New California sourcing tax rules could affect asset managers

Receipts from sale of asset management services

California’s regulations for the sourcing of sales from asset management services are technically effective as of Jan. 1, 2026, and assign such sales to California to the extent the customer of the taxpayer receives the benefit of the service in California. If the investor is holding title to the assets for a beneficial owner, the benefit of the asset management services is received at the domicile of the beneficial owner of the assets.

The domicile of an investor is presumed to be the investor’s billing address indicated in the records of the taxpayer. If the taxpayer has actual knowledge that the investor's principal place of business is different than the investor’s billing address, the presumption does not apply.

The domicile of a beneficial owner of assets managed by an asset manager is presumed to be the beneficial owner's billing address indicated in the records of the entity for whom the asset management services are rendered, or in the records of the asset manager. If the entity for whom the asset management services are rendered or the asset manager knows that the beneficial owner's primary residence or principal place of business is different than the beneficial owner's billing address, the presumption does not apply.

The newly adopted regulations state that master funds, feeder funds and participants in defined benefit plans are not beneficial owners for purposes of applying the rules governing the sourcing of asset management services.

Master and feeder funds pool investors' assets and do not make independent decisions to invest their assets because they are required by agreement with their limited partners, feeder funds or other investors to invest in the assets. As such, the regulations require the asset manager to “look through” these types of entities to the location of the investor in the master fund or feeder fund to determine where the benefit is received.  

Use of capital ratios and reasonable estimation

Once the locations of the beneficial owners are determined, receipts from asset management services are sourced to the sales factor “in proportion to the average value of the interest in the assets held by the investors or beneficial owners domiciled” in California. If the taxpayer does not have information regarding the average value of the assets held by investors or beneficial owners in California, then it may use a reasonable estimation.

The regulations define “reasonably approximated” to mean that the location where the benefit of the services is received is determined in a manner consistent with the customer’s activities to the extent that information is available to the taxpayer. For reasonable approximations based on population, U.S. census data as of the beginning of the taxable year is used. If the taxpayer can substantiate that the benefit of the service is being substantially received outside the U.S., then the populations of those foreign jurisdictions are added to the U.S. population.