<Page>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 811-04020
Morgan Stanley California Tax-Free Income Fund
(Exact name of registrant as specified in charter)
1221 Avenue of the Americas, New York, New York 10020
(Address of principal executive offices) (Zip code)
Ronald E. Robison
1221 Avenue of the Americas, New York, New York 10020
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-762-4000
Date of fiscal year end: December 31, 2005
Date of reporting period: December 31, 2005
<Page>
Item 1 - Report to Shareholders
<Page>
WELCOME, SHAREHOLDER:
IN THIS REPORT, YOU'LL LEARN ABOUT HOW YOUR INVESTMENT IN MORGAN STANLEY
CALIFORNIA TAX-FREE INCOME FUND PERFORMED DURING THE ANNUAL PERIOD. WE WILL
PROVIDE AN OVERVIEW OF THE MARKET CONDITIONS, AND DISCUSS SOME OF THE FACTORS
THAT AFFECTED PERFORMANCE DURING THE REPORTING PERIOD. IN ADDITION, THIS REPORT
INCLUDES THE FUND'S FINANCIAL STATEMENTS AND A LIST OF FUND INVESTMENTS.
THIS MATERIAL MUST BE PRECEDED OR ACCOMPANIED BY A PROSPECTUS FOR THE FUND BEING
OFFERED.
MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE
IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS
SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF
SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE
FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE
MONEY INVESTING IN THIS FUND. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE
INFORMATION ON INVESTMENT RISKS.
<Page>
FUND REPORT
For the year ended December 31, 2005
TOTAL RETURN FOR THE 12 MONTHS ENDED DECEMBER 31, 2005
<Table>
<Caption>
LIPPER
LEHMAN LEHMAN CALIFORNIA
BROTHERS BROTHERS MUNICIPAL
CALIFORNIA MUNICIPAL DEBT
EXEMPT BOND FUNDS
CLASS A CLASS B CLASS C CLASS D INDEX(1) INDEX(2) INDEX(3)
3.44% 3.74% 2.97% 3.74% 4.14% 3.51% 4.09%
</Table>
THE PERFORMANCE OF THE FUND'S FOUR SHARE CLASSES VARIES BECAUSE EACH HAS
DIFFERENT EXPENSES. THE FUND'S TOTAL RETURNS ASSUME THE REINVESTMENT OF ALL
DISTRIBUTIONS BUT DO NOT REFLECT THE DEDUCTION OF ANY APPLICABLE SALES CHARGES.
SUCH COSTS WOULD LOWER PERFORMANCE. SEE PERFORMANCE SUMMARY FOR STANDARDIZED
PERFORMANCE AND BENCHMARK INFORMATION.
BECAUSE CLASS B SHARES INCURRED LOWER EXPENSES UNDER THE 12b-1 PLAN THAN DID
CLASS A SHARES FOR THE FISCAL PERIOD ENDED DECEMBER 31, 2005, THE TOTAL
OPERATING EXPENSE RATIO FOR CLASS B SHARES WAS LOWER AND, AS A RESULT, THE
PERFORMANCE OF CLASS B SHARES WAS HIGHER THAN THAT OF THE CLASS A SHARES. THERE
CAN BE NO ASSURANCE THAT THIS WILL CONTINUE TO OCCUR IN THE FUTURE AS THE
MAXIMUM FEES PAYABLE BY CLASS B SHARES UNDER THE 12b-1 PLAN ARE HIGHER THAN
THOSE PAYABLE BY CLASS A SHARES.
MARKET CONDITIONS
Economic reports continued to show moderate growth in 2005, sustained by
consumer spending and reasonable gains in employment. Core inflation (which
excludes food and energy) remained benign, but protracted high oil prices
fostered inflationary concerns, particularly during the summer. The
unprecedented devastation caused by Hurricanes Rita and Katrina in September
heightened the market's uncertainty. While the immediate economic impact was a
major disruption of the nation's energy infrastructure, the economy showed
considerable resilience in the fourth quarter. In fact, the consensus view
developed that accelerated reconstruction in storm-ravaged areas would serve as
a stimulus to future economic growth.
Throughout the year, the Federal Open Market Committee (the "Fed") continued the
rate tightening pattern that began in June of 2004 and raised the federal funds
target rate eight times in 25 basis point (0.25 percentage points) increments.
As a result, the rate increased from 2.25 percent to 4.25 percent.
Yields on short-term municipal bonds followed the target rate during 2005 and
rose steadily. In contrast, long-term bond yields were little changed for the
period overall, reflecting strong demand for longer maturity bonds and the
market's perception that the Fed was controlling inflation pressures. The slope
of the yield curve flattened as the difference between short-term and long-term
interest rates narrowed substantially. Representative yields on 30-year AAA
rated municipal bonds ranged from a low of 4.20 percent in June to a high of
4.65 percent in November. At the end of December, the yield stood at 4.40
percent. Investors' quest for yield favored lower-quality bonds over high-grade
issues and kept credit spreads relatively tight. (Credit spreads measure the
added compensation investors require to assume additional credit risk. When
credit spreads tighten, lower-rated issues typically outperform.)
Long-term municipal volume increased 13 percent to a record $408 billion in
2005. The flatter yield curve and
2
<Page>
low long-term interest rates encouraged municipalities to refinance their debt.
Such refundings accounted for 30 percent of annual volume, nearly a 50 percent
increase over 2004. California was the leading issuer of debt and accounted for
14 percent of volume in 2005.
The municipal-to-Treasury yield ratio, which gauges the performance between the
two markets, remained attractive for tax-exempt bonds. During the year, the
ratio of 10-year municipals to 10-year Treasuries averaged 86 percent and the
30-year ratio averaged 97 percent. (The higher the ratio, the greater the
attractiveness of municipal yields relative to Treasury yields.) As a result,
institutional investors -- such as hedge funds and arbitrage accounts -- that
normally focus on taxable bond sectors "crossed-over" to purchase municipal
bonds. Demand from individual investors was less robust, given the low absolute
level of yields.
The State of California enjoyed improving economic, fiscal and credit conditions
throughout the period. Unemployment declined and the defense and high technology
sectors experienced steady growth. These economic improvements helped to boost
stronger state revenues. California also made progress in resolving some of its
structural budget imbalances, spurring further investor interest in its
municipal debt market.
PERFORMANCE ANALYSIS
Morgan Stanley California Tax-Free Income Fund Class B and D shares
underperformed the Lehman Brothers California Exempt Index, outperformed the
Lehman Brothers Municipal Bond Index and underperformed the Lipper California
Municipal Debt Funds Index for the 12 months ended December 31, 2005, assuming
no deduction of applicable sales charges. Class A and C shares underperformed
each index for the same time period, assuming no deduction of applicable sales
charges.
In anticipation of Fed tightenings and generally higher interest rates, the Fund
made modest ongoing adjustments to its long-term portfolio to reduce volatility.
For example, the Fund's interest-rate sensitivity was positioned conservatively.
At the close of the period, the Fund's option-adjusted duration* was 6.6 years.
The Fund used proceeds from the sale of refunded issues to purchase premium
coupon bonds with defensive characteristics.
Overall, the Fund maintained a high average credit quality with over 85 percent
of the bonds in its portfolio rated A or higher, at the close of the period. The
Fund reduced exposure to insured AAA holdings and increased exposure to
investment-grade credits rated A and BBB. Reflecting a commitment to
diversification, the Fund's net assets of approximately $569 million were
invested among 13 long-term sectors and 71 credits.
* A MEASURE OF THE SENSITIVITY OF A BOND'S PRICE TO CHANGES IN INTEREST RATES,
EXPRESSED IN YEARS. EACH YEAR OF DURATION REPRESENTS AN EXPECTED 1 PERCENT
CHANGE IN THE PRICE OF A BOND FOR EVERY 1 PERCENT CHANGE IN INTEREST RATES. THE
LONGER A BOND'S DURATION, THE GREATER THE EFFECT OF INTEREST-RATE MOVEMENTS ON
ITS PRICE. TYPICALLY, FUNDS WITH SHORTER DURATIONS PERFORM BETTER IN
RISING-INTEREST-RATE ENVIRONMENTS, WHILE FUNDS WITH LONGER DURATIONS PERFORM
BETTER WHEN RATES DECLINE.
THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM WELL
OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE FUND IN THE FUTURE.
3
<Page>
TOP FIVE SECTORS
<Table>
Water & Sewer 21.5%
Transportation Facilities 15.4
Hospital 14.1
General Obligation 12.2
Tax Allocation 8.8
</Table>
LONG-TERM CREDIT ANALYSIS
<Table>
Aaa/AAA 65.2%
Aa/AA 4.1
A/A 18.4
Baa/BBB 10.6
Ba/BB 1.7
</Table>
DATA AS OF DECEMBER 31, 2005. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR TOP
FIVE SECTORS ARE AS A PERCENTAGE OF NET ASSETS. ALL PERCENTAGES FOR LONG-TERM
CREDIT ANALYSIS ARE AS A PERCENTAGE OF TOTAL LONG-TERM INVESTMENTS. THESE DATA
ARE PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE DEEMED A
RECOMMENDATION TO BUY OR SELL THE SECURITIES MENTIONED. MORGAN STANLEY IS A
FULL-SERVICE SECURITIES FIRM ENGAGED IN SECURITIES TRADING AND BROKERAGE
ACTIVITIES, INVESTMENT BANKING, RESEARCH AND ANALYSIS, FINANCING AND FINANCIAL
ADVISORY SERVICES.
INVESTMENT STRATEGY
THE FUND WILL NORMALLY INVEST AT LEAST 80 PERCENT OF ITS NET ASSETS IN
SECURITIES THAT PAY INTEREST EXEMPT FROM FEDERAL AND CALIFORNIA STATE INCOME
TAXES. THE FUND'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS INC.,
GENERALLY INVESTS THE FUND'S ASSETS IN INVESTMENT GRADE, CALIFORNIA MUNICIPAL
OBLIGATIONS. MUNICIPAL OBLIGATIONS ARE BONDS, NOTES OR SHORT-TERM COMMERCIAL
PAPER ISSUED BY STATE GOVERNMENTS, LOCAL GOVERNMENTS OR THEIR RESPECTIVE
AGENCIES.
FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS
EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN
ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND
AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE
SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON
FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO
DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE
REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN
STANLEY FUND ALSO FILES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC
FOR THE FUND'S FIRST AND THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES
NOT DELIVER THE REPORTS FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS,
NOR ARE THE REPORTS POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY,
HOWEVER, OBTAIN THE FORM N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS
FILINGS) BY ACCESSING THE SEC'S WEB SITE, http://www.sec.gov. YOU MAY ALSO
REVIEW AND COPY THEM AT THE SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC.
INFORMATION ON THE OPERATION OF THE SEC'S PUBLIC REFERENCE ROOM MAY BE
4
<Page>
OBTAINED BY CALLING THE SEC AT (800) SEC-0330. YOU CAN ALSO REQUEST COPIES OF
THESE MATERIALS, UPON PAYMENT OF A DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE
SEC'S E-MAIL ADDRESS (publicinfo@sec.gov) OR BY WRITING THE PUBLIC REFERENCE
SECTION OF THE SEC, WASHINGTON, DC 20549-0102.
HOUSEHOLDING NOTICE
TO REDUCE PRINTING AND MAILING COSTS, THE FUND ATTEMPTS TO ELIMINATE DUPLICATE
MAILINGS TO THE SAME ADDRESS. THE FUND DELIVERS A SINGLE COPY OF CERTAIN
SHAREHOLDER DOCUMENTS, INCLUDING SHAREHOLDER REPORTS, PROSPECTUSES AND PROXY
MATERIALS, TO INVESTORS WITH THE SAME LAST NAME WHO RESIDE AT THE SAME ADDRESS.
YOUR PARTICIPATION IN THIS PROGRAM WILL CONTINUE FOR AN UNLIMITED PERIOD OF TIME
UNLESS YOU INSTRUCT US OTHERWISE. YOU CAN REQUEST MULTIPLE COPIES OF THESE
DOCUMENTS BY CALLING (800) 350-6414, 8:00 A.M. TO 8:00 P.M., ET. ONCE OUR
CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN SENDING
INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS.
5
<Page>
DISTRIBUTION BY MATURITY
(% OF LONG-TERM PORTFOLIO) AS OF DECEMBER 31, 2005
[CHART]
WEIGHTED AVERAGE MATURITY: 17 YEARS(a)
<Table>
0-5 7
6-10 11
11-15 27
16-20 31
21-25 11
26-30 7
30+ Years 6
</Table>
(a) WHERE APPLICABLE MATURITIES REFLECT MANDATORY TENDERS, PUTS AND CALL DATES.
PORTFOLIO STRUCTURE IS SUBJECT TO CHANGE.
