BILL ANALYSIS Ó AB 2681 Page A Date of Hearing: April 21, 2014 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Raul Bocanegra, Chair AB 2681 (Dababneh) - As Introduced: February 21, 2014 2/3 vote. Fiscal committee. Tax levy. SUBJECT : Sales and use tax: retail sale: storage use: counterfeit mark SUMMARY : Provides that a "retail sale" or "sale at retail" also includes any sale by a convicted seller, as defined, of tangible personal property (TPP) with a counterfeit mark regardless of whether the sale is for resale in the regular course of business. Specifically, this bill : 1)Provides that a "retail sale" or "sale at retail" also includes any sale by a convicted seller of TPP with a counterfeit mark on, or in connection with, that sale, regardless of whether the sale is for resale in the regular course of business. 2)Defines a "convicted seller" as a person convicted of a violation under Penal Code Section 350 or 653w or Section 2320 of Title 18 of the United States Code. The conviction must have occurred on or after the date of sale. 3)Defines a "counterfeit mark" as having the same meaning as defined by United State Code, Title 18, Section 2320. 4)Provides that Business and Professions Code Section 17200 and Civil Code Section 1750 shall only apply to a convicted seller. 5)Provides that a notice of deficiency determination to a convicted seller shall be mailed within one year after the last day of the calendar month following the date of conviction. 6)Takes effect immediately as a tax levy. AB 2681 Page B EXISTING LAW 1)Makes it a crime, punishable by fines and imprisonment, for any person to willfully manufacture, intentionally sell, or knowingly possess for sale any counterfeit of a mark registered with the Secretary of State or the Principal Register of the United States Patent and Trademark Office. 2)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 California. 3)Defines a "retail sale" as a sale for any purpose other than resale in the regular course of business. With respect to illegal sales of goods in California, the law imposes a sales or use tax on the retail sales and purchases of those goods in the same manner as legitimate sales. 4)Provides that TPP sold to a person who resells the property prior to any use of that property is not subject to Sales and Use Tax (SUT). 5)Provides that TPP sold to a person who purchases the property to incorporate into a manufactured item to be sold is not subject to SUT. 6)Imposes a complementary use tax on the storage, use, or other consumption in California 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). 7)Establishes the BOE, which consists of five voting members: the State Controller and four members elected for four-year terms at gubernatorial elections. Among its many duties, the BOE administers the SUT, sets property values for state-assessees, monitors the property tax assessment practices of county assessors, and serves as the administrative appellate body for final actions of the FTB. 8)Requires various state entities, including the BOE, the FTB, and the Department of Justice, to enforce laws relating to the AB 2681 Page C taxation and legal operation of businesses throughout the state under their respective jurisdictions. FISCAL EFFECT : The BOE estimates an annual General Fund revenue increase of $2.1 million. The BOE also adds that persons from whom this property is seized may face significant fines and imprisonment. Accordingly, total tax collections are likely to be considerably less. COMMENTS : 1)The author has provided the following statement in support of this bill: California's underground economy has a severe and negative effect on the state's competitiveness. The underground economy refers to the selling of counterfeit goods designed to exactly replicate a "name brand" item. These goods are typically imported from overseas and sold at open markets or in other unofficial venues. Because it enables illegitimate businesses to steal intellectual property and then sell it at below market costs, the underground economy places law abiding businesses at a tremendous disadvantage. Law abiding businesses make significant financial investments to develop their products, including: training and hiring employees, building manufacturing capacity, and complying with myriad state labor and environmental protection laws. At each point in the production process, these law abiding businesses also remit billions of dollars to the State in the form of tax revenues that are used to fund schools, transportation and other vital government services. The underground economy bypasses this process, giving illegitimate businesses an unfair advantage over legitimate businesses that operate in good faith and comply with State laws. One of the serious long-term effects of the underground economy is that it discourages law abiding businesses from investing in the development of new products. This has a chilling effect on the entire value chain, from the manufacturing equipment that would have been purchased to the hundreds of good jobs that would have been created. AB 2681 Page D Under existing State law, sales taxes are imposed on the "retail sale" or "sale at retail" (hereinafter referred to [as] "retail sale") of tangible personal property in California. Under Section 6007 of the Sales and Use Tax Law, a retail sale is defined as a sale for any purpose other than resale in the regular course of business. As such, retail sales of counterfeit goods and pirated intellectual property in the form of tangible personal property is subject to sales tax to the same extent as legitimate sales. However, sales, possession for resale, and/or transportation of tangible personal property (whether counterfeit, pirated, or legitimate) for reseal are not subject to tax. 2)Supporters state that "[c]ounterfeit activity is a pervasive crime that undermines the competitiveness of legitimate businesses that play by the rules. These inferior products also damage the legitimate company's brand and can also potentially cause harm to consumers. Counterfeit activity also results in the State being shortchanged. According to the Board of Equalization, the state loses out on approximately $2.1 million in uncollected sales and use taxes associated with the sale of counterfeit or pirated goods. Not only is AB 2681 sound tax policy, it will also serve as an important tool to prevent these illegal products from entering the retail stream." 