California VAT on services is included in the California sales factor

Overview

California Office of Tax Appeals (OTA) has issued an opinion in the Appeal of Robert Half International, Inc. (Robert Half) (Oct. 3, 2019). The sole issue in the appeal was whether excise taxes collected as part of the sales price of services, such as a value added tax (VAT) or goods and services tax, should be included in gross receipts for California sales factor purposes.

The OTA held that VAT on services is properly considered a gross receipt and should be included in the California sales factor.

The takeaway

This decision rejects the FTB’s longstanding position that VAT imposed on the sale of services cannot be included in the California sales factor, at least for pre-2011 tax years.

Notably, the OTA explicitly limited this decision to the tax year at issue after noting that CRTC section 25120 was revised for post-2010 taxable years, but the current definition of gross receipts in CRTC section 25120 does not appear to contain any language that would prevent the application of this decision to post-2010 taxable years.

Taxpayers collecting VAT on services should consider the implications of this decision when calculating their California sales factor, and may want to consider refund claims for this position for prior tax years. The decision will primarily benefit taxpayers filing on a worldwide basis in California, or those filing water’s-edge that have foreign affiliates subject to inclusion.  Note that the amount of VAT includible in the sales factor is the gross amount the taxpayer collects from its customers, rather than just the net amount that the taxpayer must remit after subtracting its own VAT payments made to vendors.