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Discussion Draft

CAUTION: THIS IS ONLY A DISCUSSION DRAFT. THIS IS NOT A FORMALLY NOTICED REGULATION.

Regulation Section 25128. Apportionment Formula.

(a) In General. All business income of each apportioning trade or business of the taxpayer shall be apportioned to this state by use of the formula set forth in Section 25128 of the Revenue and Taxation Code. Section 25128(a) provides that the apportionment formula is a fraction, the numerator of which is the property factor plus the payroll factor plus twice the sales factor, and the denominator of which is four. Section 25128(b), however, provides exceptions to the rule in Section 25128(a) for taxpayers who derive more than 50 percent of their "gross business receipts" (as defined in Section 25128(d)(1)) from conducting a qualified business activity (as defined in Section 25128(c) and (d)(2)-(5) and these regulations thereunder). Such taxpayers must use an apportionment formula which is a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is three.

(b) Gross Receipts and Gross Business Receipts.

(1) Except as otherwise provided under Section 25128 of the Revenue and Taxation Code, the term "gross receipts" as used in this regulation has the same meaning as it does for purposes of Section 25134 of the Revenue and Taxation Code and the regulations thereunder.

(2) The term "gross business receipts" is defined in Section 25128(d)(1) of the Revenue and Taxation Code. The term includes gross receipts described in subdivision (e) of Section 25120 of the Revenue and Taxation Code whether or not the receipts are excluded from the sales factor by operation of Section 25137 of the Revenue and Taxation Code.

(c) Combined Reports.

(1) Section 25128(d)(8) of the Revenue and Taxation Code generally provides that if the income and apportionment factors of two or more banks, savings associations, or corporations are required to be included in a combined report under Section 25101, limited (if applicable), by a water’s edge election under Section 25110, the more than 50% gross receipts test is determined with respect to the "gross business receipts" of the entire apportioning trade or business of the combined reporting group. If, after application of that test, the gross business receipts attributable to qualified sales are not more than 50% of all gross business receipts of the group, then all members of the group must apportion their income using the double weighted sales factor provided by subdivision (a) of Section 25128 of the Revenue and Taxation Code, even if an individual member, considered alone, would have qualified for a single weighted sales factor.

(2) Example. Corporation A is the parent of Corporations B and C. Corporations A and B are engaged in the manufacture and sale of oceangoing oil tankers, and oil pipe, respectively. Corporation C owns a small refinery. Corporations A, B, and C, are members of a unitary group required to file a combined report in California. The gross business receipts in all states for Corporations A and Corporation B is $880 million and $440 million, respectively. Under the provisions of Section 25128 and this regulation, none of those gross receipts are qualified gross business receipts. Corporation C’s qualified gross business receipts in all states is $320 million, and its other business receipts are $80 million. The total gross business receipts of the combined group is $1.720 billion, of which only 18.6% are qualified gross business receipts. The combined business income of the group is subject to apportionment using a double weighted sales factor, despite the fact that more than 50% of Corporation C’s gross business receipts is from an extractive trade or business.

(d) Vertically Integrated Companies.

(1) Section 25128(b) of the Revenue and Taxation Code provides that a taxpayer must use a three factor formula if it has more than 50 percent of its "gross business receipts" from conducting one or more qualified business activities. For purposes of this 50% test, Section 25128(d)(1) of the Revenue and Taxation Code provides that gross business receipts do not include gross receipts from sales or other transactions within an apportioning trade or business between members of a group of corporations whose income and apportionment factors are required to be included in a combined report under Section 25101, limited, if applicable, by Section 25110 (hereinafter referred to as intercompany sales).

[With regard to problems as to what qualifies as intercompany sales, reference will be made to the intercompany transaction regulations when they are adopted.]

(2) Because Section 25128(d)(1) expressly excludes intercompany sales, only sales to parties outside the apportioning trade or business are considered in determining the numerator and denominator of the over 50% gross receipts test of Section 25128(b), and only such gross receipts from sales to parties outside the apportioning trade or business are used to determine whether a receipt is from a qualified business activity. Therefore, in a vertically integrated operation, only the products sold to those outside of the apportioning trade or business will be considered in determining whether the apportioning trade or business is engaged in a qualified business activity.

(3) Examples.

(A) A parent company drills for oil, a combined unitary subsidiary which is part of the apportioning trade or business refines the oil into gasoline, another combined unitary subsidiary makes petrochemicals from the products obtained from the refining of oil, and another combined unitary subsidiary uses the petrochemicals to make plastic film. The apportioning trade or business sells gasoline and plastic film to third parties. Only the products sold to parties outside of the combined unitary group are considered in determining whether this group is engaged in a qualified business activity under Section 25128. In this example, the products sold to third parties are gasoline and plastic film. The intercompany sales of refined products and petrochemicals are not considered. The sale of gasoline is a receipt from a qualified business activity (extractive business activity) under Section 25128 and the regulations thereunder. The sale of plastic film is not a receipt from a qualified business activity. (See Regulation 25128-1 for determining whether an activity is a qualified extractive business activity.)

