BILL ANALYSIS Ó
AB 1326
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Date of Hearing: April 22, 2013
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 1326 (Gorell) - As Introduced: February 22, 2013
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Sales and use taxes: exemptions: unmanned aerial
vehicle manufacturing: income taxes: credits: wages
SUMMARY : Establishes a sales and use tax (SUT) exemption for
tangible personal property (TPP) used in unmanned aerial vehicle
(UAV) manufacturing, and allows UAV manufacturers an income tax
credit based on qualified wages paid to employees.
Specifically, this bill :
1)Exempts from SUT TPP purchased:
a) For use in UAV manufacturing by a qualified person "to
be used primarily in any stage of the manufacturing of
property," as specified; or,
b) By a contractor in the performance of a construction
contract for the qualified person that will use the
qualified TPP as an integral part of the manufacturing
process, or as a facility for use in connection with the
manufacturing process.
2)Defines TPP to include, without limitation, all of the
following:
a) Machinery and equipment, including component parts and
contrivances such as belts, shafts, moving parts, and
operating structures;
b) Equipment or devices used or required to operate,
control, regulate, or maintain the machinery including,
without limitation, computers, data processing equipment,
and computer software, together with all repair and
replacement parts with a useful life of one or more years;
c) Property used in pollution control, as specified;
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d) Special purpose buildings and foundations, as specified;
and,
e) Fuels used or consumed in the manufacturing process.
3)Specifies that TPP does not include:
a) Consumables with a normal useful life of less than one
year, except for fuels used in the manufacturing process;
b) Furniture, inventory, and equipment used in the
extraction process, or equipment used to store finished
products that have completed the manufacturing process; or,
c) TPP used primarily in administration, general
management, or marketing.
4)Defines a "qualified person" as either of the following:
a) A person engaged in the line of business described in
Industry Group 336411 of the North American Industry
Classification System (NAICS) published by the United
States (U.S.) Office of Management and Budget (OMB), 2012
edition, that manufactures UAVs; or,
b) An affiliate of a person described above, as specified.
5)Defines "manufacturing" as the activity of converting or
conditioning property by changing the form, composition,
quality, or character of the property for ultimate sale at
retail or use in the manufacturing of a product to be
ultimately sold at retail. Manufacturing includes any
improvements to TPP that result in a greater service life or
greater functionality than that of the original property.
6)Defines "primarily" to mean TPP used 50% or more of the time
in an activity that qualifies the taxpayer for the SUT
exemption.
7)Defines "process" to mean the period beginning at the point at
which raw materials are received by the qualified person and
introduced into the manufacturing activity of the qualified
person and ending at the point at which the qualified activity
has altered the TPP to its completed form. Raw materials are
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considered introduced into the process when the raw materials
are stored on the same premises where the qualified activity
is conducted.
8)Provides that the SUT exemption shall apply on and after
January 1, 2014, and before January 1, 2014.
9)Provides that the state shall not reimburse local agencies for
any SUT revenues lost as a result of this exemption.
10)Allows, for taxable years beginning on or after January 1,
2014, and before January 1, 2024, an income tax credit in an
amount equal to the following:
a) 50% of "qualified wages" paid or incurred during any
taxable year beginning on or after January 1, 2014, and
before January 1, 2016;
b) 40% of "qualified wages" paid or incurred during any
taxable year beginning on or after January 1, 2016, and
before January 1, 2018;
c) 30% of "qualified wages" paid or incurred during any
taxable year beginning on or after January 1, 2018, and
before January 1, 2020;
d) 20% of "qualified wages" paid or incurred during any
taxable year beginning on or after January 1, 2020, and
before January 1, 2022; and,
e) 10% of "qualified wages" paid or incurred during any
taxable year beginning on or after January 1, 2022, and
before January 1, 2024.
11)Defines a "qualified taxpayer" as any taxpayer engaged in the
line of business described in Industry Group 336411 of the
NAICS published by the OMB, 2012 edition, that manufacturers
UAVs.
12)Defines a "qualified employee" as an individual whose
services for the qualified taxpayer are performed in this
state and are at least 90% directly related to the qualified
taxpayer's manufacturing of UAVs.
13)Defines "qualified wages" as that portion of wages paid or
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incurred by the qualified taxpayer during the taxable year
with respect to qualified employees that are direct costs, as
defined, allocable to property manufactured in this state by
the qualified taxpayer.
14) Caps the credit at $20,000 per year, per qualified employee.
15)Provides that, in cases where the credit exceeds the
taxpayer's tax liability, the excess credit amount may be
carried over to reduce the taxpayer's tax liability for up to
eight years, until the credit is exhausted.
