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Discussion Draft

Section 25106.5 Regulations -- Mechanics of Combined Reporting Version 2 -- Changes In Version 1 to Reflect FTB Legal Ruling 234 (Joyce)

CAUTION: THIS IS ONLY A DISCUSSION DRAFT.  IT IS NOT A FORMALLY NOTICED REGULATION.

Note: Deletions from Version 1 are reflected in strike out. Additions are reflected in italics.

25106.5 (a) In general. Each taxpayer whose income and apportionment factor data are permitted or required to be included in a combined report shall report income in the manner provided by this regulation, and, to the extent applicable, other regulations adopted under Section 25106.5.

(b) Definitions.

(1) "Combined report" refers to the schedules which are attached to the tax return, required to be filed by Revenue and Taxation Code Section 18601, of one or more taxpayer members, which reports the taxpayer member's income from sources within this state under the combined reporting method.

(2) "Combined reporting method" refers to the method under which the total combined report business income of all members of the combined reporting group is apportioned to California, and intrastate apportioned between the California taxpayer members of the group, to determine each taxpayer member's combined report business income from California sources.

(3) "Combined reporting group" refers to those corporations with business income that is permitted or required to be included in a particular combined report under Sections 25101, 25101.15, 25102, or 25104, limited, if applicable, by application of Section 23801(c), or the effects of a water's edge election under Section 25110, or any other provision of law which precludes income and apportionment data of an entity from being included in a combined report. A combined report group also refers to those S Corporations whose income is required to be included in a combined report under Section 23801(d).

(4) "Business income" is as defined under Section 25120(a).

(5) "Combined report business income" is the business income of a member of a combined reporting group permitted or required to be included in the combined report of the group (see subsection (b)(3) of this regulation).

(6) "Total group combined report business income" is the sum or net of all combined report business income of all members of the combined reporting group.

(7) "Nonbusiness income" is the income of a member of the combined reporting group which is subject to allocation under Sections 25123 through 25127.

(8) "Apportionment" is the means by which total group combined report business income is sourced to this state under Sections 25128 through 25137 and Section 25141.

(9) "California apportionment percentage" refers to the fraction, determined under Section 25128, used to apportion the total group combined report business income to this state.

(10) "Intrastate apportionment" is the means by which the total group combined report business income, which has been apportioned to this state, is assigned to each of the taxpayer members of the combined reporting group.

(11) "Intrastate apportionment percentage" is the percentage applied by a specific taxpayer member to the total group combined report business income, after apportionment to this state, in order to determine that member's share of the group's California source apportioned income.

(9) "Taxpayer member's California apportionment percentage" refers to the fraction, determined under Section 25128, used to apportion the total group combined report business income to a taxpayer member in this state.

(12) (10) "Member" is a single corporation in a combined reporting group. The term includes both taxpayer members and all other corporations included in the combined reporting group.

(13) (11) "Taxpayer member" is a corporation which is a member of a combined reporting group which is required to file a tax return in this state.

(14) (12) "Principal member" is:

(A) Except as otherwise provided, the corporation first described below:

(i) The parent corporation which is a member of the combined reporting group. A "parent corporation" is a corporation which is a parent corporation to all members of the combined reporting group, within the meaning of paragraph (1) of subdivision (b) of Section 25105 of the Revenue and Taxation Code.

(ii) If the group does not have a parent corporation which is a member of the combined reporting group, as so defined, the "principal member" is a corporation which is a lower tier parent to all members of the combined report. A "lower tier parent" is the first corporation, down the chain of corporations, which is a member of the combined report group and which would have constituted a "parent corporation" to all members of the combined group if all corporations which own or constructively own that corporation under Section 25105 were disregarded.

(iii) If the group does not have a "lower tier parent" corporation which is a member of the combined reporting group, the "principal member" is the taxpayer member of the combined reporting group expected to have, on a recurring basis, the largest amount of income apportioned and allocated to California.

(B) Notwithstanding the provisions of subsection (A), the taxpayer members of the combined reporting group may elect to treat a member which is a domestic parent corporation participating in a consolidated return election under Section 1501-1502, Internal Revenue Code, as the "principal member," so long as consistently treated as such for the year of the election and thereafter.

