BILL ANALYSIS
AB 692
Page 1
ASSEMBLY THIRD READING
AB 692 (Charles Calderon)
As Amended May 4, 2009
Majority vote
REVENUE & TAXATION 7-0
-----------------------------------------------------------------
|Ayes:|Charles Calderon, DeVore, | | |
| |Beall, Ma, Nielsen, | | |
| |Portantino, Saldana | | |
|-----+--------------------------+-----+--------------------------|
| | | | |
-----------------------------------------------------------------
SUMMARY : Specifies the circumstances when a federal regulation
or federal administrative guidance is considered to be "in
conflict with" the provisions of the Personal Income Tax (PIT)
Law and Corporation Tax (CT) Law. Specifically, this bill :
1)Contains the following legislative findings and declarations:
a) California conforms to various provisions of the
Internal Revenue Code (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 Internal Revenue Service
(IRS) issued 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. 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 any
changes to that section as set forth in Notice 2008-83.
[Note: Date change from October 20, 2008, on the analysis
of the April 2, 2009 bill version, to September 30, 2008
AB 692
Page 2
was requested by the Franchise Tax Board (FTB).]
d) The American Recovery and Reinvestment Act of 2009 (Act)
(Public Law 111-5), signed by President Obama on February
17, 2009, repealed the notice, finding that the Secretary
of the Treasury did not have authority under IRC Section
382(m) to provide exemptions or special rules that are
restricted to particular industries or classes of
taxpayers. The Act also stated that Notice 2008-83 was
inconsistent with the congressional intent in enacting IRC
Section 382(m).
e) The Act has limited the force and effect of Notice
2008-83 to the period ending on January 16, 2009.
f) The congressional findings provide additional
confirmation that California did not, and should not,
conform to the substantive changes to IRC Section 382 that
were attempted to be made by Notice 2008-83.
1)Provides, expressly, that federal administrative guidance
regarding an interpretation of a provision of the IRC that is
applicable to the PIT Law or CT Law apply as administrative
guidance issued by the FTB, but only to the extent that the
guidance "does not conflict with" the PIT Law or CT Law,
whichever is applicable, or with regulations issued by the
FTB.
2)Defines "federal administrative guidance" as federal revenue
rulings, notices, revenue procedures, announcements, or other
published administrative guidance promulgated by the
Commissioner of Internal Revenue or the Chief Counsel of the
IRS.
3)Specifies that "federal administrative guidance" excludes
private letter rulings or any other administrative guidance
issued by the Commissioner or the Chief Counsel of the IRS
with respect to a particular taxpayer.
4)Provides that the phrase "conflict with this part" includes,
but is not limited to, any temporary or final federal
regulation or any federal administrative guidance that, except
as otherwise provided, constitutes a substantive change in
federal law that is inconsistent with the statute or statutes
to which such advice relates or is beyond the scope of the
AB 692
Page 3
Secretary of the Treasury's authority.
5)Specifies that, unless otherwise specifically provided,
federal regulations or any federal administrative guidance do
no apply for purposes of PIT and CT laws prior to the
applicable date, as provided.
EXISTING FEDERAL LAW allows a corporate taxpayer to carry
forward a net operating loss (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. 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.
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. Where state law
conforms to federal law, R&TC Sections 17024.5 and 23051 provide
that temporary and final regulations issued by the United States
(U.S.) Treasury Department apply to California, unless the
regulations conflict with state law or state regulations. Even
though the R&TC is silent with respect to other federal
administrative guidance and pronouncements, such as IRS notices,
FTB has consistently followed such guidance.
FISCAL EFFECT : FTB's legal staff concluded that Notice 2008-83
has no legal effect for purposes of California tax laws and,
therefore, FTB staff estimates that this bill will have no
revenue impact with regard to Notice 2008-83. The provision
authorizing FTB to make a determination with respect to certain
federal income regulations or other administrative guidance may
impact PIT or CT revenue in the future. However, the impact of
that provision cannot be estimated at this point.
