BILL ANALYSIS �
AB 1423
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CONCURRENCE IN SENATE AMENDMENTS
AB 1423 (Perea)
As Amended July 12, 2011
2/3 vote. Urgency
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|ASSEMBLY: | |(May 16, 2011) |SENATE: |38-0 |(August 31, 2011) |
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(vote not relevant)
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|COMMITTEE VOTE: |7-0 |(September 8, 2011) |RECOMMENDATION: |Concur |
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Original Committee Reference: REV. & TAX.
SUMMARY : Conforms several provisions of state income tax law to
the federal Regulated Investment Company (RIC) Modernization Act of
2010.
The Senate amendments delete the Assembly version of this bill and,
instead, in conformity with the federal RIC Modernization Act of
2010:
1)Revise the California income tax laws to treat RICs similarly to
individuals with regard to capital loss carryover, thus, allowing
RICs to carry over capital losses for an unlimited number of
years.
2)Allow a RIC, upon identifying a de minimis asset test failure, as
defined, at the end of the quarter, to maintain its status as a
RIC, provided that, within six months, the RIC fulfills the
requirements of the asset test, as prescribed. Allow a RIC,
which fails either the "gross income" test or the "asset test"
(outside of the de minimis range), to cure the failure by paying
tax and satisfying certain specified requirements.
3)Replace the requirement to designate distributions as certain
types of income with a requirement for RICs to report, in a
written statement furnished to shareholders, the designations of
capital gain dividends and other pass-through items. Allow RICs
to satisfy the reporting requirement by issuing to shareholders
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Form 1099.
4)Allow a capital loss carryover of a RIC to be taken into account
in determining the RIC's current and accumulated earnings and
profits. Provide that deductions associated with tax-exempt
interest income of a RIC may be taken into account in computing
current earnings and profits, thus allowing dividend
distributions to shareholders in excess of tax-exempt interest to
be treated as a return of capital gain rather than ordinary
taxable dividends.
5)Allow RICs with 50% or more of the value of its total assets
invested in other RICs to pass through exempt-interest dividends
and foreign tax credits to shareholders, as specified.
6)Authorize a RIC to declare a "spillover dividend," as defined, by
the 15th day of the 9th month following the close of the taxable
year to which the spillover dividend relates, or the extended due
date for filing the RIC's tax return, whichever is later.
Require spillover dividends, once declared, to be paid by the
date of the next dividend payment of the same type, but no later
than 12 months after the end of the tax year to which the
spillover dividend relates.
7)Specify that, if a RIC distributes dividends in a taxable year
that, in the aggregate, exceed the RIC's current and accumulated
earnings and profits, the current earnings and profits are
allocated first to distributions made prior to January 1st.
8)Treat the redemption of a publicly offered RIC stock as an
exchange, rather than a distribution of property, for tax
purposes, if the redemption is upon the demand of the shareholder
and the RIC issues only stock that is redeemable upon the
shareholder demand. Specifies that a "publicly offered RIC" is a
RIC that offers its shares publicly, trades on an established
securities market, or has at least 500 persons holding shares at
all times.
9)Provide that a publicly offered RIC, as defined, is not required
to follow the "preferential dividend" rule, as specified.
10)Authorize a RIC to choose whether or not to postpone
post-October capital losses and qualified late-year ordinary
losses to the first day of the next taxable year.
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11)Allow a RIC shareholder to claim a loss on the sale or exchange
of the stock held for six months or less, to the extent of the
amount of the exempt-interest dividend, if certain requirements
are satisfied.
12)Limit the application of the Sales Load Basis Deferral rule only
to those cases where a RIC shareholder disposes of the RIC stock
within 90 days of the acquisition but subsequently acquires RIC
stock in the same fund family without incurring a new sales load,
pursuant to the shareholder's reinvestment rights, before January
31 of the calendar year following the year of the disposal of the
original stock.
13)Add the urgency clause.
AS PASSED BY THE ASSEMBLY , this bill deleted obsolete provisions of
the Sales and Use Tax (SUT) Law, and made technical amendments to
existing SUT exemption provisions as a matter of code maintenance.
FISCAL EFFECT : The Franchise Tax Board estimates that this bill
will result in an annual General Fund revenue loss of $925,000 in
fiscal year (FY) 2011-2012, $383,500 in FY 2012-2013, and $73,500
in FY 2013-2014, followed by revenue gains from FY 2014-15 until FY
2017-18.
COMMENTS :
The Author's Statement . The author states that, "The purpose of
AB 1423 is to conform California's tax laws governing mutual fund
companies to the provisions of the federal Regulated Investment
Company Modernization Act enacted on December 22, 2010. This bill
does not change any tax rates, but rather incorporates federal
changes that update numerous tax-related provisions that have been
determined to be obsolete, unworkable, inefficient or
disproportionate. These changes will create operational
efficiencies for California-based mutual funds and will benefit
their shareholders by, among other things, ensuring that the
shareholders will receive the same tax treatment under both federal
and California laws. The vast majority of other states
automatically conform their tax laws to federal changes relating to
mutual fund taxation. California requires specific conformity
legislation and has historically passed such legislation to achieve
conformity in this area. If California does not conform in 2011 to
the federal changes, many California-based mutual funds will be
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subject to different (and, in some cases, possibly inconsistent)
federal and California tax requirements. The inconsistency may
lead to significant, and, in some instances, insurmountable,
operational problems and costs for the affected mutual funds and to
widespread confusion among shareholders about the manner in which
they are taxed on distributions received from the mutual funds. It
will also put California-based mutual funds at a competitive
disadvantage vis-�-vis their peers located in other states."
