California’s Proposition 39: Not-so-Mandatory Single Sales Factor

by Reed Smith

[authors: Brian W. Toman, Kyle O. Sollie, Marty Dakessian, Mike Shaikh]

On November 6, California voters passed Proposition 39, which changes the state’s default apportionment to a single sales factor method. Additionally, Proposition 39 adopted a mandatory market-sourcing method for sourcing sales of services and intangibles. Yet taxpayers in California may still elect to apportion income using the equally weighted three-factor formula provided for in the Multistate Tax Compact because the Compact has still not been effectively repealed.

1. Filing Options through 2012

In our October Alert,1 we stated that for tax years beginning on or after January 1, 2011, corporations
have three apportionment options:

a. Double-Weighted Sales Method (former default). Three-factor, double-weighted sales factor, with cost-of-performance sourcing for sales other than sales of tangible personal property.2

b. Compact Method. Three-factor, single-weighted sales factor, with cost-of-performance sourcing for sales other than sales of tangible personal property.3

c. Sales-Factor-Only Method. Sales factor only, with market-based sourcing for sales of services and intangibles.4

Of course, our conclusion was based on the Gillette decision, in which a California Court of Appeal held that the Legislature’s enactment of a double-weighted sales factor did not remove a taxpayer’s right to elect the Compact method.5 Additionally, the Legislature’s attempt to repeal the Compact by passing Senate Bill 1015 (2012) was invalid because that bill was not passed with a two-thirds majority vote, as required under Proposition 26.

For tax years beginning before January 1, 2013, Proposition 39 changes nothing. Taxpayers continue to have these three options for sourcing business income.

2. Filing Options beginning in 2013

For tax years beginning on or after January 1, 2013, Proposition 39 changes the default filing method. Starting in 2013, the default is a single sales factor.6 The option of using a three-factor formula that gives double weight to the sales factor is eliminated.7

Proposition 39 does not, however, repeal the Compact. Indeed, Proposition 39 contains the same language with respect to the Compact that was before the court in Gillette.8 The court in Gillette said that language did not repeal the Compact.9 That same court—the Court of Appeal—has made clear that repeals by implication do not work.10 Thus, Proposition 39 does not repeal the Compact.

Therefore, the result of Proposition 39’s passage is that for tax years beginning on or after January 1, 2013, taxpayers have two filing options:

a. Sales-Factor-Only Method (Default Option). Sales factor only, with market-based sourcing for sales of services and intangibles.11

b. Multistate Tax Compact Method (By Election). Three-factor, single-weighted sales factor, with cost-of-performance sourcing for sales other than sales of tangible personal property.

If you have questions about the Proposition 39 or California apportionment in general, please contact the authors of this Alert, or the Reed Smith lawyer with whom you usually work. For more information on Reed Smith's California tax practice, visit

1. Gillette Reinstated. If Compact is Elected, LCUP Penalty Shouldn’t Apply

2. Cal. Rev. & Tax Code § 25128 (2011). If an apportioning trade or business derives more than 50 percent of its "gross business receipts" from an agricultural, extractive, savings & loan, or banking or financial business activity, an equally weighted three-factor formula of property, payroll and sales is to be utilized to apportion income.

3. Cal. Rev. & Tax Code § 38006 (providing the compact method).

4. S.B.X.3.15 of 2009, Ch. 17, Laws 2009 adding Cal. Rev. & Tax Code § 25128.5 (providing an election to use a single sales factor to apportion income). Under S.B. 858 of 2010, Ch. 721, Laws 2010, § 27, a taxpayer that elects to apportion income using a sales-factor-only must use market-based sourcing. Taxpayers that do not elect to use a sales-factor-only may continue to use cost-of-performance sourcing.

5. See The Gillette Company & Subs. v. California Franchise Tax Board, CA. Ct. App., 1st Dist, Dkt. No. A130803; appeal from SF Sup. Ct. Dkt. No. CGC-10-495911.

6. For taxpayers in combined reporting groups, only 50 percent of receipts from video, cable, voice, and data are included in the sales factor numerator. The full amount of receipts from such services is included in the denominator. Cal. Rev. & Tax. Code § 25136.1.

7. See Proposition 39 (adding Cal. Rev. & Tax Code § 25128.7).

8. Cal. Rev. & Tax. Code § 25128.7(a) (emphasis added). Compare that with Senate Bill 1176 (1993), which adopted the double-weighted sales factor at issue in Gillette and the "Notwithstanding Section 38006 [i.e., the Compact]" Language.

9. The Gillette Company & Subs. v. California Franchise Tax Board, CA. Ct. App., 1st Dist, Dkt. No. A130803; appeal from SF Sup. Ct. Dkt. No. CGC-10-495911.

10. Kennedy Wholesale, Inc. v. State Board of Equalization, 53 Cal 3d 245 (1991) ("the law shuns repeals by implication…. Indeed, [s]o strong is the presumption against implied repeals that when a new enactment conflicts with an existing provision, [i]n order for the second law to repeal or supersede the first, the former must constitute a revision of the entire subject, so that the court may say that it was intended to be a substitute for the first." (internal citations and quotation marks omitted)).

11. Just as with the Compact method prior to Proposition 39, corporations electing the Compact may also be permitted or required to (i) use the Compact method rather than special industry methods (e.g., franchisors, mutual fund service providers), (ii) include treasury and hedging receipts in the sales factor, and (iii) use the Joyce method to compute the sales factor.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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