Contents

Overview

✅ What Business Activity in California is TAX FREE?

1️⃣ California Corporation Code

2️⃣ California Franchise Tax Board

3️⃣ California Privacy Law

4️⃣ Penalties for "Doing Business" without Registration

5️⃣ How to Register with the California Secretary of State

6️⃣ New Climate-Related "Greenwashing" ESG Disclosure Laws

7️⃣ California Income Tax

Overview

California's Corporation & Taxation Codes as well as its Privacy and ESG Disclosure Laws are as broad and far-reaching as possible. The laws are designed to trigger the obligation to register with the Secretary of State, pay taxes in California, comply with ESG Disclosure and protect the privacy of Californian Residents whenever possible.

Therefore, businesses with any exposure or connection to California, regardless of how minimal or remote, need to carefully consider whether they could be deemed to be "Doing Business" in California.

There is no clear definition of what it means to “Do Business” in California, with different Californian agencies holding different views regarding what they consider constitutes “Doing Business”.

A unique aspect of the tax law in California is the concept of a Franchise Tax which is a payment for the privilege of being registered to "Do Business" in California.
The annual $800 franchise tax is payable even if the business makes a loss.

This blog article will help you understand when these legal obligations extend to potentially include businesses that are not physically based in California.

What Business Activity in California is TAX FREE?

✅ Foreign Commerce or Trade (both overseas and interstate) is not taxed in California, so long as the sales order is accepted outside of California.

Sales Tax does NOT apply to the following:

✅ Services; and the

✅ Sale of Digital Intangible Products such as Online Legal Documents;

Usage Tax does NOT apply to the following:

✅ Sale of Digital Intangible Products, but

⚖️ Could apply to a Digital Streaming Service delivering digital content to Californian residents.

Examples of NOT "Doing Business" in California: The Swart Case

In the past, the Franchise Tax Board (FTB) has filed cases against companies that were deemed to be "Doing Business" in California and did NOT comply with their tax obligations.

✅ As an example, Swart Enterprises, an out-of-state company from Iowa owned a 0.2 percent interest in a California investment fund.

They paid their taxes and requested a refund.

The ruling of the FTB ordered Swart to pay the minimum Franchise Tax of $800 as well penalties and interest.

The FTB decision held that as the company had an interest in a California fund, they were required to file a tax return.

In 2017, on Appeal, the California Appeals Court ruled that an out-of-state corporation was NOT "Doing Business" in California when its only connection was a limited investment in a pass-through entity.

The FTB is not appealing the decision. The Franchise Tax Board will follow the Court of Appeal decision in Swart in situations with the same facts.

To the extent taxpayers believe their situation has the same facts as in Swart, they should take that into consideration in determining if they have a return filing obligation and/or file a claim for refund, as appropriate.

In any claim for refund, taxpayers should cite the holding in Swart and explain how their factual situation is the same as the facts in Swart.

Further reading: FTB Notice - 2017-01 Court of Appeal Decision in Swart Enterprises, Inc v. Franchise Tax Board

⚖️ It needs to be noted that even if the out-of-state company is not "Doing business" in California, it would still be subject to California Income Tax on any California-source income that flows from the LLC.

1️⃣ California Corporations Code

The California Corporations Code describes "Doing Business" as:

“Entering into repeated and successive transactions of its business in [the] state, other than interstate or foreign commerce.”

While the California Corporation Code does not list what activities constitute doing business, the statute provides a “nonexclusive” list of activities that
‍DO NOT  constitute "Doing Business" in California, including:

✅ Maintaining, defending or settling any action or suit or any administrative or arbitration proceeding;

✅ Effecting sales through independent contractors;

✅ Transacting any business in “interstate” commerce (i.e., between or across states); and

✅ Conducting an isolated transaction completed (within a period of 30 days) and not in the course of a number of repeated transactions of like nature.

The law also states that merely being a shareholder, member or manager, or limited partner of a California corporation, limited liability company or limited partnership (or a similar non-California entity transacting intrastate business) DOES NOT constitute “Doing Business” in California.

However, other forms of even indirect contact with California could trigger a “Doing Business” qualification requirement.

For example:

⚖️ An online business that engages in "ongoing transactions in California" would be required to qualify and pay taxes to enjoy the benefits of doing business in California.

⭐️ It is important to understand that transactions are considered to take place "in California" where the physical products being purchased (even when purchased online from an e-commerce website hosted outside of California) are warehoused and shipped from California or delivered to a physical address in California.

2️⃣ California Franchise Tax Board

Under California Revenue & Taxation Code [RTC §23101] if you are "Doing Business" in California, you are subject to California's tax laws.

