BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 759
                                                                  Page  1

          Date of Hearing:  August 26, 2010

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                              Anthony Portantino, Chair

                      AB 759 (Ma) - As Amended:  August 18, 2010
           
           Majority vote.  Fiscal committee.

           SUBJECT  :  Public contracts:  expatriate corporations:   
          definitions.

           SUMMARY  :  Exempts certain foreign companies from California's  
          public contracting ban by revising the definition of an  
          "expatriate corporation."  Specifically,  this bill  :  

          1)Revises the definition of an "expatriate corporation" under  
            the California Taxpayer and Shareholder Protection Act of 2003  
            [Chapter 1 (commencing with Section 10286) of Part 2 of  
            Division 2 of the Public Contract Code] (CTSP Act) to provide  
            that a foreign incorporated entity is  not  considered to be an  
            "expatriate corporation" if all of the following requirements  
            are met:

             a)   The foreign incorporated entity, or any predecessor, was  
               originally established in connection with a transaction  
               between unrelated publicly traded corporations; 

             b)   Immediately after the transaction, not more than 70% of  
               that entity's stock is held by former shareholders of any  
               domestic corporation that was a party to such transaction; 

             c)   The transaction, or a series of related transactions,  
               that originally established the foreign incorporated  
               entity, or any predecessor, was a taxable transaction for  
               any United States (U.S.) shareholders of any domestic  
               corporation that was a party to such transaction; and, 

             d)   The foreign country in which the entity is organized has  
               a comprehensive income tax treaty with the U.S. and the  
               entity is considered a resident of the foreign country for  
               purposes of that treaty. 

          2)States that if a foreign incorporated entity qualifies for the  
            exemption, then any successor corporation resulting from a  








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            corporate reorganization, as defined in Internal Revenue Code  
            (IRC) Section 368, or a transaction satisfying the  
            requirements of IRC Section 351, is not considered to be an  
            "expatriate corporation."  The successor must be organized in  
            a foreign country that has a comprehensive tax treaty with the  
            U.S. and be considered a resident of that country for purposes  
            of the treaty.

          3)Clarifies the intent of the Legislature to prohibit a state  
            agency from entering into any contract with an expatriate  
            corporation located in a foreign jurisdiction that does not  
            have an income tax treaty with the U.S. 
           



          EXISTING LAW  :

          1)Prohibits, except as otherwise provided, a "state agency" from  
            entering into any contract with an "expatriate corporation" or  
            its subsidiaries.  

          2)Provides that the term "state agency" means every state  
            office, department, division, bureau, board, commission, and  
            the California State University, but does not include the  
            University of California, the Legislature, the courts, or any  
            agency in the judicial branch of government.

          3)Defines an "expatriate corporation" as a foreign incorporated  
            entity that is publicly traded in the U.S., and that meets  
            other specific requirements.  First, the U.S. must be the  
            principal market for the public trading of the entity.   
            Secondly, the entity must have no substantial business  
            activities in the place of incorporation.  Finally, either of  
            the following requirements must be met:

             a)   The foreign entity was established through a transaction  
               whereby (1) the foreign entity acquired substantially all  
               of the properties held by a domestic corporation (or all of  
               the properties constituting a trade or business of a  
               domestic partnership or related foreign partnership), and  
               (2) immediately after the acquisition, more than 50% of the  
               foreign entity's publicly traded stock is held by former  
               shareholders of the domestic corporation (or by former  
               partners of the domestic partnership or related foreign  








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               partnership); or,

             b)   The foreign entity was established through a transaction  
               whereby (1) the foreign entity acquired substantially all  
               of the properties held by a domestic corporation (or all of  
               the properties constituting a trade or business of a  
               domestic partnership or related foreign partnership), and  
               (2) the acquiring foreign entity is more than 50% owned by  
               domestic shareholders or partners.  

           FISCAL EFFECT  :  Unknown.

           COMMENTS  :   

           1)Author's Statement  .  The author states that, "AB 759 clarifies  
            current law on the ability of [an expatriate corporation] to  
            contract with the State.  The original law, SB 640, was  
            intended to prevent corporations that left the United 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 county 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 savings measure." 

           2)Arguments in Support  .  The proponents argue that, while the  
            CTSP Act has been successful in stopping "expatriate  
            corporations" from receiving state contracts, it has  
            unintentionally and inadvertently prevented companies founded  
            through legitimate mergers from contracting with the state,  
            making it difficult for California to compete in this growing  
            global economy.  The proponents state that the current law  
            fails to distinguish between cross-border mergers and  
            inversions, has increased the costs of state contracts and has  
            negatively affected job growth in California.

