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  








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              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  








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                 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  








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            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.  








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                 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  








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            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  








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            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.








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            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