BILL ANALYSIS �
AB 33
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Date of Hearing: April 15, 2013
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 33 (Perea) - As Amended: April 8, 2013
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Income tax credits: patent licensing.
SUMMARY : Allows an income tax credit to a qualified taxpayer in
an amount equal to 15% of qualified royalties paid by the
taxpayer. Specifically, this bill :
1)Authorizes a tax credit, under both the Personal Income Tax
(PIT) and the Corporation Tax (CT) Laws, for taxable years
beginning on or after January 1, 2013, in an amount equal to
15% of the qualified royalties paid by a qualified taxpayer
during a taxable year.
2)Defines "qualified taxpayer" as a taxpayer that paid qualified
royalties during the taxable year and commercializes in
California, for at least one year, the licensed patent, for
which royalties were paid.
3)Defines "qualified royalties" as any royalties paid by a
qualified taxpayer for the use of a qualified patent through a
license agreement with the University of California (UC), the
California State University (CSU), or another entity.
4)Defines "qualified patent" as a patent owned by the UC or the
CSU for an invention where the research and development (R&D)
for that invention was funded, in whole or in part, by amounts
eligible for the R&D tax credit.
5)Defines "commercialize" as the process in which a taxpayer is
a licensee of a qualified patent and uses the patent in
connection with, or incorporates the patent into, intellectual
property or tangible personal property with respect to which a
qualified patent is used directly or indirectly in connection
with the manufacturing, production, growing, or extraction
process with respect to such property, or is incorporated into
such property and such incorporation serves a significant
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commercial purpose.
6)Provides that, if the qualified taxpayer fails to
commercialize a qualified patent for at least five consecutive
years, the total amount of the credit allowed to, and claimed
by, the taxpayer will be subject to recapture tax.
7)Provides that unused credit amounts may be carried over to
reduce the tax in the following years, and succeeding eight
years, until the credit is exhausted.
8)Limits the total amount of credit allowed for all taxable
years to $100 million.
9)Requires a qualified taxpayer to claim the credit on a timely
filed original return received by the Franchise Tax Board
(FTB) on or before the cutoff date established by the FTB.
10)Specifies that the cutoff date shall be the last day of the
calendar quarter within which the FTB estimates it will have
received timely filed original returns claiming the credit in
an amount totaling $100 million.
11)Provides that FTB's determinations with respect to the cutoff
date, the date a return is received, and whether a return has
been timely filed may not be reviewed in any administrative or
judicial proceeding.
12)Requires the FTB to periodically provide notice on its
Internet website with respect to the aggregated amount of the
credit claimed.
13)Is repealed as of December 1 of the calendar year after the
year of the cutoff date.
14)Takes effect immediately as a tax levy.
EXISTING FEDERAL LAW :
1)Allows a R&D tax credit that is combined with several other
credits to form the general business credit. The R&D tax
credit was extended by Congress through 2013.
2)The R&D credit is determined as the sum of 20% of the
qualified research expenses incurred during the taxable year
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that exceeds the base amount, as defined, and 20% of the
amount paid or incurred during the taxable year on research
undertaken by an energy research consortium. In addition,
corporate taxpayers are allowed a credit equal to 20% of
expenses paid to fund basic research at universities and
certain nonprofit scientific research organizations.
3)Prescribes certain requirements that must be met in order for
research expenses to qualify as eligible for the R&D credit.
EXISTING STATE LAW:
1)Allows various tax credits under both the PIT Law and the CT
Law. These credits are designed to provide relief to
taxpayers who incur specified expenses or to encourage
socially beneficial behavior, including business practices.
2)Conforms to the federal R&D credit with the following
modifications:
a) The state R&D tax credit is not combined with other
business credits.
b) Research must be conducted in California.
c) The credit percentage for qualified research in
California is 15% versus the 20% federal rate.
d) The credit percentage for basic research in California
is limited to corporations (other than S corporations,
personal holding companies, and service organizations) and
is 24% versus the 20% federal credit rate.
e) The percentages for the alternative incremental research
portion of the California R&D credit are 1.49%, 1.98%, and
2.48%.
FISCAL EFFECT : The FTB staff estimates that this bill will
result in an annual revenue loss of $23 million in the 2013-14
fiscal year (FY), $24 million in FY 2014-15, and $25 million in
FY 2015-16.
COMMENTS :
1)Author's Statement . The author provides that following
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statement in support of this bill:
California has been dealing with a high unemployment rate
for a number of years, reaching as high as 12.4 percent in
2010. We continue to see jobs relocated out of state to
lower tax jurisdictions and to more competitive business
environments elsewhere.