3)Committee Staff Comments. a) Why buy counterfeit goods ? A consumer either makes a conscious decision to purchase a counterfeit item (market equilibrium) or the consumer is fooled into thinking the counterfeit item is authentic (market failure). Studies have found that, under the first scenario, many consumers are willing to compromise on the product<1>. According to Vincent Wenxiong Yao, consumers may choose to compromise on the product because it affords them the opportunity to try a low-grade version with the intent of purchasing an authentic item at some point in the future. (Id.) -------------------------- <1> Vincent Wenxiong Yao, An Economic Analysis of Counterfeit Goods: the Case of China, Journal of the Washington Institute of China Studies (2009). AB 2681 Page E Counterfeit products also provide lesser value at a lower cost, which may be acceptable for an individual with limited means. Finally, counterfeits have improved dramatically. The ability to discern counterfeits from authentic goods is becoming increasingly difficult. Under a market failure scenario, however, the consumer is simply fooled into thinking they have purchased an authentic item. Because the quality of counterfeit items has improved dramatically, the likelihood of the second scenario increases. b) Who buys counterfeit goods ? Under the market equilibrium scenario, low-income communities are the ones most likely to purchase counterfeit items; and for a person with limited means, counterfeits may be a good substitute for brand new authentic goods. Moreover, the tendency to purchase counterfeit goods decreases as incomes increase. (Id.) This is because counterfeit goods are considered inferior products or negative goods. (Id.) When incomes increase, consumers tend to demand better quality and authentic products. Under a market failure scenario, however, counterfeit goods will be sold to consumers regardless of income because the seller has misrepresented the product. c) Enforcement of copyright laws . The underground economy is a well-documented problem in the State of California. The BOE has estimated that $8 billion in corporate, personal, and SUT revenues go uncollected in California each year, with unreported and underreported economic activity responsible for the vast majority of that total. This places a burden on state and local governments, and legitimate businesses; tackling the problem has not been easy. In 1993, the Joint Enforcement Strike Force was created to combat the underground economy by aiding in the sharing of information, coordinating enforcement efforts, and developing methods to target enforcement resources. Additionally, the Labor Task Force has also been launched in an effort to curb the underground economy. Through its information sharing program, the Labor Task Force attempts to ensure that employees receive proper payments and that California receives all employment taxes and fees owed. Despite the coordinated efforts of several state agencies, California's underground economy remains a serious problem. AB 2681 Page F d) Death and taxes, not always certain . One of the reasons why the government is unable to further crack down on the underground economy, and specifically on counterfeit goods, is because sellers of counterfeit goods rarely leave a paper trail. According to an article by the New York Comptroller, Bootleg Billions: The Impact of the Counterfeit Goods Trade on New York City, the City of New York lost an estimated $380 million in unpaid sales taxes in 2003 because sellers did not leave a paper trail. Although the lack of sales receipts poses some problems, an estimate of the value of the merchandise can be made available to the BOE upon conviction. The BOE understands that it may not be cost effective to combat counterfeit sales by enforcing the sales tax at the retail level. The purpose of this bill is to expand the imposition of the SUT Law to any sale of counterfeit TPP by a convicted seller. By expanding the imposition of SUT to transaction points along the supply chain, the BOE hopes to gain a useful and cost-effective tool in combating the underground economy. However, the collection of the SUT may still be difficult because persons from whom the property is seized have already been convicted and possibly face significant fines and imprisonment, which may not leave enough funds to pay for the uncollected sales tax. Even if a lien is placed on the property or a business, there is no guarantee that it will lead to additional tax revenue. As such, the BOE may find it no easier to collect from a person behind bars than from a vendor on the street. e) Fighting crime with tax . The "Tax Man" uses a number of tools to both discourage and encourage behavior. State and federal governments encourage homeownership by providing deductions for property taxes and interest paid on mortgages. Conversely, states have discouraged the use of certain products, such as cigarettes, by imposing a high excise tax. Despite using the tax code to discourage certain behavior, California does not usually impose a tax specifically on criminal activity. For example, California does not impose a special excise tax on the sale of illicit drugs, such as marijuana. One of the reasons for not imposing a special tax on illicit drugs is that the imposition of the tax might actually legitimize the use of the drug. As such, imposing a sales tax on certain counterfeit TPP sold by a convicted seller may have the AB 2681 Page G same effect. f) Supplier business model . Like most business models, a seller of counterfeit goods makes a profit if sales revenues exceed costs. However, unlike legitimate businesses, sellers of counterfeit goods must additionally take into account the potential costs of government prosecution and civil lawsuits from genuine producers. These considerations may have a huge impact on a seller's decision to carry counterfeit items, especially if the government has improved enforcement of copyright laws or increased jail time. The more active the government becomes in enforcing laws, the more likely sellers will choose not to carry counterfeit products. The threat of sales tax, on its face, may be seen as one additional tool to deter a person from selling counterfeit items because it increases the costs of doing business. However, the collection of sales tax is secondary to the threat of being caught. When one considers the jail time, the seizure of property, and the enormous criminal fines, it seems unlikely that a person selling counterfeit goods would be deterred by the possibility of having to remit sales tax, especially when the imposition of the tax is only imposed after a conviction. g) Criminal penalty vs. tax increase . As currently drafted, this bill increases taxes on at least one individual and is, therefore, subject to a 2/3 vote. If the author wishes to discourage the buying and selling of counterfeit goods through a majority vote proposal, he may wish to increase the criminal penalties already associated with the sale of counterfeit TPP. h) Related Legislation . AB 575 (V. Manuel Perez) amends the SUT Law to include within the definition of a "retail sale" any sale of TPP with a counterfeit mark or TPP that is pirated intellectual property, regardless of whether the sale is for resale in the regular course of business. AB 575 was held in this Committee. i) Prior Legislation . SB 1185 (Price), of the 2011-12 Legislative Session, would have established a multiagency partnership consisting of the Employment Development Department, the FTB, and the BOE, to collaborate in combating illegal underground operations. SB 1185 was held AB 2681 Page H in the Assembly Committee on Appropriations. REGISTERED SUPPORT / OPPOSITION : Support Board of Equalization (Sponsor) California Retailers Association Opposition None on file Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916) 319-2098