BILL ANALYSIS
PURSUANT TO SENATE RULE 29.10
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 759 - Ma
Amended: August 5, 2010
Hearing: August 11, 2010 Fiscal: Yes
SUMMARY: Distinguishes Cross Border Mergers from
Inversions Under California's Public Contracting
Ban
EXISTING LAW prohibits the state from entering into
any contract with an "expatriate corporation," defined as a
publicly traded foreign incorporated entity or its
subsidiary if all of the following apply (SB 640, Burton,
2003):
1) the United States is the principal market for the
public trading of the foreign incorporated entity;
2) the foreign incorporated entity has no substantial
business activities in the place of incorporation
compared to the business activity of its subsidiary or
subsidiaries; and
3) 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% of the publicly traded
stock was transferred to the same shareholders or
partners that owned the domestic corporation or
AB 759 - Ma
Page 5
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
contract to certify under penalty of perjury that it is not
an ineligible vendor pursuant to the test described above.
THIS BILL distinguishes cross border mergers,
transactions intended to gain efficiencies in scale and
scope or change a firm's competitive position or profits,
from inversions, which provide tremendous tax advantages
while not fundamentally changing a firm's business
structure, for purposes of the public contacting ban.
THIS BILL provides that a foreign incorporated entity
that is publicly traded in the United States is not an
expatriate corporation for purposes of the public contract
prohibition if all the following are true:
The entity or any predecessor entity was originally
established in connection with a transaction or series
of transactions between unrelated publicly traded
corporations.
Immediately after the transaction or series of
related transactions, not more than 70% of the
publicly traded stock, by vote or value, of the
foreign incorporated entity is held by former
shareholders of the domestic corporation or by former
partners of the domestic partnership or related
foreign partnership.
The transaction or series of related transactions
that originally established the foreign incorporated
entity, or any predecessor entity, was a taxable
transaction for any United States shareholders of any
domestic corporation that was a party to such
transaction.
The foreign incorporated entity is created or
organized under the laws of a foreign country with
which the United States has a comprehensive income tax
AB 759 - Ma
Page 5
treaty, and is considered a resident of that country
for purposes of that treaty or any successor treaty.
THIS BILL additionally states that a foreign
incorporated entity resulting from two types of corporate
reorganization as defined by the Internal Revenue Code
shall not be considered an expatriate corporation.
FISCAL EFFECT:
Because the measure does not affect state taxes,
Committee Staff estimates that AB 759 has no revenue
effect.
COMMENTS:
A. Purpose of the Bill
According to the Author, "AB 759 clarifies current law
on the ability of an expatriate corporation's ability to
contract with the State. The original law, SB 640, was
intended to prevent corporations that left the Untied
States for tax haven countries from receiving state
contracts. AB 759 establishes a set of criteria to
determine which corporations are subject to the contract
prohibitions.
The bill recognizes the legitimacy of a transaction in
which two publicly traded companies merge for legitimate
business reasons.
Such a solution assures California maintains a strong
policy against companies leaving the United States for what
is purely tax gain, while assuring that multinational
companies that do leave the United States through a
legitimate merger to a country that is a treaty partner are
not unfairly disadvantaged.
This bill will increase the amount and competitiveness of
State contract bids and has the potential to be a cost
AB 759 - Ma
Page 5
savings measure."
B. Don't Go There
The Legislature enacted SB 640 in 2002 to punish firms
which underwent a corporate inversion to avoid taxation by
disqualifying them from bidding on public contracts issued
by the state. Sponsored by then State Treasurer Phil
Angelides, the legislation followed up on federal efforts
to punish firms such as Fruit of the Loom, Ingersoll Rand,
Accenture, Foster Wheeler, and Tyco (the sponsor of this
bill) for inverting. A similar measure, SB 1067 (Speier,
2002), would have required inverted firms to include tax
haven income within the water's edge for corporate tax
purposes, but the measure died on the Senate Floor. AB
1178 (Block, 2010) would have made a similar change.
The Senate Judiciary Committee analysis of SB 640
stated:
Extensive hearings on corporate inversions or
expatriations were held last year in connection with
the Homeland Security Act then being debated in
Congress. The hearings centered on whether an
American company should be allowed to take advantage
of tax benefits when it reincorporates in a foreign
jurisdiction where the corporate taxes are lower and
protection of shareholders and investors are limited
compared to the protections afforded by the state
where the corporation was originally organized. The
problem is accentuated by the fact that many American
corporations have in fact gone global, with income and
profits coming from business ventures around the
world, and the taxation scheme of the United States
Tax Code has encouraged many of them to be "creative"
in seeking ways to minimize taxes.
Bermuda and the Cayman Islands have been identified as
favorite tax havens for corporate expatriations,
although there are others in Europe and Asia. Early
last year, news about Stanley Works, for example,
seeking to reincorporate in Bermuda to save some $30
million in taxes when it only paid $7 million in U.S.
AB 759 - Ma
Page 5
taxes on foreign income last year, led to the
conclusion that three quarters of the anticipated tax
savings would have come from U.S. profits. Amid the
hue and cry, Stanley Works stayed as a Connecticut
corporation. More recently, Ingersoll-Rand, formerly
of New Jersey but now operating as a Bermuda
corporation, is reported to have avoided $50 million
in U.S. taxes alone in 2002, almost as much as its
U.S. defense and homeland security federal contracts.