16)Takes immediate effect as a tax levy.
EXISTING FEDERAL LAW authorizes Congress, under the commerce
clause of the U.S. Constitution, to regulate commerce with
foreign nations, and among the several states. The U.S. Supreme
Court has held that the "negative" or "dormant" commerce clause
also prohibits states from enacting laws that unduly burden or
discriminate against interstate commerce.
EXISTING STATE LAW :
1)Imposes a sales tax on retailers for the privilege of selling
TPP, absent a specific exemption. The tax is based upon the
retailer's gross receipts from TPP sales in this state.
2)Imposes a complementary use tax on the storage, use, or other
consumption in this state of TPP purchased from any retailer.
The use tax is imposed on the purchaser, and unless the
purchaser pays the use tax to a retailer registered to collect
the California use tax, the purchaser remains liable for the
tax, unless the use is exempted. The use tax is set at the
same rate as the state's sales tax and must generally be
remitted to the State Board of Equalization (BOE).
3)Allows various tax credits under both the Personal Income Tax
Law and the Corporation Tax Law. These credits are generally
designed to encourage socially beneficial behavior or to
provide relief to taxpayers who incur specified expenses.
4)Establishes the following geographically-targeted economic
development areas (G-TEDAs): Enterprise Zones, Manufacturing
Enhancement Areas, Targeted Tax Areas, and Local Agency
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Military Base Recovery Areas. Special tax incentives are
provided to taxpayers conducting business activities within a
G-TEDA. These incentives include a hiring credit equal to a
percentage of wages paid to qualified employees.
5)Allows a New Jobs Tax Credit for taxable years beginning on or
after January 1, 2009, to qualified employers equal to $3,000
for each net increase in qualified full-time employees hired
during the taxable year. The credit is limited to small
businesses (i.e., taxpayers with 20 or fewer employees as of
the last day of the preceding taxable year). The credit is
capped at roughly $400 million for all taxable years.
6)Allows taxpayers engaged in a trade or business to deduct
expenses that are considered ordinary and necessary in
conducting that trade or business.
FISCAL EFFECT :
1)SUT exemption : The BOE estimates that this bill's SUT
exemption provisions would result in state and local revenue
losses of $6.9 million in fiscal year (FY) 2013-14, $15.9
million in FY 2014-15, and $17.2 million in FY 2015-16.
2)Income tax credit : The Franchise Tax Board (FTB) estimates
that this bill's income tax credit provisions would result in
General Fund revenue losses of $31 million in FY 2013-14, $40
million in FY 2014-15, and $60 million in FY 2015-16.
COMMENTS :
1)The author has provided the following statement in support of
this bill:
The unmanned aerial vehicle (UAV) market is expected to
grow tremendously in the near future. By 2018, the market
is expected to grow by 700%. Forecasts indicate that
30,000 drones will fill the nation's skies in the next 20
years. With the natural resources and the aerospace
infrastructure already in California's possession, we
should have a competitive advantage over other states to
capture the manufacturing industry, but the regulatory and
business climate continues to be an impediment. As a
result, other states have an opportunity to capture UAV
manufacturers as they aggressively seek to position
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themselves and compete for their attention. California has
an opportunity to be on [the] forefront of an emerging
sector and reap the tremendous benefits if it can create a
favorable environment for the industry. The benefits
include [a] substantial increase in jobs and tax revenue.
In California, one report indicates that the UAV industry
can potentially account for a $14 billion economic impact,
$83 million in tax revenue, and over 18,000 jobs between
2015 and 2025. As the domestic and international uses for
UAVs continue to grow with the advancement of technology,
the market will continue to expand and provide more
middle-class jobs for Californians.
2)Proponents of this bill note:
The Federal Aviation Administration (FAA) expects more than
30,000 drones to fill the nation's skies over the next
20-years. The FAA is mandating to integrate [sic] Unmanned
Aerial Systems (UAS) into the national airspace (NAS) by
2015.
According to a recent study by the Association for Unmanned
Vehicle Systems International (AUVSI), California is
projected to create over 18,000 new direct and indirect
jobs, generate $14 billion in economic activity and produce
$82 million in new tax revenue - as UAS integration
proceeds over the next decade.
[ . . . ]
States that provide industry incentives and a favorable
regulatory and business climate for the UAV industry will
be poised to benefit for many years to come. AB 1326 puts
California on solid footing to accommodate this new growth
and makes the state far more attractive to the emerging UAV
industry.
