BILL ANALYSIS
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UNFINISHED BUSINESS
Bill No: SB 663
Author: Migden (D), et al
Amended: 3/13/05
Vote: 21
SENATE REVENUE & TAXATION COMMITTEE : 5-3, 4/27/05
AYES: Machado, Alquist, Bowen, Cedillo, Scott
NOES: Dutton, Poochigian, Runner
SENATE APPROPRIATIOSN COMMITTEE : Senate Rule 28.8
SENATE FLOOR : 25-15, 5/26/05
AYES: Alarcon, Alquist, Bowen, Cedillo, Chesbro, Ducheny,
Dunn, Escutia, Figueroa, Florez, Kehoe, Kuehl, Lowenthal,
Machado, Migden, Murray, Ortiz, Perata, Romero, Scott,
Simitian, Soto, Speier, Torlakson, Vincent
NOES: Aanestad, Ackerman, Ashburn, Battin, Campbell, Cox,
Denham, Dutton, Hollingsworth, Maldonado, Margett,
McClintock, Morrow, Poochigian, Runner
ASSEMBLY FLOOR : 42-33, 4/3/06 - See last page for vote
SUBJECT : Corporation taxes: waters-edge election:
foreign affiliated
SOURCE : Franchise Tax Board
DIGEST : This bill clarifies that a corporation that has
both effectively connected income (income earned in the
U.S.) and Subpart F income must take both sources of income
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into account in determining its water's edge income base.
The bill also conforms with federal law by requiring the
Franchise Tax Board to coordinate the U.S.-source-income
and Subpart F income provisions so as to prevent under - or
over-counting such income. This bill declares that the
intent of the legislation that the clarification be
operative for taxable years stating on or after January 1,
2006.
Assembly Amendments makes clarifying changes to the intent
language and adds co-authors.
ANALYSIS : Existing law requires California's share of
the income of multinational groups of corporations to be
determined through use of the unitary three-factor formula
(California's percentage shares of worldwide payroll,
property and sales, averaged, becomes California's
percentage share of worldwide income, to which our 8.84
percent franchise tax applies).
An alternative procedure, the so-called "water's edge"
method, attempts to draw a rough line around the United
States, and only requires application of the three-factor
unitary formula to activities within that line.
The law requires inclusion within the "water's edge" (1)
certain foreign corporations that have "effectively
connected income" (income earned in the U.S.) but only to
the extent of that income; and (2) "controlled foreign
corporations" (corporations formed outside the U.S., but
owned by U.S. parent corporations) with "Subpart F" income
(income from tax haven countries or income otherwise
considered to be tax-sheltered).
An inconsistency exists in the water's edge law that may be
interpreted to permit a controlled foreign corporation with
Subpart F income to file with the Secretary of State as an
"admitted corporation" (eligible to do business in
California), pay the $800 minimum corporation tax, and
totally escape inclusion of a portion of its Subpart F
income within the water's edge apportionable income base
(i.e., avoid paying any taxes on its tax haven income).
The Franchise Tax Board (FTB) staff believe that some
corporations have begun to take advantage of this
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inconsistency and that some Subpart F income has been
excluded from the water's edge.
Specifically, SB 663:
1. Requires a controlled foreign corporation (CFC) that
is a California taxpayer or has United States (U.S.)
source income to include its Internal Revenue Code (IRC)
Subpart F income (in general, dividends, interest,
royalties, rents) in the combined report.
2. Coordinates existing laws dealing with Subpart F
income and U.S.-source income rules so that they operate
simultaneously and consistently, regardless of whether
corporations are taxpayers for California tax purposes.
3. Provides various implementation rules regarding
document production and treatment of dividends as
business income in certain, enumerated circumstances.
4. Provides that the provisions apply to taxpayers that
make a water's-edge election on or after January 1, 2006.
5.Provides a "phase-in" period so that the provisions will
not apply to taxpayers that made a water's-edge election
prior to January 1, 2006, until the taxpayer is able to
elect out of the water's-edge provisions without the
consent of the Franchise Tax Board (FTB).
6.States legislative intent with respect to taxpayers to
whom this bill applies as follows:
A. For any return containing a water's-edge
combined report filed on or before January 1, 2006,
a taxpayer that excluded income of its CFC because
the CFC had technical tax nexus to California or
had U.S.-source income shall be deemed in
compliance with the law before the amendments
provided by this bill, provided that the taxpayer
otherwise complied with the statute.
