HOUSE BILL NO. 472 "An Act relating to apportionment of business income." REPRESENTATIVE NORMAN ROKEBERG observed that the House Labor and Commerce Committee introduced HB 472 on behalf of businesses in the state of Alaska. He noted that the Alaska Supreme court ruling, State of Alaska vs. OSG BULK Ships, Inc., held that the exemption from taxation granted in 26 U.S.C. Section 883 was modified by the Alaska Corporation Net Income Tax (ANITA). Since state law modified federal law, the Court ruled that the exemption under Section 883 does not apply. He maintained that the Legislature intended that the Section 883 federal exemption apply when it enacted the Internal Revenue Code by reference. The Court's ruling has by implication created a new assessment on the net income of foreign flagged/owned carriers. He added that aircraft, railroad rolling stock and communication satellites would also be affected. He asserted that a new tax burden would be created on international trade in the State. Almost every natural resource that is produced, manufactured or exported is shipped on foreign carriers. He pointed out that the federal government, by treaty, has entered into agreements with various foreign governments. The United States government and the reciprocating governments agree not to tax net corporate income of businesses engaged in international trade. He maintained that it could create a situation of double taxation. It would also be difficult to account for the tax. The state of Alaska has never collected the tax. The State has collected waivers by not imposing the tax. The tax has been in litigation for a decade. He asserted that failure to act on the legislation would send a very bad signal. He observed that the legislation has received support from a number of national and international businesses. He read testimony by Representative Fran Ulmer during a 1991 House Finance Committee meeting on similar legislation. Representative Ulmer stated that she would not support legislation that was inconsistent with the intent to send a message that Alaska is a friendly business climate for foreign investors. ROBERT B. STILES, DRVEN CORPORATION testified in support of the legislation. He observed that in most cases the producer is not the one that arranges the shipping. Buyers often arrange for shipping. Part of the problem is identifying foreign owners. The exemption granted by Section 883 recognized that it would be difficult to collect the tax. He maintained that the state of Alaska would expose itself to retribution. GENERAL MANAGER, SHERATON ANCHORAGE HOTEL, ANCHORAGE testified in support of HB 472. He noted that they are affiliated with Korean Air. Korean Air has been in business in Alaska for 20 years. They own shares in Anchorage hotels, and employ approximately 30 people at the Anchorage airport. They have a variety of other business interests in Alaska. They employee approximately 350 people in Alaska. There are approximately 12 foreign carriers that fly into Alaska. There were approximately 20 - 25 carriers in 1987. He explained that some carriers no longer fly into Anchorage because aircraft can now over-fly Anchorage due to technological advancements. He emphasized that Anchorage is not a final destination. He stressed the fiscal impact of the 12 foreign carriers that come to Alaska. He pointed out that, currently, the cost of doing business in Anchorage is good. The state of Alaska would be the only state in the nation to levy such a tax. He asserted that collection of the tax would have a drastic impact. (Tape Change, HFC 98 - 92, Side 2) SUSAN BURKE, ATTORNEY, NORTHWEST CRUISE SHIP ASSOCIATION testified in support of the legislation. She observed that she wrote an Attorney General's opinion in 1980, regarding the retroactive clause. She noted that the situation in HB 472 is different to the situation on which the 1980 opinion was based. She added that new case law indicates that a retroactive clause can stand if it serves the public purpose. House Bill 472 has a narrow focus. She observed that state businesses rely on foreign shippers. If shippers are made to pay back taxes with interests, they may respond with rate increases. She concluded that HB 472 serves a public purpose by maintaining current rates. She did not think there would be a constitutional problem. In response to a question by Representative Martin, Ms. Burke reviewed arguments that a 1991 transmittal letter by Governor Hickel indicated that the state of Alaska intended to collect the tax. She stated that she did not interpret the letter to specify that the exemption under the federal IRS code, Section 883, did not apply. She observed that the State's position was not clear because even if the transmittal letter was meant to imply that the exemption did not apply, the Department of Revenue's position was that the exemption did apply. Section 883 was incorporated into the state tax code by reference. The Legislature also indicated that the exemption would apply. Representative Davies questioned the effect of a retroactive clause. Ms. Burke clarified that there are tax cases pending in the administrative process. Some taxes have been assessed but not collected. In response to a question by Representative Martin, Ms. Burke observed that the water's edge method was adopted in 1992. DEBORAH VOGT, DEPUTY DIRECTOR, DEPARTMENT OF REVENUE reviewed the legislation. She observed that on February 20, 1998, the Alaska Supreme Court issued a unanimous decision that a federal tax exemption does not apply in Alaska. The case was OSG Bulk Ships v. State (OSG). The federal provision exempts income from foreign-owned ships and aircraft. Result of the decision is that ships and aircraft that do business in Alaska will be taxed regardless of ownership. She did not think that either railroads or satellites would be affected. The result of the decision is that ships and aircraft that do business in Alaska would be taxed regardless of their ownership. Ms. Vogt explained that the case arose from a decision signed by Commissioner Rexwinkle, in June 1990. The taxpayer was a shipper of ANS crude on