The California Office of Tax Appeals in the Matter of the Appeal of Blair S. Bindley, OTA Case No. 18032402[1] ruled that an Arizona individual who had a contract for screenwriting services for two California LLCs had California source income on which he had to pay tax, even though all services were performed in Arizona.
California, like many other states, has moved to pure market-based sourcing for apportioning sales in a business setting. Under California Revenue & Taxation Code (RT&C) §25128.7, apportionment for the vast majority of businesses with California operations is based solely on the sales factor. RT&C §25136(a)(1) assigns a sale to California to the extent that the purchaser of a service received the benefit of the service in California.
In this case the taxpayer argued that he had performed all of the services in California Arizona, so he did not have a sufficient connection with California to trigger a requirement to file a return and report the income to the Franchise Tax Board.[2]
California imposes its tax on any nonresident carrying on a business within the state of California (RTC §18501(a)). The OTA opinion notes that nothing in the statute requires that the taxpayer be physically present in the state of California.[3] The Court found that the taxpayer received income from California LLCs, with he and his sole proprietorship deemed to be conducting business in California, making the proprietorship’s income subject to apportionment under California’s apportionment rules.[4]
So now the question becomes where did the taxpayer’s buyer receive the benefit of the services provided, not where the taxpayer performed such services. Under Reg. §25136-2(c)(2) provides that where a business is the taxpayer’s customers, the place where the customer receives the benefit of the services is determined under the following rules:
(A)The location of the benefit of the service shall be presumed to be received in this state to the extent the contract between the taxpayer [i.e., appellant] and the taxpayer’s customer[s] [i.e., Mindbender and Lakeshow] or the taxpayer’s books and records kept in the normal course of business, notwithstanding the billing address of the taxpayer’s customer, indicate the benefit of the service is in this state. This presumption may be overcome by the taxpayer or [FTB] by showing, based on a preponderance of the evidence, that the location (or locations) indicated by the contract or the taxpayer’s books and records was not the actual location where the benefit of the service was received.
(B) If neither the contract nor the taxpayer’s books and records provide the location where the benefit of the service is received, or the presumption in subparagraph (A)is overcome, then the location (or locations) where the benefit is received shall be reasonably approximated.
(C) If the location where the benefit of the service is received cannot be determined under subparagraph (A) or reasonably approximated under subparagraph (B), then the location where the benefit of the service is received shall be presumed to be in this state if the location from which the taxpayer’s customer placed the order for the service is in this state.
(D)If the location where the benefit of the service is received cannot be determined pursuant to subparagraphs (A), (B), or (C), then the benefit of the service shall be in this state if the taxpayer’s customer’s billing address is in this state.
The OTA opinion applies these rules, coming to the determination that since the LLCs are registered and located in California, the second test is met, with the benefit received in California:
Public records from the California Secretary of State provided by FTB show that both Mindbender and Lakeshow are registered and located in California. Moreover, appellant’s contracts with Mindbender and Lakeshow both list California addresses. Appellant also concedes that Mindbender and Lakeshow are California LLCs. Based on the evidence in the appeal record, we find that it was both reasonable and rational for FTB to conclude that both LLCs received the benefit of appellant’s services within California. Because we have determined that the LLCs received the benefit of appellant’s services in California under Regulation section 25136-2(b)(2)(B), there is no need to discuss the remaining cascading rules.[5]
The opinion summarized the findings as follows:
In sum, pursuant to the provisions of the UDITPA relating to the sale of services and the regulations thereunder, appellant’s physical presence does not determine whether he had income derived from California, but rather it is determined by where the benefits of appellant’s services were received.[6]
[1] https://ota.ca.gov/wp-content/uploads/sites/54/2019/08/18032402_Bindley_Decision_OTA_053019.pdf, May 30, 2019
[2] Ibid, p. 4
[3] Ibid, pp. 4-5
[4] Ibid, pp. 5-7
[5] Ibid, p. 9
[6] Ibid
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