BILL ANALYSIS                                                                                                                                                                                                    Ó




                     SENATE GOVERNANCE & FINANCE COMMITTEE
                            Senator Lois Wolk, Chair
          

          BILL NO:  AB 777                      HEARING:  2/26/14
          AUTHOR:  Muratsuchi                   FISCAL:  Yes
          VERSION:  2/19/14                     TAX LEVY:  Yes
          CONSULTANT:  Grinnell                 

                PROPERTY TAX EXEMPTION FOR SPACE FLIGHT PROPERTY
          

          Enacts a property tax exemption for property used in space  
          flight.


                           Background and Existing Law  

          I. Personal Property Taxes.  Section 1 of Article XIII of  
          the California Constitution provides that all property is  
          taxable unless explicitly exempted by the Constitution or  
          federal law.  While the Constitution limits the maximum  
          amount of any ad valorem tax on  real  property at 1% of full  
          cash value, and precludes reassessment unless the property  
          is newly constructed or changes ownership, assessors value  
           personal  property each year.  The Constitution specifically  
          allows the Legislature to exempt personal property from the  
          property tax by 2/3 vote.  

          The Legislature has previously enacted such exemptions for  
          particular things, such as fruit trees, grapevines, and  
          personal property used exclusively at a zoo, as well as  
          categories, such as pets, personal effects, and household  
          furnishings.  In 1980, the Legislature exempted all  
          business inventories from the property tax, defined as  
          items generally held for sale or lease in the ordinary  
          course of business.

          II.  Board of Equalization (BOE) and Assessors.  In 1850,  
          the Legislature first directed county assessors to tax  
          property; however, assessors in different counties often  
          applied different tax rates and methods of assessment.  The  
          California Constitution of 1879 created BOE to equalize  
          property tax rates and assessment practices among counties.  
           As part of its oversight role, BOE enacts rules and  
          regulations which generally bind county assessors; however,  
          assessors can disagree with BOE.  If an assessor believes  
          that BOE's interpretation is invalid, he or she may bring a  




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          so-called "538 action" against BOE in court for declaratory  
          relief instead of applying BOE's rule or regulation.   
          Because BOE rules clarify current law, they generally apply  
          retroactively to any fiscal year within the statute of  
          limitations. 

          BOE Property Tax Rule 133 details the business inventory  
          exemption, including a list of items explicitly defined as  
          business inventory, such as containers, oak barrels used in  
          making wine and brandy, and crops and animals used in  
          production of food and fiber.  The Rule states that  
          property used to deliver professional services such as law,  
          medicine, or architecture is taxable.  

          III.  SpaceX.  Founded by noted entrepreneur Elon Musk in  
          2002, Space Exploration Technologies Corporation (SpaceX)  
          constructs rockets that deliver satellites into space as  
          well as spacecraft that carries cargo to the International  
          Space Station.  Headquartered in Hawthorne, CA, SpaceX is  
          the first private company to launch a rocket into orbit,  
          among other milestones, and plans to reuse its rockets  
          someday.  

          In 2012, the Los Angeles County Assessor audited SpaceX,  
          and noticed property in a site visit that wasn't listed in  
          its Business Property Statement, the form taxpayers use to  
          self-report personal property to the Assessor.  In February  
          2013, Los Angeles County issued SpaceX an assessment for  
          that property for all years within the statute of  
          limitations, back to the 2007-08 fiscal year.   SpaceX  
          appealed the assessment to the Los Angeles County  
          Assessment Appeals Board. The County Clerk has not yet  
          scheduled the appeal for hearing.  

          In addition to the appeal, SpaceX is seeking regulatory  
          change from BOE, which issued an advisory, non-binding  
          opinion in December, 2013, stating that SpaceX's equipment  
          qualifies for the inventory exemption.  Additionally, BOE  
          initiated a discussion of proposed revisions to Rule 133 to  
          add specified space flight property to its list of items  
          explicitly defined as exempt business inventory.  
          SpaceX wants space flight property exempted from the  
          personal property tax by statute.  