American ships. The issue arose because corporations affiliated with the taxpayer were included in the apportionable base. They did not carry goods in Alaska. The Superior Court held against the state. The state appealed to the Supreme Court. The state of Alaska then appealed to the Supreme Court and prevailed. Ms. Vogt maintained that the OSG decision was a good decision for the State. It deals with the interrelationship of Alaska and federal tax law. The OSG decision holds that Alaska's tax policy, as articulated in tax laws passed by the Legislature, should be given as fact when reviewing the interplay between the Internal Revenue Code and the State's Corporate Income Tax. The decision brings cruise ships, foreign air operations, and foreign shippers into Alaska's tax scheme on an even footing with other shippers, American cruise ship operators and air carriers. Ms. Vogt noted that the basis for the State's holding is that the State can incorporates Internal Revenue Code into state tax, unless excepted to or modified by Alaska law. The federal exemption essentially codifies federal tax treaties, which provide that "if your country doesn't tax our ships and planes, we won't tax yours". These treaties are at a national level. They do not bind subnationals like states. She acknowledged that there could be retaliation under the treaties if one subnational begins taxing. The federal system permits federal taxes for any foreign tax paid. American businesses would receive a dollar for dollar credit on their federal taxes for any taxes paid to other nations. Ms. Vogt observed that the issue for the Court was: Does Alaska's Corporate Income Tax system except or modify the federal exemption in Section 883. The court found that the State's use of the apportionment method of taxation was so different from the federal separate accounting approach to defining income that Section 883 was not incorporated into Alaska law. This bill would reverse the Court's decision. Ms. Vogt pointed out that Alaska's corporate income tax system has always used formula apportionment to determine the in-state income of businesses that earn income in the State. Business income from all sources is assessed and apportioned by a formula related to business presence. In 1970, the State joined the Multistate Tax Commission and adopted the Uniform Division of Income for Tax Purposes Act (UDIPTA). The state of Alaska originally applied UDIPTA worldwide. There was a great deal of international objection to this form of taxation. Foreign affiliates that did not operate in the United States objected to providing books and records to the United States. In 1991, Alaska joined the majority of other states, in moving to the waters edge method. The waters edge approach excludes from the corporate family those corporations that do not do any business, or do a very small amount of business, in the United States. Ironically, the ships whose income was taxed in OSG would not be included in our tax base today because of the adoption of the waters edge method. Pursuant to the Court's decision, the State will tax foreign ships and aircraft by formula apportionment, using a "days in port" or "ground time" approach to their factors. This applies to all U.S. ships that do business in Alaska. Ships are apportioned based on the number of days a ship is in Alaskan ports versus the total number ports. Airlines are apportioned based on departures. Ms. Vogt discussed retroactivity. She referred to a memorandum from the Department of Law, which raised serious legal questions about the constitutionality of the retroactive collection of the tax. The reason the constitutional issue arises is that Alaska's Constitution provides that appropriations have to be made for a public purpose. Tax repeal is considered an appropriation. If there is no provision, the Department of Revenue is unlikely to assign any of its scarce resources to compliance efforts under a repealed tax. Ms. Vogt referred to the Department's fiscal note. She observed that, since most of these transportation companies do not file tax, the Department does not have direct information from taxpayers. The Department of Revenue estimates a potential loss of $3 to $8.5 million dollars. Representative Martin questioned how much the state of Alaska would lose in revenues, if businesses moved out of state. He emphasized that the tax could have a detrimental affect on the State. Ms. Vogt stressed that the Department would need more information to assess the impact. In response to a question by Representative Martin, Ms. Vogt clarified that the legislation does not affect the waters edge method. Foreign corporations are taxed to the extent that they do business in Alaska. The legislation only makes an exemption for certain components of foreign commerce. In response to a question by Representative Grussendorf, Ms. Vogt stated that the legislation would not preclude future action. Co-Chair Therriault asked if the Administration had taken a stand on the potential loss of business. He questioned if the cost of implementation and the loss of business would be sufficient state interest to support the legislation. In response to a question by Representative Davis, Ms. Vogt stated that the prospective audits would not be problematic. JEFF BUSH, DEPUTY COMMISSIONER, DEPARTMENT OF COMMUNITY AND REGIONAL AFFAIRS testified in support of the legislation. He acknowledged the importance of the litigation to assert the right of the state of Alaska to enact appropriate tax laws and to implement them without federal restrictions. The Department supports the legislation because there are other policy considerations. The benefits to state business out weighs increased revenues. No other states impose a similar tax. A tax would detrimentally impact the perception that Alaska is friendly to foreign owned shippers. Representative Martin MOVED to report HB 472 out of Committee with the accompanying fiscal note. There being NO OBJECTION, it was so ordered. HB 472 was REPORTED out of Committee with a "do pass" recommendation and with fiscal impact note by the Department of Revenue.