(B) The business activity of an apportioning trade or business is the sale of soup to third parties. However, an entity in the combined apportioning trade or business grows vegetables, which it provides to other entities in the combined apportioning trade or business in order to make the soup. Only the activities which lead to receipts from outside of the combined apportioning trade or business will be considered in determining whether the apportioning trade or business is engaged in an agricultural business activity. Because only the sale of soup results in gross receipts as defined in Section 25128, the sale of soup is considered to be the business activity of the apportioning trade or business. The making and sale of soup is not an agricultural business activity under the definition set forth in Section 25128(d)(2) and under these regulations because it does not directly involve the production of agricultural products; therefore, the apportioning trade or business does not qualify to use a single weighted sales factor. The fact that other companies in the combined unitary group were engaged in agricultural production and provided commodities within the combined group to be made into the final product is not taken into account because any agricultural receipts derived by these other companies are from intercompany sales as defined in paragraph (d)(1) of this regulation and therefore, are not from sales outside the apportioning trade or business. (See Regulation 25128-2 for determining whether an activity is a qualified agricultural business activity.)

(C) An apportioning trade or business operates a winery, which grows all of the grapes used in its wine. The business does not sell any grapes to third parties; all of its third party receipts come from the sale of wine. The winery would not qualify as an agricultural business activity because making and selling wine is not the direct production of an agricultural commodity. Only the product sold to third parties, wine, is considered in making this determination. (See Regulation 25128-2 for determining whether an activity is a qualified agricultural business activity.)

(D) Company A and Company B are engaged in a unitary business. A makes a water’s-edge election and as a result, B is not included in A’s combined report. A produces grapes and sells to B, which in turn processes the grapes into wine and sells the wine to unrelated customers. A is engaged in a qualified business activity, and A’s sales of grapes are considered to be gross business receipts from a qualified business activity because its sales are made to an entity outside of the combined apportioning trade or business of A. Sales by A to B are not intercompany sales because B is not in A’s combined report. (See Regulation 25128-2 for determining whether an activity is a qualified agricultural business activity.)

 

Section 25128-1 Extractive Business Activity.

Section 25128(c) of the Revenue and Taxation Code provides that one of the activities which is a "qualified business activity" is an extractive business activity. This regulation defines what is an extractive business activity and what are qualified sales from such activity.

(a) General definition of extractive business activity.

Section 25128(d)(3) of the Revenue and Taxation Code defines extractive business activity as activities relating to the production, refining or processing of oil, natural gas or minerals. In order to qualify as an extractive business activity, the apportioning trade or business need not be engaged in all of these activities. If it is engaged in one or more of these activities, the trade or business will qualify if the gross receipts test described in Section 25128 of the Revenue and Taxation Code and the regulations thereunder is met. For purposes of Section 25128 of the Revenue and Taxation Code, the term "extractive business activity" only includes the following, unless otherwise provided in this regulation:

(1) Mining activities. The term "mining" includes the extraction of minerals occurring naturally. The term "mining" also includes quarrying, well operations, milling (e.g. crushing, screening, washing, flotation), and other preparation customarily done at the mine site, or as part of the mining activity. The term mining also includes the exploration and development of mineral properties. This category consists of trade or businesses engaged in the mining of :

(A) Metallic minerals, including:

(i) iron ores and manganiferous ores valued chiefly for their iron contents. This includes production of sinter and other agglomerates except those associated with blast furnace operations; iron ore dressing (beneficiation) plants; and sintering of iron ore at the mine. This also includes the mining of the following minerals: brown ore; hematite; iron agglomerate and pellet; iron ore; iron, blocked; limonite; magnetite; manganiferous ore, valued chiefly for iron content; siderite; and taconite.

(ii) Copper ores. This also includes businesses engaged in the recovery of copper concentrates by precipitation and leaching of copper ore. Businesses included in this category include the mining of the following: chalococite; chalcopyrite; copper ore; and cuprite.

(iii) Lead ores, zinc ores, or lead-zinc ores. This category includes the mining of the following: blende; calamine; cerrusite; galena; smithsonite; sphalerite; willemite; zinc-blende (sphalerite); and zincite.

(iv) Gold ores from lode deposits or in the recovery of gold from placer deposits by any method. In addition to ore dressing methods such as crushing, grinding, gravity concentration, and froth flotation at the mine site, this category includes amalgamation, cyanidation, and the production of bullion at the mine site.

