BILL ANALYSIS Ó
AB 1423
Page 1
Date of Hearing: September 8, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 1423 (Perea) - As Amended: July 12, 2011
2/3 vote. Urgency. Fiscal Committee
SUBJECT : Income tax: federal conformity: Regulated Investment
Company Modernization Act of 2010.
SUMMARY : Conforms several provisions of state income tax laws
to the federal Regulated Investment Company (RIC) Modernization
Act of 2010. Specifically, this bill :
1)Revises the California income tax laws to treat RICs similarly
to individuals with regard to capital loss carryover, thus,
allowing RICs to carryover capital losses for an unlimited
number of years.
2)Allows a RIC, upon identifying a de minimis asset test
failure, as defined, at the end of the quarter, to maintain
its status as a RIC, provided that, within six months, the RIC
fulfills the requirements of the asset test, as prescribed.
Allow a RIC, which fails either the "gross income" test or the
"asset test" (outside of the de minimis range), to cure the
failure by paying tax and satisfying certain specified
requirements.
3)Replaces the requirement to designate distributions as certain
types of income with a requirement for RICs to report, in a
written statement furnished to shareholders, capital gain
dividends and other pass-through items. Allows RICs to
satisfy the reporting requirement by issuing to shareholders a
Form-1099.
4)Allows a capital loss carryover of a RIC to be taken into
account in determining the RIC's current and accumulated
earnings and profits. Provide that deductions associated with
tax-exempt interest income of a RIC may be taken into account
in computing current earnings and profits, thus allowing
dividend distributions to shareholders in excess of tax-exempt
interest to be treated as a return of capital gain rather than
ordinary taxable dividends.
AB 1423
Page 2
5)Allows RICs with 50% or more of the value of its total assets
invested in other RICs to pass through exempt-interest
dividends and foreign tax credits to shareholders, as
specified.
6)Authorizes a RIC to declare a "spillover dividend," as
defined, by the 15th day of the 9th month following the close
of the taxable year to which the spillover dividend relates,
or the extended due date for filing the RIC's tax return,
whichever is later. Require spillover dividends, once
declared, to be paid by the date of the next dividend payment
of the same type, but no later than 12 months after the end of
the tax year to which the spillover dividend relates.
7)Specifies that, if a RIC distributes dividends in a taxable
year that, in the aggregate, exceed the RIC's current and
accumulated earnings and profits, the current earnings and
profits are allocated first to distributions made prior to
January 1st.
8)Treats the redemption of a publicly-offered RIC stock as an
exchange, rather than a distribution of property, for tax
purposes, if the redemption is upon the demand of the
shareholder and the RIC issues only stock that is redeemable
upon the shareholder demand. Specifies that a
"publicly-offered RIC" is a RIC that offers its shares
publicly, trades on an established securities market, or has
at least 500 persons holding shares at all times.
9)Provides that a publicly offered RIC, as defined, is not
required to follow the "preferential dividend" rule, as
specified.
10)Authorizes a RIC to choose whether or not to postpone
post-October capital losses and qualified late-year ordinary
losses to the first day of the next taxable year.
11)Allows a RIC shareholder to claim a loss on the sale or
exchange of the stock held for six months or less, to the
extent of the amount of the exempt-interest dividend, if
certain requirements are satisfied.
12)Limits the application of the Sales Load Basis Deferral rule
only to those cases where a RIC shareholder disposes of the
AB 1423
Page 3
RIC stock within 90 days of the acquisition but subsequently
acquires RIC stock in the same fund family without incurring a
new sales load, pursuant to the shareholder's reinvestment
rights, before January 31 of the calendar year following the
year of the disposal of the original stock.
13)Takes effect immediately as an urgency statute.
EXISTING LAW conforms to the federal income tax law relating to
RICs, as of January 1, 2009. Specifically, the California law:
1)Treats a capital loss carryover from a prior year as a
short-term capital loss in subsequent years and allows a RIC
to carry over capital losses only for eight years.
2)Requires a RIC to satisfy, among other things, a "gross
income" and "asset diversification" tests for each taxable
year, in order to qualify for tax treatment as a RIC.
3)Requires RICs to notify shareholders within 60 days of the end
of the taxable year of the designation of capital gain
dividends and other items. Failure to designate the entire
amount of any such item in a timely fashion results in a
permanent inability of the shareholders to obtain
"pass-through" treatment of the amount of that item not
designated for that year.
