BILL ANALYSIS                                                                                                                                                                                                    



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          ASSEMBLY THIRD READING
          AB 1178 (Block)
          As Amended  January 25, 2010
          Majority vote.  Tax levy 

           REVENUE & TAXATION  5-3         APPROPRIATIONS      12-5        
           
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          |Ayes:|Charles Calderon, Coto,   |Ayes:|De Leon, Ammiano,         |
          |     |Ma, Portantino, Fong      |     |Bradford, Charles         |
          |     |                          |     |Calderon, Coto, Davis,    |
          |     |                          |     |Fuentes, Hall, John A.    |
          |     |                          |     |Perez, Skinner, Solorio,  |
          |     |                          |     |Torlakson                 |
          |     |                          |     |                          |
          |-----+--------------------------+-----+--------------------------|
          |Nays:|Beall, Harkey, Nestande   |Nays:|Conway, Harkey, Miller,   |
          |     |                          |     |Nielsen, Strickland       |
          |     |                          |     |                          |
           ----------------------------------------------------------------- 
           SUMMARY  :  Requires multinational corporations that elect to file  
          tax returns based only on income earned inside the United States  
          (U.S.), known as the water's-edge method, to include, for tax  
          years beginning on or after July 1, 2011 and before July 1,  
          2014, the income of a related corporation located in a tax haven  
          country.  Provides a partial exemption from the sales and use  
          taxes (SUT), on and after July 1, 2011, and before January 1,  
          2015, for the purchases of college textbooks and supplies by  
          college students, as defined.  Specifically,  this bill  : 

          1)Requires a corporate taxpayer, for taxable years beginning on  
            and after July 1, 2011, and before July 1, 2015, to include in  
            the taxpayer's water's-edge return the entire income and  
            apportionment factors of any affiliated corporation that was  
            doing business in, or had income derived from or attributable  
            to, a tax haven. 

          2)Defines "doing business in" a tax haven as being engaged in  
            activity that is sufficient for a tax haven jurisdiction to  
            impose a tax under United States (U.S.) constitutional  
            standards. 

          3)Defines the term "tax haven" as any jurisdiction identified in  
            Table 1 of Appendix I to the December 2008 Report of the U.S.  








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            Government Accountability Office on International Taxation  
            (GAO-09-157) for which a United States District Court order  
            granted leave for the federal Internal Revenue Service to  
            serve a "John Doe" summons.  

          4)Provides that an additional jurisdiction shall be considered a  
            "tax haven" if the U.S. Secretary of the Treasury issues  
            notice after January 1, 2011, declaring that the jurisdiction  
            is recognizes as a tax haven by the U.S.  A jurisdiction shall  
            not be considered a "tax haven" if the U.S. Secretary of the  
            Treasury issues notice declaring the jurisdiction is no longer  
            recognized as a tax haven by the U.S. 

          5)Allows a taxpayer to petition the Franchise Tax Board (FTB) to  
            exclude the income and apportionment factors of a tax haven  
            corporation from the water's-edge return if that corporation  
            is engaged in the active conduct of trade or business in a tax  
            haven, within the meaning of Internal Revenue Code (IRC)  
            Section 367(a)(3)(A) and the regulations thereunder. 

          6)Authorizes FTB, in accordance with Revenue and Taxation Code  
            (R&TC) Section 25137, to prescribe a form and manner in which  
            a taxpayer must file the petition.

          7)Allows taxpayers to appeal the FTB's determination to the  
            State Board of Equalization (BOE) in the specified form and  
            manner.  

          8)Authorizes FTB to prescribe regulations necessary to carry out  
            the purposes of this bill. 

          9)Requires FTB to issue annually a notice identifying the  
            jurisdictions that are considered tax havens.  

          10)Provides a partial exemption from SUT, on and after July 1,  
            2011, and before January 1, 2015, for the sale of, and the  
            storage, use, or other consumption of, textbooks and supplies  
            purchased by a student enrolled in an institution of higher  
            education.  Specifically, it provides that:

             a)   For purchases made between July 1, 2011, and before July  
               1, 2012, the state portion of SUT otherwise applicable to  
               those purchases is reduced to 2%;  









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             b)   Purchases made on or after July 1, 2012, and before  
               January 1, 2015, are exempted from the state portion of  
               SUT; 

             c)   The exemption does  not  apply to any of the following  
               taxes:

               i)     Tax imposed pursuant to R&TC Section 6051.2 and  
                 Section 6201.2, dedicated to local governments to fund  
                 health and welfare programs (Local Revenue Fund);  

               ii)    Tax imposed pursuant to R&TC Section 6051.5 and  
                 Section 6201.5, dedicated to the repayment of the  
                 Economic Recovery Bonds (Fiscal Recovery Fund);

               iii)   Tax imposed pursuant to Section 35 of Article XIII  
                 of the California Constitution, dedicated to local  
                 government to fund public safety services (Local Public  
                 Safety Fund); and,

               iv)    Any tax levied by a county, city, or district  
                 pursuant to the Bradley-Burns Uniform Local SUT Law or  
                 the Transactions and Use Tax Law. 