                                   Proposed Law  





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          Assembly Bill 777 exempts from the property tax tangible  
          personal property that has space flight capacity.  Property  
          exempted by the bill includes raw materials, works in  
          progress, finished goods, and includes orbital space  
          facilities, space propulsion systems, space vehicles,  
          launch vehicles, satellites, or space stations of any kind.  
           Fuel sold and used exclusively in space flight is also  
          exempt if it is not adaptable for use in ordinary motor  
          vehicles.  The property need not be returned to Earth to  
          qualify for the exemption.

          The taxpayer must provide evidence that the exempt property  
          meets the bill's definition upon the assessor's request.   
          The Assessor cannot deny the exemption for reason of launch  
          failure, postponement, or cancellation.  The bill states  
          that the exemption does not apply to any material that is  
          not intended to be launched into space.  Only taxpayers  
          that have a primary business purpose in space flight  
          activities are eligible for the exemption.

          The exemption applies to lien dates between January 1, 2014  
          and January 1, 2024, and sunsets on July 1, 2025.  The  
          measure also states that no inference be drawn from the  
          bill's changes to the law to ensure that the bill does not  
          affect SpaceX's current appeals. 


                              State Revenue Impact
           
          BOE estimates state revenue losses of $1.1 million  
          resulting from the 8/26/13 version of AB 777.  While a  
          revised estimate is pending, committee staff does not  
          expect the amendments to change the previous estimate  
          significantly.


                                     Comments  

          1.   Purpose of the bill  .   According to the author, "Space  
          exploration, until very recently, was an entirely  
          government run industry.  However, in recent years,  
          California has seen the emergence of private space  
          companies that put our state at the forefront of innovation  
          and technology.  These private companies are not only  
          creating the most advanced space vehicles, but are also  





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          significantly contributing to the state's economy and our  
          local communities.  Despite the ground-breaking advances  
          made by the aerospace industry, California has yet to adapt  
          modern tax policies that reflect the realities of this  
          burgeoning sector.  Recently, the Los Angeles County  
          Assessor stated that propulsion systems - rockets used for  
          space travel - are considered "business supplies" and are  
          therefore subject to property tax.  Space X, for example,  
          recently received a $2 million tax bill for the storage of  
          two propulsion systems.  However, rockets should not be  
          considered business supplies as they are a part of a  
          transportation service provided, and are lost or destroyed  
          in orbit after launch and do not return to Earth.   
          Previously, these propulsion systems have never been taxed  
          and represent a significant cost for the space industry,  
          because they are only used once.  Nevertheless, these  
          unexpected enormous tax liabilities represent a devastating  
          cost for this important California industry and could  
          potentially cause businesses and jobs to leave the state."

          2.   To boldly go  .  According to news reports, SpaceX is the  
          first private company to launch space vehicles, a result of  
          the National Aeronautics and Space Administration (NASA)  
          shifting from directly funding space exploration to a new  
          model of doing so through private firms.  Because NASA is  
          part of the federal government, any rockets it owns would  
          be exempt from the property tax, but SpaceX must pay them  
          as any other private entity would.  However, why should  
          SpaceX's personal property used in space flight be exempt  
          from the tax that applies to all other firms, as called for  
          by AB 777?  Exempting one kind of business may prompt other  
          industries to ask for similar treatment.  Additionally,  
          other firms that provide products and services factor in  
          the cost of taxes as part of negotiating contracts: a  
          trucking company must pay vehicle license fees (an in-lieu  
          personal property tax) on its tractor trailers, private  
          railroad car owners must pay the private railroad car tax,  
          and air cargo carriers landing in California pay personal  
          property tax on its planes.  Each firm factors the costs of  
          taxes when bidding for jobs, just as SpaceX's costs of its  
          taxes should be embedded within the price it charges to  
          NASA and other firms for its services.  While SpaceX is  
          clearly doing innovative things, what are the reasons to  
          exempt SpaceX's delivery vehicles, but not the others?  All  
          these firms basically deliver cargo for money; only the  
          vehicles and routes are different.  The Committee may wish  





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          to consider the precedent created by the bill, as well as  
          the justification for exempting one category of property  
          from a tax designed to apply equally to all taxpayers. 

