California Code of Regulations › Title 18 - Public Revenues › Division 3 - Franchise Tax Board › Chapter 3.5 - Bank and Corporation Tax › Subchapter 17 - Allocation of Income › Article 2.5 - Uniform Division of Income for Tax Purposes Act › Section 25137-2 - Contractors - Apportionment of Income, Long-Term Contracts

Current through Register 2024 Notice Reg. No. 28, July 12, 2024
(a) In General. When a taxpayer elects to use
					 the percentage of completion method of accounting, or the completed contract
					 method of accounting for long-term contracts, as provided by Revenue and
					 Taxation Code section
					 24673.2,
					 and has income from sources both within and without this state, the amount of
					 business income derived from sources within this state, including income from
					 such long-term contracts, shall be determined pursuant to these regulations. In
					 such cases, the first step is to determine which portion of the taxpayer's
					 income constitutes "business income" and "nonbusiness income" under Revenue and
					 Taxation Code section
					 25120
					 and the regulations thereunder. Nonbusiness income is directly allocated to
					 specific states pursuant to the provisions of Revenue and Taxation Code
					 sections
					 25124
					 to
					 25127,
					 inclusive. The business income of the taxpayer is divided between or among the
					 states in which the business is conducted pursuant to the property, payroll,
					 and sales apportionment factors set forth in this regulation. The sum of (1)
					 the items of nonbusiness income directly allocated to this state, plus (2) the
					 amount of business income attributable to this state constitutes the amount of
					 the taxpayer's entire net income which is subject to tax.
(b) Business and Nonbusiness Income. For
					 definitions, rules and examples for determining business and nonbusiness
					 income, see California Code of Regulations, title 18, section
					 25120.
(c) Methods of Accounting and Year of
					 Inclusion. For general rules of accounting, definitions and methods of
					 accounting for long-term construction contracts, see Revenue and Taxation Code
					 sections
					 24651
					 and
					 24673.2
					 and the regulations thereunder, relating to accounting methods and long-term
					 contracts.
(d) Apportionment of
					 Business Income.
(1) In General. For taxable
					 years beginning before January 1, 2011, under Revenue and Taxation Code section
					 25128
					 business income is apportioned to this state by a three or four factor formula
					 consisting of a property factor, a payroll factor and a single or double
					 weighted sales factor, regardless of the method of accounting for long-term
					 contracts elected by the taxpayer. In general, Revenue and Taxation Code
					 section
					 25128
					 provided for the use of a three-factor formula by all apportioning taxpayers
					 for years beginning prior to January 1, 1993. For years beginning on or after
					 January 1, 1993, that section requires most taxpayers to use a four-factor
					 formula; however, for taxpayers in specified types of businesses, the
					 three-factor formula continues to apply. The total of the property, payroll and
					 sales percentages is divided by three or four, depending on whether a three or
					 four factor formula is required, to determine the apportionment percentage. The
					 apportionment percentage is then applied to business income to determine the
					 amount apportioned to this state.
For taxable years beginning on or after January 1, 2011
						and before January 1, 2013, under Revenue and Taxation Code section
						25128.5,
						an apportionable trade or business, other than that described in subdivision
						(b) of Section
						25128,
						Revenue and Taxation Code, could have made an irrevocable annual election on an
						original timely filed return to apportion its income to this state by
						multiplying its business income by the sales factor.
For taxable years beginning on or after January 1, 2013,
						under Revenue and Taxation Code section
						25128.7,
						an apportionable trade or business, other than that described in subdivision
						(b) of Section
						25128,
						Revenue and Taxation Code, shall apportion its income to this state by
						multiplying its business income by the sales factor.
(2) Percentage of Completion Method. The
					 specific rules for determining the amount of income to be included in business
					 income when the percentage of completion method of long-term contract
					 accounting is used are found in Treasury Regulations section
					 1.451-3(c) (See
					 26 C.F.R. §
													1.451-3(c)). In
					 general, those rules provide that the amount of income from each contract to be
					 included each year is determined by determining the percentage of the total
					 contract completed during the taxable year and applying that percentage to the
					 total price, and then subtracting from the resulting amount the total
					 expenditures made during the taxable year in connection with the
					 contract.
