INSIGHT: California Franchise Tax Board’s Alternative Apportionment Regulation Project (Part 3 of 3)

Like many other states, California law provides a mechanism for a corporate taxpayer to petition the state to use an alternative apportionment methodology when California’s standard apportionment provisions do not fairly reflect that taxpayer’s activity in the state. However, California law is bereft of formal statutory or regulatory guidance regarding the process. While the California Franchise Tax Board (FTB) has issued administrative guidance on the issue, such guidance lacks detail, leaving taxpayers uncertain about many aspects of the process. In this final installment of our three-part series, we look at the FTB’s recent efforts to amend its governing regulation to provide that detail and establish a formal procedure for petitioning for alternative apportionment.

FTB’s Alternative Apportionment Regulation Project—Three Years and Counting

On June 30, 2017, the FTB held its first interested parties meeting to discuss potential amendments to Regulation 25137 to provide taxpayers with guidance regarding petitions for alternative apportionment under California Revenue and Taxation Code section 25137 (25137 Petitions). See FTB Summary of First Interested Parties Meeting, Reg. 25137 (June 30, 2017), available at https://www.ftb.ca.gov/tax-pros/law/regulatory-activity/06302017-summary-first-ipm.pdf. At that meeting, participants discussed a number of issues, including: how 25137 Petitions initially should be considered by FTB staff; whether formal time limits should be imposed regarding verbal presentations in 25137 Petitions; what the contents of a 25137 Petition should be; whether the FTB should issue written determinations in response to 25137 Petitions; whether witnesses should be permitted to testify in 25137 Petitions filed with the three-member board; and whether different procedures should exist for 25137 Petitions filed as part of an audit.

Follow-up meetings were held on Nov. 26, 2018 and Dec. 4, 2019. In advance of the second interested parties meeting in 2018, the FTB distributed a proposed draft regulation which modified existing Regulation 25137(d) to provide procedural guidance for 25137 Petitions. A copy of this 2018 version of the proposed draft regulation is available on the FTB’s website at https://www.ftb.ca.gov/tax-pros/law/regulatory-activity/11262018-draft-language.pdf. An updated version of this proposed regulation (Draft Regulation) was then circulated by the FTB in advance of the December 2019 interested parties meeting to address comments and concerns with the 2018 draft. A copy of the Draft Regulation is available on the FTB’s website at https://www.ftb.ca.gov/tax-pros/law/regulatory-activity/25137-draft-language.html.

Proposed Draft Regulation Language

The current Draft Regulation provides substantial procedural guidance for taxpayers making 25137 Petitions to the three-member board. First, the Draft Regulation provides that a taxpayer may file a petition for the board to hear its 25137 Petition. Draft Regulation at (d)(2). Such petition must be filed with the FTB Chief Counsel and explain why the taxpayer’s requested methodology is warranted. Draft Regulation at (d)(2)(A). In situations where FTB staff have not previously made a determination on the taxpayer’s petition, the FTB Chief Counsel is required to ensure that FTB staff determine whether alternative apportionment is appropriate before allowing a taxpayer to present its case to the three-member board. Draft Regulation at (d)(2)(D).

The Draft Regulation establishes deadlines for filing a 25137 Petition with the board. The deadlines vary based on the procedural posture of the underlying matter. Specifically, a taxpayer is required to file the petition no later than: 60 calendar days after a written adverse action determination by FTB staff; 120 calendar days from filing a refund claim; or 60 calendar days prior to a scheduled protest hearing. Draft Regulation at (d)(2)(A). These deadlines were added as part of the modifications made in the revised draft in 2019.

The Draft Regulation also imposes a requirement on taxpayers petitioning the board to submit a waiver of confidentiality. Draft Regulation at (d)(2)(B). This is in line with the current regulatory requirement that taxpayers submit a waiver of confidentiality in writing before the board will hear the matter. 18 Cal. Code Regs. Section 25137(d). This requirement may act as a deterrent for some taxpayers who do not wish to have a 25137 Petition, including all facts relevant to such petition, made public.