AB 33 would give California the ability to recapture those
out of state investments and provide companies with an
incentive to create jobs here. In addition, the direct
link with research and public universities would encourage
investment in our universities at a time when private
investment has decreased. In 2011, 58 startup companies
were formed from University of California inventions. This
goes to show the job creation potential within our public
universities and would provide California a significant
opportunity to help market itself as a business friendly
environment.
In European countries, the patent box has already
demonstrated the job creation potential. For example, in
the United Kingdom (UK), GlaxoSmithKline, a pharmaceutical
company, has invested $800 million to build a new
manufacturing facility with the potential to create 1,000
new jobs. According to the CEO of the company, the
decision to make the investment was based on the new UK
patent box policy which is set to be introduced in April of
this year.
Senator Feinstein will soon be introducing similar
legislation on the federal level. California should be the
first to lead that effort while building on its reputation
as a leading innovator and encourage business investments
in California that will promote innovation and create jobs.
2)Arguments in Support . The proponents of this bill argue that
AB 33 would "reduce the financial risk involved with
innovation" and would "encourage investment in research
conducted at the state's public universities and position the
state to better convert its leadership in research into the
development of new job-creating products and services." The
proponents note that this bill "would give California a
competitive advantage over others by improving its business
environment with an incentive no other state has to offer."
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The Innovation Box concept could "represent a promising and
creative policy lever that could build on the tremendous
talent resident in our universities and better position
California-based companies to innovate and compete in the
world economy." While almost all of the industries in which
California leads the world grew out of university-based
research, it is "often transferring viable research
discoveries to the marketplace that can pose the greatest
challenge to innovators and entrepreneurs." Thus, the
proponents state that providing "an incentive for these
efforts, through a tax credit on royalty payments, has the
potential to spawn greater investment in and commercialization
of UC inventions and discoveries."
3)Arguments in Opposition . The opponents argue that the tax
system is already full of incentives for R&D activities, "at a
level which is highest in the country." The opponents state
that it is "up to the market to determine the appropriate
payments and profits on those royalties" and that state
taxpayers "gain little (if anything at all) by paying out $100
million in tax credits in cases where a product is likely to
be fully commercialized in any case." The proponents also
point out that "much off-shore tax avoidance is the result of
failure to return royalties to where they have been generated"
and that "there are too many opportunities for tax avoidance
and a lack of direct benefits to California contained in this
bill."
4)What Is a "Patent" or "Innovation Box" ? A "patent box" simply
means a tax incentive that allows corporate income from the
sale of patented products to be taxed at a significantly lower
rate than other income. Literally, it is a box on the tax
form for a qualified taxpayer to check. An "innovation box"
is a similar tax incentive that provides a preferential tax
rate for income derived from commercialization of intangible
assets other than patents, such as for example, trade names,
brand names, copyrights, or technical know-how. A patent box
differs from an R&D credit. While a R&D credit is intended to
spur R&D activity, a patent or innovation box is put in place
to incentivize commercialization of innovations, rather than
just the conduct of R&D.
Eight nations - Belgium, China, France, Ireland, Luxembourg, the
Netherlands, Spain and Switzerland - have enacted patent box
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regimes. The United Kingdom is set to implement its patent
box policy in 2013 with a 10% tax rate on income generated
from patented products, in contrast to its regular rate of
26%. The United States (U.S.) does not have any similar tax
incentive, although Senator Feinstein is working on
legislation to create a federal patent box regime. Two U.S.
"patent box" bills, which were introduced in the House of
Representatives in 2012, failed to pass out of the House
before the end of session.
5)Potential Benefits of a Patent Box Regime in California .
According to Robert Atkinson, President and Founder of the
Information Technology and Innovation Foundation, the economic
theory behind a patent or innovation box regime is based on
the recognition of the fact that the process of innovation is
subject to multiple market failures and is much more global
and footloose now. (See, e.g., R. Atkinson, Patent Boxes:
Innovation in Tax Policy and Tax Policy for Innovation, p. 4).
Innovation requires substantial risk, in part because the
"time lag between R&D investments and a successful commercial
production introduction is often considerable." (Id., p. 6).
Furthermore, intellectual property is highly mobile and could
be easily migrated to a low-tax jurisdiction. For example,
many high-tech businesses in California choose to conduct
their R&D in California but commercialize the resulting
innovations in another state or country. Thus, commercial
activity from successful R&D does not necessarily occur in the
same place where the R&D was conducted. In other words, the
R&D tax credit alone is insufficient for a state or a country
to be globally competitive, and a patent box incentive is
needed to transform R&D into economic growth in the state or
country.
