Were goods destined for other states California sales merely because they paused at a California third-party warehouse for temporary transshipment?

Plain-English summary

California Chief Counsel Ruling 2013-03 held that products ultimately destined for other states were not California sales merely because they paused at a California third-party warehouse.

The destination state was known when the original shipment began, the goods were billed to a specific destination division, and they could not be redirected.

The California warehouse only stored the palletized goods temporarily and reshipped them in the same form. That stop remained part of interstate transit.

Distribution change

The supplier sold products to a multistate distributor whose state divisions historically ordered and received products directly.

To reduce logistics costs, the distributor began consolidating orders at an independent California third-party logistics warehouse.

The supplier shipped the combined orders to the California 3PL. The warehouse later forwarded each portion to the ordering division's California or out-of-state distribution center.

Destination was fixed at shipment

Regulatory recordkeeping required the parties to identify purchases and receipts in the ultimate destination states.

The supplier knew the final destination for each product when the initial shipment began and billed each destination division accordingly.

Products assigned to one division were never diverted to another.

Limited California handling

The 3PL held the goods for a redacted average period while managing inventory flow.

Products arrived on pallets and left on pallets. Although items could be shifted between pallets, there was no unpacking, repackaging, accessory installation, repair, or other substantive processing.

Section 25135 destination rule

Section 25135 assigned tangible-property sales to California when property was delivered or shipped to a purchaser within California, subject to the statutory rules.

Prior authority treated the purchaser's destination—not a temporary delivery point—as controlling when goods remained in interstate transit.

By contrast, substantive California activities on the purchaser's behalf could terminate the original shipment and create a California sale.

Why California was only a transit point

FTB found the 3PL's activity no more substantive than temporary storage pending further shipment.

The evidence overcame any presumption arising from physical receipt in California:

• the goods were not used here;
• the final state was predetermined;
• billing tracked that final state;
• there was no diversion; and
• the goods left unchanged.

The sales therefore were assigned to the ultimate destination states.

Throwback limitation

The ruling's cited guidance stated that if the seller was taxable in the destination state, the sale belonged there.

If the seller was not taxable there, California's throwback rule could still assign the sale to California because the goods originated from California.

What this means for you

Distributors and manufacturers

A California consolidation warehouse does not necessarily change destination sourcing when it serves only as a temporary transshipment point.

Supply-chain teams

Preserve purchase orders, destination coding, invoices, no-diversion controls, storage duration, handling records, and proof that goods leave in the same form.

Tax professionals

Analyze both the destination question and the seller's taxability in that state. Winning the temporary-storage issue does not eliminate a possible throwback issue.

Common questions

Q: Did physical receipt at the California 3PL make the sales California sales?

A: No.

Q: What fact was especially important?

A: The ultimate destination was fixed and known at the start of shipment.

Q: Did the warehouse perform substantive processing?

A: No. It temporarily stored and reshipped the goods in the same form.

Q: Could California throwback still apply?

A: Yes, if the seller was not taxable in the ultimate destination state.

Citations and references

• Cal. Rev. & Tax. Code §§ 21012(a)(1) and 25135
• McDonnell Douglas Corp. v. Franchise Tax Bd., 26 Cal. App. 4th 1789 (1994)
• Appeal of Mazda Motors, 94-SBE-009 (Nov. 29, 1994)
• FTB Legal Rulings 95-3 and 348 (withdrawn by 95-3)

Source

• Landing page: California FTB Chief Counsel Rulings
• Official PDF: Chief Counsel Ruling 2013-03

Original ruling text

chair John Chiang | member Jerome E. Horton | member Michael Cohen

Legal Division MS A260
PO Box 1720
Rancho Cordova, CA 95741-1720

tel: (916) 845-3306 fax: (916) 845-3648
ftb.ca.gov

09.25.13
CHIEF COUNSEL RULING 2013-03

FACTS

** * , LLC (**) Y is a single-member LLC owned by *
. *, Inc. X, a wholly owned subsidiary of * * & Co., Inc. () Z. * ** W is the ultimate parent of *** Z, and is a worldwide leader in the and industry. Y produces and *** Z bottles on behalf of Y in the United States. Y is a supplier of and * to US distributors including produced in California, * bottled in the United States and
and * imported from outside the United States.

One of the US * *** distributors to whom Y sells is *
**, Inc. and subsidiaries (*) A. * A operates in numerous states through separate operating divisions. Historically, each of ** A's state operating divisions, including its California divisions, individually placed orders for
and * products from Y. Y then shipped products FOB shipping point via common carrier to the location of each of the **** A operating division distribution centers both in California and outside California.

In an effort to achieve supply chain and logistics efficiencies, * A made a decision to use an independent, third party logistics public warehouse operator (3PL) in California to function as a central trans-shipment facility for storage of product before further shipment to
* A locations across the country, both in and outside of California. Orders for * and by the * A divisions will be shipped by Y to the California 3PL, FOB shipping point via common carrier. Under a service agreement with * A, the California 3PL will then ship those products to warehouse locations of each * A division, either in California or outside California. Overall, this process is designed to allow orders from multiple **** A divisions for the same products to be consolidated, thereby reducing shipping and logistics costs.

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Due to state regulations monitoring the purchase, sale, and movement of * and in the US, both * Y and * A are generally required to record purchases and receipts of * ** in the ultimate destination states. Therefore, * Y knows the ultimate destination (the location of the respective * A division placing the order) of the specific products at the inception of shipping of those products, and tracks and bills each shipment as such. Product which is billed and intended for a specific division of * A at the inception of shipping is never deviated to another division of *** A.

