October 10, 2002 | By Keith Martin in Washington, DC

CALIFORNIA said that out-of-state generators who sell electricity into California earn their income outside the state.

At issue is whether franchise taxes must be paid on the income. The ruling — by the State Board of Equalization in a case involving PacifiCorp — helps generators and power marketers who sell electricity into California.

PacifiCorp protested franchise taxes that California said it owed for the period 1984 through 1989. The company sold excess power during those years into California from power plants in Oregon, Washington, Wyoming and Utah. Corporations are subject to franchise taxes in California on income from California sources. A company’s California income is determined by taking all of its income and then allocating a portion to California based on a three-factor formula that looks at the percentage of its total workforce, property and sales that is in California. Sales of “tangible personal property” are considered to occur where the customer is located. However, sales of services occur where the physical work is done to create the service. The State Board of Equalization said electricity is a service. Therefore, the sales in this case occurred outside California where the electricity was generated. The board released its formal opinion in the case in late September.

There is no consistency among states on how they view electricity. The inconsistency opens the door to tax planning since it is theoretically possible to allocate sales to no state by selling into states like California from states that allocate the sales to the place where the customer is located. The issue also comes up frequently in “tolling” transactions: states are often confused about how to apply sales taxes, which are collected on retail sales of “tangible personal property,” but may or may not be collected on sales of services. In a “tolling” transaction, a gas supplier pays the owner of the power plant fees to convert its gas into electricity.