BILL ANALYSIS �
AB 780
Page A
Date of Hearing: April 25, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 780 (Charles Calderon) - As Amended: March 15, 2011
Majority vote. Fiscal committee.
SUBJECT : Public contracts: fixed price contracts: sales and
use taxes rate changes: transactions and use taxes
SUMMARY : Requires a "fixed price" contract between a
"government entity" and a contractor to authorize payment for a
change in the contract price attributable to an increase or
decrease in taxes imposed by the Sales and Use Tax (SUT) Law.
Specifically, this bill :
1)Provides that this increase or decrease shall be paid in
accordance with the provisions of the contract governing
payment for changes in the work or, if no provisions are set
forth, payment shall be as agreed to by the parties.
2)Applies only to an increase or decrease in the SUT rate
imposed with respect to the following:
a) Gross receipts from the sale of, and the storage, use,
or other consumption in this state of, the following:
i) Tangible personal property (TPP) obligated pursuant
to a contract entered into for a "fixed price" before the
operative date of the SUT rate change; or,
ii) Materials and fixtures obligated pursuant to a
construction contract entered into for a "fixed price"
before the operative date of the SUT rate change.
b) A lease of TPP, to a "government entity," that is a
continuing sale of the property for any period of time for
which the lessor is obligated to lease the property for an
amount fixed by the lease before the operative date of the
SUT rate change.
c) The possession of, or the exercise of any right or power
over, TPP pursuant to a lease, to a "government entity,"
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that is a continuing purchase of the property for any
period of time for which the lessee is obligated to lease
the property for an amount fixed by a lease entered into
before the operative date of the "increase in the �SUT]
rate."
3)Defines "fixed price" to mean either of the following:
a) "The price or prices specified in the contract or lease,
and the contract or lease does not authorize an increase or
decrease in price due to an increase or decrease in the
�SUT] rate"; or,
b) The prices or price specified in the construction
contract is a lump sum price or a stated unit price or a
guaranteed maximum price, and the construction contract
does not authorize an increase or decrease in price due to
an increase or decrease in the SUT rate.
4)Defines a "government entity" as the State of California, or
any city, county, or city and county, community college
district, school district, county superintendent of schools,
or special district in this state.
5)Applies only to an increase or decrease in the SUT rate that
occurs on or after the bill's effective date.
6)Provides that, if the SUT rate imposed pursuant to Revenue and
Taxation Code (R&TC) Sections 6051.7 and 6201.7, or any
portion thereof, is extended beyond July 1, 2011, the
extension shall be regarded as an increase in the SUT rate for
purposes of this bill.
7)Amends the Transactions and Use Tax (TUT) Law to provide that:
a) The sale or lease of TPP shall not be deemed obligated
pursuant to a contract or lease for any period of time for
which the seller or lessor (instead of either party to the
contract or lease) has the unconditional right to terminate
the contract or lease upon notice.
b) The storage, use, or other consumption of, or possession
of, or exercise of any right or power over, TPP shall not
be deemed obligated pursuant to a contract or lease for any
period of time for which the purchaser or lessee (instead
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of either party to the contract or lease) has the
unconditional right to terminate the contract or lease upon
notice.
8)Provides that, notwithstanding existing law, the state shall
not reimburse any local agency for any SUT revenues lost as a
result of this bill.
9)Provides that, if the Commission on State Mandates determines
that this bill contains costs mandated by the state,
reimbursement to local agencies and school districts shall be
made according to existing law.
EXISTING LAW imposes a:
1)Sales tax on retailers for the privilege of selling TPP,
absent a specific exemption. The tax is based upon the
retailer's gross receipts from TPP sales in this state.
2)Complementary use tax on the storage, use, or other
consumption in this state of TPP purchased from any retailer.
The use tax is imposed on the purchaser, and unless the
purchaser pays the use tax to a retailer registered to collect
the California use tax, the purchaser remains liable for the
tax, unless the use is exempted. The use tax is set at the
same rate as the state's sales tax and must be remitted to the
State Board of Equalization (BOE).
