Taxation

Ca. Tax Lawyer 2017, VOLUME 26, NUMBER 2

Economic Nexus Threatens Water’s Edge Elections: A Legislative Proposal for Relief1, 2

By Robert Keith Gray, Jr. & Joshua M Grossman 3

EXECUTIVE SUMMARY

This article proposes that California’s Legislature amend California Revenue & Taxation Code ("R&TC") Section 25113 so that unitary foreign affiliates that acquire nexus through California’s factor presence economic nexus standard that became effective in 2011 will be deemed to be included in the existing water’s-edge election made by their unitary California affiliates, and leave the effective date of the existing water’s-edge election unchanged.

Under California’s factor presence economic nexus statute that became effective in 2011, a unitary foreign affiliate with no United States ("U.S.") activity that was historically excluded from a combined report by a water’s-edge election can acquire nexus beginning in 2011 solely by having receipts assigned to California under California’s market-based sourcing rules. Under these circumstances, because the foreign affiliate taxpayer was not doing business in California prior to the adoption of California’s factor presence economic nexus standard (and therefore was not a taxpayer), it was not required to make, nor could it have made, a water’s-edge election prior to 2011. However, if California’s factor presence economic nexus statute causes the foreign affiliate to become a taxpayer after January 1, 2011, current law may not allow it to be deemed to join an existing water’s-edge election previously made by its unitary California affiliates. In fact, in certain circumstances, the foreign affiliate’s acquisition of California nexus may actually cause the termination of its unitary California affiliates’ existing water’s-edge election. Additionally, if the foreign affiliate makes its own de novo water’s-edge election after acquiring nexus, there is a lack of clarity regarding the impact its election will have on the commencement date of its unitary California affiliates’ existing water’s-edge election.

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