BILL ANALYSIS
AB 829
Page 1
Date of Hearing: May 18, 2009
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Charles M. Calderon, Chair
AB 829 (Caballero) - As Amended: April 14, 2009
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Sales and use tax exemption: tax credit: manufacturing
equipment.
SUMMARY : Creates a state sales and use tax (SUT) exemption and
a personal income tax (PIT and corporation tax (CT) credit for
purchases of manufacturing equipment and certain property used
in the research and development process. Specifically, this
bill :
1)Creates a SUT exemption, operative January 1, 2013, for
tangible personal property (TPP) purchased for use in
California.
a) Specifies that the exemption applies to any of the
following:
i) TPP purchased by a "qualified persons" for use
primarily in manufacturing, processing, refining,
fabricating, or recycling of property;
ii) TPP purchased for use by a contractor buying that
property for use in the performance of a construction
contract for the "qualified person" who will use the
property as an integral part of the manufacturing,
processing, refining, fabricating, or recycling of
property, or as a storage facility for use in connection
with the manufacturing process;
iii) Sustainable development equipment investments of TPP
purchased by a qualified person primarily in any stage of
the manufacturing, processing, refining, fabricating, or
recycling of property; and,
iv) TPP used primarily during the research and
development process on qualified research.
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b) Defines "qualified person" as an entity that satisfies
either of the following:
i) Is engaged in those lines of business described in
Codes 3111 to 3399, inclusive, or 5112 of the North
American Industrial Classification System (NAICS) Manual,
2002 edition.
ii) An affiliate of such a person, provided that the
affiliate is a member of the qualified person's unitary
group for which a combined report is required to be
filed, as provided.
c) Provides that TPP includes, but is not limited to,
machinery and equipment, pollution control that meets or
exceeds state or local standards, special purpose
buildings, fuels, and equipment or devices used to operate,
control, or maintain the machinery and equipment, including
computers, data processing equipment, and computer
software.
d) Specifies that TPP does not include:
i) Consumables with a normal useful life of less than
one year, except for fuels used in the manufacturing
process;
ii) Furniture, inventory, equipment used in the
extraction process, or equipment used to store finished
products that have completed the manufacturing process;
iii) Buildings or components of buildings used solely for
warehousing purposes after completion of the
manufacturing process; and,
iv) TPP used primarily in administration, general
management, or marketing.
e) Defines "primarily" as 50% or more of the time used in
an activity described in specified NAICS Manual Codes (the
lines of businesses that qualify the taxpayer for the SUT
exemption).
f) Defines "fabricating" as making, building, creating,
producing, or assembling components or property to work in
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a new or different manner.
g) Defines "manufacturing" as the activity of converting or
conditioning property by changing the form, composition,
quality, or character of the property for ultimate sale at
retail or use in the manufacturing of a product to be
ultimately sold at retail. Manufacturing includes any
improvements to TPP that result in a greater service life
or greater functionality than that of the original
property.
h) Defines "process" to mean the period beginning at the
point at which any raw materials are received by the
qualified taxpayer and introduced into the manufacturing,
processing, refining, fabricating, or recycling activity of
the qualified taxpayer, and ending at the point at which
the qualified activity has altered TPP to its completed
form. Raw materials are considered to have been introduced
into the process when the raw materials are stored on the
same premises where the qualified activity is conducted.
i) Defines "processing" as the physical application of the
materials and labor necessary to modify or change the
characteristics of the property.
j) Defines "refining" as the process of converting a
natural resource to an intermediate or finished product.
aa) Defines "qualified research" as research that meets the
requirements of Internal Revenue Code Section 174.
bb) Defines "sustainable development equipment" as qualified
manufacturing or research and development equipment that
meets any of the following:
i) Is consistent with meeting the goals and objectives
of the greenhouse gas emissions standards as set forth
Health and Safety Code Division 25.5
ii) Promotes the reduction of wasteful, inefficient,
unnecessary, or uneconomic uses of energy;
iii) Encourages the utilization of cost-effective water
use efficiency practices to curtail the waste of water
and to ensure that water use does not exceed reasonable
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needs.
iv) Promotes the utilization of recycled or reusable
materials in the manufacturing process.
cc) Does not extend the exemption to local taxes.
dd) Denies the exemption if the qualified property is
removed from California or from the exempt use within one
year of the date of purchase.
ee) Requires the purchaser to give the retailer a completed
exemption certificate as may be required by the Board of
Equalization (BOE).
