BILL ANALYSIS Ó
Senate Appropriations Committee Fiscal Summary
Senator Christine Kehoe, Chair
AB 1500 (J. Perez) - Mandatory single sales factor
apportionment: Middle Class Scholarship Fund.
Amended: May 25, 2012 Policy Vote: G&F n/a
Urgency: Yes Mandate: No
Hearing Date: August 16, 2012
Consultant: Mark McKenzie
SUSPENSE FILE.
Bill Summary: AB 1500, an urgency measure, would require
multistate companies to apportion income to California using the
single sales factor methodology, except as specified. The bill
would also revise rules for assigning sales to California, and
require revenue in an amount equal to the estimated amounts
derived from these tax changes to be deposited into a new Middle
Class Scholarship Fund for purposes of providing scholarship
grants to qualified students pursuant to AB 1501 (J. Perez).
Fiscal Impact:
The Franchise Tax Board (FTB) estimates that this bill
would result in tax revenue gains of $1.2 billion in
2012-13, $950 million in 2013-14, and $950 million in
2014-15 (General Fund). The bill would require the transfer
of an equivalent amount to the Middle Class Scholarship Fund
from the General Fund.
Potential additional General Fund impact in the hundreds of
millions of dollars annually if the new revenue generated by
the bill is subject to Proposition 98 minimum funding
guarantees, and net revenues generated by the bill's tax
changes, after deduction of amounts dedicated to Proposition
98, are insufficient to offset amounts annually transferred
to the Middle Class Scholarship Fund.
Potential substantial cashflow deficits to the extent that
revenues are transferred to the Middle Class Scholarship
Fund on September 1 exceed amounts available to cover
various mandated state payments. This could also create
additional General Fund impacts related to short term
borrowing costs.
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Background:
Apportionment Formula. A multistate firm generates profits
based on its operations in multiple states and has a right under
the U.S. Constitution to divide, or apportion, income among
those states for tax purposes to ensure that each state only
taxes its fair share of the firm's income. Since 1993, state
law has generally required multistate firms to use a three
factor formula to apportion income associated with a company's
payroll, property, and sales (with a double-weighted sales
factor) to California for purposes of state taxation, except for
companies that derive more than 50 percent of income from
specified activities (extraction, agriculture, savings and loan,
and banks and financials). These companies use the three factor
formula but the sales factor is not double-weighted. The
double-weighted sales formula reduces the 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 formula, a firm with all or most of its
production and payroll in California, but a smaller share of its
sales, benefits, 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 changed the
apportionment weights in the 1980s and 1990s to induce firms to
maintain or relocate facilities and employees in the state.
The February 2009 state budget agreement included provisions
that revised the formula that multistate firms use to determine
the share of total income that is taxable in California (ABx3
15, Krekorian, and SBx3 15, Calderon). As noted above, firms
previously used a weighted average of their California sales,
property, and payroll compared to its totals. Starting in 2011,
state law allows multistate firms to annually choose between
either the three factor, double-weighted sales apportionment
formula or to use only its sales factor, while ignoring property
or payroll factors, commonly known as the "single sales factor,"
to determine income apportioned to California for purposes of
taxation.
The Legislative Analyst's Office (LAO) report, Reconsidering the
Optional Single Sales Factor (May 26, 2010), recommends that
"the state require all firms to use the single sales factor,
which would help the state's competitiveness while limiting the
cost to the budget." The LAO report indicates that the elective
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single sales factor allows the taxpayer to essentially choose
the tax it pays, creating an inequity allowing taxpayers who
operate in more than one state two different ways to calculate
their income. Multistate firms can choose the formula that will
yield a lower tax each year, while businesses that operate
wholly inside California have no such option. This disparate
treatment puts the wholly in-state businesses, as well as
balanced multistate firms that would pay roughly the same taxes
under either formula, at a competitive disadvantage to its
multistate competitors that are primarily based out of state,
which tend to be larger companies. Furthermore, since the
single sales factor methodology is the dominant apportionment
formula among large states, making the single sales factor
mandatory in California would remove incentives for firms to
base operations elsewhere. To this point, the LAO report notes
that conformity with other large states' apportionment formulas
would prevent California firms from being placed at a
competitive disadvantage. While this bill is intended to remove
competitive barriers and encourage investment in California, the
state may lose some investments by those firms that would have a
higher tax liability as a result of this bill to the extent that
the benefits of current law would encourage investment in
California by those firms. Staff notes that 24 other states
have implemented or are in the process of phasing in a single
sales factor apportionment methodology. Among these, 18 states
require the use of a single sales factor and only Missouri
allows an annual election of either the single sales factor or
the traditional three factor formula.