6
<Page>
CALL AND COST (BOOK) YIELD STRUCTURE
(BASED ON LONG-TERM PORTFOLIO) AS OF DECEMBER 31, 2005
[CHART]
YEARS BONDS CALLABLE--WEIGHTED AVERAGE CALL PROTECTION: 6 YEARS
<Table>
2006(a) 7
2007 4
2008 11
2009 5
2010 2
2011 17
2012 11
2013 11
2014 5
2015 17
2016+ 10
</Table>
[CHART]
COST (BOOK) YIELD(b)--WEIGHTED AVERAGE BOOK YIELD: 5.3%
<Table>
2006(a) 6.0
2007 6.0
2008 5.3
2009 5.2
2010 6.0
2011 5.1
2012 4.8
2013 4.9
2014 5.5
2015 5.0
2016+ 6.0
</Table>
(a) MAY INCLUDE ISSUES INITIALLY CALLABLE IN PREVIOUS YEARS.
(b) COST OR "BOOK" YIELD IS THE ANNUAL INCOME EARNED ON A PORTFOLIO INVESTMENT
BASED ON ITS ORIGINAL PURCHASE PRICE BEFORE THE FUND'S OPERATING EXPENSES.
FOR EXAMPLE, THE FUND IS EARNING A BOOK YIELD OF 6.0% ON 7% OF THE
LONG-TERM PORTFOLIO THAT IS CALLABLE IN 2006.
PORTFOLIO STRUCTURE IS SUBJECT TO CHANGE.
7
<Page>
PERFORMANCE SUMMARY
[CHART]
PERFORMANCE OF $10,000 INVESTMENT--CLASS B
($ IN THOUSANDS)
ENDING VALUE
<Table>
<Caption>
LEHMAN BROTHERS LEHMAN BROTHERS LIPPER CALIFORNIA
FUND++ CALIFORNIA EXEMPT INDEX(1) MUNICIPAL BOND INDEX(2) MUNICIPAL DEBT FUNDS INDEX(3)
December 31, 1995 $ 10,000 $ 10,000 $ 10,000 $ 10,000
December 31, 1996 $ 10,313 $ 10,443 $ 10,443 $ 10,397
December 31, 1997 $ 11,087 $ 11,427 $ 11,403 $ 11,371
December 31, 1998 $ 11,712 $ 12,219 $ 12,142 $ 12,070
December 31, 1999 $ 11,244 $ 11,878 $ 11,892 $ 11,547
December 31, 2000 $ 12,626 $ 13,384 $ 13,281 $ 13,043
December 31, 2001 $ 13,076 $ 14,080 $ 13,962 $ 13,552
December 31, 2002 $ 14,139 $ 15,270 $ 15,303 $ 14,633
December 31, 2003 $ 14,742 $ 16,013 $ 16,116 $ 15,302
December 31, 2004 $ 15,365 $ 16,893 $ 16,838 $ 16,009
December 31, 2005 $ 15,939 $ 17,594 $ 17,430 $ 16,665
</Table>
8
<Page>
AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED DECEMBER 31, 2005
<Table>
<Caption>
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES+ CLASS D SHARES++
(SINCE 07/28/97) (SINCE 07/11/84) (SINCE 07/28/97) (SINCE 07/28/97)
SYMBOL CLFAX CLFBX CLFCX CLFDX
1 YEAR 3.44%(4) 3.74%(4) 2.97%(4) 3.74%(4)
(0.96)(5) (1.15)(5) 1.99(5) --
5 YEARS 4.84(4) 4.77(4) 4.25(4) 5.03(4)
3.94(5) 4.45(5) 4.25(5) --
10 YEARS -- 4.77(4) -- --
-- 4.77(5) -- --
SINCE INCEPTION 4.77(4) 7.02(4) 4.27(4) 5.03(4)
4.23(5) 7.02(5) 4.27(5) --
</Table>
PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH IS NO GUARANTEE OF
FUTURE RESULTS AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE FIGURES
SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE FIGURES, PLEASE VISIT
www.morganstanley.com OR SPEAK WITH YOUR FINANCIAL ADVISOR. INVESTMENT RETURNS
AND PRINCIPAL VALUE WILL FLUCTUATE AND FUND SHARES, WHEN REDEEMED, MAY BE WORTH
MORE OR LESS THAN THEIR ORIGINAL COST. THE GRAPH AND TABLE DO NOT REFLECT THE
DEDUCTION OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE
REDEMPTION OF FUND SHARES. PERFORMANCE FOR CLASS A, CLASS B, CLASS C, AND CLASS
D SHARES WILL VARY DUE TO DIFFERENCES IN SALES CHARGES AND EXPENSES.
* THE MAXIMUM FRONT-END SALES CHARGE FOR CLASS A IS 4.25%.
** THE MAXIMUM CONTINGENT DEFERRED SALES CHARGE (CDSC) FOR CLASS B IS 5.0%.
THE CDSC DECLINES TO 0% AFTER SIX YEARS.
+ THE MAXIMUM CONTINGENT DEFERRED SALES CHARGE FOR CLASS C IS 1.0% FOR SHARES
REDEEMED WITHIN ONE YEAR OF PURCHASE.
++ CLASS D HAS NO SALES CHARGE.
(1) THE LEHMAN BROTHERS CALIFORNIA EXEMPT INDEX TRACKS THE PERFORMANCE OF
CALIFORNIA ISSUED MUNICIPAL BONDS RATED AT LEAST Baa OR BBB BY MOODY'S
INVESTORS SERVICE, INC. OR STANDARD & POOR'S CORPORATION, RESPECTIVELY AND
WITH MATURITIES OF 2 YEARS OR GREATER. INDEXES ARE UNMANAGED AND THEIR
RETURNS DO NOT INCLUDE ANY SALES CHARGES OR FEES. SUCH COSTS WOULD LOWER
PERFORMANCE. IT IS NOT POSSIBLE TO INVEST DIRECTLY IN AN INDEX.
(2) THE LEHMAN BROTHERS MUNICIPAL BOND INDEX TRACKS THE PERFORMANCE OF
MUNICIPAL BONDS RATED AT LEAST Baa OR BBB BY MOODY'S INVESTORS SERVICE,
INC. OR STANDARD & POOR'S CORPORATION, RESPECTIVELY AND WITH MATURITIES OF
2 YEARS OR GREATER. INDEXES ARE UNMANAGED AND THEIR RETURNS DO NOT INCLUDE
ANY SALES CHARGES OR FEES. SUCH COSTS WOULD LOWER PERFORMANCE. IT IS NOT
POSSIBLE TO INVEST DIRECTLY IN AN INDEX.
(3) THE LIPPER CALIFORNIA MUNICIPAL DEBT FUNDS INDEX IS AN EQUALLY WEIGHTED
PERFORMANCE INDEX OF THE LARGEST QUALIFYING FUNDS (BASED ON NET ASSETS) IN
THE LIPPER CALIFORNIA MUNICIPAL DEBT FUNDS CLASSIFICATION. THE INDEX, WHICH
IS ADJUSTED FOR CAPITAL GAINS DISTRIBUTIONS AND INCOME DIVIDENDS, IS
UNMANAGED AND SHOULD NOT BE CONSIDERED AN INVESTMENT. THERE ARE CURRENTLY
30 FUNDS REPRESENTED IN THIS INDEX.
(4) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND DOES NOT REFLECT
THE DEDUCTION OF ANY SALES CHARGES.
(5) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND THE DEDUCTION OF
THE MAXIMUM APPLICABLE SALES CHARGE. SEE THE FUND'S CURRENT PROSPECTUS FOR
COMPLETE DETAILS ON FEES AND SALES CHARGES.
++ ENDING VALUE ASSUMING A COMPLETE REDEMPTION ON DECEMBER 31, 2005.
9
<Page>
EXPENSE EXAMPLE
As a shareholder of the Fund, you incur two types of costs: (1) transaction
costs, including sales charges (loads) on purchase payments and redemption fees;
and (2) ongoing costs, including advisory fees; distribution and service (12b-1)
fees; and other Fund expenses. This example is intended to help you understand
your ongoing costs (in dollars) of investing in the Fund and to compare these
costs with the ongoing costs of investing in other mutual funds.
The example is based on an investment of $1,000 invested at the beginning of the
period and held for the entire period 07/01/05 - 12/31/05.
ACTUAL EXPENSES
The first line of the table below provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During Period" to
estimate the expenses you paid on your account during this period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line of the table below provides information about hypothetical
expenses based on the Fund's actual expense ratio and an assumed rate of return
of 5% per year before expenses, which is not the Fund's actual return. The
hypothetical account values and expenses may not be used to estimate the actual
ending account balance or expenses you paid for the period. You may use this
information to compare the ongoing cost of investing in the Fund and other
funds. To do so, compare this 5% hypothetical example with the 5% hypothetical
examples that appear in the shareholder reports of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only and do not reflect any transactional costs, such as sales
charges (loads) and redemption fees. Therefore, the second line of the table is
useful in comparing ongoing costs, and will not help you determine the relative
total cost of owning different funds. In addition, if these transactional costs
were included, your costs would have been higher.
<Table>
<Caption>
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD *
------------- ------------- ---------------
07/01/05 -
07/01/05 12/31/05 12/31/05
------------- ------------- ---------------
CLASS A
Actual (0.57% return) $ 1,000.00 $ 1,005.70 $ 4.35
Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,020.87 $ 4.38
CLASS B
Actual (0.74% return) $ 1,000.00 $ 1,007.40 $ 3.59
Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,021.63 $ 3.62
CLASS C
Actual (0.32% return) $ 1,000.00 $ 1,003.20 $ 6.87
Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,018.35 $ 6.92
CLASS D
Actual (0.78% return) $ 1,000.00 $ 1,007.80 $ 3.09
Hypothetical (5% annual return before expenses) $ 1,000.00 $ 1,022.13 $ 3.11
</Table>
- ----------
* EXPENSES ARE EQUAL TO THE FUND'S ANNUALIZED EXPENSE RATIO OF 0.86%, 0.71%,
1.36% AND 0.61% FOR CLASS A, CLASS B, CLASS C AND CLASS D SHARES,
RESPECTIVELY, MULTIPLIED BY THE AVERAGE ACCOUNT VALUE OVER THE PERIOD,
MULTIPLIED BY 184/365 (TO REFLECT THE ONE-HALF YEAR PERIOD). IF THE FUND
HAD BORNE ALL OF ITS EXPENSES, THE ANNUALIZED EXPENSE RATIOS WOULD HAVE
BEEN 0.88%, 0.74%, 1.38% AND 0.63% FOR CLASS A, CLASS B, CLASS C AND CLASS
D SHARES, RESPECTIVELY.
