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
          _________________________________________________________________ 
          ____
          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.
          _________________________________________________________________ 
          ____
                            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)
          _________________________________________________________________ 
          ____

          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.