The California Franchise Tax Board (FTB) has made recent inquiries regarding the in-bound California activities of foreign affiliates of water’s-edge taxpayer groups. The FTB appears to be asserting that if a foreign affiliate has sales into California (including intercompany sales) exceeding $500,000, it has factor presence nexus, which causes the entity to be a California taxpayer. Because the foreign entity has not been part of the affiliated group’s water’s-edge filing, the FTB is not treating it as having a water’s-edge election in place. California Code of Regulations section 25113(c)(2)(A)4 provides if upon audit a non-electing California taxpayer is subsequently determined to be unitary with an electing water’s-edge taxpayer group, then the election or non-election of the largest taxpayer group applies. If certain assets of the foreign affiliates are larger in value than the assets of the water’s-edge taxpayer group, then the result is a termination of the water’s-edge election.
It is our understanding that California FTB auditors recently received training on this position and are now actively looking for this issue on audit.