3)The BOE notes the following with respect to this bill's SUT
exemption provisions:
a) Code 336411 includes aircraft manufacturers :
"Specifically, this code describes establishments primarily
engaged in one or more of the following: (1) manufacturing
or assembling complete aircraft; (2) developing and making
aircraft prototypes; (3) aircraft conversion (i.e., major
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modifications to systems); and (4) complete aircraft
overhaul and rebuilding (i.e., periodic restoration of
aircraft to original design specifications). However, the
proposed exemption is limited to purchases for UAV
manufacturing by these establishments."
b) What about ground control station manufacturing? : "UAVs
are aircraft piloted through ground control stations. The
bill does not specify whether the proposed exemption
additionally applies to qualifying tangible personal
property purchased for use in ground control station
manufacturing. Without such specificity, the exemption may
not apply. This distinction is illustrated in the sales
and use tax exemption for aircraft sold to foreign
governments or non-California residents for use outside
this state. With respect to [Revenue and Taxation Code]
Section 6366, a question arose whether ground control
stations used to operate the exempt aircraft also
qualified. The Legislature addressed this issue by
specifically adding ground control stations to the
exemption. If the author intends to include ground
control manufacturing, it is suggested that the bill so
specify."
4)The FTB notes the following with respect to this bill's income
tax credit provisions:
a) "The bill defines a qualified employee as an individual
whose services for the qualified taxpayer are performed in
this state and are at least 90 percent directly related to
the qualified taxpayer's line of business. However, the
bill fails to define "directly related," which could lead
to disputes between taxpayers and the department regarding
whether an employee would qualify for the credit. It is
also unclear whether this requirement is designed to
prevent non-manufacturing jobs (i.e., administrative,
accounting, legal, or secretarial) from qualifying for this
credit. The author may wish to amend the bill for clarity."
b) "This bill would allow a credit for wages that are
currently deductible as business expenses. Generally, a
credit is allowed in lieu of any deduction or credit
already allowable for the same item of expense in order to
eliminate multiple tax benefits for the same item of
expense."
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c) "Tax credits generally are designed to provide
incentives for taxpayers to perform various actions or
activities that they may not otherwise undertake. This
bill could incentivize behavior that has occurred in the
past because the bill fails to specify the date that an
individual must begin employment with the qualified
employer in order to be considered a qualified employee.
As a result, a qualified employer may be eligible for a
credit for all or part of their existing workforce."
5)Committee Staff Comments on the SUT Exemption:
a) Is the proposed SUT exemption for manufacturing
equipment good tax policy? : Businesses currently pay about
one-third of the state's SUT. A business pays SUT when it
is considered to be the final consumer of TPP. Any SUT
paid by a business will, however, be factored into the
prices it charges for goods which, in turn, may be subject
to taxation. This results in end consumers paying a tax on
a tax (i.e., pyramiding), making the overall tax system
less transparent. Requiring businesses to pay SUT on their
manufacturing equipment also increases the cost of
production in California, placing the state at a
competitive disadvantage vis-à-vis other states that
provide exemptions for certain manufacturing equipment.
Thus, nearly all economists and tax experts agree that
taxing manufacturing equipment represents poor tax policy.
Indeed, during this Committee's March 23, 2009
informational hearing on "Tax Policy in a Time of Economic
Crisis," presenters unanimously agreed that it would make
sense to eliminate the SUT on most business purchases.
Such a change, however, should likely be considered in the
context of the state's overall tax structure. A SUT
exemption would obviously result in a significant reduction
of state revenues. For this reason, Dr. Charles McClure, a
Senior Fellow with the Hoover Institute, stated during the
Committee's March 23 hearing that the SUT base should be
expanded and the rate increased to compensate for the loss
in revenues accompanying a manufacturing exemption.
b) Would a manufacturing exemption lead to job growth? :
While a manufacturing exemption represents sound tax
policy, past experience suggests that it, by itself, may
not lead to large scale job creation. Prior to January 1,
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2004, California had a similar tax incentive known as the
Manufacturers' Investment Credit (MIC), which was enacted
in response to the state's economic downturn during the
late 80s and early 90s. During this period, the state lost
about 300,000 jobs and had a 45% reduction in aerospace
alone. The MIC expired on January 1, 2004, after the
Employment Development Department (EDD) determined that
jobs on the preceding January 1 did not exceed the total
manufacturing jobs in California on January 1, 1994 by more
than 100,000. The EDD stated that from January 1, 1994 to
January 1, 2002, the total net increase in manufacturing
employment was 35,150.
c) Defining a normal useful life : This bill excludes from
the definition of exempt TPP consumables with a normal
useful life of less than one year. This bill, however,
does not provide any guidance on how normal useful life is
to be measured. This bill should reference a clear and
objective standard for determining the useful life of an
item. The BOE has suggested amendments in its staff
analysis of this bill to address this issue.