          11)Defines "institution of higher education" as the University  
            of California, the California State University, or a  
            California community college. 

          12)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. 

          13)Defines "textbooks" as any published material that is  
            principally designed for use by a student at an institution of  
            higher education as a source of instructional material and  
            includes any book or edition of a book that is directed or  
            recommended by an instructor at an institution of higher  
            education to a student to purchase for use as a basis for a  
            course of study in which that student is enrolled at that  
            institution.









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          14)Takes effect immediately as a tax levy. 

           FISCAL EFFECT  :  The FTB staff estimates that the water's-edge  
          provisions of this bill will result in an annual gain of $70  
          million in the fiscal year (FY) 2011-12, $120 million in FY  
          2012-13, and $120 million in FY 2013-14, and $50 million in FY  
          2014-15.  The State Board of Equalization (BOE) staff estimates  
          that SUT provisions of this bill will result in an annual loss  
          of $70 million in FY 2011-12, $122 million in FY 2012-13, $128  
          million in FY 2013-14, and $48 million in FY 2014-15. 

           COMMENTS  :   

           1)The Author's Statement  .  The author states that, "AB 1178  
            would close a loophole currently used by corporations that set  
            up affiliates in listed tax haven countries to primarily park  
            their income to avoid paying their equitable share of  
            California taxes.  These corporations' tax evasions through  
            this loophole result in fewer dollars for education, health,  
            and public safety programs on which Californians depend.  The  
            Franchise Tax Board (FTB) estimates that closure of this  
            loophole would generate approximately $120 million per year in  
            additional revenue to help address the substantial increased  
            costs to students and families in obtaining a higher  
            education.  The bill would simultaneously reduce the sales tax  
            burden imposed on textbooks and supplies purchased by students  
            at a UC, CSU, or California Community College store by a  
            partial exemption of the state sales tax.  According to the  
            Board of Equalization, this would result in a reduction of  
            approximately $120 million per year in revenue.  Therefore,  
            this bill would yield no net change in state revenue, while it  
            improves the affordability of materials required by students  
            to attend public higher education institutions.  Local sales  
            tax revenues would not be affected."

           2)Arguments in Support  .  The proponents of this bill argue that,  
            "as California prepares to make more devastating cuts to  
            social and human services programs in 2010, the necessity to  
            shut down abusive off-shoring practices that simply pad the  
            bottom lines of multibillion dollar corporations has never  
            been greater."  Proponents believe that moneys derived from  
            closing corporate tax loopholes could be put to better use as  
            tax relief for already struggling college students in  
            California. 








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           3)Arguments in Opposition  .  The opponents believe 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.  The  
            opponents argue that this bill violates the Foreign Commerce  
            Clause, provides for no process to appeal FTB's determination,  
            and contains unreliable revenue estimates.  Finally, the  
            opponents state that this bill runs directly contrary to the  
            Treasury Department's position on listing "tax havens" by  
            referring to the GAO list of "tax haven" countries about which  
            the Deputy Assistant Secretary of the Treasury had substantial  
            foreign policy concerns.  

           4)What Exactly Does this Bill Propose to Do  ?  This bill does two  
            things: it partially exempts from SUT the purchases of  
            textbooks and supplies by college students and revises the  
            water's-edge provisions to include the income and  
            apportionment factors of affiliated companies that are doing  
            business in, or derive income from, a tax haven country.  

           5)The Partial SUT exemption  .  The proposed exemption would apply  
            only to textbooks and supplies purchased by students enrolled  
            in the University of California, the California State  
            University, or a California community college.  Furthermore,  
            only textbooks required or recommended for a course at an  
            eligible institution would be exempted from SUT.  The intent  
            of this bill is to make college textbooks and supplies more  
            affordable for college students.  However, purchases by  
            students enrolled in a private university or college would not  
            be eligible for this exemption.  

          Under current law, the statewide base SUT rate is 8.25%, which  
            is comprised of 5% General Fund (GF) state rate, 1% GF state  
            rate (until July 1, 2011), 0.25% Fiscal Recovery Fund rate,  
            0.50% Local Revenue Fund rate, 0.50% Local Public Safety Fund  
            rate, 0.75% city and county operations rate and 0.25% county  
            transportation rate.  In addition to the statewide base rate  
            of 8.25%, cities and counties are authorized to impose  
            additional voter-approved taxes.  

