California adopts final amendments to its market-based sourcing regulation

After many rounds of proposed changes, comments and discussions, the California Franchise Tax Board (FTB) has adopted amendments to the California Code of Regulations, title 18, section 25136-2, related to its market-based sourcing rules (the Regulations). The Regulations are effective Oct. 1, 2025, and applicable to tax years beginning on or after Jan. 1, 2026.

Specifically, on Aug. 27, 2025, the California Office of Administrative Law approved the FTB’s amendments to the Regulations with a formal announcement from the FTB on Sept. 10, 2025. The final Regulations can be found here.

The Regulations update rules and provide clarification for sourcing sales of services and intangibles, with new changes for professional and financial service providers, as described below.

Assignments of sales of services

The Regulations state that sales from services are assigned to California to the extent the customer of the taxpayer receives the benefit of the service in California. The Regulations include presumptions as to the location of the benefit of the service in California as follows:

• Services that relate to real property located in California should be sourced to California.
• Services that relate to tangible personal property (TPP) located in the state should be sourced to the location of the TPP when services were received. If the TPP is directly or indirectly delivered to the customer after the service is performed, then the services are sourced to the location of the delivery.
• Services that relate to intangible property should be sourced to the location where the intangible property is used by the customer.
• Services that relate to individuals that are physically present in the state should be sourced to the location of the individual at the time the service is performed.

The Regulations provide that the FTB or the taxpayer may overcome the above presumptions by showing, based on a preponderance of the evidence, that the benefit of the service is received at a location other than the determination above, starting first with the information in the taxpayer’s contracts or books and records kept in the normal course of business.

The Regulations go on to provide a hierarchy or waterfall approach to determining the benefit of the service location if the books and records do not substantiate the location including:

• All other sources of information may be used to substantiate the location of the benefit.
• If the books and records and all other sources are not determinative, the location where the benefit of the service is received shall be reasonably approximated.
• Next, the determination would be based on the customer’s billing address as indicated in the taxpayer's books and records.

Notably, the Regulations clarify guidance for services provided under government contracts, if the location of the benefit of the service cannot be determined from the guidance above notwithstanding billing address, or in instances when a contract cannot be disclosed. In those instances, the benefit of the service is deemed received by the fifty states of the U.S. The receipt shall be assigned based on the ratio of California population over U.S. population per the most recent U.S. census data.

In order to assist taxpayers in their analysis and understanding of the sourcing rules, the Regulations removed, revised and replaced examples specific to the determination of where the benefit of the service is received based on the guidance above (e.g. Example 8 related to government contracts).

Large volume professional service providers

The Regulations include guidance for large volume professional service providers. Specifically, the Regulations provide that if the taxpayer provides services to more than 250 customers in any single professional service, then gross receipts from such services should be assigned to the customer’s billing address. However, if more than 5% of its receipts from sales of that service are derived from a single customer, then receipts from that customer do not fall under this rule.

Professional services is defined in the Regulations as, “management services, tax services, payroll and accounting services, audit and attest services, actuary services, legal services, business advisory consulting services, technology consulting services, services related to brokering securities that generate commission income, investment advisory services other than asset management services as defined in this regulation, and services related to the underwriting of debt or equity securities.”

Asset management services

The Regulations provide that when receipts are from asset management services that are not subject to Cal. Code Regs. Title 18, Section 25137-14, “the benefit of the asset management services is received at the domiciles of the investors in the assets unless the investor is holding title to the assets for a beneficial owner.” In that case, the benefit of the asset management services is the domicile of the beneficial owner of the assets. A “beneficial owner” for this purpose is further defined.

The domicile of an investor is presumed to be the investor’s billing address indicated in the records of the taxpayer, unless the taxpayer has actual knowledge that the investor’s principal place of business is different than the billing address. Further, the domicile of a beneficial owner of assets managed by an asset manager is presumed to be the beneficial owner’s billing address, unless the entity or asset manager has actual knowledge that the beneficial owner’s primary residence or principal place of business is different than the billing address.

The Regulations state the location of the receipt of the benefit of the service is determined as follows:

1. Receipts from asset management services shall be assigned to California in proportion to the average value of interest in the assets held by the asset’s investors or beneficial owners domiciled in California.
2. 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 California, the receipts shall be assigned to California based on reasonable estimation.

The Regulations provide detailed examples depicting how the guidance related to asset management services is applied.

Mixed sales of services and tangible or intangible property

When a sale is from the provision of a service and tangible or intangible property, or from provision of tangible and intangible property, if the value of each portion of the sale is determinable, then the respective values should be separately assigned. If not, then the principal purpose for the contract will determine how to assign the value.

Marketable securities

The Regulations provide sourcing guidance related to the sales from marketable securities and provide marketable securities are sourced to the location of the customer. The customer is the person without regard to intermediaries, who gains the greatest possession of economic rights in the marketable securities. The Regulations outline further details on the sourcing related to the customer in specific instances.

Complete transfer of intangible property rights

Also included in the Regulations is a clarification related to the complete transfer of all property rights in intangible property. A complete transfer of property rights is defined as “a transfer of all property rights associated with the ownership of intangible property, as distinguished from a licensing of intangible property where the licensor retains some ownership rights in connection with the intangible property licensed to a buyer.” The Regulations state “the location of the use of the intangible property shall be presumed to be in this state to the extent that at the time of the sale the contract between the taxpayer and purchaser, or the taxpayer’s books and records kept in the normal course of business, indicate that the intangible property will be used by the purchaser in this state.” The changes also clarify the rules relating to when the sale of intangible property is the shares of stock in a corporation or the sale of an ownership interest is in a pass-through entity or where the gross receipts from intangible property are derived from dividends or goodwill.

What’s next?

The application of the Regulations is complex and highly dependent on available information, such as a company’s contracts, books and records. Therefore, taxpayers with receipts from services or intangibles in California should consider reviewing the changes in the final Regulations with their tax advisor to understand the impact on the sourcing of its California receipts beginning Jan. 1, 2026, including differences from prior year income tax filings.

If you have any questions, please reach out to your Baker Tilly state tax advisor.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.