4)Provides that only accumulated, and not current, earnings and
profits of a RIC may be reduced by a net capital loss in the
taxable year the loss arose. Disallows a reduction of the
RIC's earnings and profits by the amount of its expenses
allocable to the tax-exempt interest income that is
distributed to shareholders.
5)Allows a RIC to pass through exempt-interest dividends or
foreign tax credits only if 50% or more of the RIC's assets,
respectively, consist of tax-exempt obligations or stock in
foreign corporations. Thus, if 50% or more of a RIC's assets
consist of shares in another RIC, the former RIC may not pass
through exempt-interest dividends or foreign tax credits.
6)Requires spillover dividends to be declared by the extended
deadline for filing the RIC's tax return and to be distributed
by the date of the next dividend payment, no later than 12
months after the end of the taxable year.
AB 1423
Page 4
7)Requires RICs to distribute dividends during the year in which
they generate the net income, or else the distribution is
deemed a return of capital, which requires an adjustment to
the shareholder's basis in the RIC stock and must be allocated
proportionately among all distributions made during the year.
8)Requires an open-end RIC to redeem its shares at a
shareholder's request, with some exceptions but does not
specify whether the redemption of some, but not all, shares is
treated as a dividend or a sale eligible for capital gain or
loss treatment.
9)Requires a publicly-offered RIC to follow the "preferential
dividend" rule, which mandates that dividends be distributed
pro rata with no preference to any shareholder or class of
stocks.
10)Provides that a RIC must distribute to the shareholders 98%
of its capital gain net income and net ordinary income by
December 31st each year. Imposes a 4% excise tax on amounts
not timely distributed.
11)Specifies that, if a RIC shareholder receives exempt-interest
dividends with respect to a share of RIC stock held for six or
fewer months, then the shareholder may not deduct any loss on
the sale or exchange of the share, to the extent of the amount
of the exempt-interest dividend.
12)Disallows a RIC shareholder to take into account a load
charge in determining gains or losses on the disposition of
the RIC shares if (a) the load charge was incurred in
connection with the acquisition of the RIC stock and a
reinvestment right, (b) the RIC stock was disposed of by the
shareholder within 90 days of the acquisition, and (c) the
shareholder subsequently acquired a RIC stock and the
otherwise applicable load charge was reduced due to the
reinvestment right from the prior RIC stock. Does not specify
any time limit applicable to the subsequent acquisition of RIC
stock.
FISCAL EFFECT : The Franchise Tax Board (FTB) estimates that
this bill will result in an annual General Fund revenue loss of
$925,000 in FY 2011-2012, $383,500 in FY 2012-2013, and $73,500
in FY 2013-2014, followed by revenue gains from FY 2014-15 until
AB 1423
Page 5
FY 2017-18.
COMMENTS :
1)The Author's Statement . The author states that, "The purpose
of AB 1423 is to conform California's tax laws governing
mutual fund companies to the provisions of the federal
Regulated Investment Company Modernization Act enacted on
December 22, 2010. This bill does not change any tax rates,
but rather incorporates federal changes that update numerous
tax-related provisions that have been determined to be
obsolete, unworkable, inefficient or disproportionate. These
changes will create operational efficiencies for
California-based mutual funds and will benefit their
shareholders by, among other things, ensuring that the
shareholders will receive the same tax treatment under both
federal and California laws. The vast majority of other
states automatically conform their tax laws to federal changes
relating to mutual fund taxation. California requires
specific conformity legislation and has historically passed
such legislation to achieve conformity in this area. If
California does not conform in 2011 to the federal changes,
many California-based mutual funds will be subject to
different (and, in some cases, possibly inconsistent) federal
and California tax requirements. The inconsistency may lead
to significant, and, in some instances, insurmountable,
operational problems and costs for the affected mutual funds
and to widespread confusion among shareholders about the
manner in which they are taxed on distributions received from
the mutual funds. It will also put California-based mutual
funds at a competitive disadvantage vis-à-vis their peers
located in other states."
