How does a taxpayer petition the Franchise Tax Board for alternative apportionment?

The standard: fair representation and distortion

Section 25137 is California's version of the escape clause built into the Uniform Division of Income for Tax Purposes Act, and the standard formula it measures against has changed over the years. For taxable years beginning on or after January 1, 2013, Revenue and Taxation Code section 25128.7, added by Proposition 39, requires most apportioning taxpayers to apportion business income by the sales factor alone. The equally weighted property, payroll, and sales formula of section 25128, subdivision (b), remains the standard only for taxpayers deriving more than 50 percent of gross receipts from qualified business activities: agricultural and extractive businesses today, and, for taxable years beginning before January 1, 2025, savings and loan and banking or financial businesses as well, before Senate Bill 132 (Stats. 2025, ch. 17) moved those to the single sales factor. Whichever formula applies to a given taxpayer, it is presumed to produce a fair result, and section 25137 exists for the cases where that presumption breaks down: where the allocation and apportionment provisions "do not fairly represent the extent of the taxpayer's business activity in this state," the taxpayer may petition for, or the Franchise Tax Board may require, one of four remedies: separate accounting, the exclusion of one or more of the factors, the inclusion of additional factors that better capture California activity, or any other method that produces an equitable result.

The California Supreme Court gave that language its controlling gloss in Microsoft Corp. v. Franchise Tax Board (2006) 39 Cal.4th 750. The dispute involved gross receipts from the redemption of short-term investments, a treasury function that generated an enormous volume of receipts relative to the income it produced, and the posture is worth keeping straight: the Franchise Tax Board invoked section 25137 to depart from the standard formula, and the taxpayer defended the formula as written. The court held that the full redemption proceeds counted as gross receipts includible in the sales factor under the ordinary statutory rules, a taxpayer-favorable reading on the threshold question, but went on to hold that section 25137 permits departure from that result where inclusion works a distortion. It fixed the standard every alternative apportionment dispute since has used: the party invoking section 25137 bears the burden of proving, by clear and convincing evidence, both that the standard formula's approximation is not a fair representation of business activity and that the alternative method it proposes is itself reasonable. That is demanding on both halves. A showing that the standard formula produces an unusual or unfavorable result is not enough; the party seeking the departure has to prove the formula is wrong, and then has to prove its own fix is right.

General Mills, Inc. v. Franchise Tax Board sharpened the distortion showing itself, and it arrived in the same posture. The taxpayer's hedging program, futures contracts used to manage commodity price risk in its core food business, generated gross receipts far out of proportion to the income the hedging produced, and it was again the Franchise Tax Board that invoked section 25137 to exclude those receipts while the taxpayer defended their inclusion under the standard formula. In the first appeal, General Mills, Inc. v. Franchise Tax Board (2009) 172 Cal.App.4th 1535, the Court of Appeal adopted a two-part inquiry drawn from Microsoft: the challenged activity must be qualitatively different from the taxpayer's principal business, and it must quantitatively distort the apportionment formula by a substantial amount. The case was remanded for further findings, and on remand, General Mills, Inc. v. Franchise Tax Board (2012) 208 Cal.App.4th 1290 applied that standard to the developed record, treating the qualitative and quantitative inquiries not as separate hurdles but as evidence bearing on the single ultimate question of fair representation, and upheld the Franchise Tax Board's alternative method. Together, the two decisions are the working template: identify the activity dragging the formula off course, show it is qualitatively unlike the taxpayer's ordinary business, and quantify the distortion in a way that survives the clear and convincing standard. Both cases arose in years governed by the older multi-factor formulas, but the standard they fixed does not depend on which formula supplies the baseline, and it has, if anything, more work to do under the single sales factor: a distorting category of gross receipts is no longer diluted by property and payroll factors; it drives the entire apportionment percentage. For taxable years beginning on or after January 1, 2011, Revenue and Taxation Code section 25120, subdivision (f)(2), excludes treasury function and hedging receipts from gross receipts by statute, so the specific receipts at issue in both cases no longer require a section 25137 showing; the cases remain the controlling statement of the distortion standard for other categories of receipts.

The Franchise Tax Board has also fixed what a petition can ask for. Legal Ruling 2019-01 holds that Section 25137 reaches only the allocation and apportionment of income, so a petition is not the vehicle to decombine an entity from the unitary group, to reclassify business income as nonbusiness income, to reach around water's-edge mechanics, or to change combined report mechanics, the determination of income, rates, credits, or procedure. The same ruling collects the five situations the State Board of Equalization identified in Appeal of Crisa Corporation, 2002-SBE-004, as ones in which relief may be warranted: a formula that assigns no income to a state where substantial business is done; factors mismatched to the period in which the income is earned; nowhere income; a factor biased by substantial activity unrelated to the main line of business; and a factor with no material representation in either its numerator or its denominator. A petition framed outside those lines invites a denial on subject matter before the distortion showing is ever reached.

