BILL ANALYSIS
Senate Appropriations Committee Fiscal Summary
Senator Christine Kehoe, Chair
759 (Ma)
Hearing Date: 08/17/2009 Amended: 07/15/2009
Consultant: Mark McKenzie Policy Vote: Rev&Tax 5-3
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BILL SUMMARY: AB 759 would simplify the method used to report a
water's-edge taxpayer's portion of its "controlled foreign
corporation" (CFC) income under the Corporation Tax Law by
conforming to the federal Subpart F rules for computing the
amount of income that is included in a shareholder's income.
This bill would also prohibit a foreign incorporated entity
domiciled in a jurisdiction that does not have an income tax
treaty in force with the United States from contracting with a
state agency.
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Fiscal Impact (in thousands)
Major Provisions 2009-10 2010-11 2011-12 Fund
Water's-edge provision $100 $400 $400 General
Expatriate corporationsunknown, potential increase in state
contract Various
costs to the extent more companies are
prohibited
from contracting with the state (see
staff comments)
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STAFF COMMENTS: This bill meets the criteria for referral to the
Suspense File.
Water's-edge provision
Existing federal law generally requires a U.S. corporation to be
taxed on all of its income, and provides a credit for taxes paid
to a foreign country. Foreign corporations only file returns in
the United States for income effectively connected with a trade
or business in the United States, or income from specified U.S
investments, called noneffectively connected income. Existing
federal law also defines a "controlled foreign corporation"
(CFC) as any foreign corporation with more than 50 percent
ownership held by U.S. shareholders. Federal law guiding CFCs,
known as "Subpart F," seeks to curtail abuses where companies
assign income to offshore tax havens. U.S shareholders must
include income from CFCs, and federal law treats that income as
a dividend paid by the CFC. A U.S. shareholder's income from a
CFC cannot exceed the CFC's earnings and profits for that year.
Existing state law uses the "world-wide unitary method" for
purposes of identifying the taxable income of all multinational
corporations doing business in California. Taxpayers file a
combined report for the unitary group or subsidiaries and
affiliates showing income, payroll, property and sales both in
California and worldwide, and the amount attributable to
California is calculated for taxation purposes. Alternatively,
state law allows corporations to determine their business income
on a "water's edge" basis, which generally excludes foreign
corporations from the calculation of business income but does
not exclude CFCs with Subpart F income.
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AB 759 (Ma)
Existing state law conforms to federal definitions of CFC and
U.S shareholder, but does not conform to federal Subpart F
income provisions, instead requiring a CFC to include a portion
of its net income and apportionment factors included in the
water's edge filing based on an inclusion ratio, which
determines the amount of a CFC's business and non-business
income and apportionment factors (property, payroll, and sales)
a taxpayer includes in the tax return.
AB 759 would delete California's current law for calculating CFC
income by deleting the inclusion ratios and instead conform to
federal Subpart F provisions that specify the amount of a CFC's
subpart F income included in a water's edge taxpayer's income
would be treated as a "deemed dividend," and could be excluded
under the state's dividend exclusion and deduction laws. The
measure would allow a 27% dividend deduction against the CFC's
Subpart F income that is included in the water's-edge taxpayer's
income. Any income previously taxed as Subpart F income before
the bill's effective date would be deemed previously taxed for
state purposes, and federal adjustments to the CFC's stock basis
would become the new stock basis for state purposes. This bill
also specifies that state law does not conform to rules guiding
the gain from certain sales or exchanges of CFC stock, the
temporary 85% divided received deduction from CFCs, or the
foreign tax credit. When a taxpayer terminates a water's edge
election, Subpart F rules no longer apply and only the
previously taxed income and stock basis adjustments remain the
same.
Staff notes that the revenue impact of this provision would
depend on the difference in the amounts included in the water's
edge group tax filing under current state law, which provides
for partial inclusion of Subpart F income and unitary factors,
as opposed to provisions of federal law, which specifies that
Subpart F income is treated as dividends. The particular
dividend reduction percentage was specifically chosen to
minimize the net impact on corporation tax revenues. Using a
statistically representative sample of 2004 water's edge filers
reporting CFC income on a foreign dividend deduction, FTB
estimates that this provision would result in a tax revenue loss
of approximately $100,000 in 2009-10 and $400,000 annually
thereafter.
Due to the complexity of calculations involving the treatment of
Subpart F income, FTB has found particularly low compliance
related to proper reporting requirements. Moreover, CFC
inclusion ratios are burdensome to administer and FTB audit
staff spend many hours recalculating incorrect methods used by
taxpayers to include a CFC's income and factors in the water's
edge group tax filing often only to discover that the audit
adjustments have minor tax revenue impact. Staff notes that the
simplified reporting requirements proposed by AB 759 would
likely result in increased taxpayer reporting compliance and
unknown administrative savings for FTB. Audit staff currently
engaged in reviewing CFC taxpayer calculations could be utilized
for more cost-beneficial purposes.
AB 759 would simplify reporting of income from CFCs by changing
from California's inclusion ratios to the simpler federal
standard. FTB notes that although the net tax effect for this
provision is roughly revenue neutral, more corporations in the
sample pool of taxpayers reviewed by FTB would experience a
decrease in tax liability. Specifically,
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AB 759 (Ma)
44% would experience decreased tax liability while 25% would
experience an increase and 31% would have a negligible impact.
All affected corporations would benefit from the simplified
reporting procedures.
Expatriate corporations & state contracts
Existing law prohibits the state from entering into any contract
with an expatriate corporation, defined as a foreign
incorporated entity that is publicly traded in the United States
and to which all of the following apply:
The United States is the principal market for the public
trading of the foreign incorporated entity.
The foreign incorporated entity has no substantial business
activities in the place of incorporation compared to the
business activity of its subsidiary or subsidiaries.
The foreign entity was incorporated through a transaction or a
series of transactions in which it acquired substantially all
of the properties held by a domestic corporation or
partnership and immediately after the acquisition more than 50
percent of the publicly traded stock was transferred to the
same shareholders or partners that owned the domestic
corporation or partnership.
Existing law permits the chief executive of a state agency or a
designee to waive the ineligibility of a vendor that meets the
above test by making a written finding that the contract is
necessary to meet a "compelling public interest."
AB 759 would include a foreign incorporated entity domiciled in
a jurisdiction that does not have an income tax treaty in force
with the United States in the definition of "expatriate
corporation," thereby prohibiting such an entity from
contracting with the state, except as specified.
The United States maintains an extensive network of bilateral
income tax treaties that currently includes comprehensive
treaties covering 66 countries. Bilateral income tax treaties
remove barriers to cross-border investment and trade by
allocating taxing jurisdiction between countries with
residence-and source-based claims to tax the income from such
investment and trade. Bilateral income tax treaties also
provide a framework for the exchange of information between
taxing authorities in an effort to prevent tax avoidance and
evasion.
This provision is intended to tighten the restrictions of the
California Taxpayer and Shareholder Protection Act of 2003 [SB
640 (Burton), Chapter 657 of 2003] by expanding the definition
of "expatriate corporation" for purposes of prohibiting state
contracts with such entities. It is unknown whether the state
contracts with any entities that are domiciled in a jurisdiction
that does not have a bilateral tax treaty in force that
currently do not fall under the definition of an "expatriate
corporation." If this bill limits the number of bidders on some
state contracts, there could be an increase in state contract
costs due to reduced competition. These potential costs are
unquantifiable.