2)Arguments in Support . The proponents of this bill argue that
AB 1423 "is crucial to the continual competitiveness of
California's mutual fund industry" and that, without
conformity to the RIC Modernization Act, California-based
companies would "face severe sanctions if they were to fail to
meet both California and federal law" and would be "put at a
serious competitive disadvantage" as compared to funds based
elsewhere in the country. The proponents believe that this
competitive disadvantage will result in less investment in
California-based mutual funds, "meaning fewer jobs, income,
and profits." Currently, "California management companies pay
approximately $300 million per year to California and any loss
AB 1423
Page 6
of market share could translate into a significant decrease in
tax revenue to California."
The proponents also contend that the "burdens of nonconformity
would fall not only on mutual funds, but also on their
investors and the Franchise Tax Board." Non-conformity will
result in delays and additional revisions to 1099 forms,
requiring individual investors to file several amended tax
returns, at additional costs to taxpayers and the FTB.
Furthermore, of "even greater consequence is the threat that
investors would elect to move their investments to an
out-of-state fund to avoid having to keep a different set of
books to track the highly-technical differences for their
California return and avoid any confusion and increased tax
preparation costs that would go along with it." Finally, the
proponents state that the "mutual fund industry is extremely
important to the California economy and represents an
important source of investment in California's state and local
bonds."
3)How Important Is Conformity to Federal Tax Law? When changes
are made to the federal income tax law, California generally
does not automatically adopt such provisions. Instead, state
legislation is needed to conform to most of those changes.
Conformity legislation is introduced either as individual tax
bills to conform to specific federal changes or as one omnibus
bill to conform to the federal law as of a certain date with
specified exceptions, a so-called "conformity" bill.
The last California-federal conformity bill was enacted in 2010
ÝSB 401 (Wolk), Chapter 14, Statutes of 2010]. Generally,
businesses, tax practitioners and state tax agencies advocate
to conform state tax laws to ever-changing federal tax laws.
Businesses prefer conformity to federal tax laws because it
reduces their state tax compliance costs. The tax
practitioners argue that failure to conform to federal law in
some areas may lead to improper tax reporting to California
and extra costs to the taxpayers. Finally, conformity
legislation is also important to state agencies. It eases the
burden, and reduces the costs, of tax administration because
the state may rely on federal audits, federal case law, and
regulations.
While state conformity to federal income tax provisions offers
certain advantages and reduces tax compliance costs, it can
AB 1423
Page 7
also significantly impact state revenues. Thus, it would be
difficult to achieve complete conformity with federal income
tax rules. Often, the Legislature needs to increase tax rates
to find funding for a new or expanded existing credit or
deduction allowed for federal income tax purposes. Tax
credits, deductions, and exemptions are designed to provide
incentives for taxpayers that incur certain expenses or to
influence behavior, including business practices and
decisions. Both the Federal and state governments often use
tax policy to influence taxpayers' behavior. However, federal
tax incentives may not necessarily produce the same effect on
the taxpayer's behavior at the state level, if adopted by the
state government, as they do on the federal level.
Furthermore, unlike the Federal government, California cannot
print money to subsidize its budget. Therefore, the
Legislature must be mindful of fiscal effects of conforming to
federal tax laws, even if those may not trigger significant
fiscal concerns in Congress.
4)The RIC Modernization Act of 2010: Background . On December
22, 2010, President Obama signed into law the RIC
Modernization Act of 2010 (P.L. 111-325) (Act), which revised
Subchapter M of the Internal Revenue Code (IRC) governing the
taxation of RICs and their shareholders. In general, a RIC is
an electing domestic corporation that either meets or is
excepted from certain registration requirements under the
Investment Company Act of 1940, that derives at least 90% of
its ordinary income from specified sources considered passive
investment income, has a portfolio of investments that meet
certain diversification requirements, and satisfies certain
other conditions.