10
<Page>
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND
PORTFOLIO OF INVESTMENTS - DECEMBER 31, 2005
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------
California Tax-Exempt Municipal Bonds (95.5%)
GENERAL OBLIGATION (12.2%)
California,
$ 5,000 Ser 1990 7.00% 08/01/07 $ 5,277,200
5,000 Ser 1990 7.00 08/01/08 5,436,900
3,210 Ser 1996 (Ambac) 5.25 06/01/21 3,266,464
535 Various Purpose Dtd 04/01/93 (FSA) 5.50 04/01/19 538,050
5,000 Various Purpose Dtd 04/01/02 6.00 04/01/19 5,882,050
5,000 Various Purpose Dtd 12/01/05 5.00 03/01/27 5,245,650
2,000 Veterans Ser AT 9.50 02/01/10 2,434,520
2,400 Veterans Ser BH (AMT) (FSA) 5.40 12/01/16 2,532,456
3,000 Chino Valley Unified School District, 2002 Election
2005 Ser C (MBIA) 5.25 08/01/30 3,247,590
3,000 Huntington Beach Union High School District,
Ser 2004 (FSA) 5.00 08/01/27 3,154,830
5,000 Los Angeles, Ser 2004 A (MBIA) 5.00 09/01/24 5,278,550
5,000 Los Angeles Unified School District,
2003 Ser A (FSA) 5.25 07/01/20 5,435,400
5,000 Placentia - Yorba Linda United School
District, 2002 Election
Ser A (FGIC) 5.00 08/01/26 5,211,800
5,000 San Francisco, Laguna Honda Hospital
Ser 2005 I (FSA) 5.00 06/15/30 5,204,500
Puerto Rico,
8,000 Public Impr Ser 1999 4.75 07/01/23 8,022,480
3,000 Public Impr Ser 1999 (Secondary MBIA) 4.875 07/01/23 3,107,160
- ----------- ------------
65,145 69,275,600
- ----------- ------------
EDUCATIONAL FACILITIES REVENUE (4.7%)
California Educational Facilities Authority,
2,000 California College of Arts Ser 2005 5.00 06/01/35 2,003,640
3,000 Mills College Ser 2005 A 5.00 09/01/29 3,065,580
2,000 Mills College Ser 2005 A 5.00 09/01/34 2,033,620
3,000 Pitzer College Ser 2005 A 5.00 04/01/35 3,061,260
4,240 University of Redlands Ser 2005 A 5.00 10/01/35 4,328,955
5,000 University of San Diego Ser 1998 (Ambac) 5.00 10/01/22 5,236,350
California Statewide Communities Development Authority,
1,220 Thomas Jefferson School of Law Ser 2005 B 4.875 10/01/31 1,227,161
500 Thomas Jefferson School of Law Ser 2005 A 4.875 10/01/35 501,505
5,000 University California, Ser 2003 Q (FSA) 5.00 09/01/24 5,232,700
- ----------- ------------
25,960 26,690,771
- ----------- ------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
11
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------------
ELECTRIC REVENUE (6.9%)
$ 25,000 Los Angeles Department of Water & Power,
2001 Ser A (FSA) 5.25% 07/01/22 $ 26,733,500
Southern California Public Power Authority,
3,500 Mead-Adelanto 1994 Ser A (Ambac) 7.02++ 07/01/15 4,151,455
2,500 Mead-Phoenix 1994 Ser A (Ambac) 7.02++ 07/01/15 2,965,325
2,750 Transmission Refg Ser 2002 A (FSA) 5.25 07/01/18 2,981,963
2,000 Puerto Rico Electric Power Authority,
Power Ser II (MBIA) 5.375 07/01/19 2,192,620
- ----------- -------------
35,750 39,024,863
- ----------- -------------
HOSPITAL REVENUE (14.1%)
8,000 Antelope Valley Healthcare District, Refg Ser 1997 A (FSA) 5.20 01/01/20 8,397,360
California Health Facilities Financing Authority,
4,000 Cedars-Sinai Medical Center Ser 2005 5.00 11/15/27 4,098,480
5,000 Cedars-Sinai Medical Center Ser 2005 5.00 11/15/34 5,094,600
2,500 Sutter/CHS Ser 1996 A (MBIA) 5.875 08/15/16 2,589,725
5,000 California Infrastructure & Economic
Development Bank, Kaiser Assistance Ser 2001 A 5.55 08/01/31 5,296,500
California Statewide Communities Development Authority,
5,000 Adventist Healthwest 2005 Ser A 5.00 03/01/30 5,060,200
1,595 Cedars-Sinai Medical Center Ser 1992 COPs 6.50 08/01/12 1,736,716
3,000 Daughters of Charity Health Ser 2005 A 5.25 07/01/30 3,084,750
2,500 Daughters of Charity Health Ser 2005 A 5.25 07/01/35 2,564,125
1,630 Huntington Memorial Hospital Ser 2005 5.00 07/01/27 1,690,538
14,000 Duarte, City of Hope National Medical Center Ser 1999 A COPs 5.25 04/01/19 14,368,200
5,000 Loma Linda, Loma Linda University Medical Center, Ser 2005 A 5.00 12/01/20 5,155,650
7,500 Madera County, Valley Children's Hospital Ser 1995 COPs (MBIA) 6.50 03/15/15 8,796,750
4,000 Rancho Mirage Joint Powers Financing Authority, Eisenhower
Medical Center Ser 1997 A COPs (MBIA) 5.25 07/01/17 4,189,600
7,890 University California, UCLA Medical Center Ser 2004 A (Ambac) 5.00 05/15/39 8,124,412
- ----------- -------------
76,615 80,247,606
- ----------- -------------
INDUSTRIAL DEVELOPMENT/POLLUTION CONTROL REVENUE (2.7%)
California County Tobacco Securitization Agency,
1,000 Merced County Tobacco Funding Corporation, Ser 2005 A 5.25 06/01/45 979,570
3,000 Sonoma County Securitization Corporation, Ser 2005 5.125 06/01/38 2,916,720
1,000 Sonoma County Securitization Corporation, Ser 2005 5.25 06/01/45 979,570
5,000 California Pollution Control Financing Authority,
San Diego Gas & Electric Co 1996 Ser A 5.90 06/01/14 5,724,400
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
12
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------
$ 5,000 Tobacco Securitization Authority of Northern California,
Sacramento County Tobacco Securitization Corporation
Ser 2005 A-1 5.50% 06/01/45 $ 5,020,900
- ----------- ------------
15,000 15,621,160
- ----------- ------------
MORTGAGE REVENUE - MULTI-FAMILY (0.3%)
1,490 California Housing Finance Agency, Rental II 1992 Ser B 6.70 08/01/15 1,493,233
- ----------- ------------
MORTGAGE REVENUE - SINGLE FAMILY (0.2%)
770 California Housing Finance Agency, 1995 Ser B-2 (AMT) 6.30 08/01/24 780,387
California Rural Home Financing Authority,
110 Home 1997 Ser D-CL 5 (AMT) 6.70 05/01/29 110,554
155 1997 Ser A-2 (AMT) 7.00 09/01/29 156,088
130 Home 1998 Ser A (AMT) 6.35 12/01/29 131,659
- ----------- ------------
1,165 1,178,688
- ----------- ------------
PUBLIC FACILITIES REVENUE (4.0%)
4,000 Anaheim Public Financing Authority, 1997 Ser C (FSA) 6.00 09/01/16 4,665,520
California Public Works Board,
2,000 Butterfield State Office 2005 Ser A 5.25 06/01/30 2,119,580
10,000 Department of Corrections Refg 1993 Ser A (Ambac) 5.00 12/01/19 10,805,700
1,010 Sacramento City Financing Authority, 2002 Ser A (FSA) 5.25 12/01/17 1,097,385
5,000 Puerto Rico Public Buildings Authority, 2002 Ser D (Ambac) 0.00++ 07/01/31 3,926,450
- ----------- ------------
22,010 22,614,635
- ----------- ------------
TAX ALLOCATION REVENUE (8.8%)
2,000 Capistrano Unified School District, Community Facilities
District #98-2, Ladera Special Tax Ser 2005 (FGIC) 5.00 09/01/29 2,094,360
1,500 Fontana Public Finance Authority, Ser 2003 A (Ambac) 5.375 09/01/25 1,611,165
Long Beach Bond Finance Authority,
3,205 Downtown North Long Beach 2002 Ser A (Ambac) 5.375 08/01/19 3,499,508
2,380 Downtown North Long Beach 2002 Ser A (Ambac) 5.375 08/01/20 2,573,470
20,000 Long Beach Financing Authority, Ser 1992 (Ambac) 6.00 11/01/17 23,197,400
4,000 Rancho Mirage Redevelopment Agency, Ser 2003 A (MBIA) 5.00 04/01/33 4,136,080
2,000 Riverside County Public Financing Authority Ser 2005 A (XLCA) 5.00 10/01/37 2,061,520
San Jose Redevelopment Agency,
8,000 Ser 1999 (Ambac) 4.75 08/01/23 8,100,960
3,000 Merged Area (MBIA) 5.00 08/01/32 3,082,650
- ----------- ------------
46,085 50,357,113
- ----------- ------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
13
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- --------------------------------------------------------------------------------------------------------------
TRANSPORTATION FACILITIES REVENUE (15.4%)
$ 10,000 Alameda Corridor Transportation Authority, Sr Lien
Ser 1999 A (MBIA) 5.25% 10/01/21 $ 10,672,200
4,000 Bay Area Toll Authority, San Francisco Bay Area Toll Bridge
2001 Ser D 5.00 04/01/18 4,250,880
3,000 California Infrastructure and Economic Development Bank, Bay
Area Toll Bridges Seismic Retrofit First Lien Ser 2003 A
(FSA) 5.25 07/01/21 3,261,240
Foothill/Eastern Transportation Corridor Agency,
5,000 Toll Road Ser 1999 (MBIA) 5.125 01/15/19 5,324,700
14,000 Toll Road Ser 1999 0.00++ 01/15/23 12,227,740
5,000 Orange County, Airport Refg Ser 1997 (AMT) (MBIA) 5.50 07/01/11 5,224,650
Port of Oakland,
5,200 Ser 2002 M (FGIC) 5.25 11/01/19 5,658,068
2,000 Ser 2002 M (FGIC) 5.25 11/01/20 2,155,560
5,000 San Francisco Airports Commission, San Francisco Int'l
Airport Second Ser Refg Issue 27B (FGIC) 5.125 05/01/26 5,190,900
9,500 San Francisco Bay Area Rapid Transit District, Sales Tax
Ser 1998 (Ambac) 4.75 07/01/23 9,673,280
San Joaquin Hills Transportation Corridor Agency,
6,000 Toll Road Refg Ser 1997 A (MBIA) 0.00 01/15/15 4,112,700
10,000 Toll Road Senior Lien Ser 1993 5.00 01/01/33 9,523,600
10,000 San Jose, Airport Ser 2001 A (FGIC) 5.00 03/01/25 10,308,200
- ----------- ------------
88,700 87,583,718
- ----------- ------------
WATER & SEWER REVENUE (21.5%)
20,000 California Department of Water Resources, Central Valley
Ser Y (FGIC) 5.00 12/01/25 21,169,600
4,000 Corona Public Financing Authority, Water Ser 1998 (FGIC) 4.75 09/01/23 4,075,200
10,000 East Bay Municipal Utility District, Water Ser 2001 (MBIA) 5.00 06/01/26 10,356,900
8,000 Eastern Municipal Water District, Water & Sewer
Refg Ser 1998 A COPs (FGIC) 4.75 07/01/23 8,114,880
Los Angeles Department of Water & Power,
5,000 Water 2001 Ser A 5.125 07/01/41 5,142,000
5,000 Water 2003 Ser A (FGIC) 5.00 07/01/43 5,134,500
20,000 Los Angeles Wastewater, Refg Ser 2003 B (FSA) 5.00 06/01/22 21,225,000
10,000 Sacramento Financing Authority, Water & Capital Improvement
2001 Ser A (Ambac) 5.00 12/01/26 10,752,200
5,000 San Diego County Water Authority, Ser 2004 A (FSA) 5.00 05/01/29 5,248,850
10,000 San Diego Public Facilities Authority, Sewer Ser 1993 A 5.25 05/15/20 10,006,600
San Francisco Public Utilities Commission,
5,650 Water 2002 Ser A (MBIA) 5.00 11/01/20 5,997,927
10,000 Water 1996 Ser A 5.00 11/01/21 10,191,100
5,000 West Basin Municipal Water District, Refg Ser 2003 A
COPs (MBIA) 5.00 08/01/30 5,186,650
- ----------- ------------
117,650 122,601,407
- ----------- ------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
14
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------------
OTHER REVENUE (2.8%)
$ 10,000 California Economic Recovery, Ser 2004 A 5.00% 07/01/16 $ 10,768,200
Golden State Tobacco Securitization Corporation,
1,000 Enhanced Asset Backed Ser 2005 A (Ambac) 5.00 06/01/21 1,050,500
4,000 Enhanced Asset Backed Ser 2005 A 5.00 06/01/45 4,034,240
- ----------- -------------
15,000 15,852,940
- ----------- -------------
REFUNDED (1.9%)
10,000 California Department of Water Resources, Power Supply
- ----------- Ser 2002 A ** 5.375 05/01/12+ 11,102,100
-------------
520,570 TOTAL CALIFORNIA TAX-EXEMPT MUNICIPAL BONDS
- ----------- (COST $512,697,672) 543,643,834
-------------
SHORT-TERM CALIFORNIA TAX-EXEMPT MUNICIPAL OBLIGATIONS (4.0%)
5,500 California Department of Water Resources, Power Supply
Ser 2002 B (Demand 01/03/06) 3.70* 05/01/22 5,500,000
2,500 California Economic Recovery Bonds, Ser 2004 A
Ser 280 (FGIC) (Demand 01/03/06) 3.70* 07/01/23 2,500,000
3,500 M-S-R Public Power Agency, San Juan Sub Lien
Ser 1998 F (MBIA) (Demand 01/03/06) 3.70* 07/01/22 3,500,000
6,000 San Diego County Water Authority, Ser 1991 B COPs CARs
(MBIA) 9.37++ 04/27/06+ 6,349,440
5,250 Southern California Public Power Authority, Transmission Refg
- ----------- Ser 1988 A (FGIC) (ETM) 0.00 07/01/06 5,165,580
-------------
22,750 TOTAL SHORT-TERM CALIFORNIA TAX-EXEMPT MUNICIPAL OBLIGATIONS
- ----------- (COST $22,545,072) 23,015,020
-------------
$ 543,320 TOTAL INVESTMENTS (COST $535,242,744)(a)(b) 99.5% 566,658,854
=========== OTHER ASSETS IN EXCESS OF LIABILITIES 0.5 2,742,264
----- -------------
NET ASSETS 100.0% $ 569,401,118
===== =============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
15
<Page>
- ----------
AMT ALTERNATIVE MINIMUM TAX.
CARS COMPLEMENTARY AUCTION RATE CERTIFICATES.
COPS CERTIFICATES OF PARTICIPATION.
ETM ESCROWED TO MATURITY.
* CURRENT COUPON OF VARIABLE RATE DEMAND OBLIGATION.
