The California Franchise Tax Board (FTB) and San Francisco Treasurer & Tax Collector have both proposed rules that would source receipts for asset management services using a look-through approach that focuses on the location of the ultimate investor. The proposals are substantively the same, except that the FTB’s rules measure the amount of sales sourced to the state, whereas the city treasurer’s rules measure the amount of sales sourced to the city.
While the new regulations could result in more favorable treatment for in-state asset managers with investors outside California, they could negatively affect out-of-state asset managers with investors in California. Although both the FTB and city treasurer’s proposed regulations are in draft form and not yet finalized, asset managers should continue to monitor any developments to assess the impact on their California and San Francisco gross receipts tax obligations.
Background on the Proposed Regulations
Over the past eight years, the FTB has been amending its market-based sourcing regulations, and proposed Reg. Sec. 25136-2 adds rules that apply to asset management services. In response to comments made during a public hearing and those submitted in writing, the FTB on May 20 issued a second notice of modifications to the proposed amendments. The second modified text changed the effective date of the proposed amendments from January 1, 2025, to January 1, 2026.
San Francisco voters recently approved Proposition M, which changed how businesses calculate their San Francisco gross receipts tax. Under the new framework, all businesses other than those in specific real estate and accommodation activities must determine San Francisco receipts using 75% sales allocation and 25% payroll apportionment. As required by Proposition M, the city treasurer issued proposed regulations providing guidance on how gross receipts should be sourced, including rules that apply to asset management services. The city treasurer modeled its proposed asset management rules after the FTB’s. The effective date for the city’s proposed regulations is for tax years starting on or after January 1, 2025.
As of the date of this Alert, the proposed rules have not been finalized and are still in draft form.
Overview of the Proposed Regulations
The FTB and city treasurer’s rules on asset management services mirror one another, except that the state version measures the amount of sales sourced to the state and the city version measures the amount of sales sourced to the city. The proposed asset management regulations do not apply to mutual fund service providers deriving income from the direct or indirect provision of management, distribution, or administration services to or on behalf of a regulated investment company (those service providers are subject to a different set of rules).
Both sets of proposed rules provide that the benefit of the asset management service is received at the domiciles of the investors in the assets unless the investors are holding title to the assets for a beneficial owner. In that case, the benefit of the service is received at the domicile of the assets’ beneficial owner. The proposed regulations also specify how to determine the domiciles of investors and beneficial owners.
To determine where the benefit of the service is received, the proposed rules apply a new “average value of interest” test. Under that test, receipts from asset management services are assigned to the state or city in proportion to the average value of interest in the assets held by the asset’s investors or beneficial owners domiciled in the state or city, respectively. If the taxpayer does not know the average value of interest in the assets held by the asset’s investors or beneficial owners domiciled in the state or city (as applicable), the taxpayer must reasonably estimate the average value. However, neither the city nor state has specified what the phrase “reasonably estimate” means or what would be considered a reasonable estimate.
The proposed rules provide similar definitions for the terms “asset management services,” “administration services,” “distribution services,” “management services,” “fund,” and “beneficial owner.” The proposed regulations also provide examples illustrating how the rules should apply.
BDO Insights
- While the FTB modified its proposed regulations to have an effective date of January 1, 2026, the proposed city regulations still have an effective date of January 1, 2025. As of the date of this Alert, San Francisco had not amended its proposed regulations to conform to the FTB’s effective date. Therefore, taxpayers should continue to monitor the status of the city regulations for changes that could affect the resulting tax treatment.
- Because the proposed rules introduce a new “average value of interest” test that considers the location of the ultimate investor, they could have a negative effect on out-of-state asset managers providing asset management services to investors in the state or city. On the other hand, in-state asset managers providing services to investors outside the state or city might receive more beneficial tax treatment under the new rules.
Please visit BDO’s State & Local Tax Services page for more information on how BDO can help.