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State & Local Tax Alert
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California FTB Clarifies Economic Nexus Principles Do Not Apply
to Throwback Rule for Tax Years Before 2011
The California Franchise Tax Board (FTB) has issued a Technical Advice Memorandum
to explain that economic nexus standards do not apply when applying the throwback rule
to tax years beginning before January 1, 2011. 1 During these prior tax years, California law
required physical presence to establish substantial nexus for purposes of the Commerce
Clause of the U.S. Constitution. Thus, a taxpayer must demonstrate physical presence in
the destination state to establish that it is subject to taxation in that state in order to avoid
the throwback rule for tax years prior to 2011.
Throwback Rule and Nexus Standards
In determining that a taxpayer must have a physical presence in the destination state to
avoid the throwback rule for tax years prior to 2011, rather than asserting the existence of
substantial sales in a destination state without physical presence, the FTB reviewed
California’s statutory and regulatory throwback provisions, the nexus requirements and
California’s new economic nexus standard.
Throwback Rule
For purposes of the sales factor component of the formula used to apportion income to
California, tangible personal property shipped from California is generally assigned
(thrown back) to California if the taxpayer is not taxable in the destination state. 2 For
purposes of the throwback rule, a taxpayer is taxable in another state if: (i) in that state it is
subject to a net income tax, a franchise tax measured by net income, a franchise tax for the
privilege of doing business or a corporate stock tax; or (ii) that state has jurisdiction to
subject the taxpayer to a net income tax regardless of whether, in fact, the state does or
does not. 3
If a sale is destined for a foreign country, U.S. Constitutional standards are used to
determine whether a taxpayer is subject to taxation in that country. 4 A taxpayer’s sales will
not be thrown back to California if: (i) the taxpayer is subject to an income tax in the
December 20, 2012
States
California
Issue/Topic
Corporate Income Tax
Contact details
Scot Grierson
Irvine
T 949.608.5320
E scot.grierson@us.gt.com
David Griffiths
Irvine
T 949.608.5210
E david.grifiths@gt.com
Eddie Delgado
Los Angeles
T 213.596.3448
E eddie.delgado@us.gt.com
Maria Tran
Los Angeles
T 213.596.6733
E maria.tran@us.gt.com
Giles Sutton
Dallas
T 704.632.6885
E giles.sutton@us.gt.com
Jamie C. Yesnowitz
Washington, DC
T 202.521.1504
E jamie.yesnowitz@us.gt.com
Chuck Jones
Chicago
T 312.602.8517
E chuck.jones@us.gt.com
www.GrantThornton.com/SALT
1 Technical Advice Memorandum 2012-01, California Franchise Tax Board, Nov. 29, 2012.
2 CAL. REV. & TAX. CODE § 25135.
3 CAL. REV. & TAX. CODE § 25122.
4 CAL. CODE REGS. tit. 18, § 25122.

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foreign country; or (ii) the foreign country could impose an income tax under U.S.
Constitutional standards. 5
Substantial Nexus Requirement
Before a state may impose an income tax, the Due Process and Commerce Clauses of the
U.S. Constitution require that nexus exists between the taxpayer and the taxing state. 6 For
purposes of the Due Process Clause, nexus exists if an out-of-state company purposely
avails itself of the benefits of an economic market in the state, even though it may not be
physically present in the state. 7 Nexus is present under the Commerce Clause if the
activities the state seeks to tax have substantial nexus with the state. 8 As explained by the
FTB, the rules concerning whether the Commerce Clause’s substantial nexus standards
require physical presence have evolved over time. However, the FTB noted that
“California authorities have consistently provided that physical presence is required in
order for a taxpayer to have sufficient nexus to be subject to tax.” 9
Economic Nexus Standard
California defines “doing business” as “actively engaging in any transaction for the
purpose of financial or pecuniary gain or profit.” 10 For taxable years beginning on or after
January 1, 2011, a corporation is doing business in California if the taxpayer’s sales in
California exceed the lesser of $500,000 or 25 percent of the taxpayer’s total sales. 11
Physical Presence Required Prior to 2011
Based on the authority discussed above, the FTB determined that the new economic
nexus standard only applies to tax years beginning on or after January 1, 2011. According
to the FTB, “[b]y enacting legislation providing that a taxpayer is doing business in
California where a taxpayer’s only contact with this state are sales exceeding $500,000,
California’s Legislature determined for the first time that substantial economic presence
meets Constitutional standards under California law.” The FTB further stated that “[i]n
enacting this statutory provision, California’s Legislature determined that under California
law, physical presence is no longer required in order for the state to subject a business to
tax.” Therefore, for throwback purposes in tax years before 2011, a taxpayer must
5 Id.
6 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
7 Id.
8 Id.
9 The FTB cited Appeal of Dresser Industries, Inc., California State Board of Equalization, No. 82-SBE-
307, June 29, 1982, rehearing No. 83-SBE-118, Oct. 26, 1983; Appeal of John H. Grace Co., California
State Board of Equalization, No. 80-SBE-115, Oct. 28, 1980; as well as some unpublished
decisions.
10 CAL. REV. & TAX. CODE § 23101(a).
11 CAL. REV. & TAX. CODE § 23101(b). The statute also provides that a taxpayer is doing business
in the state if the taxpayer’s tangible property or payroll in the state exceeds $50,000 or 25 percent
of the taxpayer’s total property or payroll.

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demonstrate physical presence 12 in the destination state to prove that it is subject to
taxation in that state. If it meets this requirement, the taxpayer is not required to throw
back these sales for tax years prior to 2011.
Commentary
Earlier this year, the FTB released a Chief Counsel Ruling that applied California’s new
economic nexus standard, the Finnigan rule, and market-based sourcing to determine when
the throwback rule applies to sales of items shipped from California to another
jurisdiction. 13 When examining the interplay between the economic nexus standard and
the throwback rule, the FTB noted that it was not considering the potential applicability of
the economic nexus rules for tax years prior to 2011, perhaps with the knowledge that the
FTB was considering the issuance of this Technical Advice Memorandum. As a result of
both releases, taxpayers are provided with guidance concerning the throwback rule for tax
years before 2011 (when the economic nexus standard was not in effect) as well as
subsequent tax years (when the economic nexus standard is in effect).
Apparently, some taxpayers have argued that the economic nexus standard applied to tax
years beginning before 2011 for purposes of the throwback rule, particularly as many
states other than California have administered their corporate-level taxes with statutory,
regulatory or policy-driven economic nexus rules. Under this argument, substantial sales
in the destination state would be sufficient to avoid the throwback rule. This guidance
clarifies the FTB’s position that physical presence is necessary to escape the throwback
rule for tax years prior to 2011. Thus, a taxpayer must have a stronger connection with
the destination state in these prior tax years if it does not want to throw back its sales.
The information contained herein is general in nature and based on authorities that are subject to change.
It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by
Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific
circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant
Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant
Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that
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12 Note that this can be established either directly or through agents or independent contractors.
13 Chief Counsel Ruling 2012-03, California Franchise Tax Board, Aug. 28, 2012. For more
information, see GT SALT Alert: California FTB Chief Counsel Ruling Applies New Economic
Nexus Principles to Use of Throwback Rule, Nov. 15, 2012.

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