** A PORTION OF THIS SECURITY HAS BEEN PHYSICALLY SEGREGATED IN
CONNECTION WITH OPEN FUTURES CONTRACTS IN THE AMOUNT OF $132,500.
+ PREREFUNDED TO CALL DATE SHOWN.
++ SECURITY IS A "STEP-UP" BOND WHERE THE COUPON INCREASES ON A
PREDETERMINED DATE.
++ CURRENT COUPON RATE FOR INVERSE FLOATING RATE MUNICIPAL OBLIGATIONS.
THIS RATE RESETS PERIODICALLY AS THE AUCTION RATE ON THE RELATED
SECURITY CHANGES. POSITIONS IN INVERSE FLOATING RATE MUNICIPAL
OBLIGATIONS HAVE A TOTAL VALUE OF $13,466,220 WHICH REPRESENTS 2.4% OF
NET ASSETS.
(a) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN AN AMOUNT EQUAL TO
$31,836,641 IN CONNECTION WITH OPEN FUTURES CONTRACTS.
(b) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES IS $534,857,166.
THE AGGREGATE GROSS UNREALIZED APPRECIATION IS $32,325,634 AND THE
AGGREGATE GROSS UNREALIZED DEPRECIATION IS $523,946, RESULTING IN NET
UNREALIZED APPRECIATION OF $31,801,688 .
BOND INSURANCE:
AMBAC AMBAC ASSURANCE CORPORATION.
FGIC FINANCIAL GUARANTY INSURANCE COMPANY.
FSA FINANCIAL SECURITY ASSURANCE INC.
MBIA MUNICIPAL BOND INVESTORS ASSURANCE CORPORATION.
XLCA XL CAPITAL ASSURANCE INC.
FUTURES CONTRACTS OPEN AT DECEMBER 31, 2005:
<Table>
<Caption>
DESCRIPTION,
NUMBER OF DELIVERY MONTH UNDERLYING FACE UNREALIZED
CONTRACTS LONG/SHORT AND YEAR AMOUNT AT VALUE DEPRECIATION
- ----------------------------------------------------------------------------------------
250 Short U.S. Treasury Notes 5 Year $ (26,585,938) $ (61,235)
March 2006
50 Short U.S. Treasury Notes 10 Year (5,470,312) (26,699)
March 2006
------------
Total Unrealized Depreciation $ (87,934)
============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
16
<Page>
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2005
<Table>
ASSETS:
Investments in securities, at value
(cost $535,242,744) $ 566,658,854
Cash 37,971
Receivable for:
Interest 7,636,207
Shares of beneficial interest sold 1,777,015
Variation margin 20,314
Receivable from affiliate 83,709
Prepaid expenses and other assets 26,937
--------------
Total Assets 576,241,007
--------------
LIABILITIES:
Payable for:
Dividends and distributions to shareholders 4,543,859
Shares of beneficial interest redeemed 1,729,708
Investment advisory fee 211,890
Distribution fee 189,638
Administration fee 38,801
Transfer agent fee 8,098
Accrued expenses and other payables 117,895
--------------
TOTAL LIABILITIES 6,839,889
--------------
NET ASSETS $ 569,401,118
==============
COMPOSITION OF NET ASSETS:
Paid-in-capital $ 537,654,192
Net unrealized appreciation 31,328,176
Accumulated undistributed net
investment income 479,770
Distributions in excess of net realized gain (61,020)
--------------
NET ASSETS $ 569,401,118
==============
CLASS A SHARES:
Net Assets $ 329,938,615
Shares Outstanding (unlimited authorized,
$.01 par value) 27,124,720
NET ASSET VALUE PER SHARE $ 12.16
==============
MAXIMUM OFFERING PRICE PER SHARE,
(NET ASSET VALUE PLUS 4.44% OF NET
ASSET VALUE) $ 12.70
==============
CLASS B SHARES:
Net Assets $ 159,220,738
Shares Outstanding (UNLIMITED AUTHORIZED,
$.01 PAR VALUE) 13,007,550
NET ASSET VALUE PER SHARE $ 12.24
==============
CLASS C SHARES:
Net Assets $ 26,384,724
Shares Outstanding (UNLIMITED AUTHORIZED,
$.01 PAR VALUE) 2,156,526
NET ASSET VALUE PER SHARE $ 12.23
==============
CLASS D SHARES:
Net Assets $ 53,857,041
Shares Outstanding (UNLIMITED AUTHORIZED,
$.01 PAR VALUE) 4,414,319
NET ASSET VALUE PER SHARE $ 12.20
==============
</Table>
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2005
<Table>
NET INVESTMENT INCOME:
INTEREST INCOME $ 29,983,650
--------------
EXPENSES
Investment advisory fee 2,810,269
Distribution fee (Class A shares) 590,227
Distribution fee (Class B shares) 199,690
Distribution fee (Class C shares) 200,255
Administration fee 482,745
Transfer agent fees and expenses 210,303
Shareholder reports and notices 79,613
Professional fees 73,960
Custodian fees 34,556
Trustees' fees and expenses 14,996
Other 58,196
--------------
TOTAL EXPENSES 4,754,810
Less: amounts waived (86,898)
Less: expense offset (33,080)
--------------
NET EXPENSES 4,634,832
--------------
NET INVESTMENT INCOME 25,348,818
--------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
NET REALIZED GAIN ON:
Investments 9,276,538
Futures contracts 410,774
--------------
NET REALIZED GAIN 9,687,312
--------------
NET CHANGE IN UNREALIZED
APPRECIATION/DEPRECIATION ON:
Investments (13,689,404)
Futures contracts (87,934)
--------------
NET DEPRECIATION (13,777,338)
--------------
NET LOSS (4,090,026)
--------------
NET INCREASE $ 21,258,792
==============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
17
<Page>
STATEMENT OF CHANGES IN NET ASSETS
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
----------------- -----------------
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS:
Net investment income $ 25,348,818 $ 28,753,186
Net realized gain 9,687,312 5,439,032
Net change in unrealized appreciation (13,777,338) (7,399,441)
----------------- -----------------
NET INCREASE 21,258,792 26,792,777
----------------- -----------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income
Class A shares (9,719,215) (760,362)
Class B shares (12,140,918) (24,171,667)
Class C shares (968,237) (1,021,650)
Class D shares (2,455,372) (2,765,747)
Net realized gain
Class A shares (5,480,668) (163,452)
Class B shares (2,674,136) (4,452,125)
Class C shares (436,485) (232,466)
Class D shares (895,913) (495,229)
----------------- -----------------
TOTAL DIVIDENDS AND DISTRIBUTIONS (34,770,944) (34,062,698)
----------------- -----------------
Net decrease from transactions in shares of beneficial interest (48,234,063) (71,320,691)
----------------- -----------------
NET DECREASE (61,746,215) (78,590,612)
NET ASSETS:
Beginning of period 631,147,333 709,737,945
----------------- -----------------
END OF PERIOD
(INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF
$479,770 AND $429,306, RESPECTIVELY) $ 569,401,118 $ 631,147,333
================= =================
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
18
<Page>
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND
NOTES TO FINANCIAL STATEMENTS - DECEMBER 31, 2005
1. ORGANIZATION AND ACCOUNTING POLICIES
Morgan Stanley California Tax-Free Income Fund (the "Fund") is registered under
the Investment Company Act of 1940, as amended (the "Act"), as a diversified,
open-end management investment company. The Fund's investment objective is to
provide a high level of current income which is exempt from federal and
California income tax, consistent with the preservation of capital. The Fund was
organized as a Massachusetts business trust on April 9, 1984 and commenced
operations on July 11, 1984. On July 28, 1997, the Fund converted to a multiple
class share structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within eighteen
months, six years and one year, respectively. Class D shares are not subject to
a sales charge. Additionally, Class A shares, Class B shares and Class C shares
incur distribution expenses.
Effective August 29, 2005, the Board of Trustees of the Fund approved the
implementation of a 2% redemption fee on Class A shares, Class B shares, Class C
shares, and Class D shares, which is paid directly to the Fund, for shares
redeemed within seven days of purchase. The redemption fee is designed to
protect the Fund and its remaining shareholders from the effects of short-term
trading.
The following is a summary of significant accounting policies:
A. VALUATION OF INVESTMENTS -- (1) portfolio securities are valued by an outside
independent pricing service approved by the Trustees. The pricing service uses
both a computerized grid matrix of tax-exempt securities and evaluations by its
staff, in each case based on information concerning market transactions and
quotations from dealers which reflect the mean between the last reported bid and
asked price. The portfolio securities are thus valued by reference to a
combination of transactions and quotations for the same or other securities
believed to be comparable in quality, coupon, maturity, type of issue, call
provisions, trading characteristics and other features deemed to be relevant.
The Trustees believe that timely and reliable market quotations are generally
not readily available for purposes of valuing tax-exempt securities and that the
valuations supplied by the pricing service are more likely to approximate the
fair value of such securities; (2) futures are valued at the latest sale price
on the commodities exchange on which they trade unless it is determined that
such price does not reflect their market value, in which case they will be
valued at their fair value as determined in good faith under procedures
established by and under the supervision of the Trustees; and (3) short-term
debt securities having a maturity date of more than sixty days at time of
purchase are valued on a mark-to-market basis until sixty days prior to maturity
and thereafter at amortized cost based on their value on the 61st day.
Short-term debt securities having a maturity date of sixty days or less at the
time of purchase are valued at amortized cost.
19
<Page>
B. ACCOUNTING FOR INVESTMENTS -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Discounts are accreted and premiums are amortized over the life of the
respective securities. Interest income is accrued daily.
C. MULTIPLE CLASS ALLOCATIONS -- Investment income, expenses (other than
distribution fees), and realized and unrealized gains and losses are allocated
to each class of shares based upon the relative net asset value on the date such
items are recognized. Distribution fees are charged directly to the respective
class.
D. FUTURES CONTRACTS -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. Government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the applicable futures exchange. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in the value of the contract. Such receipts or payments known as
variation margin are recorded by the Fund as unrealized gains and losses. Upon
closing of the contract, the Fund realizes a gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
E. FEDERAL INCOME TAX POLICY -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable and nontaxable
income to its shareholders. Accordingly, no federal income tax provision is
required.
F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
G. USE OF ESTIMATES -- The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures.
Actual results could differ from those estimates.
2. INVESTMENT ADVISORY/ADMINISTRATION AGREEMENTS
Pursuant to an Investment Advisory Agreement with Morgan Stanley Investment
Advisors Inc. (the "Investment Adviser") the Fund pays the Investment Adviser an
advisory fee, accrued daily and payable monthly, by applying the following
annual rates to the Fund's net assets determined as of the close of each
business day: 0.47% to the portion of the daily net assets not exceeding $500
million; 0.445% to the portion of the daily net assets exceeding $500 million
but not exceeding $750 million; 0.42% to the portion of the daily net assets
exceeding $750 million but not exceeding $1 billion; 0.395% to the portion of
the daily net assets exceeding $1 billion but not exceeding $1.25 billion; and
0.37% to the portion of the daily net assets in excess of $1.25 billion.
20
<Page>
Pursuant to an Administration Agreement with Morgan Stanley Services Company
Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund
pays an administration fee, accrued daily and payable monthly, by applying the
annual rate of 0.08% to the Fund's daily net assets.
Effective June 1, 2005, the Investment Adviser has agreed to cap the Fund's
operating expenses (except for brokerage and 12b-1 fees) by assuming the Fund's
"other expenses" and/or waiving the Fund's advisory fees, and the Administrator
has agreed to waive the Fund's administrative fees, to the extent such operating
expenses exceed 0.60% of the average daily net assets of the Fund on an
annualized basis. These voluntary assumptions/waivers may be discontinued at any
time.
3. PLAN OF DISTRIBUTION
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Adviser and Administrator. The
Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1
under the Act. The Plan provides that the Fund will pay the Distributor a fee
which is accrued daily and paid monthly at the following annual rates: (i) Class
A -- up to 0.25% of the average daily net assets of Class A; (ii) Class B -- up
to 0.75% of the lesser of: (a) the average daily aggregate gross sales of the
Class B shares since the inception of the Fund (not including reinvestment of
dividend or capital gain distributions) less the average daily aggregate net
asset value of the Class B shares redeemed since the Fund's inception upon which
a contingent deferred sales charge has been imposed or waived; or (b) the
average daily net assets of Class B; and (iii) Class C -- up to 0.75% of the
average daily net assets of Class C.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to pay expenses incurred in excess of payments made to the Distributor under the
Plan and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Trustees will consider at that time the manner in which to treat such expenses.
The Distributor has advised the Fund that there were no expenses as of December
31, 2005.
For the year ended December 31, 2005, the distribution fee was accrued for Class
B shares at the annual rate of 0.07%. At December 31, 2005, included in the
Statement of Assets and Liabilities, is a receivable from affiliate, which
represents payments due from the Distributor to the Fund.
