Client Alert

Recent California FTB Administrative Developments


Subsequent to the last issue of Insights, there have been a number of administrative developments regarding the California Franchise Tax Board (FTB) which should be of interest to taxpayers and practitioners.

FTB Notice 2003-3 (April 29, 2003) -- Earlier MIC Ruling Is Withdrawn

FTB has announced it has withdrawn Legal Ruling 2001-4, in light of the FTB's loss last year before the California State Board of Equalization in Appeals of Jon and Rita Minnis and Milpitas Materials Company, 2002-SBE-003, June 20, 2002. The issue involves what constitutes "qualified property" under the California Manufacturer's Investment Credit (MIC). Minnis held that a ready mixer truck, comprised of a truck chassis and mixer barrel (including the accompanying components and hydraulic system) constitutes a "single integrated piece of manufacturing equipment," and thus the entire truck satisfied the requirement of "qualified property" for purposes of the MIC. The FTB's position in Minnis, as well as its position in (now withdrawn) Legal Ruling 2001-4, was that cement trucks should be treated as "dual-purpose assets," so that the concrete mixing drum and related truck-mounted equipment might qualify for the MIC, but that the cost of the truck or trailer chassis would not constitute "qualified property."

FTB's track record before the SBE in MIC cases, at least so far, has been abysmal. Minnis was a clear statement by the SBE in 2002 (i.e., last year's Board), offering what the SBE had earlier stated in its decision in Appeal of Save Mart Supermarkets & Subsidiary, 2002-SBE-002, op. on rehg. February 6, 2002, that the MIC should be interpreted broadly in favor of taxpayers. Whether this same philosophy will carry over to the SBE, as reconstituted after January 1, 2003, is unclear.

FTB Notice 2003-4 (May 5, 2003) -- Sourcing Gains from Intangible Property

FTB staff has prepared a discussion draft of proposed amendments to FTB Regulation 17952 to address the timing and sourcing of gains on the sale or transfer of intangible personal property by individuals who change residency. FTB proposes to amend the current regulation to include the following language:

The source of gains and losses from intangible personal property is determined at the time of the sale or transfer of the property. For example, if a California resident sells intangible personal property under the installment method, and subsequently becomes a nonresident, any later recognized gain attributable to any installment payment receipts relating to that sale will be sourced to California. Further, a full-year California nonresident who sells intangible personal property would be taxed by California on gain as it is recognized upon receipt of future installment payments if the intangible personal property had a business situs in California at the time of the sale.
This amendment is generally consistent with FTB's audit position, and appears consistent with the position taken by the FTB in Venture Communications, Inc. et. al. , 2003 Cal. Tax LEXIS 31, February 5, 2003, an unpublished, non-precedential SBE decision. There the SBE held a California non-resident shareholder of a C corporation, which converted to an S corporation, was not taxable under a "built-in gain" theory proposed by FTB, on income the shareholder received from the corporation's sale of a partnership interest (where the partnership had substantial activities in California). However, this amendment was not motivated by Venture Communications, but instead by the passage of AB 1115, which is discussed below. This proposed change should be of interest to California residents who sell intangible property and then change their residency to another state, e.g., Nevada.

FTB Notice 2003-5 (May 6, 2003) -- Informal Claims for Refund

In 2001, the California Legislature amended the Revenue and Taxation Code to provide that a claim for refund which is otherwise valid, but is made before full payment of the disputed tax has been made, is sufficient to toll the statute of limitations. This "informal" claim for refund must later be perfected. This Notice provides guidance regarding how such informal refund claims should be filed with FTB.

FTB Notice 2003-6 (May 6, 2003) -- Small Business Stock Deferral Election

In 2002, the California Legislature amended the Revenue and Taxation Code to expand the types of taxpayers that may elect to rollover gain from the sale of qualified "small business stock." This Notice explains the procedure (and forms) for making the election to defer such gains from the sale of qualified small business stock.

FTB Legal Ruling 2003-1 (April 7, 2003) -- Sourcing Certain Gains for Part-Year Residents

In 2001, the California Legislature passed AB 1115 (Stats. 2001, ch. 920), which made significant changes to the calculation of California taxable income for taxpayers who changed from resident to nonresident status, or vice versa, for years beginning on or after January 1, 2002. AB 1115 was sponsored by the FTB, which characterized the bill in its analysis as making "comprehensive changes in the manner that nonresidents and part-year residents are taxed." This Legal Ruling provides guidance to taxpayers regarding the inclusion and sourcing of items to be reported from partnerships (including limited liability companies classified under federal and California tax law as partnerships), S corporations, and certain trusts when the partner, shareholder or beneficiary is a part-year resident during any part of its own or the partnership's, S corporation's, or trust's taxable year. FTB staff intends to propose regulations which are consistent with the principles set forth in the Ruling.

FTB Legal Ruling 2003-2 (May 6, 2003) -- 936 Corporations and Profit Split

This Ruling addresses a corporate tax issue which only will be relevant if a California water's-edge election has been made or is being contemplated and a possessions corporation is involved. The Ruling states that California has not conformed to the federal "profit split" method of allocating income and deductions of a possessions corporation under IRC 936(h)(5)(C)(ii)(1). This means that a California water's-edge taxpayer does not have a right to use the federal profit split method to allocate income and deductions involving a 936 possessions corporation which was excluded from the unitary group under the election. This is a formalization of a position which FTB has taken informally for a number of years. However, as long as use of the profit split method meets the "clearly reflects income" requirement found in Revenue and Taxation Code section 25114, the argument still can be made that FTB need not make any adjustments to transactions between possessions corporations and their affiliates to place the transactions on an arm's-length basis.

[The full text of all the above items can be found on the FTB website at]




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