How does a company with no gross receipts apportion its California income?

Why the problem exists at all

Before 2013, the zero receipts company had a workable path inside the standard rules. Under three factor apportionment, a factor with a zero denominator dropped out of the formula and the remaining factors were reweighted, which the Franchise Tax Board's Schedule R instructions still direct for three factor filers (factors with zero balances in both the everywhere and California columns are not included in the fraction), so a company with property and payroll but no sales apportioned on property and payroll without ceremony. Mandatory single sales factor removed the cushion: when the only factor in the formula fails, there is nothing left to reweight. The statute assumes a taxpayer with receipts to source, and a taxpayer without them falls outside the assumption entirely.

The fact pattern is more common than it sounds. Development stage companies can spend years with heavy California payroll and laboratory or office property, meaningful losses that matter for carryforward purposes, and no revenue. Entities holding assets under construction, ventures between funding and launch, and companies whose only inflows are items excluded from the definition of gross receipts can all present a zero denominator. The apportionment question is not academic for a loss company, because the percentage determines how much of the loss becomes a California net operating loss carryforward, and an unapportionable year leaves the attribute unmeasured.

What Section 25137 provides

Section 25137 is California's version of UDITPA's equitable relief provision, and its text supplies the menu. If the allocation and apportionment provisions do not fairly represent the extent of the taxpayer's business activity in the state, the taxpayer may petition for, or the Franchise Tax Board may require, with respect to all or any part of the taxpayer's business activity: separate accounting; the exclusion of any one or more of the factors; the inclusion of one or more additional factors that will fairly represent the taxpayer's business activity in the state; or the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer's income.

Two of the four remedies fit the zero receipts case like a key: exclude the failed sales factor, and include additional factors that fairly represent the activity. For a company whose California presence consists of people and property, the factors that fairly represent that presence are payroll and property, computed under the familiar rules that governed them when they were part of the standard formula. The result is an apportionment percentage built from what the company does in the state, which is the outcome the fair representation standard exists to produce.

The relief is exceptional by design, and the burden sits with whoever proposes the deviation. A taxpayer petitioning under Section 25137 must show that the standard formula does not fairly represent its California activity; where the denominator is zero, that showing is close to self-proving, since the standard formula produces no result at all rather than a distorted one. The remaining work is establishing that the substitute is reasonable, which is where the computation discipline matters.

Living with the answer

The deviation is not a standing election. Section 25137 relief attaches to the year whose facts justify it, and the analysis renews annually: the first year of meaningful receipts puts the sales factor back in business and ends the justification for the substitute. A company emerging from the zero receipts phase should expect its apportionment method to change in the transition year and should compute the crossover deliberately rather than by momentum, because a year with a small but real denominator presents a different question, a tiny factor that arguably distorts, rather than a failed one, and small denominator distortion arguments are harder and more contested than zero denominator ones.

The posture of the deviation also matters. When the taxpayer petitions and the FTB agrees, the parties have a shared method. When the FTB imposes an alternative method on examination, the imposition carries a collateral benefit worth knowing: an understatement attributable to the FTB's imposition of an alternative apportionment or allocation method is one of the few statutory exceptions to the Large Corporate Understatement Penalty (Revenue and Taxation Code Section 19138(f)(2)). A taxpayer that filed reasonably on the standard rules and was moved to a different method by the state is protected from that penalty on the resulting difference.

Practice notes

The zero receipts year should be documented like the petition it may become. First, prove the zero: reconcile the absence of gross receipts against the statutory definition, because receipts excluded from the factor and receipts that do not exist are different facts, and an examiner will test whether some inflow, an intercompany charge, a reimbursement, an incidental sale, belonged in the denominator after all. Second, build the substitute factors with return-quality rigor: property at original cost with the rent capitalization convention, payroll by the compensation rules, both computed as they would have been under the pre-2013 formula, so the substitute is an established methodology rather than an invention. Third, petition rather than file on a self-help variance: Franchise Tax Board Notice 2004-5 provides that a Section 25137 variation asserted on an original return without prior approval does not have a reasonable basis, which exposes the position to the accuracy-related penalty under Revenue and Taxation Code Section 19164 if it is not sustained. Transparency is a virtue when it accompanies a petition and not a substitute for petitioning when it stands alone, so an explanation attached to a return that already departs from the standard formula documents the deviation without protecting it, and the substitute-factor computation belongs in a petition rather than in a return footnote; the procedure is covered in the related article on alternative apportionment petitions. Fair representation arguments remain strongest when raised affirmatively by the party seeking them and weakest when they surface as an audit defense, which is an argument for petitioning early, not for filing first and explaining later. Fourth, plan the crossover year in advance: decide before filing how the first receipts year will be handled, because the company's own prior-year position that property and payroll fairly represent its activity will be quoted back to it the moment the sales factor produces a number it likes less. G&G State Tax Group provides apportionment analysis for early-stage and pre-revenue companies alongside its state and local tax practice.