Taxpayer Orgs Challenge Enactment of California Provision Requiring Inclusion of Net Receipts in the Sales Factor

On June 27, the California legislature enacted California Revenue and Taxation Code (CRTC) section 25128.9 under S.B. 167. The rationale behind the new provision was framed as a clarification of existing California law. Specifically, the provision states that income not included in apportionable business income “by any reason, including, but not limited to, exclusion, deduction, exemption, elimination, or nonrecognition” is excluded from the sales factor of California’s apportionment formula. Please refer to BDO’s prior alert summarizing the various changes made under S.B. 167.  

Consistent with legislative intent, the provision applies both retroactively and prospectively to tax years beginning “before, on, or after the effective date of the act adding this section.” Notably, it was intended to retroactively overturn the California Office of Tax Appeal’s decision in Appeal of Microsoft, which concluded that gross (not net) receipts are includable in the sales factor. While S.B. 167 authorized the California Franchise Tax Board (FTB) to promulgate regulations to implement the new section, it states that California’s Administrative Procedures Act does not apply to any regulation or guidance established or issued by the FTB.  

In August, the California Taxpayers Association and National Taxpayers Union filed separate actions in California superior court seeking declaratory relief. The first case, California Taxpayers Association v. California Franchise Tax Board, No. 24CECG03564, filed in Fresno County, seeks a judicial declaration that:

• CRTC section 25128.9 is not merely a clarification or statement of existing law under the separate of powers doctrine of the California Constitution.
• The retroactive application of CRTC section 25128.9 is invalid because it violates taxpayers’ due process rights under the U.S. and California constitutions.
• CRTC section 25128.9 violates the single-subject rule of the California Constitution.
• CRTC section 25128.9 violates the nondelegation doctrine of the California Constitution.

The second case, National Taxpayers Union v. California Franchise Tax Board, No. 24CV016118, filed in Sacramento County, seeks a judicial declaration that:

• CRTC section 25128.9 is vague in violation of the due process clause of the U.S. Constitution.
• The retroactive application of CRTC section 25128.9 violates the due process clause of the U.S. and California constitutions.