The consolidated orders received at the 3PL are packed and shipped in the same form they were received. Product is received in pallets of ** to ** * per pallet. Product will remain at the 3PL for an average of ** days, depending on the inventory flow at a particular
* A division location, before they are sent to the ultimate state destination warehouse. While the may be moved from one pallet to another, there is no unpacking and/or repackaging of the *** received in the pallets. The product arrives by the *** on pallets and is subsequently shipped by the *** on pallets.

ISSUE

Whether sales of **** and *** ultimately destined for another state but shipped to a third party public warehouse in California for temporary storage pending shipment in the same form as received to the ultimate destination state are considered sales within California pursuant to Revenue and Taxation Code section 25135.

HOLDING

Such sales do not constitute sales within California pursuant to Revenue and Taxation Code section 25135.

DISCUSSION

Revenue and Taxation Code section 25135 provides in pertinent part:

(a) Sales of tangible personal property are in this state if:

(1) The property is delivered or shipped to a purchaser, other than the United States government, within this state regardless of the f.o.b. point or other conditions of the sale.
(2) The property is shipped from an office, store, warehouse, factory, or other place of storage in this state and (A) the purchaser is the United States government or (B) the taxpayer is not taxable in the state of the purchaser.

In McDonnell Douglas Corporation v. Franchise Tax Board (1994) 26 Cal.App.4th 1789, the appellant manufactured commercial and military aircraft and aircraft parts. It owned a facility in Long Beach, California and the majority of its commercial aircraft were delivered to

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customers at that facility or at a facility in Arizona. Customers then arranged for transportation of the aircraft to their ultimate destination. At issue was whether aircraft manufactured for use out of California, but delivered to the purchaser in California constituted California sales as defined by Revenue and Taxation Code section 25135, subdivision (a). The court held that the phrase "within this state" modified the word "purchaser" and therefore, the sales should be apportioned to the state of destination rather than the state of delivery. The court found that including these sales in the California sales factor numerator regardless of the ultimate destination was contrary to the rules adopted by other states and contrary to the purpose of UDITPA.

The Board of Equalization subsequently issued its decision in Appeal of Mazda Motors (1994) 94-SBE-009 on November 29, 1994. In Mazda Motors, the appellant imported vehicles from Japan for sale in the United States to its regional distributors. The vehicles and parts at issue entered the U.S. through two ports of entry in California. Some of the vehicles were transferred directly to Texas via common carrier after being off-loaded from the ships. These sales were not included in the California numerator. However, other vehicles were stored in California while accessories were being installed, repairs were being made or other services were being performed by appellant and which appellant subsequently shipped pursuant to the distributor's directions. The Board of Equalization concluded that the sales of those vehicles were in this state because the activity of appellant on the purchaser's behalf, which included storing and adding accessories to the vehicles, had caused shipment to terminate in this state. The Board of Equalization noted that the activities by the appellant, on behalf of the purchaser, were "much more substantive than mere temporary storage in California for purposes of further shipment elsewhere in the stream of interstate commerce."

Following these two decisions, the Franchise Tax Board issued Legal Ruling 95-3, expressly withdrawing Legal Ruling 348 and stating that the Franchise Tax Board would follow the holding in McDonnell Douglas, supra. Legal Ruling 95-3 includes a number of scenarios. Situation 4 appears to be the most similar to the facts presented here. In this example, the purchaser transports the machinery to State A and then places the machinery with a common carrier in State A and arranges shipment to its own place of business in State B. The Ruling provides:

The purchaser did not have possession of the machinery in California or in State A for purposes other than in the process of shipment. Thus, the purchaser's receipt at its place of business in State B will control the application of Section 25135(a). If the seller is taxable in State B, the sale is a State B sale. If not, the sale is thrown back to California. The seller's taxability in State A is irrelevant.

Legal Ruling 95-3 also provides that while there is a presumption that goods taken into possession by the purchaser in California are presumed to be delivered or shipped to California for purposes of sales factor assignment, that presumption can be overcome by evidence proving that the property was not used in the state and was transported to another state. The taxpayer has met this burden. Borrowing from the language in Mazda Motors,

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supra, the activities of the 3PL are no more substantive than mere temporary storage in California. The **** are stored in California for a limited period of time and are shipped in the same form received to the ultimate destination known at the time of shipment. As such, the goods are not used in this state through activities such as warehousing, repackaging, etc. Moreover, since the ultimate destination is designated by the taxpayer at the time of the initial order and is separately billed to the division in the ultimate state of destination, the temporary storage in this state is merely for purposes of further shipment elsewhere in the stream of interstate commerce. Accordingly, the sales should be apportioned to the state of destination.

Please be advised that the tax consequences expressed in this Chief Counsel Ruling are applicable only to the named taxpayer and are based upon and limited to the facts you have submitted. In the event of a change in relevant legislation, or judicial or administrative case law, a change in federal interpretation of federal law in cases where our opinion is based upon such an interpretation, or a change in the material facts or circumstances relating to your request upon which this opinion is based, this opinion may no longer be applicable. It is your responsibility to be aware of these changes, should they occur.

This letter is a legal ruling by the Franchise Tax Board's Chief Counsel within the meaning of paragraph (1) of subdivision (a) of section 21012 of the Revenue and Taxation Code. Please attach a copy of this letter and your request to the appropriate return(s) (if any) when filed or in response to any notices or inquiries which might be issued.

Very truly yours,

Kathryn Frank
Tax Counsel