           3)What is "Corporation Expatriation"  ?  A "corporate inversion"  
            or "expatriation" occurs when a U.S. company creates a new  








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            parent corporation based in a low tax jurisdiction or a "tax  
            haven" country like Bermuda, the Bahamas, or the Cayman  
            Islands.  The hallmark of a corporate inversion is that it  
            occurs only  between the corporation and its existing  
            shareholders.  In a typical inversion transaction, a U.S.  
            company creates a foreign subsidiary and exchanges the stock  
            of that subsidiary for the U.S. company stock.  Ultimately,  
            the shareholders of the U.S. company hold shares in the  
            foreign subsidiary and the foreign subsidiary holds the shares  
            of the U.S. company.  In essence, in a corporate inversion,  
            the company enters into a transaction with itself because the  
            existing shareholders, generally, retain the same rights,  
            interests, and value as prior to the inversion.   The exchange  
            inverts (hence, the name "inversion") the original chain of  
            ownership and creates a top-tier foreign-based parent company,  
            which is often little more than a corporate charter filed, or  
            a post box located, in a low or no tax jurisdiction, with no  
            substantial presence or business operations.  Corporate  
            inversions permit the corporation to enjoy lower tax rates and  
            fewer regulations because of its new nationality, while  
            control of the company remained virtually unchanged.  

          A tax haven is a foreign jurisdiction that maintains corporate,  
            bank, and tax secrecy laws and industry practices that make it  
            very difficult for other countries to find out whether their  
            citizens are using the tax haven to avoid paying their taxes.   
            Data released by the Commerce Department indicates that, as of  
            2001, almost half of all foreign profits of U.S. corporations  
            were in tax havens.  Further, a study released by Tax Notes,  
            September 2004, found that American companies were able to  
            shift $149 billion of profits to 18 tax haven countries in  
            2002, up 68% from $88 billion in 1999.  In January 2009, a  
            report issued by the Government Accounting Office shows that  
            out of the 100 largest U.S. publicly traded corporations, 83  
            have subsidiaries in tax havens.  

           4)Federal and State Prohibitions on Contracts With Expatriate  
            Corporations  .  In 2003, the Legislature passed SB 640  
            (Burton), Chapter 657, which established the CTSP Act.  The  
            CTSP Act prohibits state agencies from contracting with  
            "expatriate corporations," i.e., U.S. companies that  
            reincorporate offshore for tax reasons.  SB 640 was sponsored  
            by the State Treasurer who estimated that the practice of  
            "expatriation" would cost the state roughly $180 million in  
            foregone tax revenues over a 10-year period and would  








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            jeopardize the rights of corporate shareholders.  

          The CTSP Act was largely modeled after Section 835 of the  
            Homeland Security Act (Public Law 107-296, Section 835), which  
            prohibits an award of federal contracts to expatriate  
            corporations.  The Homeland Security Act was enacted in  
            November of 2002 in response to a proliferation of corporate  
            inversions and expatriations in the early 2000s.  It was  
            amended in 2003 to delete the exceptions to the contract ban  
            for job loss and additional government costs and was further  
            expanded in 2004 to apply to any subsidiary of an inverted  
            domestic corporation.  Further, in 2004, Congress enacted the  
            American Jobs Creation Act (AJCA), which, among other  
            provisions, curbed the use of corporate inversions by  
            preventing those types of transactions from qualifying as  
            tax-free reorganizations and by requiring expatriated entities  
            and their shareholders to recognize gain on the inversion (IRC  
            Section 7874).  With the passage of the federal ban on  
            contracting with expatriate corporations and the federal tax  
            legislation, the practice of corporate inversion has largely  
            stopped.  

           5)Revised Definition of an Expatriate Corporation  .  Under the  
            CTSP Act, an "expatriate corporation" is currently defined as  
            a foreign incorporated entity that is publicly traded in the  
            U.S. and that meets other specified requirements.  This bill  
            would exempt from the contract prohibition a foreign  
            incorporated entity that is established as a result of a  
            legitimate cross border merger, in contrast to a corporate  
            inversion.  Specifically, in order to contract with the state,  
            a foreign entity must (a) be established in connection with a  
            taxable transaction between unrelated publicly traded  
            entities; (b) be created or organized in a jurisdiction with a  
            comprehensive income tax treaty with the U.S.; and (c) be a  
            resident of that jurisdiction for purposes of the treaty.  In  
            addition, immediately after the merger, not more than 70% of  
            the foreign entity's publicly traded stock may be held by  
            former shareholders, or partners, of the domestic corporation  
            or related foreign partnership, respectively.  Furthermore, a  
            successor of the qualified entity would not be considered an  
            "expatriate corporation" if it resides in a foreign country  
            with which the U.S. has a comprehensive tax treaty.  A foreign  
            entity that meets all of the above requirements would fall  
            outside the CTSP Act's prohibitions and would be eligible to  
            contract with state agencies.  








