INSIGHT: California’s Current Alternative Apportionment Petition Process (Part 2 of 3)

Like its apportionment regime, California’s statutory and regulatory provisions governing alternative apportionment are unexceptional as written. Mirroring Uniform Division of Income for Tax Purposes Act Section 18 and the Multistate Tax Commission’s accompanying model regulation, California Revenue and Taxation Code Section) 25137 and Franchise Tax Board (FTB) Regulation 25137 allow for relief where the standard apportionment formula does not result in a fair representation of a corporate taxpayer’s business activity in California, typically in an unusual situation. However, neither the statute nor the regulation offers taxpayers any guidance on the process for petitioning for such relief. In this second installment of our series on alternative apportionment in California, we examine the process in more detail as revealed through administrative guidance and anecdotal experience.

25137 Petition: Where Do We Go from Here?

Under both Section 25137 and the FTB’s accompanying regulation, a taxpayer may petition the FTB for relief under the State’s alternative apportionment provisions (25137 Petition). Cal. Rev. & Tax. Code Section 25137; 18 Cal. Code Regs. Section 25137(a). Taxpayers typically bring 25137 Petitions on original or amended Corporate Franchise Tax Returns, in refund claims, or when protesting an audit assessment. Consequently, 25137 Petitions are initially received and considered by FTB staff, in either the agency’s Audit or Legal Division. While the statute makes no mention of FTB staff, FTB Regulation 25137 provides that the three-member board “may elect to hear and decide petitions filed pursuant to Section 25137 instead of having this function performed by the staff.” 18 Cal. Code Regs. Section 25137(d).

Beyond that single reference, there is nothing in the law outlining the administrative process for 25137 Petitions beyond bringing the petition itself. Nevertheless, over the past few years, the FTB has shed more light on the process through its project to amend the governing regulation and various administrative pronouncements. See, e.g., FTB Summary of First Interested Parties Meeting, Reg. 25137 (June 30, 2017); FTB Legal Notice 2017-05 (Oct. 19, 2017); FTB Legal Notice 2018-02 (May 24, 2018).

The 25137 Petition Process

Upon consideration of a taxpayer’s 25137 Petition, FTB staff will prepare an initial written recommendation to grant or deny the taxpayer’s request and provide the taxpayer with an opportunity to respond in the event FTB staff recommends denial. If a taxpayer submits a written response, FTB staff may prepare a written reply. In addition to written submissions, taxpayers also have the opportunity to make an oral presentation before FTB staff. FTB Legal Notice 2017-05 (Oct. 19, 2017); see also FTB Legal Notice 2018-02 (May 24, 2018). Oral presentations are made to a group of select FTB staff referred to as the “25137 Committee.” The 25137 Committee primarily is composed of senior FTB attorneys and the director and the deputy chief counsel for FTB’s Bureau of Multistate Taxation, although other senior FTB staff may participate as well. See FTB Summary of First Interested Parties Meeting, Reg. 25137 (June 30, 2017), p. 2. Prior to 2017, taxpayers typically were not afforded an opportunity to make an oral presentation to FTB staff during the petition process.

Proceedings before the 25137 Committee are scheduled at the convenience of the taxpayer, informal in nature and confidential. The 25137 Committee meets regularly to discuss pending petitions. After reviewing the written submissions and arguments made at the oral presentation (if any), the 25137 Committee will issue a written decision to uphold or overturn the initial recommendation of FTB staff.

In the event the 25137 Committee recommends denial of the taxpayer’s 25137 Petition, the taxpayer may appeal to the three-member board for a full hearing on the matter at one of the board’s quarterly meetings. As a prerequisite for appealing to the full board, though, a taxpayer must file a waiver of confidentiality because board meetings are subject to California’s Bagley-Keene Open Meeting Act. Government Code Sections 11120 et seq. Both the taxpayer and the FTB will submit written argument in advance of the hearing. Ex parte communications with board members are prohibited while a 25137 Petition is pending a full hearing. FTB Resolution 2017-01 (Dec. 7, 2017). Before 2018, there was no formal prohibition against ex parte communications with board members while a 25137 Petition was pending. However, with the adoption of Resolution 2017-01, the board effectively put a stop to all such communications. The hearing itself alone now affords taxpayers the opportunity to present its petition to the board, address FTB staff’s recommendation, and respond to any questions from board members.

After the hearing, the board will issue its determination on the taxpayer’s 25137 Petition. Depending on the procedural posture of the underlying matter (e.g., audit, protest, claim for refund), the taxpayer ultimately will be able to pursue an appeal of the board’s determination before the Office of Tax Appeals or in an action for refund in California Superior Court. Taxpayers in a deficiency status must complete the audit and protest process before appealing to the Office of Tax Appeals. Taxpayers in a refund status will be able to appeal to the Office of Tax Appeals or bring an action in superior court when FTB acts on the 25137 Petition and overall claim.

There is no way of knowing how many 25137 Petitions have been filed and acted upon by FTB staff and the 25137 Committee during the past few years due to the confidential nature of the proceedings. Notably, there has been only one hearing on a 25137 Petition by the three-member board over the last five years.

The above process is the same if FTB staff initiates a proposed variance under Section 25137. In such situations, the taxpayer has the same opportunity to make an oral presentation to the 25137 Committee.

Considerations for 25137 Petitions

The 25137 Petition process is separate from the audit and protest processes. Thus, a taxpayer seeking alternative apportionment relief effectively creates a second, parallel administrative track. The petition must be resolved before the taxpayer may advance in the overall administrative appeal process.

This means that an audit or protest may be delayed pending a determination on the 25137 Petition. Where a taxpayer is considering seeking relief as an argument in the alternative, for example seeking factor relief in the event certain foreign dividends are characterized by the FTB as apportionable business income, it may be worth considering withdrawing the petition if pursuing the petition would unduly delay the overall proceeding. Additionally, cases ripe for settlement include those where a 25137 Petition has gone to the 25137 Committee for consideration, even though the 25137 Committee has yet to make its determination.

As stated above, appealing to the full three-member Board requires a taxpayer to waive confidentiality with regard to the 25137 Petition “and to any other facts which may be deemed relevant in making a determination.” 18 Cal. Code Regs. Section 25137(d). Accordingly, taxpayers must thoughtfully consider whether pursuing a 25137 Petition is worth abandoning confidentiality.

Why then might taxpayers ever consider taking a 25137 Petition before the full board? The answer can be found in the lack of formal guidance related to the 25137 Petition process. In the past, the FTB has communicated that its unofficial position regarding a hearing before the full board is that such a hearing is necessary in order for a taxpayer to exhaust its administrative remedies. Failure to take a petition to the board therefore was likely to result in an administrative fight in the event a taxpayer ever brought an action for refund in California Superior Court. The FTB has yet to take an official position on the exhaustion issue, which has become a flashpoint during the discussions about proposed amendments to the regulation.

Next Installment: The FTB’s Regulation Project

Exhaustion of administrative remedies is not the only topic under debate during the FTB’s project to amend Regulation 25137. Timelines for written submissions, format of proceedings and other items are all on the table. In our next and final installment, we will track the FTB’s progress since the regulation project started three years ago and examine how the proposed amendments might formalize the 25137 Petition process.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Tim Gustafson is a Partner and Justin Brown is an Associate at Eversheds Sutherland (US) LLP.

Fair Representation—An Overview of Alternative Apportionment in California (Part 1 of 3)