BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 364 HEARING: 4/27/11
AUTHOR: Yee FISCAL: Yes
VERSION: 4/25/11 TAX LEVY: No
CONSULTANT: Grinnell
BUSINESS TAX INCENTIVES: REPORTING INFORMATION
AND CLAWBACKS
Imposes a penalty on certain taxpayers that claim tax
credits but fail specified performance measures.
Background and Existing Law
Current law allows various tax credits designed to provide
incentives for taxpayers that incur certain expenses, such
as child adoption, or to influence behavior, including
business practices and decisions, such as research and
development credits and Geographically Targeted Economic
Development Area credits. The Legislature typically enacts
such tax incentives to encourage taxpayers to do something
but for the tax credit, they would otherwise not do.
State law also requires the Franchise Tax Board to
"recapture" or "claw back" tax credits from taxpayers under
specified circumstances to ensure that taxpayers do not
financially benefit when acting opposite to the intent of a
tax credit. Taxpayers who claim an enterprise zone hiring
credit then terminate an employee within 270 days must
repay the credit, and a low-income housing developer must
sacrifice tax credits if he or she raises rents at the
project to the extent that they're no longer affordable.
Additionally, tax law specifies penalties for understating
liability, failing to file returns, engaging in
transactions that lack economic substance, and engaging in
fraud, among others.
Proposed Law
SB 364 enacts a penalty on a qualified taxpayer that claims
a business tax incentive enacted by the Legislature on or
after January 1, 2012, but subsequently has a net decrease
in employees of 10% or more over the previous calendar
SB 364 -- 04/25/11 -- Page 2
year.
The bill defines a "qualified taxpayer" as a person that is
engaged in or carrying on a trade, business, profession,
vocation, calling, or commercial activity in the state and
the pays qualified wages to more than 100 annual full-time
equivalent employees. The measure uses Internal Revenue
Code definitions to treat firms owned by related parties as
a single firm.
The measure defines a "business tax incentive" as:
A sales and use tax exemption or exclusion based on
qualified wages or numbers of persons employed.
A personal income or corporation tax credit based
on qualified wages or the number of employees.
SB 364 uses a full-time equivalent measurement to determine
whether the taxpayer decreased jobs in an amount necessary
to trigger the penalty, and to calculate the amount of the
penalty. A full-time equivalent is:
In the case of an employee paid qualified wages,
the number of hours worked for the qualified taxpayer
divided by 1,820
In the case of a salaried employee, the number of
weeks worked divided by 52.
The Board of Equalization shall assess the penalty for
firms that claim sales and use tax exclusions and
exemptions, and the Franchise Tax Board levies the penalty
for taxpayers claiming income and corporation tax credits.
BOE and FTB assess a penalty of $5,000 per employee
decreased over 10% from the previous year, capped by the
amount of income and corporation tax credits generated, and
sales and use tax exemptions and exclusions obtained for
the last three years. BOE and FTB calculate the penalty as
follows, including any fractions:
Take 90% of the taxpayer's annual full-time
equivalents for the prior calendar year, minus
The annual full-time equivalents for the current
calendar year, multiplied by $5,000 per annual
full-time equivalent.
If the difference between the two is zero, FTB and
BOE do not assess the penalty.
BOE and FTB shall aggregate the employees of any trade or
business acquired by the qualified taxpayer during the
SB 364 -- 04/25/11 -- Page 3
current calendar year with the taxpayer's existing
employees, and specifies rules in existing law to determine
whether the employees of the trade or business acquired
must be included in the taxpayer's calculation.
The bill also requires qualified taxpayers doing business
to include the number of full-time equivalents for the
current year and preceding year on a timely filed original
return in the form and manner prescribed by the Franchise
Tax Board or Board of Equalization to determine the
penalty. Taxpayers failing to comply must pay an
additional penalty of an unspecified amount unless the
failure is due to reasonable cause and not willful neglect.
The measure further requires that taxpayers selling,
assigning, or otherwise transferring tax credits to another
taxpayer must expressly agree to continue to report and
actually report the number of full-time equivalents or the
sale, assignment, or transfer is invalid. The buyer or
assignee must add the penalty to net income if meets the
conditions that trigger the penalty. FTB has four years to
send the buyer or assignee a notice of proposed assessment
if the seller or assignor fails to satisfy the reporting
requirements.
