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AB-441 Corporation taxes: water’s-edge election: inverted corporations. (2005-2006)

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Amended  IN  Assembly  May 26, 2005

CALIFORNIA LEGISLATURE— 2005–2006 REGULAR SESSION

Assembly Bill
No. 441


Introduced  by  Assembly Member Chu

February 15, 2005


An act to amend Section 25110 of the Revenue and Taxation Code, relating to taxation, to take effect immediately, tax levy.


LEGISLATIVE COUNSEL'S DIGEST


AB 441, as amended, Chu. Corporation taxes: water’s-edge election: inverted corporations.
The Corporation Tax Law imposes taxes measured by income and, in the case of a business with income derived from or attributable to sources both within and without this state, apportions the income between this state and other states and foreign countries in accordance with a specified 4–factor formula based on the property, payroll, and sales within and without this state, except as otherwise provided. That law allows corporations to elect whether their income is determined on a “water’s–edge” basis or on a worldwide unitary basis. In general, a corporation that makes a water’s-edge election is subject to tax on income only from sources within the United States.
This bill would require a corporation that makes a water’s–edge election to include the income and apportionment factors of its affiliated foreign incorporated entity that is treated as an inverted domestic corporation, as defined.
This bill would result in a change in state taxes for the purpose of increasing state revenues within the meaning of Section 3 of Article XII A of the California Constitution, and thus would require for passage the approval of 2/3 of the membership of each house of the Legislature.
This bill would take effect immediately as a tax levy.
Vote: 2/3   Appropriation: NO   Fiscal Committee: YES   Local Program: NO  

The people of the State of California do enact as follows:


SECTION 1.

 The Legislature finds and declares all of the following:
(a) A number of publicly traded United States domiciled corporations that are subject to a water’s-edge election are becoming “inverted domestic corporations” in order to avoid their fare share of California taxation.
(b) An “inverted domestic corporation” is a corporation that changes the country of its legal domicile to a domicile located outside of the United States. One of the results of this change may be tax reporting advantages. In substance, these transactions are essentially “paper transactions” that have no significant effect on the business operations of the taxpayers involved. Typically, the inverted corporation has no substantial business presence in the country of its new domicile.
(c) Under the water’s-edge election rules, a domestic corporation includes all of its worldwide income in the water’s-edge group, while much of a foreign corporation’s income is excluded from income of the group. If the foreign status of an inverted domestic corporation is respected, the inverted domestic corporation can remove a large portion of its worldwide income from the California tax base of the water’s–edge group, without changing any of its operations in any material respect, and therefore, significantly reduce the net income on which California’s share of corporate income is calculated and taxed.
(d) Treating an inverted domestic corporation as if it retained its status as a United States domiciled corporation for purposes of a water’s-edge election would stem the loss of corporate tax revenue.

SEC. 2.

 Section 25110 of the Revenue and Taxation Code is amended to read:

25110.
 (a) Notwithstanding Section 25101, a qualified taxpayer, as defined in paragraph (2) of subdivision (b), that is subject to the tax imposed under this part, may elect to determine its income derived from or attributable to sources within this state pursuant to a water’s–edge election in accordance with the provisions of this part, as modified by this article. A taxpayer that makes a water’s–edge election shall take into account the income and apportionment factors of the following affiliated entities only:
(1) Domestic international sales corporations, as described in Sections 991 to 994, inclusive, of the Internal Revenue Code and foreign sales corporations as described in Sections 921 to 927, inclusive, of the Internal Revenue Code.
(2) Any corporation (other than a bank), regardless of the place where it is incorporated if the average of its property, payroll, and sales factors within the United States is 20 percent or more.
(3) (A) Corporations that are incorporated in the United States, excluding corporations making an election pursuant to Sections 931 to 936, inclusive, of the Internal Revenue Code, of which more than 50 percent of their voting stock is owned or controlled directly or indirectly by the same interests.
(B) An inverted domestic corporation.
(4) A corporation that is not described in paragraphs (1) to (3), inclusive, or paragraph (5), but only to the extent of its income derived from or attributable to sources within the United States and its factors assignable to a location within the United States in accordance with paragraph (3) of subdivision (b). Income of that corporation derived from or attributable to sources within the United States as determined by federal income tax laws shall be limited to and determined from the books of account maintained by the corporation with respect to its activities conducted within the United States.
(5) Export trade corporations, as described in Sections 970 to 972, inclusive, of the Internal Revenue Code.
(6) Any affiliated corporation which is a “controlled foreign corporation,” as defined in Section 957 of the Internal Revenue Code, if all or part of the income of that affiliate is defined in Section 952 of Subpart F of the Internal Revenue Code (“Subpart F income”). The income and apportionment factors of any affiliate to be included under this paragraph shall be determined by multiplying the income and apportionment factors of that affiliate without application of this paragraph by a fraction (not to exceed one), the numerator of which is the “Subpart F income” of that corporation for that taxable year and the denominator of which is the “earnings and profits” of that corporation for that taxable year, as defined in Section 964 of the Internal Revenue Code.
(7) (A) The income and factors of the above–enumerated corporations shall be taken into account only if the income and factors would have been taken into account under Section 25101 if this section had not been enacted.
(B) The income and factors of a corporation that is not described in paragraphs (1) to (3), inclusive, and paragraph (5) and that is an electing taxpayer under this subdivision shall be taken into account in determining its income only to the extent set forth in paragraph (4).
(b) For purposes of this article and Section 24411:
(1) (A) An “affiliated corporation” means a corporation that is a member of a commonly controlled group as defined in Section 25105.
(B) An “inverted domestic corporation” means a foreign incorporated entity, as defined in clause (iii) of subparagraph (C), if all of the following apply:
(i) Either subclause (I) or (II) applies:
(I) The foreign incorporated entity acquires, directly or indirectly, substantially all of the properties held, directly or indirectly, by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership or a related foreign partnership, and immediately after the acquisition, either:
(aa) In the case of a domestic corporation, more than 50 percent of the stock, by vote or value, of the foreign incorporated entity is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation.
(ab) In the case of a domestic partnership, more than 50 percent of the stock, by vote or value, of the foreign incorporated entity is held by former partners of the domestic partnership or related foreign partnership by reason of holding a capital or profits interest in the domestic partnership or related foreign partnership.
(II) The foreign incorporated entity acquires, directly or indirectly, substantially all of the properties held, directly or indirectly, by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership or a related foreign partnership, and more than 50 percent of the stock, by vote or value, of the foreign incorporated entity is held by domestic shareholders.
(ii) Immediately after the acquisition described in clause (i), the properties acquired constitute at least 80 percent of the assets of the foreign incorporated entity.
(C) (i) In applying subparagraph (B), the following rules apply:
(I) There shall not be taken into account, in determining ownership for purposes of subclause (I) of clause (i) of subparagraph (B), either of the following:
(aa) Stock held by members of the expanded affiliated group that includes the foreign incorporated entity.
(ab) Stock of that foreign incorporated entity that is sold in a public offering related to the acquisition described in subparagraph (B).
(II) If a foreign incorporated entity acquires, directly or indirectly, substantially all of the property of a domestic corporation or partnership during a four–year period and the ownership requirements of clause (i) of subparagraph (B) are met within two years from the date of that acquisition, then that acquisition shall be treated as having been made pursuant to a plan.
(III) The transfer of property or liabilities, including by contribution or distribution shall be disregarded if the transfers are part of a plan, a principal purpose of which is to avoid the purposes of this section.
(IV) For purposes of applying subparagraph (B) to the acquisition of a domestic partnership, all domestic partnerships that are under common control within the meaning of Section 482 of the Internal Revenue Code shall, except as otherwise provided in regulations prescribed by the Franchise Tax Board, be treated as a partnership.