(15) (13) "Fiscalization" is the process under which a member of a combined reporting group aligns the income and apportionment data from its accounting period to the accounting period of the principal member.

(16) (14) "California source carryover item" refers to an item of income or loss allocated or apportioned in an earlier year, required to be taken into account as California source income during the income year, other than net operating loss.

(17) (15) Unless the context otherwise requires, the term "income" includes loss.

(18) (16) "Total separate net income" is the total net income from all sources of a member of a combined reporting group determined from its separate books of account.

(19) (17) "Corporation," as used in this regulation and other regulations under Section 25106.5, includes banks. In the application of Section 25102, the term "corporation" also includes "persons" as the term is used in that section.

(c) Steps in determining California source income or loss from the business income of a combined reporting group. Members of a combined report group shall compute their income from California sources in the following steps, in the order indicated.

(1) Except as otherwise provided by this regulation, each member of a combined reporting group must identify its total separate net income for the period beginning and ending with the tax period of the principal member of the combined reporting group. Items of income and expense should be presented in columnar form for each member. Except as otherwise provided by this regulation or other regulations under Section 25106.5, total separate net income shall be determined by the Revenue and Taxation Code, subject to the following modifications:

(A) Adjustments with respect to transactions between members of a combined reporting group shall be determined under Reg. Section 25106.5-A.

(B) Capital, Section 1231 (Internal Revenue Code), and involuntary conversion gains and losses shall not be taken into account. Such gains and losses are apportioned and allocated as determined under Reg. Section 25106.5-B.

(C) Net operating loss deductions shall not be taken into account. The net operating loss deduction of a taxpayer member is allowed as a deduction only against the California source income (i.e., after apportionment and allocation) of the taxpayer member of the group (see subsection (d)(4)).

(2) Except as otherwise provided by this regulation or other regulations under Section 25106.5, the taxpayer members of the combined reporting group may elect to determine the net income of a member of the group under accounting methods and other elections as authorized by Division 2, Part 11 of the Revenue and Taxation Code, independently of the net income of other members of the combined reporting group. See Reg. 25106.5-C.

(3) The resulting total separate income of each member of the combined reporting group is then adjusted to remove income items attributable to the member's nonbusiness income, and any items of business income which do not relate to the combined report business income of the group.

(4) If the accounting period of the principal member and one or more of the other members of the combined reporting group do not begin and end on the same dates, adjustments must be made to fiscalize the other members' combined report business income and apportionment data, to assign an appropriate amount of those values to the accounting period of the principal member in order for total group combined report business income to be apportioned. See Reg. 25106.5-D.

(5) The combined report business income of all members, aligned to the accounting period of the principal member, is then aggregated, and total of such income is adjusted to reflect application of the interest offset, determined under Reg. Section 25106.5-E, resulting in total group combined reporting business income.

(6) Total group combined report business income for the accounting period of the principal member is multiplied by the California apportionment percentage of the combined reporting group, determined under Section 25128 of the Revenue and Taxation Code, to arrive at the group's California source combined report business income. That percentage is determined as follows:

(A) For most combined reporting groups taxpayer members, the total group combined report business income is multiplied by an the taxpayer member's California apportionment percentage consisting of the sum of the group's taxpayer member's California property factor, the payroll factor, and twice the sales factor, with that sum divided by four. However, if a combined reporting group has more than 50% of its gross business receipts from a qualified business activity, as defined in Section 25128 of the Revenue and Taxation Code, and the regulations thereunder, the taxpayer member's California apportionment percentage for the combined group consists of the sum of the group's taxpayer member's California property factor, payroll factor and sales factor, with that sum divided by three. In the determination of whether a single or double weighted sales factor applies, the gross business receipts of the combined reporting group shall be determined on the basis of gross business receipts of the accounting period of the principal member, using the applicable fiscalization method provided in subsection (c)(4) of this regulation.

(B) In the application of this subsection ((c)(6)), except as modified under Section 25137 of the Revenue and Taxation Code,

(i) The taxpayer member's California property factor of the combined reporting group is a fraction, the numerator of which is the total that member's California property of the group, and the denominator of which is the total property of the group everywhere. Property values are determined in accordance with Sections 25130 and 25131 of the Revenue and Taxation Code. The California numerator of the property factor of the combined reporting group includes all California property owned by the members of the group, whether or not the member with title to the property is a taxpayer member.

