BILL ANALYSIS                                                                                                                                                                                                    

                            Senator Robert M. Hertzberg, Chair
                                2015 - 2016  Regular 

          |Bill No:  |SB 681                           |Hearing    | 7/15/15 |
          |          |                                 |Date:      |         |
          |Author:   |Hill                             |Tax Levy:  |No       |
          |Version:  |6/29/15                          |Fiscal:    |Yes      |
          |Consultant|Grinnell                                              |
          |:         |                                                      |

              Corporation taxes:  deduction:  public utilities (Urgency)

          Denies business expense deduction for fine imposed on PG&E by  
          the California Public Utilities Commission.  

           Background and Existing Law

           On September 9th, 2010, a pipeline owned and operated by the  
          Pacific Gas and Electric (PG&E) Company exploded in the  
          Crestmoor neighborhood of San Bruno, California.  This disaster  
          killed eight people, injured 58, destroyed 38 homes, and caused  
          extensive property damage. PG&E's regulator, the California  
          Public Utilities Commission (CPUC), subsequently found that the  
          utility had not made the proper investments in gas transmission  
          infrastructure despite rates designed to generate revenue  
          necessary to do so.  CPUC initially proposed a fine of $1.4  
          billion: $950 million as a criminal penalty for the General  
          Fund, $400 million credit to rate payers, and $50 million in  
          remedies to enhance pipeline safety.  CPUC eventually fined PG&E  
          $1.6 billion: $850 million for gas safety improvements paid by  
          shareholders, $400 million to ratepayers in a one-time bill  
          credit, $300 million to the state's general fund as a fine, and  
          $50 million toward various pipeline safety-related remedies.  In  
          a subsequent letter, Commissioners stated "every dollar the  
          Commission ordered (PG&E's) shareholders pay in the final  
          decision was intended to penalize PG&E for its egregious actions  
          and legal violations."  PG&E has also been indicted by a federal  


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          grand jury, and faces civil litigation as well.  

          Current federal and state laws generally allow taxpayers engaged  
          in a trade or business to deduct all expenses that are  
          considered ordinary and necessary in conducting that trade or  
          business, unless specifically excluded by statute, such as fines  
          and penalties paid to government for violating the law.  Under  
          federal and state laws, taxpayers can deduct fines or penalties  
          paid to a non-government entity, such as a fine on a  
          professional athlete violating codes of conduct; however, last  
          year, the Legislature prohibited professional sports franchise  
          owners from deducting fines and penalties imposed by the  
          professional sports league that includes that franchise (AB 877,  
          Bocanegra, 2014).  The author wants to ensure that PG&E won't be  
          able to deduct fines imposed by CPUC on PG&E due to the San  
          Bruno pipeline explosion.

           Proposed Law

           Senate Bill 681 states that for purposes of deducting regular  
          business expenses for state tax purposes, expenses or  
          expenditures for plant and equipment by Pacific Gas and Electric  
          Company that the Public Utilities Commission determined in  
          Decision 15-04-024 (April 9, 2015),  "Decision on Fines and  
          Remedies to be Imposed on Pacific Gas and Electric Company for  
          Specific Violations in Connection with the Operation and  
          Practices of its Natural Gas Transmission System Pipelines,"  
          should be borne by the shareholders of the utility, and not the  
          utility's ratepayers, because of the utility's numerous  
          violations of law relating to public safety.  The measure also  
          states amounts that the Public Utilities Commission, in Decision  
          15-04-024, ordered Pacific Gas and Electric Company to pay to  
          reimburse the commission for its costs incurred in investigating  
          and enforcing a violation of law relating to public safety by  
          the utility.

           State Revenue Impact

           Due to the measure's limited scope, Franchise Tax Board cannot  
          estimate the revenue for SB 681 without potentially violating  
          taxpayer confidentiality laws.  However, SB 681 would deny  
          approximately $1.3 million in normally deductible expenses,  


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          which when multiplied by California's corporation tax rate of  
          8.84% equals $115 million.