(V) The Franchise Tax Board may prescribe those regulations as may be necessary to do both of the following:
(aa) Treat warrants, options, contracts to acquire stock, convertible debt instruments, and other similar interest or intangibles as stock.
(ab) Treat stock as not stock.
(ii) Notwithstanding subparagraph (A), for purposes of subparagraph (B) the term “expanded affiliated group” means an affiliated group as defined in Section 1504(a) of the Internal Revenue Code, without regard to Section 1504(b)(3) of the Internal Revenue Code, except that Section 1504 of the Internal Revenue Code shall be applied by substituting “more than 50 percent” for “at least 80 percent” each place it appears.
(iii) The term “foreign incorporated entity” means any entity that is treated as a foreign corporation for purposes of the Internal Revenue Code.
(iv) (I) Except as provided in subclause (II), the terms “person,” “domestic,” and “foreign” have the meanings given those terms by paragraphs (1), (4), and (5), respectively, of Section 7701(a) of the Internal Revenue Code.
(II) For purposes of this article and the application of provisions of the Internal Revenue Code applicable for purposes of this article, including Subpart F of the Internal Revenue Code, a foreign incorporated entity that is an inverted domestic corporation shall be treated as a domestic corporation.
(v) For purposes of this section, indirect acquisition of property includes the acquisition of stock of the owner of that property.
(2) A “qualified taxpayer” means a corporation which does both of the following:
(A) Files with the state tax return on which the water’s–edge election is made a consent to the taking of depositions at the time and place most reasonably convenient to all parties from key domestic corporate individuals and to the acceptance of subpoenas duces tecum requiring reasonable production of documents to the Franchise Tax Board as provided in Section 19504 or by the State Board of Equalization as provided in Title 18, California Code of Regulations, Section 5005, or by the courts of this state as provided in Chapter 2 (commencing with Section 1985) of Title 3 of Part 4 of, and Chapter 9 (commencing with Section 2025.010) of Title 4 of Part 4 of, the Code of Civil Procedure. The consent relates to issues of jurisdiction and service and does not waive any defenses a taxpayer may otherwise have. The consent shall remain in effect so long as the water’s–edge election is in effect and shall be limited to providing that information necessary to review or to adjust income or deductions in a manner authorized under Sections 482, 861, Subpart F of Part III of Subchapter N, or similar provisions of the Internal Revenue Code, together with the regulations adopted pursuant to those provisions, and for the conduct of an investigation with respect to any unitary business in which the taxpayer may be involved.
(B) Agrees that for purposes of this article, dividends received by any corporation whose income and apportionment factors are taken into account pursuant to subdivision (a) from either of the following are functionally related dividends and shall be presumed to be business income:
(i) A corporation of which more than 50 percent of the voting stock is owned, directly or indirectly, by members of the unitary group and which is engaged in the same general line of business.
(ii) Any corporation that is either a significant source of supply for the unitary business or a significant purchaser of the output of the unitary business, or that sells a significant part of its output or obtains a significant part of its raw materials or input from the unitary business. “Significant,” as used in this subparagraph, means an amount of 15 percent or more of either input or output.
All other dividends shall be classified as business or nonbusiness income without regard to this subparagraph.
(3) The definitions and locations of property, payroll, and sales shall be determined under the laws and regulations that set forth the apportionment formulas used by the individual states to assign net income subject to taxes on or measured by net income in that state. If a state does not impose a tax on or measured by net income or does not have laws or regulations with respect to the assignment of property, payroll, and sales, the laws and regulations provided in Article 2 (commencing with Section 25120) shall apply.
Sales shall be considered to be made to a state only if the corporation making the sale may otherwise be subject to a tax on or measured by net income under the Constitution or laws of the United States, and shall not include sales made to a corporation whose income and apportionment factors are taken into account pursuant to subdivision (a) in determining the amount of income of the taxpayer derived from or attributable to sources within this state.
(4) “The United States” means the 50 states of the United States and the District of Columbia.
(c) All references in this part to income determined pursuant to Section 25101 shall also mean income determined pursuant to this section.
(d) The amendments made to this section by the act adding this subdivision apply as follows:
(1) To a taxpayer that is required to file on a water’s–edge basis in its first taxable year beginning on or after January 1, 2005, pursuant to a water’s-edge election made in accordance with the provisions of this part, as modified by this article, made on or after January 1, 2005.
(2) To a taxpayer that is required to file on a water’s–edge basis pursuant to a water’s–edge election made in accordance with the provisions of this part, as modified by this article, made in a year prior to January 1, 2005, under Section 25111 or Section 25113, in its first taxable year beginning on or after January 1 of the taxable year immediately succeeding the expiration of the term of the water’s–edge contract in effect on January 1, 2005. succeeding 84 months after the commencement of the taxpayer’s water’s‑edge election.

SEC. 3.

 This act provides for a tax levy within the meaning of Article IV of the Constitution and shall go into immediate effect.