Intangible Sourcing. As part of the budget agreement of 2010
(SB 858, Committee on Budget & Fiscal Review, Chap 721/2010),
taxpayers electing the three-factor, double-weighted sales
formula must use the "cost of performance" method to source
sales of intangible items starting with the 2011 taxable year;
taxpayers electing sales factor-only apportionment of income
must source the sales of intangibles to California using the
"market rule." Intangible assets are not considered tangible
personal property, and include items and services such as:
online stockbrokers and telecommunications; patents, trademarks,
and copyrights; and licenses to operate software programs.
Under the "cost of performance" methodology, a company includes
no revenue from its sales of intangibles to California in the
sales factor if the firm incurs a plurality of the costs
associated with developing these products or services in another
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state; if the plurality occurs in California, then the company
includes all of its sales in its California sales factor. Under
the competitively-neutral "market rule," all firms source these
sales based on the state in which the product or service is
ultimately used, so all firms report sales based on how much
they sell in the state, instead of where they invested when
developing the intangible item or service.
Proposed Law: AB 1500 would repeal the authority for companies
to elect to use the single-sales factor apportionment
methodology, and generally impose a mandatory single-sales
factor methodology for assigning sales to California.
Specifically, this bill would make the following changes to
apportionment formulas:
Repeal the annual election to use single sales factor
apportionment formulas for years beginning on or after January
1, 2012.
Require specified corporations to use the "single sales
factor" apportionment formula for taxable years beginning on
or after January 1, 2012, as specified, except for those
deriving more than 50% of income from a qualified business
activity (extractive, agricultural, savings and loans, and
banks and financials).
Allow taxpayers to continue to use the traditional 3-factor
formula, with double-weighted sales, if it results in a
greater amount of tax owed.
Require all corporations to use the "market rule" when
assigning sales of intangible goods to the state for purposes
of determining taxable income, as specified.
Allow cable companies that have a minimum investment in this
state of $250 million or more, to assign 50% of their
intangible property to California under the market rule, and
50% would "not be assigned to this state."
This bill would also require FTB to annually report a
preliminary estimate of the amount of revenue expected to be
generated by these tax changes to the Department of Finance
(DOF), on a schedule that DOF determines, for the 2012-13
through 2015-16 fiscal years. FTB would use a different
specified method for estimating revenues for subsequent years.
DOF would then direct the State Controller to deposit an amount
equal to FTB's estimate into the newly-established Middle Class
Scholarship Fund, by September 1 each year, beginning in 2012.
Funds deposited into this new special fund would be available,
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upon appropriation by the Legislature, for the purpose of
increasing the affordability of higher education. This bill is
contingent upon the enactment of AB 1501 (J. Perez).
Related Legislation: AB 1501 (J. Perez), currently on the
Suspense File in this Committee, would establish the Middle
Class Scholarship Program, to be administered by the California
Student Aid Commission, to provide scholarships for mandatory
systemwide fees at the University of California and California
State University systems, and to fund grants for fees, books,
and other educational costs at the California Community
Colleges. AB 1501 is contingent upon the enactment of AB 1500.
Since the enactment of elective single sales factor rules as
part of the February 2009 budget agreement, several bills have
been introduced to revise apportionment formulas, including the
following:
ABX1 40 (Fuentes & Fletcher), introduced in the 2011 1st
Extraordinary Session, would have mandated the use of the
single sales factor formula for all companies except for
certain qualified business activities (extractive,
agricultural, banks and financials, and savings and loan) and
would have allowed qualified cable industry companies to
assign 50% of their mandatory sales to California. This bill
failed to pass out of the Senate by the constitutional
deadline.
SB 116 (De Leon), introduced in the 2011 Legislative Session,
would have mandated the use of the single sales factor formula
for all companies except for certain qualified business
activities (extractive, agricultural, banks and financials,
and savings and loan) and would have allowed qualified cable
industry companies to assign 50% of their mandatory sales to
California. This bill failed to pass out of the Senate by the
constitutional deadline.
AB 1935 (de Leon), introduced in the 2010 Legislature Session,
would have mandated the use of the single sales factor for all
companies except for financial institutions and oil companies,
which, as under current law, would continue to use the
three-factor formula. This bill was held under submission in
the Assembly Appropriations Committee.
Staff Comments: According to the FTB, this bill is expected to
increase General Fund revenues by approximately $1.2 billion in
2012-13, and about $950 million to $1 billion annually ongoing.
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An equivalent amount of General Fund would be deposited into the
Middle Class Scholarship Fund on September 1 of the fiscal year
in which the estimated revenues are expected to be generated.
