BILL ANALYSIS                                                                                                                                                                                                    



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          Date of Hearing:   January 21, 2010

                        ASSEMBLY COMMITTEE ON APPROPRIATIONS
                                Kevin De Leon, Chair

                   AB 1178 (Block) - As Amended:  January 13, 2010 

          Policy Committee:                              Revenue and  
          Taxation     Vote:                            5-3

          Urgency:     No                   State Mandated Local Program:  
          No     Reimbursable:              

           SUMMARY  

          This bill (a) requires multinational companies to include  
          operations located in foreign "tax havens" in their combined  
          income report for California's corporation tax, and (b) provides  
          a partial sales and use tax exemption for purchases of textbooks  
          and supplies by students of the University of California (UC),  
          California State Universities (CSU), and California Community  
          Colleges (CCC).

           FISCAL EFFECT  

          1)No impact in 2010-11.

          2)According to FTB, the corporate tax provisions will raise  
            revenues by $70 million in 2011-12, $120 million in 2012-13  
            and in 2013-14, and $50 million in 2014-15.

          3)According to BOE, the sale exemption for textbooks and  
            supplies will reduce revenues by $70 million in 2011-12, $122  
            million in 2012-13, $128 million in 2013-14, and $48 million  
            in 2014-15.
           
          SUMMARY (Continued)
           
           Specifically, the bill: 

          1)Requires multinational corporations that elect to file tax  
            returns based only on income earned inside the U.S., known as  
            the water's-edge method, to include the income and operations  
            of affiliates doing business in tax-haven countries in its  
            combined income reports.








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          2)Defines the term "tax haven" by reference to jurisdictions  
            identified in Table 1 of Appendix I to the December 2008  
            Report of the United States Government Accountability Office  
            (GAO) on International Taxation. 

          3)Allows a taxpayer to petition the Franchise Tax Board (FTB) to  
            exclude the income and operations of an affiliated corporation  
            doing business in a tax haven from the water's-edge return if  
            that corporation is engaged in the active conduct of a trade  
            or business in the tax haven. 

          4)Requires the Legislative Analyst, in consultation with the  
            FTB, to conduct a study regarding whether the jurisdictions  
            identified by the GAO are appropriate, or whether the  
            definition of the term "tax haven" should be revised.

          5)Provides an exemption from part or all of the GF portion of  
            the sales and use tax for textbooks and supplies purchased  
            anywhere by students of UC, CSU, and CCC. The first three  
            percent of the portion sales tax would be exempt between July  
            1, 2011 and June 30, 2012, and the full five percent portion  
            would be exempt from July 1, 2012 through December 31, 2014.

          6)Defines "supplies" as pens, paper, blue books, notebooks, art  
            supplies, uniforms, safety equipment, tools, computer paper,  
            and flash drives necessary for the course of study in which a  
            student is enrolled at the institution of higher education.   
            The definition of "supplies" does not include computers,  
            printers, or related hardware and software.

          7)Defines "textbooks" as any published material that, among  
            other things, is principally designed for use by a student at  
            an institution of higher education as a source of  
            instructional material.

          8)Specifies that the provisions affecting corporate taxes are in  
            effect for tax years beginning on or after July 1, 2011 and  
            before July 1, 2014. Provisions affecting the sales tax are in  
            effect from July 1, 2011 through December 31, 2014.

           COMMENTS  

           1)Rationale  .  According to the author, the purpose of the bill  
            is to close a corporate loophole and use the proceeds to  








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            provide financial relief to higher education students who have  
            faced major fee increases and financial hardship. The author  
            asserts that the corporate loophole has resulted in fewer  
            dollars for education, health, and public safety programs. He  
            also indicates that the fiscal effects of the bill's two  
            provisions are largely offsetting, thereby placing no  
            significant burden on the GF.

           2)Opponents  , including the California Taxpayers' Association and  
            a variety of business groups, state that this bill runs  
            contrary to the intent of the water's-edge election, could  
            adversely impact foreign relations, and would penalize  
            California-based U.S. companies for doing business in certain  
            countries with which the U.S. has diplomatic ties. 

           3)Background - combined income reporting and water's edge  
            election  .  A key issue relating to state-level corporation  
            franchise taxes involves the determination of California  
            income for large companies (and affiliated groups of  
            companies) that have operations throughout the country or  
            around the world. Given the numerous challenges involved in  
            separately determining receipts and expenses that are  
            attributable to a multi-jurisdictional company's operations in  
            each state, California and virtually all other states levying  
            a corporation tax determine the income attributable to each  
            state through a two-step process. This involves (a)  
            calculation of combined income from all the company's  
            operations, and (b) apportionment of the combined income to  
            the state using formulas that take into account the state's  
            share of the companies' combined property, payroll, and sales,  
            or some subset of these factors.

            Since 1987, California has allowed corporate taxpayers with  
            worldwide business activities to elect to report on a  
            "water's-edge" basis.  A water's-edge election allows the  
            taxpayer to exclude from its tax return the income and  
            apportionment factors of taxpayers' foreign affiliates.   
            However, there are certain exceptions to this foreign  
            exclusion, such as income from a domestic international sales  
            corporation, a foreign sales corporation, an export trade  
            corporation. This bill would add affiliated companies doing  
            business in a tax haven country to the list of foreign  
            operations that must be included in the combined income report  
            of a company electing to report on water's edge basis.









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           4)Background - tax havens  . Generally, a tax haven is a foreign  
            country that maintains corporate, bank, and tax secrecy laws  
            and industry practices that make it difficult for other  
            countries to find out whether their citizens are using the tax  
            haven to avoid paying their taxes. Such havens also generally  
            have low or non-existent taxes on income and royalties. In a  
            report issued in 2000, the Organization for Economic  
            Cooperation and Development (OECD) identified over 40  
            jurisdictions as tax havens. 

            U.S. companies can use affiliated companies in tax havens to  
            minimize their U.S. tax liabilities in a variety of ways. As  
            one example, they can set prices on assets transferred between  
            the two entities at levels that artificially reduce profits of  
            U.S. operations and raise profits of the affiliate in the low-  
            or no-tax region. As another example, a U.S company and its  
            financial subsidiary operating in a tax haven can set the  
            terms of a loan in a way that shifts income out of the U.S.

            Under existing California law, the income and apportionment  
            factors of affiliated tax haven companies are generally not  
            included in the water's-edge return of the California company,  
            unless the affiliated companies themselves have economic  
            presence in California.  Consequently, corporations that  
            manage to shift some income to these subsidiaries will pay  
            less tax to California. 

           Analysis Prepared by  :    Brad Williams / APPR. / (916) 319-2081