BILL ANALYSIS Ó
AB 879
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Date of Hearing: April 29, 2013
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 879 (Bocanegra) - As Amended: April 16, 2013
SUSPENSE
Majority vote. Fiscal committee.
SUBJECT : Emerging technology and biotechnology companies:
transfer of net operating losses
SUMMARY : Creates a program to allow certain emerging technology
and biotechnology companies to transfer their net operating
losses (NOLs) to other companies, as specified, in exchange for
a cash payment. Specifically, this bill :
1)Authorizes the California Treasurer (Treasurer), in
cooperation with the Franchise Tax Board (FTB), to establish a
"corporation business tax benefit certificate transfer
program" (Program) to allow new or expanding emerging
technology and biotechnology companies in California
(qualified companies) to transfer their unused NOLs to other
taxpayers. Specifically, provides that:
a) Unused, but otherwise allowed, NOLs, as described in
Revenue and Taxation Code (RTC) Section 24416.2, may be
surrendered by a qualified company for use by a taxpayer
that is subject to the Corporation Tax (CT) Law.
b) The tax benefits of the surrendered NOLs may be used by
the recipient taxpayer on a tax return filed pursuant to
the CT Law.
c) The recipient taxpayer must provide "cash payment" to
aid in the funding of costs incurred by the qualified
company.
d) The amount of the cash payment must be at least 80% of
the face value of the surrendered NOLs.
e) The cash payment shall help with funding expenses
incurred in connection with the operation of a qualified
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biotechnology company in California, including the expenses
of fixed assets, such as the construction and acquisition
and development of real estate, materials, start up, tenant
fitout, working capital, salaries, research and development
expenditures, and any other similar expenses.
2)Directs the Treasurer and FTB to review and approve
applications filed by qualified transferors to surrender their
unused NOLs in exchange for cash payment.
3)Provides that the Treasurer shall set aside at least $25
million, of the total $60 million to be allocated per fiscal
year (FY), for small qualified transferors, defined as having
less than $250,000 of available unused NOLs for transfer.
4)Specifies that the remaining amount shall be allocated on a
first-come first-served basis.
5)States that if the NOL surrender applications exceed $60
million, the excess shall be deemed as having been applied for
in the next FY.
6)Limits the amount of applicant's NOLs eligible for a transfer
to the NOLs that the applicant requests and is eligible to
surrender.
7)Provides that an otherwise qualified company is not eligible
to surrender its NOLs if the company:
a) Has demonstrated positive net operating income in any of
the two previous full years of ongoing operations, as
determined on its financial statements issued according to
the generally accepted accounting standards endorsed by the
Financial Accounting Standards Board; or
b) At least 50% of its stock is directly or indirectly
controlled or owned by another corporation that either:
i) Has demonstrated positive operating income in any of
the two previously full years of ongoing operations, as
evidence by its financial statements, as specified; or,
ii) Is part of a consolidated group of affiliated
corporations that, in the aggregate, has demonstrated
positive net operating income in any of the two previous
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full years of ongoing operations.
8)Limits the maximum lifetime value of NOLs that a corporation
is permitted to surrender to $15 million.
9)Provides that applications to surrender NOLs must be received
on or after January 1 and on or before June 30 of each FY.
10)Requires the Treasurer, in consultation with the FTB, to
establish rules for the recapture of all, or a portion, of the
amount of tax certificate if the company that surrendered the
NOLs fails to use the cash payment as required.
11)Requires the Treasurer to issue the corporation business tax
benefit transfer certificates on or before November 1.
12)Directs the Treasurer, in cooperation with the FTB, to review
and approve applications of corporate taxpayers to acquire
surrendered NOLs from companies in exchange for cash payment.
Provides that a qualified company will surrender NOLs at the
moment the corporation business tax benefit transfer
certificate is received.
13)Requires the Treasurer, in cooperation with the FTB, to
certify the amount of surrendered NOLs that a qualified
company is allowed to transfer, as evidenced by the
corporation business tax benefit transfer certificate.
14)Requires a qualified company that wishes to surrender its
NOLs to certify that, as of the date of the exchange, it is
operating as a qualified company and has no current intention
to cease operation as such.
15)Requires a qualified company to certify that the unused NOLs
have been transferred, for immediate cash payment, to a
qualified transferee.