FISCAL EFFECT : The BOE estimates that this bill would have no
impact on existing district tax revenues, since the provisions
would only apply to future district tax rate changes. Committee
staff notes, however, that this bill's "change order" provisions
would increase contract costs for government entities that enter
into fixed price contracts prior to an increase in the state SUT
rate.
COMMENTS :
1)The author has provided the following statement in support of
this bill:
AB 780 would add a provision in the Public Contract Code
that requires fixed price contracts between a contractor
and a government entity to authorize payment for a change
in the contract price that is a result of a future increase
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or decrease in the state sales and use tax rate.
2)This bill is sponsored by the Associated General Contractors
and the Engineering and Utility Contractors Association. The
sponsors state, "AB 780 provides that, in the event of a
future increase or decrease in the state sales tax, public
works contracts that were bid and entered into on a fixed
price basis prior to the tax change must provide for an
adjustment in the contract to compensate the contractor for
the increase that could not be factored into the contract and
to compensate the public agency in the event of a decrease in
the sales tax."
3)Proponents state, "When a contractor and customer enter into a
fixed price contract, the contractor assumes the risk of a
subsequent increase in costs after the contract is signed.
Thus, the potential for a subsequent cost increase is part of
the settled expectations of the parties when negotiating the
contract. Unlike the risk of an increase of the cost of
materials, labor, etc., the risk of a sales tax increase is
not part of the expectations of the parties upon entering the
contract."
4)The BOE notes the following in its staff analysis of this
bill:
a) "Under existing law, when a state sales and use tax rate
increases, a retailer is required to remit tax on all sales
made on or after the date of the rate increase at the rate
in effect at the time of sale, regardless of whether or not
the retailer is locked into a fixed price contract before
the rate increase, and regardless of whether or not the
retailer may reimburse himself or herself for the tax.
Existing state sales and use tax law does not provide an
exemption from the increased sales or use tax on sales made
after a rate increase pursuant to fixed price contracts
entered into prior to a rate increase."
b) "However, a general fixed price contract exemption is
contained in the Transactions and Use Tax Law (and has been
since 1979) for purposes of exempting all sales of property
obligated pursuant to fixed price contracts from the
various city and county tax (district) rate increases when
those contracts are entered into prior to the operative
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date of those rate increases (see Revenue and Taxation Code
Sections 7261(g) and 7262(f)). Under these provisions,
tangible personal property is not deemed obligated pursuant
to fixed price contracts (and the sale or purchase is not
exempted from the district rate increase) if either party
to the contract has the unconditional right to terminate
the contract. Accordingly, if either a purchaser or a
seller may terminate a contract, the contract is not
regarded as a qualifying fixed price contract, and the
exemption from the increased district tax is not
allowable."
c) "The proposed changes in the Transactions and Use Tax
Law would broaden the scope of the existing exemption. A
fixed price contract exemption is designed to protect the
business expectations of the parties when they entered into
the contract and protect them from an unplanned increase in
�the] tax rate. Under a fixed price contract, the
contractor assumes all of the cost variation risk and
reward. If the cost exceeds the contract price, the
difference comes out of the contractor's pocket. Absent an
exemption for fixed price contracts, when state or local
sales and use tax rates increase, for existing contracts
entered into prior to the rate increase, the contractors
are liable for the increase in the sales and use tax rate
on any purchases and sales made pursuant to the contract on
or after the date of the rate change. However, due to the
nature of a fixed price contract, the contractor may not
pass that increase on to the customer or recoup his or her
costs in any other manner. Consequently, the contractor
alone must bear the out-of-pocket cost of the rate
increase. The Transactions and Use Tax Law provides a
remedy to this, by allowing an exemption from the local
district rate increase, �for] certain sales made after the
rate increase pursuant to fixed price contracts entered
into prior to the rate increase."
d) "The changes proposed in this bill to the Transactions
and Use Tax Law were requested by the sponsors, as they
indicate that currently, government entities may not enter
into contracts for which they do not have the unconditional
right to terminate the contract. Consequently, the existing
district tax exemption would never apply to contracts with
government entities, since the law is specific that neither
party may have the unconditional right to terminate the
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contract in order for the exemption to apply."
e) "Enactment of these changes would assure that a
contractor's liability for transactions and use taxes in
connection with fixed price contracts or leases entered
into prior to a local district rate increase would be
limited to the tax rate in effect at the time the
contractor and his or her customer entered into the
contract."
