California clarifies appropriate apportionment variances


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On June 7, 2019, the California Franchise Tax Board (FTB) issued Legal Ruling 2019-01 clarifying the appropriate subject matter eligible to be considered for a request for variance from the standard apportionment formula pursuant to Cal. Rev. & Tax. Code Sec. 25137.1 The ruling addresses four situations where a taxpayer requests a variance from the standard apportionment formula and provides a view on whether granting a variance is appropriate given the subject matter surrounding the request.

Standard apportionment formula For taxable years beginning prior to 2011, businesses in California were generally required to apportion income by multiplying their business income by an apportionment formula consisting of the property factor, payroll factor and a double-weighted sales factor.2 For taxable years beginning in 2011 or 2012, taxpayers could elect to apportion their business income using a single sales factor instead of three-factor apportionment.3 For taxable years beginning in 2013 or thereafter, businesses are generally required to apportion their business income using a single sales factor.4

Alternative apportionment When the application of the standard Uniform Division of Income for Tax Purposes Act (UDITPA) apportionment formula fails to fairly reflect the extent of a taxpayer’s business in California, an alternate method may be utilized.5 The taxpayer may petition for or the FTB may require, in respect to all or any part of the taxpayer’s business activity, if reasonable:

  • Separate accounting
  • The exclusion of any one or more of the factors
  • The inclusion of one or more additional factors which will fairly represent the taxpayer’s business activity in California
  • The employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer’s income.6

Prior approval to file an original return in a manner inconsistent with the standard apportionment and allocation rules is required and if not obtained, the return will be considered erroneous.7

Alternative apportionment: requests approved by State Board of Equalization In the Appeal of Crisa Corp.,8 the California State Board of Equalization (BOE) identified five examples in which relief under Cal. Rev. & Tax. Code Sec. 25137 may be warranted:

  • A corporation doing substantial business in California has zero apportionment to California under the standard formula
  • The standard formula factors are mismatched to the time during which the income is generated
  • The standard formula creates “nowhere income” not taxed in other jurisdictions
  • One or more of the standard factors is affected by a substantial activity unrelated to the taxpayer’s main line of business
  • A particular factor in the apportionment formula is useless in reflecting business activity, for example when a zero over zero factor calculation results

As to these five examples, the BOE observed that the applicability of Cal. Rev. & Tax. Code Sec. 25137 was based on whether an analysis revealed some manner in which the standard apportionment formula did not fairly reflect the taxpayer’s business activities in California.

FTB ruling addresses variance requests Legal Ruling 2019-01 indicates that UDITPA only addresses issues relating to the allocation and apportionment of income and therefore, Cal. Rev. & Tax. Code Sec. 25137 only expressly grants statutory authority to provide variances to the apportionment formula and the allocation provisions. In the ruling, the FTB explored four specific apportionment variance requests related to:

  • Certain group members being included in, or excluded from a unitary group filing
  • The treatment of dividends received from a non-affiliated supplier as nonbusiness income
  • The exclusion of royalty income received from a unitary, foreign affiliate from a taxpayer’s apportionment factor to the extent such income is excluded from the water’s–edge combined reporting group
  • The use of an equally-weighted property and payroll factor apportionment formula instead of a three-factor formula when the taxpayer has no sales apportioned to California

The FTB determined alternative apportionment only applied to the fourth scenario, because in that instance, the request was related to the issues of allocation and apportionment of income.

Scenario One The first scenario involves a parent company attempting to decombine itself from its subsidiary on the grounds that the entities were not unitary during the tax year in question for failure to satisfy the three unities test (the three unities of ownership, operation and use).9 The FTB held the subject matter of the request inappropriate for a variance request because the request only addressed the issue of unitary combination and not the issue of allocation and apportionment of income.

Scenario Two In the second scenario, a business entity requested to exclude the dividends it received from a non-affiliated supplier from its business income, asserting that the dividend income inclusion does not fairly reflect its California business activities. The FTB determined that the request was inappropriate because Cal. Rev. & Tax. Code Sec. 25137 only addresses issues relating to the allocation and apportionment of income and not the division of income into business or nonbusiness income.

Scenario Three The third scenario presents an entity filing on a water’s-edge basis receiving royalty income from a unitary foreign affiliate excluded from the entities’ water’s-edge combined reporting group. The taxpayer argued that since the royalty income is included in its business income, the exclusion of the apportionment factors from the royalty-paying affiliate would not fairly reflect its business activities in California. The FTB held the taxpayer’s request inappropriate because Cal. Rev. & Tax. Code Sec. 25137 does not apply to water’s-edge mechanics.

Scenario Four The final scenario presents a business-entity taxpayer deriving more than 50% of its gross business receipts from its extractive business activity, which is statutorily allowed to be apportioned via an equally-weighted payroll, property and sales factor formula. However, the taxpayer has no includible sales within or outside California for purposes of the sales factor. The taxpayer requests use of an equally-weighted property and payroll factor formula, as the inclusion of the zero sales factor would not fairly reflect its business activities in California. Here, the FTB held the request would be appropriate under Cal. Rev. & Tax. Sec. 25137 because the request pertained to issues of income allocation and apportionment and avoided use of a zero-over-zero factor.

Commentary Legal Ruling 2019-01 highlights a few common scenarios that the FTB sees when reviewing and responding to a taxpayer’s request for a variance from the standard apportionment formula. In granting or denying such a request, this ruling makes it clear that the focus of the FTB’s analysis will be on whether the essential issue in the taxpayer’s request addresses income allocation and apportionment. When requesting alternative apportionment, taxpayers should ensure the request is framed and drafted in a way that makes it apparent that the content of the request pertains to the taxpayer’s income allocation or apportionment methodology. By making this clear on the face of the request, it will increase the probability that the FTB will grant the request.

Additionally, the context surrounding the release of this ruling and the overall amount of attention the FTB has given to Cal. Rev. & Tax. Sec. 25137, its related regulations and legal notices is noteworthy. In November 2018, the FTB held a second interested parties meeting to consider draft amendments to the alternative apportionment regulation to provide procedures for variance actions and appeals.10 Thus, it seems that amendments to the regulation may be on the horizon. These developments, taken together, suggest the FTB may issue further clarifications. Accordingly, taxpayers and tax professionals should continue to monitor changes in this area as a means to ensure compliance with applicable law, and potentially present planning opportunities to minimize tax exposure.

1 Legal Ruling 2019-01, California Franchise Tax Board, June 7, 2019.
2 CAL. REV. & TAX. CODE § 25128.
3 CAL. REV. & TAX. CODE § 25128.5.
4 CAL. REV. & TAX. CODE § 25128.7.
5 CAL. CODE REGS. tit. 18, § 25137; Microsoft Corp. v. Franchise Tax Board, 139 P.3d 1169 (Cal. 2006).
6 CAL. REV. & TAX. CODE § 25137.
7 Notice 2004-5, California Franchise Tax Board, Aug. 6, 2004.
8 In the Appeal of Crisa Corp., California State Board of Equalization, 2002-SBE-004, June 20, 2002.
9 As developed in Butler Brothers v. McColgan, 315 U.S. 501 (1942).
10 For further information on the proposed amendments to CAL. CODE REGS. tit. 18, § 25137, see

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