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California denies tax refund over receipts evidence

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On May 2, 2022, the California Office of Tax Appeals (OTA) held in a non-precedential decision that a taxpayer was not entitled to a refund of franchise tax because it could not include gross receipts from its internal treasury function activities in the sales factor of its California apportionment formula.1 While the OTA concluded that vendor allowances were potentially includible in the sales factor computation as part of the sale of tangible personal property (TPP), the OTA nonetheless denied the taxpayer’s refund request on the basis that insufficient evidence was provided by the taxpayer to support the claim.

Background The taxpayer, Bed Bath & Beyond Inc. (BBB), operates home merchandise retail stores throughout North America and its treasury department, located at its New Jersey headquarters, regularly invests cash generated by its retail operations to maintain working capital for its daily needs. During the 2009-2011 tax years, BBB received allowances from vendors for various services and recorded such allowances as a reduction to cost of goods sold (COGS).2

Following an audit examination, the California Franchise Tax Board (FTB) adjusted BBB’s franchise tax returns for the 2009-2011 tax years and denied the company’s refund claims of approximately $1.2 million for the same three-year period. The denied refund claims in these years related to the inclusion of additional gross receipts in BBB’s sales factor from internal treasury function activities and vendor allowances. Upon request from the FTB, BBB provided vendor information for the 2011 tax year and other tax years outside the audit period but did not provide vendor information for the 2009 or 2010 tax years.

BBB appealed the FTB’s refund claim denials, arguing that gross receipts from internal treasury function activities and vendor allowances are properly includible in the computation of the company’s sales factor denominator of its apportionment formula.

OTA decision The OTA considered the following two questions on appeal: (i) whether BBB’s receipts from its treasury function should be included in its sales factor; and (ii) whether BBB had sufficiently shown that it was entitled to a refund on the ground that claimed vendor allowances should be included in its sales factor.

Treasury function receipts properly excluded from sales factor by FTB regulation With respect to the treasury receipts, BBB argued that Cal. Code Regs. Sec. 25137(C)(1)(D), the FTB’s 2007 regulation excluding treasury receipts from a taxpayer’s sales factor, was not valid or applicable under existing case law.3 Specifically, BBB cited to Microsoft Corp. v. Franchise Tax Board, which determined that the word “gross” in the term “gross receipts” refers to the total amount received, not just any amount in excess of the purchase price.4 Under BBB’s interpretation, treasury function gross receipts must be included in the computation of the sales factor unless such inclusion would distort the amount of business activity attributed to California under the standard formula. Further, BBB contended that the FTB’s imposition of a default treasury receipts exclusion via regulation beginning in 2007 was an improper exercise of the FTB’s administrative rulemaking authority.

The OTA disagreed, finding that the FTB acted within its broad rule-making authority to adopt a regulation excluding treasury gross receipts from the sales factor. Citing to Appeal of Fluor Corporation, the OTA reasoned that the regulation promulgated under Cal. Rev. & Tax Code Sec. 25137 becomes part of the standard apportionment formula, and therefore controls unless the taxpayer can show by “clear and convincing evidence” that the application of the regulation would not fairly represent the extent of the taxpayer’s activities within California.5 The OTA panel concluded that BBB had not met its burden of showing by clear and convincing evidence that the standard apportionment formula (inclusive of the treasury receipts exclusion in Cal. Code Regs. Sec. 25137(C)(1)(D)) failed to fairly reflect BBB’s in-state business activities. In particular, the OTA noted that under Appeal of Fluor Corporation, “[i]f appellant wishes to deviate from Regulation section 25137(c)(1)(D), it needs to prove by clear and convincing evidence that excluding the treasury function receipts would be distortive, and that its alternative of including the treasury function receipts in the sales factor is reasonable.”

Vendor allowances includible in sales factor as sales of TPP The OTA next considered BBB’s argument that vendor allowances should be included in the sales factor as gross receipts. Citing Microsoft Corp. and General Motors Corp. v. Franchise Tax Board,6 the PTA panel agreed in principle with the broad interpretation of the definition of “gross receipts” for sales factor purposes. Unconvinced by the FTB’s argument that vendor allowances are offsets to COGS and thus do not qualify as “gross receipts,” the OTA reasoned that the applicable case law did not support such a strict interpretation of the term.

While the OTA agreed with BBB that vendor allowances are potentially includible as gross receipts in the sales factor, the OTA disagreed with BBB on how to classify such amounts. The panel explained that based on the functional integration with other segments of BBB’s unitary business, the vendor allowances are “so critically intertwined” with inventory purchased from vendors that the two items cannot be segregated. Based on a review of BBB’s vendor agreements, the OTA found that there would be no vendor allowance but for BBB’s sale of the vendor’s products. For these reasons, the OTA concluded that the vendor allowances are “additional compensation” paid to BBB for its unitary business of selling vendors’ TPP, rather than sales of intangible items. Recognizing that some vendor allowances could merit treatment as an intangible, the OTA declined to make such a determination based on the record.

Failure to substantiate refund claim Although the OTA agreed with BBB that vendor allowances may be included in the sales factor, the panel nonetheless upheld the denial of the refund claims on the basis that BBB provided insufficient evidence to show that it was entitled to a refund. Specifically, the panel found that BBB did not substantiate the total amount of its claimed vendor allowances, or the amount attributable to each type of allowance. In other words, BBB failed to show that it was “entitled to a refund, or, if it is entitled to a refund, what the amount of that refund should be.” Noting the FTB’s broad authority to examine tax returns, the OTA found that FTB’s information requests were reasonable and relevant to determine whether BBB was entitled to the claimed refunds. Finding that BBB failed to meet its burden of proof in substantiating the amount of the refund, the OTA upheld the FTB’s denial of the refund.