(3) Completed Contract
					 Method. The specific rules for determining the amount of income to be included
					 in business income when the completed contract method of long-term contract
					 accounting is used are found in Treasury Regulations section
					 1.451-3(d) (See
					 26 C.F.R. §
													1.451-3(d)). In
					 general, under this method of accounting business income derived from long-term
					 contracts is reported for the taxable year in which the contract is finally
					 completed and accepted. Therefore, a special computation that apportions the
					 income using the apportionment percentages for the years in which the contract
					 was performed is required to compute the amount of business income attributable
					 to this state from each completed contract. (See subsection (e) of this
					 regulation.) Business income from all other activities not related to long term
					 contracts subject to the completed contract method of accounting is then
					 apportioned to this state using the apportionment formula as determined in
					 accordance with Section
					 25128, Section
					 25128.5, or Section
					 25128.7,
					 Revenue and Taxation Code, whichever is applicable. The apportionment
					 percentages used for apportioning the income from other activities (income not
					 attributable to completed long term contracts) is computed as provided in
					 subsections (4), (5) and (6) of this regulation for each of the taxable years
					 in which such other income is recognized.
(4) Property Factor. In general the numerator
					 and denominator of the property factor shall be determined as set forth in
					 Revenue and Taxation Code sections
					 25129,
					 25130
					 and
					 25131
					 and the regulations thereunder. However, the following special rules are also
					 applicable when either the completed contract or percentage of completion
					 method of long term contract accounting is used:
(A) The average value of the taxpayer's cost
					 (including materials and labor) of work in progress, to the extent such costs
					 exceed progress billings (accrued or received depending on whether the taxpayer
					 is on the accrual or cash basis for keeping its accounts) shall be included in
					 the denominator of the property factor. The value of any such costs
					 attributable to projects in this state shall be included in the numerator of
					 the property factor.
Example 1:
Taxpayer commenced building a ship in this state under a
						long-term contract as of the beginning of a given year. By the end of its
						second taxable year its equity in the costs of production to be reflected in
						the numerator and denominator of its property factor for such year is computed
						as follows:
1st
								Year
2nd Year
Beginning
Ending
Beginning
Ending
Project
								Costs..............................................................................................
..........................0
$1,000,000
Progress
								billings.....................................................................................................................
600,000
Balance 12/31-( 
								1/1
								)..........................
..........................$400,000
$400,000
Total project costs from beginning of
								project................................................................................................................................
..........................$5,000,000
Total progress billings from beginning
								of
								project..........................................................................................................................................................................
4,000,000
Balance 
								12/31
								.........................................................................................................................................................
1,000,000
Balance beginning of
								year..............................................................................................................................................................................................................
400,000
Total...................................................................................................................................................................................................................................................
$1,400,000
Average ( ½ )--Value
								(*) used in property
								factor...................................................................................................................................
$700,000
(*) It may be necessary to use monthly averages if yearly
						averages do not properly reflect the average value of the taxpayer's equity;
						see Revenue and Taxation Code section
						25131
						and the regulations thereunder.
Example 2:
Same facts as in Example 1, except that progress billings
						exceeded project costs. No value for the taxpayer's equity in the project is
						shown in the property factor.
(B) Rent paid for the use of equipment
					 directly attributable to a particular project is included in the property
					 factor at eight times the net annual rental rate even though such rental
					 expense may be included in the cost of the project.
(C) The property factor is computed in the
					 same manner regardless of which long-term contract method of accounting the
					 taxpayer has elected and is computed for each taxable year even though under
					 the completed contract method of accounting, business income is computed
					 separately (See subsection (e) of this regulation).
(5) Payroll Factor. In general the numerator
					 and denominator of the payroll factor shall be determined as set forth in
					 Revenue and Taxation Code sections
					 25132
					 and
					 25133
					 and the regulations thereunder. However, the following special rules are also
					 applicable when either the completed contract or percentage of completion
					 method of long term contract accounting is used:
(A) Compensation paid employees which is
					 attributable to a particular project is included in the payroll factor even
					 though included in the cost of the project.
(B) Compensation paid to employees engaged in
					 performing services at a project site are attributed to the state in which the
					 services are performed. Compensation paid all other employees is governed by
					 Revenue and Taxation Code section
					 25133.
Example:
A taxpayer engaged in a long-term contract in state X
						assigns several key employees to that state to supervise the project. The
						taxpayer, for unemployment tax purposes reports these employees to state Y
						where the main office is maintained and where the employees reside. For payroll
						factor purposes, such compensation is assigned to the numerator of state
						X.
(C) The payroll factor is
					 computed in the same manner regardless of which long-term contract method of
					 accounting the taxpayer has elected and is computed for each taxable year even
					 though under the completed contract method of accounting, business income is
					 computed separately (See subsection (e) of this
					 regulation).
