BILL ANALYSIS                                                                                                                                                                                                    Ó




                                                                  AB 780
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          Date of Hearing:  May 2, 2011

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                Henry T. Perea, Chair

               AB 780 (Charles Calderon) - As Amended:  March 15, 2011

                                      VOTE ONLY

          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.  










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             c)   The possession of, or the exercise of any right or power 
               over, TPP pursuant to a lease, to a "government entity," 
               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 ÝSUT] 
               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 
               ÝSUT] 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 









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               be deemed obligated pursuant to a contract or lease for any 
               period of time for which the purchaser or lessee (instead 
               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 









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               and a government entity to authorize payment for a change 
               in the contract price that is a result of a future increase 
               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 









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               various city and county tax (district) rate increases when 
               those contracts are entered into prior to the operative 
               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 
               Ýthe] 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, Ýfor] 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 









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               government entities, since the law is specific that neither 
               party may have the unconditional right to terminate the 
               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 
               -------------------------
          <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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                 fixed price contract with a government entity.  (Page 3, 
                 lines 14-18).  This bill further specifies that TPP shall 
                 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 









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                 only be entitled to a change order covering the period 
                 from this bill's effective date (January 1, 2012) through 
                 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 









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               protect the expectations expressed by both contracting 
               parties.  Specifically, under standard exemption 
               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 









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                    overly broad and permanent exemption which effectively 
                    shifts the burden of paying both state and local sales 
                    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)
          Asphalt Pavement Association of California
          Associated Builders and Contractors of California
          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 Nevada Cement Association
          California Precast Concrete Association
          California State Council of Laborers
          California Taxpayers' Association 
          Concrete Contractors Association
          Engineering Contractors' Association
          Engineering & Utility 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 










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