California: Draft apportionment rules, action steps for asset managers

California: Draft apportionment rules

Proposed changes to California’s apportionment rules could have a substantial impact on the California filing requirements of asset managers.

Related content

The California Franchise Tax Board (FTB) issued draft regulations—Cal. Code Regs. tit. 18, § 25136-2—with a retroactive effective date of January 1, 2015.

Until the rules are finalized, they have no legal effect. In the meantime, what steps do asset managers need to consider?


Beginning in 2013, California’s single sales factor apportionment and customer-based sourcing for receipts from services became mandatory for most taxpayers. Cal. Rev. & Tax. Code §§ 25128.7 (single sales factor) and 25136(a)(1) (market-based sourcing).

Under the statute, receipts from services are sourced to California “to the extent the purchaser of the service received the benefit of the services” in California. Cal. Rev. & Tax. Code § 25136(a)(1). That phrase is further defined by the existing regulation to mean, “the location where the taxpayer’s customer has either directly or indirectly received value from delivery of that service,” Cal. Rev. & Tax. Code § 25136(b)(1).

A number of other states have adopted customer-based sourcing rules for gross receipts from services. Asset managers, in applying these rules to management fees received from funds, generally have sourced such receipts to the commercial domicile of the fund paying the management fees.

Draft rules in California

The California FTB’s draft rules take a different approach. Specifically, the draft regulations would require an asset manager collecting fees from certain investment accounts, including funds, pension plans and retirement accounts,* to “look-through” to the investors in the accounts or funds to determine where the benefit of the service was received. Under this approach, fees from asset management services generally would be sourced based on the domiciles of the investors in the accounts or funds.

*The draft regulations do not apply to taxpayers that provide services to at least one regulated investment company (RIC). Instead, the rules for sourcing fees of taxpayers that provide management services to a RIC are included in Cal. Code Regs. tit. 18, § 25137-14 (the “-14 regulation”). The -14 regulation provides that fees relating to the provision of management, distribution, or administration services are sourced based on the domicile of the RIC’s shareholders. Additionally, if a taxpayer that provides such services to a RIC also provides asset management services to non-RICs, the fees for those services are sourced to the state of the domicile of the beneficial owners. FTB has suggested that the -14 and -2 regulations would derive similar results; however, there are differences in the two regulations.

Although this “look-through” provision would be effective January 1, 2015, the regulations could be applied retroactively to tax years beginning on or after January 1, 2012, at the election of the taxpayer.

These look-through sourcing rules would also be applied in determining whether an asset manager has economic nexus in California (asset managers with receipts in excess of $519,000 from California sources are deemed to have nexus for the 2015 tax year).

KPMG observation

In light of the approach taken in the draft rules, asset managers need to determine how these rules (if finalized) would apply, given their specific circumstances. Such an analysis might include the following considerations:

  • Would a fund manager, in applying the look-through rule, have enough receipts from California sources to trigger a 2015 California filing responsibility? Note that if fund employees travel into California to attract investors, the taxpayer may have a responsibility to file in California, independent of economic nexus considerations.
  • How would the look-through rule apply to certain fund investors such as pension plans, other funds, or omnibus accounts?
  • What related tax liabilities and filing fees could arise as a result of the requirement to file in California?If the asset manager is a pass-through entity, how would taxes paid to California under these rules affect the state tax liabilities of the asset manager’s partners? Would partners that are residents of other states be entitled to a credit for taxes paid to California?
  • If an asset manager that is a pass-through entity has nexus in California, would the asset manager’s nonresident partners consent to allow the asset manager to file a composite return in California on their behalf? If so, what approvals or other documentation would need to be gathered from the partners?

Asset managers also would need to make certain decisions regarding the application of the draft regulation to their circumstances and take affirmative steps to enable them to comply with the rules. For example:

  • Would an asset manager affected by the look-through rule need to begin to withhold California tax on behalf of its owners (in the case of asset managers that are partnerships or LLCs) or make estimated tax payments (in the case of asset managers that are corporations) or wait until the draft regulations are finalized?
  • Would an asset manager elect to apply the look-through rule retroactively to 2012 and forward?
  • How could an asset manager have timely access to the data necessary to comply with this sourcing rule once finalized?

Comparison to similar approach in other states

Currently, only a couple of other states specifically require this look-through approach in sourcing asset management fees from investment accounts and funds.

**See, e.g., Del. Code Ann. tit. 30, § 1903(b)(7)(b)(1), N.J. Admin Code § 18:7-8.10(e)(1). Note, however, a number of states apply this approach to management fees received from a mutual fund set up as a RIC, see, e.g., Conn. Gen. Stat. § 12-218(f); Minn. Stat. Ann. § 290.191(subd. 5(k)); N.Y. Tax Law § 210-A(5)(d); Tex. Tax Code Ann. § 171.106(b).

Therefore, it is possible that, under the rules of other states, the same fees that are received by asset managers and sourced to California under the draft regulations also could be sourced to such other states.

For example, another customer-based sourcing state may source an asset manager’s fees to an account’s or fund’s state of commercial domicile or state to which the service is delivered (if the state does not apply California’s look-through approach).

Further, that same income also could be sourced by certain other states to the state in which the asset manager is located if the state uses cost-of-performance sourcing. Or, in the case of services provided by a California-based asset manager to an account or fund domiciled in California with investors located outside California, some management fees could end up not being sourced to any state at all.


For more information, contact a tax professional with the Alternative Investment Fund practice of KPMG’s State and Local group:

Doug Bramhall  |+1 (480) 459-3491 |

Abner Chong | +1 (213) 593-6618 |

Mike Deal | +1 (312) 665-1798 |

Julia Flanagan | +1 (212) 954-8139 |

Scot Grierson | +1 (949) 885-5643 |

Scott Salmon | +1 (202) 533-4202 |

Hernan Stigliano | +1 (212) 872-6967 |

Dave Turzewski | +1 (212) 872-5628 |

Lori Wiseman | +1 (214) 840-6041 |

© 2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.

Connect with us


Request for proposal



KPMG's new digital platform

KPMG International has created a state of the art digital platform that enhances your experience, optimized to discover new and related content.