BILL ANALYSIS
AB 11
Page 1
ASSEMBLY THIRD READING
AB 11 (De Leon)
As Amended April 23, 2009
Majority vote
REVENUE & TAXATION 8-0
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|Ayes:|Charles Calderon, DeVore, | | |
| |Beall, Coto, Ma, Nielsen, | | |
| |Portantino, Saldana | | |
|-----+--------------------------+-----+--------------------------|
| | | | |
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SUMMARY : Declares that Internal Revenue Service (IRS) Notice
2008-83, which exempts banks from the restrictions of Internal
Revenue Code (IRC) Section 382, constitutes a substantive change
in law and directs the Franchise Tax Board (FTB) not to apply
this notice for purposes of state income tax laws.
Specifically, this bill :
1)Includes the following legislative findings and declarations:
a) California conforms to various provisions of the IRC, as
enacted on a specified date; and, for taxable years
beginning on or after January 1, 2005, the conformity date
prescribed in the Revenue and Taxation Code (R&TC) for
those referenced provisions is January 1, 2005;
b) California conforms to IRC Section 382, as enacted
January 1, 2005, relating to limitations on net operating
loss carry forwards and certain built-in losses following
ownership change, and, as of January 1, 2005, IRC Section
382 applied to financial institutions;
c) On September 30, 2008, the IRS issued Notice 2008-83,
2008-42 I.R.B. 905 (Notice 2008-83) stating that, after an
ownership change, any deduction properly allowed to a bank
with respect to losses on loans or bad debts would not be
subject to the limitations of IRC Section 382;
d) Notice 2008-83 constitutes a substantial change to IRC
Section 382 and, while California conforms to IRC Section
382, as enacted on January 1, 2005, it has not conformed to
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any changes to that section as set forth in Notice 2008-83;
e) The American Recovery and Reinvestment Act of 2009
(Public Law 111-5) (Act), signed by President Obama on
February 17, 2009, questioned the legal authority of Notice
2008-83 and repealed it. Notice 2008-83 was repealed
prospectively only, in order to protect the reliability of
guidance letters generally, and to avoid punishing
taxpayers that had relied on the guidance; and,
f) California should not conform to the construction of IRC
Section 382 as described in Notice 2008-83, inasmuch as the
legality of that construction has been questioned in
federal statute.
2)States that Notice 2008-83 does not apply for purposes of the
Personal Income Tax (PIT) Law or Corporation Tax (CT) Law
either prospectively or retroactively.
EXISTING FEDERAL LAW allows a corporate taxpayer to carry
forward an NOL for 20 years, or carry it back for two years, to
reduce future or past taxable income, as long as the
corporation's legal identity is maintained. After certain asset
acquisitions in which the acquired corporation goes out of
existence, the acquired corporation's NOL carry forwards,
generally, are inherited by the acquiring corporation. However,
in order to limit tax-motivated acquisitions of loss
corporations, the use of those NOLs and other carry forwards may
be subject to special limitations. Acquired losses also include
what is called an "unrealized built-in loss", which is the
amount of the value of assets reported on the acquired
corporation's books that exceeds the fair market value of its
assets immediately before the corporation is acquired.
IRC Section 382 limits the amount of acquired losses that the
acquiring corporation may use to offset its income in the year
of acquisition and the following years. Generally, the
acquiring corporation may use the acquired corporation's losses
in the amount equal to the value of the acquired corporation,
measured by the value of its stock immediately before the
acquisition, multiplied by the long-term tax exempt rate, a base
interest rate computed by the IRS.
In 2003, the IRS published Notice 2003-65 to explain two
alternative methods for identifying built-in gains and losses
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(also known as the 1374 approach and the 388 approach).
Taxpayers were permitted to rely upon Notice 2003-65 until the
IRS and the United States Treasury Department issue temporary or
final regulations. In 2008, the Treasury Department issued
Notice 2008-83, in which it indicated that it is studying the
proper treatment of built-in losses allowed after an ownership
change for a bank. Notice 2008-83 further provided that any
deduction properly allowed, after an ownership change, to a bank
with respect to losses on loans or bad debts (including any
deduction for a reasonable addition to a reserve for bad debt)
will not be treated as a built-in loss or a deduction that is
attributable to periods before the change date and, therefore,
would not be subject to IRC Section 382 limitations, thus,
allowing banks to utilize the acquired losses fully in the year
of acquisition and the following years. Notice
2008-83 was clear that banks may rely on the treatment allowed
by Notice 2008-83 unless and until additional guidance is
issued, meaning that any bank acquisition done before or after
Notice 2008-83 would qualify for this treatment.
