BILL ANALYSIS                                                                                                                                                                                                    Ó




                   Senate Appropriations Committee Fiscal Summary
                            Senator Kevin de León, Chair


          SB 412 (Knight) - Sales and Use Tax: Exemption: Aerospace  
          Products Manufacturing
          
          Amended: May 14, 2013           Policy Vote: G&F 7-0
          Urgency: No                     Mandate: No
          Hearing Date: May 23, 2013      Consultant: Robert Ingenito
          
          SUSPENSE FILE.


          Bill Summary: SB 412 would establish a sales and use tax (SUT)  
          exemption for equipment used to manufacturing aerospace  
          products. 

          Fiscal Impact: The Board of Equalization (BOE) estimates that  
          this bill would result in a revenue loss of $12.5 million in  
          2013-14, $26 million in 2014-15, and $28 million in 2015-16.  
          Additionally, BOE would incur administration costs, likely in  
          the range of $50,000 to $250,000 (General Fund), to reprogram  
          for the partial exemption, revise and process returns, notify  
          retailers, audit claimed exemptions, and answer inquiries from  
          taxpayers and the general public. 

          Background: The aerospace industry in Southern California began  
          roughly 100 years ago. Over the last century, early aviation  
          pioneers in the region transitioned from small workshops to  
          large factories that produced bombers and fighters and employed  
          tens of thousands of Southern Californians. In 1933, all the  
          airplane factories in Southern California employed approximately  
          1,000 people combined. By November 1943, that number had risen  
          to 280,300 workers. After World War II, technological  
          innovations pioneered by the region's aerospace firms made the  
          industry an important driver of economic growth in Southern  
          California. However, with the end of the Cold War in the late  
          1980s came defense budget cuts and military base closures. In  
          response, the industry's largest firms contracted in a wave of  
          consolidations and, as a result, many smaller, second and third  
          tier contractors were forced to close their doors. The result  
          was the loss of thousands of jobs. According to the Employment  
          Development Department's Labor Market Information Division,  
          state employment in aerospace product and manufacturing declined  
          by nearly half, from 139,300 in 1993 to 70,800 in 2013; however,  








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          almost the entire decline occurred between 1993 and 2004.

          The SUT is a tax on final sales of tangible personal property,  
          such as clothing, household furnishings, appliances, and motor  
          vehicles. Intermediate sales of goods (from a wholesaler to a  
          retailer, for example) are not taxed and, in addition, certain  
          individual items are specifically exempted from the SUT. The  
          largest of these tax expenditure programs (TEPs) involve  
          utilities and home-consumed food. California's state-level SUT  
          was established in the 1930s and its local SUT in 1955.

          Currently, most sales and use tax exemptions apply to the total  
          applicable SUT. However, current law contains five partial  
          exemptions, currently at a 5.50 percent rate:

          (1) Farm equipment and machinery,
          (2) Diesel fuel used for farming and food processing,
          (3) Teleproduction and postproduction equipment,
          (4) Timber harvesting equipment and machinery, and
          (5) Racehorse breeding stock.

          The SUT rates in California differ by county and locality, and  
          range from 7.50 percent to 10.00 percent, depending on whether  
          optional taxes are levied. The current statewide SUT rate is  
          8.38 percent (weighted by sales). This includes:

                 A state rate of 6.50 percent-3.9375 percent for the  
               General Fund, 2.0625 percent for specified local purposes,  
               0.25 percent for schools and community college funding, and  
               0.25 percent to pay off the deficit-financing bonds.

                 A weighted average local rate of 1.88 percent, including  
               0.75 percent for general purposes, 0.25 percent for county  
               transportation purposes, and the remaining 0.88 percent  
               from optional SUTs largely used for transportation.