(v) Silver ores. This includes the production of bullion at the mine site.

(vi) Ferroalloy ores, except vanadium. This includes the mining of : chromite; chromium ore; cobalt ore; columbite; ferberite; huebnerite; manganese ore; manganite; molybdenite; molybdenum ore; molybdite; nickel ore; psilomelane; pyrolusite; rhodochrosite; scheelite; tantalite; tantalum ore; tungsten ore; wolframite; and wulfenite.

(vii) Uranium-radium-vanadium ores. This includes the leaching of uranium, radium or vandiaum ores at the mine site; and the mining of: carnotite; pitchblende; radium ore; roscoelite (vanadium hydromica); tyuyamunite; uraninite (pitchblende); uranium ore mining; and vanadium ore.

(viii) Miscellaneous metal ores, not elsewhere classified. This includes the mining of: aluminum ore; antimony ore; bastnasite ore; bauxite; beryl; beryllium ore; cerium ore; cinnabar; ilmenite; iridium ore; mercury ore; microlite; monazite; osmium ore; palladium ore; platinum group ore; quicksilver (mercury) ore; rare-earths ore; rhodium ore; ruthenium ore; rutile; thorium ore; tin ore; titaniferous-magnetite, valued chiefly for titanium content; titanium ore; and zirconium ore. Production of metallic mercury by furnacing or retorting at the mine site is also included.

(B) Trades or businesses engaged in mining or producing bituminous coal or lignite at surface mines or in developing bituminous coal or ignite surface mines. This includes auger mining, strip mining, culm bank mining, and other surface mining. Bituminous coal and ignite preparation plants performing such activities as cleaning, crushing, screening or sizing are included if operated in conjunction with a mine site. Trades or businesses engaged in producing bituminous coal in underground mines or in developing bituminous coal underground mines. Bituminous coal preparation plants performing such activities as cleaning, crushing, screening or sizing are included if operated in conjunction with a mine. Trades or businesses engaged in mining or producing anthracite or in developing anthracite mines are also included.

(C) Trades or businesses engaged in mining or quarrying of nonmetallic minerals, except fuels. This includes mining or quarrying of:

(i) Dimension stone and businesses engaged in producing rough blocks and slabs. This also includes argillite, basalt, bluestone, calcareous tufa, diabase, diorite, dolomite, dolomitic marble, flagstone mining, gabbro, gneiss, granite, greenstone, limestone, marble, mica schist, onyx marble, quartzite, rubble mining, sandstone, serpentine, slate, syenite (except nepheline), trap rock, travertine, verde’ antique, and volcanic rock.

(ii) Crushed and broken limestone, including related rocks, such as dolomite, cement rock, marl, travertine, and calcareous tufa.

(iii) Crushed and broken granite, including related rocks, such as gneiss, syenite, and diorite.

(iv) Crushed and broken stone, not elsewhere classified. This category includes: boulder, ganister, grits, and riprap.

(v) Sand and gravel pits and dredges, including common sand; construction sand ; gravel; pebble; abrasive sand ; blast sand; enamel sand; filtration sand; foundry sand; glass sand; grinding sand; industrial sand; and molding sand.

(vi) Clays, ceramic and refractory minerals. This includes the quarrying of clays (common); nepheline syenite; shale (common); and the mining of : ball clay; china clay; kaolin; paper clay; rubber clay; slip clay; alusite; aplite; bentonite; brucite; burley; cornwall stone; cyanite; diaspore; dumortierite; feldspar; fire clay; flint clay; fuller’s earth; kyanite; magnesite; nepheline syenite quarrying; olivine (nongem); pegmatite (feldspar); pinite; plastic fire clay; sillimanite; stoneware clay; and topaz (nongem).

(vii) Natural potassium, sodium, or boron compounds, including grounding and pulverizing of crude borax. This category includes the mining of alum; borate compounds; borax; boron mineral; colemanite; glauber’s salt; kernite; potash; potassium compounds; probertite; saltines (except common salt); soda ash; sodium compounds (except common salt); trona; and ulexite.

(viii) Phosphate rock, including apatite.

(ix) Chemical or fertilizer mineral raw materials, including mining alunite, amblygonite, arsenic mineral, barite, barium ore, brimstone, celestite, fluorite, fluorspar, guano, lepidolite, lithium mineral, marcasite, mineral pigment, ocher, pyrites, pyrrhotite, rock salt, common salt, sienna, spodumene, strontianite, strontium mineral, sulfur (native), and umber.