The Franchise Tax Board consider you to be “Doing Business” if you meet any of the following criteria:

⚖️ Engage in any transaction for the purpose of financial gain within California;

⚖️ Are organized or incorporated (commercially domiciled) in California (that is, all California legal entities including Corporations & LLCs) and Foreign companies registered to do business in California.

⚖️ Your California sales, property or payroll exceed the following amounts:

California sales, property or payroll

Important: Foreign or out of state businesses that have less than the above threshold sales and property interest in California might still need to register, as they can still be deemed to be "Doing Business" in California.

Does you Business engage in any transaction within California?

In other words, is your Foreign Business or Out-of-State LLC “Doing Business” in California?

If you have a foreign-based business or an out-of-state LLC, and you carry out business activities in California, you are liable to paying business tax in the state.

If you invest in a business, for example a limited liability company,  you may be obliged to file tax obligations, even if your main business is not located in California.

When determining tax liabilities in California, the Board takes into consideration where the acceptance of sales takes place.

As an example, if your company is located overseas or out-of-state, but you have agents conducting business in California on your behalf,  you will still need to register and pay the tax.

The cost of getting it wrong, includes at a minimum:

⚖️ Payment of the taxes due, plus an annual $2,000 failure-to-file penalty, together with interest on all amounts payable.

Different rules apply with respect to California Sales Tax

A retailer of products making sales in California MUST register for, collect and remit California Sales Tax when its combined sales in California exceed $500,000 in the current or preceding year.

This requirement applies regardless of whether the retailer has a physical presence in California, or is below the thresholds described above, with respect to California Franchise Tax.

TAX-EXEMPT ENTITIES

Certain entities may seek an exemption from the California franchise and income tax.

While most nonprofit entities are tax-exempt, such exemption is not automatic, and entities seeking tax-exempt status must apply for and receive an “exempt status” letter from the California Franchise Tax Board (FTB), even if it has already received federal tax exemption.

California tax-exempt status may be obtained by submitting an FTB 3500 (Exemption Application) form or an FTB 3500A (Submission of Exemption Request) form (applicable to entities that have received a federal tax exemption under the Internal Revenue Code Section 501(c)(3), (c)(4), (c)(5), (c)(6), (c)(7) or (c)(19)) to the FTB.

3️⃣  California Privacy Law

The California Consumer Privacy Act (CCPA) applies to companies “Doing Business” in the state but fails to define that phrase.

What does "Doing Business" mean? and how could the judicial interpretation of this phrase impact out-of-state companies that find themselves defending against alleged violations of the CCPA?

The answer may lie in different parts of California law:

⚖️ California’s tax laws,

⚖️ Judicial decisions about California’s requirements for out-of-state companies to register with the state, and

⚖️ Judicial decisions about when California courts can exercise jurisdiction over non-California companies.

Defence ➲ Can't be sued in California!

A business not based in California, if defending themselves against alleged violations of the CCPA may raise as a defenc the submission that they have not purposely availed themselves of the privilege of doing business in California. See, e.g., Boschetto v. Hansing, (9th Cir. 2008), and therefore, can't be sued in California.

As out-of-state companies begin to defend lawsuits brought under the CCPA—either by the California attorney general or by private plaintiffs—they will be looking for procedural and substantive defenses to avoid liability.

Each uses the term “Doing Business,” and for each the definition can be different.

There may soon be a body of substantive case law setting forth what it means for a company to “do business in state of California” for purposes of the CCPA.

But until that time, companies potentially can avail themselves of the defense that they are not “doing business in” California by arguing in a motion to dismiss that they do not fall within the definition in any of these three related contexts.

To be clear, other defenses and interpretations exist as well that may result in a company avoiding CCPA liability.

4️⃣ Penalties for "Doing Business" without Registration

Requirement to Register with the California Secretary of State as a non-California company

Unlike California’s tax code, the law governing this registration requirement uses different language:

⚖️ The trigger is whether a non-California company “transact[s] intrastate business.”

How is “transact[s] intrastate business” any different to "Doing Business" in California?

Both California’s statutes and judicial opinions interpreting the registration requirement use the words “doing business” as interchangeable with the concept of “transact[ing] intrastate business.” See Hurst v. Bueczek Enters. LLC,(N.D. Cal. 2012).

Failure to Register

According to the California Corporations Code, if you:

⚖️ Fail to register with the California Secretary of State; and

⚖️ You engage in any transaction that has the sole purpose of financial gain or profit, you will face a penalty of $2,000 for each tax year your business was doing business in California.

If you don't file a tax return in the state, and you still do business in the state, you will need to pay the missed taxes due and the fees as well.

In case you are unsure whether your out-of-state LLC needs to file tax returns in California, you should contact us to obtain legal advice.

Whether or not you are required to file taxes in the state is determined by the FTB.

If your business needs to pay a penalty, you will be notified through a written demand letter.

