BILL ANALYSIS Ó SENATE GOVERNANCE & FINANCE COMMITTEE Senator Lois Wolk, Chair BILL NO: AB 780 HEARING: 6/29/11 AUTHOR: Calderon FISCAL: Yes VERSION: 5/10/11 TAX LEVY: No CONSULTANT: Grinnell FIXED PRICE CONTRACTS Alters contractor payments when the sales and use tax rate changes. Background and Existing Law State law imposes the sales tax on every retailer "engaged in business in this state" that sells tangible personal property to collect the appropriate tax from the purchaser and remit the amount to the Board of Equalization (BOE). The Legislature increased the statewide sales and use tax rate from 5% to 6% between April 1, 2009 and July 1, 2011 (ABx3 3, Committee on Budget, 2009), but did not include an exemption for property obligated pursuant to a fixed-price contract between a contractor and a government entity, who agrees to pay the contractor a specific price for materials procured in the course of constructing a project. Previous to ABx3 3, the Legislature exempted sales of tangible personal property obligated pursuant to fixed- price contracts and fixed-price leases from the rate increase, both for the general sales tax increase in 1991, and for the sales tax increase after the Loma Prieta earthquake in 1989. Cities and counties may impose their own sales taxes, known as transactions and use taxes, for general or specific purposes. The taxes range from 1/10% to 2.5%. Since 2009, voters in about 30 different local jurisdictions have approved new district taxes within their local areas. Altogether, voters have approved over 100 district taxes that are levied in various cities and counties throughout California. The Transactions and Use Tax Law exempts all sales of property obligated pursuant to fixed price contracts from the various city and county tax rate increases when those contracts are entered into prior to the operative date of those rate increases. Tangible AB 780 - 5/10/11 -- Page 2 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. AB 780 - 5/10/11 -- Page 3 Proposed Law Assembly Bill 780 provides that the contractor in a fixed price contract is entitled to an increase in payment for a change in the contract price attributable to an increase in the state sales and use tax rate. The bill also provides that the government entity is entitled to a reduction in payment when the sales and use tax rate is reduced. Increases or decreases shall be made in accordance with the contract, or by agreement if the contract does not so provide. The bill applies only when the contract is entered into prior to the rate increase, and does not apply to property, materials, or fixtures obligated pursuant to a contract during the period of time contractor has the right to terminate the contract unconditionally or upon notice, whether or not the right is exercised. The measure similarly applies to leases that are continuing sales and purchases of property. The bill applies only to contracts entered into on or after its effective date. The measure also defines some of its terms. AB 780 changes the exemption in the Transactions and Use Tax law to state that property is deemed obligated whenever the contractor does not have the unconditional right to terminate the contract, instead of when both the public agency and the contractor lack that right. State Revenue Impact BOE estimates no revenue effect. Comments 1. Purpose of the bill . According to the Author, "AB 780 will provide fairness to contractors and public agencies who entered into fixed price construction contracts prior to any change in the state sales tax rate. AB 780 provides that, in the event of a future increase or decrease in the state sales tax, public works fixed price contracts that were entered into prior to the tax change must provide for an adjustment in a contract to compensate the contractor AB 780 - 5/10/11 -- Page 4 for the increase if it was not factored into the contract. If the tax is decreased, the contractor will compensate the public agency. Because this provision was not included in the current sales tax increase, contractors have been forced to absorb the additional tax. A similar statute was enacted in 1989 and 1991 when the sales tax was temporarily increased. This bill will only apply to any future adjustment to the sales tax and has no current or future revenue loss to the state." 2. Surprise ! Contractors in fixed price contracts bid on projects based on its estimated costs of time and materials necessary to complete the job. When the state increases the sales tax rate on property necessary to complete the project, the contractor unexpectedly has to eat the difference due to the now higher costs that can't be passed on because the parties fixed the price of the job in the contract. Conversely, the contractor may receive a windfall if the state decreases the rate after signing the contract but before he or she procures the materials. AB 780 resolves this difference by providing for an increase or decrease in payment whenever the rate changes after the contractor buys the property. 3. Two to tango . AB 780 changes transactions and use tax law that allows the current exemption from local tax increases. Currently, the exemption applies only when both the contractor and the government lack the right to terminate the contract. Sponsors state that governments no longer enter contracts that lack the right to terminate, so the exemption will never apply. AB 780 revises this requirement to state that the exemption applies only when the contractor lacks the right to cancel the contract. 4. Have we met before ? Last year, the Committee approved AB 2060 (Calderon), which exempted fixed price contracts with government agencies from sales and use tax increases. At the time, the Committee was concerned that the measure exempted only one class of taxpayers, contractors with fixed price contracts, when many other classes of taxpayers that had reasonably relied on a lower sales and use tax rate when signing contracts or making investments were not afforded a similar exemption. The Senate Appropriations Committee then amended AB 2060 into a measure similar to AB 780. However, Governor Arnold Schwarzenegger vetoed AB 2060, stating: AB 780 - 5/10/11 -- Page 5 "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 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. For these reasons, I am unable to sign this bill." 5. Amendment needed . To ensure that public agencies can access information to verify contractors' cost changes resulting from sales and use tax rate changes, the Committee should amend AB 780 on page 3, line 19, after "parties.", to add: "The government entity may require the contractor to submit invoices for those tools, materials, or supplies specifically purchased for actual incorporation into the public works contracts, including, but not limited to, tools, materials, or supplies consumed solely for use in the contract entered into by the government agency and contractor." Assembly Actions Assembly Revenue and Taxation 8-0 Assembly Appropriations 17-0 Assembly Floor 78-0 Support and Opposition (6/22/11) Support : Associated Builders and Contractors of California; Associated General Contractors; California AB 780 - 5/10/11 -- Page 6 Landscape Contractors Association; California Nevada Cement Association; California Precast Concrete Association; California Taxpayers Association; Concrete Contractors Association; Engineering and Utility Contractors Association. Opposition : Unknown.