5)Committee Staff Comments:
a) Background : On February 20, 2009, Governor
Schwarzenegger signed into law AB 3 X3 (Evans), Chapter 18,
Statutes of 2009. Among other things, AB 3 X3 temporarily
increased the General Fund SUT rate by 1% effective April
1, 2009. Unlike prior bills increasing the SUT rate, AB 3
X3 did not provide an exemption for sales of TPP obligated
pursuant to fixed price contracts entered into before the
rate increase.<1>
Instead of providing an exemption for sales of TPP
obligated under a fixed price contract, this bill would
allow contractors with fixed price public contracts to
obtain a change order compensating them for an
unanticipated increase in the state SUT rate. This bill
would also ostensibly entitle government entities to a
reduction of the fixed contract price in cases where the
state SUT rate is reduced.
b) Outstanding issues : Committee staff has identified the
following technical concerns with this bill:
i) What happens in the case of a SUT rate reduction ?
This bill applies to any increase or decrease in the SUT
rate imposed with respect to TPP obligated pursuant to a
fixed price contract with a government entity. (Page 3,
lines 14-18). This bill further specifies that TPP shall
-------------------------
<1> Past SUT rate increases have been accompanied by legislative
provisions exempting fixed price contracts from the rate
increase. For example, in July 1991, California increased its
state SUT rate in response to budget shortfalls, and enacted
fixed price contract exemption provisions to cover the increase.
In addition, BOE notes that a general fixed price contract
exemption is also contained in the TUT Law.
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not be considered obligated pursuant to a contract "for
any period of time for which the contractor has the right
to terminate the contract . . . ." (Page 3, lines
21-24). Thus, if a contractor possesses the right to
terminate the underlying agreement, the contractor would
not be entitled to an additive change order following a
SUT rate increase. Instead, the contractor would be
given the choice of either bearing the cost of the SUT
increase or terminating the agreement.
It is unclear to Committee staff, however, what would
happen in the case of a SUT rate reduction. Given that
this bill refers to both increases and decreases in the
SUT rate, government entities would seemingly be entitled
to a change order lowering the contract price in such
circumstances. Again, however, this bill refers to TPP
"obligated pursuant to a contract" and states that TPP
shall not be considered obligated when the contractor has
the right to terminate the agreement. As such, would
government entities be entitled to a reduction in the
contract price in cases where the contractor has
termination rights? It seems inherently inequitable to
predicate the government's right to a change order on the
contractor's ability to terminate the contract.
ii) What happens if the temporary 1% SUT component is
extended beyond July 1, 2011 ? The temporary 1% SUT
increase is currently set to expire on July 1, 2011.
This bill provides, however, that if the 1% component is
extended beyond July 1, 2011, this extension shall be
regarded as an increase for purposes of this bill. This
seems odd given that this bill would only become
operative on January 1, 2012. Specifically, it is not
clear to Committee staff how this provision would
operate. Let's assume a public works contractor enters
into a fixed price contract on May 1, 2011. Let's
further assume that, thereafter, the Legislature acts to
extend the temporary 1% SUT component for two years
beyond July 1, 2011. Finally, let's assume that the
contractor closes out its public contract in July 2012.
Under this scenario, would the contractor be entitled to
an additive change order covering the entire period from
July 1, 2011 through July 2012? Or would the contractor
only be entitled to a change order covering the period
from this bill's effective date (January 1, 2012) through
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July 2012? Moreover, would an attempt to retroactively
impose a change order requirement constitute the improper
impairment of an existing contract? To address these
issues and alleviate uncertainty, Committee staff
suggests eliminating these provisions, and narrowing the
scope of this bill to operate prospectively.
iii) This bill's definition of a "fixed price" contract
creates an internal inconsistency . As noted above, this
bill requires certain "fixed price" contracts to
authorize payment for a change in the contract price
attributable to an increase or decrease in the state SUT
rate. At the same time, this bill defines a "fixed
price" contract as one that does not authorize an
increase or decrease in price due to an increase or
decrease in the SUT rate. In light of this
contradiction, the author may wish to amend this bill's
definition of a "fixed price" contract.