Exemptions of Taxation

You can apply to be exempt from California tax if you have an out-of-state status if you meet some special requirements.

If you don't transact interstate business, you might need to contact us to obtain legal advice on obtaining exempt status from the FTB.

Frequently Asked Questions

Do I still have to register my business if I run my venture online?

Yes. You may still need to register your business, even if you don't have a physical location.

What if my company is an international franchise?

If your revenues from doing business in California account for at least 25 percent of your total income, or are above $500,000, you will need to register your business in the state.

Penalties

Penalties California has statutory provisions imposing fines on non-California companies and individuals acting on behalf of non-California companies that have not complied with qualification or taxation requirements.

For example, a person who does “intrastate” business in California on behalf of a non California company that has not qualified to transact business in California can be guilty of a misdemeanor and may be subject to penalties of up to $600, regardless of the title or position held by the individual.

A company transacting business in California without having properly registered (i.e., qualified) is subject to a penalty of $20 for each day (up to $1,000) that unauthorized intrastate business is conducted AND is denied access to state courts for purposes of maintaining an action or proceeding upon any intrastate business conducted in the state.

In other words, and quite importantly, an unqualified company cannot enforce contracts it made in the state of California, and its failure to so qualify may be used as a defense against a suit brought by the unqualified company in California.

This can have particularly serious consequences from an operational and risk perspective.

5️⃣ How to Register with the California Secretary of State

While California law requires non-California companies to “qualify” (i.e., get a Certificate of Authority) as a condition to doing business in the state, ....

A non-California corporation “doing business” in California MUST register in California by filing a Statement and Designation by Foreign Corporation (or a Form-LLC 5, if a limited liability company). The entity MUST be in good standing in its place of organization at the time of the filing.

Once registered, a Statement of Information MUST be filed with the California Secretary of State within 90 days and each year thereafter (or every two years in the case of a limited liability company), or the entity risks being assessed a penalty, suspension or forfeiture of its qualification (see “Penalties” below).

Registering with the California Attorney General (for Charities) In addition to qualifying with the Secretary of State, entities found to be “doing business” in California that are holding property for charitable purposes MUST register with the California Attorney General within 30 days of first receiving charitable assets, and renew their registrations annually thereafter.

6️⃣ New California ➲ Climate-Related "Greenwashing" Disclosure Laws

Big Businesses & Any Business Marketing, Selling, Purchasing or Using Voluntary Carbon Offsets

On October 7 2023, Governor Gavin Newsom signed Senate Bill 253[1] into law, which requires companies with revenues over $1 billion annually that "do business" in California to measure and publicly disclose three types of greenhouse gas emissions.[4]

On the same day, Governor Newsom also signed into law SB 261, the Climate-Related Financial Risk Act (“CFRA”),[2] as well as AB 1305, governing voluntary carbon market disclosures and aimed at combatting greenwashing.

[3] While the new laws are aimed at increasing transparency regarding the impact of big businesses on the environment, they also create increased Securities and Exchange Commission (“SEC”) enforcement risk and private securities class action litigation risk for large publicly traded companies doing business in California.

SB 253

The new California law requires public and private companies operating in California and earning more than $1 billion a year to measure and publicly disclose three types of greenhouse gas emissions.[4]

Scope 1: All direct greenhouse gas emissions that stem from sources that a reporting entity owns or directly controls, regardless of location, including, but not limited to, fuel combustion activities.

Scope 2: All indirect greenhouse gas emissions from consumed electricity, steam, heating, or cooling purchased or acquired by a reporting entity, regardless of location.

Scope 3: All indirect upstream and downstream greenhouse gas emissions, other than scope 2 emissions, from sources that the reporting entity does not own or directly control and may include, but are not limited to, purchased goods and services, business travel, employee commutes, and processing and use of sold products.

These disclosures are in accordance with the Greenhouse Gas Protocol, the world’s most widely used climate disclosure framework.[5]

Companies will have to start disclosing emissions from their direct operations and energy use (Scope 1 and 2) by 2026. Emissions reporting from supply chains and other indirect sources (Scope 3) is required by 2027.[6]

Many companies pushed back against the new law, saying it will create significant new costs as they work to build systems and infrastructure to track and report the data.

Even though many companies already have some level of internal tracking in place for direct greenhouse gas emissions (Scope 1 and Scope 2), and some provide related disclosures, they may face substantial hurdles to track and report Scope 3 emissions, which are linked to supply chains and end users.

These Scope 3 emissions are particularly difficult to track, as they require companies to coordinate with suppliers, contractors, and other third parties up and down their supply chain.[7]

Though they are challenging to track, they are not insignificant.

