How does California source receipts from services and intangibles?

The statutory frame, and why sourcing is the whole game

Market-based sourcing began in 2011 for taxpayers that elected the single sales factor and has applied to all taxpayers, including those still apportioning under the three-factor formula of section 25128(b), for taxable years beginning on or after January 1, 2013 (Cal. Code Regs., tit. 18, section 25136-2(i)(1) in the prior text, carried as (j)(1) in the amended text). Since 2013, apportionment for most taxpayers is the sales factor alone (Rev. and Tax. Code section 25128.7), which concentrates the entire apportionment result into the assignment of receipts. Cost of performance is gone for these receipts. For most service and intangible receipts, the location of the taxpayer's own people, servers, and offices does not drive the factor; interest from investments other than loans is the exception, because it is assigned to California if the investment is managed in California (Cal. Code Regs., tit. 18, section 25136-2(d)(1)(A)2.a). Because Revenue and Taxation Code section 23101(b) counts California sales toward the doing business thresholds using these same assignment rules, sourcing decides not only how much income California taxes but whether a company must file at all. A service provider with no California presence whose customers receive the benefit in California has California receipts, and enough of them create a filing obligation on their own. There is no throwback for services and intangibles; receipts assigned to a state where the taxpayer is not taxable are not California receipts, which is how the zero and near-zero factor questions covered in the related article on zero sales factor apportionment arise.

Section 25136 is a California rule, and the conformity date change made by SB 711 in 2025, which moved the specified date of the Internal Revenue Code from January 1, 2015 to January 1, 2025, did not change it; the 2025 amendments to the regulation are their own, unrelated event. The regulation does borrow federal definitions at the margin: its securities and commodities dealer definition is built on Internal Revenue Code sections 475 and 1256 (Cal. Code Regs., tit. 18, section 25136-2(b)(8) in the amended text), so a dealer analysis still begins with those federal provisions.

The regulation through 2025: the cascade as filed returns know it

For services sold to businesses, the prior regulation presumes the benefit is received where the contract or the taxpayer's books and records indicate, and if that cannot be determined, the taxpayer reasonably approximates the location; failing that, the receipts follow the place from which the customer placed the order, and finally the customer's billing address (Cal. Code Regs., tit. 18, section 25136-2(c)(2)(A) through (D), prior text). Services to individuals start from the billing address, with reasonable approximation behind it (section 25136-2(c)(1), prior text). Intangibles divide by the nature of the transaction: a complete transfer of all property rights follows the location of use of the intangible, a license of marketing intangibles follows where the ultimate customers are, and a license of non-marketing intangibles follows where the licensee uses them. Mixed licenses allocate between the two only where the fees are separately stated in the contract and the separate statement is reasonable; where they are not separately stated, the fees are presumed paid entirely for the marketing intangible unless the taxpayer or the FTB establishes otherwise by a preponderance of the evidence (section 25136-2(d)(2)(C)). Sales of stock, sales of interests in pass-through entities, dividends, and goodwill look through to the entity itself: the receipt is assigned by the entity's average payroll and property factors if 50 percent or more of its assets at original cost are real or tangible property, and by its sales factor if more than 50 percent are intangible (section 25136-2(d)(1)(A)1). Substantial receipts from an occasional sale, such as a factory, a patent, or an affiliate's stock, are excluded from the sales factor altogether, and a sale is substantial if excluding it reduces the denominator by 5 percent or more (Cal. Code Regs., tit. 18, section 25137(c)(1)(A)). Marketable securities go to the customer, defined for businesses by commercial domicile and for individuals by billing address. Interests in real property and tangible personal property follow the property. Threaded through everything is reasonable approximation, the workhorse concept for taxpayers whose contracts and books do not speak in geography, and a recurring source of dispute under the prior text, which left room to argue about whose approximation controls.

For business customers in these years, FTB Legal Ruling 2022-01 (March 25, 2022) is the FTB's governing interpretation of where the benefit is received. It places the benefit where the customer's own operations or customers receive the value: at the event location for services tied to an event, at the location of a health plan's members for a pharmacy benefit manager, and at the end customer's plant for a subcontractor. The ruling also revoked Chief Counsel Rulings 2015-03 and 2017-01, so a filed position that rests on either of those rulings is standing on withdrawn ground. The Office of Tax Appeals has held in precedential opinions that the place a nonresident performs the work does not control; the question is where the customer receives the benefit. In Appeal of Bindley, 2019-OTA-179P, an out-of-state screenwriter with California business customers had California-source receipts by reasonable approximation, because the taxpayer's physical presence does not determine whether income is derived from California. In Appeal of Sheward, 2022-OTA-228P, the contract presumption placed the benefit of an out-of-state steward's services for a California state agency in California, and the nonresident's business income was then apportioned rather than sourced to California in its entirety.