          3.   Something different  .  Property tax statutes in  
          California are old, and for the most part, haven't kept  
          pace with a rapidly evolving California economy.  For  
          example, California's statute that describes storage media  
          for computer programs, last amended in 1973, refers to  
          punched cards, tapes, discs or drums.  Antiquated statutes  
          like the above example cause disagreements between  
          taxpayers and assessors when modern businesses make  
          products or provide services that don't fit neatly into the  
          old legal boxes.  AB 777 presents such a case.  SpaceX and  
          the Assessor disagree regarding whether today's rockets  
          that are consumed as part of delivery are either taxable  
          business supplies or tax exempt business inventories, but  
          if the firm can make reusable rockets, they look more like  
          taxable cargo delivery vehicles from the above example.   
          Given the increasing rate of change in today's modern  
          California economy, AB 777 presents an opportunity to  
          provide valuable certainty to both assessors and taxpayers  
          that regardless of how the business model of the space  
          flight industry develops, the property used in space flight  
          isn't taxable.  

          4.   Reverse thrust  .  AB 777 exempts space flight property  
          from the property tax, beginning with the January 1, 2014  
          lien date for the 2014-15 fiscal year.  As such, SpaceX's  
          property tax appeals to assessments for previous tax years  
          will be adjudicated based on the  law  in place at the time  
          the assessor issued the assessment, because the measure  
          doesn't change the law retroactively, and contains  
          direction not to consider the bill when adjudicating  
          appeals.  However, the  rules  that the assessment appeals  
          board will apply to the appeal may change. BOE may change  
          Property Tax Rule 133 to state that space flight property  
          is an exempt business inventory, a change that would apply  
          retroactively.  If BOE changes Rule 133 in such a way, the  
          assessor may bring a 538 action against the BOE if he or  
          she believes its change to Rule 133 is invalid.  If the  
          assessor does not bring a 538 action, or if the court finds  
          BOE's rule valid, the assessment appeals board will then  
          consider SpaceX's appeals in light of BOE's rule change.  

          5.   Solo mission  ?  While SpaceX is currently the sole  





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          provider of private space flight at commercial scale, they  
          may not be alone for long.  News reports indicate that  
          Google recently submitted a proposal to NASA to use a  
          hangar at Moffet Federal Airfield near Mountain View, CA  
          for new robots, planetary rovers and other space or  
          aviation technology.  Additionally, Sir Richard Branson's  
          Virgin Galactic's SpaceShip Two space planes used its  
          rocket engines for the first time in a test flight out of  
          California's Mojave Air and Spaceport in April, 2013.  

          6.   Vote key  .  Generally, when the Committee considers a  
          measure in which Legislative Counsel has keyed the measure  
          a 2/3 vote, it means that the bill increases state taxes,  
          but AB 777 doesn't.  Instead, the measure contains the  
          higher vote threshold because the Constitution explicitly  
          authorizes the Legislature to exempt personal property from  
          the property tax, but only by a 2/3 vote.


                                 Assembly Actions 

          Assembly Floor           69 - 5
          Assembly Appropriations       16 - 0
          Assembly Revenue and Taxation  7 -  0
          Assembly Rules             9 -  0


























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                        Support and Opposition  (02/19/14)

           Support  :  California Board of Equalization Chairman Jerome  
          E. Horton; Aerojet  Rocketdyne;  California Chamber of  
          Commerce; California Unmanned Aircraft System; City of  
          Hawthorne; Commercial Space Flight Federation; El Camino  
          Community College District; Los Angeles Area Chamber of  
          Commerce; Los Angeles County Economic Development  
          Corporation; Mojave Air and Space Port; Northrop Grumman  
          Aerospace Systems; Palos Verdes Peninsula Chamber of  
          Commerce; South Bay Association of Chambers of Commerce;  
          SpaceX; the Aerospace and Defense Forum, Torrance Area  
          Chamber of Commerce.

           Opposition  :  Santa Clara County Assessor Larry Stone.