Legal ruling 1995-3

Delivery or Shipment of Tangible Personal Property in the Sales Factor Legal Ruling 348 Withdrawn

Issues

1. For purposes of Sections 25135(a) and (b), does a movement of goods using a transportation vehicle of the purchaser constitute shipment?
2. For purposes of Sections 25135(a) and (b), does a movement of goods using a transportation vehicle of the seller constitute shipment?
3. Does property have to be received at a place of business of the purchaser to be considered "delivered" to the purchaser within a state?

Facts

In each of the situations described below, the seller manufactures machinery in California, and sells it to a purchaser which has a place of business in State A and State B. In the first six situations, the purchaser takes title and physically receives the machinery in California, and uses its own truck to transport the machinery to another state.

Situation 1: The purchaser transports the machinery to its own place of business in State A.

Situation 2: The purchaser transports the machinery to its own place of business in State A. The purchaser also happens to have a research facility in California.

Situation 3: The purchaser transports the machinery to its own place of business in State A, and a few days later transports the machinery to another of its places of business in State B using its own transportation vehicle.

Situation 4: The purchaser transports the machinery to State A and then places the machinery with a common carrier in State A and arranges shipment to its own place of business in State B.

Situation 5: The purchaser transports the machinery to its own customer in State C.

Situation 6: The purchaser transports the machinery to a location owned by a third party in State B. Title to the machinery is transferred to the purchaser's customer at that location. The third party then, under a separate contract, adds accessories and repackages the machinery at the direction of the purchaser's customer. The goods are then transported by common carrier to the purchaser's customer to its place of business in State C.

Situation 7: While the machinery is in California, the seller transfers title to the machinery to the purchaser and then adds accessories to the machinery at the direction of the purchaser, and subsequently places the machinery with a common carrier for transportation to State C.

Law and Analysis

Section 25135 of the California Revenue and Taxation Code, adopted from Section 16 of the Uniform Division of Tax Purposes Act (UDITPA), provides, in pertinent part:

Sales of tangible personal property are in this state if any of the following apply:

(a) The property . . . is delivered or shipped to a purchaser, other than the United States government, within this state regardless of the f.o.b. point or other conditions of sale.

(b) The property . . . is shipped from an office, store, warehouse, factory, or other place of storage in this state and (1) the purchaser is the United States government or (2) the taxpayer is not taxable in the state of the purchaser.

Legal Ruling 348, February 21, 1973, held that when a taxpayer transferred physical possession of goods to a customer in California, and the customer subsequently transported the goods to another state using its own transportation, the sale was considered to be "delivered . . . to a customer within this state," on the basis that the phrase "within this state" modified the word "delivered."

This view was challenged by the taxpayer in McDonnell Douglas v. Franchise Tax Board (1994) 26 Cal.App.4th 1789. In that case, the seller manufactured aircraft in California and transferred physical possession of the aircraft to its customer's employees in this state. The customer's employees then flew the aircraft to another state or country for use in out-of-state operations. After reviewing a number a cases in other states, the Court of Appeal declined to follow the rationale of Legal Ruling 348 and held that the phrase "within this state" modified the word "purchaser." Despite the fact that the purchasers' employees or agents were in the state of California at the time that possession of the aircraft was transferred to them, the court held that the purchasers were not "in this state," if the goods were "destined for use" in another state. In so doing, the court emphasized the drafter's objective of the sales factor: to reflect contributions of the consumer state in the production of the taxpayer's income, 26 Cal.App.4th at 1796, citing Reich, Dock Sales--The New State Income Tax Battleground (1982) 1 J. St. Taxation 42, 43. See also, Pierce, The Uniform Division of Income for State Tax Purposes (1957) 35 Taxes 747. The McDonnell Douglas court also cited with approval Keesling & Warren, California's Uniform Division of Income for Tax Purpose Act (1968) 15 UCLA L.Rev. 655, for the proposition that "sales of tangible personal property should be apportioned to the state or country of destination, provided the taxpayer is subject to tax in such state or country. If [not] . . . the sales are apportioned to the state or country from which shipped."

The Franchise Tax Board will follow the holding in McDonnell Douglas v. Franchise Tax Board, supra. Legal Ruling 348 is withdrawn.

