California FTB Updates Sourcing Rules for Sales of Services and Intangibles

After eight years of public hearings and several rounds of draft language, the California Franchise Tax Board (FTB) has finally adopted important amendments to its market-based sourcing regulation (Cal. Code Reg., Title 18, §25136-2). The amendments, which largely mirror the most recent draft language, will apply to tax years beginning on or after January 1, 2026 (see our previous Alert: California FTB Sets Public Hearing Date for Proposed Market-Based Sourcing Regulations). 

The changes to California’s market-based sourcing regulation include eliminating rules that were based on whether the customer was an individual or a business and updating the rules for sales of marketable securities. They also require that a taxpayer’s reasonable approximation method be used unless the FTB shows by a preponderance of the evidence that the method is not reasonable. Taxpayers that want to change their reasonable approximation method must submit notification and a brief description for prior approval by the FTB.

The amendments also add:

• Presumptions that apply to sales of services or intangibles (regardless of whether the customer is an individual or business) based on whether the service predominantly relates to real property, tangible personal property, intangible property, or individuals located in the state;
• Rules allowing the use of books, records, and all other sources of information to substantiate the location of the receipt of the benefit of the service or a reasonable approximation of the location if other information is unavailable;
• Rules for providing services under U.S. government contracts when the contract itself cannot be disclosed and no further information is accessible; 
• Rules for asset management services, generally using a new “average value of interest” test and applying a look-through approach to the domiciles of the investors or beneficial owners (see our related Alert: California and San Francisco Propose Sourcing for Asset Management Services Based on Ultimate Investor); 
• A large-volume professional services rule for taxpayers providing services to more than 250 customers;
• Modifications to rules for sales of corporate and pass-through intangibles and receipts from dividends, providing guidance on how to address the 50% asset test when the taxpayer lacks the necessary information to properly apply the test; and
• Rules that apply to sales involving the provision of a service and tangible or intangible property, or of both tangible and intangible property.