A recently issued California Franchise Tax Board Chief Counsel ruling provides important guidance on the scope of a regulation regarding qualification as a “financial corporation” for California corporation franchise tax purposes. Cal. FTB Chief Counsel Rul. 2018-01 (Nov. 2, 2018). The ruling discusses categories of a corporation’s “financial” income that qualify in determining whether the corporation predominantly deals in “money or moneyed capital” so as to be considered a financial corporation.
Background. Financial corporations are taxed at a higher rate than general corporations under the California franchise tax, and use a different apportionment formula. Financial corporations use an equally weighted three-factor apportionment formula, including a property factor that includes certain intangibles, while most other corporations apportion their income using a single sales factor.
A “financial corporation” is a corporation that “predominantly” deals in “money or moneyed capital” and that is in substantial competition with national banks. FTB Regulation § 23183 provides some guidance, defining “money or moneyed capital” to include such items as cash, mortgages, loans, commercial paper, and accounts receivable. However, there is no comprehensive definition for the term “money or moneyed capital.” The regulation provides an annual gross income test, classifying as a “financial corporation” a corporation having more than 50% of its total gross income for the year from dealings in “money or moneyed capital.”
Mortgage Servicing Fees. The Chief Counsel ruling addresses two discrete questions. The first involves a corporation that originates and purchases mortgage loans, and then proceeds to securitize and sell them to government-sponsored entities or to institutional investors. While the corporation earns some interest income, loan origination fees, and gains or losses during the brief time that it owns the mortgage loans, more than 50% of its gross income is from servicing the mortgage loans that it sells. The Chief Counsel ruling concludes that the corporation is not a financial corporation because, while making and selling mortgage loans constitutes dealing in “moneyed capital,” servicing loans does not. An earlier Chief Counsel ruling had reached a similar conclusion, but that ruling involved a special-purpose entity that, unlike the entity in the new ruling, did not originate mortgage loans but only provided loan servicing. Cal. FTB Chief Counsel Rul. 2000-0236 (Oct. 11, 2000).
Interest Rate Hedging Contracts. The second question was whether a corporation’s gains and losses from interest rate hedging contracts constitute “financial” income for purposes of the 50% gross income test. Here the Chief Counsel, while acknowledging the lack of clarity regarding what constitutes “money or moneyed capital,” found that, although national banks also engage in the same interest hedging activities, such contracts are not from “moneyed capital” because they do not evidence “a debt obligation.” Therefore, according to the FTB Chief Counsel, the gains and losses from interest rate hedging contracts are not attributable to “money or moneyed capital” and therefore are not “financial” income for purposes of the 50% gross income test for a “financial corporation.” The ruling makes explicit that to constitute “financial” income, the income must either be from actual legal tender or from an instrument evidencing a debt obligation. Depending on the particular facts, the ruling’s narrow interpretation of “financial” income may benefit certain corporations, particularly those with a significant presence in California, since general corporations apportion using a single sales factor.