BILL ANALYSIS Ó SENATE COMMITTEE ON GOVERNANCE AND FINANCE Senator Robert M. Hertzberg, Chair 2015 - 2016 Regular ------------------------------------------------------------------ |Bill No: |SB 1449 |Hearing |4/27/16 | | | |Date: | | |----------+---------------------------------+-----------+---------| |Author: |Nguyen |Tax Levy: |Yes | |----------+---------------------------------+-----------+---------| |Version: |4/18/16 |Fiscal: |Yes | ------------------------------------------------------------------ ----------------------------------------------------------------- |Consultant|Grinnell | |: | | ----------------------------------------------------------------- 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 SB 1449 (Nguyen) 4/18/16 Page 2 of ? 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. SB 1449 (Nguyen) 4/18/16 Page 3 of ? 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 SB 1449 (Nguyen) 4/18/16 Page 4 of ? 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 SB 1449 (Nguyen) 4/18/16 Page 5 of ? 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. -- END --