), Att. D, p. 2 (FTB Staff Report and Recommendation, Definitions For Regulation 25137(c)(1)(A) Text).

22 Cal. Code Regs. tit. 18 § 1595(a)(1). This California sales tax regulation referring to "occasional sales" states that for purposes of determining whether a seller must obtain a seller's permit, "generally" a person who makes three or more sales for substantial amounts in a period of 12 months is required to hold a seller's permit.

23 While no published, precedential decision has been issued (and is not anticipated), the SBE ruled recently that gross receipts from sales of 13 television stations by a diversified media company were not excluded from the sales factor under Regulation 25137(c)(1)(A) as occasional sales. Appeal of Emmis Communications Corp., SBE Case No. 547964 Meeting of the Bd. of Equal. Transcript (June 11, 2013).

24 Cal. Franchise Tax Bd., Staff Report and Recommendation on Proposed Amendments to Regulation 25137(c)(1)(A), Att. D, p. 2 (FTB Staff Report and Recommendation, Definitions For Regulation

25137(C)(1)(A) Text). 25 See Cal. Rev. & Tax. Code § 25120; see also Hoechst Celanese Corp. v. Franchise Tax Bd., 25 Cal. 4th 508, 520-26 (2001). The functional test for business income, as compared to the alternative so-called "transactional test," focuses on the income-producing property and, in applying the functional test, the "critical inquiry" is the "relationship between this property and the taxpayer's business operations." Id. at 527 (internal quotations and citation omitted); see also Jim Beam Brands v. Franchise Tax Bd.,133 Cal. App. 4th 514 (1st Dist. 2005).

26 Legal Ruling 97-1, Cal. Franchise Tax Bd. (Oct. 15, 1997).

27 Id.

28 This same approach was taken recently by the Arizona Department of Revenue, whose comparable regulation refers only to the sale of a "fixed asset." The Arizona Department of Revenue found FTB Legal Ruling 97-1 "legally sound and persuasive" and concluded a taxpayer's gross receipts from a (deemed) sale of assets, including goodwill, was excluded from the sales factor. Hearing Officer Decision, No. 201200235, Ariz. Dep't of Rev. (May 31, 2013).

29 See Notice 99-3, Cal. Franchise Tax Bd. Request for Public Comment, Discussion Draft Addition to Regulation 25137(c) (Mar. 29, 1999); see also Cal. Franchise Tax Bd., Regulation Hearing of Proposed Title 18, California Code of Regulations Section 25137(c)(1)(A), Transcript of Proceedings, pp. 5-6 (May 8, 2000).

30 Id. at p. 6.

31 Id.

32 Microsoft Corp. v. Franchise Tax Bd., 39 Cal. App. 4th 750, 765 (1st Dist. 2006).

33 General Mills, Inc. v. Franchise Tax Bd., 208 Cal. App. 4th 1290, 1301 (2012), citing Microsoft Corp. v. Franchise Tax Bd., 39 Cal. 4th 750, 766 (2006) and Limited Stores, Inc. v. Franchise Tax Bd., 152 Cal. App. 4th 1491, 1498 (1st Dist. 2007) (emphasis in original).

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These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

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