Were substantial receipts from an incidental or occasional sale of a business intangible included in California's sales factor?

Plain-English summary

Legal Ruling 1997-1 excluded substantial receipts from an incidental or occasional sale of intangible property held or used in a taxpayer's regular business from California's sales factor.

The ruling used the same distortion rationale already stated in the regulation for an occasional sale of a fixed asset such as a factory or plant. A one-time recognition of years of built-in value could overwhelm the sales factor for that year and fail to represent the taxpayer's day-to-day business activity.

FTB found no logical reason to treat a business intangible differently. The ruling's examples were a patent used in the business and affiliate stock whose sale produced business income.

The hypothetical sale

The taxpayer sold an intangible asset and generated substantial gross receipts. The asset could be a patent used in the trade or business or stock of an affiliate.

The taxpayer performed income-producing activity and incurred costs of performance connected with the sale. That fact distinguished the ruling's main analysis from a separate regulatory rule for receipts where no income-producing activity or cost of performance existed.

Why ordinary inclusion distorted the factor

Revenue and Taxation Code section 25134 defined the sales factor as California sales over total sales everywhere. Section 25120(e) broadly defined sales as gross receipts not separately allocated.

Regulation 25137(c)(1)(A), however, excluded substantial receipts from an incidental or occasional sale of a fixed asset used in the regular business. The exclusion recognized that a large one-time sale did not reflect ordinary operating activity and could assign excessive income to the state where the sale occurred.

The concern was strongest when the asset's appreciation accumulated over several years but the entire gross receipt appeared in one apportionment year.

Applying the rule to intangibles

FTB extended the fixed-asset rationale to intangible property under Revenue and Taxation Code section 25137.

The ruling required three features:

• The sale was incidental or occasional.

• The receipts were substantial.

• The intangible was held or used in the regular course of the taxpayer's trade or business.

When those features were present, the receipts were excluded from both the numerator and denominator of the sales factor.

Separate no-activity rule

The ruling also noted that if the taxpayer performed no income-producing activity and had no cost of performance for the intangible sale, regulation 25137(c)(1)(C) independently excluded the receipt from both the numerator and denominator.

That was not the basis of the main holding because the hypothetical taxpayer did have sale-related activity and costs.

What this means for you

Businesses selling a major intangible

Do not assume a large gross receipt belongs in the sales factor simply because the asset produced business income. Analyze whether the transaction was part of recurring operations or an incidental, occasional disposition.

Tax departments

Document the asset's business use, sale frequency, gross-receipt magnitude, appreciation period, and effect on the factor. The exclusion was aimed at distortion, not every intangible sale.

Accountants and tax professionals

Keep income characterization separate from factor treatment. The ruling's affiliate-stock example could produce business income while its substantial occasional gross receipts were still excluded from the sales factor.

Common questions

Q: Were all receipts from intangible sales excluded?

A: No. The ruling addressed substantial receipts from incidental or occasional sales of intangibles held or used in the regular business.

Q: Did the ruling cover patents?

A: Yes. A patent used in the taxpayer's business was one stated example.

Q: Did it cover affiliate stock?

A: Yes, where the stock sale generated business income and met the substantial occasional-sale facts.

Q: Why exclude the gross receipts?

A: A large one-time receipt could distort the factor and fail to represent day-to-day business activity, especially when value accumulated over years.

Q: What if no income-producing activity occurred for the sale?

A: The ruling says regulation 25137(c)(1)(C) separately excluded that receipt from both numerator and denominator.

