BILL ANALYSIS
AJR 12
Page 1
Date of Hearing: June 15, 2009
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Charles M. Calderon, Chair
AJR 12 (Block) - As Amended: June 3, 2009
Majority vote.
SUBJECT : Offshore tax haven jurisdictions
SUMMARY : Requests that the President and the United States
Congress enact legislation that closes the corporate federal tax
loopholes relating to tax haven countries. Specifically, this
bill :
1)States all of the following legislative findings and
declarations:
a) In bad economic times, states are forced to cut
essential services or raise taxes in order to balance their
budgets.
b) Recapturing lost revenues otherwise due to a state is
one mechanism by which government can reduce painful cuts
without raising new taxes.
c) A U.S. corporation is taxed on all of its income,
regardless of source, and is allowed a credit for any taxes
paid to a foreign country.
d) A U.S. corporation can operate globally in foreign
countries directly through a branch or indirectly through
its ownership in a foreign subsidiary.
e) The Organization for Economic Cooperation and
Development (OECD) prepared reports identifying tax haven
countries and financial privacy jurisdictions.
f) The U.S. Department of Treasury has found that some U.S.
corporations have aggressively moved income to offshore
jurisdictions to avoid U.S. taxes and the U.S. Senate
Permanent Subcommittee on Investigations released findings
regarding the growth of multinational corporations' use of
tax haven countries to shelter income.
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g) President Obama has voiced his support for efforts to
combat offshore tax evasion and the U.S. Commissioner of
the Internal Revenue Service (IRS) stated that it is a top
priority for the IRS.
h) U.S. Senator Carl Levin introduced the Stop Tax Haven
Abuse Act on March 2, 2009, to target offshore tax abuses
that deny the U.S. Treasury an estimated $100 billion in
revenue each year.
i) Some states have enacted legislation to include the
income and apportionment factors of affiliated corporations
doing business in, or having income derived from, or
attributed to, a tax haven country.
j) California permits corporations that conduct business in
this state to elect to calculate their state corporate tax
liability based on income only from sources within the U.S.
aa) As identified by federal officials, corporations are
known to redirect income to foreign subsidiaries located in
offshore tax haven countries to hide those corporations'
true income and to avoid paying their fair share of state
tax;
bb) The Franchise Tax Board (FTB) estimates that California
incurs an annual revenue loss of approximately $130 million
due to corporations' sheltering income in tax haven
countries.
2)Respectfully requests the President and the U.S. Congress to
enact legislation that would close the corporate federal tax
loopholes currently allowing the sheltering of income in
offshore tax haven countries and would, instead, promote
transparency, cooperation, and tax compliance.
3)Requires the Chief Clerk of the Assembly to transmit copies of
this resolution to the President and the Vice President of the
U. S., to the Speaker of the House of Representatives, to the
Majority Leader of the Senate, and to each Senator and
Representative from California in the U.S. Congress.
EXISTING LAW :
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1)Imposes an annual tax on corporations measured by income
sourced to California, unless otherwise exempted. Income
sourced to California from corporations operating both within
and outside of the state is determined on a worldwide
basis applying the unitary method of taxation. The unitary
method combines the income of affiliated corporations that are
members of a unitary business and apportions the combined
income to California based upon the average of four factors
(the property factor, the payroll factor, and two sales
factors). This four-factor formula identifies the relative
levels of business activity in the state and apportions the
combined income to California using the determined share of
California business activity. For taxable years beginning on
or after January 1, 2011, certain corporate taxpayers may make
an annual election to apportion its income to California using
a single sales factor apportionment formula.
2)States that taxpayers with worldwide business activities may
elect to report income to California on a water's-edge basis.
Taxpayers that make a water's-edge election include income and
apportionment factors of businesses operating only within the
U. S., plus a few other jurisdictions, thereby excluding the
income and apportionment factors of most foreign affiliates.
In exchange for this election to file on a water's-edge basis,
a taxpayer agrees to file consistently using the water's-edge
method for at least seven years.
3)Provides that the entire income and apportionment factors of
certain affiliated entities, which are unitary with an entity
that is the water's-edge taxpayer, are includable in the
water's-edge return.
FISCAL EFFECT : Unknown, but probably none.
COMMENTS :
1)The author states that "California corporations are stashing
millions of dollars in overseas tax haven countries, and are
avoiding paying their fair share of taxes to the state through
code loopholes. President Obama and the U.S. Congress have
hinted they would like to close these loopholes at the federal
level, in which case California would benefit as well. I
applaud their efforts and hope the California Legislature can
join me by passing AJR 12, which will encourage the federal
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government to act to solve the tax haven abuse loopholes."
2)What is the problem with incorporating a subsidiary in a tax
haven country ? Some corporations and individuals use tax
havens to avoid payment of U.S. taxes. Generally, a tax haven
is a foreign jurisdiction that maintains corporate, bank, and
tax secrecy laws and industry practices that make it very
difficult for other countries to find out whether their
citizens are using the tax haven to avoid paying their taxes.
