Was a nonresident independent director's compensation sourced to California merely because the director attended a company board or shareholder meeting there?

Plain-English summary

California Chief Counsel Ruling 2019-03 held that a nonresident independent director's compensation was not sourced to California merely because the director attended a board or shareholder meeting in California.

Because the directors were represented to be nonemployees, FTB did not apply the employee-compensation sourcing regulation. It applied the market-based service rules instead.

For these corporate-governance services, the benefit was received where the company's highest-ranking officers carried out the board's directions.

Company and board facts

The redacted company was commercially domiciled outside California and managed under the direction of its board.

Most of its directors were independent under the described New York Stock Exchange requirements. The company represented that the independent directors were not employees under state or federal law.

The directors established management and oversight policies, made decisions on major company issues, supervised senior management, reviewed major risks, and served on committees addressing audit, compensation, and other governance matters.

The ruling addressed a nonresident independent director who attended a company board or shareholder meeting in California.

Why the meeting location did not control

California's employee-compensation rule did not apply because the company represented that the independent directors were not employees.

FTB instead used the apportionment and market-based sourcing rules applicable to a nonresident's business or service income.

Under those rules, service receipts were sourced to the place where the customer received the benefit of the service.

Where the company received the benefit

FTB treated an independent director's service as distinct from consulting. The board did not merely recommend actions; acting collectively, it authorized and directed management to act.

The value therefore did not arise where the board met and made its decisions. It arose where the company's highest-ranking officers executed the board's directions.

That officer-execution location controlled the sourcing result on the submitted facts.

What this means for you

Nonresident independent directors

Physical attendance at a California board or shareholder meeting was not enough, by itself, to source the compensation to California under this ruling.

Corporate tax departments

Confirm whether a director is an employee or an independent service provider before choosing a sourcing rule. For a nonemployee director under these facts, document where the senior officers carried out the board's directions.

Tax professionals

Do not assume the meeting location or the director's work location is automatically the benefit location. The ruling focused on where the company implemented the board's governance decisions.

Common questions

Q: Did attending a California board meeting make the director's fees California-source income?

A: No, not merely because the meeting occurred in California.

Q: What location controlled instead?

A: The place where the company's highest-ranking officers carried out the board's directions.

Q: Why did FTB not use the employee-compensation rule?

A: The company represented that its independent directors were not employees under state or federal law.

Q: Did FTB treat board service like ordinary consulting?

A: No. It described independent directors as a distinct class of service providers because the board authorizes and directs management rather than merely recommending possible actions.

Q: Could the answer change for an employee-director?

A: The ruling did not decide that situation. Its analysis expressly depended on the directors being nonemployees.

Citations and references

• Cal. Rev. & Tax. Code §§ 17041(i)(1), 17951, 25120-25139, 25136(a)(1), and 21012(a)(1)
• Cal. Code Regs., tit. 18, §§ 17951-2, 17951-4, 17951-5, and 25136-2(b)(1)
• NYSE Rule 303A.02

Source

• Landing page: California FTB Chief Counsel Rulings
• Official PDF: Chief Counsel Ruling 2019-03

Original ruling text

STATE OF CALIFORNIA
FRANCHISE TAX BOARD
chair Betty T. Yee| member Malia M. Cohen| member Keely Bosler

Legal Division MS A260
PO Box 1720
Rancho Cordova, CA 95741-1720
tel: 916.845.6729 fax: 916.843.6162

10.07.2019

Chief Counsel Ruling 2019-03

RE: Chief Counsel Ruling Request for the Independent Directors of ****** Co.

Dear *,

This letter is in response to your request for guidance with respect to the sourcing of income paid by ****** Co. to its independent directors for California tax purposes.

FACTS

*** Co., a corporation (the "Company"), represents that it is commercially domiciled outside of California, in the State of ***.

