BILL ANALYSIS                                                                                                                                                                                                    Ó



          SENATE COMMITTEE ON GOVERNANCE AND FINANCE
                         Senator Robert M. Hertzberg, Chair
                                2015 - 2016  Regular 

                              
          
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          |Bill No:  |SB 1449                          |Hearing    |4/27/16  |
          |          |                                 |Date:      |         |
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          |Author:   |Nguyen                           |Tax Levy:  |Yes      |
          |----------+---------------------------------+-----------+---------|
          |Version:  |4/18/16                          |Fiscal:    |Yes      |
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          |Consultant|Grinnell                                              |
          |:         |                                                      |
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                      Personal income tax: credit for taxes paid



          Requires multistate taxpayers when calculating the other state  
          tax credit to use the apportionment and allocation rules of the  
          state in which the taxpayer paid the tax. 


           Background 

           California taxes its residents on all income regardless of  
          source, including income from residents performing services  
          outside California.  Part-year residents pay tax on all income  
          generated while they are a resident, again including from  
          sources outside the state.  Nonresidents pay tax based on all  
          income from California sources.  California applies various  
          sourcing rules to certain items of nonresident income for  
          retirees, nonresident salespeople's commissions, performances by  
          athletes and entertainers, professional services like attorneys  
          and physicians, officers of corporations, and operators of  
          trucks, trains, and ships.  

          California and many other states allow a nonrefundable credit  
          against the personal income tax for taxes paid to other states  
          to avoid double taxation, known as the "other state tax credit"  
          (OSTC).  Even though it's a credit against the personal income  
          tax, taxpayers calculate California OSTC using laws,  
          regulations, and rules from its Corporation Tax, such as its  
          formula for apportioning corporate income by using only the  







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          sales factor, and assigning the sales of intangibles to the  
          state where the property is used, and not the rules in place in  
          the other states where the taxpayer does business.  Because  
          rules for assigning or apportioning income vary from state to  
          state, a taxpayer's OSTC in California can be less than the  
          actual tax paid; however, California does not allow an OSTC that  
          exceeds the actual amount of taxes paid to the other state.

          One significant difference is the standards for sourcing sales  
          of intangible property, like sales of services of royalties from  
          licensing intellectual property. California mostly requires  
          taxpayers to include sales of intangibles in their California  
          sales factor to the state where the customer uses it  
          (market-based sourcing), but many other states allocate the same  
          sales from intangibles like services to the location of the  
          income producing activity (cost-of-performance sourcing).  For  
          example, consider a California resident taxpayer who developed  
          an intangible service in "State B," and only sells here and in  
          State B, with total sales of $200,000 equally split between the  
          two states.  This taxpayer:

                 Includes $200,000 in sales in her State B income under  
               costs of performance sourcing because the service was  
               developed there, and pays $20,000 in tax at State B's tax  
               rate of 10%, thereby generating an OSTC.

                 Calculates California tax based on that half of sales to  
               customers in California ($100,000) based on market based  
               sourcing, to be further reduced by her State B OSTC.
                 Recalculates and claims on the return only $10,000 of  
               OSTC ($100,000 times 10%), because California requires the  
               taxpayer to use California's rules for sourcing intangibles  


          As a result, more than 100% of the taxpayer's income is subject  
          to tax.  Similar differences can occur because of other  
          apportionment and allocation provisions, such as income from  
          sales of interests in partnerships.  However, a different fact  
          pattern could result in less than 100% of income subject to tax,  
          depending on the laws and rules in states outside California in  
          which the taxpayer does business.  The author wants to modify  
          California's OSTC to prevent the possibility of double-taxation.










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           Proposed Law

           Senate Bill 1449 requires taxpayers when calculating their other  
          state tax credit to use the apportionment and allocation rules  
          of the other state, not California's, when doing so will either  
          maintain or increase the amount of credit a taxpayer is allowed.  
           The measure also makes legislative findings and declarations  
          supporting its purposes, including preventing residents from  
          being subject to tax on more than 100% of their income, and  
          precluding any risk from current law being an impermissible  
          burden on interstate commerce.