16)Specifies that any NOLs transferred pursuant to this program
to a taxpayer are allowed beginning on or after the first day
of the fourth taxable year after the date of issue of the
certificate.
17)Prevents a qualified transferee to carryback any NOLs
acquired under this program.
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18)Defines "biotechnology" as the continually expanding body of
fundamental knowledge about the functioning of biology systems
from the macro level to the molecular and subatomic levels, as
well as novel products, services, technologies, and
sub-technologies developed as a result of insights gained from
research advances that add to that body of fundamental
knowledge.
19)Defines a "technology company" as an emerging corporation
that meets all of the following requirements:
a) Owns, has filed for, or has a valid license to use
protected, proprietary intellectual property; and
b) Employs some combination of highly educated or trained
managers and workers, or both, in California who use
sophisticated scientific research service or production
equipment, processes or knowledge to discover, develop,
test, transfer, or manufacture a product or service.
20)Defines a "biotechnology company" as an emerging corporation
that:
a) Owns, has filed for, or has a valid license to use
protected, proprietary intellectual property; and,
b) Is engaged in the research, development, production, or
provision of biotechnology for the purpose of developing or
providing products or processes for specific commercial or
public purposes, as provided.
21)Defines the phrase "new or expanding" as a technology or
biotechnology company that, at the end of the calendar year
prior to the year in which the company applies for the NOL
surrender, has fewer than 225 employees in the United States,
and (a) has at least one full-time employee working in
California if the company has been incorporated for less than
three years, (b) five full-time employees if the company has
been incorporated for more than three years but less than five
years, or (c) at least ten employees if the company has been
incorporated for more than five years.
22)Defines a "full-time employee" as any of the following:
a) A person employed by a new or expanding emerging
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technology or biotechnology company for consideration for
at least 35 hours a week;
b) A person who renders any other standard of service
generally accepted by custom or practice as full-time
employment and whose wages are subject to withholding, as
required by Unemployment Insurance Code Division 6
(commenting with Section 13000);
c) A partner of a new or expanding emerging technology or
biotechnology company who works for the partnership other
than as an employee for at least 35 hours a week; or
d) A partner who works for the partnership other than as an
employee and who renders any other standard of service
generally accepted by custom or practice as full-time
employment, and whose distributive share of income, gain,
loss, or deduction, or guaranteed payments are subject to
the payment of estimated taxes.
23)Provides that, in order to qualify as a "full-time employee,"
an employee shall receive from the company health benefits
under a group health plan, a health benefits plan, or a
specified policy or contract issued pursuant to the Insurance
Code.
24)Excludes from the definition of a "full-time employee" any
person who works as an independent contractor or on a
consulting basis.
25)Provides that "group health plan" means an employee welfare
benefit plan, as defined in Title 1 of Section 3 of the
Employee Retirement Income Security Act of 1974, to the extent
that the plan provides medical care, including items and
services paid for as medical care to employees of their
dependents, as specified.
26)Limits the program to taxable years beginning on or after
January 1, 2014, and before January 1, 2019.
EXISTING FEDERAL LAW :
1)Allows, in general, a corporate taxpayer to carry forward an
NOL for 20 years, or carry it back two years, to reduce future
or past income, as long as the corporation's legal identity is
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maintained.
2)Denies a taxpayer the ability to sell its NOLs to another
taxpayer.
3)Provides that, after certain asset acquisition in which the
acquired corporation goes out of existence, that acquired
corporation's NOL carryforwards, generally, are inherited by
the acquiring corporation. However, in order to limit
tax-motivated acquisitions of loss corporations, the use of
those NOLs and other carryforwards may be subject to special
limitations. Acquired losses also include what is called an
"unrealized built-in loss," which is the amount of the value
of assets reported on the acquired corporation's books that
exceeds the fair market value of its assets immediately before
the corporation is acquired.
4)Limits the amount of acquired losses that the acquiring
corporation may use to offset its income in the year of
acquisition and the following years [Internal Revenue Code
(IRC) Section 382]. Generally, the acquiring corporation may
use the acquired corporation's losses in the amount equal to
the value of the acquired corporation, measured by the value
of its stock immediately before the acquisition, multiplied by
the long-term tax exempt rate, a base interest rate computed
by the Internal Revenue Service.
