California Bill Won’t Target Tax Rules for Multinationals

By Laura Mahoney

A California senator has dropped plans to change the state’s tax treatment of multinational companies with foreign affiliates, but is pushing a bill to end three other tax provisions he calls loopholes for the wealthy.

S.B. 567, by Sen. Ricardo Lara (D), passed the Senate Governance and Finance Committee 5-2 on May 17 after Lara deleted provisions to end California’s water’s edge election. The election, in place for 30 years, allows multinational companies to exclude their affiliates that are beyond the “water’s edge” of the U.S. from the reported income tax base upon which California may levy the corporation tax.

Opposition to the provisions “was just insurmountable,” Lara told Bloomberg BNA after the committee hearing. “We will revisit it in the future.”

Seven-Year Election

Lara proposed to phase out the water’s edge method as the seven-year election expires for corporations using it. Those corporations would have shifted to the worldwide combined reporting method, which is what corporations that don’t elect to use the water’s edge method now use.

The election is California’s most expensive corporate income tax expenditure and its phaseout would have increased state revenue by $1.5 billion a year by the 2019-20 fiscal year, according to the Franchise Tax Board. About 15,000 corporate returns used the water’s-edge method in 2013, the most recent year for which return data is available, according to the California Department of Finance.

The water’s edge method is the required or default method in 25 of 29 states that require combined corporate income reporting, according to Bloomberg BNA data.

Executive Pay

Without the water’s edge election provisions, Lara is pushing for:

•  elimination of a provision that allows people who earn more than $1 million a year and inherit California property to set the basis in the property at the fair market value at the time of a decedent’s death, allowing heirs to avoid tax on the property’s gain in value, for a state revenue gain of about $8 million a year;
•   an increase to 40 percent from 10 percent the amount of assets that must remain in a charitable remainder trust and ultimately transfer to a charitable purpose to qualify for a tax exemption, with a state revenue impact the hasn’t been determined by the FTB yet; and
•  elimination of the ability of corporations to deduct executive compensation of more than $1 million, for a state revenue gain of about $100 million a year.

Break From Trump

The three provisions would make California inconsistent with federal law.

Sen. John Moorlach (R) voted against the bill, saying he doesn’t want California to stray further from conformity with federal law. He also took issue with Lara calling the provisions “loopholes,” and cautioned against targeting wealthy people who provide about one third of the state’s income tax revenue.

“I’m nervous about the rule of unintended consequences,” Moorlach said.

Lara said tax proposals from President Donald Trump’s administration and Republicans in Congress that largely benefit the wealthy are a signal that California should break from conformity with federal tax policy.

“How do we allow our lower and middle income families to be able to compete against the 1 percenters who are using these shelters?” Lara said. “Ivanka Trump and Barron Trump are going to be okay. This is what we need to do now to protect ourselves.”

Support, Opposition

The California Tax Reform Association, the California Reinvestment Coalition and the Service Employees International Union support the bill. Dozens of business groups, including the Computing Technology Industry Association (CompTIA), the California Chamber of Commerce, and the Family Business Association of California, oppose it.

Chris Micheli, a lobbyist representing CompTIA, said the association wants Lara to eliminate the provision related to executive compensation, which has been part of the federal tax code since 1993.

“We are not aware of people abusing it, and we are deeply troubled by characterizing it as a loophole,” Micheli said.

The bill will be heard next in the Senate Appropriations Committee.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif. at LMahoney@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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