BILL ANALYSIS                                                                                                                                                                                                    

                                                                AB 759
                                                                Page  1

        AB 759 (Ma)
        As Amended  August 18, 2010
        Majority vote
        |ASSEMBLY: |     |(May 28, 2009)  |SENATE: |31-2 |(August 23, 2010)    |
                            (vote not relevant)

        |COMMITTEE VOTE:  |9-0  |(August 26, 2010)   |RECOMMENDATION: |concur    |
        |                 |     |                    |                |          |

        Original Committee Reference:    B.P. & C.P.  

         SUMMARY  :  Makes substantive changes to the California Taxpayer and  
        Shareholder Protection Act of 2003 (CTSP Act) by revising the  
        definition of an "expatriate corporation" to allow certain foreign  
        incorporated entities to contract with the state. 

         The Senate amendments  delete the Assembly version of this bill, and  

        1)Revise the definition of an "expatriate corporation" for purposes  
          of Act [Chapter 1 (commencing with Section 10286) of Part 2 of  
          Division 2 of the Public Contract Code] 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 incorporate 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 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  


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             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)State that if a foreign incorporated entity qualifies for the  
          exemption, then any successor corporation resulting from a  
          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)Clarify 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 United States. 

         AS PASSED BY THE ASSEMBLY  , this bill included architectural,  
        engineering, and information technology contracts in existing  
        reporting requirements on the participation levels of businesses  
        that include the owner's race, ethnicity, and gender in state  

         FISCAL EFFECT  :  Unknown, but probably none. 

         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  


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          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 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  


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          $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 jeopardize the rights of corporate  

        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  


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          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  

         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  


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          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 would  
          distinguish legitimate non-tax motivated transactions from  
          corporate inversions.
        7)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 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."  
         Analysis Prepared by  :  Oksana Jaffe / REV. & TAX. / (916) 319-2098

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