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State of California Franchise Tax Board

Explanation of the Discussion Draft

18 Cal. Code of Reg. Section 25137(c)(1)(A). Special Rules. Sales Factor.

Attached is a discussion draft of a proposed addition to the regulation addressing special rules for the sales factor of the apportionment formula.

The addition to the regulation will apply to sales of intangible property, e.g., stock in an affiliate, patents, and trademarks. The proposed addition excludes from the sales factor substantial amounts of gross receipts which arise from the incidental or occasional sale of intangibles.

The draft reflects the Franchise Tax Board's position, as set forth in Legal Ruling 97-1, that the same rationale that applies to the current regulation's treatment of occasional sales of fixed assets also applies with equal force to the occasional sale of intangibles. The inclusion of such gross receipts in the sales factor does not fairly reflect the taxpayer's day to day business activity and therefore causes excessive income to be apportioned to the state where the occasional sale took place. This is especially true if the growth of built-in appreciation occurs over a substantial period of time, because taking the gross receipts into account in the year of a recognition event does not reflect the gradual effects of appreciation over several years.

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