(6) Sales
					 Factor. In general the numerator and denominator of the sales factor shall be
					 determined as set forth in Revenue and Taxation Code sections
					 25134,
					 25135
					 and
					 25136
					 and the regulations thereunder. However, the following special rules are also
					 applicable:
(A) Gross receipts derived from
					 the performance of a contract are attributable to this state if the project is
					 located in this state. If the project is located partly within and partly
					 without this state, the gross receipts attributable to this state are based
					 upon the ratio which costs for the project in this state incurred during the
					 taxable year bears to the total of such costs for the entire project during the
					 taxable year or any other method, such as engineering cost estimates, which
					 will provide a reasonable apportionment.
Example 1:
A ship building project was undertaken in this state by a
						calendar year taxpayer, which had elected one of the long-term contract methods
						of accounting. The following gross receipts were derived from the contract
						during the three taxable years the contract was in progress.
1st
								Year
2nd Year
3rd
								Year
Gross
								Receipts..........................
$1,000,000
$4,000,000
$3,000,000
The gross receipts to be reflected in both the numerator
						and denominator of the sales factor for each of the three years are the amounts
						shown.
Example 2:
A taxpayer contracts to build a dam on a river at a
						point, which lies half within this state and half within state X. During the
						taxpayer's first taxable year construction costs in this state were $2,000,000.
						Total construction costs for the project during the taxable year were
						$3,000,000. Gross receipts for the year were $2,400,000. Accordingly, gross
						receipts of $1,600,000 ($1,600,000 = 66 2/3% X $2,400.000) are included in the
						numerator of the sales factor.
(B) If the percentage of completion method is
					 used, the sales factor includes only that portion of the gross contract price,
					 which corresponds to the percentage of the entire contract, which was completed
					 during the taxable year.
Example:
A taxpayer which had elected the percentage of completion
						method of accounting entered into a long-term contract. At the end of its
						current taxable year (the first since starting the project) it estimated that
						the project was 30% completed. The bid price for the project was $9,000,000 and
						it had received $2,500,000 from progress billings as of the end of its current
						taxable year. The amount of gross receipts to be included in the sales factor
						for the current taxable year is $2,700,000 (30% of $9,000,000), regardless of
						whether the taxpayer uses the accrual method or the cash method for accounting
						for receipts and disbursements.
(C) If the completed contract method of
					 accounting is used, the sales factor includes the portion of the gross receipts
					 received or accrued, whichever is applicable, during the taxable year
					 attributable to each contract.
Example 1:
A taxpayer which had elected the completed contract
						method of accounting entered into a long-term contract. By the end of its
						current taxable year (the second since starting the project) it had billed, and
						accrued on its books a total of $5,000,000 of which $2,000,000 had accrued in
						the first year the contract was undertaken, and $3,000,000 had accrued in the
						current (second) year. The amount of gross receipts to be included in the sales
						factor for the current taxable year is $3,000,000.
Example 2:
Same facts as in Example 1 except that the taxpayer keeps
						its books on the cash basis, and as of the end of its current taxable year had
						received only $2,500,000 of the $3,000,000 billed during the current year. The
						amount of gross receipts to be included in the sales factor for the current
						taxable year is $2,500,000.
(D) The sales factor, except as noted above
					 in subparagraphs (B) and (C) of this subsection (6), is computed in the same
					 manner regardless of which long-term contract method of accounting the taxpayer
					 has elected and is computed for each taxable year even though under the
					 completed contract method of accounting, business income is computed
					 separately.
(7)
					 Apportionment Percentage. For taxable years beginning before January 1, 2011,
					 the apportionment percentage is determined under Revenue and Taxation Code
					 section
					 25128
					 using the property, payroll and sales factors determined as provided under
					 subsections (4), (5) and (b) above, except that when computing the fraction
					 described in Revenue and Taxation Code section
					 25128,
					 subdivision (a), for years beginning before January 1, 1993, the payroll
					 factor, the property factor and the sales factor shall be weighted equally and
					 the denominator of the fraction described in Revenue and Taxation Code section
					 25128,
					 subdivision (a), shall be three. That percentage is then applied to business
					 income to establish the amount apportioned to California.
For taxable years beginning on or after January 1, 2011
						and before January 1, 2013, under Revenue and Taxation Code section
						25128.5,
						any apportionable trade or business, other than that described in subdivision
						(b) of Section
						25128,
						Revenue and Taxation Code, could have made an irrevocable annual election on an
						original timely filed return to apportion its income to this state by
						multiplying its business income by the sales factor.
For taxable years beginning on or after January 1, 2013,
						under Revenue and Taxation Code section
						25128.7,
						an apportionable trade or business, other than that described in subdivision
						(b) of Section
						25128,
						Revenue and Taxation Code, shall apportion its income to this state by
						multiplying its business income by the sales factor.