BOE and FTB may issue rules, guidelines, or procedures
necessary to carry out the purposes of the bill, and such
rules, guidelines, and procedures are exempt from the
Administrative Procedures Act. The bill further provides
that it does not limit the audit authority of BOE or FTB.
SB 364 also makes legislative findings and declarations
regarding unemployment rates, and job creation.
State Revenue Impact
No estimate.
Comments
1. Purpose of the bill . According to the Author, "SB 364
brings much needed accountability to corporate tax
expenditures. This bill will levy a penalty on corporations
that claim tax credits and then fail to meet employment
requirements.
SB 364 -- 04/25/11 -- Page 4
This bill would require corporations that claim tax breaks
with the goal of job creation to annually submit to the
Franchise Tax Board specified information
relating to the number and type of employees for the
current and preceding taxable years. Specifically, if a
company cuts 10% of their workforce in a year, then they
are subject to a penalty of $5,000 for each full-time job
lost beyond the 10%.
The penalty will not exceed the total amount of credit
claimed by the taxpayer on the previous year's return.
Clawback provisions make tax expenditures more effective,
transparent, and accountable. This bill will set clear
expectations for corporations and guarantee that the
state's investment will yield measurable
results in the form of job retention and creation."
2. Beware the Jabberwock, My Son, the Jaws that Bite, the
Claws that Catch ! Martin Helmke, consultant to the Senate
Revenue and Taxation Committee for many years until his
retirement in 2006, often cited poems as part of his
analyses, including Lewis Carroll's famous Jabberwocky,
which evokes the image of a scary monster. To many firms,
SB 364 may be similarly perceived, because it penalizes
firms that claim a future tax benefit but subsequent lay
off more than 10% of total payroll. The Legislature
generally enacts tax incentives in the hopes that firms
will act on the incentive and increase employment. Adding
a penalty negatively affects the return on investment for a
firm that did what the government wanted them to do at the
time, but sheds payroll due to what could be unforeseen
events. This penalty may also undermine the incentive
effect of future employment-related tax benefits because
companies would have to assess the risk of the penalty when
initially claiming a hiring credit or sales tax exclusion,
making it less likely that they will act on the credit and
hire workers here. As shown in recent years, the economy
can change rapidly, and firms that at first carry a larger
payroll necessary to produce a product or service may have
to shed workers in response to economic conditions through
no fault of their own.
3. Taking it back . California's key business tax credits,
the Research and Development Tax Credit and the
Geographically Targeted Economic Development Area Hiring
Credit and Sales and Use Tax Credit, are neither capped to
a specified amount of foregone revenue nor specifically
SB 364 -- 04/25/11 -- Page 5
allocated by a state agency. If firms legitimately satisfy
the conditions necessary to claim the credit, such as
increasing research and development year-over-year or
hiring a qualified worker (with proper documentation), the
firm claims the credit on its return, thereby reducing its
tax in the current tax year, or carrying the credit over to
be used against tax due in a future year. Once granted,
the state cannot cancel the credit and make the firm repay
the amount, a procedure known as a claw back, if the firm
followed the law. In that way, California's key business
tax expenditures function similarly to entitlement
programs, but unlike spending programs, cannot be limited
or eliminated without 2/3 vote required by Section 3 of
Article XIIA of the California Constitution.
Other states operate economic development programs by
application, and claw back incentives when companies leave
the state or decrease employment. Many firms must apply
for tax incentives, which the state awards up to an amount
specified in each state's budget, or sign memorandums of
understanding with the state. Next, the state requires
reports from firms to ensure that it meets specified
employment totals, wage amounts, and investment thresholds.
If the firm does not meet the targets, it must pay back
the entire value of the tax credit in some cases, sometime
with a penalty. A chart from the organization "Good Jobs
First" details these provisions for 20 states.
SB 364 brings California part of the way there. First, it
requires all firms to include the number of its full-time
employees in California for the current and preceding year.
