BILL ANALYSIS                                                                                                                                                                                                    



                                                                       



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          |SENATE RULES COMMITTEE            |                   AB 759|
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                                 THIRD READING


          Bill No:  AB 759
          Author:   Ma (D)
          Amended:  7/15/09 in Senate
          Vote:     21

           
           SENATE REVENUE & TAXATION COMMITTEE  :  5-3, 7/8/09
          AYES:  Wolk, Alquist, Florez, Padilla, Wiggins
          NOES:  Walters, Ashburn, Runner
           
          SENATE APPROPRIATIONS COMMITTEE  :  8-5, 8/27/09
          AYES:  Kehoe, Corbett, Hancock, Leno, Oropeza, Price, Wolk,  
            Yee
          NOES:  Cox, Denham, Runner, Walters, Wyland
           
          ASSEMBLY FLOOR  :  52-28, 5/28/09 - See last page for vote


           SUBJECT  :    Contracts with expatriate corporations:   
          Corporation Tax 
                        Law:  waters-edge election 

          SOURCE  :     Author


           DIGEST  :    This bill simplifies the method used to report a  
          waters-edge taxpayers 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 also prohibits a foreign incorporated  
          entity domiciled in a jurisdiction that does not have an  
          income tax treaty in force with the United States from  
                                                           CONTINUED





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          contracting with a state agency.

           ANALYSIS  :    

          I.  Controlled Foreign Corporations
           
             Existing federal law provides that all income of a  
             corporation regardless of source is taxable, and allows  
             a credit for taxes paid to foreign countries.  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.   
             Defines a "controlled foreign corporation" (CFC) as any  
             foreign corporation where more than 50 percent of the  
             voting power, or 50 percent of the value of the stock,  
             is 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"  
             with respect to 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 California and worldwide.  Since 1986, state law  
             also allows a "water's-edge election," where taxpayers  
             may limit their combined reports to just to those  
             affiliates domiciled within the "water's edge" of the  
             United States, although state law may require taxpayers  
             to include certain foreign subsidiaries and affiliates  
             under specified circumstances.  Determines the portion  
             of a multi-state or multi-national corporation's net  
             income is taxable by California using "formulary  
             apportionment," under which three apportionment factors  
             are computed: a property factor (the amount of property  
             the corporation has in California divided by it's total  
             (nation-wide or world-wide) property); a payroll factor  
             (California payroll divided by total payroll); and a  
             sales factor (California sales divided by total sales).   







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             The actual amount of income apportioned to California  
             using this formula is computed by adding the payroll  
             factor, the property factor and twice the sales factor,  
             then dividing that sum by four (the so-called  
             "double-weighted sales factor").  The formula serves to  
             calculate a corporation's tax due in an amount equal to  
             its demand on public services, assuming that taxpayers  
             derive profits from the effective marshalling of labor  
             and capital in the presence of a market.  The formula  
             comes from the Universal Division of Tax Purposes Act  
             (UDITPA), a model statute developed by the National  
             Conference on Uniform State Laws in 1957.  California  
             adopted UDITPA and the apportionment formula in 1966 (AB  
             11, Petris), and double-weighted the sales factor in  
             1993 (SB 1176, Kopp).  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 income and apportionment factors a  
             taxpayer includes in the tax return.  The numerator of  
             the ratio is the CFC's current year Subpart F income,  
             and the denominator is the CFC's current earnings and  
             profits.  The CFC then multiplies its business income,  
             nonbusiness income, and apportionment factors by the  
             ratio to determine its includible income for California  
             tax purposes.  The ratio cannot fall below zero or  
             exceed 100 percent; in such a case, the CFC is included  
             in the water's edge group and its income taxed  
             accordingly.  

             This bill deletes California's current law for  
             calculating CFC income by deleting the inclusion ratios  
             and conforming to federal Subpart F provisions that  
             state that 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 allows a 27 percent dividend deduction  
             against the CFC's Subpart F 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  







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             stock basis would become the new stock basis for state  
             purposes.  States that state law does not conform to  
             rules guiding the gain from certain sales or exchanges  
             of CFC stock, the temporary 85 percent 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.  The  
             bill also required that a taxpayer's High Foreign Tax  
             Rule election must be the same for state purposes as it  
             is for federal.  The Franchise Tax Board (FTB) may also  
             proscribe regulations as it deems necessary to carry out  
             these provisions.