          
          For a ten-year period ending December 31, 2003, the law provided  
          new manufacturers a state General Fund SUT exemption on their  
          purchases of specified manufacturing equipment. Also, the law  
          provided manufacturers income and corporation tax credits (MIC)  
          of six percent for similar equipment placed in service in  
          California. Similar to the exemption proposed in this bill, the  
          partial exemption and credit related to equipment used primarily  








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          for manufacturing, refining, processing, fabricating or  
          recycling. New manufacturers could claim the partial exemption  
          or the MIC. However, existing manufacturers could only claim the  
          MIC.

          This partial exemption and MIC contained a conditional sunset  
          date. The law required these provisions to sunset when  
          nonaerospace manufacturing employment failed to exceed January  
          1, 1994 manufacturing employment by more than 100,000. On  
          January 1, 2003, the employment figures fell below the 1994  
          number by over 10,000. The partial exemption and MIC therefore  
          sunset at the end of 2003. Since then,19 bills have been  
          introduced to reinstate, expand, or modify the SUT exemption  
          and/or MIC, but all failed to pass. 

          Proposed Law: Beginning January 1, 2014 and before January 1,  
          2019, this bill would provide a 3.9375 percent state sales and  
          use tax exemption for a "qualified person's" purchases of:

                 Tangible personal property to be used 50 percent or more  
               in aerospace products and parts manufacturing

                 Tangible personal property purchased for use by a  
               contractor, as specified, in the performance of a qualified  
               person's construction contract. The qualified person must  
               use the property, however, as an integral part of any  
               manufacturing process or as a facility for use in  
               connection with the manufacturing process.

          This bill defines "qualified person" as either:

                 A person who is primarily engaged in aerospace product  
               and part manufacturing described in the 2012 edition of  
               North American Industry Classification System (NAICS), Code  
               3364, or

                 A qualified person's affiliate, if the affiliate is a  
               member of that person's unitary group, as specified.

          The bill defines "manufacturing," "primarily," and "process."  
          The bill also specifies which tangible personal property the  
          proposed exemption includes or excludes.

          The proposed partial exemption excludes:








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                 Consumables with less than a one year useful life, 

                 Furniture, inventory, equipment used in the extraction  
               process or equipment used to store finished products that  
               have completed the manufacturing process, and 

                 Tangible personal property primarily used in  
               administration, general management, or marketing.

          The bill would require the Legislative Analyst's Office to  
          report on the exemption's effect on aerospace and related  
          industries' employment, as specified.

          Related Legislation: Senator Knight also introduced SB 19 to  
          exempt from sales and use tax equipment and materials purchased  
          for use in the construction or improvement of specified  
          facilities at commercial space launch sites. Other bills  
          introduced this year related to exempting from sales and use tax  
          manufacturing equipment purchases include:

                 SB 235 (Wyland) provides manufacturers and their  
               affiliates a 3.9375 percent exemption for their qualifying  
               tangible personal property purchases.
                
                 AB 486 (Mullin) provides manufacturers, software  
               producers, various researchers and developers, and their  
               affiliates, a 5.25 percent exemption for their qualifying  
               tangible personal property purchases. 

                 AB 653 (V. Perez) provides manufacturers, software  
               publishers, biotechnology research entities, and renewable  
               power generator facilities, and their affiliates a state  
               and local exemption for their qualifying tangible personal  
               property purchases.
           
                 AB 1326 (Gorell) provides unmanned aerial vehicle  
               manufacturers a state and local exemption for their  
               qualifying tangible personal property purchases. 
          
          Staff Comments: Unlike the other partial SUT exemptions that are  
          current law, this bill proposes a new 3.9375 percent exemption  
          rate. This requires a SUT return revision with a new, separate  
          return computation. If enacted, some retailers may be required  








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          to segregate the exempt 3.9375 percent sales, the exempt 5.50  
          percent sales, fully exempted sales (e.g., sale to the US  
          government or interstate commerce sale), and fully taxable  
          sales. This adds a new level of complexity, and potentially  
          increases tax reporting errors. Consequently, BOE's tax  
          administrative functions and retailers' reporting obligations  
          become more complex.