(Statement of Senator Carl Levin on Introducing The Stop Tax
Haven Abuse Act, Tax Analyst, December 2009, p. 4). Data
released by the Commerce Department indicates that, as of
2001, almost half of all foreign profits of U.S. corporations
were in tax havens. Further, a study released by Tax Notes,
September 2004, found that American companies were able to
shift $149 billion of profits to 18 tax haven countries in
2002, up 68% from $88 billion in 1999. In January 2009, a
report issued by the Government Accounting Office (GAO) shows
that out of the 100 largest U.S. publicly traded corporations,
83 have subsidiaries in tax havens. For example, Morgan
Stanley has 273, Citigroup has 427, and Oracle has 77 tax
haven subsidiaries.
U.S. Senator Levin, in his statement, gives a simplified example
of how U.S. corporations may transfer taxable income from the
United States to tax havens to escape taxation. He states
that, "Suppose a profitable U.S. corporation establishes a
shell corporation in a tax haven. The shell corporation has no
office or employees, just a mailbox address. The U.S. parent
transfers a valuable patent to the shell corporation? [and
then] begin to pay a hefty fee to the shell corporation for
use of the patent, reducing its U.S. income through deducting
the patent fees and thus shifting taxable income out of the
United States to the shell corporation. The shell corporation
declares a portion of the fees as profit, but pays no U.S. tax
since it is a tax haven resident." In addition, the shell
corporation may lend its funds to the U.S. parent that, in
turn, will pay interest on the loan to the shell corporation,
shifting more taxable income out of the U.S. to the tax haven.
Often, those subsidiaries of U.S. companies are shell
corporations that are engaged in no or very little business
activity. (Id, at p. 6).
Under existing California law, income and apportionment factors
of those subsidiaries located in tax haven countries are not
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included in the water's-edge return of the parent company,
unless the subsidiaries are certain affiliated entities such
as, for example, an export trade corporation, a domestic
international sales corporation, a foreign sales corporation,
or a controlled-foreign corporation with Subpart F income.
Consequently, companies that manage to shift some of its
income to their subsidiaries in tax haven countries will pay
less tax to California.
3)Proposed Federal Legislation . Section 103 of the Stop Tax
Haven Abuse Act would deny tax benefits for foreign
corporations managed and controlled in the United States. It
focuses on the situation where a corporation is incorporated
in a tax haven as a mere shell operation with little or no
physical presence or employees in the jurisdiction. The
impetus for this legislation came from a hearing held by the
U.S. Senate Finance Committee in July 2008. The Committee
considered the findings made by GAO with regard to the
infamous Ugland House, a five-story building that is located
in the Cayman Islands and is the official address for over
18,800 registered companies. GAO determined that about half
of the alleged Ugland House tenants have a billing address in
the United States and were not actual occupants of the
building. In fact, GAO found that none of the nearly 19,000
companies registered at the Ugland House was an actual
occupant. The only occupant of that building was a Cayman law
firm that established and registered those companies.
Section 103 of the Stop Tax Haven Abuse Act states that, if a
corporation is publicly traded or has aggregate gross assets
of $50 million or more, and its management and control occurs
primarily within the United States, then that corporation will
be treated as a U.S. domestic corporation for income tax
purposes. Section 103 provides an exception for foreign
corporation with U.S. parents but makes clear that mere
existence of a U.S. parent corporation is not sufficient to
shield a foreign corporation from being treated as a domestic
corporation. According to U.S. Senator Levin, the proposed
federal legislation "would put an end to the unfair situation
where some U.S.-based companies pay their fair share of taxes,
while others who set up a shell corporation in a tax haven are
able to defer or escape taxation, despite the fact that their
foreign status is nothing more than a paper fiction."
(Statement of Senator Carl Levin on Introducing The Stop Tax
Haven Abuse Act, Tax Analyst, December 2009, p. 13).
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4)How would California benefit from the proposed federal
legislation ? If the Stop Tax Haven Abuse Act is enacted into
law, it will change taxpayers' behavior and, presumably, put
an end to financial gimmicks used by certain corporate
taxpayers to avoid or minimize their U.S. taxes. Most likely,
California would indirectly benefit from that change in the
taxpayers' behavior. It is unclear, however, and depends on
the specific federal act, whether California would need to
conform to the new federal law to see an actual increase in
state tax collection.
5)Similar Legislation .
AB 1178 (Block), introduced in this legislative session, would
require multinational corporations that elect to file tax
returns based only on income earned inside the United States,
known as the water's-edge method, to include the entire income
and apportionment factors of any related corporation doing
business in or having income derived from or attributable to a
tax haven.
AB 34 (Ruskin), introduced in the 2005-06 legislative session,
was nearly identical to AB 1178 and would have required
taxpayers filing on a water's-edge basis to include the income
and apportionment factors of affiliated corporations doing
business in, or having income derived from or attributable to,
a tax haven. AB 34 failed to pass out of the Assembly.
AB 441 (Chu), introduced in the 2005-06 legislative session,
would have required a corporation that makes a water's-edge
election to include the income and apportionment factors of
certain foreign affiliates. AB 441 failed to pass out of the
Assembly.
SB 663 (Migden, Ch. 22, Stats. 2006) clarified specific
provisions of the franchise tax law relating to water's-edge
taxpayer and reformed the water's-edge procedure by replacing
existing rules creating a contract between the taxpayer and
FTB with election procedures.
REGISTERED SUPPORT / OPPOSITION :
Support
AJR 12
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California Professional Firefighters
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098