Thus, the outcry to restructure the tax code to
recapture these taxes, and to force domestic companies
to stay in-country led to various measures proposed in
Congress last year, though none was actually passed.
Rep. Neal, in reintroducing his measure this year,
stated that corporate expatriation is a $4 billion
problem for the federal treasury.
Besides the tax implications of corporate
expatriation, concerns about its detrimental effect on
shareholder rights have bolstered the cry for reform.
Especially in light of rampant corporate
irresponsibility exposed by accounting scandals and
sleight-of-hand business dealings by major American
companies of global stature, corporate expatriation of
a publicly held company to a tax haven where
shareholder rights are diminished is seen as another
insult to the American public.
C. Inversions versus Cross Border Mergers
In an inversion, a United States company enters into a
transaction or a series of transactions whereby the
ultimate corporate parent headquartered in the United
States, and subject to U.S. tax laws, becomes a foreign
entity, guided by the tax law in the foreign jurisdiction
which usually imposes little to no tax. Typically,
shareholders swap stock in the domestic company with the
foreign company in exchange for its stock. The result is
that the shareholders become owners in a foreign company,
which then holds all the stock in the domestic company,
making it a subsidiary of the foreign "parent," although
firms have used different transaction models such as an
AB 759 - Ma
Page 5
asset transfer or "drop down" transaction to achieve an
inversion. In 2004, Congress enacted the American Jobs
Creation Act (AJCA), which among other provisions, removed
the tax advantage for inversion by redefining inverted
companies as domestic companies for tax purposes if:
The firm is a subsidiary of a foreign
company or transfers all its assets to a foreign
company.
Former shareholders of the domestic
entity hold 80% or more of the stock in the new
foreign entity, by vote or value, after the
transaction.
The foreign incorporated entity does not
conduct substantial business activities in the
entity's country of incorporations.
The law also limited firms with former shareholders of
the domestic entity holding between 60% and 80% of the
stock in the foreign entity from transferring assets from
the domestic to the foreign parent.
Cross border mergers are much different transactions
than inversions. In a cross border mergers, unrelated
companies directed by different boards, owned by separate
sets of shareholders, and possibly located in separate
countries consolidate into a new firm. In inversions,
shareholders swap stock in a domestic entity for stock in a
foreign one, and retain the same rights, interest, and
value in the foreign firm as they did the domestic one. In
cross border mergers, the separate firm's operations are
consolidated; in an inversion, they remain largely
unchanged. In essence, firms invert to avoid tax, but
merge to achieve functional efficiencies and enhance
profits.
The sponsor of this measure, Tyco International,
argues that SB 640's prohibition on inverted firms
receiving state contracts wrongly defines firms that
entered into cross border mergers and not inversions as
"expatriate corporations." SB 640 largely relied on the
AJCA's definition of an inversion, except that firms where
shareholders held more than 50% of the stock after the
AB 759 - Ma
Page 5
transaction or series of transactions were disqualified
from bidding on state contracts. In 1997, Tyco (U.S) and
ADT, which moved to Bermuda in 1984, merged, becoming Tyco
International (Bermuda), a transaction that Tyco asserts
resulted in a taxable gain to Tyco shareholders of at least
$2 billion. Ten years later, Tyco International split into
Tyco Electronics (Switzerland), Tyco International (Bermuda
then Switzerland), and Covidien (Ireland). The two new
firms, Tyco Electronics and Covidien were formed outside
the U.S and were never domestic companies; however, Tyco
International once was, subjecting it and perhaps the new
firms to the provisions of SB 640 because its former
shareholders retained more than 50% of the stock in the new
entity.
AB 759 remedies this problem by distinguishing cross
border mergers from inversions by carving out of the public
contract prohibition firms that meet the following
conditions:
The former shareholders do not retain
more than 70% of the stock in the new entity.
The transaction or series of transactions
that established the former entity were taxable.
The foreign incorporated entity is a
resident in a country with a comprehensive tax
treaty with the United States.
D. Do It Again
The Committee approved AB 759 on July 8, 2009 when it
contained a more simplified version of the changes to the
public contract code, and replaced the inclusion ratio for
firms with subpart (f) income from controlled foreign
corporations with conformity to the federal method of
treating the income. However, the measure failed passage
on the Senate Floor. On August 5, 2010, the Author amended
the measure to delete the subpart (f) provisions, and
inserted the changes to the Public Contract Code described
above. The Senate Rules Committee referred the measure
back to the Committee for its consideration.
AB 759 - Ma
Page 5
E. Amendment Needed
On Page 4, Lines 16 through 20 should be replaced with
the following to ensure clarity:
(B) Any successor corporation resulting from a
corporate reorganization as defined in Section 368 of
the Internal Revenue Code or a transaction satisfying
the requirements of Section 351 of the Internal
Revenue Code shall not be considered an expatriate
corporation for purposes of this section if it meets
the requirements of (iv).
Support and Opposition
Support:National Foreign Trade Council, Inc.; Tyco;
Organization for International Investment; Covidien
Oppose:None received.
---------------------------------
Consultant: Gayle Miller and Colin Grinnell