2)Allows a tax credit, under the PIT Law, for SUT paid on
purchases of TPP by a qualified taxpayer for transactions
occurring between January 1, 2010 and January 1, 2013.
a) Specifies that the credit amount is equal to 5% of the
gross receipts or sales price on purchases of TPP by either
of the following:
i) A qualified person for use primarily in
manufacturing, processing, refining, fabricating, or
recycling of property, or
ii) A contractor for use in the performance of a
construction contract for the "qualified person" who will
use the property as an integral part of the
manufacturing, processing, refining, fabricating, or
recycling of property, or as a storage facility for use
in connection with the manufacturing process.
b) Specifies that the credit amount is equal to 6% of the
gross receipts or sales price on purchases of either of the
following:
i) Sustainable development equipment investments of TPP
purchased by a qualified person for use primarily in
manufacturing, processing, refining, fabricating, or
recycling of property; or,
ii) TPP purchased by a qualified person and used
primarily during the research and development process on
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qualified research.
3)Allows a tax credit, under the CT Law, for SUT paid on
purchases of TPP by a qualified taxpayer for transactions
occurring between January 1, 2010 and January 1, 2013.
Specifically:
a) Specifies that the credit amount is equal to 6% of the
gross receipts or sales price on purchases of TPP by either
of the following:
i) A qualified person for use primarily in
manufacturing, processing, refining, fabricating, or
recycling of property, or,
ii) A contractor for use in the performance of a
construction contract for the "qualified person" who will
use the property as an integral part of the
manufacturing, processing, refining, fabricating, or
recycling of property, or as a storage facility for use
in connection with the manufacturing process.
b) Specifies that the credit amount is equal to 5% of the
gross receipts or sales price on purchases of either of the
following:
i) Sustainable development equipment investments of TPP
purchased by a qualified person for use primarily in
manufacturing, processing, refining, fabricating, or
recycling of property; or,
ii) TPP purchased by a qualified person and used
primarily during the research and development process on
qualified research.
4)Provides that the credit, under either the PIT law or CT law,
may only be claimed in three equal amounts over the three
successive tax years beginning with the taxable year 2013.
Allows a carryover of unused credits to the succeeding four
taxable years, if necessary.
5)Does not reduce regular tax below tentative minimum tax (TMT).
EXISTING STATE LAW :
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1)Imposes sales tax on the retail sale of TPP to be used or
consumed in California. Use tax is imposed on the storage,
use or other consumption in California of TPP purchased
outside of California.
2)Allows numerous exemptions from SUT, primarily based upon the
type of TPP.
3)Allows a PIT or CT taxpayer to deduct ordinary and necessary
expenses related to a trade or business but requires a
taxpayer to capitalize the costs of acquiring assets used in
the taxpayer's trade or business that provide
economic benefits for more than one year. Taxpayers recover
their investment in assets through depreciation, which
approximates the useful or economic life of the asset.
Oftentimes, tax incentives, such as accelerated depreciation
or credits, will be enacted that operate as an incentive for
certain behaviors or to reduce the costs of acquiring assets.
4)Does not provide special tax treatment for entities engaged in
manufacturing activities that make purchases of equipment and
other supplies.
5)Provides the SUT credit for purchases of qualified machinery
to be used in an economic development area, except a
Manufacturing Enhancement Area.
6)Allows corporate taxpayers who are members of a combined
reporting group to make a one time, irrevocable assignment of
eligible credits to an eligible assignee. Assigned credits
may reduce tax for taxable years beginning on or after January
1, 2010.
