BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB x1 40 HEARING: 9/9/11
AUTHOR: Fuentes FISCAL: Yes
VERSION: 9/8/11 TAX LEVY: Yes
CONSULTANT: Miller
STATE TAX POLICY
Makes six changes to personal income, corporation and sales
and use tax law.
Background and Existing Law
I. Apportionment Formula . A multistate firm generates
profits based on its operations in many states, and has a
right under the U.S. Constitution to divide income between
these states for tax purposes, a process known as
"apportionment," to ensure that no state taxes more than
its fair share of that firm's income. The 1957 Uniform
Division of Income for Tax Purposes Act (UDITPA) created
the three-factor double weighted apportionment framework to
capture the factors of production; specifically, property
to represent capital, payroll to represent labor, and sales
to represent market presence.
In 1966, California adopted UDITPA where each of the three
factors had an equal weight of one-third. In 1993,
California adopted a "double-weighted" formula, reducing
the formula's weights on both property and payroll from
33.3% to 25%, but increasing the weight on sales from
33.3% to 50%, thereby reducing that share of a the firm's
income apportioned to states where it employs relatively
more people and produces more goods in the state compared
to its sales. Under the change, a firm with all or most of
its production and payroll in California, but a smaller
share of its sales, benefits from the change, whereas a
firm that either employs few or no people or owns little to
no property here, but sells into California, pays more tax.
Many other states also changed the apportionment weights
in the 1980s and 1990s to induce firms to maintain or
relocate facilities and employees in the state.
Starting in 2011, California's apportionment formula allows
AB 40x -- 9/8/11 -- Page 2
multi-state firms to annually choose either the above
apportionment formula or to use only its sales, commonly
known as the "single sales factor."
Each of the factors in the apportionment formula is a
fraction: the numerator is the value of the item in
California and the denominator is the value of the item
everywhere. The property factor generally includes all
tangible property owned or rented during the taxable year.
The payroll factor includes all forms of compensation paid
to employees. The sales factor includes all gross receipts
from the sale of tangible and intangible property.
Since 1993, the apportionment formula for most taxpayers
has been a three-factor double weighted formula consisting
of payroll, property and double weighted sales as
illustrated below.
---------------------------------------------------------
| Average | + |Average |+ |Californ|) | California |
|Californi| |Californ| (2x| ia | = |Apportionment|
| a | | ia | | Sales | | Formula |
|Property | |Payroll | | | | |
|---------+----+--------+------+--------+---+-------------|
| Average | |Average | | Total | | |
| Total | | Total | | Sales | | |
|Property | |Payroll | | | | |
---------------------------------------------------------
The only exceptions to this rule are four industries:
agriculture, extraction, including oil, savings and loan
and financial services. These four industries must use the
three factor formula without the double weighted sales
factor.
Beginning in 2011, as illustrated below, a qualified
business may elect to use a single sales factor based on
100 percent sales, instead of the three factor formula
described above. The industries listed above still do not
qualify for the single sales factor.
---------------------------
|Californi| = |California |
| a Sales | |Apportionmen|
| | | t Formula |
|---------+----+------------|
AB 40x -- 9/8/11 -- Page 3
| Total | | |
| Sales | | |
---------------------------
II. Sales & Use Tax Exemption. Existing law provides no
special tax treatment to entities engaged in manufacturing
or software production for purchases of equipment and other
supplies. Business entities engaged in manufacturing,
research and development, and software producing activities
that make purchases of equipment and supplies for use in
the conduct of their manufacturing and related activities
are required to pay sales and use tax on their purchases to
the same extent as any other person either engaged in
business in California.
The state sales and use tax rate is 8.25% as detailed
below. Cities and Counties may increase the sales and use
tax rate up to 2% for either specific or general purposes
with a vote of the people.
AB 40x -- 9/8/11 -- Page 4
---------------------------------------
|4.75%| State | Goes to State's |
| | | General Fund |
| | | |
|-----+---------+-----------------------|
|0.25%| State | Goes to State's |
| | | General Fund |
| | | |
|-----+---------+-----------------------|
|0.25%| State | Goes Towards State's |
| | | Fiscal Recovery Fund, |
| | | to pay off Economic |
| | | Recovery Bonds (2004) |
|-----+---------+-----------------------|
|0.50%| State | Goes to Local Public |
| | |Safety Fund to support |
| | |local criminal justice |
| | | activities (1993) |
|-----+---------+-----------------------|
|0.50%| State | Goes to Local Revenue |
| | | Fund to support local |
| | | health and social |
| | | services programs |
| | | (1991 Realignment) |
|-----+---------+-----------------------|
|1.00%| Local | 0.25% Goes to county |
| | | transportation funds |
| | |0.75% Goes to city and |
| | | county operations |
|-----+---------+-----------------------|
|Total| | |
| : | | |
|-----+---------+-----------------------|
|7.25%|State/Loc| Total Statewide Base |
| | al |Tax Rate |
| | | |
---------------------------------------
For a ten-year period ending December 31, 2003, California
law provided a partial (General Fund only) sales and use
tax exemption for purchases of equipment and machinery by
new manufacturers, and income and corporation tax credits
for existing manufacturers' investments (MIC) in equipment
AB 40x -- 9/8/11 -- Page 5
(SB 671, Alquist, 1993). The bill provided an exemption to
the state tax portion for sales and purchases of qualifying
property, and the income tax credit was equal to six
percent of the amount paid for qualified property placed in
service in California. Qualified property was depreciable
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.