(ii) The taxpayer member's California payroll factor of combined reporting group is a fraction, the numerator of which is the total that member's California payroll of the group, determined under Section 25133 of the Revenue and Taxation Code, and the denominator of which is the total payroll of the group everywhere. The California numerator of the payroll factor of the combined reporting group includes all California payroll costs incurred by the members of the group, whether or not the member which incurred those costs is a taxpayer member.

(iii) The taxpayer member's California sales factor of the combined reporting group is a fraction, the numerator of which is the total that member's California sales of the group, determined under Sections 25135 and 25136 of the Revenue and Taxation Code, and the denominator of which is the total sales of the group everywhere. In the application of this subsection, a sale of tangible personal property shall be assigned to the state from which the property is shipped under Section 25134(a)(2) of the Revenue and Taxation Code only if no member of the combined reporting group is taxable in the state of the purchaser. In addition, a sale of goods shipped to this state shall be assigned to this state, if any member of the combined reporting group is taxable in this state. In the application of Section 25135, Rev. and Tax Code, the term "taxpayer" refers to the specific member of the group which transferred title to tangible personal property to the purchaser. Thus, if a member of the combined reporting group sells goods shipped to a purchaser in California, and that member is not taxable in that state, the sale is not assigned to California, even if another member of the combined report group is taxable in that state. Likewise, if a taxpayer member sells goods to a purchaser in another state which are shipped from California, and that member is not taxable in the other state, the sale is a California sale, even if another member of the combined group is taxable in the other state.

(C) The taxpayer member's California apportionment percentage is the sum of that member's California payroll, property, and a doubled weighted sales factor (or a single weighted sales factor, if applicable), with that sum divided by either four or three, as determined under Section 25128 and the regulations thereunder.

(D) Finally, each taxpayer member multiplies the group's total combined report business income by its respective taxpayer member's California apportionment percentage to arrive at the taxpayer member's California source apportioned income.

(7) The resulting California source combined report income of the combined reporting group, determined under the preceding subsection ((c)(6)), is intrastate apportioned between the taxpayer members of the group, to arrive at each taxpayer member's California source combined report business income. That value is determined by multiplying the group's California source combined report business income by that member's intrastate apportionment percentage to arrive at the taxpayer member's California source combined report business income. The steps of intrastate apportionment are as follows:

(A) Each taxpayer member of the combined reporting group (and only the taxpayer members) determines its California property factor, payroll factor and sales factor.

(i) The taxpayer member's California property factor is a fraction, the numerator of which is the California property of that member, and the denominator of which is the total property of the group everywhere. Property values are determined in accordance with Sections 25130 and 25131 of the Revenue and Taxation Code.

(ii) The taxpayer member's California payroll factor is a fraction, the numerator of which is that member's California payroll, determined under Section 25133 of the Revenue and Taxation Code, and the denominator of which is the total payroll of the group everywhere.

(iii) The taxpayer member's California sales factor is a fraction, the numerator of which is the California sales of that taxpayer member, determined under Sections 25135 and 25136 of the Revenue and Taxation Code, and the denominator of which is the total sales of the group everywhere.

(iv) If, in the application of subsection (c)(6) of this regulation, the property, payroll, and sales factors of the combined reporting group have been modified under Section 25137, comparable modifications shall be made in the determination of the taxpayer member's California factors in this subsection ((c)(7)).

(B) The taxpayer member then determines its California apportionment percentage. The California apportionment percentage is the sum of that member's California payroll, property, and a doubled weighted sales factor (or a single weighted sales factor, if applicable), with that sum divided by either four or three, as was determined with respect to the combined reporting group under subsection (c)(6) of this regulation.

(C) Next, the taxpayer member determines its intrastate apportionment percentage. That percentage is the ratio of the taxpayer member's California apportionment percentage to the sum of all of the California taxpayer members' California apportionment percentages.

(D) Finally, the taxpayer member multiplies the group's California source combined report business income by its intrastate apportionment percentage to arrive at the taxpayer member's California source combined report business income.

