When California passed its economic nexus legislation last year, many in the taxpayer community figured it would at least provide a bright-line test for when out of state corporations needed to file corporate income tax returns in the state. The new rules, effective for all tax years beginning on or after January 1, 2011 provide that a taxpayer has corporate income tax nexus if it has more than $500,000 in gross receipts from California-sourced sales (or more than 25% of the taxpayer's sales were California-sourced). The statute also establishes that nexus exists if a taxpayer has more than $50,000 of property or payroll in the state. These provisions conform closely to the MTC's model nexus standard.
Last week, the Franchise Tax Board published a summary of the new law. What may have seemed like a bright line suddenly became much less clear. The information published on the FTB's website states that the amendment to the state's nexus statute did not limit the FTB's ability to find nexus when a taxpayer "actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California."
The guidance goes on to conclude that "[a]n out-of-state taxpayer that has less than the threshold amounts of property, payroll and sales in California may still be considered doing business in this state if the taxpayer actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California.”
Here is the example used in the FTB’s summary:
Partnership A, an out-of-state partnership, has employees who work out of their homes in California. The employees sell and provide warranty work to California customers. Partnership A's property, payroll and sales in California fall below the threshold amounts. Is Partnership A considered to be doing business in California?
Yes. Partnership A is considered doing business in California even if the property, payroll and sales in California fall below the threshold amounts. Partnership A is considered doing business in California through its employees because those employees are "actively engaging" in transactions for profit on behalf of Partnership A.
It seems odd that the FTB would choose to enforce nexus and the associated filing obligation of taxpayers with so little in the way of California activity. At the same time, the FTB has recently restated that it is constitutionally bound to enforce tax statutes until they have been found unconstitutional by an appellate court (see Legal Division Guidance 2011-01-01 – providing that the FTB would enforce the provisions of SB 401 even though it may be retroactively repealed as a result of Proposition 26). In this case, that approach would seem inconsistent with the reason for enacting the economic nexus statute (i.e., the establishment of a clear nexus test).
Click here to read the FTB’s summary of the new nexus legislation.