Secondly, if a firm claims a future tax credit as a jobs
incentive, and the firm cuts payroll by more than 10%, the
firm must pay a penalty of $5,000 for each employee after
the first 10%. SB 364 ensures that firms that avail
themselves of tax credits cannot enjoy the financial
benefit of tax credits hen subsequently sack the employees
that qualified it for the tax credit.
4. Of crystal balls and tea leaves . Few can predict the
future accurately, especially so the course of tax policy
in California. SB 364 presumes to do so by applying a
penalty to tax benefits not yet enacted by applying its
provisions to future business tax incentives. SB 364 could
apply its penalty to existing tax benefits, but doing so
would functionally operate as a clawback not initially part
SB 364 -- 04/25/11 -- Page 6
of the credit the Legislature enacted. As such,
potentially penalized taxpayers could not enjoy the full
value of a credit to which they would be otherwise lawfully
entitled, and the measure would require a 2/3 vote under
Section 3 of Article XIIA of the California Constitution.
Additionally, SB 364 applies only contingently to the
future; this or a subsequent Legislature could waive the
section of law it puts in place, as this Legislature cannot
affirmatively bind future ones under County of Los Angeles
v. State of California (1984) 153 Cal.App.3d 568, 573.
Future authors of business tax incentive bills could simply
add a "notwithstanding clause" to future measures to
nullify the bill's penalty.
5. Hangnails . SB 364 applies penalties to taxpayers who
claim benefits under income taxes as well as sales taxes;
however, the personal income tax and the corporation tax
are assessed and collected in fundamentally different ways
than the sales and use tax. Taxpayers explicitly claim and
list tax credits and deductions on their returns, but for
sales tax exemptions, the purchaser of exempted property
simply doesn't pay the tax at the cash register. Because
of this difference, applying a penalty for taxpayers who
obtain sales and use tax exclusions and exemptions may be
very difficult because BOE won't likely know who benefitted
from the exemption and who didn't, unless the tax incentive
is structured through a capped and allocated mechanism or
by using a resale certificate, similar to sales tax
exemptions granted by the California Alternative Energy and
Transportation Financing Authority (SB 71, Padilla, 2010).
6. Feather in the cap ? SB 364 caps the penalty at the
amount of credits "generated" by the firm in the last three
years and sales and use tax exclusions and exemptions
"obtained" by the qualified taxpayer in the same period.
Taxpayers don't generate credits; instead, they "claim"
them, and when they do so, they either use them to reduce
tax in the current year or carry them over to reduce tax in
future years if the credit so allows. If SB 364's cap
applied only to those generated to reduce tax, a firm that
had no net income, paid no tax, and therefore couldn't use
credits to reduce tax in one year, but laid off more than
ten percent the next would evade the bill's penalty
entirely. The Committee may wish consider amending SB 364
to clarify that the cap on penalties is the total amount
SB 364 -- 04/25/11 -- Page 7
claimed in the last three years.
7. Not my problem . SB 364 compels all firms in California
to report their annual full-time equivalents for the
current and preceding year. The information is necessary
for BOE and FTB to determine whether the penalty applies,
and if so, the amount of the penalty. However, the great
majority of firms don't claim tax credits, but would have
to comply with SB 364's reporting requirement. The
Committee may wish to consider limiting the reporting
requirement only to firms that claim a business tax
incentive.
Support and Opposition (4/21/11)
Support : California Labor Federation (sponsor); American
Federation of State, County & Municipal Employees;
California Conference of the Amalgamated Transit Union;
California Conference of Machinists; California Nurses
Association; California Professional Firefighters;
California Tax Reform Association; California Teamsters
Public Affairs Council; Having our Say Coalition;
International Longshore & Warehouse Union; National Nurses
Organizing Committee; Professional & Technical Engineers,
Local 21; Service Employees International Union, Local
1000; Sierra Club California; State Building and
Construction Trades Council of California; Untied Food &
Commercial Workers Union, Western States Council; Unite
Here!;
Opposition : BICOM; California Chamber of Commerce;
California Aerospace and Technology Association; California
Bankers Association; California Grocers Association;
California Manufacturers & Technology Association ;
California Taxpayers Association; Council on State
Taxation; TechAmerica