(8) (7) If applicable, California source combined report business income of a taxpayer member, determined by intrastate apportionment under subsection (c)(7) (c)(6), is then proportionately assigned to the applicable portion of that member's income year, based on the number of months falling within the common income year of the principal member. The resulting income from such portions is then aggregated (or netted) together for the member's income year to determine that member's business income from California sources attributable to the combined reporting group. (see Reg. Section 25106.5-D)

(d) Steps in determining a taxpayer member's income from sources within this state, for purposes of imposition of tax. The California source income of a taxpayer member of a combined reporting group subject to the imposition of the income or franchise tax is the sum (or net) of the member's California source business income; carryover items; capital, Section 1231 and involuntary conversion gains and losses; and nonbusiness income. The resulting income is adjusted by the taxpayer member's California interest offset, charitable contribution adjustment and net operating loss. The steps of that determination are as follows:

(1) To each taxpayer member's California source combined report business income, determined under subsection (c), is added (or netted) any other California source business income--

(A) Determined by apportionment of combined report business income of another combined reporting group of which the taxpayer is a member,

(B) From apportionment of income from a distinct business income activity conducted within and without the state wholly by the taxpayer member, or

(C) From a trade or business conducted wholly by the taxpayer entirely within the state, if any.

(2) The amount determined under the preceding subsection is increased by or decreased by any

(A) California source carryover items (see Reg. Section 25106.5-F),

(B) California source income from the sales or exchange of capital or Section 1231 assets, and from involuntary conversions (see Reg. Section 25106.5-B),

(C) California source nonbusiness income.

(3) The value determined under subsection (d)(2) is reduced by the member's California interest offset, determined under Reg. 25106.5-E, and the member's California source net operating loss carryforward deduction and increased or decreased by the taxpayer member's charitable contribution adjustment (see Reg. 25106.5-G). The final resulting value is the taxpayer member's California source income.

(4) If after apportionment, intrastate apportionment, allocation of nonbusiness items, and application of the member's California interest offset and charitable contribution adjustment (if applicable) the final resulting value of subsection (d)(3) is a loss for a taxpayer member, that taxpayer member has a California source net operating loss (CSNOL). The CSNOL is subject to the net operating loss limitations and carryforward provisions of Sections 24416, 24416.1, 24416.2, 24416.3 and 25108. If applicable, the CSNOL must be recomputed to apply the Water's-Edge limitation of Section 24416(c). CSNOL, as adjusted, is applied as a deduction in a subsequent year only when the taxpayer has California source positive net income, whether or not the taxpayer is a member of a combined report group in the subsequent year. A CSNOL incurred by one member of a combined report group cannot be used to reduce the income of any other member in a subsequent income year. Whether the CSNOL resulted from an apportioned business loss or an allocated nonbusiness loss, or a combination of both, the CSNOL is a deduction against positive California source income in a subsequent year, regardless of the composition of that income as apportioned, allocated or wholly within California.

(e) Steps in determining the taxpayer member's tax liability.

(1) The taxpayer member's positive California source income is multiplied by the applicable tax rate for the income year to arrive at the member's regular tax liability before tax credits.

(2) The taxpayer member's tentative minimum tax and AMT liability (if any) is determined in accordance with Reg. Section 25106.5-H.

(3) The taxpayer member's tax liability before tax credits is then reduced by any tax credits allowed to that member, subject to limitations with respect to tax computed under the alternative minimum tax. Unless otherwise provided by law, tax credits are available to reduce the tax liabiltity of the specific taxpayer member which incurred the costs related to the creditable activity, and cannot not be utilized to reduce the tax liability of another taxpayer member of the group.

(4) In no event shall the tax of a taxpayer member, subject to the minimum tax provisions of Section 23153, be less than the minimum tax prescribed by that section.

25106.5-B. Capital, Section 1231, and involuntary conversion gains and losses.

(a) Gains or losses from the sale or exchange of a capital asset (or gains or losses treated as capital gains or losses under Subchapter P of Chapter 1 of Subtitle A of the Internal Revenue Code (hereafter also described as capital gains and losses)), property described by Section 1231(a)(3) of the Internal Revenue Code (Section 1231 property), or property subject to a involuntary conversion shall be apportioned and allocated as provided in this regulation. Reg. Section 25106.5(c) requires that the total separate net income of each member of a combined reporting group be determined without taking into account any capital, Section 1231, or involuntary conversion gain or loss. Thereafter, subsections (c)(3) through (c)(6) shall apply in the determination of a taxpayer member's California source combined report business income, without regard to gains or losses described by this subsection. However, the effect of removal of such gains and losses from the total separate net income of the members shall have no effect upon the apportionment factors of the group or any of its members.