The business of the Company is managed under the direction of its Board of Directors. Pursuant to the requirements of the New York Stock Exchange (NYSE), of which the Company is a member, a majority of the members of the Board of Directors must be independent, as defined by the NYSE rules. NYSE Rule 303A.02 provides, in pertinent part:

(b) In addition, a director is not independent if:
(i) The director is, or has been within the last three years, an employee of the listed company, or an immediate family member is, or has been within the last three years, an executive officer, of the listed company.

(ii) The director has received, or has an immediate family member who has received, during any twelve-month period within the last three years, more than $120,000 in direct compensation from the listed company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service).

* of the Company's *** directors are independent directors. The Company represents that its independent directors, sometimes referred to as nonemployee directors or outside directors, are not employees under state or federal law.

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Chief Counsel Ruling

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Directors are primarily elected to represent shareholders, but also govern a company with all stakeholders in mind. A board's obligation is to establish policies for corporate management and oversight; making decisions on major company issues and providing oversight of the highest levels of management. The Company has attendance guidelines for the directors which require a certain level of participation in both board of directors and shareholder meetings, which are conducted both within and without *.

ISSUE

Whether compensation paid to an independent director, who is a nonresident of California, is sourced to California if the Company holds a shareholder meeting or board of directors meeting in California which the director attends?

HOLDING

No. The fees or other compensation received from the Company by the independent director of the Company for services performed in California will be sourced to where the highest-ranking corporate officers carry out the Board's directions.

DISCUSSION

California Revenue and Taxation Code ("CRTC") section 17951 specifies:

(a) For purposes of computing “taxable income of a nonresident or part-year resident” under paragraph (1) of subdivision (i) of Section 17041, in the case of nonresident taxpayers the gross income includes only the gross income from sources within this state.

California Code of Regulations, title 18, section ("Regulation section") 17951-2 provides that income from sources within California includes income from a trade, business or profession and income from personal services performed in California. 1

However, Regulation section 17951-5 only sources compensation of employees. In this case, the Company has represented the directors are not employees under state or federal law.

Therefore, the appropriate California regulation to apply is Regulation section 17951-4. The amount of income of a nonresident independent director derived from California sources shall be determined in accordance with the provisions of the apportionment rules of the Uniform Division of Income for Tax Purposes Act (UDIPTA), sections 25120 to 25139, inclusive. Specifically, the source of income is determined by applying these market-based sourcing rules. 2

1 See Regulation sections 17951-4 and 17951-5.
2 Regulation sections 25136-2. (See also Regulation section 17951-4(c)(2).)

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Chief Counsel Ruling

Page 3 of 3

CRTC section 25136 states, in pertinent part:

(a)(1) Sales from services are in this state to the extent the purchaser of the service received the benefit of the services in this state.

The benefit of a service is received in the location where taxpayer's customer has either directly or indirectly received value from delivery of that service. 3

Here, the independent director is providing a service to the Company and its shareholders that is unique – to act, with the other directors, to govern the Company. One role of the Board of Directors is to oversee management's assessments of major risk factors facing the Company and review options to mitigate such risks. Directors also serve on Board committees which require their independence to meet best practices and NYSE requirements with respect to audit policies, compensation practices and other corporate governance requirements.

The benefit of that service is received where the Company received value from the delivery of that service. 4 The value of an independent director's services does not derive from the place from which the Board of Directors confers and makes decisions, but rather from that place the decisions and actions of the Board detailed above are executed. Unlike consulting or similar services, these services do not merely recommend actions that may be taken by management. Independent directors are in a very distinct class of service-providers. The Board of Directors, acting as a body, gives authority to and directs management to take action. Since these services go to the core of the governance of the Company and the implementation of any such decisions are taken by the highest echelons of management, the location of that benefit is the place where the highest-ranking corporate officers carry out these directions.

Please be advised that the tax consequences expressed in this Chief Counsel Ruling are applicable only to the named taxpayers 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 CRTC. 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,

Natasha S. Page
Tax Counsel IV

3 Regulation section 25136-2(b)(1).
4 Regulation section 25136-2(b)(1).