BILL ANALYSIS AB 1178 Page 1 ASSEMBLY THIRD READING AB 1178 (Block) As Amended January 25, 2010 Majority vote. Tax levy REVENUE & TAXATION 5-3 APPROPRIATIONS 12-5 ----------------------------------------------------------------- |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. AB 1178 Page 2 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%; AB 1178 Page 3 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. AB 1178 Page 4 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. AB 1178 Page 5 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 AB 1178 Page 6 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 AB 1178 Page 7 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 AB 1178 Page 8 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