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Explanation of the Discussion Draft

Explanation of the Discussion Draft, 18 Cal. Code of Reg. Section 25137 or 25137-__. Net Gains from Sale of Certain Intangibles--Apportionment of Income.

Attached is a discussion draft of a proposed amendment to the regulations addressing the allocation and apportionment of income from the sale of certain intangibles. The proposed amendment, if adopted, will be added to the current Reg. Section 25137 or will be added as a separate regulation under California Revenue & Taxation Code Section 25137.

The proposed amendment to the regulations will apply to gains and losses on the sale of liquid assets not excluded from the sales factor by other provisions of Reg. Section 25137. The proposed amendment applies to receipts arising from liquid assets held in connection with one or more treasury functions of the taxpayer. The overall net gain from the sale, exchange or other disposition of liquid assets producing business income will be included in the sales factor.

The definition of a liquid asset is found at subparagraph B. Treasury function is defined at subparagraph C. The proposed amendment expressly does not apply to taxpayers engaged in the trade or business of purchasing and selling financial instruments or other items included in the definition of liquid assets, e.g., securities brokers.

The proposed amendment reflects the conclusion that inclusion of gross receipts from the sale of certain short term investments and reinvestments of certain intangible assets distorts the apportionment of the taxpayer’s business income. The proposed amendment to the regulations will provide for a uniform method of treatment of the gain from these transactions. Dealers and traders of securities would be excepted and would continue to be required to continue to include the gross receipts from such transactions in their sales factors.

The proposed amendment reflects the holding of the California State Board of Equalization in Appeals of Pacific Telephone and Telegraph Company, Cal. State Bd. of Equal., May 4, 1978, 78-SBE-028, CCH §205-858. There the California State Board of Equalization determined that the capital element of investment receipts derived from working capital pools should be excluded from the sales factor in order to achieve a reasonable apportionment of the taxpayer’s income. The proposed amendment extends the holding in Appeals of Pacific Telephone and Telegraph Company to all receipts from liquid assets in connection with the treasury function and eliminates a distortion threshold requirement.