Corporations or entities treated as such for tax purposes are
subject to many of the regular rules of corporate tax, both on
federal and state level. However, RICs, most of which are
more commonly known as mutual funds, qualify for a special tax
treatment under Subchapter M of the IRC and specified
provisions of the Revenue and Taxation Code. The Subchapter M
prescribes the rules that a corporate entity must satisfy in
order to qualify as a RIC for the taxable year and provides a
special tax treatment for a qualified RIC and its
shareholders. Specifically, a RIC that distributes at least
90% of its net ordinary income and net tax-exempt interest to
the shareholders may deduct the dividend amount in computing
its tax. While no corporate income tax is imposed on RIC's
AB 1423
Page 8
income distributed to the shareholders, the dividends are
generally included in the income of the shareholders, and
thus, the shareholders must report the distributions on their
own personal income tax returns. Those distributions may be
characterized as long-term or short-term capital gains or
tax-exempt interest and this characterization depends on the
type of income distributed by the RIC. The RIC may pass
through to its shareholders the character of its long-term
capital gain income by paying "capital gain dividend" and
tax-exempt interest by paying "exempt-interest dividends." A
RIC may also pass-through foreign tax credits and credits on
tax-credit bonds, as well as certain other income received by
the RIC. If a RIC fails to comply with the provisions of
Subchapter M, it may be subject to the federal and state
corporate income taxes. In addition, its distributions to the
shareholders will be characterized as "ordinary income"
instead of "capital gain" or "tax-exempt interest," and thus
will result in a greater amount of tax payable to the federal
and state governments.
The Act has not affected the fundamentals of the tax treatment
afforded to RICs and their shareholders; instead, it updated
the applicable tax rules, which were originally enacted in
1936, to alleviate the unnecessary tax compliance burdens and
to reflect the realities of the modern economy. The Act
revised certain provisions of the federal tax law that affect
a RIC's characterization as a RIC and the manner in which a
RIC's shareholders are taxed on the distributions received
from the RIC and gains that may be realized when the
shareholders dispose of RIC shares.
5)The RIC Capital Loss Carryovers . AB 1423 conforms
California's income tax laws to several provisions of the Act,
including a provision allowing for an unlimited carryover of
net capital losses, similarly to the present-law treatment of
net capital loss carryovers applicable to individuals. Under
prior law, a capital loss carryover was treated as a
short-term capital loss in subsequent years and was allowed
only for eight taxable years. Under the transition rule
prescribed by the Act, capital loss carryovers arising in
taxable years beginning after December 22, 2010, are deemed to
be absorbed first, which may lead to prior losses to expire
unutilized.
As explained by the Investment Company Institute, the failure to
AB 1423
Page 9
conform to the new carryover provisions would, in some cases,
result in capital losses arising in prior taxable years to be
absorbed for California purposes more quickly than for federal
tax purposes, thereby potentially allowing more loss
carryovers to be utilized over time by RICs under California's
law. In turn, RICs may be forced to distribute greater
amounts for federal tax purposes than would be necessary under
California's "non-conforming rules," which will lead to
shareholder confusion and substantial tax compliance costs.
6)The "Asset Diversification" and "Qualifying Income" Tests . In
order to qualify for tax treatment as a RIC, a mutual fund
must satisfy, among other requirements, "gross income" and
"asset diversification" tests for each taxable year.
Generally, if a RIC does not meet either of the "gross income"
or "asset diversification" test, it has 30 days to remedy the
violation or lose its RIC status. Under the "gross income"
test, a RIC must derive 90% of its gross income for a taxable
year from qualifying types of income, such as, for example,
dividends, interest, payments with respect to securities loans
or foreign currencies, and net income derived from an interest
in a qualified publicly traded partnership. The Act modified
the definition "qualifying income" to include within this
definition a RIC's gains from the sale of commodities and
other income of a RIC derived with respect to its business of
investing in commodities.
Furthermore, the Act provided that a corporation that fails to
meet the "gross income" test will nonetheless be deemed to
have met the test if it describes each item of gross income in
a schedule and shows that the failure to meet the test is due
to reasonable cause and not willful neglect. In addition, if
the corporation exceeds the limit on non-qualifying income, it
will be required to pay a tax equal to 100% of such excess.
In order to satisfy the "asset diversification" test, at the
close of each quarter of the taxable year, a RIC (a) must hold
at least 50% of its total assets in cash, cash items,
government securities, securities of other RICs, and (b) may
hold other securities, as long as the shares of one issuer's
does not exceed 5% of the RIC's total assets and are limited
to no more than 10% of the outstanding voting securities of
such issuer. Moreover, at the end of each taxable year, not
more than 25% of a RIC's total assets may be invested in the
securities of any one issuer, the securities of two or more
AB 1423
Page 10
issuers that are engaged in a similar trade or business and
are under the RIC's control, or the securities of one or more
qualified publicly traded partnerships.
