Can a California service subsidiary of a foreign parent amend prior years to market sourcing, and where does the parent receive the benefit?

Whether the question exists: the combined report and the water's edge line

The sourcing question arises only when the fees stay in the subsidiary's own sales factor. If the parent and subsidiary are engaged in a unitary business and file a worldwide combined report, the parent is a member of the combined reporting group, and "[i]ntercompany transactions are disregarded for purposes of the sales factor" (FTB Publication 1061, Guidelines for Corporations Filing a Combined Report (2024), describing Cal. Code Regs., tit. 18, section 25106.5-1). The amended regulation says the same thing in its own terms: "service" does not include "services rendered to another member of the taxpayer's combined reporting group" (Cal. Code Regs., tit. 18, section 25136-2(b)(11)). In a worldwide combined report, apportionment is measured by the group's sales to outsiders, and the fee is not a receipt at all.

The question becomes live when the group has made a water's edge election. A foreign parent then enters the water's edge combined report only on the conditions of section 25110, such as substantial United States factors or income effectively connected with a United States business; the library's article on when a foreign corporation is excluded from a water's edge combined report walks through those conditions. A parent outside the water's edge report is, for sourcing purposes, the subsidiary's customer, and the fee is a sale of services assigned under section 25136.

The election is fixed for the years being amended. The FTB's Form 100X instructions state that corporations "are not allowed to elect or terminate a water's-edge election on an amended tax return." A subsidiary that filed on a worldwide basis cannot amend into a water's edge posture to create the sourcing question.

The threshold: a subsidiary must be taxable outside California to apportion

A subsidiary with all of its people and property in California faces a question before sourcing: whether it apportions at all. UDITPA's apportionment provisions apply to a taxpayer that has income from business activity taxable both within and without the state (Rev. and Tax. Code section 25121, as described in Appeal of Suurs, 2026-OTA-238, a nonprecedential opinion). A taxpayer whose business income is taxable only in California has nowhere else to apportion it.

Section 25122 defines the test. "[A] taxpayer is taxable in another state if (a) in that state it is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax, or (b) that state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not." A foreign country is a "state" for this purpose, and Regulation 25122(c) supplies the rule for it: "the determination of whether such 'state' has jurisdiction to subject the taxpayer to a net income tax shall be made as though the jurisdictional standards applicable to a state of the United States applied in that 'state,'" and a treaty does not take away jurisdiction that is otherwise present (Cal. Code Regs., tit. 18, section 25122(c), as quoted in FTB Chief Counsel Ruling 2012-03 (August 2012)).

The FTB applied that standard in Chief Counsel Ruling 2012-03, which binds only the taxpayers that requested it. Reasoning by analogy to California's own sales threshold in section 23101(b), the ruling concluded that "for taxable years beginning on or after January 1, 2011, when [the taxpayer's] sales exceed $500,000 in a foreign jurisdiction, [the taxpayer] is taxable, as defined under section 25122, in that foreign jurisdiction." Applied to a subsidiary whose service receipts are assigned to the parent's country, the same logic can support taxability there once the receipts are substantial. The analysis is circular: the receipts that would make the subsidiary taxable abroad are the receipts whose assignment is in question, so the sourcing work carries both issues.

Where a foreign parent receives the benefit in the open years

The statute is short: "Sales from services are in this state to the extent the purchaser of the service received the benefit of the services in this state" (Rev. and Tax. Code section 25136(a)(1), as quoted in FTB Legal Ruling 2022-01). Under the regulation as it stood before 2026, the benefit is received at "the location where the taxpayer's customer has either directly or indirectly received value from delivery of that service" (former Cal. Code Regs., tit. 18, section 25136-2(b)(1)). For a business customer, the location is fixed first by the contract or the taxpayer's books and records; if neither shows it, by reasonable approximation; then by "the location from which the taxpayer's customer placed the order for the service"; and only at the end by the customer's billing address (former section 25136-2(c)(2)(A) through (D), as quoted in Appeal of Sheward, 2022-OTA-228P). For most taxpayers, apportionment is the sales factor alone (Rev. and Tax. Code section 25128.7; FTB Multistate Audit Technique Manual 7005), so the assignment of the parent's fee is most of the apportionment result.