PRIOR STATE LAW : Prior to January 1, 2004, California tax law
contained various tax incentives referred to as the MIC to
encourage investment in manufacturing equipment to be used in
California as follows:
1)Provided for an exemption from the state share of SUT (equal
to 5%) for purchases of manufacturing equipment, or a credit
against the PIT or CT liability (equal to 6%) of the amount
paid or incurred for qualified property placed in service in
California. Specifically:
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a) Defined a "qualified taxpayer" as any taxpayer engaged
in the manufacturing activities described in specific
Standard Industrial Classification (SIC) Manual Codes.
b) Limited the availability of the SUT exemption to a
qualified taxpayer engaged in a new trade or business,
i.e., one that has been conducted by the taxpayer for not
more than 36 months.
2)Defined "qualified property" as equipment used primarily for
manufacturing, refining, processing, fabricating, or
recycling; for research and development; for maintenance,
repair, measurement, or testing of qualified property; and for
pollution control meeting state or federal standards. Special
purpose buildings were also included as qualified property.
3)Provided that the MIC was repealed on the later of January
2001 or on January 1 of the earliest subsequent year if total
manufacturing jobs in California, as determined by the
Employment Development Department (EDD) on the preceding
January 1, did not exceed the total manufacturing jobs in
California on January 1, 1994 by 100,000 jobs.
FISCAL EFFECT : The Board of Equalization (BOE) estimates that
this bill will result in an annual revenue loss of $921 million
due to the SUT exemption. The Franchise Tax Board (FTB) staff
estimates that this bill will result in a revenue loss of $70
million in fiscal year (FY) 2012-13, $270 million in FY 2013-14,
and $385 in FY 2014-15.
COMMENTS :
1)The author states that, "A healthy economy means new jobs,
higher wages and increased entrepreneurial opportunities.
While dealing with a recession, California's leaders must
develop a long-term strategy to capitalize on an eventual
economic recovery. The real issue for the state is not the
choice between cutting programs or increasing taxes, rather it
is how California can attract new business and good quality
jobs. Removing a devastating barrier to manufacturing
investment in the state provides more certainty to business
that those investments are welcome and protected."
2)Proponents of a MIC cite that California is one of only three
states that taxes manufacturing equipment with no credit or
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exemption. They believe that AB 829 will make California more
competitive with many other states, which already offer a
sales tax exemption on such purchases. The proponents are
confident that the implementation of a SUT exemption and a tax
credit will financially benefit the state through the creation
of high wage jobs and intensive capital investment projects.
The proponents also argue that removing barriers to investment
to promote new machinery and equipment purchases in California
will help the state to achieve its goal of reducing global
warming.
3)Opponents of this bill assert that the previous MIC had a
negligible impact on economic growth and business decisions
and failed to meet even the minimal 100,000 jobs threshold.
Furthermore, they argue, the MIC cannot reverse the decline of
manufacturing jobs in California because tax policy
considerations are far outweighed by other cost of doing
business considerations in determining where companies will
choose expand or contract manufacturing operations. The MIC
disproportionately benefits large corporations and rewards
economic activity that would take place anyway. Finally, the
opponents state that the MIC squanders taxpayer dollars that
could be put to more productive uses and suggest that the
state eliminate the CT breaks recently enacted in the last two
budgets and, instead provide an exemption, not a credit, from
sales tax for depreciable manufacturing equipment at no
revenue loss to the state.
4)Background : Prior to January 1, 2004, California tax law
contained various tax incentives referred to as the MIC to
encourage investment in manufacturing equipment to be used in
California. The MIC expired on January 1, 2004 pursuant to a
finding by EDD that total manufacturing jobs on the preceding
January 1 did not exceed the total manufacturing jobs in
California on January 1, 1994 by 100,000 jobs.
a) According to EDD, from the time of implementation of
the MIC in 1994 to January 1, 2002, the net increase in
manufacturing employment was 35,150.
b) According to the Legislative Analyst's Office (LAO),
most studies conducted on manufacturing jobs created by
tax incentives show revenue reductions were greater than
revenue increases.