(x) Miscellaneous nonmetallic minerals (except fuels). This includes mining of the following minerals: agate, alabaster, amethyst, asbestos, asphalt (native), asphalt rock, bitumens (native), calcite, catlinite, corundum, cryolite, diamond, diatomaceous earth, diatomite, emery, garnet gem stone, gilsonite grahamite, graphite, greensand, gypsite, gypsum, Iceland spar (optical grade calcite), jade, meerschaum, mica, muscovite, natural abrasives, ozokerite, peat humus, peat, perlite, phlogopite, pipestone, pozzolana, precious stones, pumice, pumicite, pyrophyllite, quartz crystal, reed peat, ruby, sapphire, scoria, sedge peat, selenite, semiprecious stones, shell, steatite, talc, tripoli, turquoise, vermiculite, volcanic ash, and wurtzlite. This also includes: bituminous limestone quarrying, bituminous sandstone quarrying, burrstone quarrying, fill dirt pits, grindstone quarrying, millstone quarrying, oilstone quarrying, pulpstone quarrying, rubbing stone quarrying, scythestone quarrying, sharpening stone quarrying, soapstone quarrying, and whetstone quarrying.

(D) Trades or businesses engaged in oil and gas extraction. This includes production of crude petroleum and natural gas; extraction of oil from oil sands and oil shale; production of natural gasoline and cycle condensate; and production of gas and hydrocarbon liquids from coal at the mine site. Types of activities included are exploration, drilling, oil and gas well operation and maintenance, the operation of natural gasoline and cycle plants, and the gasification, liquefaction, and pyrolysis of coal at the mine site. This also includes such basic activities as emulsion breaking and desilting of crude petroleum in the preparation of oil and gas customarily done at the field site. Pipeline transportation of petroleum, gasoline, and other petroleum products (except crude petroleum field gathering lines) is not included. Included are trades or businesses engaged in:

(i) operating oil and gas field properties. Such activities include exploration for crude petroleum and natural gas; drilling, completing, and equipping wells; tertiary recovery; operation of separators, emulsion breakers, desilting equipment, and field gathering lines for crude petroleum; and all other activities in the preparation of oil and gas up to the point of shipment from the producing property. This includes the production of oil through mining and extraction of oil from oil shale and oil sands and the production of gas hydrocarbon liquids through gasification, liquefaction, and pyrolysis of coal at the mine site.

(ii) producing liquid hydrocarbons from oil and gas field gases. This includes: butane (natural) production; casing-head butane and propane production; cycle condensate production (natural gas); ethane (natural) production; fractionating natural gas liquids; isobutane (natural) production; liquefied petroleum gases (natural) production; natural gas liquids production; natural gasoline production; and propane (natural) production.

(2) Trades or businesses engaged in petroleum refining. This includes producing gasoline, kerosene, distillate fuel oils, residual fuel oils, and lubricants, through fractionation or straight distillation of crude oil, redistillation of unfinished petroleum derivatives, cracking or other processes. This also includes the production of aliphatic and aromatic chemicals as byproducts. This includes the production of the following products in petroleum refineries: acid oil; alkylates; aromatic chemicals; asphalt and asphaltic materials (liquid and solid); benzene; butadiene; butylene; coke, petroleum; ethylene; fractionation products of crude petroleum; gas, refinery or still oil; gases, liquefied petroleum; greases, lubricating; hydrocarbon fluid; kerosene; mineral jelly; mineral oils, natural; mineral waxes, natural; naphtha; naphthenic acids; oils, partly refined, sold for rerunning; oils: fuel, lubricating and illuminating; paraffin wax, petrolatums; propylene; road materials, bituminous; road oils; solvents; tar or residuum. This category also includes the production of: gasoline with additives, blended gasoline and jet fuels.

(3) Trades or businesses engaged in primary smelting and primary refining of natural ore. This includes the production of coke; manufacturing hot metal, pig iron, and silvery pig iron directly from iron ore; primary smelting copper from the ore; primary refining copper; blister copper; copper blocks; copper ingots and refinery bars; copper pigs; copper slabs (primary); businesses engaged in primary production of aluminum from alumina; aluminum ingots and primary production shapes from bauxite or alumina; extrusion ingot, aluminum (primary); aluminum pigs; aluminum slabs, primary. This also includes smelting and refining nonferrous metals other than copper and aluminum, including primary nonferrous refining; nonferrous smelting; and primary refining of: antifriction bearing metals, lead-base; antimony; babbitt metal; beryllium metal; bismuth; zinc blocks; cadmium; chromium; cobalt; columbium; germanium; gold; nonferrous metals ingots; iridium; primary lead pigs, blocks, ingots, and refinery shapes; lead smelting and refining; magnesium; nickel; platinum group metals; precious metal; rhenium; selenium; silicon; silver; slabs (nonferrous metals); speltzer (zinc); tantalum; tellurium; tin base alloys; tin; titanium metal sponge and granules; zinc dust; and zirconium metal sponge and granules.