          II.  Public Contracts Code
           
             Existing law prohibits the state from entering into any  
             contract with a publicly traded foreign incorporated  
             entity or its subsidiary if all of the following apply:

             A.    The United States is the principal market for the  
                public trading of the foreign incorporated entity.

             B.    The foreign incorporated entity has no substantial  
                business activities in the place of incorporation  
                compared to the business activity of its subsidiary  
                or subsidiaries.
              
             C.    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."  

             Existing law requires each vendor submitting a bid or  







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             contract to certify under penalty of perjury that it is  
             not an ineligible vendor pursuant to the test described  
             above.

             This bill adds another requirement to the list of  
             contract prohibitions as follows: 

                The foreign incorporated entity is domiciled in a  
                jurisdiction that does not have an income tax treaty  
                in force with the United States.

           Prior/Related Legislation
           
          SB 640 (Burton), Chapter 657, Statutes of 2003, was a  
          method to compel businesses to either repatriate back to  
          the United States or not be allowed to do business with the  
          state.  According to the author at the time, it is  
          "[P]articularly reprehensible that these publicly held U.S.  
          expatriate corporations are reaping the benefits of their  
          relocations at a time when the State is struggling to pay  
          for critical needs such as education, mental health and  
          public safety, and when the nation is shouldering the heavy  
          responsibilities of national defense and national  
          security."

          AB 1178 (Block), 2009-10 Session, requires multinational  
          corporations that elect to file tax returns based only on  
          income earned inside the U.S. (known as the water's edge  
          method) to include the income of related corporations in a  
          tax haven country.  If enacted, the analysis projects  
          revenue gains of $130 million in 2010-11 and $160 million  
          in 2011-12.  The bill is a two-year bill that requires a  
          two-thirds vote.

          AB 1561 (Calderon), 2007-08 Session.  In this state,  
          calculating a CFC income and apportionment factors for a  
          California water's-edge taxpayer is extremely burdensome -  
          time consuming and expensive - for the taxpayer and the  
          department, resulting in frequent taxpayer misapplications  
          of the law and the need for audit.  In the bill, the state  
          simplified the method used to report a water's-edge  
          taxpayer's portion of its CFC's income by conforming to the  
          federal Subpart F rules for computing the amount of a CFC's  
          income that is included in a shareholder's income.  The  







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          bill died on the Senate Inactive File.

           NOTE:  Refer to Senate Revenue and Taxation Committee  
                 analysis for 
                  further background.

           FISCAL EFFECT  :    Appropriation:  No   Fiscal Com.:  No    
          Local:  No

          According to the Senate Appropriations Committee:

                          Fiscal Impact (in thousands)

           Major Provisions      2009-10     2010-11     2011-12         Fund  

          Water's-edge provision        $100      $400           
          $400General

          FTB audits/administration     potentially significant  
          administrative savings        General

          Expatriate corporations       unknown, potential increase  
          in state            Various
                              contract costs to the extent more  
          companies
                              are prohibited from contracting with  
          the state


           ASSEMBLY FLOOR  :
          AYES:  Ammiano, Arambula, Beall, Block, Blumenfield,  
            Brownley, Buchanan, Caballero, Charles Calderon, Carter,  
            Chesbro, Coto, Davis, De La Torre, De Leon, Eng, Evans,  
            Feuer, Fong, Fuentes, Furutani, Galgiani, Hall, Hayashi,  
            Hernandez, Hill, Huber, Huffman, Jones, Krekorian, Lieu,  
            Bonnie Lowenthal, Ma, Mendoza, Monning, Nava, Nielsen,  
            John A. Perez, V. Manuel Perez, Portantino, Price,  
            Ruskin, Salas, Saldana, Skinner, Solorio, Swanson,  
            Torlakson, Torres, Torrico, Yamada, Bass
          NOES:  Adams, Anderson, Bill Berryhill, Tom Berryhill,  
            Blakeslee, Conway, Cook, DeVore, Duvall, Emmerson,  
            Fletcher, Fuller, Gaines, Garrick, Gilmore, Hagman,  
            Harkey, Jeffries, Knight, Logue, Miller, Nestande,  
            Niello, Silva, Smyth, Audra Strickland, Tran, Villines







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          DLW:mw  9/1/09   Senate Floor Analyses 

                       SUPPORT/OPPOSITION:  NONE RECEIVED

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