Two directions: taxpayer-initiated and FTB-initiated petitions

Section 25137's language is symmetrical, and the practice runs both ways, though the leading cases sit on the state's side of it. A taxpayer petitions when it believes the standard formula overstates its California activity, typically because some category of receipts or some factor input skews the result the way the treasury receipts did in Microsoft or the hedging receipts did in General Mills. Those cases supply the distortion pattern for such a petition but not its posture: in both, the Franchise Tax Board was the moving party and the taxpayer was defending the standard formula, so a taxpayer borrowing their reasoning is borrowing the test rather than the procedural stance. The taxpayer's petition asks the Franchise Tax Board to accept a substitute method, most often the exclusion of the distorting item from a factor or the substitution of net for gross figures, and the taxpayer carries the full Microsoft burden on that request. Under the single sales factor, the remedy menu's inclusion option matters more than it once did: a taxpayer arguing that a receipts-only formula overstates its California activity may petition for the inclusion of additional factors, property or payroll among them, rather than only the exclusion of a distorting receipt.

FTB staff can move the other direction, proposing a variance from the standard formula when a return position appears to produce an unfairly low California apportionment percentage. Historically, a staff-initiated variance arrived as a proposed adjustment with limited opportunity for the taxpayer to be heard before it was imposed. Franchise Tax Board Notice 2017-05, issued October 19, 2017, extended an oral presentation option to taxpayers whose own petitions were pending before staff, and Franchise Tax Board Notice 2018-02, issued in 2018, closed the gap on the other side by giving a taxpayer facing a staff-initiated variance proposal the same right to present its opposition orally before the variance is imposed. Both notices operated at the staff level, and the presentation opportunities they created are rights; what the regulation adds at the Board level, discussed below, is narrower than that.

Whichever direction a petition runs, the burden allocation does not change. The party invoking section 25137 has to prove distortion and prove its proposed fix is reasonable. A taxpayer facing a staff-initiated variance is not required to defend the standard formula; it only has to hold the FTB to its burden.

Petition mechanics under the current regulation

The petition-procedure regulation took years to finish. The FTB ran Interested Parties Meetings toward amending Cal. Code Regs., title 18, section 25137 across 2017 through 2020, working through questions about deemed denials, administrative exhaustion, and notice requirements that had never been resolved by notice alone. That rulemaking record culminated in an adopted amendment to section 25137(d), and the procedure on the books today is considerably more structured than the earlier notice-based practice.

A petition is addressed to the Chief Counsel of the Franchise Tax Board and must explain why the taxpayer's requested alternative method is appropriate, or, where FTB staff has proposed a variance, why that proposed method is not appropriate. The filing window depends on where the matter stands procedurally: 60 days from a written adverse variance determination, 120 days from the filing of a refund claim, 60 days from a protest filing, 5 days from an appeal to the Office of Tax Appeals, and 60 days from a Settlement Bureau rejection letter (Reg. 25137(d)(2)(B)). Briefing is page- and font-limited, 30 double-spaced pages for opening briefs and 15 for replies in 12-point type, and runs opening brief, FTB staff response, and taxpayer reply on fixed timetables (Reg. 25137(d)(2)(H)). Where no notice of proposed deficiency assessment has yet issued for the years at stake, the taxpayer must agree in writing to extend the statute of limitations until 180 calendar days after the Board itself has made its decision (Reg. 25137(d)(2)(G)), which keeps the assessment clock from running out while the petition is pending.

Petition materials that sit with FTB staff remain confidential under the ordinary return-information protections. Once a petition reaches the Board itself (the three-member Franchise Tax Board, as distinct from FTB staff), that changes: as a condition of Board consideration, the petitioning taxpayer waives the confidentiality otherwise afforded its return information, and the matter becomes subject to open-meeting and public-records treatment at the Board level; records submitted to the Board itself, and its decision, are open to public inspection under the California Public Records Act (Reg. 25137(d)(2)(A)). That waiver is a real cost of taking a petition to the Board and belongs in the calculus of whether a petition is worth bringing at all.

None of this displaces the more basic point Franchise Tax Board Notice 2004-5 made years earlier and that remains good law: seeking a variation does not grant it. A taxpayer that files an original return using a non-standard apportionment method without prior FTB approval, rather than filing on the standard formula and petitioning separately, exposes that return position to the accuracy-related penalty under Revenue and Taxation Code section 19164 if the position is not sustained. The notice recognized a handful of situations where advance approval can fairly be treated as already given: the position matches a permitted variation in an operative FTB audit manual on substantially similar facts, it is permitted by a published opinion of the Board of Equalization or a California appellate court on substantially similar facts, or it is covered by a prior written petition approval or a closing agreement that extends to the year in question. Outside those narrow situations, the safer course is the standard formula on the filed return with the alternative position developed through the petition process, not self-help on the return itself.