The MIC had a conditional sunset date which required that
the provisions sunset in any year following a year when
manufacturing employment (as determined by the Employment
Development Department) did not manufacturing employment by
more than 100,000. On January 1, 2003, manufacturing
employment, less aerospace, did not exceed the 1994
employment number by more than 100,000 (it was less than
the 1994 number by over 10,000), and therefore the MIC and
partial sales tax exemption sunset at the end of 2003.
III. Standard Deduction. Existing state and federal law
allow taxpayers who do not elect to itemize their
deductions for the taxable year to deduct from adjusted
gross income a basic standard deduction amount in
calculating their taxable income. The law provides for an
annual indexing of the standard deduction. The current
rates are approximately $3,500 for individual filers and
$7,000 for joint filers. The standard deduction is a "tax
preference item" under the alternative minimum tax (AMT)
which means it is used in the calculation of AMT to ensure
that taxpayers do not escape taxation.
IV. Personal Income Tax. Under existing law, the personal
income tax imposes taxes based on taxable income for both
individuals and corporations of rates up to 10.3%.
Business income, under the personal income tax, is income
of a taxpayer from a trade or business whether conducted by
the taxpayer or by a pass through identity in which the
taxpayer is a shareholder.
AB 40x -- 9/8/11 -- Page 6
V. Corporation Tax. The state's corporation tax law
imposes taxes measured by income at a rate of 8.84%. The
law also imposes a minimum franchise tax of $800 for every
corporation in this state for the privilege of doing
business in this state and on all Limited Liability
Corporations (LLCs).
Proposed Law
I. Apportionment formula . Assembly Bill 40x amends the
apportionment formula in three ways:
1. Single sales factor : This bill makes the single
sales factor apportionment formula mandatory for all
taxpayers except those in a qualified business
activity (extractive, agricultural, savings and loans,
and banks and financial services) for taxable years
beginning on or after January 1, 2011.
2. Elective single sales factor & 50% assignment of
intangibles to this state . As introduced, SB 116
required all taxpayers to use the mandatory single
sales factor. As amended, this bill allows taxpayers
to choose the 3-factor formula only when it results in
a greater amount of tax owed.
3. Intangible sourcing. 50/50 market costs of
performance . SB 858 (Committee on Budget, 2010)
requires that companies that elect single sales factor
choose the "market" rule and source all intangible
property to this state and taxpayers that elect to pay
taxes under the 3-factor formula source intangible
property to where the goods originate. AB 40x allows
cable companies to choose either that have a "minimum
investment" in this state of $250 million or more, to
assign 50% of their intangible property to "this
state" under the market rule and 50% shall "not be
assigned to this state."
II. Manufacturing equipment Sales Tax exemption . Current
AB 40x -- 9/8/11 -- Page 7
law provides that all tangible personal property in this
state is subject to the sales and use tax.
AB 40x creates a new manufacturing sales & use tax
exemption. In general, manufacturing firms would be
eligible for a 1 percent exemption from state sales and use
tax on equipment purchases. Start-up firms, conducting
activities in this state for three or fewer years, would be
eligible for a 3.94 percent exemption from the state
portion of the sales and use tax.
The exemptions in the bill are available to manufacturing
firms and software publishers. Qualified businesses are
those in manufacturing industries such as food and
beverage; textiles and apparel; wood and paper products;
chemicals, plastics and rubber; metal fabrication and
machinery; transportation and related, and computer,
electronics and software. The exemption is available only
to corporations that which are allowed to elect single
sales factor for purposes of income apportionment. AB 40X
also requires that:
Equipment that would qualify for the exemption includes
equipment when used primarily (50 percent or more), (1) In
any stage of manufacturing, processing, refining,
fabricating, or recycling of any tangible personal
property; (2) For research and development; (3) To
maintain, repair, measure or test tangible personal
property; and, (4) In the performance of construction
conducted in connection with manufacturing or research and
development.
III. Standard deduction. AB 40x increases the standard
deduction for taxpayers who do not itemize deductions under
the personal income tax by $1,000 for single filers and
$2,000 for joint filers for tax years beginning on and
after January 1, 2012.. Thus, the amount of the standard
deduction would rise to approximately $4,780 for single
filers and $8,540 for joint filers. (The standard deduction
is annually computed based on changes in the cost of living
and 2012 levels have not yet been established.)