Citations and references

• Cal. Rev. & Tax. Code §§ 25120(e), 25134, and 25137
• Cal. Code Regs., tit. 18, § 25137(c)(1)(A), (C)

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 1997-1

Original ruling text

Home

Legal ruling 1997-1

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division
PO Box 1720
Rancho Cordova CA 95741-1720

916 845 3309

FAX: 916 845 3648

Kathleen Connell, Chair
Ernest J. Dronenburg, JR., Member
Craign L. Brown, Member

October 15, 1997

Control Number: 410:RDB:CL-92-991

Exclusion of Gross Receipts from Incidental or Occasional Sales of Intangible Property from the Sales Factor

Issue

If substantial amounts of gross receipts arise from an incidental or occasional sale of intangible property which is held or used in the regular course of a taxpayer’s trade or business, should such gross receipts be excluded from the sales factor?

Facts

A taxpayer sells an intangible asset, generating substantial amounts of gross receipts. Such asset, for example, may be a patent used in the taxpayer’s trade or business or stock of an affiliate whose sale creates business income. The taxpayer engages in income producing activity and has costs of performance in connection with the sale.

Law and Analysis

Revenue and Taxation Code (R&TC) § 25134 states:

The sales factor is 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.

R&TC § 25120 states, in pertinent part:

(e) "Sales" means all gross receipts of the taxpayer not allocated under Sections 25123 through 25127 of this code.

R&TC § 25137 states:

If the allocation and apportionment provisions of this act do not fairly represent the extent of the taxpayer’s business activity in this state, the taxpayer may petition for or the Franchise Tax Board may require, in respect to all or any part of the taxpayer’s business activity, if reasonable:

(a) Separate accounting;
(b) Exclusion of any one or more of the factors;
(c) The inclusion of one or more of additional factors which will fairly represent the taxpayer’s business activity in this state; or
(d) The employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer’s income.

Title 18, California Code of Regulations (CCR) § 25137(c)(1)(A) states:

Where substantial amounts of gross receipts arise from an incidental or occasional sale of a fixed asset used in the regular course of the taxpayer’s trade or business, such gross receipts shall be excluded from the sales factor. For example, gross receipts from the sale of a factory or plant will be excluded.

The exclusion from the sales factor pursuant to 18 CCR § 25137(c)(1)(A) of substantial amounts of gross receipts from an incidental or occasional sale of a fixed asset is based on the rationale that such gross receipts do not fairly reflect the taxpayer’s day-to-day business activity and therefore cause excessive income to be apportioned to the state where the occasional sale took place. This is especially so if the growth of built-in appreciation occurs over a substantial period of time, because taking the gross receipts into account in the year of a recognition event does not reflect the gradual effects of appreciation over several years.

The same rationale can be applied to gross receipts from an incidental or occasional sale of intangible property held or used in the regular course of taxpayer’s trade or business. There is no logical basis for distinguishing between fixed assets and intangibles. Accordingly, under authority of section 25137, gross receipts from an incidental or occasional sale of intangible property held or used in the regular course of taxpayer’s trade or business will be excluded from the sales factor, if substantial.

Where some income producing activity has been identified, the "occasional sale" analogy to 18 CCR § 25137(c)(1)(A) will be used to exclude from the sales factor substantial amounts of gross receipts from an incidental or occasional sale of intangible property, held or used in the regular course of taxpayer’s trade or business. [Note, however, if a taxpayer does not in fact engage in any income producing activity or have cost of performance with respect to the sale of an intangible described by this ruling, the receipt from the sale is, under any circumstances, properly excluded from both the numerator and denominator of the sales factor pursuant to 18 CCR § 25137(c)(1)(C).]

Holding

If substantial amounts of gross receipts arise from an incidental or occasional sale of intangible property, held or used in the regular course of taxpayer’s trade or business, such gross receipts shall be excluded from the sales factor. In the facts described, gross receipts from the sale of a patent, or affiliate stock will be excluded.

Drafting Information

The principal author of this ruling is Caglar Caglayan of the Franchise Tax Board Legal Branch. For further information regarding this notice, contact Ms. Caglayan at the Franchise Tax Board Legal Branch, P.O. Box 1720, Rancho Cordova, CA 95741-1720.

Last updated: 09/24/2025