The hearing and the ex parte rules

The Board-level hearing is permissive, and the distinction matters. Regulation 25137(d)(2)(I) provides that the Franchise Tax Board may schedule a hearing during an open session at a regularly scheduled meeting to consider the taxpayer's petition. That is discretion to convene a hearing, not an entitlement to demand one, and a petition can be resolved without a Board session ever being scheduled. Where a hearing is scheduled, each side gets a fixed block of time to present its position, with an additional block reserved for the taxpayer's reply, and the presentations are supplemented by whatever written record the briefing schedule has already built. The staff-level oral presentation rights established by the 2017 and 2018 notices sit underneath all of this and are unaffected, which leaves a petitioning taxpayer heard before the staff member developing the position as a matter of right, and heard before the body that decides only if the Board elects to hear it.

Once a petition is pending, an ex parte communications restriction applies to substantive discussion of the matter with any Board member. Communications about scheduling logistics, involving only one Board member at a time and with notice to all parties, are permitted; substantive discussion of the merits outside the structured hearing process is not, absent notice and an opportunity for every party to participate. Where a communication happens anyway, the regulation requires the Board member involved to document its substance in writing and share it with the other Board members and the parties. The restriction runs from the point the petition is received through the Board's decision, which makes the briefed record and whatever proceedings are scheduled, not informal contact, the channel through which a petitioning party's position reaches the decision-makers, a real discipline compared to the earlier, largely informal practice.

What wins, what fails, and where a denied petition goes

The pattern across Microsoft and General Mills is consistent. What tends to win is a showing that a specific, identifiable category of receipts or activity is qualitatively unlike the taxpayer's core business and is quantitatively large enough, relative to the income it generates, to swing the apportionment percentage by a substantial margin. Treasury operations generating receipts far out of proportion to the income they produced carried the distortion question in Microsoft, and a hedging program with the same lopsided receipts-to-income profile did the same in General Mills, in each case for the Franchise Tax Board as the party that had invoked the section. What tends to fail is a petition built on the argument that the standard formula produces an unwelcome number. Distortion is not the same thing as an unfavorable result, and neither Microsoft nor General Mills rewards a petition that cannot connect a specific factor input to a specific, substantial skew.

A denied petition is not a dead end, and it does not create a separate right of appeal apart from the underlying tax matter. Where a taxpayer's own petition is denied, the position falls back into the ordinary assessment and protest track: the resulting notice of proposed assessment is protested through the standard protest procedure, and, if the protest is unsuccessful, the matter proceeds to the Office of Tax Appeals like any other apportionment dispute, market-based sourcing questions included. Where the FTB's own staff-initiated variance is upheld over a taxpayer's opposition, the same path runs the other direction. Section 25137 petitions do not run on a separate appellate track; they run inside the audit, protest, and appeal structure the rest of the Franchise Tax Board's procedure already uses, which is why a 25137 dispute is best planned as part of the audit strategy from the outset rather than as an afterthought once an assessment has already issued.

Practice notes

A section 25137 petition is worth bringing when the fact pattern produces the kind of lopsided receipts-to-income profile Microsoft and General Mills describe, not merely when the standard formula produces a result the taxpayer would rather not have. Before drafting a petition, the petitioner should quantify the distortion: what share of gross receipts, or what factor weight, the challenged activity contributes, set against the income it generates, expressed in terms that can be evaluated against the clear and convincing standard in the short oral presentation the staff-level notices guarantee, and in a Board session if the Franchise Tax Board schedules one. A petition that cannot state that comparison in a sentence or two is not ready to file.

The confidentiality waiver required to bring a matter before the Board is a real cost, not a formality, and it buys access to a hearing the Board may or may not schedule, since Regulation 25137(d)(2)(I) makes the open-session hearing permissive. Both points belong in the initial cost-benefit conversation about whether to petition at all versus developing the same alternative-method argument through the ordinary protest and appeal process without ever reaching the Board. The statute-of-limitations extension required when no notice of proposed deficiency assessment has yet issued is another item to plan around, since it keeps exposure open for a defined period after the Board's decision. And the Franchise Tax Board Notice 2004-5 penalty point remains a live consideration for any taxpayer tempted to file a return on a self-selected alternative method rather than the standard formula: absent one of the narrow situations where prior approval is treated as already given, the safer sequence is standard formula on the return, alternative position developed through the petition. Where a petition ties into a market-based sourcing dispute already under examination, the two issues should be developed together, since the sourcing analysis often supplies the factor evidence the distortion showing needs. G&G State Tax Group provides alternative apportionment petitions and apportionment controversy representation alongside its state and local tax practice.