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           6)Who Does this Bill Help  ?  The sponsor of this measure, Tyco  
            International, argues that the existing prohibition on  
            contracting with the state wrongly defines companies that  
            enter into legitimate cross-border transactions as "expatriate  
            corporations."  It asserts that a cross-border merger between  
            unrelated companies owned by different sets of shareholders  
            and directed by independent boards must be distinguished from  
            an inversion where a domestic entity, for tax reasons, moves  
            outside of the U.S., with no or little change in business  
            operations and the existing shareholders maintaining control  
            in the new entity.  As noted in the Senate Revenue and  
            Taxation Committee's analysis of this bill, the circumstances  
            surrounding the establishment of Tyco International highlight  
            how a bona fide a cross-border merger may be inadvertently  
            drawn into the existing definition of an inversion under the  
            CSTP Act.  In 1997, Tyco and ADT, which moved to Bermuda in  
            1984, merged, becoming Tyco International (Bermuda), a taxable  
            transaction that the sponsor asserts resulted in a gain  
            recognition to Tyco shareholders of at least $2 billion. Ten  
            years later, Tyco International split into Tyco Electronics  
            (incorporated in Switzerland), Tyco International (originally  
            a Bermuda corporation that is presently residing in  
            Switzerland), and Covidien (incorporated in Ireland).  
           
           While Tyco International believes this legislation is needed to  
            enable it to bid on state contracts, it is not clear whether  
            Tyco International even meets the current definition of an  
            expatriate corporation.  To be deemed an expatriate  
            corporation under current law, a corporation must have "no  
            substantial business activities in the place of  
            incorporation."  Tyco, in turn, is currently incorporated in  
            Switzerland and it is committee staff's understanding that  
            Tyco employs roughly 1,000 individuals in that county.   
            Nevertheless, Tyco representatives state that it is currently  
            unclear whether their business activities in Switzerland would  
            be considered "substantial" by a reviewing entity.  The  
            "substantial presence" test mirrors federal law and it has  
            been an exceedingly difficult standard to implement for both  
            California and the federal government.  Thus, Tyco  
            International is effectively seeking a safe harbor, under  
            which it (and its subsidiaries) would be excluded from the  
            statutory definition of an expatriate corporation.  Its  
            representatives also argue that creating a clear safe harbor  
            would ease administration of the state's contracting law and  








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            would distinguish legitimate non-tax motivated transactions  
            from corporate inversions.
           
          7)What Is an Income Tax Treaty?   The U.S. has tax treaties with  
            a number of foreign countries.  Under these treaties,  
            residents (not necessarily citizens) of foreign countries are  
            taxed at a reduced rate, or are exempt from U.S. taxes on  
            certain items of income they receive from sources within the  
            U.S.  These reduced rates and exemptions vary among countries  
            and specific items of income.  Under these same treaties,  
            residents or citizens of the U.S. are taxed at a reduced rate,  
            or are exempt from foreign taxes, on certain items of income  
            they receive from sources within foreign countries.  Most  
            income tax treaties contain what is known as a "limitation on  
            benefit" (LOB) provision, which establishes a required level  
            of corporate presence in each treaty country necessary to  
            qualify for benefits under the tax treaty.  An LOB provision  
            exists in most U.S. income tax treaties to prevent "treaty  
            shopping," which is an attempt by a foreign corporation based  
            in a non-U.S. tax treaty jurisdiction (for example, a tax  
            haven country) to create a subsidiary in a country that has a  
            tax treaty with the U.S. for the purpose of obtaining tax  
            treaty benefits that would otherwise be unavailable if the  
            payments were made directly to the non-treaty foreign parent  
            company.  An LOB provision is considered an objective  
            anti-abuse tool to protect the integrity of the U.S. tax  
            treaty network.  The LOB provisions represent the U.S.  
            Department of Treasury's best efforts to ensure that an  
            appropriate level of corporate presence is maintained in each  
            foreign country with which the U.S. maintains a treaty  
            relationship.  Under AB 759, California would rely on the U.S.  
            tax treaty network as a proxy for ensuring an appropriate  
            "substantial presence" standard in a particular country.  By  
            conditioning a company's eligibility to contract with  
            California on its status as a resident of a foreign country  
            for U.S. income tax treaty purposes, AB 759 would create an  
            additional safeguard against inverted domestic corporations. 
           
          8)Does this Bill Preserve the Original Intent of SB 640  ?  As  
            noted above, SB 640 was designed to prohibit U.S. companies  
            that reincorporate offshore for tax reasons from contracting  
            with the state.  If this bill is passed, companies that  
            expatriate to tax haven counties without a U.S. tax treaty  
            will still be barred from contracting with the state.   
            Similarly, a company that was established in a tax-free  








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            reorganization would be disqualified from competing for state  
            contracts.  Thus, arguably, this bill preserves the original  
            intent of SB 640 by including a number of stringent  
            requirements that must be met before a company will fall  
            outside of the definition of an "expatriate corporation."  
           
           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          Tyco International (sponsor)
          National Foreign Trade Council, Inc.
          Covidien
          National Electrical Manufacturers Association
          Organization for International Investment

           Opposition 
           
          None on file

           Analysis Prepared by  :  Oksana Jaffe / REV. & TAX. / (916)  
          319-2098