'Doing business' in California: substantial economic presence nexus and the 'throwback' rule.

• Author: Lim, Linda

In Technical Advice Memorandum (TAM) 2012-01 (11/29/12), the legal staff of the California Franchise Tax Board (FTB) answered a question from the FTB audit staff regarding whether a taxpayer is subject to taxation in another state for purposes of Cal. Rev. & Tax. Code Section 25122 when the taxpayer's only contact with that state was more than $500,000 in sales of tangible personal property for tax years beginning before Jan. 1, 2011. Pursuant to Cal. Rev. & Tax. Code Section 25120(g), the term "state" means any state of the United States, the District of Columbia, the Commonwealth of Puerto Rico, any territory or possession of the United States, and any foreign country or political subdivision thereof. This TAM raises a number of interesting issues related to California's new definition of "doing business" and its impact on taxpayers engaging in foreign commerce.

The Holding

The TAM holds that for tax years starting before Jan. 1, 2011, physical presence in a state is necessary to subject a corporation to taxation. Such physical presence can be manifested by the presence of employees, agents, or contractors, or by having an office or other types of activity or property being used in the business within a state. Being subject to taxation permits a corporation to avoid having to assign sales of property on the basis of where the shipment of the property originates if such property is destined for states where the taxpayer is not taxable, commonly referred to as the "throwback" rule.

Analysis of the Holding

This TAM solely addresses the sale of tangible personal property. Therefore, it is important to note that the activity of soliciting for sale of tangible personal property in the context of interstate commerce remains protected under the Interstate Income Tax Act of 1959, P.L. 86-272. However, in the TAM, the FTB noted that limitations under P.L. 86-272 do not apply to sales to and from foreign jurisdictions or sales of other than tangible personal property. Accordingly, the TAM appears to have been issued in response to questions specifically directed at sales of tangible property in foreign commerce. The question most likely raised by taxpayers is with respect to the newly expanded definition of "doing business" set forth in Cal. Rev. & Tax Code Section 23101--specifically, the $500,000 rule and its application in foreign commerce. Basically, the TAM holds that the $500,000 threshold test is applicable for tax years starting Jan. 1...