(b) Before any netting of gains and losses from the sale or exchange of capital assets, Section 1231 property, and involuntary conversion gain or loss, such gains and losses are classified as business income or loss, or nonbusiness income or loss, as the case may be.

(c) Each member's business gains and losses from the sale or exchange of capital assets, Section 1231 property, and involuntary conversions are then assigned to the accounting period of the principal member in accordance with the procedures of Reg. §25106.5(c)(4). All of the members' business gains and losses in each class are aggregated and then apportioned, before netting of gain or loss between classes, using the group's taxpayer member's California apportionment percentage for that accounting period, determined under Reg. §25106.5(c)(6), to arrive at the group's taxpayer member's California source gain or loss, for the respective class of income or loss. The resulting California source gain or loss for each respective class is then intrastate apportioned to each taxpayer member of the combined reporting group, using the intrastate apportionment percentage determined under Reg. §25106.5(c)(7) and adjusted to align such income to the income year of the taxpayer member to which it relates in accordance with the procedures of Reg. §25106.5(c)(8) (7).

(d) Nonbusiness gains and losses from the sale or exchange of capital assets, Section 1231 property, and involuntary conversions which are allocated to California, and business gains and losses from such transactions which are apportioned to California (including business gains and losses from other combined reporting groups, if any), are then netted by each taxpayer member using the rules of Sections 1231 and 1222 of the Internal Revenue Code, without regard to any of the taxpayer member's gain or loss from such transactions from any other state source.

(e) Any California source net Section 1231 gain of a member produced in the application of the preceding subsection, shall be treated as California source ordinary income to the extent that the taxpayer member had California source Section 1231 losses in preceding income years, in accordance with the provisions of Section 1231(c) of the Internal Revenue Code.

(f) Any resulting California source income (or loss, if the loss is not subject to the limitations of Section 1211 of the Internal Revenue Code) of a taxpayer member produced by the application of the preceding subsections shall then be applied to California source apportioned income or loss for that member under subsection (d) of Reg. §25106.5.

(g) Any resulting California source net capital loss, which is required to be carried forward under the rules of Section 1212, Internal Revenue Code, as modified by Section 24990.5, Revenue and Taxation Code, shall be treated by the taxpayer member as a California source short term capital loss for the applicable member's income year of the carryover.

Reg. 25106.5-C. Accounting Methods and Elections.

(a) Except as otherwise provided by this regulation or other regulations under Section 25106.5, the taxpayer members of the combined reporting group may elect to determine the net income of a member of the group under accounting methods and other elections as authorized by Division 2, Part 11 of the Revenue and Taxation Code, independently of the net income of other members of the combined reporting group.

(1) Once an accounting method or other election is made for that member, that member's net income must be consistently treated in the combined report of all members of the combined reporting group. In the event that the taxpayer members do not file in a consistent manner, the Franchise Tax Board may, in its discretion, resolve the inconsistency as it deems necessary or appropriate.

(2) Once an accounting method or election is applied to income included in a combined report, the election is irrevocable (unless expressly revocable under the applicable provision of Division 2, Part 11 of the Revenue and Taxation Code). If, under the provisions of Division 2, Part 11, an accounting method or election must continue to be applied in a subsequent tax period, the accounting method or election made in the tax period of the election shall apply to the net income of that member in such subsequent period.

(b) In the event of an audit examination (represented by a notice of additional tax proposed to be assessed, a notice of proposed overpayment, or a letter from the tax auditor regarding a computational effect which does not result in a current year adjustment (e.g., a computation of net operating loss carryover)) which determines that a corporation, which is not itself a California taxpayer, was erroneously excluded from the combined reporting group, the taxpayer members of the combined reporting group may elect to determine the net income of that corporation under accounting methods and other elections as authorized by Division 2, Part 11 of the Revenue and Taxation Code, whether or not such accounting methods or other elections are otherwise required to be made on a timely filed return. For an election under this subsection to be effective, all taxpayer members must agree to the same accounting method or other election for the erroneously excluded entity.

