California’s Last-Minute Budget Maneuver: Retroactive Corporate Taxes on Foreign Dividends

Imagine if, after carefully planning your household budget based on existing tax rules, you received a letter from the state demanding back taxes for the last five years. That’s exactly what the newest version of the Assembly’s budget proposes for businesses in California.

It’s no secret that the California budget is a shambles after years of unaffordable spending increases, tax hikes, and residents fleeing to lower-tax states. As legislators hunt for solutions to a gaping $55 billion deficit, the new budget takes aim at leading employers while shattering the predictability and transparency that businesses of all sizes rely upon to flourish.

Thanks to a last-minute budget maneuver originally proposed by Democrat Governor Gavin Newsom in his May Budget Revise, California plans to retroactively impose state corporate taxes on foreign dividends – a startling move that would result in the double taxation of billions of dollars in private earnings. That’s bad for business and could put at risk thousands of California jobs provided by companies that also sell their products overseas.

In fact, the California Office of Tax Appeals (OTA) already determined that foreign income received by certain companies, such as Microsoft, ought to be fully included in the sales apportionment factor and therefore exempt from double taxation. The statutes were clear: the Franchise Tax Board (FTB) had no right to exclude overseas income in their tax assessment. But the Legislature continues to advance a provision that undermines the OTA and its honest reading of the law.

This provision would ultimately dismantle the ability of taxpayers to defend themselves against flawed decisions from an overzealous tax collector. If well-reasoned decisions from the OTA can be flippantly reversed by a legislature that refuses to cut spending instead, taxpayers must live in perpetual fear of overpaying their taxes with no reliable recourse.

While Gov. Newsom swears he will not raise taxes to cure the budget deficit, it’s clear that taxpayers are still footing the bill. If this new provision is included in the final budget, Microsoft’s $100 million corporate tax refund, granted by the OTA, will vanish into state coffers – even though those taxes should never have been paid in the first place. Newsom’s proposed “clarification” is merely a poorly disguised tax hike.

$100 million is a devastating hit for a private company. But it does not come close to filling the state’s budget gap of at least $55 billion, which Gov. Newsom and legislative leaders are frantically working to close while avoiding long-overdue cuts to major spending programs. In one striking example, Gov. Newsom is refusing to curb the cost of a program enacted just last year that pays for Medi-Cal healthcare benefits on behalf of illegal immigrants. That program alone leaves taxpayers on the hook for up to $6 billion every year.

It’s clear that the Assembly can and should find places to cut revenue, rather than target successful companies for lawmakers’ self-imposed budgetary woes.

The consequences of this “apportionment fix” will have lasting repercussions. California businesses already face one of the nation’s highest corporate tax burdens and are burdened by more regulations than in any other state. Predictability in a businesses’ tax liability is essential to success in this restrictive environment. The last thing that budding entrepreneurs need is a government that changes the rules after the fact – or, worse, forces them to pay up retroactively.

Even worse for California businesses, this provision could lead to rampant double taxation. Many companies operating in California have more foreign than domestic income. By not offsetting foreign income when calculating sales factor representation, that overseas revenue would essentially be taxed twice: once by other countries where the money was earned, and again by the state of California, even though those sales have virtually nothing to do with the Golden State.

As budget negotiations heat up in Sacramento ahead of Saturday’s constitutional deadline, legislators should reject provisions that result in double taxation, impose retroactive tax liabilities, or undermine the authority of taxpayer protection agencies like the OTA. Government ought to be upfront with businesses and consumers about their tax burden and opt to cut spending, rather than capriciously target successful companies.