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c) According to the LAO, industry representatives noted
that a SUT exemption is preferable to an income tax
credit, since it would be less complicated to calculate,
results in less administrative work and auditing, and
would not be limited only to firms with taxable income.
The LAO noted that a partial exemption of the state SUT
may even be preferable in some respects to an income tax
credit as provided under the previous MIC.
5)Prior MIC program and economic activity. As explained in the
LAO's report prepared for this Committee in October 2002,
legitimate arguments may be made both in favor of and against
the basic MIC program. The empirical evidence, however,
suggests that while taxes do influence economic activity,
state-level investment tax credits have little impact on
business decisions relative to other factors. (LAO report, p.
11). Investment tax credits have also been found to have only
small or undetectable effects on investments. One explanation
for this phenomenon is that the benefits of such credits are
passed onto producers of inputs and employees, as opposed to
showing up as increased investment. But based on the EDD
numbers, it appears that the prior MIC may have had a marginal
impact of holding jobs in California or bringing other jobs to
California.
6)How is this bill different from the prior MIC law ? For a
10-year period ending December 31, 2003, the law allowed a SUT
exemption for purchases of equipment and machinery by new
manufacturers, and a tax credit for existing manufacturers'
investment in equipment. This bill is broader than the prior
MIC which, generally, applied only to equipment used by
manufacturers engaged in activities described in specific
codes of the SIC manual. AB 829 applies to manufacturers,
entities engaged in research and development, and TPP
purchased to be used in the research and development (R&D)
process on qualified research. Furthermore, the prior MIC
limited the availability of the SUT exemption only to
qualified taxpayers engaged in a new trade or business, i.e.
one that has been conducted by the taxpayer for not more than
36 months. The prior SUT exemption was intended to assist new
businesses that had no income tax liability. This bill does
not differentiate between start ups and established companies
and is focused on TPP involved or included in the
manufacturing and research, rather than just manufacturing
equipment used by manufacturers. At the same time, AB 829
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contains a limited income tax credit that is available to
taxpayers only for three years (as a "refund" mechanism for
the SUT incurred prior to the operative date of the SUT
exemption).
7)Exemption for R&D property is too broad . The BOE staff notes
that the proposed SUT exemption would apply to virtually any
purchase of TPP that qualifies for an allowable deduction for
income tax purposes by anyone performing the research.
Therefore, property used in research projects in areas such as
pharmaceuticals, nuclear science, biotechnology, within
universities, and marketing would qualify for the proposed SUT
exemption. Committee staff recommends that this bill be
amended to narrow its application only to specific industries,
as identified by reference to NAICS codes.
8)Definition of "qualified person ." BOE staff further notes
that AB 829 does not require a qualified person to be
primarily engaged in manufacturing or software production. By
focusing on the SUT exemption for TPP, this bill simply does
not address the issue of whether the person claiming the
exemption must be primarily engaged in the required
activities. For example, if a grocery store that has a bakery
department buys an oven, would the purchase of the oven
qualify for the exemption? In order to avoid disputes between
taxpayers and tax agencies, Committee staff recommends that AB
829 be amended to require a qualified person to be primarily
engaged in one of the specified activities.
9)Is the proposed SUT exemption for business purchases good tax
policy ? Most economists who study government finance and
taxation agree that inputs to business (e.g., business
equipment, research costs, raw materials, etc.) should be
exempt from sales tax because, generally, the outputs from
business are subject to sales tax, and to tax both business
inputs and business outputs results in double taxation.
