California Registration and Taxation of Foreign Entities
When must a foreign entity (i.e., a corporation, LLC, or limited partnership formed under the laws of another state) register with the California Secretary of State as a foreign entity doing business in California? As described below, the bar for this is actually set somewhat high. Does the same analysis also apply to the question of when a foreign entity is subject to California taxes and fees? No. As described below, the bar for this (perhaps not surprisingly) is set significantly lower.
Registration with the California Secretary of State.
The standard for when a foreign entity must register with the California Secretary of State is, with only slight variations, uniform among corporations, LLCs and limited partnerships: an entity must register when the entity is “transacting intrastate business” in California. An entity is “transacting intrastate business” in California when it is “entering into repeated and successive transactions of its business in this state, other than in interstate or foreign commerce.”
The definition of “transacting intrastate commerce” means that an entity regularly completes transactions in which the entire transaction is carried out in the State of California. If the entity owns no property in California, and does no business in California, the entity likely has no duty to register, even if its equity holders and management personnel live in California. The definition of “transacting intrastate commerce” for each entity contains a list of actions that do not constitute transacting intrastate commerce, and the lists are substantially identical among the entities. For example, the list of such items for an LLC is:
- Maintaining or defending any action, suit, administrative, or arbitration proceeding;
- Holding meetings of managers or members;
- Being a shareholder, a limited partner, or a member or manager of an LLC;
- Maintaining bank accounts;
- Selling through independent contractors;
- Soliciting or procuring orders, whether by mail or electronic means or through employees or agents or otherwise, if the orders require acceptance outside California before they become contracts;
- Borrowing money (“creating … evidences of indebtedness mortgages, liens, or security interests”);
- Securing, collecting, and enforcing debts;
- Engaging in certain isolated transactions;
- Transacting interstate business; and
- Having a subsidiary that transacts intrastate business in California.
In summary, an entity can have fairly significant connections with California, through its personnel or subsidiaries, or through interstate transactions, and not meet the “transacting intrastate commerce” standard necessitating registration with the California Secretary of State.
Taxation by the California Franchise Tax Board (FTB).
If the standard for registration described above is “transacting intrastate business,” the standard for taxation is “doing business.” Every entity “doing business” in the State of California, whether registered in the state or not, is subject to taxation by the state. “Doing business” is defined in Rev. & Tax Code Section 23101, which is divided into two definitional parts.
Section 23101(b) provides that an entity is “doing business” if it is organized or commercially domiciled in California, or if any of three different quantitative tests (adjusted for inflation), involving the entity’s sales, property, or payroll are met. The threshold for California sales is currently the lesser of $601,967 or 25 percent of the LLC’s total sales; the threshold for California real and tangible personal property is currently the lesser of $60,197 or 25 percent of the LLC’s total real and tangible personal property; and the threshold for compensation paid to California employees is currently the lesser of $60,197 or 25 percent of total compensation paid by the LLC. Section 23101(d) provides that the sales, property, and payroll of the taxpayer entity include the taxpayer’s pro rata or distributive share of pass-through entities. As described in an earlier Tax Notebook Blog post (“The Long Arm of California’s Franchise Tax Board,” published 12/12/20), as evidenced by The Matter of the Appeal of Aroya Investments I, LLC, the objective criteria of Section 23101(b) and (d) are rigorously applied.
Section 23101(a) sets forth a more subjective standard, and provides that “doing business” means “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” According to the FTB, this does not require a regular course of business or multiple transactions to trigger an obligation to file a return and pay applicable taxes and fees. Any activity in California that meets the definition is sufficient. A transaction need not result in an actual profit if the transaction or activity was motivated by financial gain or profit.
The FTB has been particularly aggressive in its rulings with respect to LLCs. In FTB Publication 689 titled “Doing Business in California,” the FTB takes the position that any actions undertaken by a member or manager located in California on behalf of the LLC is enough to subject the LLC to California tax laws: “A business entity is subject to any applicable entity tax if its business is conducted in California by its managers, directors, or other persons acting as its agents.”
In FTB Legal Ruling 2014–01, the FTB took the position that entities that are members of an LLC classified as a partnership for tax purposes and doing business in California, are deemed to be doing business in California and therefore are subject to California taxation. This position was rejected by the Court of Appeal in Swart Enterprises, Inc. v Franchise Tax Bd. in which the court found that a foreign corporation owning a 0.2% ownership interest in a California LLC, with no right of control over business of LLC, is not doing business in California. The FTB attempted to limit Swart to its facts and establish that a 0.2% membership interest is a bright-line test. This approach was rejected by the Office of Taxpayer Appeals (OTA) in In the Matter of the Appeal of Jali LLC where, in a precedential opinion, the OTA explicitly rejected the FTB’s 0.2% bright-line test in favor of a “‘fact intensive inquiry’ into the nonresident member’s relationship with the instate LLC.” However, as demonstrated in The Matter of the Appeal of Aroya Investments I, LLC, mentioned above, if any of the factors in Section 23101(b) are met, there is no need for an inquiry under Section 23101(a).
- The bar for “doing business,” and therefore being subject to taxation in California, is significantly lower than the bar for “transacting intrastate business,” and therefore being subject to registration with the Secretary of State.
- Entities that are registered with the Secretary of State are subject to taxation in California by virtue of being registered.
- Entities that are not required to register with the Secretary of State may still meet the “doing business” requirement and be subject to California taxation.
 Cal. Corp. Code §§ 2100, 17708.02(a), and 15909.03.
 Cal. Corp. Code §§ 191, 17708.03(a), and 15901.02(ai)(1).
 Cal. Corp. Code § 17708.03(b).
 Cal. Rev. & Tax Code §§ 23151(a), 17941(a), and 17935(a).
 OTA Case No. 19074982 (July 7, 2020)
 See, e.g., FTB Legal Ruling 2014–01, issued July 22, 2014, as modified by FTB Legal Ruling 2018–01.
 7 CA5th 497 (2017).
 OTA Case No. 18073414 (July 8, 2019).
 See, e.g., Cal. Rev. & Tax Code §§ 17941(b) and 17935(b).
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