Cal. Code Regs. tit. 18 § 25137-1

Current through Register 2024 Notice Reg. No. 18, May 3, 2024

Section 25137-1 - Apportionment and Allocation of Partnership Income

(a) In General. When a taxpayer has an interest in a partnership as defined in Section 17008, Revenue and Taxation Code, the division of its distributive share of partnership items shall be determined in accordance with Chapter 10 of Part 10 of Division 2 of the Revenue and Taxation Code. The determination of the portion of such distributive share (constituting business and nonbusiness income) which has its source in this state or which is includible in the taxpayer's business income subject to apportionment, shall be made in accordance with these regulations provided that the taxpayer, or the partnership, or both, have income from sources within and without this state. The taxpayer in computing net income for its taxable year shall include its distributive share of partnership items referred to above for any partnership year ending within or with the taxpayer's taxable year. The same principle applies when a taxpayer has an interest in a partnership that itself owns an interest, directly or indirectly, in one or more other partnerships.

The first step is to determine which portion of the taxpayer's income and its distributive share of the partnership items constitute "business income" and "nonbusiness income" under Section 25120, Revenue and Taxation Code, and the regulations thereunder. The various items of nonbusiness income are then directly allocated to specific states pursuant to the provision of Section 25124 to 25127, Revenue and Taxation Code. The taxpayer's distributive share of partnership business income is apportioned by the formula set forth in subsections (f) or (g), whichever is applicable. Even in the partnership's business and the taxpayer's business are not unitary, such that subsection (g) applies, the distributive share of income allocated to the taxpayer is from a separate trade or business of the taxpayer, not nonbusiness income of the taxpayer. The determination of whether an item of income is apportionable business income or allocable nonbusiness income is made at the partnership level based on the trade or business of the partnership. Revenue and Taxation Code section 23040 is not applicable. The sum of (1) the items of nonbusiness income directly allocated to this state, plus (2) the amount of business income attributed to this state is the portion of the taxpayer's entire net income which is subject to tax.

Income arising from transactions and activity in the regular course of the partnership's trade or business constitutes business income. Thus, a corporate-partner's distributive share of partnership business income constitutes business income to the corporate-partner, but the determination of whether the partnership's activities and the activities of the corporate-partner constitutes a single trade or business or more than one trade or business turns on the facts in each case. If the partnership's activities and the taxpayer's activities constitute a unitary business under established standards, disregarding ownership requirements, the taxpayer's share of the partnership's trade or business shall be combined with the taxpayer's trade or business as constituting a single trade or business.

EXAMPLE 1:

Corporation A's distributive share of income in partnership P is 20%. Corporation A manufactures toys which are sold in the seven western states by partnership P. Corporation A's business income for the year was $1,000,000 and partnership P's business income for the same year was $800,000. The business income of Corporation A is $1,160,000 ($1,000,000 plus 20% of $800,000).

EXAMPLE 2:

Corporation A's distributive share of income in partnership P is 90%. Partnership P manufactures toys of which approximately 30% are sold by Corporation A in the seven western states. The remainder is sold to outsiders by partnership P. In addition, Corporation A also sells other lines of toys not manufactured by partnership P. Corporation A handles all financing, management, accounting, advertising, and purchasing functions for partnership P as well as for itself. Corporation A incurred a loss of $500,000 for the year but partnership P's income was $1,000,000. The business income of Corporation A is $400,000 (90% of $1,000,000 = $900,000 less the loss of $500,000).

When the activities of the partnership and the taxpayer do not constitute a unitary business under established standards, disregarding ownership requirements, the taxpayer's share of the partnership's trade or business shall be treated as a separate trade or business of the taxpayer. In such a case the taxpayer is engaged in two trades or businesses.

EXAMPLE:

Corporation A's distributive share of income in partnership P is 20%. Corporation A manufactures and sells toys in the seven western states. Partnership P operates farms within and without this state. Corporation A's income for the year is $1,000,000 and partnership P's income is $800,000 for the same year. Corporation A is engaged in two trades or businesses, and will be required to apportion its income of $1,000,000 from its own operations to this state on the basis of a three factor apportionment formula. Partnership P would attribute part of its business income of $800,000 to this state on the basis of its own three factor apportionment formula. Accordingly, Corporation A would report 20% of the partnership income apportioned to this state plus a portion of its income from its toy manufacturing business.