Indeed, this bill probably should not be looked upon as a "tax
expenditure" with the intent of stimulating the economy, so
much as a fundamental reform of the tax structure to one more
closely akin to a Value Added Tax (VAT). The VAT, used to
finance most European governments, is economically equivalent
to a sales tax with a broad exemption for business inputs. It
is a sophisticated sales tax that allows VAT-registered
businesses a credit for tax paid on purchases against
liability for tax on sales. At this Committee's informational
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hearing on March 23, 2009, the presenters unanimously agreed
that it is good tax policy to eliminate the SUT on business
purchases. However, the Committee Members were urged against
implementing a VAT in California before a federal VAT has been
enacted.
Furthermore, this bill would be added to a system of credits,
expenditures and exemptions and would not be allowed to
operate as a true VAT. Before passing a measure like this
one, which is arguably good tax policy, the committee may wish
to consider it in the context of the existing tax structure.
In fact, Mr. C. McLure, in his testimony before this
Committee, emphasized that a drastic reduction in the taxation
of business inputs would reduce sales tax revenues and would
require both, the tax base expansion and tax rate increase, to
compensate for the revenue loss. (C. McLure, Jr., Improving
California's Tax System, A testimony before the California
Assembly Revenue and Taxation Committee, March 23, 2009). In
most countries that use a VAT system, for example, the system
includes some taxation of services (although not as inputs to
businesses). Therefore, before California could move in this
direction, it would also need to consider which services-in
addition to goods-should be taxed.
10)Implementation concerns . Both the BOE and FTB staff
identified several implementation problems with this bill.
The BOE staff noted that, currently, most SUT exemptions apply
to the total applicable SUT. Although there are a few partial
exemptions for purchases of teleproduction and farm equipment,
it is difficult for both retailer and the BOE to administer
those partial exemptions. Because this bill proposes two
different exemptions - a 5% and a 6% exemption - it would add
additional complexity to the administration of SUT. In
addition, the FTB staff cited various definitional and
implementation problems and noted that the credit percentages
of 5% and 6^ are reversed in the PIT and CT provisions. If it
is the author's intent for the same credit to apply to both
PIT and corporate taxpayers, the percentages should be changed
for consistency. The Committee staff understands that the
author is working with the FTB to resolve those issues.
11)Notification requirement . This bill does not require the
manufacturer to notify BOE if the property is removed from
California or converted from an exempt use within one year,
and there is currently no means, other than an audit, through
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which BOE would learn of the new sales tax liability.
12)Sunset Date . Committee staff also notes that this bill does
not contain a sunset date, unlike the previous MIC. Arguments
in favor of no sunset include the desire for certainty that is
needed for long-term planning purposes. Arguments in favor of
a sunset include the ability to review the effectiveness of
the program and, if not deemed to be effective, allow for the
program to end; if the program is deemed effective, then its
term can be extended. The Committee staff suggests that this
bill be amended to include a sunset date.
13)Suggested technical amendments . The BOE staff recommended
replacing "6351" with "6001" on page 7, line 19; page 8, line
2; page 11, lines 15 and 37. The FTB staff recommended
replacing the word "and" with "an" on page 11, line 31.
14)Related Legislation . Several bills have been introduced in
the last few legislative sessions that would have reinstated
the expired exemption for specific manufacturing or research
and development property.
SB 699 (Alquist), introduced in the current legislative session,
contains the same provisions as this bill and would allow a
credit for sales or use tax paid on the purchase of tangible
property that is placed in service in the state by qualified
manufacturers. SB 699 is pending in the Senate Committee on
Revenue and Taxation.
AB 1452 (Committee on Budget) Chapter 763, Statutes of 2008,
allows a corporate taxpayer that is a member of a combined
report to make a one time, irrevocable assignment of certain
credits to an affiliated corporation, as defined, for taxable
years beginning on or after July 1, 2008. Assigned credits
can not reduce tax for taxable years beginning before January
1, 2010.
SB 552 (Alquist), introduced in the 2005-06 Legislative
Session, would have provided a state and local SUT exemption
for purchases of materials, supplies, machinery and equipment
used by entities engaged in manufacturing, research and
development, and telecommunications, but would have allowed
taxpayers, beginning on January 1, 2006, to accrue credits on
their purchases that may be redeemed during the first FY of
the state budget when state revenues match expenditures. SB
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552 died in the Senate Revenue and Taxation Committee.