The parent's address enters only near the bottom of that cascade. Legal Ruling 2022-01 (March 25, 2022), issued under the prior text, gives the FTB's reading of where a business customer receives value. "[I]t is always the value to the taxpayer's customer that is analyzed and not the value provided to any other party," so the parent, not its affiliates or end users, is the customer. Yet the ruling locates the parent's value by what the work is aimed at: when the service "is directed at the customer's customer(s)," the benefit "is likely located at the customer's customer(s)' location," and the ruling names sales and marketing services and customer support services as "[c]ommon examples of direct engagement."

For a captive subsidiary, that reading cuts both ways. Work the parent consumes in its own operations abroad, such as engineering for its foreign plants or back-office functions for its foreign headquarters, is received abroad. Work directed at the parent's customers, or at a United States affiliate's operations, follows those customers or operations, and some of it can land in California even though the subsidiary never invoices anyone in the state. A related-party customer also weakens the fallback steps, because the subsidiary usually has access to its parent's sales data.

An example shows the split. A California corporation owned by a software publisher headquartered abroad performs three services for the parent under a cost-plus agreement: quality-assurance testing of new releases before the parent licenses them worldwide; telephone and chat support for the parent's North American business users; and research on the United States market for a planned expansion. Its returns for the open years assigned the whole fee to California. On amendment, the support fees follow the parent's North American users, with the California share drawn from the parent's own customer records; the market research is received where the parent will use it, which points to the United States market as a whole and calls for a documented approximation, not a default to the parent's country; and the testing fees are the contestable piece, because testing can be read as value the parent consumes in its own product development abroad or as value directed at the licensees who use the software. Assigning all three to the parent's country because the invoices go there starts at the bottom of the cascade.

The 2026 cascade, and the captive-provider question it raises

For taxable years beginning on or after January 1, 2026, the amended regulation keeps the definition, now at subsection (b)(3), and rebuilds the order of analysis (Cal. Code Regs., tit. 18, section 25136-2(j)(3)). The first step is a set of presumptions: the benefit is presumed received in California to the extent the service predominantly relates to real property in California, tangible personal property located in California when the service is received, "[i]ntangible property that is used in this state," or individuals physically present in California when the service is delivered (section 25136-2(c)(1)(A)1). Either party may overcome a presumption by a preponderance of the evidence, considering the taxpayer's contracts and books and records first (section 25136-2(c)(1)(A)2). Behind the presumptions, the location is substantiated from contracts or books and records, then from all other sources of information, then by reasonable approximation, and only then by billing address (section 25136-2(c)(1)(B) through (E)).

The intangible-property presumption matters most for a captive provider. The regulation's own example assigns an outside research firm's milestone payments to the states where its customer will use the intangible the work relates to, because the clinical tests are "a service related to an intangible used in this state and State B" (section 25136-2(c)(1)(G)5). Testing, development and support work for a parent whose software or patents are exploited in the United States market can be presumed received, in part, where the intangible is used, which can include California. The call center example reaches the same result for support work done for a customer's customers: the provider uses outside information about where its customer's sales are made and assigns that share of its fees to California (section 25136-2(c)(1)(G)7).

Two definitions narrow the fallbacks. "Cannot be determined" means, in both texts (section 25136-2(b)(4), former (b)(2)), the taxpayer's records "or the records of the taxpayer's customer which are available to the taxpayer" do not show the location, which reaches a parent's records the subsidiary can see. And a population-based approximation uses the United States population unless the taxpayer substantiates that the benefit is "substantially received" outside the United States, in which case the populations of those foreign jurisdictions are added (section 25136-2(b)(10)); the prior text carried a similar rule in terms of foreign countries. A taxpayer that adopts an approximation method must continue to use it unless the FTB permits a change (section 25136-2(i)(2)(C)), and the FTB uses the taxpayer's method unless it shows by a preponderance of the evidence that the method is not reasonable (section 25136-2(i)(2)(A)). The FTB's Final Statement of Reasons states that there is no election to apply the amendments to earlier years.