In the case of Class A shares and Class C shares, expenses incurred pursuant to
the Plan in any calendar year in excess of 0.25% or 0.75% of the average daily
net assets of Class A or Class C, respectively, will not be reimbursed by the
Fund through payments in any subsequent year, except that expenses representing
a gross sales credit to Morgan Stanley Financial Advisors or other selected
broker-dealer representatives may be reimbursed in the subsequent calendar year.
For the year ended December 31, 2005, the distribution fee was accrued for Class
A shares and Class C shares at the annual rate of 0.25% and 0.75%, respectively.
21
<Page>
The Distributor has informed the Fund that for the year ended December 31, 2005,
it received contingent deferred sales charges from certain redemptions of the
Fund's Class B shares and Class C shares of $219,136 and $1,023, respectively
and received $129,324 in front-end sales charges from sales of the Fund's Class
A shares. The respective shareholders pay such charges which are not an expense
of the Fund.
4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the year ended December 31, 2005 aggregated
$133,266,051 and $179,562,297, respectively. Included in the aforementioned
transactions is a purchase of $5,416,400 and a sale of $5,343,350 with another
Morgan Stanley fund including net realized gain of $443,891.
Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and
Distributor, is the Fund's transfer agent.
The Fund has an unfunded noncontributory defined benefit pension plan covering
certain independent Trustees of the Fund who will have served as independent
Trustees for at least five years at the time of retirement. Benefits under this
plan are based on factors which include years of service and compensation. The
Trustees voted to close the plan to new participants and eliminate the future
benefits growth due to increases to compensation after July 31, 2003. Aggregate
pension costs for the year ended December 31, 2005 included in Trustees' fees
and expenses in the Statement of Operations amounted to $7,384. At December 31,
2005, the Fund had an accrued pension liability of $63,399 which is included in
accrued expenses in the Statement of Assets and Liabilities.
The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan")
which allows each independent Trustee to defer payment of all, or a portion, of
the fees he receives for serving on the Board of Trustees. Each eligible Trustee
generally may elect to have the deferred amounts credited with a return equal to
the total return on one or more of the Morgan Stanley funds that are offered as
investment options under the Compensation Plan. Appreciation/depreciation and
distributions received from these investments are recorded with an offsetting
increase/decrease in the deferred compensation obligation and do not affect the
net asset value of the Fund.
5. EXPENSE OFFSET
The expense offset represents a reduction of the custodian fees for earnings on
cash balances maintained by the Fund.
6. RISKS RELATING TO CERTAIN FINANCIAL INSTRUMENTS
The Fund may invest a portion of its assets in residual interest bonds, which
are inverse floating rate municipal obligations. The prices of these securities
are subject to greater market fluctuations during periods of changing prevailing
interest rates than are comparable fixed rate obligations.
22
<Page>
To hedge against adverse interest rate changes, the Fund may invest in financial
futures contracts or municipal bond index futures contracts ("futures
contracts").
These futures contracts involve elements of market risk in excess of the amount
reflected in the Statement of Assets and Liabilities. The Fund bears the risk of
an unfavorable change in the value of the underlying securities. Risks may also
arise upon entering into these contracts from the potential inability of the
counterparties to meet the terms of their contracts.
7. SHARES OF BENEFICIAL INTEREST
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
-------------------------------- --------------------------------
SHARES AMOUNT SHARES AMOUNT
-------------- -------------- -------------- --------------
CLASS A SHARES
Sold 510,370 $ 6,347,742 559,337 $ 7,038,418
Conversion from Class B 26,881,166 333,835,771 -- --
Reinvestment of dividends and distributions 709,137 8,718,752 28,186 350,747
Redeemed (2,517,480) (31,217,088) (431,256) (5,340,734)
-------------- -------------- -------------- --------------
Net increase -- Class A 25,583,193 317,685,177 156,267 2,048,431
-------------- -------------- -------------- --------------
CLASS B SHARES
Sold 636,974 7,964,926 1,325,952 16,676,138
Conversion to Class A (26,729,720) (333,835,771) -- --
Reinvestment of dividends and distributions 545,578 6,775,281 1,188,509 14,881,743
Redeemed (3,444,670) (43,042,005) (7,931,795) (99,245,593)
-------------- -------------- -------------- --------------
Net decrease -- Class B (28,991,838) (362,137,569) (5,417,334) (67,687,712)
-------------- -------------- -------------- --------------
CLASS C SHARES
Sold 223,514 2,798,084 382,653 4,832,637
Reinvestment of dividends and distributions 73,982 915,630 65,456 819,425
Redeemed (338,227) (4,230,339) (340,847) (4,273,996)
-------------- -------------- -------------- --------------
Net increase (decrease) -- Class C (40,731) (516,625) 107,262 1,378,066
-------------- -------------- -------------- --------------
CLASS D SHARES
Sold 211,330 2,634,719 274,779 3,446,290
Reinvestment of dividends and distributions 154,996 1,915,329 139,106 1,737,213
Redeemed (628,321) (7,815,094) (982,554) (12,242,979)
-------------- -------------- -------------- --------------
Net decrease -- Class D (261,995) (3,265,046) (568,669) (7,059,476)
-------------- -------------- -------------- --------------
Net decrease in Fund (3,711,371) $ (48,234,063) (5,722,474) $ (71,320,691)
============== ============== ============== ==============
</Table>
23
<Page>
8. LEGAL MATTERS
The Investment Adviser, certain affiliates of the Investment Adviser, certain
officers of such affiliates and certain investment companies advised by the
Investment Adviser or its affiliates, including the Fund, are named as
defendants in a consolidated class action. This consolidated action also names
as defendants certain individual Trustees and Directors of the Morgan Stanley
funds. The consolidated amended complaint, filed in the United States District
Court Southern District of New York on April 16, 2004, generally alleges that
defendants, including the Fund, violated their statutory disclosure obligations
and fiduciary duties by failing properly to disclose (i) that the Investment
Adviser and certain affiliates of the Investment Adviser allegedly offered
economic incentives to brokers and others to recommend the funds advised by the
Investment Adviser or its affiliates to investors rather than funds managed by
other companies, and (ii) that the funds advised by the Investment Adviser or
its affiliates, including the Fund, allegedly paid excessive commissions to
brokers in return for their efforts to recommend these funds to investors. The
complaint seeks, among other things, unspecified compensatory damages,
rescissionary damages, fees and costs. The defendants have moved to dismiss the
action and intend to otherwise vigorously defend it. On March 9, 2005,
Plaintiffs sought leave to supplement their complaint to assert claims on behalf
of other investors. While the Fund and Adviser believe that each has meritorious
defenses, the ultimate outcome of this matter is not presently determinable at
this stage of the litigation, and no provision has been made in the Fund's
financial statements for the effect, if any, of this matter.
9. FEDERAL INCOME TAX STATUS
The amount of dividends and distributions from net investment income and net
realized capital gains are determined in accordance with federal income tax
regulations which may differ from generally accepted accounting principles.
These "book/tax" differences are either considered temporary or permanent in
nature. To the extent these differences are permanent in nature, such amounts
are reclassified within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification. Dividends and
distributions which exceed net investment income and net realized capital gains
for tax purposes are reported as distributions of paid-in-capital.
The tax character of distributions paid was as follows:
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
----------------- -----------------
Tax-exempt income $ 25,232,039 $ 28,687,522
Ordinary income 51,809 31,904
Long-term capital gains 9,487,096 5,343,272
----------------- -----------------
Total distributions $ 34,770,944 $ 34,062,698
================= =================
</Table>
24
<Page>
As of December 31, 2005, the tax-basis components of accumulated earnings were
as follows:
<Table>
Undistributed tax-exempt income $ 158,408
Undistributed long-term gains --
-------------
Net accumulated earnings 158,408
Post-October losses (148,589)
Temporary differences (64,581)
Net unrealized appreciation 31,801,688
-------------
Total accumulated earnings $ 31,746,926
=============
</Table>
As of December 31, 2005, the Fund had temporary book/tax differences primarily
attributable to post-October losses (capital losses incurred after October 31
within the taxable year which are deemed to arise on the first business day of
the Fund's next taxable year), mark-to-market of open futures contracts and book
amortization of discounts on debt securities and permanent book/tax differences
attributable to tax adjustments on debt securities sold by the Fund. To reflect
reclassifications arising from the permanent differences, accumulated
undistributed net investment income was charged and distributions in excess of
net realized gain was credited $14,612.
25
<Page>
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ----------- ----------- -----------
CLASS A SHARES
SELECTED PER SHARE DATA:
Net asset value, beginning of period $ 12.46 $ 12.58 $ 12.68 $ 12.34 $ 12.49
----------- ----------- ----------- ----------- -----------
Income (loss) from investment operations:
Net investment income 0.52 0.54 0.55 0.57 0.57
Net realized and unrealized gain (loss) (0.10) (0.02) (0.01) 0.44 (0.10)
----------- ----------- ----------- ----------- -----------
Total income from investment operations 0.42 0.52 0.54 1.01 0.47
----------- ----------- ----------- ----------- -----------
Less dividends and distributions from:
Net investment income (0.51) (0.53) (0.55) (0.57) (0.58)
Net realized gain (0.21) (0.11) (0.09) (0.10) (0.04)
----------- ----------- ----------- ----------- -----------
Total dividends and distributions (0.72) (0.64) (0.64) (0.67) (0.62)
----------- ----------- ----------- ----------- -----------
Net asset value, end of period $ 12.16 $ 12.46 $ 12.58 $ 12.68 $ 12.34
=========== =========== =========== =========== ===========
TOTAL RETURN+ 3.44% 4.26% 4.31% 8.37% 3.90%
RATIOS TO AVERAGE NET ASSETS(1):
Expenses (before expense offset) 0.86%(2) 0.81% 0.78% 0.80% 0.80%
Net investment income 4.11%(2) 4.29% 4.34% 4.53% 4.62%
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands $ 329,938 $ 19,203 $ 17,422 $ 20,775 $ 17,147
Portfolio turnover rate 23% 10% 11% 12% 13%
</Table>
- ----------
+ DOES NOT REFLECT THE DEDUCTION OF SALES CHARGE. CALCULATED BASED ON THE NET
ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
(2) IF THE FUND HAD BORNE ALL ITS EXPENSES THAT WERE REIMBURSED OR WAIVED BY
THE INVESTMENT ADVISER AND ADMINISTRATOR FOR THE PERIOD JUNE 1, 2005
THROUGH DECEMBER 31, 2005, THE ANNUALIZED EXPENSE AND NET INVESTMENT INCOME
RATIOS WOULD HAVE BEEN 0.87% AND 4.10%, RESPECTIVELY.
SEE NOTES TO FINANCIAL STATEMENTS
26
<Page>
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ----------- ----------- -----------
CLASS B SHARES
SELECTED PER SHARE DATA:
Net asset value, beginning of period $ 12.52 $ 12.65 $ 12.75 $ 12.42 $ 12.57
----------- ----------- ----------- ----------- -----------
Income (loss) from investment operations:
Net investment income 0.54 0.54 0.55 0.56 0.55
Net realized and unrealized gain (loss) (0.08) (0.02) (0.02) 0.42 (0.11)
----------- ----------- ----------- ----------- -----------
Total income from investment operations 0.46 0.52 0.53 0.98 0.44
----------- ----------- ----------- ----------- -----------
Less dividends and distributions from:
Net investment income (0.53) (0.54) (0.54) (0.55) (0.55)
Net realized gain (0.21) (0.11) (0.09) (0.10) (0.04)
----------- ----------- ----------- ----------- -----------
Total dividends and distributions (0.74) (0.65) (0.63) (0.65) (0.59)
----------- ----------- ----------- ----------- -----------
Net asset value, end of period $ 12.24 $ 12.52 $ 12.65 $ 12.75 $ 12.42
=========== =========== =========== =========== ===========
TOTAL RETURN+ 3.74% 4.22% 4.27% 8.13% 3.56%
RATIOS TO AVERAGE NET ASSETS(1):
Expenses (before expense offset) 0.68%(3) 0.78%(2) 0.83%(2) 0.93%(2) 1.04%(2)
Net investment income 4.29%(3) 4.32%(2) 4.29%(2) 4.40%(2) 4.38%(2)
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands $ 159,221 $ 526,026 $ 599,737 $ 682,046 $ 696,481
Portfolio turnover rate 23% 10% 11% 12% 13%
</Table>
- ----------
+ DOES NOT REFLECT THE DEDUCTION OF SALES CHARGE. CALCULATED BASED ON THE NET
ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
(2) IF THE FUND HAD BORNE ALL OF ITS EXPENSES THAT WERE REIMBURSED BY THE
DISTRIBUTOR, THE ANNUALIZED EXPENSE AND NET INVESTMENT INCOME RATIOS WOULD
HAVE BEEN AS FOLLOWS:
<Table>
<Caption>
EXPENSE NET INVESTMENT
PERIOD ENDED RATIO INCOME RATIO
----------------- ------- --------------
DECEMBER 31, 2004 1.03% 4.07%
DECEMBER 31, 2003 1.35 3.77
DECEMBER 31, 2002 1.35 3.98
DECEMBER 31, 2001 1.34 4.06
</Table>
(3) IF THE FUND HAD BORNE ALL OF ITS EXPENSES THAT WERE REIMBURSED OR WAIVED BY
THE INVESTMENT ADVISER AND ADMINISTRATOR FOR THE PERIOD JUNE 1, 2005
THROUGH DECEMBER 31, 2005, THE ANNUALIZED EXPENSE AND NET INVESTMENT INCOME
RATIOS WOULD HAVE BEEN 0.69% AND 4.28%, RESPECTIVELY.