Section 25135(a) provides that a sale of tangible personal property is assigned to "this state" if it is delivered or shipped . . . to a purchaser within this state. Thus, a sale, to be a California sale under Section 25135(a), requires both the fact of delivery or shipment within this state and receipt by a purchaser within this state. Receipt of property by a purchaser at its place of business in California is clearly one way property may be delivered or shipped to a purchaser within this state. To reflect the holding in McDonnell Douglas, however, a purchaser's receipt of goods within California by an employee or agent for the mere purpose of immediate transportation to another state, is not adequate to treat the purchaser as being "within" California for purposes of Section 25135(a).

However, nothing in Section 25135(a) requires that the purchaser receive property at its own place of business within the state, only that it be "within" the state at the time of delivery or shipment. Thus, if the purchaser takes possession (or constructive possession through an agent or bailee) in this state for purposes such as warehousing, repackaging, adding accessories, etc., the property is "delivered

. . . to a purchaser within the state," and the sale is a California sale (see, Appeal of Mazda Motors, Inc., 94-SBE-009, November 29, 1994). After the sale terminates in such fashion, any subsequent transportation by the purchaser to another state will not affect assignment of the sale, 18 Calif. Code of Regs. §25135(a)(3). The Mazda case illustrates an application of the concept of "delivery" in Section 25135(a), because transportation of goods was not necessary to afford treatment of the goods as being "delivered . . . to a purchaser within this state."

For ease of administration, goods taken into possession (or constructive possession) by the purchaser, or its employee, agent, or bailee in a state will be presumed to have been delivered or shipped to the purchaser within that state. Thus, for example, goods sold and physically delivered to a customer at a retail store in this state will be presumed to be a California sale. The presumption could be rebutted by demonstrating that the customer made no use of the property in California and immediately transported the property to another state.

In McDonnell Douglas, the court held that if goods are received by a purchaser in California and transported by the purchaser to its place of business in another state, to reflect the purposes of UDITPA and the contributions of the consumer state, the sale should properly be treated as a sale in the destination state. Under the same analysis, if physical possession of goods is transferred by a seller to a purchaser in another state and the goods are taken by the purchaser into California to its place of business in this state, the sale is a California sale unless the seller is not taxable in this state. Because, in such case, the property would not have been delivered in California, to be a California sale, the property must therefore have been "shipped" to meet the conditions of Section 25135(a). Thus, to be consistent with the court's holding, transportation by the purchaser, inclusive of transporting mobile property under its own power, must be considered "shipment" to the purchaser within this state.

Section 25135(b) provides that sales of tangible property "shipped" from California to another state will be considered a California sale if the seller is not taxable in the "state of the purchaser" (the so-called "throwback rule"). Given the complementary nature of Sections 25135(a) and (b), the latter subdivision applies whenever a sale relates to tangible personal property shipped to a purchaser within the state of destination, but the seller is not taxable in that state. (See the quoted portion of Keesling and Warren, supra.)

Using the same construction of the word "shipped," appearing in both Sections 25135(a) and (b), if a seller transfers possession of tangible personal property to a purchaser in this state, and the purchaser immediately transports the property (whether or not under its own power) to its place of business in another state, that sale will be assigned to California if the seller is not taxable in the other state.

If a seller transports tangible personal property from California to its purchaser in another state using its own vehicle, in most cases, the seller will be taxable in that state by virtue of its presence in that state. In that case, the sale will be assigned to that state under that state's statute comparable to Section 25135(a) (Section 16(a) UDITPA), whether the transportation and physical transfer of goods is characterized either as a "delivery" or as a "shipment." On the other hand, if a seller is, for some reason, not taxable in that state, Section 25135(b) provides for throwback of a sale only if it is "shipped" to the destination state. To provide comparable effects for all forms of vehicular transportation, a seller's transportation to that state will also be considered a form of "shipment," and the provisions of Section 25135(b) apply, notwithstanding that the physical transfer of goods to the purchaser in the destination state might also be considered delivery. Accordingly, the sale would be a California sale.

If a shipment of goods originates in California (whether transported by seller, purchaser, or common carrier), and the goods are received by the purchaser at its place of business in a second state, the sale is considered terminated in that state and properly assigned to that state under that state's statutory equivalent to Section 25135(a). If the purchaser actually or constructively receives possession of the property in the second state at some location other than its place of business in that state, and the property is held for purposes other than mere retransportation (such as warehousing, assembly, repackaging, etc.) the sale is likewise treated as shipped to a purchaser within the second state, under the Mazda holding. (See the same analysis with respect to goods similarly received in California, above.) If the seller is taxable in that state, the sale will be assigned to that other state. However, if, under any of the above described situations, the seller is not taxable in the second state, the sale is a California sale under Section 25135(b), even if the purchaser later transports the goods to another state where the seller is taxable (18 Cal. Code of Regs. §25135(a)(3)).