(4) Trades or businesses engaged in calcining, polishing, pulverizing, blending, applying thermal action to, treatment affecting chemical change to or of natural, raw, or crude minerals. This includes burning of carbonate rock to produce lime, the heating of gypsum to produce calcined gypsum or plaster of Paris, or the heating of clays to reduce water of crystallization; sawing applied to finish rough cut blocks of stone, sand finishing, buffing, or otherwise smoothing blocks of stone; the burning of bricks, the expansion or popping of perlite, the exfoliation of vermiculite, the heat treatment of garnet, and the heating of shale, clay or slate to produce lightweight aggregates.

(5) Trades or businesses which conduct processes and refinements which are incidental to and do not affect the basic character of any of the products, the production of which is provided for in this regulation as a qualifying business activity. Processes and refinements shall be considered to be incidental and as not affecting the basic character of any product if the nonqualifying addition consists of 10% or less of the qualifying product.

EXAMPLES:

(A) A company refines oil which results in gasoline, adds additives to the gasoline and sells the enhanced gasoline. This company will still be considered to be engaged in a qualified extractive business because the additives represent incidental refinements and do not affect the basic character of the gasoline, the production of which is listed in these regulations as a qualified business activity.

(B) A company mines raw iron ore, smelts the ore and adds 2.25 percent of carbon to make steel. The processing of carbon into an alloy is not listed as a qualifying business activity. This company will still be considered to be engaged in a qualified extractive business because the additive (carbon) consists of 10% or less of the qualifying product and the refining of iron ore is included as a qualifying business activity. The carbon may be self-produced or purchased.

(b) Businesses not included as an "extractive business activity."

Trades or businesses which are engaged in performing services for others on a contract or fee basis are not an "extractive business activity" for purposes of Section 25128. Examples of services which do not qualify as extractive business activity include, but are not limited to:

(1) metal mining services for others on a contract or fee basis, including but not limited to, the removal of overburden, strip mining for metallic ores, prospect and test drilling, mine exploration and development, and operation of mines.

(2) coal mining services for others on a contract or fee basis. These include the following services: operation of mines; culm bank recovery; draining or pumping of bituminous coal, anthracite, or lignite mines; drilling for coal; overburden removal; sinking shafts for coal; stripping services; and tunneling.

(3) nonmetallic minerals services on a contact or fee basis, such as removal of overburden, strip mining, and other services.

(4) oil and gas field services or in operating oil and gas wells for others on a contract or fee basis.

(c) Qualified Sales.

(1) "Qualified Sales" are sales by a combined apportioning trade or business (excluding sales between members of the combined apportioning trade or business) which are derived from products produced, refined or processed in the conduct of an extractive business activity, as defined in subdivision (a). Only the receipts from qualified sales are "gross business receipts" from a qualified business activity for purposes of Section 25128. Sales of products by an apportioning trade or business engaged in a qualifying business activity which are not produced, refined, or processed by the apportioning trade or business are not qualified sales. Sales of services are not qualified sales. Intercompany sales are not included.

Examples:

(A) If a company purchases gasoline from an unrelated entity which has already refined crude oil to gasoline, the sale of such gasoline by the company to a third party will not be a qualified sale and would not be from an extractive business activity because such sales were not derived from a qualified business activity, defined in Section 25128 and the regulations thereunder, conducted by the company.

(B) The business of a combined unitary group is drilling wells for oil and gas field operations for others on a contract or fee basis. The sale of such services is not a qualified sale and will not be included as gross receipts from the conduct of an extractive business activity for purposes of Section 25128.

(C) A combined apportioning trade or business is engaged in a business which involves exploration for and extraction of crude oil, purchase of crude oil from third parties, and refining crude oil, both self-produced and purchased, into gasoline, which the business sells to third parties. The business in its records classifies revenue into three categories: exploration, refining and marketing. The marketing category includes receipts from the products the business sells to third parties, including the gasoline it has refined. The receipts from the sales of gasoline, which are included in marketing revenues, are qualified sales because the refining of crude oil into gasoline is a qualified business activity conducted by the apportioning trade or business regardless of whether the crude oil was self-produced or purchased from third parties.

(2) If an apportioning trade or business has sales of products from its qualifying business activity and sales of products purchased from another party, tracing is required to determine which portion of the receipts is from its qualified business activity and which portion is not. In some cases, it may be difficult to trace because records are not available and cannot be reasonably obtained. In these cases, reasonable estimates may be provided. [We are open to suggestions from industry as to practicalities in this area and on how to handle situations where data cannot be reasonably obtained.]