(1) The election described in subsection (b) regulation may not be made if the erroneously excluded entity was obligated to file a U.S. income tax return, and made an election on its U.S. return with respect to the available election or accounting method. In such case, the federal election or accounting method shall apply.

(2) An election or a selection of an accounting method under subsection (b) should ordinarily be made during the course of the audit examination. However, except as otherwise authorized by the Franchise Tax Board in its discretion, the election or accounting method authorized under this subsection must be made no later than sixty days after the date of the applicable notice, and such election or accounting method must be clearly specified. The Franchise Tax Board may extend such sixty day period for good cause, not to exceed 180 days. Information to substantiate the effect of the election or accounting method may be provided within a reasonable time after the election under this subsection is made.

(3) Elections made under subsection (b) may be made on a protective basis, contingent upon a final determination that the excluded member was properly included in the combined reporting group, and do not operate as a concession that the inclusion of the corporation in the combined reporting group was correct. In the event of a protective election, substantiation of the effect of the election may be deferred until the final determination is made whether the excluded member was properly included in the combined reporting group. However, the taxpayer must retain all records to substantiate the effect of the election, under Section 19141.6 of the Revenue and Taxation Code, and assumes the effects described therein associated with failure to retain the appropriate records.

(4) An election under subsection (b) may only be invoked for the first set of income years under examination, in the first year for which the nontaxpayer's accounting method or election is applicable.

Example: Taxpayer was under a single audit examination for income years 1992, 1993, and 1994. In the course of the examination, the auditor proposed to include Corporation A, a nontaxpayer, in the combined reporting group. Had Corporation A been originally included in the combined reporting group, the taxpayer would have been able to make an election to expense research and development costs on behalf of Corporation A. The first year in which such eligible costs were incurred was 1993. The taxpayer did not contest the inclusion of Corporation A in the combined reporting group, and did not invoke this subsection to elect to expense such costs. The taxpayer was reexamined for income years 1995, 1996, and 1997, and the auditor again proposed to include corporation A in the combined reporting group. The taxpayer may not invoke this section to expense research and development costs for 1995-1997, and may only apply for permission to change that method on a timely basis for a current income year.

(5) In the event that an audit examination determines that a California taxpayer, which had previously filed a California return, was erroneously excluded from the combined reporting group, the accounting methods and elections reflected in the return of that taxpayer shall continue to apply.

Section 25106.5-D. Fiscalization.

(a) If the accounting period of the principal member and one of the other members of the combined reporting group do not begin and end on the same dates, adjustments must be made to the other members' combined report business income and apportionment data, to assign an appropriate amount of those values to the accounting period of the principal member in order for total group combined report business income to be apportioned. Each member of the group should generally use combined report business income and apportionment data from its books of account, earned during the accounting period of the principal member. This will require an interim closing of the books for members whose normal accounting period differs from the principal member. However, a pro rata method of converting income to the principal member's accounting period will be accepted as long as the method does not produce a material misstatement of income apportioned to this state. Unless otherwise permitted or required by the Franchise Tax Board, the treatment of both the income and the apportionment data of any particular member must use the same method. If one method was used to account for a member's income and apportionment data in the combined report for the principal member's preceding accounting period and another method will be used in the combined report for the principal member's next accounting period, adjustments to income and apportionment data of the member shall be made to prevent income and apportionment data from being omitted or duplicated.

(b) Interim closing method.

(1) The combined report business income and expense of a member of the commonly controlled group may be determined by reference to the sum (or net) of such income from the actual books and records (determined under the Revenue and Taxation Code) of that member for each of the partial accounting periods of the member shared with the principal member. For example, if the principal member has an accounting period ending on December 31, 1997, and another member has an accounting period ended March 31, 1998, the other member may determine its income from its actual books and records for the partial accounting periods beginning January 1, 1997 and ending March 31, 1997, and from April 1, 1997 and ending December 31, 1997.

(2) The apportionment data (property, payroll, and sales in California, and everywhere) shall also be determined by reference to the member's books and records, as provided in Sections 25129-25137, Revenue and Taxation Code, and the regulations thereunder, for the appropriate partial accounting year. Under the interim method, the property factor computation should reflect the actual, not prorated, property owned and rented during the principal member's accounting period.

