BILL ANALYSIS                                                                                                                                                                                                    

          |SENATE RULES COMMITTEE            |                        SB 681|
          |Office of Senate Floor Analyses   |                              |
          |(916) 651-1520    Fax: (916)      |                              |
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                                   THIRD READING 

          Bill No:  SB 681
          Author:   Hill (D), et al.
          Amended:  7/16/15  
          Vote:     27  - Urgency


           SENATE GOVERNANCE & FIN. COMMITTEE:  4-2, 7/15/15
           AYES:  Hertzberg, Beall, Lara, Pavley
           NOES:  Nguyen, Moorlach
           NO VOTE RECORDED:  Hernandez


           SUBJECT:   Corporation taxes: deduction: public utilities

          SOURCE:    Author

          DIGEST:  This bill prohibits the Pacific Gas & Electric Company  
          (PG&E) from claiming a deduction against its income for tax  
          purposes for fines imposed on it by the California Public  
          Utilities Commission (CPUC) in its case regarding the San Bruno  
          pipeline explosion.


          Existing law:


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          1)Allows taxpayers engaged in a trade or business to deduct from  
            taxable income for state and federal purposes all expenses  
            that are considered ordinary and necessary in conducting that  
            trade or business. 

          2)Allows taxpayers to deduct most fines or penalties paid to  
            government for compensatory, non-punitive actions such as  
            amounts paid subject to civil litigation. 

          3)Prohibits taxpayers from deducting fines and penalties paid to  
            government for violating the law.

          4)Allows deductions for fines and penalties paid to a  
            non-government entities, such as a fine on a professional  
            athlete violating codes of conduct.

          5)Prohibits professional sports franchise owners from deducting  
            fines and penalties imposed by the professional sports league  
            that includes that franchise (AB 877, Bocanegra, Chapter 792,  
            Statutes of 2014).

          This bill:

          1)Prohibits PG&E from deducting the following amounts amount it  
            pays or incurs identified by the CPUC in its "Decision on  
            Fines and Remedies to be Imposed on Pacific Gas & Electric  
            Company for Specified Violations in Connection with the  
            Operations and Practices of its Natural Gas System Pipelines."

             a)   $850 million in future gas infrastructure improvements  
               related to transmission pipeline safety,

             b)   $400 million in bill credits for gas ratepayers, and

             c)   $50 million to implement other remedies.


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          1)Requires PG&E to certify under penalty of perjury that it did  
            not take any of the above expenses into account in determining  
            its income.


          On September 9, 2010, a pipeline owned and operated by PG&E  
          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,  
          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 grand jury, and faces  
          civil litigation as well.

          Because California law conforms to federal law regarding expense  
          deductions, the Franchise Tax Board (FTB) would follow the  
          Internal Revenue Service's (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 recovers  
          actual damages and court costs from taxpayer.  Other important  
          factors include the severity of the conduct, and whether the  


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          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.


          SB 681 alters long-standing tax law that applies 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 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.  

          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 years 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 federal.  

          FISCAL EFFECT:   Appropriation:    No          Fiscal  
          Com.:YesLocal:   Yes

          SUPPORT:   (Verified8/18/15)


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          None received

          OPPOSITION:   (Verified8/18/15)

          California Taxpayers Association

          ARGUMENTS IN SUPPORT:     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  

          ARGUMENTS IN OPPOSITION:     According to the California  
          Taxpayers Association, "Current law authorizes individuals and  
          corporations to take tax deductions for the payment of monetary  
          damages in legal cases.  The principles of sound tax policy  
          dictate that tax law should be uniform and applied equitably to  
          all taxpayers, but this bill proposes to use California's  
          Revenue and Taxation Code as a weapon against one taxpayer,  
          running counter to 30 years of strong public policy regarding  
          applying principles of tort law to the tax code.  Taxpayers  
          should have assurance that tax laws apply uniformly to all in  
          the state, and should be able to predict how the law will be  
          applied to them.  Targeting a single company by altering tax law  
          after the fact sets a dangerous precedent that will have a  
          chilling effect on any business considering operating in  
          California.  [Additionally] California conforms to the federal  
          rule allowing deductions for ordinary and necessary business  
          expenses, which includes the payment of monetary damages in  
          legal cases.  Deductions prohibited by the this bill will  


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          continue to be allowed under federal law, this creating a state  
          and federal difference."

          Prepared by:Colin Grinnell / GOV. & F. / (916) 651-4119
          8/19/15 20:43:04

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