This is the version of the rules that governs every open year through 2025: the returns being filed this fall, every amended return for earlier years, and every audit and protest working those periods. Positions built for those years should cite it, not the amendments.

The regulation from 2026: what the amendments change

The amended regulation, applicable to taxable years beginning on or after January 1, 2026, keeps the market principle and rebuilds the machinery. It replaces the separate individual and business branches with one set of rules, and it begins with rebuttable presumptions. To the extent a service predominantly relates to real property located in California, tangible personal property located in California when the service is received, intangible property used in California, or individuals physically present in California when the service is delivered, the benefit is presumed received in California, and either the taxpayer or the Franchise Tax Board may overcome a presumption by a preponderance of the evidence, considering the taxpayer's contracts and books and records first (Cal. Code Regs., tit. 18, section 25136-2(c)(1)(A)). For consumer-facing businesses, the in-person presumption replaces the old billing-address starting point for individuals. For any service, the location is then substantiated from the taxpayer's contracts or books and records, then from all other sources of information, then by reasonable approximation, and finally by the customer's billing address (section 25136-2(c)(1)(B) through (E)). A blended-sale rule sits alongside the cascade: where a single sale combines services with tangible or intangible property and the value of each portion is readily ascertainable, each portion is separately assigned; otherwise the principal purpose for entering into the contract determines how the revenue is assigned (section 25136-2(e)).

The taxpayer's reasonable approximation gains protection: the taxpayer's method is used unless the Franchise Tax Board shows by a preponderance of the evidence that the method is not reasonable, and only on that showing does the FTB substitute its own approximation (section 25136-2(i)(2)(A)). That converts approximation from a negotiation into a documented position with a burden allocated against the agency, and it makes the workpapers behind the approximation the most valuable pages in the file. The consistency rule carries forward alongside it: a taxpayer that has used a reasonable approximation method must continue to use it in later years unless the Franchise Tax Board permits a change, and where the FTB has examined the method and accepted it in writing, the FTB will continue to accept it absent a change of material fact (section 25136-2(i)(2)(C)).

Three industry rules change the most results. Asset management services are sourced by look-through to the domicile of the investors or beneficial owners, in proportion to the average value of their interests, extending to the general rule an approach Regulation 25137-14 already applied to the services within its reach, covered in detail in the related article on asset management fee sourcing. Professional services get a volume rule: a taxpayer that provides a single professional service to more than 250 customers assigns the receipts from that service to each customer's billing address (section 25136-2(c)(3)). The rule reaches only the services the regulation lists, and the list is closed: management, tax, payroll and accounting, audit and attest, actuarial, legal, business advisory consulting, technology consulting, brokering of commission-generating securities, investment advisory services other than asset management, and underwriting of debt or equity securities (section 25136-2(b)(9)). For those practices it replaces customer-by-customer benefit analysis with a mailing list. The regulation's 5 percent proviso is a per-customer carve-out rather than a condition the whole stream must satisfy: where more than 5 percent of the receipts from that service are derived from a single customer, receipts from that customer do not fall under the billing-address rule and are assigned under the general cascade instead, while receipts from every other customer continue to follow billing address. The distinction decides the result for a firm with 300 clients, one of which accounts for 6 percent of the receipts from the service. The rule survives for the other 299, and only the large client is sourced individually; reading the proviso as a threshold the entire stream must clear would forfeit the rule on a fact the regulation addresses customer by customer. The third rule covers services provided under U.S. government contracts: where the benefit location cannot be determined from contracts and books, other sources, or reasonable approximation, as when the contract cannot be disclosed and nothing about the service is public, the benefit is deemed received by the fifty states, and the receipt is assigned to California by the ratio of California population to U.S. population under the most recent census as of the beginning of the taxable year, in place of the billing-address step (section 25136-2(c)(1)(F)). The customer-location rule for marketable securities, billing address for individuals and commercial domicile for businesses, carries forward; the amendments change who counts as the customer, excluding intermediaries so that the rule looks through to the underlying purchaser (section 25136-2(f)(1)).