Example 1. If the principal member has an accounting period ending on December 31, 1997, and another member has an accounting period ended March 31, 1998, and monthly weighted averaging of the property factor is not required under Section 25131, Revenue and Taxation Code, the other member will determine its total property and its California property on the dates of January 1, 1997 and December 31, 1997 from its actual books and records.

Example 2. Assume the same facts as Example 1, except monthly weighted averaging is required. In that case, the actual monthly California property and total property values of the member required to fiscalize to accounting period of the principal member will be determined for each of the twelve months during the 1997 calendar year from that member's actual books and records.

(3) Interim combined report business income and apportionment data from the respective partial periods is then combined with the income and apportionment data of the income year of the principal member, along with business income and apportionment data of other members of the combined reporting group for the same period, using, if applicable, the methods prescribed in this regulation.

(c) Pro rata method.

(1) At the election of the members of a combined reporting group, fiscalization of combined report business income of one or more members of the group to the accounting period of the principal member may be determined by use of a pro rata method. Under a pro rata method, the apportionment data and combined report business income from the member's adjusted separate books of account (i.e., adjusted to reflect the determination of income under the California Revenue and Taxation Code) is assigned to the respective portion of the principal member's income year based on the ratio of months in common with that member. For example, if the principal member's income year ends on December 31, 1997, a member whose income year ends on March 31 will reflect 3/12ths of its adjusted separate combined report business income and its payroll and sales for its income year ended March 31, 1997 in the December 31, 1997 income year of the principal member. That member will then reflect 9/12ths of its adjusted separate combined report business income and its payroll and sales for its income year ended March 31, 1998 in the December 31, 1997 income year of the principal member.

(2) For members utilizing the pro rata method, if the property factor is not required to be determined on a monthly weighted averaging method described by Section 25131, the property factor data used for a member using that method will be the pro rata portion of the member's property numerator and denominator values for its respective separate accounting periods, reflecting beginning and ending average property values for those separate accounting periods.

Example. Assume that the principal member's income year ends on December 31, 1997, and another member's income year ends on March 31. That member is required to fiscalize its income to the accounting period of the principal member. The fiscalizing member determines its California beginning and ending property, and its total beginning and ending property to determine its California and total property for the period ended March 31, 1997. That member then makes a comparable determination for the period ended March 31, 1998. The fiscalizing member will apply 3/12ths of the California property and total property for the March 31, 1997 income year and 9/12ths of the California property and total property for the March 31, 1998 income year of to the principal member's December 31, 1997 income year for computation of the property factor for the combined reporting group.

(3) The combined report business income and apportionment data from the respective partial periods is then combined with the income and apportionment data of the income year of the principal member, along with business income and apportionment data of other members of the combined reporting group for the same period, using, if applicable, the methods prescribed in this regulation.

(4) In the event that the pro rata method requires the determination of income and apportionment data of a corporation whose income year has not yet closed, and the information cannot be obtained in time to for the other members to file an accurate return, the income and apportionment data for that period shall be estimated based on available information. If the use of actual income and apportionment data results in a material change in the tax liabilities of the taxpayer members of the group, the taxpayer members must file an amended return to reflect the change.

(d) After the combined reporting group's income is apportioned to California, and then intrastate apportioned to the respective taxpayer members, California source combined report business income of a taxpayer member is then proportionately assigned to the applicable portion of that member's income year, based on the number of months falling within the common income year of the principal member. For example, if the principal member's income year ends on December 31, 1997, a taxpayer member whose income year ends on March 31 will reflect 3/12ths of its share of intrastate apportioned income from the principal member's December 31, 1997 income year in its income year ended March 31, 1997, and 9/12ths of its share of such income in its income year ended March 31, 1998. The resulting income from such segments is then aggregated (or netted) together for the member's income year to determine that member's business income from California sources attributable to the combined reporting group.

25106.5-I. Partial combined reporting periods.

