Existing law provides various sources of funding for transportation and other infrastructure purposes.

This bill, until July 1, 2025, would require the Department of Finance, in consultation with the Franchise Tax Board, to estimate, on an annual basis by November 1 of each year, the amount of revenue to be received from state taxes in the next fiscal year as a consequence of enactment of a federal corporate repatriation statute pursuant to which foreign earnings of United States-based corporations that are currently invested abroad are moved to the United States.

The bill, until July 1, 2025, after reservation of appropriate amounts required to be allocated by the California Constitution for Proposition 98 education funding requirements and the Budget Stabilization Account, would require the remaining repatriation revenues to be transferred to the Repatriation Infrastructure Fund in the State Treasury, which the bill would create. The bill would continuously appropriate the revenues in the Repatriation Infrastructure Fund to an unspecified entity for expenditure infrastructure projects.

SENATE COMMITTEE ON GOVERNANCE AND FINANCE

Senator Mike McGuire, Chair

2017 - 2018 Regular

Repatriation Infrastructure Fund

Shifts any increase in estimated state tax revenue resulting from a federal repatriation statute for infrastructure projects.

Background

Corporate taxes at the federal and state level apply to different bases. Until recently, the Internal Revenue Code generally applied a graduated tax rate schedule, with a top rate of 35%, on the total worldwide income of United States-headquartered companies, including its foreign subsidiaries. The Code allows taxes on income derived by U.S. corporations from foreign subsidiaries to be deferred in some cases, but not in others. For example, tax on foreign subsidiaries’ operating income is generally deferred until “repatriated” in the form of a dividend paid to the U.S. parent corporation (less a credit for any foreign taxes paid on that income).

Most foreign subsidiaries are considered Controlled Foreign Corporations (CFCs) under the Code. A CFC is a corporate entity that is registered and conducts business in a different country, such as Ireland, than the residency of its U.S. owners. CFCs pay tax in the current taxable year on any U.S. income, as well as specified sources of passive, highly mobile non-operating income, such as dividends, royalties, interest, and rents, regardless of whether the subsidiary has paid a dividend. Subpart F of the Code specifies the forms of a CFC’s income which are taxable on a current basis.

On December 22^nd, 2017, President Trump signed HR 1, which enacted fundamental changes to the federal corporate income tax. Among other changes, the measure:

• Eliminates the graduated rate schedule for corporate income with a top rate of 35%, and replaces it with a single rate of 21%, effective in the 2018 taxable year.
• Enacts a “forced repatriation” that requires U.S. taxpayers to include in income in the last taxable year any deferred foreign income not previously taxed, with some exceptions. Corporate taxpayers can partially offset the repatriation with a deduction, the amount of which depends on whether the income is held in the form of liquid or illiquid assets. The net effect is a 15.5-percent tax rate on foreign earnings held in the form of cash or cash equivalents, and an 8-percent tax rate on all other earnings. Taxpayers can pay the tax on repatriated earnings in equal installments over eight years. HR 1 accomplishes the forced repatriation by increasing a CFC’s Subpart F income for the last taxable year.
• Limits significantly taxation of a U.S. taxpayer’s foreign source income by adopting a “territorial system,” which allows a 100% deduction for the foreign-source portion of dividends received from its 10% owned foreign corporations, including CFCs, beginning in the 2018 taxable year. Only “C” corporations can claim the dividend.

California instead taxes at a rate of 8.84% the net apportioned business income and allocated net nonbusiness income of a multistate or multinational corporation doing business in California, or imposes the $800 minimum tax, whichever is greater, with some exceptions. Business income generally includes any income derived from the taxpayer’s trade or business, while nonbusiness income typically includes rents, royalties, interest and dividends not connected to the taxpayer’s trade or business.

California also applies the combined report method of corporate taxation, where the income and expenses of a firm’s unitary subsidiaries and affiliates must be included as a group on a single tax return. While determining unity for purposes of a combined report has been subject to disputes, this method generally allows for the cancellation of any intercompany transactions, such as dividends paid from a foreign subsidiary to a domestic parent. However, taxpaying corporations can elect to exclude the income and expenses of its foreign subsidiaries from the combined report, called the “water’s edge” election. Despite the water’s edge election, state law requires taxpayers to include specified income of certain foreign subsidiaries and affiliates in the combined report, including CFCs. California requires taxpayers making the water’s edge election to include a specified portion of its CFC’s Subpart F income, plus its apportionment factors, based on an inclusion ratio, on a current basis. However, taxpayers can deduct 75%, and in some cases 100%, of dividends it receives from specified foreign subsidiaries.

Seeking additional funds for infrastructure purposes, the author wants to shift any additional state tax revenue resulting from HR 1 to infrastructure purposes.

Proposed Law

Senate Bill 1384 creates the Repatriation Infrastructure Fund in the State Treasury, which is continuously appropriated to an unnamed entity for expenditure on infrastructure projects for allocation to undefined projects.