According to the Environmental Protection Agency (EPA), supply chain emissions account for more than 90% of a company’s greenhouse gas emissions.[8]

However, under the law, companies have time to grapple with these tracking challenges, as misstatements regarding Scope 3 emissions do not give rise to penalties until 2030.

The law also provides a safe harbor thereafter for good faith disclosures.

SB 261

SB 261 will require public and private companies with total annual revenues exceeding US$500 million that do business in California to prepare a biennial climate-related financial risk report and publish a copy of the report publicly on the company website.

The report MUST disclose the company’s climate-related financial risk based on the framework provided in the Final Report of Recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”).[9]

Alternatively, compliance can be achieved by preparing a climate-related risk disclosure report under another comparable law, regulation, or listing requirement issued by a regulated exchange or government that incorporates consistent disclosure requirements.

That reciprocity provision recognizes that several governments around the world have adopted or are contemplating disclosures aligned with the TCFD.

Companies may also voluntarily use a framework that meets the requirements of the International Financial Reporting Standards Sustainability Disclosure Standard.[10]

These disclosure requirements begin on January 1, 2026.

Failure to publish such a report can result in penalties up to $50,000 per year.

AB 1305

AB 1305 is primarily focused on implementing disclosure requirements applicable to business entities operating in California and marketing, selling, purchasing, and/or using voluntary carbon offsets.[11]

Companies will need to disclose on their websites information pertaining to the applicable carbon offset project including location, timeline, relevant standards, durability, independent third-party verification, and emissions reduced or removed.

AB 1305 also requires that companies disclose accountability measures that apply if a carbon offset project is not completed or does not meet projected emission reduction or removal goals.

However, even some companies not engaged in voluntary carbon offset activity will have disclosure requirements imposed by AB 1305.

Specifically, a company that operates within California or makes the following claims in California will now be required to disclose on its website specified information documenting the support and accuracy of such claims:

⚖️ The achievement of net zero emissions,

⚖️ Claims that the company or a product is “carbon neutral,” or other claims implying the company or a product does not add net carbon dioxide or greenhouse gases to the climate, or has made significant reductions to its carbon dioxide or greenhouse gas emissions.

These disclosure requirements go into effect January 1, 2024.

Failure to comply may result in a civil penalty of not more than $2,500 per day for each day the information is not available or accurate on the company website, not to exceed $500,000.

7️⃣ California Income Tax

California also imposes corporate income tax on every corporation, domestic or foreign, which is not doing business in California and not expressly exempt, but which derives income from sources within California or from activities carried on in California.

If there is income from both within and outside the state, a portion of the total is apportioned to California.

The term "Doing Business" means actively engaging in any transaction for the purpose of financial gain or profit (see also Question 15, Corporate income and franchise tax).

For tax years beginning on or after 1 January 2011, a corporate taxpayer will be considered to be "doing business" in California for California corporate income tax purposes if it meets any of the following conditions:

• The taxpayer is organised or commercially domiciled in California.
• The taxpayer's sales in California exceed the lesser of US$500,000 or 25% of the taxpayer's total sales.
• The value of the taxpayer's real and tangible personal property in California exceeds the lesser of US$50,000 or 25% of the taxpayer's total real and tangible personal property.
• The taxpayer pays compensation in California exceeding the lesser of US$50,000 or 25% of the total compensation paid by the taxpayer.

The threshold amounts used in this test are adjusted annually for inflation.

Public Law 86-272

Public Law 86-272 potentially applies to companies located outside of California whose only in-state activity is the solicitation of sale of tangible personal products or property to California customers.

Businesses that qualify for the protections of Public Law 86-272 are exempt from state taxes that are based on your net income.

These entities, however, still may be considered to be "Doing Business" in California and may be liable for filing and paying the applicable amounts (as in liable to pay the annual minimum Franchise Tax).

For more information, download the Application & Interpretation of Public Law 86-272 (FTB 1050).

Apportionment and allocation

A trade or business with income inside and outside of California may be subject to California apportionment and allocation rules.

Visit Apportionment and allocation for more information.

Further Reading:

"Greenwashing": An international perspective ➲ How are California, Australia & NZ dealing with this concerning business practice?

Doing business in California [Franchise Tax Board of California]

California Code, Revenue & taxation Code - RTC § 23101

California Poised to Overtake Germany as World’s No. 4 Economy by Matthew A. Winkler in Bloomberg [Published October 24, 2022].

California Passes New ESG Disclosure Laws Ahead of SEC, Triggering Increased Regulatory and Litigation Risk for Companies Doing Business in California [Published November 28, 2023]

Social Sharing Image: Photo courtesy of Robert Bye on Unsplash

Credits: This blog article was written by James D. Ford Esq., GAICD CIPP/US CC | Attorney-at-Law, Blue Ocean Law Group℠.

State of California Bar Number: 346590

Important Notice:

This blog article is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.