(b) Distributive Items of Nonbusiness Income. Partnership income from interest, dividends, rents, royalties or capital gains is nonbusiness income when such income does not constitute business income. The taxpayer's distributive share of such nonbusiness income shall be reported in the same manner as other nonbusiness income derived from other activities of the taxpayer (see Sections 25123 to 25127, inclusive).

(c) Business and Nonbusiness Income; Application of Definitions. The classification of income by the labels customarily given such as interest, dividends, rents, royalties, capital gains, etc., is of no aid in determining whether partnership income is business or nonbusiness income. The gain or loss recognized on the sale of property, for example, may be business income or nonbusiness income depending upon the relation to the partnership's trade or business. Rules and examples for determining whether these types of income constitute business or nonbusiness income are set forth in Regulation 25120(c) and are applicable to partnerships under this regulation.

(d) Proration of Deductions. In most cases an allowable deduction of a partnership will be applicable only to the business income arising from a particular trade or business or to a particular item of nonbusiness income. In some cases an allowable deduction may be applicable to the business incomes of more than one trade or business and/or to several items of nonbusiness income. In such cases the deduction shall be prorated among such trades or businesses and such items of nonbusiness income in a manner which fairly distributes the deduction among the classes of income to which it is applicable.

(e) Distributive Items of Expense. Any items of expense allocated to the taxpayer in accordance with Chapter 10 of Part 10 of Division 2 of the Revenue and Taxation Code, shall be taken into account in computing the taxpayer's business and nonbusiness income, to the extent allowable under the law and in accordance with these regulations as to determining their applicability to the taxpayer's business or nonbusiness income.

(f) Apportionment of Business Income--Single Trade or Business. If the partnership's activities and the taxpayer's activities constitute a unitary business under established standards, disregarding ownership requirements, the business income of such single trade or business attributable to this state shall be determined by an apportionment formula, pursuant to either Section 25128, Section 25128.5 or Section 25128.7, Revenue and Taxation Code, whichever is applicable, of the taxpayer and its share of the partnership's factors for any partnership taxable year ending within or with the taxpayer's taxable year. The apportionment factors related to the taxpayer's interest in the partnership shall be determined as follows:

(1) Property Factor. In general the numerator and denominator of the property factor shall be determined as set forth in Regulations 25129 to 25131, inclusive, and 25137(b). However, the following special rules shall apply:

(A) A portion of the partnership's real and tangible personal property, both owned or rented and used during the taxable year in the regular course of such trade or business, to the extent of the taxpayer's interest in the partnership, shall be included in the denominator of the taxpayer's property factor. The value of such property located in this state shall also be included in the numerator of the property factor.

(B) The value of property which is rented or leased by the taxpayer to the partnership or vice versa shall, with respect to the taxpayer, be excluded from the property factor of the partnership or eliminated to the extent of the taxpayer's interest in the partnership, whatever the case may be, in order to avoid duplication.

EXAMPLE 1:

Corporation A's interest in partnership P is 20%. Corporation A's distributive share of partnership P's income is included in business income of Corporation A to be apportioned by formula. Corporation A owns a building (original cost of $100,000) which is rented to partnership P for $12,000 per year. Corporation A must include the original cost of $100,000 for the building in its property factor. Therefore, no portion of the value of the rented property will be reflected in the property factor of Corporation A.

EXAMPLE 2:

Same facts as in Example 1 except partnership P owns the building and rents it to Corporation A. Corporation A will include $20,000 (20% of $100,000) in its property factor because of its interest in partnership P. In addition, Corporation A will take into account $9,600 ($12,000 less 20% thereof) of rental expense into its property factor in order to give weight in the property factor to the rented building used in Corporation A's operation. Thus, the value of the building to be used in the property factor of Corporation A is $96,800 ($20,000 plus 8 x $9,600).

(2) Payroll Factor. In general the numerator and denominator of the payroll factor shall be determined as set forth in Regulations 25132 and 25133. However, the following special rules shall apply:

The partnership's payroll used to produce business income, shall be included in the denominator of the taxpayer's payroll factor to the extent of the taxpayer's interest in the partnership. The amount of any such payroll applicable to this state shall also be included in the numerator of the taxpayer's payroll factor.

EXAMPLE 1:

Corporation A's interest in partnership P is 20% and its distributive share of partnership P's income is included in business income of Corporation A to be apportioned by formula. Corporation A's own payroll is $1,000,000 and the payroll of partnership P is $800,000. Corporation A's total payroll for purposes of the payroll factor is $1,160,000 ($1,000,000 plus 20% of $800,000).