B. For any return containing a water's-edge
combined report filed after January 1, 2006, no
inference be drawn from this bill with respect to
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the correctness of the taxpayer's return position.
A proposal similar to this one was included in AB 1469
(Ortiz), in 1998, as part of a "taxpayer bill of rights"
package. The bill (passed in the last two weeks of
session) was unopposed when heard in this committee, but
was vetoed by Governor Wilson when business interests
erroneously asserted to the Governor that the existing law
is as intended to be by the Legislature, and that various
taxpayers were utilizing it to reduce their tax
liabilities. In fact, the inconsistency is not intentional,
and at the time of the veto no taxpayers had attempted to
use it.
A virtually identical bill, SB 1571 (Alpert), of 2004,
reached the Assembly Floor but the author did not ask that
it be taken up for vote.
FISCAL EFFECT : Appropriation: No Fiscal Com.: Yes
Local: No
FTB estimates the revenue loss from the implementation
provisions of this bill will be $1 million for fiscal year
(FY) 2006-07 and minor revenue losses (less than $500,000)
for each of FY 2007-08 and FY 2008-09. FTB notes a recent
trend in returns filed by multinational corporations to
exclude income from CFCs, contrary to FTB's position on the
issue. The clarification contained in this bill eliminates
any risk that taxpayers' positions will be sustained in
court and FTB estimates that this bill potentially will
save $50 million annually, commencing after FY 2008-09,
plus the costs of extended litigation.
Note that the bill is keyed "majority vote" (i.e., not a
tax increase), as Legislative Counsel agrees with FTB that
the bill clarifies rather than changes current law.
SUPPORT : (Verified 4/5/06)
Franchise Tax Board (source)
American Federation of State
County and Municipal Employees
AFL-CIO
SEIU, Local 1000
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OPPOSITION : (Verified 4/5/06)
California Bankers Association
California Chamber of Commerce
California Taxpayers Association
Johnson and Johnson
ARGUMENTS IN SUPPORT : According to the author's office,
the purpose of this bill is to clarify existing law, reduce
taxpayer confusion, and eliminate unintended opportunities
for tax avoidance.
FTB is concerned that an existing inconsistency and
ambiguity in our tax law may be used by taxpayers to avoid
including in the their water's edge group
otherwise-includible tax haven activities (Subpart F
income) by establishing a de minimus tax presence in
California.
ARGUMENTS IN OPPOSITION : According to the California
Chamber of Commerce, the taxpayers affected by this bill
already made their decisions to enter into a water's edge
election based on the exclusion of Subpart F income.
Moreover, these taxpayers entered into seven-year
agreements with the state (which is required by law when
making a water's edge election). As a result, they believe
it is only fair to apply this proposed change in the law on
a prospective basis. They are also concerned about FTB's
revenue estimate of a $50 million increase and that the
bill is only a majority vote bill.
ASSEMBLY FLOOR :
AYES: Arambula, Bass, Berg, Bermudez, Calderon,
Canciamilla, Chavez, Chu, Cohn, Coto, De La Torre,
Dymally, Evans, Frommer, Goldberg, Hancock, Jerome
Horton, Jones, Karnette, Klehs, Koretz, Laird, Leno,
Levine, Lieber, Lieu, Matthews, Montanez, Mullin, Nation,
Nava, Oropeza, Pavley, Ridley-Thomas, Ruskin, Saldana,
Salinas, Torrico, Vargas, Wolk, Yee, Nunez
NOES: Baca, Benoit, Blakeslee, Bogh, Cogdill, Daucher,
DeVore, Emmerson, Garcia, Harman, Shirley Horton,
Houston, Huff, Keene, La Malfa, La Suer, Leslie, Maze,
McCarthy, Mountjoy, Nakanishi, Negrete McLeod, Niello,
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Parra, Plescia, Richman, Sharon Runner, Spitzer,
Strickland, Tran, Umberg, Villines, Wyland
NO VOTE RECORDED: Aghazarian, Chan, Haynes, Liu, Walters
DLW:do 4/5/06 Senate Floor Analyses
SUPPORT/OPPOSITION: SEE ABOVE
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