Moreover, it is not entirely clear what types of
contracts this bill's definition of "fixed price" is
designed to cover. This bill defines a "fixed price"
contract as one that "does not authorize an increase or
decrease in price" due to a change in the SUT rate.
Clearly, this would seem to cover standard fixed price
contracts where the question of a SUT rate increase is
simply not addressed. But what would happen, under this
bill, if a public works contract explicitly provided that
the contractor bore the risk of an increase in the
applicable SUT rate? Would this bill's provisions render
the clause invalid, despite the fact that both parties
contemplated the issue and agreed to be bound by the
contract's terms?
Committee staff is available to work with the author to
address these and any other technical issues identified
in the future
c) Is this bill's approach preferable to the standard
exemption provisions passed with prior SUT rate increases ?
Past SUT rate increases have been accompanied by
legislative provisions exempting fixed price contracts from
the rate increase. Such provisions were designed to
protect the expectations expressed by both contracting
parties. Specifically, under standard exemption
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provisions, the contractor would continue to bear the same
SUT burden (and, all things being equal, maintain the same
profit margin) and the government entity would experience
no change in its bargained-for contract price. Of course,
such exemption provisions necessarily entailed the loss of
certain SUT revenues. This bill attempts to address the
same fundamental problem without causing a similar
reduction in SUT moneys. Specifically, this bill would do
nothing to change the underlying SUT rate applied to fixed
price contracts, but would entitle public works contractors
to an additive change order in cases where the state SUT
rate unexpectedly increases. Thus, while this bill serves
to preserve the expectations of the public works
contractor, it necessarily also serves to disrupt the
expectations of the government entity by shifting the risk
of a SUT rate increase to that government entity. Thus,
the Committee is essentially presented with the question of
whether it is preferable to preserve the expectations of
both parties though an exemption that results in SUT
revenue losses, or whether it is preferable to shift the
risk to government entities, which would potentially result
in those entities paying more for public works contracts.
d) Related legislation :
i) AB 1523 (Charles Calderon), of the 2009-10
Legislative Session, would have relieved parties who
entered into a fixed price contract or a fixed price
lease prior to the 1% SUT increase. AB 1523 was held in
the Assembly Appropriations Committee.
ii) AB 2060 (Charles Calderon), of the 2009-10
Legislative Session, contained provisions nearly
identical to those in this bill. Governor Schwarzenegger
vetoed AB 2060, noting:
First, I can understand the impact of new taxes on
businesses and the frustration that contractors may
have when they are not exempted from sales tax
increases. This is one of the reasons I have
continued to oppose raising additional taxes because
it slows our state's economic recovery efforts and
dampens job creation. However, this bill seeks an
overly broad and permanent exemption which effectively
shifts the burden of paying both state and local sales
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tax increases from the contractor to the government
entity and ultimately, on California's taxpayers. In
addition, I believe this bill is unnecessary because
current law allows an exemption to fixed-price
contracts for city and county tax increases, and such
exemptions have been allowed on past statewide sales
and use tax increases. I believe this process is
appropriate and does not affect district tax revenues,
as this bill would propose to do.
REGISTERED SUPPORT / OPPOSITION :
Support
Associated General Contractors (co-sponsor)
Engineering and Utility Contractors Association (co-sponsor)
California Chapter of the American Fence Association
California Fence Contractors' Association
California Landscape Contractors Association
California Legislative Conference of the Plumbing, Heating and
Piping Industry
California State Council of Laborers
California Taxpayers' Association
Engineering Contractors' Association
Flasher Barricade Association
Golden State Builders Exchange
Marin Builders' Association
National Electrical Contractors Association (California
chapters)
Opposition
None on file
Analysis Prepared by : M. David Ruff / REV. & TAX. / (916)
319-2098