Today I want to talk about California income taxation of an out of state outsourcing service company that performs all its services from its non-California office for a California service provider. Let’s say that you are an Omaha, Nebraska based company that provides IT services to a Los Angeles medical insurance claims processing company.
You provide all your services from your Omaha office. Your customer performs all its medical insurance claims processing services from Los Angeles, for insurance companies located throughout the United States.
It is a large contract for you, earning annual fees of $20,000,000. You understand that California sources these fees based upon a single sales factor apportionment formula. That means that California taxes all this revenue even though you performed the services in Omaha, if the services were provided to a California market.
You shake your head and think sourcing it to high tax rate California is a no brainer. Your customer is a California business. California is where it processes the insurance claims. All your customer’s employees work is performed in California.
But then you say: wait a minute. What about the fact that your customer is processing claims mostly for medical insurance companies that are located outside of California. Would that change the outcome and shift some or all the state income taxation to lower tax rate states?
Unfortunately, the answer is probably no. The California Franchise Tax Board would probably say that the Omaha company’s market is in California where its customer is located. The Chief Counsel’s Office of the California Franchise Tax Board recently gave this answer in a written ruling to an out of state taxpayer, in a similar situation.
I will simplify the facts of the ruling for illustration. There, a taxpayer performed administrative and management support or outsourcing services from its out of state offices to a health plan company located in California. The health plan company performed all its work in California. Its health plan members were located throughout the country.
The ruling said that the market where the taxpayer provided the administrative and management services for the health plan company, is located where the benefit of the services is received by the health plan. And the benefit of taxpayer’s services was received by the health plan company in California.
So, the market for the ruling’s taxpayer’s services is California, the principal location of the health plan company, and not the location of health plan company’s members.
The California ruling is Chief Counsel Ruling 2017-01, California Franchise Tax Board, April 7, 2017, and can be found at: https://www.ftb.ca.gov/law/ccr/2017/01.pdf
Comment. The Chief Counsel Ruling only applies to the taxpayer that requested the ruling. However, it certainly represents the current thinking of California on this issue.
By John McCauley: I help people buy and sell businesses.
Email: jmccauley@mk-law.com
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