AB 692
Page 4
COMMENTS : According to the author, this bill is also needed to
ensure that, in the future, the Legislature's authority to enact
laws is not impinged by any federal notice or guidance of
doubtful legal authority and that General Fund (GF) revenues are
protected.
The proponents believe that this measure is necessary to protect
California's GF from losing desperately-needed tax revenue.
Proponents argue that, while the FTB has already taken
regulatory action to address this issue, this bill will bolster
FTB's efforts and will provide heightened legal assurances to
the FTB's actions against any legal challenges.
Committee staff notes all of the following:
1)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
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)Generally, IRS administrative pronouncements are issued
without much notice from the public, but the issuance of
Notice 2008-83 created quite a controversy. The questions
were raised regarding the circumstances under which Notice
2008-83 was issued and the Treasury Department's legal
AB 692
Page 5
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 Notice 2008-83 (See, e.g., A Quiet
Windfall for U.S. Banks, by Amit R. Paley, Washington Post,
Page A01, November 10, 2008). 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." Bush's tax breaks for banks could
cost California $2 billion, Evan Harper, Los Angeles Times,
November 11, 2008. 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 Notice 2008-83 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)Even though Notice 2008-83 was repealed by Congress as of
January 16, 2009, a few bank acquisitions that took place
prior to that date still qualify for the preferential tax
treatment bestowed on them by the U. S. Treasury Department,
albeit illegally. Thus, for federal tax purposes, Notice
2008-83 applies retroactively for all open years; apparently,
it was done to protect the reliability of guidance letters,
generally, and to avoid punishing taxpayers that relied on
Notice 2008-83. No such problems exist for California. The
FTB did not issue that Notice 2008-83 and, even though as a
practical matter, FTB has consistently followed federal
administrative guidance in the past, including notices, there
was no reason for taxpayers to rely on Notice 2008-83 for
California tax purposes because it was clearly indefensible as
a matter of substantive law. If California were to conform to
AB 692
Page 6
the policy articulated by the IRS in Notice 2008-83, or were
to allow the notice to apply retroactively it would, in
effect, be using state revenue to help fund federal bank
bailouts that took place before January 16, 2009.
4)Federal and state laws are very complex and taxpayers are
often overburdened with, if not overwhelmed by, the
differences in California and federal tax laws. Generally,
conformity to federal law improves taxpayer compliance and
reduces administrative costs incurred by tax agencies in
auditing taxpayers. The issuance of Notice 2008-83, however,
highlighted the risks of conforming to federal law and federal
administrative guidance and pronouncements. When, on those
rare occasions, a federal agency unwittingly exceeds its
authority to interpret existing federal law, California may
suffer disastrous consequences and lose revenues, without ever
being consulted on the matter. This bill expressly provides
that federal administrative guidance regarding an
interpretation of a provision of the Internal Revenue Code
that is applicable to the PIT Law or CT Law applies as
administrative guidance issued by the FTB, but only to the
extent that the guidance "does not conflict with" the PIT Law
or CT Law, whichever is applicable, or with regulations issued
by the FTB. The phrase "in conflict with" includes, but is
not limited to, any federal regulation or administrative
guidance that constitutes a substantive change in federal law
that is inconsistent with the statute to which such advice
relates or is beyond the scope of the Secretary of the
Treasury's authority. By allowing FTB to make that type of a
determination with regard to federal administrative
interpretations of law to which California conforms, this bill
will provide additional safeguards against future "Notices
2008-83".
5)AB 11 (De Leon), introduced in the 2009-10 Regular Legislative
Session, makes legislative findings and declarations similar
to those made in this bill and directs FTB not to apply Notice
2008-83 for purposes of California tax laws. AB 11 passed the
Assembly Floor with a vote of 75-0 and was transmitted to the
Senate.
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098
AB 692
Page 7
FN: 0000528