BILL ANALYSIS Ó
AB 185
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Date of Hearing: May 18, 2015
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Philip Ting, Chair
AB 185
(Eduardo Garcia) - As Introduced January 26, 2015
Majority vote. Tax levy. Fiscal committee.
SUBJECT: Income taxation: insurance taxation: credits:
California New Markets Tax Credit
SUMMARY: Establishes the California New Markets Tax Credit
(NMTC) Program (Program), with the stated purpose of stimulating
private sector investment in lower income communities, as
specified. Specifically, this bill:
1)Contains the following legislative findings:
a) While many areas of California have recovered from the
economic and community development impacts of the 2006
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Financial Crisis and the 2010 global recession,
Californians in a number of communities and neighborhoods
are still experiencing their lingering effects. In some
cases, this has resulted in small and medium businesses in
low-income areas lacking sufficient access to capital and
technical assistance. Given that California has many needs
and limited resources, moneys from the private sector are
necessary to fill this capital and investment gap.
b) Initially enacted in 2000, the Federal Government
established the NMTC Program, which uses a market-based
approach for expanding capital and technical assistance to
businesses in lower income communities. The federal
program is jointly administered by the Community
Development Financial Institutions Fund (CDFI Fund) and the
Internal Revenue Service. The Program allocates federal
tax incentives to community development entities (CDEs),
which they then use to attract private investors who
contribute funds that can be used to finance and invest in
businesses and develop real estate in low-income
communities.
c) Through the 2013-14 funding round, the CDFI Fund had
awarded approximately $40 billion in NMTC in 836 awards
including $3 billion in American Recovery and Investment
Act of 2009 awards and $1 billion of special allocation
authority to be used for the recovery and redevelopment of
the Gulf Opportunity Zone.
d) The federal NMTC totals 39% of the original investment
amount in the CDE and is claimed over a period of seven
years (5% for each of the first three years, and 6% for
each of the remaining four years). Any investment by any
taxpayer in the CDE redeemed before the end of the
seven-year period will be recaptured.
e) Fourteen states in the United States (U.S.) have adopted
state programs using the NMTC model including Alabama,
Florida, Illinois, Nevada, and Oregon. While some of the
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programs substantially mirror the federal program, others
vary in both the percentage of the credit and some of the
policies that form the foundation of the credit. One of
the reasons cited for establishing state-level programs is
to make a state more attractive to CDEs, which results in
increasing the amount of federal NMTCs being utilized in
the state. Further, several studies, including a January
1, 2011, case study by Pacific Community Ventures, showed
that for every dollar of foregone tax revenue, the federal
NMTC leverages $12 to $14 of private investment.
2)Requires the California Alternative Energy and Advanced
Transportation Financing Authority (CAEATFA) to determine the
amount of the $100 million in exclusions not granted in the
assigned calendar year under Public Resources Code (PRC)
Section 26011.8. An amount equal to that amount shall be
granted in the subsequent calendar year through the Program.
3)Requires the California Competes Tax Credit Committee
(Committee) and the Governor's Office of Business and Economic
Development (GO-Biz) to administer the Program.
4)Allows, for taxable years beginning on or after January 1,
2016, and before January 1, 2028, a credit in an amount
determined in accordance with Internal Revenue Code (IRC)
Section 45D, as modified. For a taxpayer holding a "qualified
equity investment" on that investment's "credit allowance
date," the credit shall equal a percentage of the amount paid
to a "qualified CDE" for such investment at its original
issue. The applicable percentage shall be:
a) Zero percent with respect to the first two "credit
allowance dates";
b) Seven percent with respect to the third "credit
allowance date"; and,
c) Eight percent with respect to the remainder of the
"credit allowance dates".
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5)Modifies the federal definition of a "qualified CDE" to
include only those qualified CDEs (and their subsidiaries)
that have entered into an allocation agreement with the CDFI
Fund of the U.S. Treasury Department, with respect to credits
authorized by IRC Section 45D, that includes California within
the service area and is dated on or after January 1, 2012.