As before, for purposes of administrative convenience, it will be presumed, for purposes of the application of the throwback rule, that the state where the purchaser first took actual or constructive possession of goods is the state "within" which the property was shipped to the purchaser. Unless the presumption is rebutted, the taxability of the seller will be examined in that state in the application of Section 25135(b).

On occasion, goods may be delivered or shipped directly to the purchaser's customer, without passing through a purchaser's location. In that case, 18 Cal. Code of Regs. §25135(a)(4) treats the sale as assigned to the state where the ultimate recipient takes delivery or shipment, by construing the phrase "a purchaser within this state" to include the purchaser's customer in such situations. This interpretation would likewise apply if shipment to the purchaser's customer occurs by means of the purchaser's transportation vehicle.

The preceding analysis is applied to the above described situations, as follows:

Situation 1: The described situation is squarely within the holding of the McDonnell Douglas opinion. Because the purchaser's transportation is considered "shipment," the machinery is considered shipped to the purchaser in State A. If the seller is taxable in that state, the sale is a State A sale. If not, the sale is thrown back to California.

Situation 2: Despite the fact that the purchaser might be considered "within this state" for some purposes because of its research facility in California, the research facility was not related to the sale. Section 25135(a) requires the "delivery or shipment" to be made "to" the purchaser "within this state." To reflect the objective that the sales factor should reflect the market contributions of State A, the consumer state, the phrase "within this state," properly relates to the first location of the purchaser where the property which was the object of the sale was received. Thus, the machinery is considered shipped to the purchaser "within" State A.

Situation 3: Because the purchaser took possession of the machinery at its place of business in State A, the machinery is considered shipped to a purchaser in State A. The shipment and sale is considered terminated in that state, and the subsequent transportation of the machinery to State B has no effect on the application of the sales factor (18 Cal. Code of Regs. §25135(a)(3)). If the seller is taxable in State A, the sale is a State A sale. If not, the sale is thrown back to California.

Situation 4: The purchaser did not have possession of the machinery in California or in State A for purposes other than in the process of shipment. Thus, the purchaser's receipt at its place of business in State B will control the application of Section 25135(a). If the seller is taxable in State B, the sale is a State B sale. If not, the sale is thrown back to California. The seller's taxability in State A is irrelevant.

Situation 5: The purchaser did not have possession of goods in California for purposes other than in the process of shipment. The purchaser's customer will be considered the "purchaser" for purposes of Section 25135(a) (see 18 Cal Code of Regs. §25135(a)(4)). If the seller is taxable in state C, the sale is a State C sale. If not, the sale is thrown back to California.

Situation 6: Because the purchaser's customer has constructive possession of the goods in State B under the Mazda holding, and because the goods were not delivered or shipped to the original purchaser "within" any state, the purchaser's customer is considered the purchaser under 18 Cal. Code of Regs. §25135(a)(4). If the seller is taxable in State B, the sale is a State B sale. If not, the sale is thrown back to California. The seller's taxability in State C is irrelevant.

Situation 7: Because title to the goods passed to the purchaser while located in California, and the seller, at the direction of the purchaser, installed accessory equipment, the purchaser is considered to be "within this state" at the time possession was constructively delivered to the purchaser, and the sale is a California sale. (See Appeal of Mazda Motors, Inc., supra.)

Holdings

1. For purposes of Sections 25135(a) and (b) a movement of goods by a transportation vehicle of the purchaser constitutes "shipment."
2. For purposes of Sections 25135(a) and (b) a movement of goods by a transportation vehicle of the seller constitutes "shipment."
3. Property does not have to be received at a purchaser's place of business to be considered "delivered" to the "purchaser within" a state. If the purchaser takes possession in a state for a purpose other than transportation to another state, the purchaser is considered "within the state" for purposes of Section 25135.

Drafting Information

The principal author of this ruling is Michael E. Brownell of the Franchise Tax Board Legal Division. For further information regarding this ruling, contact Mr. Brownell at the Franchise Tax Board Legal Division, P.O. Box 1468, Sacramento, California 95812-1468.

NOTE: ((---)) = Indicates obsolete information.