BILL ANALYSIS Ó SB 506 Page A Date of Hearing: June 27, 2011 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Henry T. Perea, Chair SB 506 (Simitian) - As Amended: June 21, 2011 Majority vote. Fiscal committee. SENATE VOTE : 39-0 SUBJECT : State finance: warrants SUMMARY : Revises the statutory provisions that allow any taxpayer named as a payee on a registered warrant (RW) to satisfy certain tax liabilities by issuing a check that cannot be cashed until the RW is redeemable. Specifically, this bill : 1)Provides that, if the state issues a RW to pay principal or interest on a "state bond" that is held in book entry form by a securities settlement system, the bond's beneficial owner shall be deemed to be the taxpayer permitted to submit a check to pay taxes owed. 2)Allows the bond's beneficial owner to submit a check to the appropriate state agency in payment of a tax liability. Such a check must be accompanied by evidence of bond ownership and such other information as the State Controller prescribes. 3)Bars the state from cashing the beneficial owner's check until the RW is payable. 4)Bars any beneficial owner who submits such a check from receiving interest accruing on the RW after the date of the check's submission. Moreover, the beneficial owner must promptly repay the state any interest accruing on the RW after the date of submission that may be paid to or ultimately received by the beneficial owner. 5)Provides that, upon submitting such a check to the state in payment of a tax liability, the beneficial owner shall not be permitted to sell, transfer, or assign its beneficial ownership of the "state bond " until the RW has been redeemed by the state and the beneficial owner has repaid any interest SB 506 Page B received that is attributable to the period after the check's submission. 6)Defines a "state bond" as any general obligation bond or revenue anticipation note issued by the state. 7)Authorizes the State Controller to promulgate implementing regulations. 8)Specifies that no state entity shall take any action that would materially adversely impair, limit, or restrict the rights of a beneficial owner of a state bond, as set forth in Government Code (GC) Section 17280.1, or any successor provision, as that provision was in effect when the person or party became a beneficial owner of the state bond, until the state bond is fully paid. 9)Makes other conforming changes to the GC. EXISTING LAW : 1)Allows any taxpayer named as a payee on a RW to satisfy their liability for certain taxes by issuing a check in an amount no greater than the RW, exclusive of any interest thereon. In such cases, the state may not present the check for payment until the RW is payable upon its presentation to the State Treasurer. These provisions apply only to liabilities for personal income taxes and bank and corporation taxes. İGC Section 17280.1(a)] 2)Precludes any taxpayer who submits a check pursuant to the above provisions from receiving interest on the RW from the date the check is submitted. İGC Section 17280.1(b)] 3)Provides that, if a tax liability is paid with a RW that is redeemable at the time the tax liability is paid, specified interest shall be credited to the taxpayer's account. İGC Section 17280.2] FISCAL EFFECT : Unknown COMMENTS : 1)The author has provided the following statement in support of this bill: SB 506 Page C Some major corporations in California are currently precluded from investing in California debt because California debt does not meet the companies' investment criteria. A remedy to this problem exists in current law but the statute needs to be updated. In the past, ownership of bonds was in a paper form. Now, those documents are in electronic form. This bill defines the beneficial owner of a registered warrant, issued for the principal or interest due on a state bond that is held in book entry by a security settlement system, to be the taxpayer who is permitted to submit the check in payment of existing taxes. The original statute was drafted during a time when most bond owners had paper certificates showing that they own the bonds. As advancements have been made, electronic systems have been created so that the owner no longer has a "coupon" to clip. While this is a technical issue the clarification will remove an impediment so that California corporations can invest in California bonds in the unlikely event that a registered warrant is ever issued for its bond obligation, the corporation can use the warrant to offset tax liabilities. 2)Proponents state: Due to concerns over the state's fiscal condition, many Fortune 500 companies are limited in their ability to invest in California state-issued bonds. Corporate treasuries are bound by strict investment criteria to ensure good returns to shareholders at a minimum risk. SB 506 will help to improve the attractiveness of these investments by allowing warrants to be used to pay taxes, providing greater investment certainty. This process will provide the security necessary for these firms İto] invest in California debt, thereby bringing potential new buyers to market. 3)Committee Staff Comments: a) RWs : In normal times, the state issues warrants to SB 506 Page D satisfy its obligations to vendors, contractors, hospitals, workers, and other entities. Warrants are the government equivalent of checks, and are issued by the State Controller. During periods of serious cash shortfalls, however, the state may have to issue RWs. This occurs when, after ranking all of the state's obligations and setting aside money that must be set apart for higher ranking obligations, the State Controller determines that there are insufficient funds to pay a warrant. In such cases, a warrant is registered, and the state promises to pay the face value as soon as money is available. b) When did the State Controller last issue RWs? : On June 24, 2009, the State Controller announced plans to issue RWs in an effort to manage the state's cash crisis. To ensure the General Fund's ability to make priority status payments, the State Controller's Office began issuing RWs (also known as IOUs) on July 2, 2009, for all General Fund payments without priority status under the Constitution, federal law, or court order. These RWs earned interest at a rate of 3.75% as determined by the State Pooled Money Investment Board. c) RWs and tax liabilities : Since 1983, state law has allowed any taxpayer named as a payee on a RW to satisfy their liability for certain taxes by issuing a check in an amount no greater than the RW, exclusive of any interest thereon. In such