California expected to require broader registration of corporate tax shelter transactions | Norton Rose Fulbright
Until now, any company required to register a transaction as a corporate tax shelter with the IRS under the federal income tax laws had also to report it to the Franchise Tax Board in California, but only if the tax shelter was “organized in California.” The California legislature voted in September to broaden the reporting by requiring any “tax shelter organizer” to report to the board those tax shelters required to be registered with the IRS that are “organized,” involve “doing business” or “derive[e] income from sources” in California. The organizer must also report any transactions considered tax shelters under federal law if one or more of the participants is a “California taxpayer.”
Governor Gray Davis has until October 12 to veto the bill or it will go into effect automatically. A Franchise Tax Board official said he does not expect the governor to veto the bill. The bill passed both chambers on party-line votes, with Democrats voting for it. If Davis loses the recall election and is replaced by Arnold Schwarzenegger, Schwarzenegger might not take office until as late as the last week in November.
California defines tax shelter basically the same way as the US tax code. The definition under California law is “a partnership or other entity, any investment plan or arrangement, or any other plan or arrangement if a significant purpose of that partnership, entity, plan, or arrangement is the avoidance or evasion of federal income tax or [any California income or franchise taxes].”
The new law will also require any “organizer, seller, or material advisor” of a “potentially abusive tax shelter” to keep a list of investors in such transactions as is the case under federal law. It adopts the same definition of organizer, seller and material advisor as the IRS uses. A “potentially abusive tax shelter” refers both to any tax shelter that organizers are required to register with the IRS under the federal tax laws and any “entity, investment plan or arrangement, or other plan or arrangement which is of a type that the Secretary of the Treasury or the Franchise Tax Board determines by regulations as having a potential for tax avoidance or evasion.” The requirement to maintain a list of investors applies only to those tax shelters that are organized, that involve doing business, or that derive income from sources in California, or tax shelters in which a California taxpayer is an investor.
Failure to register a tax shelter will result in a $15,000 fine. Failure to provide the list of investors in a “listed transaction” will lead to a fine of $100,000 or 50% of the gross income that the organizer derived from the transaction, if greater. If the failure was due to “intentional disregard” of the law, then the penalty increases to 75% of the gross income. The Franchise Tax Board is required to publish the “listed transactions” through notices and on its website.
The bill provides an amnesty for companies that should already have registered transactions under existing law but failed to do so. Between January 1, 2004 and April 15, 2004, a taxpayer may file an amended return to report participation in a tax shelter. If the taxpayer at the same time agrees not to appeal the Franchise Tax Board’s determination of tax liability, the board will waive all penalties related to underreporting due to participation in a tax shelter. The board will also waive its right to bring criminal action. If the taxpayer reserves its right to appeal, thus preserving the option to file a claim for refund, then the board will waive the penalties and its right to bring criminal action, but if the taxpayer does not win on appeal, it will be subject to accuracy related penalties based on the amount of the understatement.