The special-industry regulations sit on top of the market rules in both eras. Regulation 25136-2 incorporates Regulations 25137 through 25137-14 (section 25136-2(h)(3) in the prior text, (i)(3) in the amended text), so a mutual fund service provider, a bank, or another taxpayer within one of those regulations applies its industry rule first. In Appeal of Janus Capital Group, 2023-OTA-443, a nonprecedential opinion that serves only as an illustration, the Office of Tax Appeals treated Regulation 25137-14 as the standard apportionment rule for a mutual fund service provider rather than a deviation from it. A party that instead seeks relief from the standard rules under section 25137 carries the heavier burden of proving by clear and convincing evidence that the standard formula does not fairly represent its California activity (Microsoft Corp. v. Franchise Tax Board (2006) 39 Cal.4th 750).

The effective date is a line, not a wall. The Final Statement of Reasons states that the amendments are prospective for taxable years beginning on or after January 1, 2026 and that there is no election to apply them to earlier years, in contrast to the regulation's 2016 amendments, which carried a retroactive election. The years before 2026 stay governed by the prior text, but both sides will use the amendments as rhetoric in old-year disputes. The Franchise Tax Board can argue that a given amendment merely clarifies what the rule always meant, and the Notice of Proposed Rulemaking of September 13, 2024 hands it that hook by describing subsection (c) as clarifying existing rules of assignment for sales of services; taxpayers can argue that a rule the state needed a decade of rulemaking to adopt is evidence the prior rule said something else. Both arguments are live in every open year, and which one helps depends entirely on which side of the assignment the taxpayer sits.

The procedural endgame: what "open years" means

The pre-2026 years stay open on the FTB's side for four years after the return is filed (Rev. and Tax. Code section 19057(a)), subject to the longer periods for omissions and the unlimited period where no return is filed. A notice of proposed assessment that reassigns receipts is protested within 60 days (Rev. and Tax. Code section 19041), and the FTB's action on the protest is appealed to the Office of Tax Appeals within 30 days (Rev. and Tax. Code section 19045). On the taxpayer's side, a refund claim for an overstated California factor must be filed within the later of four years from a timely filed return, four years from the original due date of the return, or one year from the date of payment (Rev. and Tax. Code section 19306(a)), and a claim that is not filed within that window cannot be revived by an audit of the same year. The burdens inside the sourcing analysis are set by the regulation: a presumption under the amended text is overcome by a preponderance of the evidence (section 25136-2(c)(1)(A)2), the FTB displaces a taxpayer's approximation only by a preponderance (section 25136-2(i)(2)(A)), and section 25137 relief requires clear and convincing evidence.

Practice notes

The first discipline is era control: every sourcing memo, return position, and audit response should state on its face which version of regulation 25136-2 it applies, because from now until the pre-2026 years close, the two regimes run in parallel and the differences change the result in common fact patterns, such as services delivered in person, services tied to property, and professional services sold at volume. The second is the estimate calendar: calendar-year taxpayers are paying 2026 estimates now on the amended rules, and a professional services firm newly under the billing-address rule, or an asset manager whose look-through percentages shift, can find its California factor moving materially between the 2025 return and the 2026 estimates with no change in the business. Third, the reasonable approximation upgrade rewards paper: the preponderance standard is best defended when the method is documented as a method, with its data sources and logic recorded when the return is filed, rather than reverse-engineered when the audit letter arrives. Fourth, sourcing is upstream of everything: the same assignments drive the apportionment factor, the section 23101(b) filing thresholds, the nonresident owner distributive-share computations, and the pass-through withholding settings covered in the related withholding articles, so a sourcing change that looks like an apportionment refinement can quietly create filing obligations and withholding duties elsewhere in the structure. Fifth, the limitations calendar runs in both directions: a pre-2026 year still open for assessment is also open for a refund claim only while section 19306 allows it, and the sound practice is to file a protective claim on any year where the sourcing position under review could cut the other way. The related articles on asset management fees, customer pickup sales, and throwback carry the adjacent pieces of the map. G&G State Tax Group provides market-based sourcing analysis for service and intangible receipts alongside its state and local tax practice.