(3) Sales Factor. In general the numerator and denominator of the sales factor shall be determined as set forth in Regulations 25134 to 25136, inclusive, and 25137(c). However, the following special rules shall apply:

(A) The partnership's sales which give rise to business income, shall be included in the denominator of the taxpayer's sales factor to the extent of the taxpayer's interest in the partnership. The amount of such sales attributable to this state shall also be included in the numerator of the taxpayer's sales factor. Intercompany sales between the partnership, on the one hand, and the taxpayer or any member of the taxpayer's combined reporting group, on the other, shall be eliminated from the denominator of the taxpayer or the taxpayer's combined reporting group (if applicable), as well as the numerator of the taxpayer's sales factor or the numerator of another member of the taxpayer's combined reporting group, whomever made the sale to the partnership, as follows:

(i) Sales by the taxpayer, or any member of the taxpayer's combined reporting group, to the partnership to the extent of the taxpayer's interest in the partnership.

(ii) Sales by the partnership to the taxpayer, or any member of the taxpayer's combined reporting group, not to exceed the taxpayer's interest in all partnership sales.

(B) Notwithstanding any intercompany eliminations described in subparagraph (A) above, sales made to nonpartners, other than members of the partner taxpayer's combined reporting group, shall be included in the denominator of the taxpayer's sales factor in an amount equal to such taxpayer's interest in the partnership.

(C) Application of the above rules are illustrated by the following examples:

EXAMPLE 1:

Corporation A's interest in partnership P is 20%, and its distributive share of partnership P's income is included in business income of Corporation A to be apportioned by formula. Corporation A's sales were $20,000,000 for the year, $5,000,000 of which were made to partnership P. Partnership P made sales of $10,000,000 during the same year, none of which were to Corporation A or other partners.

The denominator of Corporation A's sales factor is $21,000,000 determined as follows:

Sales by Corporation A.............................................................................................................................................................................................................................................................			..........................$20,000,000
Add: Corporation A's interest (20%) in Partnership P's sales	$2,000,000
Less: Corporation A's interest (20%) in Corporation A's sales to Partnership P.....................................................................................	..........................1,000,000		1,000,000
Denominator of Sales Factor....................................................................................................................................................................................................................................................			..........................$21,000,000

EXAMPLE 2.

The following facts are applicable to Examples 2(a) to (c), inclusive. Corporation A's interest in partnership P is 20% and Corporation B's interest is 80%. The distributive share of partnership income is included in business income of Corporation A and Corporation B, respectively.

The sales made by Corporation A, Corporation B, and Partnership P are as follows:

Corporation A......................................................................................................................................................................................		..........................$20,000,000
Corporation B......................................................................................................................................................................................		..........................60,000,000
Partnership P:
To Corporation A..................................................................................................................................	..........................$2,000,000
Corporation B.......................................................................................................................................	..........................8,000,000	$10,000,000

The denominator of Corporation A's sales factor is $20,000,000 determined as follows:

Sales by Corporation A........................................................................................................................................................................		..........................$20,000,000
Add: Corporation A's interest (20%) in Partnership P's sales........................................................	..........................$2,000,000
Less: Partnership P's Sales Sales by Corporation A......................................................................	..........................2,000,000	-0-
Denominator of Corporation A's sales factor....................................................................................................................................		..........................$20,000,000

The denominator of Corporation B's sales factor is $60,000,000 determined as follows:

Sales by Corporation B...........................................................................................................................................		..........................$60,000,000
Add: Corporation B's interest (80%) in Partnership P's sales..........................	..........................$8,000,000
Less: Partnership P's sales to Corporation B.....................................................	..........................8,000,000	-0-
		60,000,000

The sales made by Corporation A, Corporation B, and Partnership P are as follows:

Corporation A...............................................................................		..........................$20,000,000
Corporation B...............................................................................		..........................60,000,000
Partnership P:
To Corporation A..........................	..........................$1,000,000
To Corporation B..........................	..........................9,000,000	$10,000,000

The denominator of Corporation A's sales factor is $21,000,000 determined as follows:

Sales by Corporation A..........................................................................................................................................		..........................$20,000,000
Add: Corporation A's interest (20%) in Partnership P's sales..........................	..........................$2,000,000
Less: Partnership P's sales to Corporation A....................................................	..........................1,000,000	1,000,000
Denominator of Corporation A's sales factor......................................................................................................		..........................$21,000,000