           1.  Purpose of the bill  .  According to the author, "The CPUC's  
          decision to apply the majority of the PG&E's penalty to safety  
          improvements and bill reduction rather than sending it to the  
          General Fund was not made to reduce PG&E's financial  
          responsibility for the gas explosion that killed 8 and leveled a  
          neighborhood, but to ease the burden faced by PG&E's customers  
          who continue to pay PG&E to bring its neglected gas system to an  
          acceptable safety standard.  The CPUC made it clear to the IRS  
          and the FTB that the penalty for this tragedy should not be  
          considered a business expense but a punishment.  This bill is  
          meant to ensure that FTB will be able to carry out the CPUC's  
          intention to levy an historic penalty against PG&E for its  
          negligence.  "

           2.  Special treatment  .  As a general matter in tax law, taxpayers  
          can deduct fines and penalties levied by government when no  
          violation of the law occurred.  Taxpayers can also deduct  
          business expenses incurred to improve physical infrastructure,  
          such as pipelines.  SB 681 would alter these standards that  
          apply to almost all taxpayers because of a singular event.   
          While the damage to lives and property of the San Bruno pipeline  
          explosion is horrific, is changing tax law meant to apply  
          equally to all taxpayers the appropriate way to sanction PG&E?   
          CPUC could have simply increased the non-deductible penalty  
          amount payable to the General Fund instead.  On the other hand,  
          SB 681 is not unprecedented; AB 877 responded to the National  
          Basketball Association's fine against Donald Sterling in a very  
          similar way.  The Committee may wish to consider whether  
          amending tax law is the best response to this tragedy.  

           3.   Follow the lead  .  Generally, FTB would follow IRS's  
          determination regarding whether a fine is deductible for state  
          purposes.   Section 162(f) of the Internal Revenue Code simply  
          states "No deduction shall be allowed ? for any fine or similar  
          penalty paid to a government for the violation of any law."   
          Federal regulations and an extensive body of case law generally  
          holds that compensatory, non-punitive damages paid to government  
          are deductible, such as civil judgment where the government  


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          recovers actual damages and court costs from taxpayer.  Other  
          important factors include the severity of the conduct, and  
          whether the penalty was punitive or compensatory in nature,  
          among others.  As such, the tax treatment of fines and penalties  
          can be different according to the facts and circumstances of  
          each case. In its letter to IRS Commissioner John Koskinen, CPUC  
          Commissioners state that their intent in levying the penalty  
          against PG&E was punitive, not compensatory.  However, absent  
          legislation, the deductibility of the penalty for federal or  
          state purposes will remain unknown because any information on  
          PG&E's return is protected by taxpayer confidentiality laws.

          4.   Reverse nonconformity  .  California law does not  
          automatically conform to changes to federal tax law, except  
          under specified circumstances.  Instead, the Legislature must  
          affirmatively conform to federal changes.  Generally, when the  
          federal government changes its tax laws, California catches up  
          by enacting its own legislation in subsequent year to reduce  
          differences between the two codes, thereby easing the tax  
          preparation burden on taxpayers, tax preparers, and the  
          Franchise Tax Board.  As discussed above, IRS may allow PG&E to  
          claim the deduction based on its interpretation of current law  
          as applied to CPUC's fine, but if SB 681 is enacted, the same  
          deduction denied for state tax purposes may be allowed for  

          5.   Another way  ?  SB 681 refers to Section 162(a) of the  
          Internal Revenue Code (IRC) when denying a deduction for state  
          purposes; however, PG&E could be applying IRC 162(f), 167, or  
          179, depending on the nature of the expense.  Instead of  
          referring to federal law, the Committee may wish to consider  
          amending SB 681 to instead enact a stand-alone section of the  
          Corporation Tax stating that expenses of expenditures resulting  
          from the CPUC's decision are not deductible for state tax  

          6.   To tell the truth  .  The tax return of a firm as  
          sophisticated as PG&E will be long and complex.  As such, it may  
          be difficult for FTB to easily determine whether PG&E complies  
          with SB 681 should it be enacted.  The Committee may wish to  
          consider requiring any taxpayer to additionally certify under  
          penalty of perjury that it didn't claim any expenses affected by  
          the bill.   


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          7.   2/3  .  Because SB 681 denies a normally deductible business  
          expense, it increases a tax on any taxpayer for purposes of  
          Section Three of Article XIIA of the California Constitution.   
          As such, Legislative Counsel has keyed the measure a 2/3 vote.

          8.   Urgency  .  In order for the bill to apply in the current  
          taxable year, and to ensure the effectiveness of PG&E decisions,  
          SB 681 contains an urgency clause, and is keyed a 2/3 vote.

           Support and  
          Opposition   (7/9/15)

           Support  :  None received.

           Opposition  :  California Taxpayers Association.  

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