Did California's historical double-weighted sales formula change the test for water's-edge group membership or the former water's-edge election fee?

Plain-English summary

Legal Ruling 1995-5 kept three calculations separate:

1. Water's-edge group membership under section 25110.

2. California apportionment of the completed group's business income under section 25128.

3. The former water's-edge election fee under repealed section 25115.

Double weighting the sales factor changed only the second calculation. It did not change the simple-average membership threshold or the sales amount used in the former fee.

The hypothetical corporation

Corporation A was incorporated in California, commercially domiciled in Puerto Rico, and had made a federal section 936 election. It maintained a small Florida sales office and some California inventory.

Its United States factors were:

• Property: 5%.

• Payroll: 5%.

• Sales: 40%.

Its California facts included $50x of inventory, $0.5x annual warehouse rent, and $100x of sales to California customers.

Group-membership test

Section 25110(a)(3) included a corporation in the water's-edge group when the simple average of its U.S. property, payroll, and sales factors was at least 20%.

For Corporation A:

(5% property + 5% payroll + 40% sales) ÷ 3 = 16.67%.

That result was below 20%. Corporation A therefore was not included as a full group member under paragraph (a)(3); the ruling included only its U.S.-source income and U.S. factors under paragraph (a)(5).

The later double weighting of sales in the apportionment formula did not convert the simple average into a weighted average.

Apportionment came afterward

After determining which entities belonged in the group, section 25128 apportioned the group's business income using property plus payroll plus twice sales, divided by four.

The sales factor itself—California sales over everywhere sales—did not change. Only its relative weight in this separate formula changed.

Former election fee

Former section 25115 calculated the historical election fee using California property, payroll, and the numerator of the California sales factor. A discrete sales amount did not become larger merely because the sales factor received twice the weight in the income-apportionment formula.

The ruling calculated Corporation A's fee as the greater of:

• 0.03% of $100x California sales = $0.03x.

• 0.01% of $100x sales + $50x inventory + $4x capitalized warehouse rent = $0.0154x.

The resulting historical fee was $0.03x.

Repealed-fee warning

The ruling expressly states that section 25115 had been repealed and that the fee applied only to income years beginning before January 1, 1994. The fee calculation is preserved for historical research, not current compliance.

What this means for you

Water's-edge group analysis

Apply the membership rule as written before using the apportionment formula. A weight assigned in one statutory calculation does not automatically carry into another.

Tax professionals reviewing historical years

Separate factor percentages from factor weights and from raw numerator amounts. The ruling's outcome depended on keeping those concepts distinct.

Current returns

Do not use the former election-fee computation as a present obligation. Research current California water's-edge election requirements and apportionment formulas.

Common questions

Q: Was the 20% group threshold computed with double-weighted sales?

A: No. It used the simple average of property, payroll, and sales.

Q: What was Corporation A's simple average?

A: 16.67%, below the 20% threshold.

Q: Did double weighting change the former election fee?

A: No. The fee used the California sales-factor numerator, not a weighted factor.

Q: Where did double weighting apply?

A: In the separate formula apportioning the completed group's business income to California.

Q: Is the election fee current?

A: No. The ruling says the fee provision was repealed and applied only before 1994.

Citations and references

• Cal. Rev. & Tax. Code §§ 25110(a)(3), (5), 25115, 25128, and 25134
• Cal. Code Regs., tit. 18, §§ 25115(c)(3) and 25130(b)(1)
• I.R.C. § 936
• 1993 SB 1176, Stats. 1993, ch. 946

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 1995-5

Original ruling text

Home

Legal ruling 1995-5

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division
PO Box 1468
Rancho Cordova CA 95812-1468

916 845 3309

FAX: 916 845 3648

Kathleen Connell, Chair
Dean Andal, Member
B. Timothy Gage, Member

October 13, 1995

Control Number: 410:CKL: DL-95-0184

Effect of the Double Weighted Sales Factor on Water’s Edge Group Entities and Election Fees

Issue

Do amendments to Revenue & Taxation Code (RTC) section 25128, which generally provide for double weighting the sales factor for most corporations, affect the determination of entities to be included in a water's-edge group, or the calculation of the former water's-edge election fee?

Facts

Corporation A was incorporated in California in 1992 and made a water's-edge election for that income year. It is commercially domiciled in Puerto Rico and has made an election under § 936 of the Internal Revenue Code. It operates a small sales office in Florida. Its United States payroll and property are each 5% of its total payroll and property; its United States sales to unaffiliated parties are 40% of its total sales. Corporation A maintains a $50x stock of inventory in California which, together with the annual rental expense of $0.5x on the warehouse where it is stored, amounts to 4% of its property in the United States. Its sales of $100x to California customers represent 10% of its total United States sales.

Law and Analysis

Section 25128 specifies the apportionment formula to be used by corporations doing business within and without California. That section was amended, effective for income years beginning on or after 1/1/93, to provide for double weighting of the sales factor in that formula (except for certain corporations conducting extractive, agricultural, savings and loan or banking or financial business activities). (Stats. 1993, ch. 946.) Section 25110 enumerates the entities included in a water's-edge electing group. Paragraph (a)(3) of that section provides that a corporation, wherever incorporated, is included if the average of its payroll, property and sales factors in the United States is 20% or more.

