California Issues Guidance on Sourcing Sales of Services
On March 25, 2022, the California Franchise Tax Board (FTB) issued Legal Ruling 2022-01 regarding how to source sales of services in California, specifically in business-to-business sales. The ruling presents hypotheticals that demonstrate how to properly analyze and source sales of services under California’s current market-based sourcing rules.
Based on the rules from the FTB’s market-sourcing regulation, 18 California Code of Regulations Section 25136, the ruling provides four questions to consider when properly assigning the source of sales of services:
- Who is the customer?
- What is the service being provided?
- What is the benefit of the service being received by the customer?
- Where is the benefit of the service being received by the customer?
In the three hypotheticals provided, the ruling ultimately concluded that when the taxpayer “directly engages” with the customer’s customer, the benefits are received at the location of the customer’s customer. This is assuming the taxpayer kept this information in its book and records. However, if such records are not kept, the taxpayer is expected to use another reasonable practice to source the sales. The ruling did not address circumstances where the customer’s customer is only indirectly engaged by the taxpayer. Presumably, the benefit would be received at the location of the direct customer.
Notably, this ruling revokes previous Chief Counsel Rulings (CCR), CCR 2015-03 and CCR 2017-01, which previously provided support for sourcing sales at the location of the taxpayer’s direct customer. Taxpayers providing services should re-examine their California sourcing to determine if potential refund opportunities exist.