The Act created a special rule for de minimis asset-test
failures and a mechanism by which a RIC can cure the failure
and pay a penalty tax. Specifically, the Act allows for de
minimis asset test failures when the assets owned that violate
the test do not exceed the lesser of 1% of RIC's total assets
or $10 million. Under this so-called "saving" provision, the
RIC shall be considered to have satisfied the "asset" test, if
within six months it disposes of assets in order to meet the
test, or the RIC otherwise meets the requirements of the test.
In the case of other asset-test failures that do not qualify as
de minimis, a RIC nevertheless will be considered to have
satisfied the test requirements if (a) the RIC describes each
asset that cause the failure in a schedule filed with the
Secretary of the Treasure; (b) the failure was due to
reasonable cause, and not willful neglect; (c) the RIC, within
six months, disposes of the assets that triggered the failure
or otherwise meets the test requirements; and, (d) pays a tax
on the income that resulted from the failure. The amount of
this tax may not be less than $50,000.
AB 1423 would conform to the above provisions with three
modifications:
a) The tax imposed on asset-test failures would be computed
by applying the California corporate tax rate in lieu of
the highest federal tax rate.
b) The minimum amount of tax imposed on asset-test failures
would be $12,500 in lieu of the federal minimum amount of
$50,000.
c)The federal tax imposed on income-test failures would not
apply.
The failure to conform to the new modified federal "saving"
provisions would essentially result in a fund, which qualifies
as a RIC for federal purposes, losing its preferential tax
treatment as a RIC for California purposes, even if minor,
inadvertent issues caused the disqualification. As a result
AB 1423
Page 11
of this discrepancy between the federal and state laws, the
RIC and its shareholders will incur substantial costs.
7)Other Conforming Provisions . AB 1423 would also conform
California's tax law to the following provisions of the Act:
a) Modification of Dividend Designation Requirements for
RICs . As explained above, a qualifying RIC may
pass-through to its shareholders the character of certain
types of income earned and distributed by the RIC. For
example, a capital gain dividend paid by a RIC is generally
treated by the RIC's shareholders as long-term capital
gain, exempt interest may be designated as an
exempt-interest dividend or as an item of tax-exempt
interest, and foreign tax credit may be passed to the
shareholders as well. Under prior federal law, in each
case, the qualifying amount had to be designated in a
written notice mailed to the shareholders not later than 60
days after the close of the RIC's taxable year. The Act
replaced the designation requirement with a reporting
requirement. Thus, a RIC must report a capital gain
dividend or other amounts in a written statement or a Form
1099 submitted to its shareholders. The Act also provided
for a special rule in cases of over-designations,
essentially requiring RICs to make an adjustment to the
overstated amounts and allocate those adjustments, to the
extent possible, to the post-December period of the
affected taxable year. The new rules minimize the need for
the shareholders to amend their tax returns for the
calendar year that ended within the RIC's affected taxable
year and, thus, allow RICs greater flexibility in making
designations and avoid potentially disastrous effects of
inadvertent over-designations. The failure to conform to
these new federal rules would put RICs subject to the
California rules, and their shareholders, at a significant
disadvantage vis-à-vis similar RICs operating elsewhere.
b) Earnings and profits calculations . Under prior law, a
RIC could not reduce its earnings and profits (E&P) by any
amount that is not allowable as a deduction in computing
taxable income for the taxable year. For example, a net
capital loss, even when absorbed against capital gain, did
not reduce a RIC's current E&P. Similarly, a RIC investing
principally in state and local indebtedness was not allowed
to reduce its E&P by the amount of its expenses allocable
AB 1423
Page 12
to the tax-exempt interest income that it distributed to
the shareholders. Consequently, as a result, a RIC would
have to distribute taxable dividends to shareholders for
income that was not economically a return of capital. In
contrast, under the present federal tax law, a RIC is
allowed to reduce its current E&P with net capital losses
as well as expenses associated with tax-exempt income. If
California fails to conform to these new federal provisions
governing the calculations of E&P, the amounts of RIC
distributions for California tax purposes may differ from
those computed under the federal law, and may cause
shareholders of the California-based RICs to keep track of
those differences in their RIC shares tax basis for many
years.
