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 AB 777 - 2/19/14 -- Page 2 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 AB 777 - 2/19/14 -- Page 3 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 AB 777 - 2/19/14 -- Page 4 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 AB 777 - 2/19/14 -- Page 5 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 AB 777 - 2/19/14 -- Page 6 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 AB 777 - 2/19/14 -- Page 7 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.