The measure requires the Department of Finance in consultation with the Franchise Tax Board to annually estimate by each November 1^st the amount of taxes received from state taxes as a result of the enactment of HR 1’s international tax provisions. For the 2019-20 fiscal year, the measure directs the estimate to be completed as soon as practicable after January 1^st, 2019.

The measure provides that after reserving amounts from the total estimate calculated above for Proposition 98 and the Budget Stabilization Amount, remaining revenues must be transferred to the Repatriation Infrastructure Fund, notwithstanding any other law. Each amount reserved in each fiscal year and included in each Budget Act, as well as transfers to the Fund, must be based on the estimate, which is subject to adjustment based on actual revenues received during the budget year.

The measure becomes inoperative on July 1^st, 2025, and is repealed as of January 1^st, 2026.

State Revenue Impact

No estimate.

Comments

1. Purpose of the bill. According to the author, “SB 1384 establishes the Repatriation Infrastructure Fund to collect California tax windfall from businesses bringing money back to California to repair our roads. For California to have a vibrant economy, one that creates jobs and financial security for all, we must maintain, rebuild and repair the vital infrastructure that keeps everything and everyone moving. In recent years, local streets and roads have faced an estimated shortfall of $73 billion in deferred maintenance. Caltrans estimates that 55% of the state’s pavement is in either fair or poor condition. The California State University system estimates that they have over $4 billion in deferred maintenance systemwide. The State Water Resources Control Board has a significant need for revenue for capital costs for noncompliant systems in disadvantaged communities that do not have safe drinking water, which totals $428.96 million. Requiring the state to use any tax proceeds from repatriated foreign earnings to fund infrastructure projects would help supplement our efforts to re-establish California as a leader in the world. The amount of revenue that could be generated in California taxes is uncertain. However, this would be new funding for the state, generated by corporate earnings, after requirements have been met for Proposition 98 and the Rainy Day Fund. According to the U.S. Congress Joint Committee on Taxation, the total of ‘undistributed’ and ‘not previously taxed’ foreign earnings of American companies amounted to $2.6 trillion as of 2015. The amount of repatriated dollars could be tremendous for our state. Companies like Apple have made a significant commitment to repatriating these dollars. We believe these dollars should be focused on vital and one-time projects that will sustain our state.”

2. Appropriate? Revenue from the state’s general taxes are generally not dedicated to specific purposes. Instead, the Legislature and the Governor set the state’s spending priorities each year when they enact the State Budget. SB 1384 sets a precedent by transferring revenues resulting from one act of Congress for specific purposes outside the budget process, at the cost of other funding priorities, albeit only after reserving amounts for Proposition 98’s education funding guarantee and Proposition 2’s budgetary reserve. As a result, SB 1384 would reduce the funds available for the Legislature to appropriate any additional revenues as part of the Budget, thereby reducing its flexibility to meet other needs or maintain current program funding in the event of a recession or increased costs resulting from federal cuts to state-administered programs, such as Medi-Cal. Because the bill continuously appropriates funds, the Legislature would have to enact a new statute to undo its transfer. The Committee may wish to consider the precedent established by SB 1384, and whether the measure may limit the Legislature’s flexibility to respond to a budget shortfall.

3. Accurate? Any estimate that compels shifting funds away from health and human services, corrections, and other parts of the state’s budget outside the Budget Act should be as accurate as possible. However, completing an accurate estimate of any incremental funding from HR 1’s international tax provisions will be difficult. While firms’ consolidated financial reports show more than $2.6 trillion in untaxed earnings, revenue estimators may have to make assumptions to implement SB 1384, including:

• The share of repatriated income taxable in California.
• Whether the taxable income will be considered apportioned business income, or allocated nonbusiness income.
• Whether firms repatriating income make the water’s edge election, or file under the worldwide combined method, in which case any repatriated funds will be cancelled out.
• The effect of importing factors from CFCs.
• Whether amounts stated on original returns will be subsequently subject to refund claims, especially given the incentive for larger firms to file conservative original returns due to California’s Large Corporate Understatement Penalty.
• Whether California conforms provisions of its corporate income tax to HR1.
• The degree in which California’s foreign dividend deduction (R&T §24411) applies to any dividends.
• The impact of any litigation or subsequent technical cleanup legislation.

On March, 20, 2018, FTB issued “A Preliminary Report on Specific Provisions of the Federal Tax Cuts and Jobs Act,” which included an estimate for HR 1’s repatriation provisions. The estimate states:

“We examined tax returns for taxpayers linked in media reports to approximately $950 billion that may be subject to IRC section 965 (HR 1’s forced repatriation). This examination assumed that these taxpayers will repatriate all of the $950 billion, will not change their election to file on a water’s-edge or worldwide basis, and have the same apportionment factors in the year of repatriation as in the tax year that we examined. Based on these assumptions, we estimate that the examined taxpayers would have an increase of approximately $1.25 billion in tax before credits, but would offset about $1 billion of this with available credits for a net revenue gain of about $250 million. Taxpayers are not, however, required to repatriate all of these earnings. If we assume that taxpayers in this group who are not able to offset the tax increase with unused credits only repatriate about 50 percent of the available funds, the revenue increase from this group would be about $125 million. The taxpayers examined have only about 35 percent of publicly reported unrepatriated earnings. If unexamined taxpayers are similar to examined taxpayers, the revenue gain could be approximately $350 million. We believe that taxpayers not included in this analysis likely will not be able to offset as high a percentage of their increased tax before credits with unused tax credits as those included in the analysis. On the other hand, a higher percentage of taxpayers in the unexamined group file on a worldwide basis, and we believe that the ones who file water’s-edge returns are likely to repatriate a smaller portion of their overseas cash than those in the examined group. We do not know with certainty which of these effects will be larger, so the net increase in California revenue from the adoption of IRC 965 could be greater or less than $350 million. This revenue increase could be smaller if taxpayers change their water’s-edge election, their apportionment factors, or their generation of credits, or if a recession occurs within the next few years and taxpayers generate net operating losses to offset the additional income from repatriation. The timing of this increase in revenues depends on when taxpayers actually repatriate the money. We do not know when this will occur. If we assume that 50 percent of the $350 million is from dividends paid in 2018, 30 percent in 2019, and 20 percent in 2020, the impact by fiscal year would be $50 million in 2017-18, $150 million in 2018-19, $110 million in 2019-20, and $40 million in 2020-21. Finally, to the extent that some repatriation would have occurred in future years if federal law had not been changed, there would be a revenue loss in those future years partially offsetting the immediate revenue increases.”

While FTB completed an estimate, it is based on several assumptions, and indicates in key passages that both the overall amount and the timing are uncertain. SB 1384 does allow subsequent adjustments to estimates, which could offset uncertainty. However, any subsequent adjustments would make the measure’s revenue source less stable, which could make planning, constructing, and completing infrastructure projects more difficult. The Committee may wish to consider whether it’s desirable to require shifting funds from needed purposes given the potential uncertainties in developing an estimate.

4. Make it rain. In 2014, voters approved Proposition 2, which fundamentally changed the state’s rainy day fund, known as the Budget Stabilization Account (ACA 1, Perez). Among other changes, that measure:

• Increased annual required deposits to the BSA to 1.5% of General Fund revenues, plus an amount equal to revenues associated with capital gains above 8.0% of General Fund revenues, less transfers to the Public School System Stabilization Account, also created by Proposition 2.
• Provided that deposits to the reserve fund would be made until the account balance reaches an amount equal to 10% of General Fund revenues.
• Directed 50% of the revenues that would otherwise be deposited in the BSA to instead repay unfunded prior General Fund obligations, budgetary loans to the General Fund, payable mandate claims incurred prior to 2004-05, and unfunded liabilities of state-level pension plans.
• Stated that in the event the BSA reaches a balance equal to 10% of General Fund revenues, additional revenues deposited in the reserve fund may be only be spent for infrastructure costs, including any associated deferred maintenance.

In his proposed 2018-19 Budget, Governor Brown states that the BSA will have a balance of $8.4 billion by the end of 2018-18, or 65% of General Fund revenues. He calculates a $1.5 billion deposit based on Proposition 2’s requirements, and proposes an additional $3.5 billion discretionary deposit, for a total BSA of $13.4 billion by the end of the fiscal year. Should the Legislature approve the Governor’s proposal, the BSA will likely reach the 10% of General Fund revenue limit in 2019-20, after which the state would have to spend any further mandatory BSA deposits on infrastructure. As a result, Proposition 2 will likely accomplish SB 1384’s goal on its own, assuming the revenues resulting from HR 1’s repatriation provisions materialize.

5. Details. SB 1384 lacks important details necessary for implementation, such as the entity responsible for allocating funds from the Repatriation Infrastructure Fund, and the categories of projects eligible for funding.

6. Is more needed? In addition to Proposition 2’s requirement for the state to fund infrastructure projects if the BSA exceeds 10% of General Fund revenues, voters have authorized several billion dollars in general obligation bonds to meet the state’s infrastructure needs. California voters approved $38.4 billion of general obligation bonds between 1974 and 1999, which increased significantly to $112 billion between 2000 and 2010, but receded to $17 billion between 2011 and 2018. Additionally, voters will consider the $4 billion California Drought, Water, Parks, Climate, Coastal Protection, and Outdoor Access for All Act of 2018 (SB 5, De Leon, 2017), and the $3 billion Veterans and Affordable Housing Bond Act (SB 3, Beall, 2017), at the June, 2018, primary election and the November, 2018, general election, respectively. The Committee may wish to consider whether SB 1384’s continuous appropriation outside the Budget Act is necessary given these other efforts.

7. Recent legislation. SB 1384 is substantially identical to SB 337 (Bates), which the Committee heard twice last year. Both times testimony was taken, but the Committee did not vote on the measure.

Support and Opposition

(4/20/18)

Support: Association of California Construction Managers.

Opposition: Unknown.

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