The denominator of Corporation B's sales factor is $60,000,000 determined as follows:

Sales by Corporation B..........................................................................................................................................................		..........................$60,000,000
Add: Corporation B's interest (80%) in Partnership P's sales.........................................	..........................$8,000,000
Less: Intercompany sales between Partnership P and Corporation B*..........................	..........................8,000,000	-0-
Denominator of Corporation B's sales factor.......................................................................................................................		..........................$60,000,000

The sales made by Corporation A, Corporation B, and Partnership P are as follows:

Corporation A..........................................................................................................................................................		..........................$20,000,000
Corporation B...........................................................................................................................................................		..........................80,000,000
Partnership P:
To Corporation A...................................................................................................	..........................$3,000,000
To Corporation B...................................................................................................	..........................6,000,000
To Corporation X...................................................................................................	..........................1,000,000	$10,000,000

The denominator of Corporation A's sales factor is $20,200,000 determined as follows:

Sales by Corporation A.............................................................................................................................................................................................................................................................			..........................$20,000,000
Add: Corporation A's interest in Partnership P's sales to Nonpartner X Corporation (20% x $1,000,000)....................................................................................................................			..........................200,000
	Corporation A's interest in Partnership P's sales to Partners (20% x $9,000,000).......................................................................................................	..........................$1,800,000
Less: Intercompany sales from Partnership P to Corporation A *......................................................................................................................................		..........................1,800,000	-0-
Denominator of Corporation A's sales factor..........................................................................................................................................................................................................................			..........................$20,200,000

The denominator of Corporation B's sales factor is $81,800,000 determined as follows:

Sales by Corporation B.............................................................................................................................................................................................................................................................			..........................$80,000,000
Add: Corporation B's interest in Partnership P's sales to Nonpartners x Corporation (80% x $1,000,000)...................................................................................................................			..........................800,000
	Corporation B's interest in Partnership P's sales to Partners (80% x $9,000,000)..........................	..........................$7,200,000
Less: Intercompany sales from Partnership P to Corporation B...........................................................................................................................................		..........................6,000,000	1,200,000
Denominator of Corporation B's sales factor..........................................................................................................................................................................................................................			..........................$82,000,000

__________

* Not to exceed taxpayer's interest in Partnership P's sales

(4) Partnership Interest--Defined. A taxpayer's partnership interest for the purpose of computing the portion of the partnership's property, payroll and sales to be included in the taxpayer's property, payroll or sales factor shall be determined by the taxpayer's "interest in the partnership". The taxpayer's interest in the partnership shall be determined by reference to its interest in profits of the partnership.

(5) Common Accounting Period. If a partnership and a corporation are engaged in a unitary business and their accounting periods are different, if necessary, in order to avoid distortion, the income and factors of the partnership will be determined on the basis of the corporate partner's accounting period.

(g) Apportionment of Business Income--Two or More Trades or Businesses. When the activities of the partnership and the taxpayer do not constitute a unitary business under established standards, disregarding ownership requirements, the taxpayer's share of the partnership's trade or business shall be treated as another trade or business of the taxpayer. The determination of the amount of the partnership's business income and the taxpayer's distributive share of that income attributable to sources within this state shall be as follows:

(1) If the partnership derives business income from sources within and without this state, the amount of business income derived from sources within this state shall be determined on the basis of the applicable apportionment formula. The factors shall be determined in accordance with the provisions of Sections 25129 to 25137, inclusive, Revenue and Taxation Code, and the regulations thereunder. The apportionment formula shall be determined in accordance with Section 25128, Section 25128.5, or Section 25128.7, Revenue and Taxation Code, whichever is applicable. After determining the amount of business income attributable to this state by the applicable apportionment formula, the taxpayer's distributive share of such business income shall be reported as business income from a separate business by the taxpayer. That income when added to the taxpayer's other business income apportioned to this state and nonbusiness income allocable to this state is the taxpayer's measure of tax for its taxable year.

EXAMPLE:

Corporation A's distributive share of income in partnership P is 20%. Partnership P derives income from sources within and without this state but its business is unrelated to the business of Corporation A. Partnership P has business income of $500,000 for the year of which 40% is apportioned to this state by the applicable apportionment formula of property, payroll and sales. Corporation A shall include in its measure of tax its income received from partnership P $40,000 ($500,000 x 40% x 20%).

