On September 28, 2006, the California Franchise Tax Board ("FTB") issued Notice 2006-3 ("Notice") regarding the effect of the recent decision by the California Supreme Court in Microsoft Corp. v. FTB on Notice 2004-5. Notice 2004-5, issued by the FTB in August 2004, generally stated that where a taxpayer took a position in its original return that was based on Revenue and Taxation Code section ("section") 25137, without the prior approval of the FTB, that taxpayer could have been subject to the accuracy-related penalty under section 19164 (based on IRC sections 6662-6665).
The Court’s August 17, 2006 decision in Microsoft, ___4 Cal.4th ___ (petition for rehearing pending) held (in part) that the total amount realized on the redemption of marketable securities as part of a business’s treasury function constitutes "gross receipts" for sales factor purposes. The Microsoft decision had raised issues for taxpayers that are about to file returns, many due on October 15, 2006, regarding whether they were required to include such gross amounts in the sales factor on their original returns. Many such taxpayers, especially those with California-based treasury functions, believed that inclusion of such gross amounts would not fairly reflect the extent of their business activities in California within the meaning of section 25137. Under Notice 2004-5, taxpayers wishing to include only net (instead of such gross) amounts on original returns were required under Notice 2004-5 either to seek approval from the FTB prior to filing the original return to use net receipts under section 25137, or to risk imposition of the section 19164 accuracy-related penalty.
Notice 2006-3 removes the risk of incurring that penalty. The Notice states that under authority of Microsoft and the California State Board of Equalization decision in Appeal of Pacific Telephone & Telegraph (May 4, 1978, 78-SBE-028), for purposes of applying Notice 2004-5, a taxpayer that excludes the amount realized on the redemption of marketable securities as part of its treasury function from the sales factor, and includes only the interest income and net gains from such securities, will not be subject to the accuracy-related penalty under section 19164. However, the FTB may review and audit such returns filed under section 25137 and may make adjustments.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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