In addition, the Draft Regulation provides for official acknowledgement of a 25137 Petition by the FTB Chief Counsel after FTB staff have made a determination on whether the alternative apportionment formula methodology is appropriate. Draft Regulation at (d)(2)(E). This acknowledgement triggers the rules regarding ex-parte communications (these communications generally are prohibited), which do not expire until the board renders its decision. Draft Regulation at (d)(2)(E), (d)(3).

The Draft Regulation provides a deadline of 60 days from the date of such acknowledgement for a taxpayer to file a brief, and gives FTB staff 30 days to submit its opening brief. Draft Regulation at (d)(2)(E). Briefs are limited to 30 double-spaced pages and reply briefs are limited to 15 double-spaced pages. With respect to hearings before the board, the Draft Regulation provides that each party shall have 30 minutes to present its position and the taxpayer shall have an additional 15 minutes for a reply. Draft Regulation at (d)(2)(F). Finally, the Draft Regulation provides that the board shall render its decision during an open session of a regularly-scheduled board meeting. Draft Regulation at (d)(2)(J). In the event a notice of proposed deficiency assessment has not been mailed to the taxpayer with respect to the tax year at issue in the 25137 Petition, the taxpayer must agree to extend the statute of limitations for the FTB to issue a notice until 180 days after the board makes a determination. Draft Regulation at (d)(2)(F).

Lingering Questions Regarding the Petition Process

A number of questions remain after the FTB’s last interested parties meeting, particularly with regard to 25137 Petitions which ultimately do not go to the board—the vast, vast majority of all 25137 Petitions. For example, there is uncertainty regarding what rules—if any—apply for 25137 Petitions filed with FTB staff. As written, the Draft Regulation appears only to provide rules for 25137 Petitions made directly to the board itself.

Additionally, the mandatory timeframes for taxpayers to file 25137 Petitions with the board may create inadvertent problems. Consider a scenario where a taxpayer wants to take a 25137 Petition to FTB’s Settlement Bureau. FTB’s Settlement Bureau only accepts cases that are factually-developed. The Draft Regulation does not address how far along in the process the 25137 Petition must go before it will be accepted. Must a taxpayer file a petition with FTB staff and wait for a recommendation from a group of select FTB staff referred to as the “25137 Committee” before applying for settlement? Once the committee issues a recommendation, though, will the taxpayer need to file its 25137 Petition with the board in 60 days before moving to settlement just to preserve its right to appeal?

Lastly, the Draft Regulation’s silence on the issue of exhaustion of administrative remedies leaves taxpayers in a difficult position. As previously noted, the FTB has communicated that its unofficial position is that a hearing before the board is necessary in order for a taxpayer to exhaust its administrative remedies prior to bringing a refund action in California Superior Court. A refund claim is deemed denied if the FTB does not act on it within six months. Once a claim is deemed denied, a taxpayer may bring an action in California Superior Court. If that refund claim is based on a 25137 Petition, even if only in part, must a taxpayer take the petition all the way to the board before bringing suit? If a taxpayer does not go to the board, is it only inviting a legal battle on jurisdiction? The FTB should consider these and other issues moving ahead with its regulation project as leaving these issues unresolved will only increase the likelihood of litigation down the road.

Conclusion: the Future of 25137 Petitions

While the FTB is still in the process of finalizing the Draft Regulation, it is safe to say that formal adoption of the rules will provide more clarity for taxpayers considering making a 25137 Petition, which would be a welcome development. However, there are a number of issues that have not yet been addressed by the FTB in its Draft Regulation, including the rules that apply to petitions filed with FTB staff and the requirement to have a hearing before the board in order to exhaust one’s administrative remedies. While the comment period for the 2019 version of the Draft Regulation has expired, interested parties should be on the lookout for the next iteration of the Draft Regulation and consider providing comments. We will continue to follow the FTB’s regulation project closely and update readers as new developments arise.

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)