(3) Exchanges. Exchanges are an exception to the requirement that the product sold must be derived from the apportioning trade or business’ qualified business activity as set forth in (1) above. If products from a qualified business activity are exchanged for similar products owned by parties outside of the apportioning trade or business, the subsequent sale of the products received in the exchange shall be treated as from the apportioning trade or business’s qualified business activity to the extent the exchange has not been considered in the sales factor. For example, Company A refines oil and markets gasoline in California and Washington. Company B, an unrelated party, refines oil in Washington and markets gasoline in Oregon and Washington. A’s refinery in Washington has a small fire and it is unable to provide gasoline for a short period to its Washington market. B needs gasoline to sell in its Oregon market. B exchanges some of its Washington refined gasoline for A’s California refined gasoline which B sells in its Oregon market. Title to B’s Washington gasoline transfers to A at the time of the exchange and title to A’s California gasoline transfers to B at the same time. The exchange is of substantially identical materials. No money is paid by either A or B to each other, neither includes the sales in its factors as a result of the exchange, and there is no income for tax purposes. Although A has not refined the gasoline obtained from B, A’s subsequent sale of such gasoline to parties outside of its apportioning trade or business is considered a qualified sale from an extractive business activity because it was exchanged for gasoline which was refined by A. This is also true of B’s subsequent sales of the gasoline obtained from A to parties outside of its apportioning trade or business.

 

Section 25128-2 Agricultural Business Activity

Section 25128(c) of the Revenue and Taxation Code defines "qualified business activity" and includes agricultural business activity in this term. This regulation defines what is an agricultural business activity and what is a qualified sale from such activity.

(a) General definition of agricultural business activity

Section 25128(d)(2) of the Revenue and Taxation Code provides a general definition of "agricultural business activity." For purposes of Section 25128, the term only includes the following trades or businesses, unless otherwise provided in these regulations:

(1) The production of crops, plants, vines and trees (excluding forestry operations; for forestry operations, see (6) and (7) below). This category also includes businesses engaged in the operation of sod farms, and cranberry bogs; in the production of mushrooms, bulbs, flower seeds, and vegetable seeds; and in the production of hydroponic crops. The businesses in this category include the following:

(A) The production of wheat; rice; field corn for grain or seed; sweet corn; popcorn; soybeans; and other cash grains, including production of dry field and seed peas and beans, safflowers, sunflowers, barley, buckwheat, cowpea, flaxseed, lentil, milo, mustard seed, oat, rye, and sorghum.

(B) The production of field crops, including cotton, cottonseed, tobacco, sugarcane, sugarbeets, potato, alfalfa, broomcorn, clover, grass seed, hay, hop, mint, peanut, sweet potato, timothy, yam, other roots, and tubers.

(C) The production of vegetables and melons, including asparagus, bean, beet, bok choy, broccoli, cabbage, cantaloupe, cauliflower, celery, cucumber, English pea, green lima bean, green pea, lettuce, market gardens, onion, pepper, romaine, snap bean, squash, tomato, and watermelon. This category also includes truck farms.

(D) The production of fruits and tree nuts, including berry crops, such as blackberry, blueberry, cranberry, currant, dewberry, loganberry, raspberry, and strawberry; grapes; tree nuts, including almond, filbert, macadamia, pecan, pistachio, and walnut; citrus fruits, including grapefruit, lemon, lime, orange, and tangerine; deciduous tree fruits, including apple, apricot, cherry, nectarine, peach, pear, persimmon, plum, pomegranate, prune, and quince; avocado; banana; coffee; date; fig; kiwi; olive; pineapple; plantain; and tropical fruits.

(E) The production of ornamental plants and other nursery products, such as bulbs, florists’ greens, flowers, shrubbery, flower and vegetable seeds, and plants and sod. These products may be grown under cover or outdoors.

(F) The production of food crops grown under cover, such as mushrooms, bean sprouts, fruits, greenhouse crops, hydroponic crops, mushroom spawn, rhubarb, seaweed, tomatoes, truffles, and vegetables grown under cover.

(2) The keeping, grazing, or feeding of livestock for sale of livestock or livestock products. These businesses include farms, ranches, dairies, certain feedlots as specified below, egg production facilities, poultry hatcheries, and apiaries. Livestock includes cattle, hogs, sheep, goats, poultry, horses, rabbits, bees, pets, fish in captivity, and fur-bearing animals in captivity. "Livestock products" must come directly from the livestock without processing, such as serums. This includes the following.

(A) The fattening of beef cattle in a confined area for a period of at least 30 days, holding title to the cattle for their own account. Businesses which feed beef cattle for periods of less than 30 days, in connection with their transport, are not included.

(B) The production or feeding of beef cattle, such as beef cattle farms, cattle raising farms, and cattle ranches.