The regulation also raises a question it does not answer, in both texts. Subsection (b)(11), former subsection (b)(8), provides that "service" "does not include activities performed by a person who is not in a regular trade or business offering its services to the public." A subsidiary whose only customer is its parent does not offer its services to the public in any ordinary sense. One reading is that the definition is aimed at activities that are not sales at all, and that an arm's length fee under a service agreement remains a sale of services under section 25136, which the regulation implements rather than narrows. The other is that a captive provider's receipts fall outside subsection (c) entirely, leaving their assignment to a rule the regulation does not name. The FTB's Initial and Final Statements of Reasons do not discuss the definition, and no ruling or opinion applying it was found as of October 14, 2026.

Amending the open years, and what a federal examination changes

The refund window is the ordinary one. A refund claim is timely if filed within the latest of four years from the date the return was filed, if it was filed within the extension period, four years from the original due date, or one year from the date of overpayment (Rev. and Tax. Code section 19306(a)). The claim is an amended return on Form 100X with a recomputed Schedule R (FTB Form 100X instructions). Schedule R-2 asks whether reasonable approximation was used to assign sales and whether the approximation or apportionment method changed from prior years, so the amended return discloses the change in method on its face. The library's article on what follows a market-sourcing refund claim covers the examination such a claim can draw, the offsets and the appeal deadlines.

A federal examination adds its own clock. When the IRS changes the subsidiary's federal return, the corporation "must report those changes to the FTB within six months of the final federal determination" (FTB Form 100X instructions; Rev. and Tax. Code section 18622(a); FTB Publication 1008 (rev. 05/2020)). The date of the final federal determination is "the date on which each adjustment or resolution resulting from an Internal Revenue Service examination is assessed pursuant to Section 6203 of the Internal Revenue Code" (section 18622(d)). A timely report gives the FTB two years from receipt to assess on it (Rev. and Tax. Code section 19059(a)), and Publication 1008 states that a late report gives the FTB four years from receipt of sufficiently detailed information.

On the refund side, "a claim for credit or refund resulting from the adjustment may be filed by the taxpayer within two years from the date of the final federal determination" or within the section 19306 period, "whichever period expires later" (section 19311(a)(1)). The operative words are "resulting from the adjustment," and on that text a sourcing correction unrelated to the federal changes does not result from them. The federal examination therefore neither shortens the four-year window for the sourcing claim nor extends it; the two-year window covers what the federal change produces. Appeal of Bobeck, 2026-OTA-079, a nonprecedential opinion, shows the boundary from the other side, holding the extended period unavailable where the IRS made no adjustment.

The two clocks meet when the federal examination adjusts the intercompany fee itself, as a transfer pricing examination of a cost-plus service provider can. An upward adjustment adds receipts to the subsidiary's sales factor, and those receipts are assigned under section 25136 like the rest of the fee, so the California share of the federal change turns on the same benefit analysis as the amended years. Where the section 19306 period is still open, the efficient sequence is a single amended return that reports the federal change within six months and carries the sourcing correction for the same year; where it has closed, only the part of the claim that results from the adjustment is timely on that reading.

Practice notes

The analysis runs in a fixed order: the filing method for each year being amended; taxability outside California under section 25122 and Regulation 25122(c); the benefit analysis under the prior text for every year through 2025, built from the service agreement, the transfer pricing documentation and the parent's own customer and operations data, with the billing address held for the bottom of the cascade; and a limitations table showing the section 19306 date for each year and, for any year under federal examination, the six-month reporting date and the two-year section 19311 date measured from the assessment date on the federal transcript. For 2026 and later years, the intangible-property and in-person presumptions belong in the current-year provision before the first estimate, and the reach of "cannot be determined" into the parent's records and the open (b)(11) question apply to every year, amended or current. A subsidiary whose services benefit United States affiliates or end users can expect part of its fee to stay in California. G&G State Tax Group provides market-based sourcing analysis and refund claim representation for foreign-owned California service subsidiaries alongside its state and local tax practice.