The timing of these advance payments, especially the initial
transfer of funds in 2012, would appear to create substantial
cashflow deficits that could temporarily inhibit the ability of
the Controller to make mandated payments. It will likely take
some time for taxpayers to adjust to the changes in this bill
and make any tax payments resulting from the mandatory single
sales factor apportionment formulas. In addition, calendar year
taxpayers are not required to make estimated payments for the
third quarter. This could result in additional General Fund
expenditures related to short-term borrowing to cover any
insufficient cashflows until tax payments are received. In
addition, the bill does not include a "settle-up" mechanism to
reconcile the estimated revenues to actual amounts generated by
the enacted tax changes. The Committee may wish to consider
whether it would be preferable to transfer revenues to the
Middle Class Scholarship Fund based upon actual amounts received
over the 2012-13 fiscal year, and make those revenues available
beginning in the 2013-14 academic year, upon appropriation by
the Legislature in the Budget Act.
As proceeds of taxes, the revenues generated by the mandatory
single sales factor provisions in this bill would appear to be
subject to inclusion in Proposition 98 calculations and minimum
funding guarantees for K-14 schools. The specific effect will
vary from year to year, and depend significantly on the
year-to-year change in General Fund revenues. Based upon the
formulas in Proposition 98, the amount of funding owed to
schools in arrears (referred to as the "maintenance factor"),
and the maintenance factor approach adopted in the 2012-13
budget, between 40 percent and 95 percent of any new revenues
could go to satisfy Proposition 98 obligations in test 1 years.
Since AB 1500 bill would require the full amount of the
anticipated revenue increases from the tax changes enacted in
the bill to be transferred to the Middle Class Scholarship Fund,
the bill could create General Fund losses of hundreds of
millions of dollars if it is determined that a large proportion
of actual tax revenues collected must be dedicated to
Proposition 98 obligations instead of filling the hole created
by the diversion of funds to the scholarship program.
Proposition 39, the "California Clean Energy Jobs Act," is an
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initiative sponsored by Tom Steyer that will appear on the
November, 2012 ballot. Beginning on January 1, 2013, the
initiative proposes imposing a mandatory single sales factor on
California corporations and dedicating up to $550,000,000
annually for five years for the Job Creation Fund. These
revenues would be used to fund projects that create jobs in
California, improve energy efficiency, and expand clean energy
production. Retrofitting schools and public facilities to be
more energy efficient, job training in the clean energy sector,
and nourishing public-private partnerships to promote job
creation and clean energy expansion are examples of possible
projects. The remaining revenues derived from the imposition of
a mandatory single sales factor apportionment methodology would
be deposited in the General Fund. If both this bill and
Proposition 39 pass, the initiative would chapter out AB 1500 as
of November 6, 2012. However, this bill, if enacted, would go
into effect immediately and apply the mandatory single sales
factor apportionment method for the 2012 taxable year. Pursuant
to the bill's provisions, over $1 billion would be transferred
to the Middle Class Scholarship Fund prior to the potential date
in which AB 1500 is superseded by Proposition 39.
Certain provisions of AB 1500 provide special treatment for two
types of taxpayers. For example, the bill would apply the
market rule to all taxpayers with respect to sourcing the sales
of intangibles, except for cable companies which would have to
allocate half of its sales based on that percentage of its sales
in California compared to its total sales if it met qualified
investment targets. According to the Senate Governance and
Finance Committee analysis, cable companies primarily invest in
California to serve customer demand, and have consistently
avoided California with its discretionary investments, resulting
in its opposition to the market rule and support for the cost of
performance method. This so-called "cable fix" has been in all
previous bills proposing to impose a mandatory single sales
factor methodology as well as Proposition 39, noted above. The
revenue loss related to the cable company carve out is $20
million 2012-13, $34 million in 2013-14 and $35 million in
2014-15, which is incorporated into FTB's overall revenue
estimate. AB 1500 also contains a so-called "Silicon Valley
fix," which allows companies that, before the application of any
credits, would pay the same or more under the 4-factor formula
to choose to pay taxes under that method, rather than the
mandatory single sales factor formula. This is intended to
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allow companies to show shareholders that their tax credits,
which often may only be monetized for 8 years according to
accounting rules, still have viability and may be fully utilized
because they may still use them under the higher tax scenario.
The FTB estimates no additional cost or revenue loss associated
with this change. The Committee may wish to consider whether
these complications to the tax system should be enacted in a
bill that is intended to raise revenue for scholarship grants
for higher education.
Staff notes that there are several key inconsistencies between
this bill and AB 1501 that need to be reconciled. AB 1500
specifies that the revenues in the Middle Class Scholarship Fund
would only be available upon appropriation by the Legislature,
while AB 1501 specifies that specified amounts are continuously
appropriated from the Middle Class Scholarship Fund to the
Student Aid Commission for allocations, as specified. AB 1501
also specifies that the Middle Class Scholarship Fund is
established by Section 70026 of the Education Code, but that
special fund is established by Section 70201 in AB 1500.