The California Franchise Tax Board has amended Section 25106.5, Title 18 of the California Code to reflect the legislature’s adoption in 2009 of the Finnigan rule for taxable years beginning on or after Jan. 1, 2011. As explained below, the Finnigan rule is one of two primary methods which states use to calculate the sales factor for income tax apportionment formula purposes.
Taxpayers that have business activities within California and other states are required to determine the amount of income properly attributable to California by applying one of California’s apportionment formulas. Such formulas include a sales factor, which is a fraction, the numerator of which is the taxpayer’s sales of tangible personal property in California during the taxable year, and the denominator of which is the taxpayer’s sales of tangible personal property everywhere during the taxable year.
The general rule is that sales of tangible personal property should be assigned to the sales factor numerator of the state of destination of such property. An exception to this rule is if the taxpayer is not taxable in the state of destination, then such sales are “thrownback” to the state from which the tangible personal property was shipped and included in the sales factor numerator of such state of shipment for purposes of the apportionment formula.
States differ in how the sales factor is calculated when the taxpayer is part of a unitary or combined reporting group for state tax purposes. In such cases, the states generally follow either the Joyce rule or the Finnigan rule. The Joyce and Finnigan rules differ in whether the term “taxpayer” refers to each separate entity in a unitary or combined reporting group (Joyce) or to the unitary or combined reporting group as a whole (Finnigan).
Since a 1999 court decision, California has applied the Joyce rule, which requires that receipts from sales of tangible personal property be assigned to the sales factor numerator of a state only when the selling member of a combined reporting group has nexus with that state. Under the Joyce rule, if the selling member is not taxable in California, then any sales made by the selling member to California purchasers would be “thrownback” to be included as part of the sales factor numerator of the state of shipment even if another member of the seller’s combined reporting group was taxable in California.
In 2009, the California legislature amended Section 25135 of the California Code to adopt the Finnigan rule replacing the Joyce rule. Beginning for taxable years on or after Jan. 1, 2011, revised Section 25135 requires that receipts from sales of tangible personal property delivered or shipped to a purchaser in California be assigned to the California sales factor numerator if the seller or any member of the seller’s combined reporting group is taxable in California. In addition, all sales receipts from sales of tangible personal property delivered to a state other than California are not thrown back to the California sales factor numerator of the seller if any member of the seller’s combined reporting group is taxable in that state.
The California Franchise Tax Board amended regulation Section 25106.5 to implement the change in the law from the Joyce rule to the Finnigan rule and to provide guidance to multistate taxpayers on when and how to assign sales receipts from sales of tangible personal property to the California sales factor under the Finnigan rule.