           State Revenue Impact

           FTB states that SB 1449's revenue impact is unknown due to a  
          lack of available data, but estimates that for every one percent  
          of taxpayers impacted, the measure would result in a revenue  
          loss of approximately $8.8 million.


           Comments

           1.  Purpose of the bill  .   According to the author, "SB 1449 will  
          reform the current calculation of the Other State Tax Credit  
          (OSTC) to prevent Californians with income from other states  
          from being double taxed.  This bill would change the current  
          calculation of the OSTC to simply allow credit for the income  
          taxes actually paid to another state, instead of requiring these  
          taxpayers to calculate the income that would have been paid in  
          the other state, if it was subject to California's apportionment  
          and allocation rules."  

           2.   Rough justice  .  State corporation income taxes have always  
          been challenged by multi-state and multinational taxpayers,  
          resulting in a line of court cases, regulations, and statutes  
          where each state seeks to both levy a tax that reflects the  
          corporation's true demand for public services a state must  
          provide, and ensures fairness, especially compared to the  
          state's tax treatment of wholly in-state companies.  Consistent  
          with federal requirements, each state sets its own apportionment  
          formulas, allocation rules, and other state tax credit  
          calculations, according to its own priorities and values.   
          Absent future federal preemption, each state's business tax  








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          regime will always differ to some degree, so the goal of taxing  
          100% of a multistate taxpayer's income, no more or no less, is  
          highly unlikely to happen anytime soon.  SB 1449 results in a  
          tax reduction for many of these firms; however, the Legislature  
          enacted California's rules based on its values, and they  
          continue to be one of the nation's most effective to limit  
          corporations from shifting its tax base.  The Committee may wish  
          to consider whether SB 1449 is consistent with California's  
          policies regarding corporate taxation. 

          3.   Winning  .  SB 1449 requires taxpayers to make two OSTC  
          calculations: first, using California laws and rules, and  
          second, using those of the state where they paid the tax that  
          gave rise to the OSTC.  The measure then requires the taxpayer  
          to use whichever calculation either maintains or increases the  
          OSTC amount, and therefore provides the greater taxpayer  
          benefit.  However, having to complete both calculations means  
          the measure doesn't reduce the current administrative burden on  
          the taxpayer and FTB.  The bill could instead require other  
          states laws and rules be applied when calculating the OSTC  
          regardless of whether it increased or maintained the amount of  
          credit.  That way, there would be no need to calculate using  
          California's system, but doing so would likely increase a tax on  
          any taxpayer for purposes of Section Three of Article XIIIA of  
          the California Constitution, which requires a 2/3 vote of each  
          house of the Legislature.  

          4.   Wynning  .  The United States Constitution, federal law  
          enacted by Congress pursuant to the Commerce Clause, and case  
          law, determine the limits on state taxing authority.  While  
          these limits haven't changed significantly in recent years, the  
          United States Supreme Court decided Maryland Comptroller of the  
          Treasury v. Wynne in May, 2015, holding that Maryland's tax  
          scheme unconstitutional, using the internal consistency test,  
          which courts have used in several cases to determine whether a  
          state's tax system discriminates against interstate commerce.   
          That test requires the court to imagine a state of affairs where  
          every state in the Union adopted an identical tax scheme, and  
          determine whether the state imposes a higher tax burden on  
          commerce that crosses state lines than commerce that stays  
          entirely within one state.  While the court's decision in Wynne  
          made clear that states must offer other state tax credits to the  
          extent they tax residents' out-of-state income, the decision was  
          specific only to Maryland, and said that states could comply in  








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          different ways.  The decision does not appear to require  
          California to change its credit in any way, because internal  
          consistency is not violated if all states calculated their  
          credits using their own rules.  However, a future court could  
          enhance the holding in Wynne to require a full offset of taxes  
          paid to other states whenever states choose to tax its  
          residents' out-of-state income.

           Support and  
          Opposition   (4/21/16)


           Support  :  California Chamber of Commerce, California Taxpayers  
          Association, Taxation Section of the Business Law Section of the  
          State Bar of California.


           Opposition :  California Tax Reform Association.



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