d) Notification requirement : This bill includes a
provision eliminating the SUT exemption if the purchased
property is removed from California or converted to a
non-exempt use within one year of the purchase date. This
bill allows the BOE to collect taxes not paid if any of the
above occurs, but AB 1326 does not provide a method for
notifying the BOE. Short of an audit, the BOE would have
no means of learning of the liability.
e) Where do all those exemption certificates go? : This
bill requires retailers to provide the BOE a copy of each
exemption certificate received from a purchaser. The BOE
staff recommends eliminating this requirement. Instead,
BOE staff suggests requiring retailers to retain exemption
certificates in their records for subsequent BOE
examination upon request.
f) Additional technical concerns : Committee staff has
identified additional technical concerns with this bill's
SUT provisions, and will work with the author to address
these issues and any others that may be identified in the
future.
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6)Committee Staff Comments on the Income Tax Credit:
a) What is a "tax expenditure"? : Existing law provides
various credits, deductions, exclusions, and exemptions for
particular taxpayer groups. In the late 1960s, U.S.
Treasury officials began arguing that these features of the
tax law should be referred to as "expenditures," since they
are generally enacted to accomplish some governmental
purpose and there is a determinable cost associated with
each (in the form of foregone revenues). This bill would
enact a new tax expenditure program, in the form of an
income tax credit, to incentivize the hiring and retention
of employees engaged in drone manufacturing.
b) How is a tax expenditure different from a direct
expenditure? : As the Department of Finance notes in its
annual Tax Expenditure Report, there are several key
differences between tax expenditures and direct
expenditures. First, tax expenditures are reviewed less
frequently than direct expenditures once they are put in
place. This can offer taxpayers greater certainty, but it
can also result in tax expenditures remaining a part of the
tax code without demonstrating any public benefit. Second,
there is generally no control over the amount of revenue
losses associated with any given tax expenditure. Finally,
it should also be noted that, once enacted, it takes a
two-thirds vote to rescind an existing tax expenditure
absent a sunset date. This effectively results in a
"one-way ratchet" whereby tax expenditures can be conferred
by majority vote, but cannot be rescinded, irrespective of
their efficacy, without a supermajority vote.
c) The not-so-dormant commerce clause : The credit this
bill proposes is only available for wages paid to employees
whose services are performed in California. By limiting
the credit to in-state activity, this credit could arguably
be susceptible to challenge under the dormant commerce
clause of the U.S. Constitution.
The U.S. Constitution authorizes Congress to regulate
commerce with foreign nations, and among the several
states. (U.S. Constitution, Article I, Section 8, Clause
3). While the commerce clause is phrased as a positive
grant of regulatory power, it "has long been seen as a
limitation on state regulatory powers, as well as an
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affirmative grant of congressional authority." [Fulton
Corp. v. Faulkner (1996) 516 U.S. 325, 330.] This negative
aspect, commonly referred to as the dormant commerce
clause, prohibits economic protectionism in the form of
state regulation that benefits "instate economic interests
by burdening out-of-state competitors." (Ibid.)
Both the U.S. Supreme Court and the California courts have
addressed challenges to various state tax provisions on
dormant commerce clause grounds. Most recently, the Court
of Appeal struck down a California statute that allowed
taxpayers a deferral for income received from the sale of
stock in corporations maintaining assets and payroll in
California, while providing no such deferral for income
from the sale of stock in corporations maintaining assets
and payroll elsewhere. [Cutler v. Franchise Tax Board
(2012) 208 Cal.App.4th 1247, 1250.] Specifically, the
court held that "the deferral provision discriminates on
its face on the basis of an interstate element in violation
of the commerce clause." (Ibid.)
While noting that no court decision has yet invalidated, as
a general matter, a state income tax credit that provides
an incentive for in-state activity, the FTB notes that such
credits "may be subject to constitutional challenge."
d) Suggested technical amendments :
i) On page 6, line 34, strike "2013" and insert "2014";
ii) On page 6, line 34, strike "2023" and insert "2024";
and,
iii) On page 7, line 39, and on page 8, line 1, replace
all references to "net tax" with "tax".
REGISTERED SUPPORT / OPPOSITION :
Support
California Chamber of Commerce
California Manufacturers & Technology Association
California State Council of Laborers
Camarillo Chamber of Commerce
Chambers of Commerce Alliance of Ventura & Santa Barbara
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Counties
Simi Valley Chamber of Commerce
Opposition
None on file
Analysis Prepared by : M. David Ruff / REV. & TAX. / (916)
319-2098