EXISTING STATE LAW :
1)Conforms to the federal NOL carryback rules for taxable years
beginning on or after January 1, 2013, [SB 858 (Senate Budget
and Fiscal Review Committee), Chapter 721, Statutes of 2010
and AB 1452 (Committee on Budget), Chapter 763, Statutes of
2008] with the following modifications:
a) An NOL may be carried back only two years.
b) The amount of an NOL carryback attributable to taxable
year 2013 is limited to 50 percent of the NOL.
c) The amount of an NOL carryback attributable to taxable
year 2014 is limited to 75 percent of the NOL.
d) The amount of an NOL carryback attributable to taxable
year 2015 and thereafter is 100 percent of the NOL.
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2)Allows taxpayers to carry forward NOLs for 20 years.
FISCAL EFFECT : The FTB estimates revenue losses of $1.8 million
for FY 2017-18, $4.6 million for FY 2018-19, and $5.1 million
for FY 2019-20, and $5.1 million for FY 2020-21.
COMMENTS :
1)The author has provided the following statement in support of
this bill:
"California has more high tech jobs than any other state in
the country. In fact, with more than 931,000 thousand jobs,
California has twice as many as second ranked Texas, and three
times as many as third ranked New York. Additionally,
California has over 2,300 biomedical companies employing over
267,000 workers. The average salary for an employee in the
biomedical field is $72,000 a year. Industries like these
provide high wage, high quality jobs, and greatly improve the
overall economy in California. The biotech industry alone
accounts for $115 billion in revenue to the state of
California every year. Recognizing the importance of this
industry, California needs to do all it can to assist the
development and growth of new emerging technology and
biotechnology companies.
"Unfortunately, biotechnology projects generally require a
long development period before generating revenue, in some
cases 10 to 12 years. As such, they may be considered riskier
investments. Because of this, biotechnology companies must
secure sufficient funding to meet cash flow needs.
Unfortunately, obtaining adequate funding to keep the company
operational until the point of profitability is difficult
during these tough economic times. In order to help bridge
funding gaps, AB 879 will provide an innovative way for new
startup biotechnology and emerging technology companies to
raise much needed capital by allowing the sale of unused net
operating losses. The sale of net operating losses will allow
startups to meet cash flow needs, expedite growth, and improve
the company's chances of bringing a product to market.
Because the cost of funds for early stage companies can be
extremely high and in some cases unavailable, the sale of net
operating losses may be critical to the survival of newly
formed companies."
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2)Proponents of this measure state :
"AB 879 will allow small biotechnology companies to transfer
unused net operating loss (NOL) credits to other companies.
Along with research and development (R&D) credits, [NOLs] are
one of the most valuable tools the state of California has to
remain competitive with other states in the life sciences
industry. This bill will allow small companies to realize a
monetization of those unused credits.
"A lingering effect of the recession is that venture capital,
once the lifeblood of the life sciences industry, has been
significantly reduced, and that which is being invested has
tended to be in later stage companies. Early stage companies
face the challenge of a long (often 10-12 year) period of
development before approval, and have far fewer options to
access the tremendous capital needed to take a candidate from
discovery to approval, which can cost upwards of $1.2 billion,
according to some studies. This bill may give many of these
young companies a lifeline while they work through the very
difficult period of early stage development.
"? A favorable tax environment encourages startup companies to
locate in our state, and gives established companies incentive
to stay. By passing AB 879, we hope to ensure that California
remains the preeminent place for biomedical research and
manufacturing."
3)NOLs: Background . Generally speaking, an NOL is the excess
of business deductions over gross income in a particular tax
year. In other words, an NOL is incurred when a business
taxpayer has negative taxable income. An NOL can be used to
obtain a refund for taxes paid in the past and/or to reduce
future tax obligations. The process of using an NOL to refund
previously paid taxes is known as an NOL carryback, whereas
the process of using an NOL to reduce future taxes is known as
a carryforward. Individuals, Subchapter C corporations,
estates and trusts and charitable organizations (with respect
to the unrelated business income tax) can benefit from NOLs.
Pass-through entities such as partnerships and Subchapter S
corporations do not benefit from the NOLs themselves, but
rather they pass through the benefit of the NOL to the
partners or shareholders, respectively.