IV. Personal Income Tax. AB 40x excludes 10% of the first
$50,000 (or a maximum of $5,000) of the business income of
a taxpayer for tax years beginning on or after January 1,
2012.
AB 40x -- 9/8/11 -- Page 8
V. Corporation Tax. AB 40x reduces the corporation tax
rate by % for the first $50,000 in income for tax years
on and after January 1, 2012 for most corporations. A rate
of 8.34% would apply to the first $50,000 and the current
rate of 8.84 % would apply to income $50,000. The reduction
would not apply to corporations whose income and
apportionment factor data are required to be included in a
combined report, such as large multistate and multinational
corporations. (Combined reporting is required of multistate
companies and groups of affiliated corporation that operate
as one integrated business, and results in treating the
operation as a single taxpayer.)
AB 40x also reduces the minimum franchise tax under the
corporation tax from the current level of $800 to $750
annually for tax years beginning on or after January 1,
2012. The minimum franchise tax is paid by all corporations
with an otherwise computed corporation tax liability of
less than this amount.
VI. Trigger. AB 40x directs the Franchise Tax Board and
the Board of Equalization to report to the Department of
Finance whether the bill resulted in a revenue change
during the 2012-13 fiscal year relative to the amount of
revenue that would have been raised absent the enactment of
the bill. The Director of Finance would adjust the general
sales and use tax exemption in a manner that would result
in no gain or loss in state tax revenue in 2015-16 due to
this act.
State Revenue Impact
According to the Department of Finance, AB 40x would have
the following revenue impact:
----------------------------------------------------------------------
|Revenue Impact of Jobs Proposal - all Provisions Operative for 1/1/12 |
| except SUT equipment exemption (Dollars in Millions) |
----------------------------------------------------------------------
|-------------------------------------------+-----+-----+-----+-------|
| |2011-|2012-|2013-| 3 - |
| | 12| 13| 14| year |
| | | | | total |
|-------------------------------------------+-----+-----+-----+-------|
AB 40x -- 9/8/11 -- Page 9
|8.34% Corporate tax rate for the first | -$9| -$18| -$20| -$46|
|$50,000 of SNI - No lower rate for | | | | |
|combined report returns | | | | |
|-------------------------------------------+-----+-----+-----+-------|
|PIT 10% exemption of first $50,000 of |-$149|-$255|-$269| -$673|
|positive business income | | | | |
|-------------------------------------------+-----+-----+-----+-------|
|Decrease Minimum Tax from $800 to $750 | -$28| -$59| -$67| -$154|
|-------------------------------------------+-----+-----+-----+-------|
|Increase Standard Deduction by 27% |-$180|-$306|-$317| -$804|
| | | | | |
|-------------------------------------------+-----+-----+-----+-------|
|Mandatory SSF - with Cable Carve out and | $445| $894| $964| $2,303|
|option to use double-weighting if it | | | | |
|results in higher tax | | | | |
|-------------------------------------------+-----+-----+-----+-------|
|SUT manufacturer's equipment exemption 1% | -$91|-$299|-$323| -$713|
|(3.9735% for start-ups), operative 3/1/12 | | | | |
|-------------------------------------------+-----+-----+-----+-------|
|Total | -$12| -$44| -$31|-$87 |
| | | | | |
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Comments
1. Purpose of the bill . This bill is one of Governor
Brown's "California Jobs First plan" intended to create
jobs in this state. The Governor stated: "Boosting job
growth in California is a top priority, and this proposal
is a critical step in making sure the state does everything
it can to support local job creation," said Brown. "Our
state has added 116,000 jobs since January, but we must do
more to build economic momentum. This legislation would
expand a currently existing job credit to make it more
effective while adding new tax incentives for growth in the
manufacturing sector."
2. Clarifying amendments. The committee may wish to
consider the following technical amendments to this bill:
1. On page 13, between lines 14 and 15, insert:
"nothing in this section shall be interpreted to allow
any person who is not in an enumerated NAICS code a
sales and use tax exemption pursuant to this section."
This amendment would eliminate any ambiguity with
regards to the administrative implementation of this
AB 40x -- 9/8/11 -- Page 10
bill.
2. The standard deduction language has two technical
errors which can be corrected on page 23, line 20,
insert "and before the income year referred to in
subparagraph (A) of paragraph (1) of subdivision (f).
3. Insert a severability clause on page 24, between
lines 14 and 15: (4) If this subdivision, or any
portion of this subdivision, is held invalid, or the
application of this subdivision to any person or
circumstance is held invalid, the tax rate specified
in paragraph (2) of subdivision (f), without regard to
the amendments to that paragraph by the act adding
this subdivision, shall apply.
3. Movie credit? AB 40x contains no language to either
provide for the movie credit or a mechanism by which to
specifically pay for it through the trigger.
Assembly Actions
Not relevant to the bill as amended September 8, 2011
Support and Opposition (9/9/11)
Support : Unknown.
Opposition : Unknown.