- California recently amended its sourcing rules effective January 1, 2026.
- Pursuant to voters’ approval of Proposition M in 2024, the San Francisco Tax Collector (the “Tax Collector”) implemented similar regulations for purposes of San Francisco’s business taxes.
- The final regulation, San Francisco Regulation 25-1, is effective for tax years beginning on or after January 1, 2025.
Overview
Voters went to the polls in San Francisco in 2024 and approved Proposition M, effective January 1, 2025. The regulation changed the due date for the annual business tax, increased the threshold amount for exemption, and reduced the number of business activity classes. It also authorized the Tax Collector to implement market sourcing regulations.
Forvis Mazars Insight: San Francisco is the latest jurisdiction to switch to market-based sourcing, which is now the law in approximately two thirds of the states for purposes of apportioning income.
General Rules
The location of the gross receipts should be presumed to be in the city if the service relates to: real property located in the city; tangible personal property located in the city when the service is received (although if this property is delivered directly or indirectly to a customer after the service was performed, the benefit of the service is deemed to be at the place where the property is delivered); intangible personal property used within the city; sales of financial instruments if the customer is in the city; and services provided to individuals physically present in the city at the time the service is provided.
Regulation 2025-1 provides “waterfalls”, or series of steps, to determine where the gross receipts should be allocated; once you are able to source receipts using a step, the inquiry ends without moving to the next step. The first “waterfall” for sourcing services uses the contracts or books and records kept in the normal course of business. The next step is “[a]ll other sources of information” relevant to sourcing. The next step, assuming that you cannot determine the proper assignment of gross receipts using the first two steps, is reasonable approximation (including census approximation or gross domestic product approximation). As a final resort, gross receipts are sourced using the billing address of the customer. There are similar waterfalls for gross receipts from the sale of intangible property as well as from the sale of financial instruments.
Asset Management Services
Gross receipts from asset management services, defined as the direct or indirect provision of management, distribution or administrative services to funds, are sourced based upon the domicile of the investors in the asset, unless the investor is holding title for a beneficial owner or owners. In the latter case, the billing address of the beneficial owner(s) should be used.
Receipts from asset management services are allocated to the city based on the average value of the interest held by investors or beneficial owners domiciled in the city averaging these values at the beginning and the end of the year. If the taxpayer does not know the average value of interest held by those domiciled in the city in the assets, then a reasonable estimation may be used.
Forvis Mazars Insight: San Francisco’s regulation follows California, and other states, in applying the so-called “look-through” rules for asset management services, looking to the investors rather than the putative domicile of a fund.
Professional Services
Gross receipts from large volume professional services should be allocated to customers’ billing addresses if taxpayers provide services to more than two hundred and fifty customers in a single professional service and less than 5% of its receipts are from a single customer. For any receipts that do not meet this large volume professional services test, the general sourcing rules would apply.
Sales of Intangibles
Gross receipts from intangible property, other than sales of financial instruments, are sourced to the city if at the time of the sale, the taxpayer’s books and records indicate that the purchaser will use the intangible property in the city. Special rules apply if the receipts are dividends, goodwill, or interest from investments. If the location of the use of intangible property cannot be determined, then the taxpayer’s books and records for the most recent period may be used to determine the location of the intangible property used. As a last resort, receipts should be sourced to the billing address of the purchaser if no other methods can be used to determine sourcing.
Bundled Transactions
Gross receipts from a bundled transaction including both services and tangible or intangible property should be separately allocated using the value of each portion of the sales which are readily ascertainable. The principal purpose of entering the contracts will determine how the gross receipts are allocated if the value of each portion is not ascertainable.
Forvis Mazars Insight: Something akin to the “true object” test, traditionally a sales tax concept, is used to determine whether the sale is a sale of property or of services, which in turn determines which sourcing rules apply.
Financial Instruments
Gross receipts from sales of financial instruments are allocated to the city if the customer is an individual and the billing address at the end of the year is in the city. If customer is a corporation or other business entity, the commercial domicile where the books and records kept in the normal course of business should be used. If customer’s billing address and corporation’s domicile address do not yield a definitive result, then the location of customer shall be determined using reasonable approximation.
How Forvis Mazars Can Help
Forvis Mazars can assist you in understanding the impact of both the California and San Francisco market sourcing regulations, how it will impact your business going forward, and the concomitant changes to your apportionment factors because of these changes.