c) Pass-through of exempt-interest dividends and foreign
tax credits . In a typical "fund of fund structures" -
where one RIC holds stock in one or more other RICs - the
character of income and gain passed through from the
lower-tier fund to the upper-tier fund and its shareholders
is retained. However, prior to the enactment of the Act,
exempt-interest dividends and foreign tax credits could be
passed through by a RIC only if 50% of the RIC's total
assets consisted, respectively, of tax-exempt obligations
or stock and securities in foreign corporations. An
upper-tier RIC, which holds stock in other RICs, generally
did not meet the 50% asset test. As such, it could not
pass-through exempt-interest dividends and foreign tax
credits to its shareholders, even though those items were
passed through to it by a lower-tier RIC. Under present
law, in the case of a qualified fund of funds, the
upper-tier RIC may pay exempt-interest dividends or pass
through foreign tax credits to its shareholders without
regard to the 50% asset requirement.
d) Modification of rules for spillover dividends . A RIC
may elect to designate certain dividends paid after the
close of a tax year as having been paid during the tax year
for purposes of the 90% distribution requirement and
determining the RIC's taxable income. These dividends are
commonly called "spillover dividends." To qualify, the
dividends must be declared by a RIC as "spillover
dividends" prior to filing its tax return for the tax year
and the distribution must be made in the 12-month period
following the close of the RIC's tax year, but no later
AB 1423
Page 13
than the date of the next dividend payment. The Act
postponed the declaration of a spillover dividend until the
later of the 15th day of the 9th month following the close
of the tax year or the extended due date for filing the tax
return. In addition, the Act provided that the
distribution must be made not later than the date of the
first dividend payment of the same type of dividend made
after the declaration.
e) Return of capital distributions . A dividend is a
distribution of property by a corporation either out of its
accumulated E&Ps or its current E&Ps, which are prorated
among current year distributions. Distributions of
property that are not dividends reduce a shareholder's
basis in the stock and are treated as return of capital and
then gain to the extent it is in excess of the stock
adjusted basis. When a RIC adopts a taxable year other
than the calendar year, it may show, as dividends, amounts
distributed before January 1 of a taxable year. However,
if the RIC's distributions for the full taxable year exceed
its E&Ps, those pre-January dividends would be overstated
and a portion of those dividends would have to be
reclassified as return of capital. The re-classification
may lead to amended Forms 1099-DIV and amended shareholder
tax returns. To remedy this problem and to lessen the
shareholder confusion, the Act provides that, if a RIC
distributes, prior to January 1, amounts in excess of the
RIC's E&Ps, it must allocate its current E&P first to
distributions made before January.
f) Distributions in redemption of stock of RICs . Previous
federal law did not clearly classify as an exchange the
redemption of some, but not all, shares in open-ended RICs.
Except to the extent provided in regulations, the Act
specifies that the redemption of shares of a
publicly-offered RIC is treated as an exchange for tax
purposes if the redemption is upon the demand of the
shareholder and the RIC issues only stock that is
redeemable upon a shareholder's demand.
In addition, any deduction with respect to a loss from the
sale or exchange of property between members of a
controlled group of corporations is deferred until the
transfer of the property outside the group. The Act
created an exception to this loss deferral rule in the case
AB 1423
Page 14
of any redemption of a RIC stock, provided that the RIC
issues only stock that is redeemable upon the shareholder
demand and the shareholder demanding the redemption is
another RIC.
g) Repeal of preferential dividend rule for publicly
offered RICs . While RICs are allowed a deduction for
dividends paid to their shareholders, those dividends must
not be "preferential," which are defined as dividends
distributed in unequal amounts per share within the same
class of shares or paid to a class of shares in an amount
more or less than the proper entitlement for that class.
The Act made the preferential dividend rule inapplicable
for publicly-offered RICs.
h) Elective deferral of certain late-year losses . Under
the federal excise tax provision, RICs are required to
distribute practically all of their capital gain net income
and net ordinary income by December 31 annually or become
subject to a 4% excise tax on amounts not timely
distributed. The required distribution is the sum of 98%
of the RIC's ordinary income for the calendar year and 98%
of the capital gain net income for the one-year period
ending October 31 of such calendar year. However, RICs
with a taxable year ending on June 30th may lose money
between October 1st and the end of the tax year, changing
the character of distributions from dividends to returns of
capital. This change will necessitate shareholder filings
of amended tax returns to claim a refund or credit. Under
the Act, RICs are allowed to elect to "push" all or part of
any post-October capital loss or any qualified late-year
ordinary loss to the first day of the next taxable year.
