California expands ‘sales factor’ definition

Definition includes foreign excise taxes assessed on services performed by worldwide unitary affiliates


Josh Grossman
San Francisco
T +1 415 354 4798 

Dana Lance
San Jose
T +1 408 346 4325

Jamie C. Yesnowitz
Washington, D.C.
T +1 202 521 1504

Chuck Jones
T +1 312 602 8517

Lori Stolly
T +1 513 345 4540

Patrick Skeehan
T +1 215 814 1743 
The California Office of Tax Appeals (OTA) has issued its opinion in Robert Half International Inc., holding that “sales” for purposes of the corporate franchise tax sales factor includes foreign excise taxes assessed on services, such as a value-added tax (VAT), as part of the full amount received on sales of services by the taxpayer’s worldwide unitary affiliates.1 This decision is one of the most significant California decisions addressing the definition of “sales” in many years, and warrants careful consideration by taxpayers and tax practitioners alike.

Background Robert Half International Inc. and Subsidiaries (Robert Half) filed its original California return for the 2008 tax year on a worldwide unitary combined reporting basis, which generally requires income and apportionment factor data to be included for all worldwide unitary affiliates. Although broad-based excise taxes on services are rare in the United States, as a worldwide filer, Robert Half’s foreign affiliates invoiced and collected material amounts of VAT in certain foreign countries imposing broad-based excise taxes on all sales of goods and services. Accordingly, Robert Half calculated its sales factor denominator on its original return to include foreign excise taxes, such as VAT, as part of the purchase price of services provided by its worldwide unitary affiliates.

On audit, the California Franchise Tax Board (FTB) sought to remove these amounts from the sales factor denominator based on the FTB’s interpretation of Cal. Code Regs. tit. 18, Sec. 25134(a)(1) as not specifically allowing the inclusion of excise taxes on services in the computation of “gross receipts.” The FTB interpreted this regulation in an exclusionary manner based on subparagraph (a)(1)(A) specifically stating that “gross receipts” from sales of tangible goods include all excise taxes included as part of the purchase price, while subparagraph (a)(1)(C) of this regulation contains no parallel provision addressing the inclusion of excise taxes invoiced as part of the purchase price of services. Due to the silence in Cal. Code Regs. tit. 18, Sec. 25134(a)(1)(C) on the treatment of excise taxes assessed on services, the FTB argued that all excise taxes on services (such as VAT) must be excluded from a taxpayer’s gross receipts for sales factor purposes.

The OTA’s decision Consistent with several decades of California precedents addressing the definition of “gross receipts” for sales factor purposes, the OTA began its analysis by considering the definition of “sales” in Cal. Rev. & Tax. Code Sec. 25120(e).2 Citing the California Supreme Court’s companion 2006 decisions in Microsoft3 and General Motors4 interpreting this statutory definition of “sales,” the OTA noted that “[t]he California Supreme Court has interpreted ‘all gross receipts’ under R&TC section 25120(e) as being ‘the whole amount received, without deduction.’” Citing these California Supreme Court precedents and prior decisions of the Court of Appeals and State Board of Equalization, the OTA concluded that “VAT on sales of services comes within the court’s interpretation of ‘all gross receipts’ under R&TC section 25120(e).”

The OTA then rejected the FTB’s attempted interpretation of silence in Cal. Code Regs. tit. 18, Sec. 25134(a)(1)(C) as an exclusion, noting that similar arguments based on the negative implications of silence were rejected by the California Supreme Court in its Microsoft decision. Rather, the OTA noted that the plain language of the regulation reads in an inclusive manner, “particularly when it uses the terms ‘includes,’ ‘including,’ and ‘and similar items.’” Thus, the OTA noted that:

To read a negative implication in the inclusion of certain language in subparagraph (a)(1)(A) . . . but not in subparagraph (a)(1)(C) . . ., as FTB argues on appeal, would be to create a specific exclusion in subparagraph (a)(1)(C) that goes beyond the plain reading of that subparagraph.

Due to the OTA’s finding that Cal. Code Regs. tit. 18, Sec. 25134(a)(1) contained no exclusion of excise taxes on services, the OTA did not have to address the taxpayer’s arguments that the FTB’s restrictive reading of Cal. Code Regs. tit. 18, Sec. 25134(a)(1)(C) would render the regulation an invalid exercise of the FTB’s interpretive rulemaking authority.

Finally, the OTA noted that alternative apportionment could remedy a situation under which the standard provisions governing the California apportionment formula do not fairly represent the extent of a taxpayer’s California business activity, and the proposed alternative is reasonable.5 In this matter, the FTB conceded that alternative apportionment should not be invoked as the additional income that would be sourced to California under an alternative would be minimal, and so the inclusion of VAT in the denominator, but not the numerator of the California sales factor was not distortive.

Commentary The OTA’s decision in this case is consistent with California’s extensive body of case law interpreting the meaning of “all gross receipts” as it appears in the definition of “sales” in Cal. Rev. & Tax. Code Sec. 25120(e).

The FTB’s Multistate Audit Technique Manual has for many years reflected the FTB’s position that excise taxes on services, such as VAT, are not included in the sales factor denominator, which may have historically caused similarly situated taxpayers filing on a worldwide basis in California to have excluded foreign excise taxes on services in the computation of their sales factor denominator.6 Because the OTA’s decision in Robert Half International reverses the FTB’s historical position regarding the sales factor inclusion of excise taxes on services, taxpayers should carefully consider whether their facts align with those at issue in this case, and whether an amended California return is warranted.

Although both parties in Robert Half International agreed that the inclusion of VAT in the sales factor did not result in any distortion that would warrant alternative apportionment, taxpayers should carefully analyze whether their fact patterns similarly support the non-existence of distortion under California precedents interpreting the application of California’s alternative apportionment statute, Cal. Rev. & Tax. Code Sec. 25137.

Lastly, it is important to note that California’s legislature amended the definition of “sales” in Cal. Rev. & Tax. Code Sec. 25120 for tax years beginning on or after Jan. 1, 2011, to include a new definition of “gross receipts” that was not at issue in Robert Half International, which concerned the 2008 tax year.7 The OTA’s opinion noted that it “only concerns the law in effect for the year at issue, and does not speculate as to the effect of the subsequent revision to the law.” Because these amendments were identified as “clarifying, nonsubstantive changes,”8 it is unknown what impact, if any, they would have on the reasoning underlying the OTA’s decision in Robert Half International.

1 In re Robert Half International Inc. and Subs., California Office of Tax Appeals, No. 18011756, Oct. 3, 2019 (note: the OTA’s preliminary decision was dated Oct. 3, 2019, which under the OTA’s regulations became final 30 days thereafter absent a request for rehearing).
2 On June 25, 2019, Josh Grossman participated in the oral hearing during his former employment with another accounting firm. The OTA’s livestream video of the oral hearing can be found at the following link:
3 Microsoft Corp. v. Franchise Tax Board, 139 P.3d 1169, 1174 (Cal. 2006).
4 General Motors Corp. v. Franchise Tax Board, 139 P.3d 1183, 1188 (Cal. 2006).
5 CAL. REV. & TAX. CODE § 25137.
6 See California FTB Multistate Audit Technique Manual, Sec. 7540.
7 See CAL. REV. & TAX. CODE § 25120(f)(2) as applicable in tax years beginning on or after Jan. 1, 2011.
8 CAL. REV. & TAX. CODE § 25120(f)(4).

This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.