SEE NOTES TO FINANCIAL STATEMENTS
27
<Page>
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ----------- ----------- -----------
CLASS C SHARES
SELECTED PER SHARE DATA:
Net asset value, beginning of period $ 12.52 $ 12.65 $ 12.74 $ 12.42 $ 12.57
----------- ----------- ----------- ----------- -----------
Income (loss) from investment operations:
Net investment income 0.45 0.47 0.48 0.50 0.51
Net realized and unrealized gain (loss) (0.08) (0.02) 0.00 0.42 (0.11)
----------- ----------- ----------- ----------- -----------
Total income from investment operations 0.37 0.45 0.48 0.92 0.40
----------- ----------- ----------- ----------- -----------
Less dividends and distributions from:
Net investment income (0.45) (0.47) (0.48) (0.50) (0.51)
Net realized gain (0.21) (0.11) (0.09) (0.10) (0.04)
----------- ----------- ----------- ----------- -----------
Total dividends and distributions (0.66) (0.58) (0.57) (0.60) (0.55)
----------- ----------- ----------- ----------- -----------
Net asset value, end of period $ 12.23 $ 12.52 $ 12.65 $ 12.74 $ 12.42
=========== =========== =========== =========== ===========
TOTAL RETURN+ 2.97% 3.61% 3.80% 7.59% 3.33%
RATIOS TO AVERAGE NET ASSETS(1):
Expenses (before expense offset) 1.36%(2) 1.36% 1.35% 1.35% 1.34%
Net investment income 3.61%(2) 3.74% 3.77% 3.98% 4.09%
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands $ 26,385 $ 27,519 $ 26,435 $ 25,825 $ 16,745
Portfolio turnover rate 23% 10% 11% 12% 13%
</Table>
- ----------
+ DOES NOT REFLECT THE DEDUCTION OF SALES CHARGE. CALCULATED BASED ON THE NET
ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
(2) IF THE FUND HAD BORNE ALL OF ITS EXPENSES THAT WERE REIMBURSED OR WAIVED BY
THE INVESTMENT ADVISER AND ADMINISTRATOR FOR THE PERIOD JUNE 1, 2005
THROUGH DECEMBER 31, 2005, THE ANNUALIZED EXPENSE AND NET INVESTMENT INCOME
RATIOS WOULD HAVE BEEN 1.37% AND 3.60%, RESPECTIVELY.
SEE NOTES TO FINANCIAL STATEMENTS
28
<Page>
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ----------- ----------- ----------- -----------
CLASS D SHARES
SELECTED PER SHARE DATA:
Net asset value, beginning of period $ 12.49 $ 12.61 $ 12.71 $ 12.39 $ 12.53
----------- ----------- ----------- ----------- -----------
Income (loss) from investment operations:
Net investment income 0.54 0.56 0.57 0.60 0.60
Net realized and unrealized gain (loss) (0.08) (0.01) (0.01) 0.41 (0.10)
----------- ----------- ----------- ----------- -----------
Total income from investment operations 0.46 0.55 0.56 1.01 0.50
----------- ----------- ----------- ----------- -----------
Less dividends and distributions from:
Net investment income (0.54) (0.56) (0.57) (0.59) (0.60)
Net realized gain (0.21) (0.11) (0.09) (0.10) (0.04)
----------- ----------- ----------- ----------- -----------
Total dividends and distributions (0.75) (0.67) (0.66) (0.69) (0.64)
----------- ----------- ----------- ----------- -----------
Net asset value, end of period $ 12.20 $ 12.49 $ 12.61 $ 12.71 $ 12.39
=========== =========== =========== =========== ===========
TOTAL RETURN+ 3.74% 4.48% 4.50% 8.41% 4.12%
RATIOS TO AVERAGE NET ASSETS(1):
Expenses (before expense offset) 0.61%(2) 0.61% 0.60% 0.60% 0.59%
Net investment income 4.36%(2) 4.49% 4.52% 4.73% 4.84%
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands $ 53,857 $ 58,399 $ 66,143 $ 75,332 $ 83,638
Portfolio turnover rate 23% 10% 11% 12% 13%
</Table>
- ----------
+ CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE
PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
(2) IF THE FUND HAD BORNE ALL OF ITS EXPENSES THAT WERE REIMBURSED OR WAIVED BY
THE INVESTMENT ADVISER AND ADMINISTRATOR FOR THE PERIOD JUNE 1, 2005
THROUGH DECEMBER 31, 2005, THE ANNUALIZED EXPENSE AND NET INVESTMENT INCOME
RATIOS WOULD HAVE BEEN 0.62% AND 4.35%, RESPECTIVELY.
SEE NOTES TO FINANCIAL STATEMENTS
29
<Page>
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS AND BOARD OF TRUSTEES OF
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley California Tax-Free Income Fund (the "Fund"), including the portfolio of
investments, as of December 31, 2005, and the related statements of operations
for the year then ended and changes in net assets for each of the two years in
the period then ended, and the financial highlights for each of the five years
in the period then ended. These financial statements and financial highlights
are the responsibility of the Fund's management. Our responsibility is to
express an opinion on these financial statements and financial highlights based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of December 31, 2005, by correspondence with the
custodian and brokers. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Morgan
Stanley California Tax-Free Income Fund as of December 31, 2005, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended, and the financial highlights for each
of the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
Deloitte & Touche LLP
NEW YORK, NEW YORK
FEBRUARY 17, 2006
30
<Page>
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND
TRUSTEE AND OFFICER INFORMATION
INDEPENDENT TRUSTEES:
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) OVERSEEN OTHER DIRECTORSHIPS
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* DURING PAST 5 YEARS** BY TRUSTEE*** HELD BY TRUSTEE
- ----------------------------------- ------------ -------------- ------------------------- ------------- -----------------------
Michael Bozic (64) Trustee Since April Private Investor; 197 Director of various
c/o Kramer Levin Naftalis 1994 Director or Trustee of business organizations.
& Frankel LLP the Retail Funds (since
Counsel to the Independent Trustees April 1994) and the
1177 Avenue of the Americas Institutional Funds
New York, NY 10036 (since July 2003);
formerly Vice Chairman of
Kmart Corporation
(December 1998-
October 2000), Chairman
and Chief Executive
Officer of Levitz
Furniture Corporation
(November 1995-November
1998) and President
and Chief Executive
Officer of Hills
Department Stores (May
1991-July 1995); formerly
variously Chairman, Chief
Executive Officer,
President and Chief
Operating Officer
(1987-1991) of the Sears
Merchandise Group of
Sears, Roebuck & Co.
Edwin J. Garn (73) Trustee Since Consultant; Director or 197 Director of Franklin
1031 N. Chartwell Court January 1993 Trustee of the Retail Covey (time management
Salt Lake City, UT 84103 Funds (since January 1993) systems), BMW Bank of
and the Institutional North America, Inc.
Funds (since July 2003); (industrial loan
member of the Utah corporation), Escrow
Regional Advisory Board Bank USA (industrial
of Pacific Corp. (utility loan corporation),
company); formerly United Space Alliance
Managing Director of (joint venture between
Summit Ventures LLC Lockheed Martin and
(2000-2004) (lobbying and the Boeing Company)
consulting firm); United and Nuskin Asia
States Senator (R-Utah) Pacific (multilevel
(1974-1992) and Chairman, marketing); member of
Senate Banking Committee the board of various
(1980-1986), Mayor of civic and charitable
Salt Lake City, Utah organizations.
(1971-1974), Astronaut,
Space Shuttle Discovery
(April 12-19, 1985), and
Vice Chairman, Huntsman
Corporation (chemical
company).
Wayne E. Hedien (71) Trustee Since Retired; Director or 197 Director of The PMI
c/o Kramer Levin Naftalis September Trustee of the Retail Group Inc. (private
& Frankel LLP 1997 Funds (since mortgage insurance);
Counsel to the Independent Trustees September 1997) and the Trustee and Vice
1177 Avenue of the Americas Institutional Funds Chairman of The Field
New York, NY 10036 (since July 2003); Museum of Natural
formerly associated with History; director of
the Allstate Companies various other business
(1966-1994), most and charitable
recently as Chairman of organizations.
The Allstate Corporation
(March 1993-December 1994)
and Chairman and Chief
Executive Officer of its
wholly-owned subsidiary,
Allstate Insurance
Company (July
1989-December 1994).
</Table>
31
<Page>
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) OVERSEEN OTHER DIRECTORSHIPS
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* DURING PAST 5 YEARS** BY TRUSTEE*** HELD BY TRUSTEE
- ----------------------------------- ------------ -------------- ------------------------- ------------- -----------------------
Dr. Manuel H. Johnson (56) Trustee Since July Senior Partner, Johnson 197 Director of NVR, Inc.
c/o Johnson Smick Group, Inc. 1991 Smick International, (home construction);
888 16th Street, NW Inc., a consulting firm; Director of KFX
Suite 740 Chairman of the Audit Energy; Director of
Washington, D.C. 20006 Committee and Director RBS Greenwich Capital
or Trustee of the Retail Holdings (financial
Funds (since July 1991) holding company).
and the Institutional
Funds (since July 2003);
Co-Chairman and a
founder of the Group of
Seven Council (G7C), an
international economic
commission; formerly
Vice Chairman of the
Board of Governors of
the Federal Reserve
System and Assistant
Secretary of the U.S.
Treasury.
Joseph J. Kearns (63) Trustee Since President, Kearns& 198 Director of Electro
c/o Kearns & Associates LLC July 2003 Associates LLC Rent Corporation
PMB754 (investment consulting); (equipment leasing),
23852 Pacific Coast Highway Deputy Chairman of the The Ford Family
Malibu, CA 90265 Audit Committee and Foundation, and the
Director or Trustee of UCLA Foundation.
the Retail Funds (since
July 2003) and the
Institutional Funds
(since August 1994);
previously Chairman of
the Audit Committee of
the Institutional Funds
(October 2001-July 2003);
formerly CFO of the
J. Paul Getty Trust.
Michael E. Nugent (69) Trustee Since General Partner of 197 None.
c/o Triumph Capital, L.P. July 1991 Triumph Capital, L.P., a
445 Park Avenue private investment
New York, NY 10022 partnership; Chairman of
the Insurance Committee
and Director or Trustee
of the Retail Funds
(since July 1991) and
the Institutional Funds
(since July 2001);
formerly Vice President,
Bankers Trust Company
and BT Capital
Corporation (1984-1988).
Fergus Reid (73) Trustee Since Chairman of Lumelite 198 Trustee and Director
c/o Lumelite Plastics Corporation July 2003 Plastics Corporation; of certain investment
85 Charles Colman Blvd. Chairman of the companies in the
Pawling, NY 12564 Governance Committee and JPMorgan Funds complex
Director or Trustee of managed by J.P. Morgan
the Retail Funds (since Investment Management
July 2003) and the Inc.
Institutional Funds
(since June 1992).
</Table>
32
<Page>
INTERESTED TRUSTEES:
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) OVERSEEN OTHER DIRECTORSHIPS
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* DURING PAST 5 YEARS** BY TRUSTEE*** HELD BY TRUSTEE
- ----------------------------------- ------------ -------------- ------------------------- ------------- -----------------------
Charles A. Fiumefreddo (72) Chairman of Since July Chairman and Director or 197 None.
c/o Morgan Stanley Trust the Board 1991 Trustee of the Retail
Harborside Financial Center, and Trustee Funds (since July 1991)
Plaza Two, and the Institutional
Jersey City, NJ 07311 Funds (since July 2003);
formerly Chief Executive
Officer of the Retail
Funds (until
September 2002).
James F. Higgins (57) Trustee Since June Director or Trustee of 197 Director of AXA
c/o Morgan Stanley Trust 2000 the Retail Funds (since Financial, Inc. and
Harborside Financial Center, June 2000) and the The Equitable Life
Plaza Two, Institutional Funds Assurance Society of
Jersey City, NJ 07311 (since July 2003); the United States
Senior Advisor of Morgan (financial services).
Stanley (since August
2000); Director of the
Distributor and Dean
Witter Realty Inc.;
previously President and
Chief Operating Officer
of the Private Client
Group of Morgan Stanley
(May 1999-August 2000),
and President and Chief
Operating Officer of
Individual Securities of
Morgan Stanley (February
1997-May 1999).
