BILL ANALYSIS
AB 759
Page 1
CONCURRENCE IN SENATE AMENDMENTS
AB 759 (Ma)
As Amended August 18, 2010
Majority vote
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|ASSEMBLY: | |(May 28, 2009) |SENATE: |31-2 |(August 23, 2010) |
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(vote not relevant)
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|COMMITTEE VOTE: |9-0 |(August 26, 2010) |RECOMMENDATION: |concur |
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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
instead:
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
contracts.
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
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
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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
agencies.
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
FN: 0006809