Arguments in Support . The proponents of this bill argue that AB
1423 "is crucial to the continual competitiveness of California's
mutual fund industry" and that, without conformity to the RIC
Modernization Act, California-based companies would "face severe
sanctions if they were to fail to meet both California and federal
law" and would be "put at a serious competitive disadvantage" as
compared to funds based elsewhere in the country. The proponents
believe that this competitive disadvantage will result in less
investment in California-based mutual funds, "meaning fewer jobs,
income, and profits." Currently, "California management companies
pay approximately $300 million per year to California and any loss
of market share could translate into a significant decrease in tax
revenue to California."
The proponents also contend that the "burdens of nonconformity
would fall not only on mutual funds, but also on their investors
and the Franchise Tax Board." Non-conformity will result in delays
and additional revisions to 1099 forms, requiring individual
investors to file several amended tax returns, at additional costs
to taxpayers and the FTB. Furthermore, of "even greater
consequence is the threat that investors would elect to move their
investments to an out-of-state fund to avoid having to keep a
different set of books to track the highly-technical differences
for their California return and avoid any confusion and increased
tax preparation costs that would go along with it." Finally, the
proponents state that the "mutual fund industry is extremely
important to the California economy and represents an important
source of investment in California's state and local bonds."
How Important Is Conformity to Federal Tax Law? When changes are
made to the federal income tax law, California generally does not
automatically adopt such provisions. Instead, state legislation is
needed to conform to most of those changes. Conformity legislation
is introduced either as individual tax bills to conform to specific
federal changes or as one omnibus bill to conform to the federal
law as of a certain date with specified exceptions, a so-called
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"conformity" bill.
The last California-federal conformity bill was enacted in 2010 �SB
401 (Wolk), Chapter 14, Statutes of 2010]. Generally, businesses,
tax practitioners and state tax agencies advocate to conform state
tax laws to ever-changing federal tax laws. Businesses prefer
conformity to federal tax laws because it reduces their state tax
compliance costs. The tax practitioners argue that failure to
conform to federal law in some areas may lead to improper tax
reporting to California and extra costs to the taxpayers. Finally,
conformity legislation is also important to state agencies. It
eases the burden, and reduces the costs, of tax administration
because the state may rely on federal audits, federal case law, and
regulations.
While state conformity to federal income tax provisions offers
certain advantages and reduces tax compliance costs, it can also
significantly impact state revenues. Thus, it would be difficult
to achieve complete conformity with federal income tax rules.
Often, the Legislature needs to increase tax rates to find funding
for a new or expanded existing credit or deduction allowed for
federal income tax purposes. Tax credits, deductions, and
exemptions are designed to provide incentives for taxpayers that
incur certain expenses or to influence behavior, including business
practices and decisions. Both the Federal and state governments
often use tax policy to influence taxpayers' behavior. However,
federal tax incentives may not necessarily produce the same effect
on the taxpayer's behavior at the state level, if adopted by the
state government, as they do on the federal level. Furthermore,
unlike the Federal government, California cannot print money to
subsidize its budget. Therefore, the Legislature must be mindful
of fiscal effects of conforming to federal tax laws, even if those
may not trigger significant fiscal concerns in Congress.
The RIC Modernization Act of 2010: Background . On December 22,
2010, President Obama signed into law the RIC Modernization Act of
2010 (P.L. 111-325) (Act), which revised Subchapter M of the
Internal Revenue Code (IRC) governing the taxation of RICs and
their shareholders. In general, a RIC is an electing domestic
corporation that either meets or is excepted from certain
registration requirements under the Investment Company Act of 1940,
that derives at least 90% of its ordinary income from specified
sources considered passive investment income, has a portfolio of
investments that meet certain diversification requirements, and
satisfies certain other conditions.
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Corporations or entities treated as such for tax purposes are
subject to many of the regular rules of corporate tax, both on
federal and state level. However, RICs, most of which are more
commonly known as mutual funds, qualify for a special tax treatment
under Subchapter M of the IRC and specified provisions of the
Revenue and Taxation Code. The Subchapter M prescribes the rules
that a corporate entity must satisfy in order to qualify as a RIC
for the taxable year and provides a special tax treatment for a
qualified RIC and its shareholders. Specifically, a RIC that
distributes at least 90% of its net ordinary income and net
tax-exempt interest to the shareholders may deduct the dividend
amount in computing its tax. While no corporate income tax is
imposed on RIC's income distributed to the shareholders, the
dividends are generally included in the income of the shareholders,
and thus, the shareholders must report the distributions on their
own personal income tax returns. Those distributions may be
characterized as long-term or short-term capital gains or
tax-exempt interest and this characterization depends on the type
of income distributed by the RIC. The RIC may pass through to its
shareholders the character of its long-term capital gain income by
paying "capital gain dividend" and tax-exempt interest by paying
"exempt-interest dividends." A RIC may also pass-through foreign
tax credits and credits on tax-credit bonds, as well as certain
other income received by the RIC. If a RIC fails to comply with
the provisions of Subchapter M, it may be subject to the federal
and state corporate income taxes. In addition, its distributions
to the shareholders will be characterized as "ordinary income"
instead of "capital gain" or "tax-exempt interest," and thus will
result in a greater amount of tax payable to the federal and state
governments.
The Act has not affected the fundamentals of the tax treatment
afforded to RICs and their shareholders; instead, it updated the
applicable tax rules, which were originally enacted in 1936, to
alleviate the unnecessary tax compliance burdens and to reflect the
realities of the modern economy. The Act revised certain
provisions of the federal tax law that affect a RIC's
characterization as a RIC and the manner in which a RIC's
shareholders are taxed on the distributions received from the RIC
and gains that may be realized when the shareholders dispose of RIC
shares.
Analysis Prepared by : Oksana G. Jaffe / REV. & TAX. / (916)
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319-2098
FN: 0002833