</Table>
- ----------
* THIS IS THE EARLIEST DATE THE TRUSTEE BEGAN SERVING THE FUNDS ADVISED BY
MORGAN STANLEY INVESTMENT ADVISORS INC. (THE "INVESTMENT ADVISER") (THE
"RETAIL FUNDS").
** THE DATES REFERENCED BELOW INDICATING COMMENCEMENT OF SERVICES AS
DIRECTOR/TRUSTEE FOR THE RETAIL FUNDS AND THE FUNDS ADVISED BY MORGAN
STANLEY INVESTMENT MANAGEMENT INC. AND MORGAN STANLEY AIP GP LP (THE
"INSTITUTIONAL FUNDS") REFLECT THE EARLIEST DATE THE DIRECTOR/TRUSTEE BEGAN
SERVING THE RETAIL OR INSTITUTIONAL FUNDS, AS APPLICABLE.
*** THE FUND COMPLEX INCLUDES ALL OPEN-END AND CLOSED-END FUNDS (INCLUDING ALL
OF THEIR PORTFOLIOS) ADVISED BY THE INVESTMENT ADVISER AND ANY FUNDS THAT
HAVE AN INVESTMENT ADVISER THAT IS AN AFFILIATED PERSON OF THE INVESTMENT
ADVISER (INCLUDING, BUT NOT LIMITED TO, MORGAN STANLEY INVESTMENT
MANAGEMENT INC.).
33
<Page>
OFFICERS:
<Table>
<Caption>
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
EXECUTIVE OFFICER REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS**
- --------------------------- ------------------- ------------------- ------------------------------------------------------------
Ronald E. Robison (66) President and Since May 2003 President (since September 2005) and Principal Executive
1221 Avenue of the Americas Principal Executive Officer of funds in the Fund Complex (since May 2003);
New York, NY 10020 Officer Managing Director of Morgan Stanley & Co. Incorporated and
Morgan Stanley; Managing Director and Director of Morgan
Stanley Investment Management Inc., Morgan Stanley
Distribution Inc. and Morgan Stanley Distributors Inc.;
Managing Director, Chief Administrative Officer and
Director of Morgan Stanley Investment Advisors Inc. and
Morgan Stanley Services Company Inc.; Chief Executive
Officer and Director of Morgan Stanley Trust; Director of
Morgan Stanley SICAV (since May 2004); President (since
September 2005) and Principal Executive Officer (since May
2003) of the Van Kampen Funds; previously, Executive Vice
President (July 2003-September 2005) of funds in the Fund
Complex and the Van Kampen Funds. He was also previously
President and Director of the Institutional Funds (March
2001-July 2003), Chief Global Operations Officer of Morgan
Stanley Investment Management Inc. and Chief Executive
Officer and Chairman of Van Kampen Investor Services.
J. David Germany (51) Vice President Since February 2006 Managing Director and Chief Investment Officer - Global
25 Cabot Square, Fixed Income of Morgan Stanley Investment Management Inc.,
Canary Wharf, London, Morgan Stanley Investment Advisors Inc., and Van Kampen
United Kingdom E144QA Asset Management. Managing Director and Director of Morgan
Stanley Investment Management Ltd. Vice President (since
February 2006) of the Morgan Stanley Retail Funds and Morgan
Stanley Institutional Funds.
Dennis F. Shea (52) Vice President Since February 2006 Managing Director and Chief Investment Officer - Global
1221 Avenue of the Americas Equity of Morgan Stanley Investment Advisors Inc., Morgan
New York, NY 10020 Stanley Investment Management Inc. and Van Kampen Asset
Management. Vice President (since February 2006) of the
Morgan Stanley Retail Funds and Morgan Stanley
Institutional Funds. Previously, Managing Director and
Director of Global Equity Research at Morgan Stanley.
Barry Fink (50) Vice President Since February 1997 General Counsel (since May 2000) and Managing Director
1221 Avenue of the Americas (since December 2000) of Morgan Stanley Investment
New York, NY 10020 Management; Managing Director (since December 2000)of the
Investment Adviser and the Administrator; Vice President of
the Retail Funds; Assistant Secretary of Morgan Stanley DW;
Vice President of the Institutional Funds (since July
2003); Managing Director, Secretary and Director of the
Distributor; previously Secretary (February 1997-July 2003)
and General Counsel (February 1997-April 2004) of the Retail
Funds; previously Secretary(1997-2006) and
Director(1997-2005)of the Investment Adviser and the
Administrator; and Secretary and Director of the
Distributor(1997-2005).
Amy R. Doberman (43) Vice President Since July 2004 Managing Director and General Counsel, U.S. Investment
1221 Avenue of the Americas Management; Managing Director (since July 2004) and
New York, NY 10020 Secretary (since February 2006) of Morgan Stanley
Investment Management Inc. and the Investment Adviser,
Managing Director and Secretary of the Distributor (since
February 2006); Managing Director (since February 2005) and
Secretary (since February 2006) of the Administrator; Vice
President of the Institutional and Retail Funds (since July
2004); various positions with the Van Kampen Funds and
certain of their service providers; previously, Managing
Director and General Counsel - Americas, UBS Global Asset
Management (July 2000-July 2004).
</Table>
34
<Page>
<Table>
<Caption>
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
EXECUTIVE OFFICER REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS**
- --------------------------- ------------------- ------------------- ------------------------------------------------------------
Carsten Otto (42) Chief Compliance Since October 2004 Managing Director and U.S. Director of Compliance for Morgan
1221 Avenue of the Americas Officer Stanley Investment Management Inc. (since October 2004);
New York, NY 10020 Managing Director of the Investment Adviser and Morgan
Stanley Investment Management Inc.; formerly Assistant
Secretary and Assistant General Counsel of the Morgan
Stanley Retail Funds.
Stefanie V. Chang (39) Vice President Since July 2003 Executive Director of Morgan Stanley & Co. Incorporated,
1221 Avenue of the Americas Morgan Stanley Investment Management Inc. and the
New York, NY 10020 Investment Adviser; Vice President of the Institutional
Funds (since December 1997) and the Retail Funds (since
July 2003); various positions with the Van Kampen Funds;
formerly practiced law with the New York law firm of Rogers
& Wells (now Clifford Chance US LLP).
Francis J. Smith (40) Treasurer and Chief Treasurer since Executive Director of the Investment Adviser and the
c/o Morgan Stanley Trust Financial Officer July 2003 and Chief Administration (since December 2001); previously, Vice
Harborside Financial Center, Financial Officer President of the Retail Funds (September 2002-July 2003);
Plaza Two, since September Vice President of the Investment Adviser and the
Jersey City, NJ 07311 2002 Administrator (August 2000-November 2001).
Thomas F. Caloia (59) Vice President Since July 2003 Executive Director (since December 2002) and Assistant
c/o Morgan Stanley Trust Treasurer of the Investment Adviser, the Distributor and
Harborside Financial Center, the Administrator; previously Treasurer of the Retail Funds
Plaza Two, (April 1989-July 2003); formerly First Vice President of the
Jersey City, NJ 07311 Investment Adviser, the Distributor and the Administrator.
Mary E. Mullin (38) Secretary Since July 2003 Executive Director of Morgan Stanley & Co. Incorporated,
1221 Avenue of the Americas Morgan Stanley Investment Management Inc. and the
New York, NY 10020 Investment Adviser; Secretary of the Institutional Funds
(since June 1999) and the Retail Funds (since July 2003);
formerly practiced law with the New York law firms of
McDermott, Will & Emery and Skadden, Arps, Slate, Meagher &
Flom LLP.
</Table>
- ----------
* THIS IS THE EARLIEST DATE THE OFFICER BEGAN SERVING THE RETAIL FUNDS. EACH
OFFICER SERVES AN INDEFINITE TERM, UNTIL HIS OR HER SUCCESSOR IS ELECTED.
** THE DATES REFERENCED BELOW INDICATING COMMENCEMENT OF SERVICE AS AN OFFICER
FOR THE RETAIL AND INSTITUTIONAL FUNDS REFLECT THE EARLIEST DATE THE
OFFICER BEGAN SERVING THE RETAIL OR INSTITUTIONAL FUNDS, AS APPLICABLE.
2005 FEDERAL TAX NOTICE (UNAUDITED)
During the year ended December 31, 2005, the Fund paid to its shareholders
the following per share amounts from the sources indicated below:
<Table>
<Caption>
CLASS A CLASS B CLASS C CLASS D
Tax-Exempt Income 0.51 0.53 0.45 0.54
Long-Term Capital Gains 0.21 0.21 0.21 0.21
</Table>
35
<Page>
TRUSTEES
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael E. Nugent
Fergus Reid
OFFICERS
Charles A. Fiumefreddo
CHAIRMAN OF THE BOARD
Ronald E. Robison
PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER
J. David Germany
VICE PRESIDENT
Dennis F. Shea
VICE PRESIDENT
Barry Fink
VICE PRESIDENT
Amy R. Doberman
VICE PRESIDENT
Carsten Otto
CHIEF COMPLIANCE OFFICER
Stefanie V. Chang
VICE PRESIDENT
Francis J. Smith
TREASURER AND CHIEF FINANCIAL OFFICER
Thomas F. Caloia
VICE PRESIDENT
Mary E. Mullin
SECRETARY
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT ADVISER
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
This report is submitted for the general information of the shareholders of the
Fund. For more detailed information about the Fund, its fees and expenses and
other pertinent information, please read its Prospectus. The Fund's Statement of
Additional Information contains additional information about the Fund, including
its trustees. It is available, without charge, by calling (800) 869-NEWS.
This report is not authorized for distribution to prospective investors in the
Fund unless preceded or accompanied by an effective Prospectus. Read the
Prospectus carefully before investing.
Investments and services offered through Morgan Stanley DW Inc., member SIPC.
Morgan Stanley Distributors Inc., member NASD.
(C) 2005 Morgan Stanley
[MORGAN STANLEY LOGO]
37900RPT-RA06-00106P-Y12/05
[GRAPHIC]
MORGAN STANLEY FUNDS
MORGAN STANLEY CALIFORNIA TAX-FREE INCOME FUND
ANNUAL REPORT
DECEMBER 31, 2005
[MORGAN STANLEY LOGO]
<Page>
Item 2. Code of Ethics.
(a) The Fund has adopted a code of ethics (the "Code of Ethics") that applies
to its principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the Fund or a third
party.
(b) No information need be disclosed pursuant to this paragraph.
(c) The Fund has amended its Code of Ethics during the period covered by the
shareholder report presented in Item 1 hereto to delete from the end of the
following paragraph on page 2 of the Code the phrase "to the detriment of the
Fund.":
"Each Covered Officer must not use his personal influence or personal
relationship improperly to influence investment decisions or financial reporting
by the Fund whereby the Covered Officer would benefit personally (directly or
indirectly)."
Additionally, Exhibit B was amended to remove Mitchell M. Merin as a covered
officer.
(d) Not applicable.
(e) Not applicable.
(f)
(1) The Fund's Code of Ethics is attached hereto as Exhibit A.
(2) Not applicable.
(3) Not applicable.
Item 3. Audit Committee Financial Expert.
The Fund's Board of Trustees has determined that it has two "audit committee
financial experts" serving on its audit committee, each of whom are
"independent" Trustees: Dr. Manuel H. Johnson and Joseph J. Kearns. Under
applicable securities laws, a person who is determined to be an audit committee
financial expert will not be deemed an "expert" for any purpose, including
without limitation for the purposes of Section 11 of the Securities Act of 1933,
as a result of being designated or identified as an audit committee financial
expert. The designation or identification of a person as an audit committee
financial expert does not impose on such person any duties, obligations, or
liabilities that are greater than the duties, obligations, and liabilities
imposed on such person as a member of the audit committee and Board of Trustees
in the absence of such designation or identification.
<Page>
Item 4. Principal Accountant Fees and Services.
(a)(b)(c)(d) and (g). Based on fees billed for the periods shown:
2005
<Table>
<Caption>
REGISTRANT COVERED ENTITIES(1)
AUDIT FEES $ 30,447 N/A
NON-AUDIT FEES
AUDIT-RELATED FEES $ 540 (2) $ (2)
TAX FEES $ 4,699 (3) $ (4)
ALL OTHER FEES $ - $ -
TOTAL NON-AUDIT FEES $ 5,239 $
TOTAL $ 35,686 $
</Table>
2004
<Table>
<Caption>
REGISTRANT COVERED ENTITIES(1)
AUDIT FEES $ 29,002 N/A
NON-AUDIT FEES
AUDIT-RELATED FEES $ 452 (2) $ 3,746,495 (2)
TAX FEES $ 5,335 (3) $ 79,800 (4)
ALL OTHER FEES $ - $ - (5)
TOTAL NON-AUDIT FEES $ 5,787 $ 3,826,295
TOTAL $ 34,789 $ 3,826,295
</Table>
N/A- Not applicable, as not required by Item 4.