The post-October capital loss means the greatest of the
RIC's net capital loss, net long-term capital loss, or the
net short-term capital loss.
i) Exception to holding period requirement for
exempt-interest dividends declared on daily basis . Under
prior law, a shareholder that received an exempt-interest
dividend with respect to a share of RIC stock had to hold
that stock for more than six months in order to claim a
loss, if one occurs. The Act made this loss disallowance
rule inapplicable, except as otherwise provided by
regulations, to a regular dividend paid by a RIC that
declares exempt-interest dividends on a daily basis in an
AB 1423
Page 15
amount equal to at least 90% of its net tax-exempt interest
and distributes the dividends on a monthly or more frequent
basis. As explained by the Investment Company Institute in
its paper entitled "The Need for Mutual Fund Tax Law
Conformity in 2011," deductibility of recognized losses on
dispositions of investment securities is a fundamental
tenet of the California tax system. If California fails to
conform to this federal provision, the denial of loss
deductions to California residents in the above-described
circumstances would place them in a worse tax position that
residents of other states disposing of the same investment.
j) Modification of Sale Load Basis Deferral Rule for RIC
Shareholders . In acquiring shares of a RIC, the purchaser
may be required to pay a load charge. However, the load
charge may be reduced when the investor acquires rights to
sell the initial stock and reinvest in a different stock
offered by the same RIC. Under prior federal law,
investors that paid reduced load charges to acquire
reinvestment rights and subsequently disposed of the stock
within 90 days were not permitted to take into account the
load charge in determining gain or loss of the original
stock. Instead, the reduced load charge was treated as
incurred in acquiring the subsequently acquired stock. The
Act limits the applicability of this rule only to those
cases where the taxpayer subsequently acquires stock before
January 31 of the calendar year following the calendar year
in which the taxpayer disposed of the original stock.
This limitation eliminates the need for retroactive
adjustments to gain or loss calculations.
8)Would This Bill Save the General Fund (GF) Revenue? The
proponents of this bill argue that, without conformity,
in-state companies would be burdened with the cost of
maintaining two sets of books (estimated to be $24 million
annually). The increased costs would result in lower industry
profits, potentially lower distributions to shareholders,
reduced competitiveness for California funds, and potentially
major revenue losses to the state. As an illustration, they
calculated that an eventual 5% loss of market share due to
California fund disadvantages or investor migration to
out-of-state funds would translate into a revenue loss of $27
million. They also emphasize that near-term costs of
conformity - $319,000 - are likely less than the
AB 1423
Page 16
administrative costs that the FTB would incur under the
non-conformity regime. Finally, the proponents argue that the
GF loss estimates attributable to the capital loss carryover
provision beginning in 2020 are overstated, because it is
unrealistic to assume that out-of-state funds, which represent
75% of the industry, will report according to the California
law, instead of the federal law, if California does not
conform. Funds based in other states that have already
conformed to the Act will make distributions to all of their
shareholders in accordance with the federal law, since
following California law would result in negative consequences
(i.e. losing a RIC status or making greater than necessary
distributions) that would affect investors in all states, not
just those residing in California. Furthermore, the GF revenue
loss that will result from the conformity to the carryover
provision is not permanent. To the extent the new federal law
results in smaller distributions of capital gains, there will
be an offsetting increase in the funds' net asset values,
which will translate into higher capital gains to the
shareholders (and higher amount of tax for California) when
the shares are redeemed.
REGISTERED SUPPORT / OPPOSITION :
Support
Bill Lockyer, California State Treasurer
California Taxpayers Association
BlackRock
California Bankers Association
California Chamber of Commerce
California Retailers Association
California Society of Enrolled Agents
Capital Group Companies
Charles Schwab and Company
Dodge & Cox
Fireman's Fund Insurance Company
Franklin Templeton Investments
Investment Company Institute
Pacific Life Insurance Company
PIMCO
Securities Industry and Financial Markets Association
AB 1423
Page 17
Spidell Publishing, Inc.
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098