AB 845 (Ridley-Thomas), introduced in the 2005-06 Legislative
Session, would have reinstated the manufacturer's exemption,
provided a conditional sunset date depending on the growth in
employment, and limited the exemption based on the
manufacturers' aggregate gross assets. AB 845 would have also
restored the PIT and CT credit. AB 845 was held under
submission in this Committee.
AB 2076 (Dutton), introduced in the 2003-04 Legislative
Session, would have reinstated the previous MIC only for
electric services. AB 2076 failed passage in this Committee.
AB 1998 (Dutton), introduced in the 2003-04 Legislative
Session, would have reinstated the previous MIC for taxable
years beginning on or after January 1, 2005, and extended the
MIC to activities related to electric service (power
generation, transmission, or distribution). AB 1998 failed
passage in this Committee.
AB 2070 (Houston), introduced in the 2003-04 Legislative
Session, would have reinstated the previous MIC for taxable
years beginning on or after January 1, 2005. AB 2070 failed
passage in this Committee.
SB 1295 (Morrow), introduced in the 2003-04 Legislative
Session, would have reinstated the previous MIC for taxable
years beginning on or after January 1, 2004, and increased the
rate of credit from 6% to 8%. SB 1295 failed passage in the
Senate Revenue and Taxation Committee.
SB 676 (Alquist), Chapter 751, Statutes of 1994, made
clarifying changes to the MIC, and added provisions allowing
the credit for leased property, but only to the lessee.
SB 671 (Alquist) Ch. 881, Stats. 1993, enacted the MIC.
REGISTERED SUPPORT / OPPOSITION :
Support
California Manufacturers & Technology Association (Sponsor)
TechAmerica
Abbott Laboratories
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ACE Clearwater Enterprises
AEM
Support
Alcoa Fastening Systems
Alvaka Networks
AMCC
Anheuser - Busch Companies
Aperio
Apple Computer
Applied Solar
Astute Networks
Atheros
Atel Communications
Axesstel
Baxter Bioscience
Baran Access Solutions
BIOCOM
Blackball
Bloom Energy
Boeing Corporation
California Aerospace & Technology Association
California Association of Sheet Metal and Air Conditioning
Contractors
California Chamber of Commerce
The California Chapters of the National Electrical Contractor
Association
California Health Institute
California Legislative Conference of the Plumbing, Heating and
Piping Industry
California Space Authority
California Taxpayers Association
Cardiodynamics
Chemical Industry Council of California
Cymer
Datron
Dow
DST Output
eBay Inc.
Entropic
Eventful
Falcon Sales
General Dynamics - NASSCO
General Mills
Georgia-Pacific
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Goodrich Corporation
Grocery Manufacturers Association
Hewlett - Packard Company
Honeywell
Industrial Environmental Association
Indyme Solutions
Intel Corporation
IntelliDOT
International Paper
Support
ITECH
Kimberly-Clark Corporation
Kraft Foods
Kratos
Let's Go Robotics
LMI Global
Lockheed Martin
Managed Solution
Manufacturers Council of the Central Valley
Microsoft
MillerCoors
Mitek Systems
National Federation of Independent Business
National Semiconductor
Networkfleet
New United Motor Manufacturing, Inc.
Nextivity
Nik Software
Northrup Grumman
Nu-Trek
NXP Semiconductors
O-I
Ortiva Wireless
Palm
PLX Technology
Proctor & Gamble
ProQuo
Rancho Santa Fe Technology
Sequoia Communications
Silicon Valley Leadership Group
State Building & Construction Trades Council
Synopsys
TechNet
Varian
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Vektrex Electronic Systems
Verari Systems
Verimatrix
VersaCall
ViaSat
Vintalk
Vivid IP
Z Microsystems
ZummCraft
Opposition
American Federation of State, County and Municipal Employees,
AFL-CIO
California Tax Reform Association
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098