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California Superior Court Deems P.L. 86-272 Franchise Tax Board Guidelines to Be “Underground Regulations”

Tax Development Dec 21, 2023

California Superior Court Deems P.L. 86-272 Franchise Tax Board Guidelines to be Underground Regulations

As reported previously, the American Catalog Mailers Association (ACMA) filed a complaint1 in San Francisco Superior Court of California on August 19, 2022, seeking to have published guidance on internet activities that establish taxability declared invalid. In the proceedings, the ACMA filed a motion for summary judgment declaring the guidance invalid. The court denied the motion for summary judgment on August 24, 2023, stating that the California Franchise Tax Board’s (FTB’s) pronouncements do not, on their face, contradict Public Law (P.L.) 86-272. While the court denied summary judgment, the case was heard, and the court issued its ruling on December 13, 2023.2

The California FTB had issued Technical Advice Memorandum (TAM) 2022-01, detailing whether the P.L. 86-272 protections apply to common fact patterns in the current economy based on technological advancements for purposes of California income and franchise tax. P.L. 86-272 protects out-of-state businesses from income tax when their only activity in the state is solicitation of sales of tangible personal property. Publication 1050 was updated in 2022 to include changes to protections available under P.L. 86-272.

The ACMA petition consisted of the following three counts:

  • Declaratory judgment that TAM 2022-01 and FTB Publication 1050 are invalid because they contradict P.L. 86-272.
  • Declaratory judgment that TAM and Publication 1050 are invalid because the FTB failed to comply with the Administrative Procedure Act (APA) rulemaking process.
  • Declaratory judgment under the Code of Civil Procedure § 1060 that TAM and Publication 1050 are invalid or, in the alternative, limit the application of the TAM and Publication 1050 prospectively.

In its complaint, the ACMA specifically addressed the issues of post-sales assistance and internet cookies. In the August 24, 2023, ruling mentioned above, the court found that the FTB’s rationale in providing the new guidance to P.L. 86-272 was questionable. The ability of the FTB to determine the purpose for which an out-of-state business used cookies and the location of the cookies on computers was not explained. However, the court could not conclude as a matter of law that the publications contradicted the law in a manner that would invalidate them. Since that ruling on August 24, the court heard arguments separately as to the complaint’s additional argument: whether TAM and Publication 1050 should be invalidated as underground regulations that failed to comply with the California APA.

Based on this issue, the taxpayer was granted summary judgment on December 13, 2023, as the court agreed with the ACMA that TAM and Publication 1050 were not optional tools for its auditors but rather rules declaring how certain cases would be decided by the agency. This determination classifies both documents within the definition of a regulation under the APA and subjects them to the APA. The court deemed the documents void, as invalid “underground regulations,” as the APA procedural requirements were not followed for either document.

“If the FTB appeals the decision and loses, the FTB and likely other state agencies may need to take an inventory of their other published ‘guidance’ and determine their validity,” said Gina Rodriquez in the Ryan Advocacy practice.

“Taxpayers will appreciate the court’s focus on giving them a forum in the creation of sweeping policies,” noted Josh Booth, Principal in Ryan’s State Income and Franchise Tax practice. However, this decision could come with negative effects for taxpayers as well. Mr. Booth further stated, “The risk remains that the agencies may continue to establish these strict positions for audit but simply not publicize them in a manner that allows taxpayers to rely on the positions when they benefit taxpayers. For example, one would assume that California would continue granting refund claims removing throwback when relying on an expanded definition of P.L. 86-272 if the FTB believes that position to be consistent with the law, but this ruling may obfuscate the push for consistent treatment across taxpayers.”

Taxpayers should note that the court did not address whether the documents contradicted P.L. 86-272. Additionally, as an agency, the FTB does not consider itself bound by a trial court decision, as in the instant case, until confirmed by an appellate court.

Thus, although the guidance is in flux, the FTB may continue to enforce expanded nexus determinations for companies that touch the state through the internet. If you have concerns as to whether your internet practices have established nexus in California, or any other state, the experts at Ryan are here to assist you in interpreting your practices and the laws and protections surrounding your activities. We will keep you posted on any further developments on this issue. Please contact us for further assistance.

American Catalog Mailers Association v. Franchise Tax Board, Superior Court of California, San Francisco County. Case No. CGC-22-601363, December 13, 2023.

2 Ibid.


Josh Booth

Gina Rodriquez


Mark L. Nachbar

Mary Bernard

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