CA Issues Asset Management Sourcing Guidance

The California Franchise Tax Board issued amended California Regulation Section 25136-2 to provide new apportionment rules for certain asset management revenue. The new regulations are applicable for tax years beginning on or after Jan. 1, 2026.

Amended regulations

Revised California Regulation Section 25136-2 provides apportionment treatment for asset management service revenue not subject to California Regulation Section 25137-14, which addresses revenue of regulated investment companies and mutual fund service providers.

The amended regulation provides that receipts from asset management services are assigned to California in proportion to the average value of interest in the assets held by the assets’ investors or beneficial owners domiciled in California.

To calculate the average value of interest, the regulation provides that businesses can use one of two methods:

• Add the percentage of the value of interest in the assets held by investors or beneficial owners domiciled in California at the beginning of the taxable year to the percent of the value of interest in the assets held by investors or beneficial owners domiciled in California at the end of the taxable year, and divide by two.
• If the ownership by investors or beneficial owners domiciled in California is unknown, then the taxpayer must provide a reasonable estimate of this percentage.

The two methods require a business to assign revenue based not on the location of its customer (the managed entity) but rather on the location of the managed entity’s customers. This change will require a broader group of service companies to use investor-based sourcing, which previously was required only for mutual fund service providers.

Crowe observation

These new rules could be challenging for some asset managers to apply because they will need to determine the domicile of ultimate beneficial owners. This is not generally the type of information lower tiers have because federal tax rules generally do not require upper-tier partnerships to disclose investors to lower tiers.

Beneficial owners

If the investor holds title on behalf of a beneficial owner, the benefit of the service is deemed received at the domicile of the beneficial owner.

The amended regulations define “beneficial owner” as any person who made an independent decision to invest assets. For purposes of this definition, “independent decision to invest assets” means a decision to invest assets made by a person who was not required or committed to do so by contract, agreement, or any other arrangement, understanding, or relationship except pursuant to law.

Feeder funds and similar pooling entities, shareholders of a public corporation where the board decides to invest in an investment vehicle, or participants in defined benefit plans do not meet the definition of a beneficial owner.

Determining domicile

Under the amended regulations, the domicile of an investor or beneficial owner is presumed to be its billing address unless the asset manager has actual knowledge that the investor’s principal place of business or residence is different from the investor’s billing address.

Other changes

The amended regulations broadly define “asset management services” as the direct or indirect provision of management, distribution, or administrative services to funds. They also define other key terms such as “administrative services,” “distribution services,” “management services,” and “fund.” The amended regulations also provide several examples applying the new sourcing treatment.

Looking ahead

To comply with California’s new asset management apportionment regulations, a fund that has partnership investors will need to adopt a method to expand the information it receives from upper tiers regarding the upper-tier investors and beneficiaries. This could mean expanding subscription documents to collect that information or developing methods to create a reasonable estimate of investor and beneficiary domiciles. Additionally, the new regulation will require many asset management businesses that have never filed a California income tax return in the past to file a tax return based solely on having investors in the state.

Affected taxpayers should consult their tax advisers to determine the proper application of the new California asset management apportionment regulations and evaluate the potential impact of the new law, including how it could create new California filing obligations or affect the California income tax returns required to be filed for tax years beginning in 2026.