California Office of Tax Appeals’ Decision Finds Excise Taxes on Services Includible in Sales Factor

In an opinion issued by the California Office of Tax Appeals (OTA) in Robert Half International Inc.,¹ the OTA held that “all gross receipts” under Revenue and Taxation Code (R&TC) Section 25120(e) include excise taxes [i.e., value added tax (VAT) and good and services tax (GST)] on sales of services. This decision is important in the calculation of the California apportionment factor on a taxpayer’s California franchise (income) tax return.

The Franchise Tax Board (FTB) has historically agreed with the treatment of including excise taxes such as VAT invoiced on the sale of tangible goods.² This decision broadens the definition of includible gross receipts in the California sales factor by allowing the full amount received by service providers that include excise taxes on their invoices.

The Taxpayer is a global human resource and consulting firm based in California. For corporate income/franchise tax purposes, the Taxpayer filed an original California return in 2008 on a worldwide combined report basis with its unitary affiliates. The Taxpayer’s foreign affiliates invoiced and collected excise taxes on the sale of its goods and services. These amounts were included on its original return as part of the Taxpayer’s sales factor denominator.

The FTB took issue with the inclusion of excise taxes invoiced and collected on the Taxpayer’s services by relying upon its interpretation of California Code of Regulations Title 18, Section 25134(a)(1)(C) that the silence as to excise taxes in the regulation implies the exclusion of such items from the definition of “sales.”

The OTA rejected the FTB’s interpretation and referenced Microsoft³ and other authorities to find that California Code of Regulations Title 18, Section 25134(a)(1)(C) “does not exclude VAT on the sales of services from the definition of sales in R&TC section 25120(e).”

Final Thoughts

This OTA decision dealt with tax year 2008. However, the position taken by the corporate taxpayer may very well have application to all subsequent years. For those filing a worldwide combined report, an amended return to include excise taxes in the sales factor denominator should be carefully considered, as this decision reverses FTB’s longstanding position that excise taxes on services are not included in the sales factor denominator.

¹ In the Matter of the Appeal of: Robert Half International Inc. and Subs., California Office of Tax Appeals, No. 18011756, October 3, 2019.
² MultiState Audit Technique Manual explicitly includes this position.
³ Microsoft Corp. v. Franchise Tax Board, 139 P.3d 1169, 1174 (Cal. 2006).

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