(1) Covered Entities include the Adviser (excluding sub-advisors) and
any entity controlling, controlled by or under common control
with the Adviser that provides ongoing services to the
Registrant.
(2) Audit-Related Fees represent assurance and related services
provided that are reasonably related to the performance of the
audit of the financial statements of the Covered Entities' and
funds advised by the Adviser or its affiliates, specifically data
verification and agreed-upon procedures related to asset
securitizations and agreed-upon procedures engagements.
(3) Tax Fees represent tax compliance, tax planning and tax advice
services provided in connection with the preparation and review
of the Registrant's tax returns.
(4) Tax Fees represent tax compliance, tax planning and tax advice
services provided in connection with the review of Covered
Entities' tax returns.
(5) All other fees represent project management for future business
applications and improving business and operational processes.
<Page>
(e)(1) The audit committee's pre-approval policies and procedures are as
follows:
APPENDIX A
AUDIT COMMITTEE
AUDIT AND NON-AUDIT SERVICES
PRE-APPROVAL POLICY AND PROCEDURES
OF THE
MORGAN STANLEY RETAIL AND INSTITUTIONAL FUNDS
AS ADOPTED AND AMENDED JULY 23, 2004,(1)
1. STATEMENT OF PRINCIPLES
The Audit Committee of the Board is required to review and, in its sole
discretion, pre-approve all Covered Services to be provided by the Independent
Auditors to the Fund and Covered Entities in order to assure that services
performed by the Independent Auditors do not impair the auditor's independence
from the Fund.
The SEC has issued rules specifying the types of services that an independent
auditor may not provide to its audit client, as well as the audit committee's
administration of the engagement of the independent auditor. The SEC's rules
establish two different approaches to pre-approving services, which the SEC
considers to be equally valid. Proposed services either: may be pre-approved
without consideration of specific case-by-case services by the Audit Committee
("GENERAL PRE-APPROVAL"); or require the specific pre-approval of the Audit
Committee or its delegate ("SPECIFIC PRE-APPROVAL"). The Audit Committee
believes that the combination of these two approaches in this Policy will result
in an effective and efficient procedure to pre-approve services performed by the
Independent Auditors. As set forth in this Policy, unless a type of service has
received general pre-approval, it will require specific pre-approval by the
Audit Committee (or by any member of the Audit Committee to which pre-approval
authority has been delegated) if it is to be provided by the Independent
Auditors. Any proposed services exceeding pre-approved cost levels or budgeted
amounts will also require specific pre-approval by the Audit Committee.
The appendices to this Policy describe the Audit, Audit-related, Tax and All
Other services that have the general pre-approval of the Audit Committee. The
term of any general pre-approval is 12 months from the date of pre-approval,
unless the Audit Committee considers and provides a different period and states
otherwise. The Audit Committee will annually review and pre-approve the services
that may be provided by the Independent Auditors without obtaining specific
pre-approval from the Audit Committee. The Audit Committee will add to or
subtract from the list of general pre-approved services from time to time, based
on subsequent determinations.
- ----------
(1) This Audit Committee Audit and Non-Audit Services Pre-Approval Policy and
Procedures (the "POLICY"), adopted as of the date above, supersedes and
replaces all prior versions that may have been adopted from time to time.
<Page>
The purpose of this Policy is to set forth the policy and procedures by which
the Audit Committee intends to fulfill its responsibilities. It does not
delegate the Audit Committee's responsibilities to pre-approve services
performed by the Independent Auditors to management.
The Fund's Independent Auditors have reviewed this Policy and believes that
implementation of the Policy will not adversely affect the Independent Auditors'
independence.
2. DELEGATION
As provided in the Act and the SEC's rules, the Audit Committee may delegate
either type of pre-approval authority to one or more of its members. The member
to whom such authority is delegated must report, for informational purposes
only, any pre-approval decisions to the Audit Committee at its next scheduled
meeting.
3. AUDIT SERVICES
The annual Audit services engagement terms and fees are subject to the specific
pre-approval of the Audit Committee. Audit services include the annual financial
statement audit and other procedures required to be performed by the Independent
Auditors to be able to form an opinion on the Fund's financial statements. These
other procedures include information systems and procedural reviews and testing
performed in order to understand and place reliance on the systems of internal
control, and consultations relating to the audit. The Audit Committee will
approve, if necessary, any changes in terms, conditions and fees resulting from
changes in audit scope, Fund structure or other items.
In addition to the annual Audit services engagement approved by the Audit
Committee, the Audit Committee may grant general pre-approval to other Audit
services, which are those services that only the Independent Auditors reasonably
can provide. Other Audit services may include statutory audits and services
associated with SEC registration statements (on Forms N-1A, N-2, N-3, N-4,
etc.), periodic reports and other documents filed with the SEC or other
documents issued in connection with securities offerings.
The Audit Committee has pre-approved the Audit services in Appendix B.1. All
other Audit services not listed in Appendix B.1 must be specifically
pre-approved by the Audit Committee (or by any member of the Audit Committee to
which pre-approval has been delegated).
4. AUDIT-RELATED SERVICES
Audit-related services are assurance and related services that are reasonably
related to the performance of the audit or review of the Fund's financial
statements and, to the extent they are Covered Services, the Covered Entities or
that are traditionally performed by the Independent Auditors. Because the Audit
Committee believes that the provision of Audit-related services does not impair
the independence of the auditor and is consistent with the SEC's rules on
auditor independence, the Audit Committee may grant general pre-approval to
Audit-related services. Audit-related services include, among others, accounting
consultations related to accounting, financial reporting or disclosure matters
<Page>
not classified as "Audit services"; assistance with understanding and
implementing new accounting and financial reporting guidance from rulemaking
authorities; agreed-upon or expanded audit procedures related to accounting
and/or billing records required to respond to or comply with financial,
accounting or regulatory reporting matters; and assistance with internal control
reporting requirements under Forms N-SAR and/or N-CSR.
The Audit Committee has pre-approved the Audit-related services in Appendix B.2.
All other Audit-related services not listed in Appendix B.2 must be specifically
pre-approved by the Audit Committee (or by any member of the Audit Committee to
which pre-approval has been delegated).
5. TAX SERVICES
The Audit Committee believes that the Independent Auditors can provide Tax
services to the Fund and, to the extent they are Covered Services, the Covered
Entities, such as tax compliance, tax planning and tax advice without impairing
the auditor's independence, and the SEC has stated that the Independent Auditors
may provide such services.
Pursuant to the preceding paragraph, the Audit Committee has pre-approved the
Tax Services in Appendix B.3. All Tax services in Appendix B.3 must be
specifically pre-approved by the Audit Committee (or by any member of the Audit
Committee to which pre-approval has been delegated).
6. ALL OTHER SERVICES
The Audit Committee believes, based on the SEC's rules prohibiting the
Independent Auditors from providing specific non-audit services, that other
types of non-audit services are permitted. Accordingly, the Audit Committee
believes it may grant general pre-approval to those permissible non-audit
services classified as All Other services that it believes are routine and
recurring services, would not impair the independence of the auditor and are
consistent with the SEC's rules on auditor independence.
The Audit Committee has pre-approved the All Other services in Appendix B.4.
Permissible All Other services not listed in Appendix B.4 must be specifically
pre-approved by the Audit Committee (or by any member of the Audit Committee to
which pre-approval has been delegated).
7. PRE-APPROVAL FEE LEVELS OR BUDGETED AMOUNTS
Pre-approval fee levels or budgeted amounts for all services to be provided by
the Independent Auditors will be established annually by the Audit Committee.
Any proposed services exceeding these levels or amounts will require specific
pre-approval by the Audit Committee. The Audit Committee is mindful of the
overall relationship of fees for audit and non-audit services in determining
whether to pre-approve any such services.
8. PROCEDURES
All requests or applications for services to be provided by the Independent
Auditors that do not require specific approval by the Audit Committee will be
submitted to the Fund's Chief Financial Officer and must include a detailed
description of the services to be
<Page>
rendered. The Fund's Chief Financial Officer will determine whether such
services are included within the list of services that have received the general
pre-approval of the Audit Committee. The Audit Committee will be informed on a
timely basis of any such services rendered by the Independent Auditors. Requests
or applications to provide services that require specific approval by the Audit
Committee will be submitted to the Audit Committee by both the Independent
Auditors and the Fund's Chief Financial Officer, and must include a joint
statement as to whether, in their view, the request or application is consistent
with the SEC's rules on auditor independence.
The Audit Committee has designated the Fund's Chief Financial Officer to monitor
the performance of all services provided by the Independent Auditors and to
determine whether such services are in compliance with this Policy. The Fund's
Chief Financial Officer will report to the Audit Committee on a periodic basis
on the results of its monitoring. Both the Fund's Chief Financial Officer and
management will immediately report to the chairman of the Audit Committee any
breach of this Policy that comes to the attention of the Fund's Chief Financial
Officer or any member of management.
9. ADDITIONAL REQUIREMENTS
The Audit Committee has determined to take additional measures on an annual
basis to meet its responsibility to oversee the work of the Independent Auditors
and to assure the auditor's independence from the Fund, such as reviewing a
formal written statement from the Independent Auditors delineating all
relationships between the Independent Auditors and the Fund, consistent with
Independence Standards Board No. 1, and discussing with the Independent Auditors
its methods and procedures for ensuring independence.
10. COVERED ENTITIES
Covered Entities include the Fund's investment adviser(s) and any entity
controlling, controlled by or under common control with the Fund's investment
adviser(s) that provides ongoing services to the Fund(s). Beginning with
non-audit service contracts entered into on or after May 6, 2003, the Fund's
audit committee must pre-approve non-audit services provided not only to the
Fund but also to the Covered Entities if the engagements relate directly to the
operations and financial reporting of the Fund. This list of Covered Entities
would include:
MORGAN STANLEY RETAIL FUNDS
Morgan Stanley Investment Advisors Inc.
Morgan Stanley & Co. Incorporated
Morgan Stanley DW Inc.
Morgan Stanley Investment Management Inc.
Morgan Stanley Investment Management Limited
Morgan Stanley Investment Management Private Limited
Morgan Stanley Asset & Investment Trust Management Co., Limited
Morgan Stanley Investment Management Company
Van Kampen Asset Management
Morgan Stanley Services Company, Inc.
Morgan Stanley Distributors Inc.
Morgan Stanley Trust FSB
<Page>
MORGAN STANLEY INSTITUTIONAL FUNDS
Morgan Stanley Investment Management Inc.
Morgan Stanley Investment Advisors Inc.
Morgan Stanley Investment Management Limited
Morgan Stanley Investment Management Private Limited
Morgan Stanley Asset & Investment Trust Management Co., Limited
Morgan Stanley Investment Management Company
Morgan Stanley & Co. Incorporated
Morgan Stanley Distribution, Inc.
Morgan Stanley AIP GP LP
Morgan Stanley Alternative Investment Partners LP
(e)(2) Beginning with non-audit service contracts entered into on or after May
6, 2003, the audit committee also is required to pre-approve services to Covered
Entities to the extent that the services are determined to have a direct impact
on the operations or financial reporting of the Registrant. 100% of such
services were pre-approved by the audit committee pursuant to the Audit
Committee's pre-approval policies and procedures (attached hereto).
(f) Not applicable.
(g) See table above.
(h) The audit committee of the Board of Trustees has considered whether the
provision of services other than audit services performed by the auditors to the
Registrant and Covered Entities is compatible with maintaining the auditors'
independence in performing audit services.
Item 5. Audit Committee of Listed Registrants.
(a) The Fund has a separately-designated standing audit committee established
in accordance with Section 3(a)(58)(A) of the Exchange Act whose members are:
Michael Bozic, Edwin J. Garn, Wayne E. Hedien, Manual H. Johnson, Joseph J.
Kearns, Michael Nugent and Fergus Reid.
(b) Not applicable.
Item 6. Schedule of Investments
Refer to Item 1.
<Page>
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Applicable only to reports filed by closed-end funds.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Applicable only to reports filed by closed-end funds.
Item 9. Closed-End Fund Repurchases
Applicable only to reports filed by closed-end funds.
Item 10. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 11. Controls and Procedures
(a) The Fund's principal executive officer and principal financial officer
have concluded that the Fund's disclosure controls and procedures are sufficient
to ensure that information required to be disclosed by the Fund in this Form
N-CSR was recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, based
upon such officers' evaluation of these controls and procedures as of a date
within 90 days of the filing date of the report.
(b) There were no changes in the registrant's internal control over financial
reporting that occurred during the registrant's most recent fiscal half-year
(the registrant's second fiscal half-year in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
Item 12. Exhibits
(a) The Code of Ethics for Principal Executive and Senior Financial Officers
is attached hereto.
(b) A separate certification for each principal executive officer and
principal financial officer of the registrant are attached hereto as part of
EX-99.CERT.
<Page>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Morgan Stanley California Tax-Free Income Fund
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
February 9, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
February 9, 2006
/s/ Francis Smith
Francis Smith
Principal Financial Officer
February 9, 2006