cases, the state may not present the check for payment until the RW is payable upon its presentation to the State Treasurer. These provisions currently apply only to liabilities for personal income taxes and bank and corporation taxes. d) What would this bill do ?: This bill provides that, in the unlikely event the state issues RWs to pay interest or principal owed on state bonds, the beneficial owners<1> of those bonds will be able to satisfy certain tax liabilities by issuing a check, which the state may not cash until the RWs are redeemable. -------------------------- <1> While not explicitly defined in this bill, the term "beneficial owner" describes a situation where specific property rights in equity belong to a person even though legal title to the property belongs to another (i.e., a financial intermediary holding bonds for another's benefit). SB 506 Page E e) Arguments in support : Many companies are apparently reluctant to invest in California bonds, given concerns over the state's creditworthiness. If the state were ever forced to issue RWs to pay bondholders, this bill would enable the beneficial bond owners (and not the financial intermediaries who may hold legal title) to use the RWs to satisfy existing tax liabilities. Proponents argue that this assurance will incentivize additional investment in California debt. f) Unintended consequences? : i) Given existing concerns over the value of California's bonds, the Senate Governance and Finance Committee questioned whether the state should "put into practice a statutory process that assumes bondholders will be paid in warrants, something that's never happened before and could only come to pass in apocalyptic circumstancesİ.]" The analysis further states, "The measure may give current and future investors in the state's debt caution when they see that the state is explicitly creating a process not to pay in the accustomed medium of cash." Proponents of this bill, however, counter that existing law already contemplates the issuance of RWs to pay state bonds. Specifically, they point to GC Section 17280, which provides in full: If at any time it is necessary to register warrants for the payment of principal and interest on State bonds, warrants so registered have a prior lien in the order of their issuance on any money thereafter received into the General Fund, and shall be paid before any other warrants regardless of the prior issuance of the latter. ii) Committee staff fully appreciates that this bill is designed to alleviate the concerns of certain corporations that are hesitant to invest in California bonds. Nevertheless, it seems highly improbable that the state would ever attempt to satisfy its bond payment obligations by issuing RWs. If California were to reach this "apocalyptic" scenario, allowing large companies to satisfy their corporate tax liabilities through RWs would only exacerbate an already dire situation. Then again, proponents note that this bill really only clarifies that SB 506 Page F beneficial bond owners (and not the financial intermediaries who hold legal title) shall be able to take advantage of existing tax payment provisions for RW recipients. Absent this bill, if the state were to issue RWs to the financial intermediaries directly, they could conceivably use the RWs to satisfy their own tax liabilities. g) Open questions and conflicting legislation : Currently, the special tax payment provisions available to RW recipients only apply to personal income tax and corporation tax liabilities. Earlier this year, however, this Committee heard AB 1044 (Butler), which would expand these provisions to cover taxes, fees, and surcharges paid to the State Board of Equalization (BOE), provided certain conditions are met. AB 1044 would also delete the somewhat cumbersome provisions requiring the submission of a check. Instead, AB 1044 would allow entities to satisfy tax and fee liabilities by simply submitting the original RW, signed on the reverse side by the payee and endorsed as payable to the agency to which the liability is owed. Finally, AB 1044 would codify apparent tax agency practice by precluding those who submit a RW from receiving interest on the warrant except in cases where the warrant is redeemable at the time of its submission. AB 1044 was voted out of this Committee on a 9-0 vote on May 2, 2011, and is currently pending in the Senate Governance and Finance Committee. SB 506 seeks to amend two of the very same code sections amended by AB 1044 - GC Sections 17280.1 and 17280.2. SB 506, however, is inconsistent with AB 1044 in the following three respects: i) SB 506 retains the check submission procedures outlined in current law, while AB 1044 provides for the endorsement of the original RW. This inconsistency could potentially be resolved by allowing beneficial bond owners to submit checks (because they may not have physical possession of the RW) and by requiring all other taxpayers to endorse their original RW. SB 506 Page G ii) SB 506 repeatedly provides that a taxpayer shall not be entitled to any interest accruing on the RW "after the date the taxpayer İsubmits] the check . . . ." The logical inference is that the taxpayer is, in fact, entitled to interest for the period from the RW's issuance to its submission. AB 1044, however, eases tax agency administration by providing that a taxpayer shall only be entitled to interest on a RW if the RW is redeemable when presented. iii) Finally, while AB 1044 would extend the special tax payment provisions to taxes and fees owed to the BOE, SB 506 retains the provisions limiting eligible liabilities to personal and corporation tax liabilities. SB 506 does, however, modify GC Section 17280.1 to provide that checks shall be submitted "to the appropriate state agency responsible for collection of İthe] tax . . . ." Given that one agency, the Franchise Tax Board, is charged with collecting both personal and corporation tax liabilities, this language may lead to inadvertent confusion on the part of some taxpayers, unless the bill is, in fact, expanded to other tax liabilities. h) Double-referral : This bill was double referred with the Assembly Committee on Banking and Finance, which passed the bill out on a 9-0 vote on June 20, 2011. For additional discussion of this bill, please refer to that committee's analysis. REGISTERED SUPPORT / OPPOSITION : Support Apple Inc. Cisco Systems, Inc. eBay Inc. Google Inc. Oracle Corporation Qualcomm Inc. TechAmerica TechNet Opposition SB 506 Page H None on file Analysis Prepared by : M. David Ruff / REV. & TAX. / (916) 319-2098