(a) If a member of a combined reporting group is not a member of the combined reporting group during the entire accounting period of the principal member (e.g., because of lack of unity of ownership under Section 25105, Revenue and Taxation Code, or termination of a unitary relationship), modified combined reporting procedures apply as provided herein. Business income and apportionment data of a member is included in the combined report of the remaining members only for the period (or partial period) for which all of the members are in the combined reporting group. Thus, if a member of a combined report group enters or leaves the group at a time during the middle of the accounting period of the principal member, a separate combined report determination is required to be made only for the partial period of combination. The partial period combination is made using the same combined reporting procedures for a 12 month period, except that payroll, property and sales data will reflect only the amounts applicable to the partial period. Establishment or termination of a combined reporting relationship will not, by itself, cause a short period filing requirement. However, in many cases, the effect of leaving or entering an affiliated group of corporations cause a short period filing requirement under other provisions of law, independently of this regulation.

Example: (Reserved.)

(b) If a taxpayer member's income year does not begin and end on the same dates as the partial period combination (e.g., a short period return is not required), the taxpayer member's California source income earned during that portion of the income year before and after the partial period combination is aggregated (or netted) with the taxpayer member's California source combined report income from the partial period combination. The California source income so described may include income from two or more partial period combinations.

Example: Corporation P owns all of the stock of Corporation S for the 12 month period ended December 31, 1998. Corporations P and S are unitary and are obligated to file a combined report for the entire period. Corporation P acquires 51% of the stock possessing voting power of Corporation A on March 7, 1998. The acquision does not compel the filing of a short period return by Corporation A. All of the Corporations have an calendar accounting period. Corporation A becomes unitary with Corporations P and S on July 1, 1998 and is obligated to file a combined report with Corporations P and S for the partial period beginning on July 1, 1998. The income and apportionment data of Corporation A for the period prior to July 1, 1998 may not be included a combined report with corporations P and S. Under the rule prescribed by subsections (a) and (b), two separate partial period combined report calculations are required. One is for the P-S group for the partial period ended June 31, 1998, and the other is for the P-S-A group for the partial period from July 1, 1998 to December 31, 1998. Assume that Corporation P's California source combined report income is $250,000 for the partial period ended June 31, 1998 and is ($60,000) for the partial period ended December 31, 1998. Corporation P's California source combined reporting income for its income year ended December 31, 1998 is $190,000. Assume that Corporation A has California source income from its unaffiliated and nonunitary partial period (or from another combined reporting group, if applicable) of $50,000 and California source combined reporting income of ($30,000) for the combined report partial period after it joined the combined reporting group. Corporation A's California source income for its income year ended December 31, 1998 is $20,000.

(c) In lieu of partial period combination method described by subsection (a), the taxpayer members of the commonly controlled group may elect to utilize the method provided in this subsection. The election must be consistently used by all taxpayer members. The election may not be utilized if the results of that method, compared with the provisions of subsections (a) and (b) result in a material misstatement of the taxpayer member's California source income. Under the method described in this subsection, the partial period combined reporting income of a member, which is not in a combined reporting relationship with the principal member for the entire accounting period of the principal member, is considered to be reflected by the relative weighting of the apportionment data of the partial period member to the apportionment data of the rest of the combined reporting group for the accounting period of the principal member. The method applies as follows:

(1) The principal member's income and apportionment data are determined for its entire accounting period (usually a 12 month period). All other members which were members of the combined reporting group during the entire period of the principal member, also include their income and apportionment data for that period, using fiscalization methods, if appropriate.

(2) Members who were not members of the combined reporting group for the entire accounting period of the principal member include in the combined report only their income for the partial period during which they were a member. Normally this income will be determined by an interim closing of the taxpayer's books of account (determined in accordance with the Revenue and Taxation Code). Similarly, the apportionment data of that member is included only for that same partial period.

(3) Property factor data for the partial period member (both California property and total property) must be adjusted to reflect the fact that the property was not utilized in the combined reporting group for the entire period of the principal member. For example, if the partial period member was in the combined reporting group for only 7 months of the 12 month accounting period of the principal member, and monthly weighted averaging is not required under Section 25131, only 7/12's of the member's average California and total property for the period are reflected in the combined report.

(4) Apportionment and intrastate apportionment is then computed using the amounts included in the preceding subsection, as if the partial period members were members for the entire accounting period of the principal member. The amounts apportioned to the individual taxpayer members then reflects the member's California source combined reporting income for the partial period. That member then aggregates (or nets) Califonria source combined reporting income with its California source income from other activity to compute income subject to taxation for the entire income year.

Example: (Reserved.)