(C) The production or feeding of hogs for their own account.

(D) The production of sheep, lambs, goats, goats’ milk, wool, and mohair. This includes the fattening of lambs in a confined area (in feedlots) for a period of at least 30 days, for their own account. Feeding of lambs for periods less than 30 days, in connection with their transport are not included.

(3) The production of cows’ milk and other dairy products and in raising dairy heifer replacements.

(4) The production of poultry and eggs. This category includes the following.

(A) The production of chickens for slaughter, including Cornish hens.

(B) The production of turkeys and turkey eggs.

(C) Operating poultry hatcheries for their own account.

(D) The production of poultry and eggs, not elsewhere included. This includes duck farms, egg (from other than chicken or turkey) farms, geese farms, pheasant farms, pigeon farms, quail farms, and squab farms.

(5) The production of animal specialties. This includes the production of following.

(A) fur and fur-bearing animals and rabbits, including chinchilla, fox, game, and mink.

(B) horses and other equines, including burros, donkeys, mules, and ponies.

(C) finfish and shellfish, such as crustaceans and mollusks, within a confined space and under controlled feeding, sanitation, and harvesting procedures. These include catfish farms, fish farms, goldfish farms, minnow farms, tropical aquarium fish farms, and trout farms.

(D) other animal specialties, such as alligators, apiaries, aviaries (e. g. parakeet, canary, love birds), bees, cats, dogs, earthworms, frogs, honey, and kennels which breed and raise their own stock; laboratory animal farms (e.g. rats, mice, guinea pigs), and rattlesnake, silkworm, and worm farms.

(6) The operation of timber tracts or tree farms for the purpose of selling timber grown on the land, including Christmas tree farms. The holding of timber tracts as real property (not for sale of timber) and logging businesses are not included.

(A) Examples

(i) Company A owns land and the growing timber on it. Company A sells the right to cut and sell timber on its land to unrelated company B and receives royalties on the sale of the timber. The royalties earned by A are sales from a qualified business activity. Company B is not engaged in a qualified business activity.

(ii) Company A owns land and the timber on it. Company A harvests the timber and sells the timber. The sales by A are sales from a qualified business activity.

(7) Growing trees for purposes of reforestation or in gathering forest products. The concentration or distillation of forest products is included when carried on in the forest. These forest products include balsam needles; gums, if carried on at the gum farm; turpentine and rosin if carried on at the gum farm; forest nurseries; forest products (e.g. gums, barks, seeds); ginseng; huckleberry greens; lac; maple sap; moss; pine gum; rubber; Spanish moss; sphagnum moss; teaberries; and tree seed.

(8) Under Section 25128(d)(2) of the Revenue and Taxation Code, the following are also included in the definition of agricultural activity:

(A) Services relating to cultivating of the soil, raising or harvesting of any agricultural or horticultural commodity, but only if the owner, tenant, or operator of the farm regularly produces more than one-half of the commodity cultivated, raised or harvested;

(B) Services relating to raising, shearing, feeding, caring for, training, or management of animals on a farm, but only if the owner, tenant, or operator of the farm regularly produces more than one-half of the commodity raised, sheared, fed, cared for, trained, or managed;

(C) Services relating to handling, drying, packing, grading or storing on a farm any agricultural or horticultural commodity in its unmanufactured state, but only if the owner, tenant, or operator of the farm regularly produces more than one-half of the commodity handled, dried, packed, graded or stored.

(i) The more than one-half production test set forth above in (A), (B), (C) and in Section 25128(d)(2) of the Revenue and Taxation Code is applied only to affect service receipts from outside the apportioning trade or business and is not applied against the apportioning trade or business’ self-produced agricultural products. For example, if a farming corporation stores both its own and other corporations’ agricultural products on its farm premises, and it self-produces over 50% of the agricultural products stored there, then the entire proceeds received from the third parties (outside of the apportioning trade or business) for providing storage services would be included as from an agricultural business activity. However, if the farmer self-produces less than 50% of the products stored, the receipts from services to third parties will not be counted as from an agricultural business activity. The amounts received from the sales of the self-produced agricultural products which had been stored by the farmer on its farm would still qualify as receipts from an agricultural business activity.

(b) Businesses not included as an "agricultural business activity."

(1) Trades or businesses engaged in performing services for others on a contract or fee basis are not engaged in an "agricultural business activity" for purposes of Section 25128 of the Revenue and Taxation Code except as provided under Section 25128(d)(2) of the Revenue and Taxation Code and under paragraph (a)(8) of this regulation.