No final or temporary regulations have been issued by the
Treasury Department following Notice 2008-83, but on February
17, 2009, President Obama signed the Act, which stated that
Notice 2008-83 is inconsistent with the congressional intent in
enacting IRC Section 382. The Act declared that the IRS was not
authorized under federal law to provide exemptions or special
rules that are restricted to particular industries or classes of
taxpayers and repealed Notice 2008-83. However, Congress
grandfathered in transactions that occurred on or before January
16, 2009, in order to protect taxpayers that have relied upon
the guidance.
EXISTING STATE LAW conforms to the IRC either by reference to
federal law as of a "specified date" or by stand-alone language
that mirrors the federal provision. Currently, certain
provisions of the PIT Law and CT Law are conformed to the IRC as
of January 1, 2005, unless otherwise provided. AB 115 (Klehs),
Chapter 691, Statutes of 2005 was the last California/federal
conformity bill.
FISCAL EFFECT : FTB's legal staff has concluded that Notice
2008-83 has no legal effect for purposes of California tax laws
and, therefore, FTB staff estimates that this bill will not have
revenue impact.
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COMMENTS : The author states that, "On December 1, 2008, I
introduced AB 11 to protect California's budget from the recent
guidance letter by the U.S. Treasury Department designed to
provide a new federal tax break for bank mergers. While
then-Secretary Paulson may have had substantial reason to
unilaterally rewrite federal tax law to facilitate the takeover
of failing banks, our state's General Fund should not be
adversely impacted by that decision. Unfortunately, state law
requires the State to conform with Internal Revenue Services
(IRS) tax regulations. California should take explicit action
to ensure that the Franchise Tax Board does not conform to this
ruling. According to the Franchise Tax Board's estimates, if we
were to conform with this federal tax break, the state would
lose approximately $300 Million in tax revenue during the
current fiscal year, and up to $2 Billion in future years.
"California was not consulted on this breathtaking tax break.
Although recently enacted federal statute (HR 1) now asserts
that Treasury exceeded its legal authority in issuing IRS Notice
2008-83, and declares that the ruling shall have not force or
effect after January 16, 2009, AB 11 will ensure that our
state's budget is absolutely protected from the massive
corporate tax give away. It is anticipated that the Franchise
Tax Board will adopt regulations in March 2009, to affirm that
California will not comply with IRS Notice 2008-83, AB 11 would
add assurances that FTB's actions cannot be challenged."
Committee staff notes all of the following:
1)Background. IRC Section 382, originally added to the IRC in
1954 and completely re-written in 1986, was enacted to limit
tax-motivated acquisitions of loss corporations. Prior to the
enactment of IRC Section 382, corporations with large losses
were attractive to buyers with large taxable income simply
because the acquired corporation's losses could be used to
reduce the buyer's taxable income and, effectively, the cost
of acquisition. The limitations currently in place preclude a
buyer from using the NOLs and built-in losses of the acquired
entity at a rate that is faster than the rate at which the
acquired corporation could have used them if it had sold its
assets and invested the proceeds in tax-exempt governmental
obligations. Built-in losses are also subject to special
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limitations because they are economically equivalent to
pre-acquisition NOL carry forwards. If "built-in losses were
not subject to limitations, taxpayers could reduce or
eliminate the impact of the general rules by causing a loss
corporation (following an ownership change) to recognize its
built-in losses free of the special limitations" and "then
invest the proceeds in assets similar to the assets sold."
(General Explanation of the Tax Reform Act of 1986, Joint
Committee on Taxation, p. 298, May 4, 1987). The purpose of
this IRC Section 382 limitation is to make losses a neutral
factor in a corporate acquisition.
2)Controversial History of Notice 2008-83. Generally, IRS
administrative pronouncements are issued without much notice
from the public, but the issuance of Notice 2008-83 created
quite a controversy. Questions were raised regarding the
circumstances under which the notice was issued and the
Treasury Department's legal authority to substantively change
a 22-year old tax law that limits the use of losses by banks
following acquisitions. Some current and former congressional
staff members, as well as many tax attorneys, concluded that
the Treasury Department had no authority to issue the notice
(See, e.g., "A Quiet Windfall for U.S. Banks," by Amit R.
Paley, Washington Post, Page A01, November 10, 2008).
