BILL ANALYSIS                                                                                                                                                                                                    Ó




                     SENATE GOVERNANCE & FINANCE COMMITTEE
                            Senator Lois Wolk, Chair
          

          BILL NO:  AB 1143                     HEARING:  6/5/13
          AUTHOR:  Skinner                      FISCAL:  Yes
          VERSION:  4/22/13                     TAX LEVY:  No
          CONSULTANT:  Grinnell                 

             TAX ADMINISTRATION: SUSPENSION OR FORFEITURE: LIMITED 
                              LIABILITY COMPANIES
          

          Applies contract voidability law that applies to foreign  
          corporation to foreign LLCs.


                           Background and Existing Law  

          Corporations in California form by filing articles of  
          incorporation with the Secretary of State.  Before  
          transacting intrastate business in California, a  
          corporation formed elsewhere must first qualify and  
          register with the California Secretary of State.  A foreign  
          business entity can also qualify and register to transact  
          business in California by filing the appropriate forms with  
          the California Secretary of State.  California law requires  
          corporations and limited liability companies to update the  
          records of the California Secretary of State on an annual  
          or biennial basis by filing a statement.  Franchise Tax  
          Board (FTB) or the Secretary of State can suspend a  
          corporation for:
                 Failure to pay an amount due,
                 Failure to file a statement of information with the  
               Secretary of State's       office, or
                 Failure to file any past due returns.

          A suspended or forfeited business entity loses the right to  
          enforce its legal contracts, known as "contract  
          voidability."  The counterparty to a contract with a  
          suspended entity may seek to void the contract by filing  
          suit against the suspended corporation.  If a business  
          enters a contract while suspended or forfeited, and then  
          revives its active legal status, the business still cannot  
          enforce that contract unless it gets relief from contract  
          voidability by applying to FTB.  Contract voidability is  
          only found in state law; federal law does not allow for it.  
           




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          A limited liability company (LLC) is a hybrid between a  
          corporation and a partnership.  LLCs are generally a  
          partnership for operational and taxation purposes, although  
          California imposes a specific fee on LLCs, but its members  
          enjoy the immunity provided by a corporation to its  
          shareholders for contract debts or tort liability.  The  
          interest of a member in an LLC is an economic interest, in  
          the same manner that a partnership interest or a corporate  
          share is an economic interest, that may be transferred  
          under terms and conditions provided by the LLC agreement,  
          the partnership agreement, or the corporate structure.   
          California first recognized LLCs in 1994 with the enactment  
          of the Beverly-Killea Limited Liability Company Act which  
          provided comprehensive provisions for the organization,  
          management, and dissolution of LLCs (SB 469, Beverly,  
          1994).  

          Foreign corporations are subject to contract voidability:  
          if they have an FTB account number contract voidability  
          commences within 60 days of FTB mailing a final notice, if  
          not, it begins on the first day of the taxable year in  
          which the foreign corporation failed to file a return.   
          However, foreign LLCs are not subject to contract  
          voidability at all.  


                                   Proposed Law  

          Assembly Bill 1143 adds foreign limited liability companies  
          onto the list of 
          corporations that are subject to contract voidability, and  
          specifies that it commences identically to current  
          treatment of foreign corporations.  The measure also makes  
          a technical and conforming change.  


                               State Revenue Impact
           
          According to FTB, AB 1143 results in revenue increases of  
          $50,000 in 2013-14, $30,000 in 2014-15, and $50,000 in  
          2015-16.


                                     Comments  






          AB 1143 - 4/22/13 -- Page 3



          1.   Purpose of the bill  .  According to the author, "In  
          1994, the Legislature authorized the formation of limited  
          liability companies (LLCs) in California by enacting the  
          Beverly-Killea Limited Liability Company Act. LLCs  
          organized within California are required to register with  
          the Secretary of State (SOS) and to pay taxes to the  
          Franchise Tax Board (FTB).  Out-of-state LLCs who do  
          business in California are supposed to register with the  
          SOS and pay taxes to the FTB.  However, out-of-state LLCs  
          do not always register with the SOS and do not always pay  
          taxes to the FTB.  In these cases, the penalties for not  
          paying taxes cannot be enforced because of a loophole in  
          the law.  AB 1143 would close this loophole.
          Companies organized within California are termed  
          "domestic," while companies organized beyond California are  
          termed "foreign." Companies that are registered with the  
          SOS are termed "qualified," while companies that are not  
          registered with the SOS are termed "nonqualified." All  
          domestic LLCs are qualified, but not all foreign LLCs are  
          qualified, though they are supposed to be. Foreign  
          nonqualified LLCs can still pay taxes to the FTB even if  
          they are not registered with the SOS, but not all of them  
          do.  When domestic and foreign qualified LLCs fail to pay  
          taxes, penalties, fees, or interest, or when they fail to  
          file required tax returns, they are subject to "contract  
          voidability."  When an entity is subject to contract  
          voidability, any contract entered into may be voided by  
          another party to the contract, which is a significant  
          penalty for any business.  While domestic and foreign  
          qualified LLCs are subject to this penalty, foreign  
          nonqualified LLCs were inadvertently not included.  This  
          contract voidability penalty is also applied to all  
          corporations under the same tax situations.  Contract  
          voidability even applies to foreign nonqualified  
          corporations.  In fact, foreign nonqualified LLCs are the  
          only group of LLCs or corporations that is excluded from  
          the contract voidability penalty.  The law does not treat  
          foreign nonqualified LLCs in the same manner as it treats  
          other LLCs and corporations in regards to contract  
          voidability, resulting in inequitable treatment between  
          similarly situated business entities."

          2.   Equity  .  AB 1143 advances horizontal equity by applying  
          the same rules of contract voidability to foreign LLCs that  
          currently apply to foreign C-Corporations.  Horizontal  
          equity is one of the key values of any tax system:  





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          taxpayers with the same amount of income should pay the  
          same tax, and be subject to the same rules.  Without  
          horizontal equity, tax systems distort economic decisions  
          as taxpayers make different decisions that they would have  
          to take advantage of differences.  When California created  
          LLCs in 1994, the Legislature was concerned that taxpayers  
          would choose to form them instead of C-Corporations because  
          of tax and corporate reasons, and imposed a fee on LLCs  
          that sought to equalize the tax difference.  While the  
          Legislature subsequently abandoned horizontal equity for  
          LLCs when it changed the fee to eliminate this  
          equalization, taxpayers are choosing the LLCs form instead  
          of C-Corporations:  LLCs have grown in number from 26,186  
          in 2000-01 to 75,018 in 2012-13, and while S-Corporations  
          have also grown, fewer C-Corporations file returns today  
          than they did in 2000, suggesting that the California  
          Corporation Tax lacks horizontal equity as taxpayers find  
          an advantage in forming LLCs.  

          3.   Urgency  .  AB 1143 is an urgency measure that takes  
          effect immediately.  As such, Legislative Counsel has  
          assigned the measure the 2/3 vote key under Section 8(d) or  
          Article IV of the California Constitution.  


                                 Assembly Actions  

          Assembly Revenue and Taxation8-0
          Assembly Appropriations       17-0
          Assembly Floor           73-0





















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                        Support and Opposition  (05/30/13)

           Support  :  Franchise Tax Board, California Federation of  
          Teachers, California Tax Reform Association, SEIU  
          California.

           Opposition  :  None received.