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Under federal law, taxpayers are allowed to carry back an NOL
from a trade or business to apply as a deduction against
income in prior taxable years. Generally, NOLs can be carried
back to the two years preceding the loss year and then forward
to the 20 years following the loss year. Recently, the
federal carryback period was extended from two to five years
for 2008 and 2009 NOLs. California mostly conforms to the
federal law for NOLs and recently authorized NOL carrybacks
beginning in the 2013 tax year. For NOLs generated in the
2013 taxable year, taxpayers may carry back 50% of the loss.
For NOLs generated in the 2014 taxable year, taxpayers may
carry back 75% of the loss, and for NOLs generated in the 2015
taxable year and thereafter, taxpayers may carry back 100% of
the loss.
The basic rationale for allowing losses to be carried forward
and back flows from recognition that businesses are
established with the goal of making a profit over a business
cycle rather than in any particular year. The NOL deductions
help smooth out the income and taxes paid over a business
cycle, thereby allowing a business to make efficient decisions
regarding financing and investment. For example, consider two
firms, one with a $100 loss in year one and a $300 gain in
year two, the second with a $100 gain in each year. Without a
NOL deduction, over the two years, the first firm would report
$300 taxable income, while the second would report $200, even
though each had $200 net income. [Department of Finance
(DOF), Annual Tax Expenditure Report, 2008-09].
The NOL deduction levels the playing field for firms with
volatile and steady income and is not considered to be a tax
expenditure by the DOF. Similarly, the federal Joint
Committee on Taxation does not view NOL carrybacks or
carryforwards as tax expenditures. It is assumed that the
general limits on the number of years that such losses may be
carried back or forward were chosen for reasons of
administrative convenience and compliance concerns and
represents normal income tax law.
4)Transfers of NOLs under Existing Law . Neither federal nor
state law allows taxpayers to sell NOLs and severely restrict
the taxpayers' ability to transfer NOLs. IRC Section 382,
originally added to the IRC in 1954 and completely re-written
in 1986, was enacted to limit tax-motivated acquisitions of
loss corporations. Prior to the enactment of IRC Section 382,
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corporations with large losses were attractive to buyers with
large taxable income simply because the acquired corporation's
losses could be used to reduce the buyer's taxable income and,
effectively, the cost of acquisition. The limitations
currently in place preclude a buyer from using the NOLs and
built-in losses of the acquired entity at a rate that is
faster than the rate at which the acquired corporation could
have used them if it had sold its assets and invested the
proceeds in tax-exempt governmental obligations. Built-in
losses are also subject to special limitations because they
are economically equivalent to pre-acquisition NOL
carryforwards. If "built-in losses were not subject to
limitations, taxpayers could reduce or eliminate the impact of
the general rules by causing a loss corporation (following an
ownership change) to recognize its built-in losses free of the
special limitations" and "then invest the proceeds in assets
similar to the assets sold." (General Explanation of the Tax
Reform Act of 1986, Joint Committee on Taxation, p. 298, May
4, 1987). The purpose of this IRC Section 382 limitation is
to make losses a neutral factor in a corporate acquisition.
5)The Proposed Transfers of NOLs . AB 879 would allow small
biotechnology and technology companies to transfer unused NOLs
to other unaffiliated companies in exchange for cash payment
assistance. The program would be administered by the
Treasurer, in cooperation with the FTB. The total amount of
transferable NOLs in any given year would be capped at $60
million, with $25 million set aside for small qualified
transferors. In addition, to qualify as eligible, a company
has to employ at least one full-time person in California, if
the company has been incorporated for more than three years,
at least five full-time employees, if the company has been
incorporated for more than three more but fewer than five
years, and at least 10 full-time employees if the company has
been incorporated for more than five years. Any NOLs
transferred pursuant to AB 879 would be allowed to a taxpayer
beginning on or after the first day of the fourth taxable year
after the date of issue of the corporation business tax
benefit certificate. Overall, the proposed program is
patterned after the New Jersey corporation business tax
benefit certificate transfer program and is very limited.
6)Limitations of NOLs . An NOL carryback/carryforward provision
provides taxpayers with the ability to smooth out changes in
business income, and therefore tax liability, over the
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business cycle. Under certain circumstances, extending the
carryback/carryforward period indefinitely would minimize the
distorting effects that taxation has on investment decisions,
which could lead to increased economic efficiency. Despite
the benefits of an NOL carryback/carryforward provision,
practical and legal limitations exist. First, an NOL
carryback provision is generally limited to the preceding two
years. Second, an NOL carryforward can only be utilized if
the qualified company reaches the point of profitability,
which may never occur. Qualified companies, as described in
this bill, are unlikely to take advantage of either.