As suggested by Mr. Atkinson at this Committee's hearing
"California's High-Tech Sector: Promoting Job Creation and
Innovation Through Sound Tax Policy" on December 5, 2011, a
successful patent box regime should be designed in a way that
links the incentive to conduct R&D and production of the
patented product in California. Such a tax incentive would
spur the creation of innovation-based jobs, including
manufacturing jobs, in California more than a regular patent
box regime. Notably, Dr. Atkinson emphasized three key issues
that must be considered in designing a patent box in
California. First of all, California should consider
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implementing a patent box rate that is at least half of the
regular corporate tax rate of 8.84%. Secondly, the definition
of "qualifying income" should not be overly restrictive since
some industries, such as software, do not rely as much on
patents to protect intellectual property. For example, the
Netherlands created an innovation box system where income from
innovation-based products qualifies for the lower rate, not
just income from patented products. Finally, it is important
to establish a policy link between the lower rate and
production in California by requiring that patented products
are developed and produced in state. Given the nature of
global supply chains, Dr. Atkinson recommended that a share of
the profits be taxed at a lower rate based on the share of
total R&D and production that is performed in California. In
his opinion, this approach would provide flexibility as well
as an incentive to produce R&D and products in the state.
6)What Does This Bill Do ? AB 33 sets out to accomplish two
goals. It seeks to encourage companies to increase their R&D
activity at the UC and CSU and to commercialize in California
the patented products resulting from that activity. This bill
does not create a "patent box" regime per se. Instead, it
establishes a credit in an amount equal to a percentage of the
royalty payments made by a qualified taxpayer - the taxpayer
that commercializes the licensed patent in California - during
a taxable year. Qualified royalties are defined as any
royalties paid for the use of a qualified patent through a
license agreement with the UC, CSU, or other entity (i.e. an
original licensor). In other words, the credit is structured
in a way that requires a firm to invest in qualified research
at the UC or CSU first, at the time when state funding for
public universities is decreasing. Then, if and when the
research results in a patented product, the UC or CSU,
whichever is applicable, will grant an exclusive license to
the firm that will have to commercialize the product in
California in order to be eligible for the proposed credit.
This bill also contemplates a situation where the original
licensor may decide to sub-license the right to develop the
patented product to another firm. In that case, the
sub-licensor will be eligible for the credit as long as it
commercializes the product in California. Thus, AB 33 is
intended to link privately-funded R&D done by the UC or CSU
with the commercialization of the resulting product in
California. In addition, AB 33 imposes a cap on the total
amount of credit available to qualified taxpayers to $100
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million.
7)R&D Funding at the UC. In FY 2010-11, the UC's direct
research expenditures totaled $4.44 billion, of which 50% were
funded by federal contracts and grants, 23% by private gifts
and grants, including corporate and nonprofit entities, and
12% by the State & UC general funds. Approximately $207
million of research expenditures came from corporate entities
and $7 million came from individuals. In the same FY, the UC
received $16.9 million in royalty income from California
companies (excluding royalties from plant varieties), $5
million in royalty income from Californian plant nurseries (as
a result of plant varieties), and $6.9 million from
non-California companies.
8)The Limited Incentive . Under this bill, a patent must be
commercialized in California in order to qualify a taxpayer
for the credit. However, as noted above, the nature of global
supply chains would significantly limit the use of the tax
incentive for firms that are willing to locate a significant
portion of their production in California but also have to
produce some overseas. The author may wish to consider
utilizing a pro rata approach, whereby a credit amount is
prorated in the case of a product that is partly made outside
of California. In such a case, the eligible credit amount may
be based on the share of production that was performed in
California.
9)FTB Implementation Concerns. In the analysis of this bill,
the FTB staff notes the following implementation concerns:
a) The patent is required to be owned by the UC or CSU, but
lacks a requirement that the work underlying the patent be
performed at the UC or CSU. This would allow a credit on
royalties for patents that were donated to the UC or CSU by
a third party and then licensed by the UC or CSU to another
third party.
b) A qualified taxpayer would be required to commercialize
the patent for five consecutive years to avoid having to
recapture the credit. The language, however, does not
specify if those are taxable or calendar years; nor does it
state when the first year begins. Additionally, the
recapture language is unclear with regard to when the five
consecutive years of commercialization must begin and in
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which tax year the taxpayer must include the recapture by
adding additional tax equal to the previously claimed
credits for prior years. As written, the language may be
interpreted to require the additional tax to be assessed
for each prior year, some of which could be beyond the
statute of limitations by the time the recapture is
required.
c) This bill allows a credit for royalties paid to the UC,
CSU, or any other entity, which may result in multiple
taxpayers claiming a credit for royalties paid to use the
same patent. For example, company A could license the
patent from the UC and pay royalties eligible for the
credit. Subsequently, this company may sublicense the
patent to company B, which would also be entitled to claim
the credit.
REGISTERED SUPPORT / OPPOSITION :
Support
BayBio
BIOCOM
California Healthcare Institute
Central Valley Business Incubator
TechNet
University of California
Opposition
American Federation of State, County and Municipal Employees
SEIU California
California Tax Reform Association
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098