(2) If the partnership derives business income from sources entirely within this state, or entirely without this state, such income shall not be subject to formula apportionment. The taxpayer's distributive share of such business income attributable to this state (if any) shall be added to the taxpayer's other business income apportioned to this state plus nonbusiness income, if any, allocable to this state, the total of which is the taxpayer's measure of tax for its taxable year.

EXAMPLE 1:

Corporation A's distributive share of income in Partnership P is 20%. The distributive share of P's business income is not an integral part of A's trade or business so as to be considered one business. Corporation A derives business income from sources within and without this state. Partnership P is engaged in business wholly within this state. Corporation A's business income for the year is $5,000,000 of which 50% is apportioned to this state. Partnership P has a loss on its operation for the same year of $500,000. Corporation A's measure of tax is $2,400,000 ($5,000,000 x 50% = $2,500,000 - $100,000 ($500,000 x 20%)).

EXAMPLE 2:

Same facts as in Example 1 except Partnership P operates its business wholly outside this state. Corporation A's measure of tax is $2,500,000 ($5,000,000 x 50%) as no portion of Partnership P's loss is attributable to this state.

(h) Apportionment of Business Income--Long-Term Construction Contracts for Unitary Business. If the partnership's activities and the taxpayer's activities constitute a unitary business under established standards, disregarding ownership requirements, so as to constitute a single trade or business and the partnership is engaged in long-term construction contracts and has elected either the percentage of completion method of accounting, or the completed contract method of accounting, the distributive share of partnership business income to be reported each year by the taxpayer shall be determined by Regulation section 25137-2, as well as reference to the preceding sections of this regulation where applicable, regardless of whether the partnership's operations are carried on entirely within this state, entirely without this state, or partly within and partly without this state.

(i) Apportionment of Business Income--Long-Term Construction Contracts for Non Unitary Business. If the activities of the partnership and the taxpayer do not constitute a unitary business under established standards, disregarding ownership requirements and the partnership is engaged in long-term construction contracts reporting income therefrom under the percentage of completion or completed contract method of accounting, the taxpayer's distributive share of partnership income (or loss) attributable to this state shall be determined as follows:

(1) When the partnership is engaged in a construction project entirely within this state, the determination of its business income shall be made in accordance with the method of accounting elected by the partnership for reporting income from long-term contracts and the taxpayer's distributive share shall be reported as business income from sources within this state derived from a separate trade or business.

(2) Where the partnership is engaged in construction both within and without this state, the determination of the amount of business income therefrom attributable to the taxpayer derived from sources within this state shall be made in accordance with the method of reporting for such long-term construction contract as elected by the partnership and as set forth in Section 25137-2 applicable to corporations engaged in long-term construction contracts, as if the partnership were a corporation.

(3) Where the partnership is engaged in a construction project entirely without this state, the determination of the taxpayer's distributive share of such business income shall be made as though the taxpayer were engaged in a separate trade or business, no portion of which is carried on within this state.

(j) The amendments to subsections (a), (e), (f), (h) and (i) are applicable only as of the effective date of amendments to these subsections of the regulation.

Cal. Code Regs. Tit. 18, § 25137-1

1. Editorial correction renumbering and amending former Section 25137(e) to Section 25137-1 filed 3-27-85; effective upon filing pursuant to Government Code Section 11346.2(d) (Register 85, No. 13). For prior history, see Registers 76, No. 46 and 74, No. 46.
2. Change without regulatory effect amending subsections (f), (g)(1) and (h)(2) and amending NOTE filed 12-9-2013 pursuant to section 100, title 1, California Code of Regulations (Register 2013, No. 50).
3. Amendment filed 11-20-2018; operative 1-1-2019 (Register 2018, No. 47).

Note: Authority cited: Section 19503, Revenue and Taxation Code. Reference: Section 25137, Revenue and Taxation Code.

1. Editorial correction renumbering and amending former Section 25137(e) to Section 25137-1 filed 3-27-85; effective upon filing pursuant to Government Code Section 11346.2(d) (Register 85, No. 13). For prior history, see Registers 76, No. 46 and 74, No. 46.
2. Change without regulatory effect amending subsections (f), (g)(1) and (h)(2) and amending Note filed 12-9-2013 pursuant to section 100, title 1, California Code of Regulations (Register 2013, No. 50).
3. Amendment filed 11-20-2018; operative 1/1/2019 (Register 2018, No. 47).