BILL ANALYSIS AB 759 Page 1 CONCURRENCE IN SENATE AMENDMENTS 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 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 AB 759 Page 2 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 AB 759 Page 3 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 AB 759 Page 4 $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 AB 759 Page 5 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 AB 759 Page 6 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