September 2008

CALIFORNIA BUDGET INCLUDES NEW
20 PERCENT CORPORATE INCOME TAX PENALTY


California’s budget compromise, signed into law on September 23, includes a new 20 percent penalty on corporations for an “understatement of tax” in excess of $1 million (Revenue and Taxation Code Section 19138). The effective date of this new law is January 1, 2009.

The $1 million threshold is applied to the aggregate California income tax liability of all affiliated corporations that are members of the same combined reporting group and that file a California combined report. The penalty applies to understatements for taxable years beginning on or after January 1, 2003.

The understatement is measured against the tax reported on the original return, or an amended return filed on or before the original or extended due date. However, for taxable years beginning before January 1, 2008, an understatement does not include amounts reflected on an amended return filed on or before May 31, 2009.

Accordingly, taxpayers should review their previously filed tax returns and determine if an amended return should be filed on or prior to May 31, 2009 to reduce the possible imposition of this new 20 percent penalty on prior years. In particular, the possible impact of a federal income tax audit on the California return should be considered. If a taxpayer decides to increase the amount of income previously reported by filing an amended California return, the taxpayer may subsequently file a timely protective claim for refund to preserve its rights to challenge amounts reported on the amended return. Where the claim is made with respect to a possible federal tax adjustment, the taxpayer may wish to request a deferral of Franchise Tax Board action on the claim until any pending federal audit is complete.

As noted above, for tax years beginning on or after January 1, 2008, the penalty will apply to all returns that reflect an understatement of tax without affording the taxpayer an opportunity to file an amended return after the expiration of the original or extended due date. For these years, taxpayers will need to consider whether it may be prudent to file a California return that is more conservative than the federal return. Such taxpayers will also need to consider whether to subsequently file a timely protective claim for refund to preserve their rights to challenge amounts reported on the original return.

There are very limited exceptions to the new 20 percent penalty. The penalty will not be imposed on an understatement that is attributable to a “change in the law.” For this purpose, a change in the law means a statutory change or a change in the interpretation of a law by regulation, legal ruling of counsel or published federal or California court decision that is enacted, promulgated, issued or becomes final after the earlier of (i) the date the taxpayer files the return for the year the change is operative or (ii) the extended due date for the taxpayer’s return for the taxable year for which the change is operative. Penalties are likewise not imposed on understatements attributable to a taxpayer’s reliance on a written legal ruling issued by the Franchise Tax Board’s Chief Counsel. There are no other exceptions. Thus, reliance on independent advice is not sufficient to eliminate the penalty regardless of the strength of that advice.

Taxpayers will also need to take this new law into account for FIN 48 purposes when considering the imposition of possible penalties. In fact, if the cumulative existing FIN 48 reserves for California income taxes in any one year exceeds $1 million, then this penalty will need to be added to the reserve for that year unless a timely amendment is filed on or before
May 31, 2009.

In summary, California has adopted a 20 percent penalty to “encourage” corporate taxpayers to file amended returns on or before May 31, 2009 to reduce its budget deficit. In addition, the law applies with equal punitive effect to tax years beginning on or after January 1, 2008. Taxpayers will need to review return positions to evaluate the possible application of this penalty. Given the complexity of California tax law and the many significant issues that turn on factual and valuation issues, this “strict liability” penalty is likely to have a significant negative impact on corporate taxpayers doing business in California.

WE WELCOME A NEW ARRIVAL

Luiz Dardes has joined DLA Piper as a foreign legal consultant, based in our New York office. Before joining us, Luiz was with KPMG São Paulo in the international corporate tax department, and had spent nearly five years in the United States as director of KPMG’s Brazilian Tax Desk based in Chicago.

Luiz focuses his work on international tax planning, tax compliance and corporate reorganizations. His wide range of experience also includes value-added tax, customs, tax controversies, taxation of investments, IP and software, and transfer pricing.

His contact information:

luiz.dardes@dlapiper.com
(212)335-4741

DLA PIPER IN THE NEWS

Coming soon

Closing Down Your Business in the People’s Republic of China - What Are the Corporate, Employment and Tax-related Obligations?

On Tuesday, November 25, DLA Piper will present an in-house seminar in its Hong Kong offices for companies that are considering the strategic business decision to cease some of their operations in the PRC.

Closing down a business in the PRC requires careful attention to corporate, employment and tax issues. This seminar will address the practical legal considerations, supported by actual case studies. Among the scenarios to be discussed: closing down a manufacturing operation or a representative office, converting a direct operation to an outsourcing model, terminating a work force and transferring operations.

For more information, please contact Yuming Lu.

Recent events

Luiz Dardes (New York) was among the speakers at a lunch seminar, “The Brazilian Tax System,” sponsored by the Brazilian Embassy in Washington, DC on September 24, 2008.

Eric Ryan (East Palo Alto) recently participated in a panel discussion, “Stock-Based Compensation: Transfer Pricing Issues,” for the ABA Section of Taxation’s annual meeting in San Francisco. Jon Doyle (San Francisco) provided some of the materials related to the subtopic of stock option re-charge arrangements.