BILL ANALYSIS
AB 1178
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Date of Hearing: January 21, 2010
ASSEMBLY COMMITTEE ON APPROPRIATIONS
Kevin De Leon, Chair
AB 1178 (Block) - As Amended: January 13, 2010
Policy Committee: Revenue and
Taxation Vote: 5-3
Urgency: No State Mandated Local Program:
No Reimbursable:
SUMMARY
This bill (a) requires multinational companies to include
operations located in foreign "tax havens" in their combined
income report for California's corporation tax, and (b) provides
a partial sales and use tax exemption for purchases of textbooks
and supplies by students of the University of California (UC),
California State Universities (CSU), and California Community
Colleges (CCC).
FISCAL EFFECT
1)No impact in 2010-11.
2)According to FTB, the corporate tax provisions will raise
revenues by $70 million in 2011-12, $120 million in 2012-13
and in 2013-14, and $50 million in 2014-15.
3)According to BOE, the sale exemption for textbooks and
supplies will reduce revenues by $70 million in 2011-12, $122
million in 2012-13, $128 million in 2013-14, and $48 million
in 2014-15.
SUMMARY (Continued)
Specifically, the bill:
1)Requires multinational corporations that elect to file tax
returns based only on income earned inside the U.S., known as
the water's-edge method, to include the income and operations
of affiliates doing business in tax-haven countries in its
combined income reports.
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2)Defines the term "tax haven" by reference to jurisdictions
identified in Table 1 of Appendix I to the December 2008
Report of the United States Government Accountability Office
(GAO) on International Taxation.
3)Allows a taxpayer to petition the Franchise Tax Board (FTB) to
exclude the income and operations of an affiliated corporation
doing business in a tax haven from the water's-edge return if
that corporation is engaged in the active conduct of a trade
or business in the tax haven.
4)Requires the Legislative Analyst, in consultation with the
FTB, to conduct a study regarding whether the jurisdictions
identified by the GAO are appropriate, or whether the
definition of the term "tax haven" should be revised.
5)Provides an exemption from part or all of the GF portion of
the sales and use tax for textbooks and supplies purchased
anywhere by students of UC, CSU, and CCC. The first three
percent of the portion sales tax would be exempt between July
1, 2011 and June 30, 2012, and the full five percent portion
would be exempt from July 1, 2012 through December 31, 2014.
6)Defines "supplies" as pens, paper, blue books, notebooks, art
supplies, uniforms, safety equipment, tools, computer paper,
and flash drives necessary for the course of study in which a
student is enrolled at the institution of higher education.
The definition of "supplies" does not include computers,
printers, or related hardware and software.
7)Defines "textbooks" as any published material that, among
other things, is principally designed for use by a student at
an institution of higher education as a source of
instructional material.
8)Specifies that the provisions affecting corporate taxes are in
effect for tax years beginning on or after July 1, 2011 and
before July 1, 2014. Provisions affecting the sales tax are in
effect from July 1, 2011 through December 31, 2014.
COMMENTS
1)Rationale . According to the author, the purpose of the bill
is to close a corporate loophole and use the proceeds to
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provide financial relief to higher education students who have
faced major fee increases and financial hardship. The author
asserts that the corporate loophole has resulted in fewer
dollars for education, health, and public safety programs. He
also indicates that the fiscal effects of the bill's two
provisions are largely offsetting, thereby placing no
significant burden on the GF.
2)Opponents , including the California Taxpayers' Association and
a variety of business groups, state that this bill runs
contrary to the intent of the water's-edge election, could
adversely impact foreign relations, and would penalize
California-based U.S. companies for doing business in certain
countries with which the U.S. has diplomatic ties.
3)Background - combined income reporting and water's edge
election . A key issue relating to state-level corporation
franchise taxes involves the determination of California
income for large companies (and affiliated groups of
companies) that have operations throughout the country or
around the world. Given the numerous challenges involved in
separately determining receipts and expenses that are
attributable to a multi-jurisdictional company's operations in
each state, California and virtually all other states levying
a corporation tax determine the income attributable to each
state through a two-step process. This involves (a)
calculation of combined income from all the company's
operations, and (b) apportionment of the combined income to
the state using formulas that take into account the state's
share of the companies' combined property, payroll, and sales,
or some subset of these factors.
Since 1987, California has allowed corporate taxpayers with
worldwide business activities to elect to report on a
"water's-edge" basis. A water's-edge election allows the
taxpayer to exclude from its tax return the income and
apportionment factors of taxpayers' foreign affiliates.
However, there are certain exceptions to this foreign
exclusion, such as income from a domestic international sales
corporation, a foreign sales corporation, an export trade
corporation. This bill would add affiliated companies doing
business in a tax haven country to the list of foreign
operations that must be included in the combined income report
of a company electing to report on water's edge basis.
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4)Background - tax havens . Generally, a tax haven is a foreign
country that maintains corporate, bank, and tax secrecy laws
and industry practices that make it difficult for other
countries to find out whether their citizens are using the tax
haven to avoid paying their taxes. Such havens also generally
have low or non-existent taxes on income and royalties. In a
report issued in 2000, the Organization for Economic
Cooperation and Development (OECD) identified over 40
jurisdictions as tax havens.
U.S. companies can use affiliated companies in tax havens to
minimize their U.S. tax liabilities in a variety of ways. As
one example, they can set prices on assets transferred between
the two entities at levels that artificially reduce profits of
U.S. operations and raise profits of the affiliate in the low-
or no-tax region. As another example, a U.S company and its
financial subsidiary operating in a tax haven can set the
terms of a loan in a way that shifts income out of the U.S.
Under existing California law, the income and apportionment
factors of affiliated tax haven companies are generally not
included in the water's-edge return of the California company,
unless the affiliated companies themselves have economic
presence in California. Consequently, corporations that
manage to shift some income to these subsidiaries will pay
less tax to California.
Analysis Prepared by : Brad Williams / APPR. / (916) 319-2081