Dissenting and concurring opinion In a dissenting and concurring opinion, one judge wrote that he would have granted BBB’s refund claims in finding that treasury receipts are property included in the company’s sales factor. In the judge’s view, Cal. Code Regs. Sec. 25137(c)(1)(D) was inconsistent with prior case law finding that income generated from treasury function activities constitutes gross receipts for sales factor purposes.7 The dissent also cited to case law for the proposition that the burden lies with the FTB to clearly show distortion according to California law. In amending Cal. Code Regs. Sec. 25137, the FTB shifted that burden to taxpayers by requiring the taxpayer to prove by clear and convincing evidence that the exclusion of treasury function receipts does not fairly represent a taxpayer’s activity in California. For these reasons, the dissent would have allowed for the inclusion of treasury function receipts in the sales factor.

While the judge agreed with the majority that vendor allowances are considered gross receipts for sales factor purposes, he disagreed with the finding that the allowances constitute sales of TPP. In any event, the dissent agreed that BBB did not meet its burden of proof in substantiating its refund claim for the vendor allowances.

Commentary For many years, taxpayers have disputed that the FTB’s 2007 adoption of Cal. Code. Regs. Sec. 25137(c)(1)(D) was a valid exercise of the FTB’s administrative rulemaking authority, and many have raised arguments that such a change would have required legislative action (which occurred in 2009 when Cal. Rev. & Tax. Code Sec. 25120 was amended to incorporate a definition of “gross receipts” applicable in years beginning on or after January 1, 2011). Interestingly, although the Bed Bath & Beyond Inc. decision concerned the validity of this FTB’s regulation, it was not identified as a precedential decision by the OTA.

The OTA’s decision relating to the exclusion of treasury receipts from BBB’s sales factor calculation shows a substantial amount of deference to the FTB’s regulations and rulemaking authority in general. This perhaps contrasts with the prior approach of the Board of Equalization (“BOE”), which on occasion had more closely scrutinized and invalidated regulations promulgated by the FTB.8 In its decision, the OTA found that “FTB properly excluded the treasury gross receipts under Regulation section 25137(c)(1)(D), which was validly adopted and within FTB’s well established broad rule-making authority.” The FTB’s regulation requiring the exclusion of treasury receipts from the sales factor was part of the “standard apportionment” formula in the eyes of the OTA. As part of the standard formula, under the logic of the BOE’s decision in Appeal of Fluor Corporation, the OTA believed the burden is shifted to the taxpayer to support using alternative apportionment under Cal. Rev. & Tax. Code Sec. 25137 to depart from the standard formula, which would require clear and convincing evidence that excluding such receipts from the sales factor is distortive, and that an alternative method including such receipts in the sales factor is reasonable. Although the Bed Bath & Beyond Inc. decision is not precedential, there was a recent precedential decision, Appeal of Amarr Company,9 in which the OTA similarly denied a taxpayer’s request to depart from a special rule required under Cal. Code Regs. Sec. 25137, as incorporated into the standard formula, for lack of a showing that the application of the regulation would cause the standard formula to fail to fairly reflect the taxpayer’s in-state business activity.

This OTA’s decision in Bed Bath & Beyond Inc. also provides helpful insight into the potential treatment of vendor allowances for California sales factor purposes. While the taxpayer argued that its vendor allowances would be subject to California’s sourcing rules for sales other than sales of tangible personal property, the OTA rejected this argument on the basis that the allowances were so interrelated with vendor purchases of inventory that the two could not be segregated for accounting purposes. Further acknowledging that certain vendor allowances such as advertising would merit treatment as the sale of intangible property, the panel declined to address that argument in this case.

Based on the OTA’s decision, taxpayers receiving vendor allowances may consider reexamining the treatment of such allowances and the merits of reclassifying as TPP for purposes of their California sales factor calculation. Due to the wide variety of vendor allowances, close examination of the facts and circumstances relating to each vendor allowance may be needed to understand the proper treatment for sales factor purposes. Based on the OTA’s denial of BBB’s refund claim for lack of substantiation, taxpayers should be prepared to support the calculation of vendor allowances with relevant documentation.



1 In re Bed Bath & Beyond Inc., California Office of Tax Appeals, No. 18011340, dated Mar. 17, 2022.
2 The vendor allowances included markdown reimbursements, vendor rebates, supply distribution charges, vendor compliance and cooperative advertising.
3 Under CAL. CODE REGS. tit. 18, § 25137(c)(1)(D), gross receipts from a taxpayer’s treasury function are excluded from the numerator and denominator of the sales factor. The FTB promulgated this regulation as part of a series of rules providing alternative apportionment methods to address situations under which the standard apportionment method would result in distortion. CAL. CODE REGS. tit. 18, § 25137(a).
4 139 P.3d 1169 (Cal. 2006).
5 No. 95-SBE-016, Cal. State Board of Equalization, Dec. 12, 1995.
6 139 P.3d 1183 (Cal. 2006).
7 Citing Appeal of Pacific Telephone & Telegraph Co., No. 78-SBE-028, Cal. St. Bd. of Eq., May 4, 1978; Microsoft Corp. v. Cal. Franchise Tax Board, 139 P.3d 1169 (Cal. 2006).
8 See Appeal of Save Mart Supermarkets, No. 2002-SBE-002, Cal. St. Bd. of Eq., Feb. 6, 2002.
9 California Office of Tax Appeals, No. 2022–OTA–041P, Dec. 9, 2021.



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