          This bill would reduce the  state  rate of 5% to 2% for purchases  
            of eligible textbooks and supplies between July 1, 2011 and  








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            June 30, 2012.  On and after July 1, 2012 and until January 1,  
            2015, those purchases would be completely exempted from the  
            state portion of SUT.  However, this partial exemption would  
            not apply to the Bradley-Burns local taxes, transactions and  
            use taxes, the 0.25% tax dedicated to the repayment of  
            Economic Recovery Bonds, the 0.50% dedicated to local  
            government for funding of local health and welfare programs or  
            the 0.50% tax dedicated to funding local public safety  
            services.  

           6)The Water's-Edge Provision  .  Under existing law, a corporate  
            taxpayer with worldwide business activities may elect to  
            report income to California on a "water's-edge" basis.  A  
            water's-edge election, generally, allows the taxpayer to  
            exclude from its tax return the income and apportionment  
            factors of taxpayer's foreign affiliates.  Currently, in order  
            to be  included  in the taxpayer's water's-edge return, a  
            foreign affiliated company must be a domestic international  
            sales corporation, a foreign sales corporation, an export  
            trade corporation, a CFC with Subpart F income, or must have  
            U.S.-source income or some U.S. presence (i.e. an average of  
            the property, payroll, and sales factors within the U.S. of  
            20% or more).  This bill would expand the list of foreign  
            affiliated companies whose income and apportionment factors  
            must be included in the taxpayer's water's-edge tax return.   
            It would require  any  foreign affiliated company doing business  
            in, or deriving income attributable to, a tax haven country to  
            be on that list, which means that a foreign company that has  
            neither U.S.-source income nor U.S. presence (no payroll,  
            property or sales factor) would qualify for the inclusion.   
            Furthermore, all income and apportionment factors of a CFC  
            would be included in the taxpayer's return, instead of the  
            percentage based on the ratio of its Subpart F income to the  
            current year earnings and profits.  It should be remembered,  
            however, that this proposal would apply only to the taxpayer's  
             affiliated  foreign companies, i.e. companies that are members  
            of a commonly controlled group, that are unitary with the  
            taxpayer.   

           7)Similar Legislation:  Water's-Edge Provisions  .

          AJR 12 (Block), introduced in the 2009 legislative session,  
            would request that the President and the U.S. Congress enact  
            legislation that closes the corporate federal tax loopholes  








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            relating to tax haven countries.  AJR 12 is in the Senate  
            Revenue and Taxation Committee.

          AB 34 (Ruskin), introduced in the 2005-06 legislative session,  
            was nearly identical to AB 1178 and would have required  
            taxpayers filing on a water's-edge basis to include the income  
            and apportionment factors of affiliated corporations doing  
            business in, or having income derived from or attributable to,  
            a tax haven.  AB 34 failed to pass out of the Assembly.  

          AB 441 (Chu), introduced in the 2005-06 legislative session,  
            would have required a corporation that makes a water's-edge  
            election to include the income and apportionment factors of  
            certain foreign affiliates.  AB 441 failed to pass out of the  
            Assembly. 

          SB 663 (Migden), Chapter 22, Statutes of 2006, clarified  
            specific provisions of the franchise tax law relating to  
            water's-edge taxpayer and reformed the water's-edge procedure  
            by replacing existing rules creating a contract between the  
            taxpayer and FTB with election procedures.  SB 663 applies to  
            a taxpayer making a water's-edge election on or after January  
            1, 2006, and to those taxpayers that made a water's-edge  
            election before January 1, 2006, but not until the expiration  
            of the seven-year period during which a taxpayer is prohibited  
            from terminating that election without the consent of the FTB.  


           8)Similar Legislation:  SUT Exemption for Purchases of Textbooks  
            and Supplies  . 

          AB 2636 (Leonard), introduced in the 2001-02 legislative  
            session, would have provided a state SUT exemption for the  
            purchase of any instructional materials, as defined, by any  
            qualifying school entity, as defined.  AB 2636 was held under  
            submission in this Committee.

          AB 1077 (Mountjoy), introduced in the 2001-02 legislative  
            session, would have provided a state SUT exemption for the  
            purchase of any TPP by a K-12 public school or school district  
            for use by that school or district.  AB 1077 was held under  
            submission in this Committee. 

          SB 546 (McClintock), introduced in the 2001-02 legislative  








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            session, would have provided a SUT exemption for the sale and  
            purchase of any textbook, as defined, purchased by a K-12  
            public school or school district, or an accredited private  
            school, or sold to a student of an accredited private school  
            or institution of higher education.  SB 546 failed passage in  
            the Senate Revenue and Taxation Committee. 


           Analysis Prepared by  :    Oksana Jaffe / REV. & TAX. / (916)  
          319-2098 
                                                               FN:  0003625