Specifically, these companies do not have taxable income in
the preceding two years, and because of the long product
development period, may never reach the point of
profitability.
Despite the practical limitations associated with NOLs, it is
possible for California, under the provisions of this bill, to
provide the benefits of an NOL deduction to certain start-up
companies today, while at the same time shifting revenue
losses to the future. Specifically, AB 879 would allow for
the sale of NOLs, which infuses the qualified company selling
the NOL with immediate cash. AB 879 also allows California to
shift revenue losses to the future. As noted by the FTB's
analysis, California will not incur any revenue losses until
2016. Additionally, unlike in the case of carryback NOLs,
even though the state will incur limited revenue losses as a
result of this bill, it will not have to pay tax refunds.
This is because surrendered NOLs, under the provisions of this
bill, may only be utilized to offset taxable income of the
purchaser in the fourth year after being purchased.
7)Technology Business Tax Certificate Transfer Program: The New
Jersey Experience . In 1995, New Jersey (NJ) created a program
- the NJ Technology Business tax Certificate Transfer Program
- authorizing new and emerging technology and biotechnology
companies in NJ to transfer their unused research and
development (R&D) tax credits, as well as unused NOLs, to
other unaffiliated corporations doing business in the state.
These tax benefits may be acquired and used by the
unaffiliated corporations in exchange for private financial
assistance to the qualifying technology and biotechnology
companies. The NJ Program is very similar to one created by
AB 879, although the California program would not allow a sale
of R&D tax credits.
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In 2010, the NJ Institute of Technology conducted an evaluation
of the NJ Program to determine the program effectiveness. The
study found that the primary goal of the program - creation of
high wage and high quality jobs in NJ in a cost-effective
manner - was achieved but only for biotechnology companies.
The study concluded that, while "technology companies are an
important opportunity for job creation in New Jersey, other
programs like direct grants to promising startups, support of
the business incubator networks, and co-investment in startups
through the Edison Innovation Fund would be a more effective
way to generate and maintain significant technology employment
in New Jersey." (New Jersey's Science & Technology
University, Program Evaluation: New Jersey Technology Business
Tax Certificate Transfer Program, p. 2). The study also
states that "the cost of the tax transfers is less than the
benefit of the NJ income tax revenues generated by the
beneficiary companies." Id. The authors of the study made
several recommendations to improve the effectiveness of the
almost 20-year old program but concluded that it should be
continued only for biotechnology companies. They also
suggested an amendment to the program to incorporate issuance
of warrant to NJ in connection with the authorization of
credits and a provision for a discounted direct state buyback
of the issued credits.
8)Implementation Concerns . The FTB has identified the following
implementation concerns:
a) This bill uses the undefined terms and phrases,
"emerging company," and "unused but otherwise allowable net
operating losses." The absence of a definition to clarify
these phrases could lead to disputes with taxpayers and
would complicate the administration of this program.
b) This bill omits from the definition of "new or
expanding," companies that have been incorporated exactly
three years and exactly five years.
9)Technical Concerns . The FTB has identified the following
technical concerns:
a) On page 4, the definition of "qualified transferor"
excluded banks and financials, but did so only indirectly.
The author may wish to specifically exclude corporations
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subject to tax under Section 23181.
b) On page 4, in the definition of "new or expanding", the
term "working in this state" is included in two of the
three requirements for employees in California, depending
on the length of time the corporation has been
incorporated. The author may wish to add "working" after
"employees" on line 17, to make the requirements
consistent.
c) Paragraph (6) of subdivision (e) needs to be amended
where the phrase "employees in the state" appears, as it
should be "employees working in the state" for consistency
within the paragraph.
d) The definition of "qualified transferor" needs to be
amended where the phrase "new or expanding emerging"
appears as it should be "new or expanding" to correspond
with the definition in paragraph (6) of subdivision (e).
e) On page 5, line 32, the word "transferee" should be
"transferor."
10)Related Legislation . AB 2045 (Perea), introduced in the
2011-12 legislative session, a substantially similar bill,
would have created a business tax benefit certificate transfer
program. AB 2045 was held in the Assembly Appropriations
Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
BayBio
BIOCOM
California Healthcare Institute
Opposition
California Tax Reform Association
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098
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