On August 27, 2025, the California Franchise Tax Board (“FTB”) approved the Final Regulations for Cal. Code Regs. tit. 18, §25136, which will be required for tax years beginning after January 1, 2026. The new rules outline significant changes made to the sourcing of revenue for non-tangible property transactions. The changes can be divided into three (3) sections – professional services, asset management services and intangible property transactions.
California applies standard market-based sourcing for gross receipts and indicates that receipts from the provision of services is sourced to California if the benefit of the services is received in California. As standard practice with many other states, California provides a series of cascading rules to be applied in sequential order to determine where the customer is receiving the services. Currently, the state has separate cascading rules for individual customers versus business customers. If the location cannot be determined under the existing rules, the state allows a method of reasonable approximation to determine where the benefit is received. Under the prior regulations, sourcing of revenue from professional and asset management services was not specifically enumerated.
In general, California continues to use the standard of sourcing non-tangible property based on where the benefit is received and has added additional presumptions for specific services. The location of the benefit is where the taxpayer’s customer directly or indirectly received value from the delivery of the service. For example, if a service relates to real property, the presumption is that it is sourced to the location of the real property. For services related to tangible personal property, the benefit is received where the property is delivered, regardless of where the service is performed. For intangible property, the presumption is to source the revenue where the intangible property is used. With each of the standard presumptions, both the taxpayer and the FTB can overcome the general sourcing presumptions by a thorough analysis of the taxpayer’s contracts or normal course of business.
For bundled transactions that contain both tangible property and a service, if the value of each is not readily available, to source the revenue, consider the underlying purpose of the transaction. If the purpose is to purchase the tangible property and the service is an add-on for the property, it would be sourced using the tangible property rules (i.e. where product is delivered).
In the event that the books and records of the business are not able to provide a billing address and the location of the benefit is unknown, the statute provides that the census method can be used. This could be the case for advertising or internet service revenue or with government contracts. In the 2020 U.S. Census, the updated California population ratio was 11.95%.
Professional Services
The first area of change is in the sourcing of professional services. Previously, there were no special rules, and they were sourced to the location where the benefit was received. The new statute provides specific definitions for types of services considered to be professional such as management services, tax, payroll and accounting, audit and attestation services, actuary, business and technical consulting, and investment advisory services (other than asset management services). If a taxpayer provides services in more than one of the listed in the definition, each revenue stream must be tracked separately. If any service line has more than 250 customers, the billing address of the customer is used for sourcing revenue. The exception to this rule is when a single customer accounts for more than 5% of the taxpayer’s total receipts.
If a taxpayer provides multiple service lines, each revenue stream should be broken out to determine whether the 250-customer threshold is met. If there are multiple streams and one type of service exceeds the threshold and the other type does not, according to the statute, each one must be sourced using separate methods. For the revenue that is from the service that does not exceed 250 customers, revenue is sourced based on the standard presumptions of where the benefit is received. Several new examples replace old examples and demonstrate how the new method should be implemented.
Asset Management Services
Another area with significant changes is in both the definition and direction for asset management services which are considered the direct or indirect provision of management, distribution or administration of investment vehicles or funds.
As defined, a beneficial owner is simply an investor who made the investment in a fund but was not required to do so by contract. Examples of types of investors who would not be considered beneficial owners are master funds or feeder funds that pool investors’ assets, shareholder in a publicly traded corporation that invested in assets, or a participant in a defined benefit plan. The excluded types of owners are either obligated under contract to make specific investments or did not actually make the decision to invest.
Under the new statute, revenue should be sourced to the location of either the investor or the beneficial owner. For each type, revenue should be sourced to the billing address unless the asset manager has additional information for different a primary residence or place of business. To calculate the amount of sales sourced to California, add the beginning and ending value of the average value of interest in the assets held by investors/beneficial owners and divide by 2. If the average value of interest is not known, a reasonable estimate is allowed. A new filing requirement may be required if an asset management company is located outside of California and has an in-state average value of assets that is greater than the current year bright line nexus standard ($735,019 in 2024).
For securities dealers, the gains associated with the sale of marketable securities to customers is updated to indicate an individual customer’s address at the end of the year is used to determine thesourcing. For a business entity, the rules remain the same and are based on the customer’s business domicile. If that information is unknown, reasonable approximation can be used.
Intangible Property
One final area of change updated in the statute is the sourcing of intangible property. The general method of sourcing revenue to the location where the intangible property is used remains the same. Such location depends on where the intangible is employed by the taxpayer’s customer or the licensee. Under California statute, there are three types of intangible properties – marketing, non-marketing and manufacturing intangibles, and mixed. The definitions of the three types of intangibles didn’t change, but the sourcing method was clarified.
Clarifications in the statute were made to assist in identifying where “use” occurs. For transactions involving the sale of intangibles that involve the complete transfer of property rights, the current rule specifies that the sale is sourced to the state where the asset is used at the time of sale. Under the new sourcing rules, the transaction is sourced to the location where the buyer intends to use the intangible asset.
Another area of intangible asset sales relates to the sale of shares of stock in a corporation or ownership in a pass-through entity. The current sourcing method is determined by the value of the underlying assets sold in the transaction. Depending on whether more than 50% of the underlying value in the business sold is either tangible versus intangible property, the amounts are sourced to using a ratio of average California property and payroll or sales factor, respectively.
The presumption for the rules remains the same but the statute added alternative methods if the underlying data (property/payroll or sales or the value of the assets) are not available. Under the new cascading rules, the following chart shows the methods.
| Information Not Available | Method to Use |
|---|---|
| Whether more than 50% assets sold was Tangible Property of Intangible Property |
Average Property and Payroll Factor |
| No access to property and payroll data |
Sales Factor |
| No access to sales data | Average Property and Payroll Factor |
| No access to property, payroll or sales data |
Sourced to Seller’s Commercial Domicile |
Considerations
- Professional service providers that provide services to California customers are affected by the new rules. Evaluate multiple service lines to separate distinct services lines and determine if any customers have greater than 5% of the total revenue.
- For asset management services located outside of California, the new look-through method to assign average value of interest to in-state investors, may create economic nexus in California.
- The clarifications to the rules provide more defined guidance for taxpayers to use normal business practices to determine reasonable approximation when sourcing non-tangible property sales.
- Rules will go into effect beginning January 1, 2026 so now is the time to plan for estimates due beginning on March 15, 2026.
Author: Penny Sweeting, CPA | [email protected]
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