California Code of Regulations › Title 18 - Public Revenues › Division 3 - Franchise Tax Board › Chapter 2.5 - Personal Income Tax (Taxable Years Beginning After 12-31-54) › Subchapter 11 - Gross Income of Nonresidents › Section 17951-6 - Income from a Covenant Not to Compete

Current through Register 2024 Notice Reg. No. 28, July 12, 2024
(a) General. Income from a covenant not to
				  compete executed in connection with the sale of a business conducted entirely
				  within California or within and without California has a source in California
				  to the extent the income is assigned to this state under this regulation.
(1) Income from a covenant not to compete is
				  assigned to California by first identifying the legally enforceable area within
				  which the promisor forfeits the right to act. The income is then assigned to
				  locations within the legally enforceable area according to a formula consisting
				  of the average of property, payroll and sales factors of the business which was
				  sold weighted in accordance with Section
				  25128(a),
				  Revenue and Taxation Code, or a single sales factor in accordance with either
				  Section 25128.5 or Section
				  25128.7,
				  Revenue and Taxation Code, as in effect for the taxable year of the
				  sale.
(2) The factors to be used
				  are those of the business which was sold for the taxable year in which the sale
				  of the business occurs.
(3) Except
				  as otherwise provided, the denominator of the factors consists of property,
				  payroll and sales assigned to the legally enforceable area, in accordance with
				  the provisions of the Uniform Division of Income for Tax Purposes Act, Sections
				  25120
				  through
				  25139,
				  inclusive, Revenue and Taxation Code, and the regulations thereunder. The
				  numerator of the factors consists of property, payroll and sales included in
				  the denominator which are assigned to California in accordance with the
				  provisions of the Uniform Division of Income for Tax Purposes Act, Sections
				  25120
				  through
				  25139,
				  inclusive, Revenue and Taxation Code, and the regulations thereunder, except as
				  otherwise provided. For purposes of computing the numerator and the denominator
				  of the sales factor pursuant to Section
				  25135,
				  Revenue and Taxation Code, all sales of tangible personal property are assigned
				  to the state of the purchaser where the property is delivered or shipped, and
				  the provisions of Section
				  25135(b),
				  Revenue and Taxation Code (relating to throwback sales), shall not
				  apply.
(4) A covenant not to
				  compete includes any arrangement to refrain from engaging in an activity,
				  directly or indirectly, similar to the business activity carried on by the
				  business which was sold. This definition includes, but is not limited to,
				  covenants not to create or acquire an interest in a competitor, covenants not
				  to solicit employees, and covenants not to disclose proprietary
				  information.
(5) The sale of a
				  business includes all of the following:
(A)
				  The sale or disposition of the goodwill of a sole proprietorship, partnership,
				  limited liability company, S corporation or C corporation.
(B) The sale or disposition of substantially
				  all of the assets, together with the goodwill, of a sole proprietorship,
				  partnership, limited liability company, S corporation or C
				  corporation.
(C) The sale or
				  disposition of substantially all of an individual's interest in a sole
				  proprietorship, partnership, limited liability company, S corporation or C
				  corporation, including, but not limited to, the following:
1. The sale or disposition by a shareholder
				  of substantially all of its shares in a corporation.
2. The sale or disposition by a partner of
				  substantially all of its interest in a
				  partnership.
(6) The use of the apportionment factors of
				  the business that was sold for the year in which the sale occurs is required in
				  all but unusual circumstances. However, if the use of these factors does not
				  fairly reflect the nature of prohibited activities expressed or reasonably
				  implied from the covenant not to compete, or does not accurately represent the
				  location of recent historical business activities of the business sold, such
				  that there is a gross distortion of income assigned within the legally
				  enforceable area, the Franchise Tax Board may require, or the promisor may
				  petition the Franchise Tax Board for:
(A) The
				  use of factors of the business which was sold for another year or combination
				  of years; or
(B) The employment of
				  another method of assigning income; provided the use of another year or years
				  or another method produces a fair and equitable assignment of income within the
				  legally enforceable area.