Lawmakers were looking at "whether the notice was introduced
to benefit specific banks, as well as whether it
inappropriately accelerated bank takeovers." (Id.). On
November 18, 2008, Senator Chuck Grassley, ranking member of
the Committee on Finance, asked Eric Thorson, the Treasury
Department's Inspector General, to review the circumstances
and any possible conflicts of interest involving the Treasury
Department's administrative move that gives a big tax break to
banks that acquire poorly performing banks. (Senate Finance
Committee Release, "Grassley Seeks Inspector General Review of
Treasury Bank Merger Move," 110th Congress, November 18,
2008). Senator Charles E. Schumer and Senator Max Baucus
also wrote to Mr. Paulson asking similar questions regarding
the Treasury Department's authority to enact the tax break
without Congressional review and expressing concerns over the
subsidy. The Treasury Department, however, insisted that the
new tax break was not intended to benefit any particular bank
and had been under "development for many, many weeks." (See,
e.g., "Bush's tax breaks for banks could cost California $2
billion," Evan Harper, Los Angeles Times, November 11, 2008).
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It was reported, however, that days after the tax rule was
changed, "Wells Fargo moved to acquire Wachovia Corp., whose
losses on loans could reach more than $70 billion," and "PNC
Financial Services Croup, which recently acquired National
City Corp, could receive as much as $5 billion in tax
savings." (Id.).
Finally, Congress put the controversy to rest when it enacted
the Act, which President Obama signed on February 17, 2009.
The Act clearly states that Notice 2008-83 was inconsistent
with the congressional intent in enacting IRC Section 382 and
that the Treasury Department's legal authority to prescribe
the notice was doubtful. Therefore, the Act repealed Notice
2008-83, but grandfathered in the acquisitions that occurred
prior to January 16, 2009. Notice 2008-83 is also effective
for acquisitions that occurred after January 16, 2009, if any
ownership change was pursuant to a written binding contract
entered on or before that date, or under a written agreement
entered into on or before that date, if the agreement was
described on or before January 16, 2009, in a public
announcement or in a filing with the Securities and Exchange
Commission required by reason of such ownership change.
3)Does FTB have existing authority to disregard Notice 2008-83?
Yes. California law [R&TC Section 17024.5(d), in the case of
the PIT Law, and R&TC Section 23051.5(d), in the case of CT
Law] expressly provides that, for purposes of applying those
provisions of the IRC to which California conforms, federal
final or temporary regulations apply, but only to the extent
that those federal regulations do not conflict with California
law or with regulations issued by FTB. No federal regulations
have ever been issued to address the change in law effectuated
by Notice 2008-83.
On December 4, 2008, FTB directed its staff to begin regulatory
action to make Notice
2008-83 inapplicable for California purposes. At its March 19,
2009 meeting, FTB authorized staff to proceed with formal
procedures under the Administrative Procedures Act to adopt
this regulation.
4)Significance of this bill. While FTB is currently working on
the regulations that would clarify that Notice 2008-83 has no
legal effect for California tax purposes (either prospectively
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or retroactively), a legislative act, such as this bill, would
protect FTB's position, and this state, from any potential
legal challenge seeking to invalidate those regulations.
Similar legislation. AB 692 (Calderon) of 2009, pending in the
Assembly, declares that Notice 2008-83 is not applicable to
California law. AB 692 also clarifies that FTB has authority to
provide that any federal tax regulations or other administrative
guidance do not apply if the legal authority of the federal
interpretation is doubtful and automatic conformity to the
federal interpretation may infringe on the Legislature's
authority to make laws involving significant policy issues.
ABx1 1 (Calderon) introduced in the 2009-10 First Extraordinary
Session, is similar to this bill. ABx1 1 died in the Assembly.
ABx1 14 (De Leon), introduced in the 2009-10 First Extraordinary
Session, which died in the Assembly, and ABx3 21(De Leon),
introduced in the 2009-10 Third Extraordinary Session, are
almost identical to AB 11.
ABx4 6 (Laird), introduced in the 2007-08 Fourth Extraordinary
Session, directed FTB not to apply Notice 2008-83 nor any other
administrative guidance issued after October 20, 2008, that have
the same or similar effect for purposes of the PIT Law and CT
Law. ABx4 6 died in the Assembly.
ABx4 18 (Calderon), introduced in the 2007-08 Fourth
Extraordinary Session, was similar to this bill. ABx4 18 died
in the Assembly.
AB 2998 (Frommer), introduced in the 2005-06 Regular Legislative
Session, would have amended current law that limits the usage of
deductions, losses, and tax credits from acquired corporations
by taking the federal limitation on acquired NOLs and
multiplying it by average of the acquired corporation's
California apportionment percentages for the year of the
acquisition and the two immediately preceding tax years. AB
2998 was never heard by a Committee.
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098
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FN: 0000427