(2) EXAMPLES

(A) A is a company whose business is soil preparation. A contracts with B, a farming corporation to provide soil preparation services. A breaks the land, plows, fertilizes, prepares the seed bed and performs other related services for improving the soil for crop planting. B pays A a fee for the soil preparation services it performs. A has no interest in the land or in the crops. A is not engaged in a qualified agricultural business. B, however, may be engaged in a qualified agricultural business activity.

(B) A is a company which is engaged in providing management services for other businesses. A contracts with B, a farming corporation, to manage B’s farms. A cultivates, harvests, and maintains the farm for B. A receives a fee from B for its services and has no interest in the land or the crops. A is not engaged in a qualified agricultural business.

(c) "Production" and "Processing"

(1) Wherever the term "agricultural business activity" as specified above in subdivision (a) provides for the production of a product, the term "production" means planting, growing, breeding, raising or fattening one’s own agricultural commodity.

(2) The term "production" includes processing activities which are normally incident to the growing, raising, planting, breeding, or fattening of agricultural products. For example, assume an apportioning trade or business is in the business of growing and selling fruits and vegetables. When the fruits and vegetables are ready to be harvested, the business picks, washes, inspects, and packages the fruits and vegetables for sale. Such activities are normally incident to the raising of these crops by farmers. The receipts from the sale of the fruits and vegetables are from a qualified agricultural business activity.

(3) The term "production" does not include the processing of agricultural products beyond those activities which are normally incident to the production of such products according to industry practice.

Examples:

(A) The processing of grain that a company has grown and harvested in order to produce flour, breads, cereals, and other similar food products, which it then sells to customers in the course of its business is not an agricultural business activity.

(B) The processing of grapes, whether grown or purchased from third parties, into wine and the sale of such wine is not an agricultural business activity.

(C) The processing of nuts by shelling and the sale of such processed nuts is not an agricultural business activity.

(D) A farmer raises cattle, slaughters the cattle and sells the carcasses. The sales of the slaughtered cows are not qualified sales and therefore are not from an agricultural business activity.

(d) Qualified Sales.

(1) Sales, excluding sales between members of an apportioning trade or business, derived from products produced in the conduct of a qualifying business activity by the apportioning trade or business are qualified sales. Only the receipts from such qualified sales shall be considered to be "gross business receipts" from a qualified business activity for purposes of Section 25128 of the Revenue and Taxation Code. Sales of products from a qualifying business activity which are not produced by the apportioning trade or business are not a qualified sales. Sales of services are not qualified sales except as provided in Section 25128(b)(2) of the Revenue and Taxation Code and under paragraph (a)(8) of this regulation.

Examples:

(A) If a broker purchases peaches from an unrelated farming business which has produced the peaches, the sale of peaches by the broker will not be a qualified sale. The broker did not produce the peaches; therefore, the sales were not derived from a qualified business activity, as defined in Section 25128 of the Revenue and Taxation Code and these regulations thereunder, conducted by the broker.

(2) If the combined apportioning trade or business sells products produced from its qualifying business activity and sells products purchased from another party, tracing is required to determine which portion of the receipts is from its qualified business activities and which portion is not. In some cases, it may be difficult to trace because records are not available and cannot be reasonably obtained. In these cases, reasonable estimates may be provided. [We are open to suggestions from industry as to practicalities in this area and on how to handle situations where data cannot be reasonably obtained.]

(3) Exchanges. Exchanges are an exception to the requirement that the product must be derived from the combined apportioning trade or business’ qualified business activity as set forth in paragraph (1) above. If products from a qualified business activity are exchanged for similar products owned by parties outside of the combined apportioning trade or business, the subsequent sale of the products received in the exchange will be treated as a qualified sale from the apportioning trade or business’ qualified business activity to the extent the exchange has not been considered in the sales factor.

(e) Cooperatives

(1) Agricultural associations organized and operated on a cooperative or mutual basis (as set forth in Revenue and Taxation Code Section 24404) are not engaged in a qualified agricultural business activity because the association itself, which is a separate entity from its members, does not conduct an agricultural business activity as defined in Section 25128 of the Revenue and Taxation Code and the regulations thereunder.

(2) Sales to cooperatives of products produced in the conduct of a qualifying business activity by an apportioning trade or business are qualified sales. Example: If a farming corporation engaged in growing artichokes sells artichokes to a non-unitary cooperative, the sales of the artichokes it grows are qualified sales.

(f) Patronage Dividends

For purposes of determining "gross business receipts" from an agricultural business activity, patronage dividends (as defined in Section 24404 or Section 24273.5 of the Revenue and Taxation Code) from agricultural cooperatives shall not be included in the producer’s receipts as from an agricultural business activity.

 

CAUTION: THIS IS ONLY A DISCUSSION DRAFT. THIS IS NOT A FORMALLY NOTICED REGULATION.