Questions have arisen as to whether the double weighting of the sales factor in the apportionment formula affects (1) the calculation of the threshold level of activities for inclusion of an entity within the water's-edge group under RTC § 25110 (a)(3) and (2) the fee formerly prescribed in RTC § 25115 which is based upon California payroll, property and sales. For the following reasons neither RTC § 25110 nor RTC § 25115 is affected by the amendment to RTC § 25128. Section 25115 is now repealed, but was operative for income years beginning prior to January 1, 1994.

1. Calculation of Threshold Level of Activity Under RTC § 25110(a)(3)

Section 25110, which specifies the entities to be included in the water's edge group, provides in pertinent part:

(a) Notwithstanding Section 25101, a qualified taxpayer. . . may elect, subject to the provisions of Section 25111, to account for and determine its income derived from or attributable to sources within this state pursuant to a water's-edge election in accordance with the provisions of this part, as modified by this article. A taxpayer which makes that water's-edge election shall take into account the income and apportionment factors of the following affiliated entities only:

. . .(3) Any corporation, regardless of the place where it is incorporated if the average of its property, payroll, and sales factors within the United States is 20 percent or more.

. . .(5) A bank or corporation which is not described in paragraphs (1) to (4), inclusive, or paragraph (6), but only to the extent of its income derived from or attributable to sources within the United States and its factors assignable to a location within the United States in accordance with paragraph (3) of subdivision (b). Income of such a bank or corporation derived from or attributable to sources within the United States as determined by federal income tax laws shall be limited to and determined from the books of account maintained by the bank or corporation with respect to its activities conducted within the United States.

Thus, paragraph (a)(3) of RTC § 25110 provides for the inclusion of an entity within the water's edge group based upon its presence within the United States as measured by the simple average of its property, payroll and sales factors.

After the determination is made as to which entities are to be included in the group, RTC § 25128 provides the formula by which the business income of the group is assigned to California. As amended by SB 1176 (Stats. 1993, ch. 946), RTC § 25128 provides that:

. . . [a]ll business income shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus twice the sales factor, and the denominator of which is four. . .

The sales factor is defined in RTC § 25134 as:

. . . [a] fraction, the numerator of which is the total sales of the taxpayer in this state during the income year, and the denominator of which is the total sales of the taxpayer everywhere during the income year.

The fraction resulting from the calculation of the sales factor is either single or double weighted depending on the context of its use. The factor itself remains unchanged. Both RTC § 25110 and RTC § 25128 measure corporate activity within a jurisdiction by reference to the sales, property and payroll factors, however the relative weight of the factors is specifically and differently provided for by the two statutes.

Once the composition of the water's-edge group is determined pursuant to RTC

§ 25110 its business income is independently apportioned pursuant to RTC § 25128. Therefore, the recent amendment of RTC § 25128 has no effect upon the determination of the members of a water's-edge group or the group's income subject to apportionment.

Under the facts as given above, Corporation A would be included in the water's-edge group only to the extent of its United States source income and factors. (Section 25110(a)(5).) The average of its payroll, property and sales in the United States is 16.67% (5% property, plus 5% payroll, plus 40% sales divided by 3 equals 16.67%), well under the 20% threshold for membership in the group.

2. Calculation of Water’s-edge Election Fee Under Former RTC § 25115

Section 25115(b) provided that a taxpayer making a water's edge election shall pay an amount

. . . equal to thirty-thousandths of 1 percent of the sum of the taxpayer’s property and payroll assigned to this state for an income year of 12 full months ending during the calendar year 1986 and its sales assigned to this state for the current income year . . .

Section 25115(i) provided that

In no event shall the amount determined pursuant to this section be less than ten-thousandths of 1 percent of the sum of the taxpayer’s property, payroll, and sales in this state for the current year.

California Code of Regulations, title 18, section 25115 (c)(3), defines sales for purposes of calculating the fee as:

. . . the total sales of the taxpayer included in the numerator of the sales factor calculated for California for the base year . . .

Because the fee was calculated with reference to the numerator of the sales factor, the same reasoning set forth above with respect to the effect of double weighting the sales factor in the apportionment formula on the calculation of the members of the water's-edge group applies. The numerator of the sales factor is a discrete number, unaffected by any use to which the sales factor is put or any weight that it is given. Thus the amendment of RTC § 25128 has no effect on the calculation of the water's edge election fee.

Under the facts as given above, because it has no 1986 property or payroll, Corporation A's election fee, is the greater of .03% of its current California sales of $100x (.03% x 100x = $.03x) or .01% of the sum of its current California sales and property ($100x plus $50x plus $4x (rental of warehouse times 8, 18 Cal. Code of Regs. § 25130(b)(1)), or $ .0154x). Its fee would therefore be $.03x.

Holding

Inclusion of an entity in a water's edge group under RTC § 25110(a)(3) is based upon the simple average of the payroll, property and sales factors. The calculation of the water's election fee is based in part on the numerator of the sales factor. Neither of these calculations is affected by amendments to RTC § 25128 providing for an apportionment formula which double weights the sales factor.

Drafting Information

The principal author of this legal ruling is Claudia Land of the Franchise Tax Board Legal Branch. For further information regarding this legal ruling, contact Ms. Land at the Manhattan District Office, 1212 Avenue of the Americas, 4th Floor, New York, NY 10036-1601, 212-575-5959.

Last updated: 09/24/2025