6)Modifies the federal definition of a "qualified active
low-income community business" as follows:
a) Allows the services of employees of a service-based
qualified active low-income community business to be
performed outside the low-income community. "A
service-based qualified active low-income community
business" is defined as a business that primarily earns
revenue through providing intangible products and services
and leases or owns real property in the low-income
community that is used for the operation of the business;
b) A qualified active low-income community business shall
not include any business that derives, or projects to
derive, 15% or more of its annual revenue from the rental
or sale of real estate, subject to certain exceptions;
c) A qualified active low-income community business shall
only include a business that, at the time the initial
investment is made, has 250 or fewer employees and is
located in one or more California low-income communities;
d) A qualified active low-income community business shall
only include a business located in specified census tracts
based on poverty and unemployment rates;
e) A qualified active low-income community business shall
not include any business that operates or derives revenues
from the operation of a country club, gaming establishment,
massage parlor, liquor store, or golf course;
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f) A qualified active low-income community business shall
not include a sexually oriented business, as defined; and,
g) A qualified active low-income community business shall
not include a charter school.
7)Provides that the aggregate amount of qualified equity
investments that may be allocated in any calendar year under
the Program shall be an amount based upon any unused portion
of the $100 million in exclusions, authorized under Revenue
and Taxation Code Section 6010.8, as determined by CAEATFA and
reported to the Committee, not to exceed an amount based upon
a credit of $40 million.
8)Requires the Committee to limit the allocation of investments
that may be designated to a cumulative total amount based on
credits of no more than $200 million.
9)Specifically modifies federal law to add the following events
triggering a credit recapture:
a) The qualified CDE fails to invest at least 15% of the
qualified equity investment in a qualified low-income
community business in consultation or partnership with
either of the following:
i) A qualified CDE that has not received a federal NMTC
allocation on or after January 1, 2012, as specified; or,
ii) A nonprofit organization certified by GO-Biz, as
specified.
b) The qualified CDE made an investment without performing
a revenue impact assessment that satisfies this bill's
requirements.
10)Provides that enforcement of each of the recapture provisions
shall be subject to a six-month cure period. Specifically,
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recapture shall not occur until the qualified CDE gives notice
of potential noncompliance to GO-Biz and is afforded six
months to cure the noncompliance.
11)Provides that in cases where a qualified CDE fails to send
the required notice of potential noncompliance or GO-Biz has
information from the annual report or other sources indicating
that the entity is in potential noncompliance, GO-Biz shall
send the notice, and the date GO-Biz sends the notice shall
begin the six-month cure period.
12)Provides that if a qualified CDE makes a capital or equity
investment or a loan with respect to a qualified low-income
building under the state Low-Income Housing Tax Credit
Program, the investment or loan is not a qualified low-income
community investment under the Program.
13)Requires GO-Biz to adopt guidelines necessary or appropriate
to carry out its responsibilities with respect to the
allocation of the qualified equity investments and recapture
of credit. The adoption of these guidelines shall not be
subject to the rulemaking provisions of the Administrative
Procedure Act (Government Code Section 11340 et seq.).
14)Requires GO-Biz to establish and impose reasonable fees upon
entities that apply for an allocation that, in the aggregate,
defray the cost of reviewing applications.
15)Requires GO-Biz to adopt an allocation process that does all
of the following:
a) Creates an equitable distribution process that ensures
that low-income community populations across the state are
engaged and have an opportunity to benefit from the
Program;
b) Sets minimum organizational capacity standards that
applicants must meet to receive an allocation, as
specified;
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c) Considers the qualified CDE's prior qualified low-income
community investments under IRC Section 45D;
d) Considers the qualified CDE's prior qualified low-income
community investments under the Program;
e) Does not require the qualified CDE to identify the
qualified active low-income community businesses in which
the qualified CDE will invest in an application for
qualified equity investment allocation; and,
f) Does not disqualify a low-income community investment
for the single reason that public or private incentives,
loans, equity investments, technical assistance, or other
forms of support have been or continue to be provided.
16)Provides that GO-Biz shall begin accepting applications on or
before May 15, 2016, and shall award authority to designate
qualified equity investments annually through 2020, to the
extent that allocations are available under PRC Section
26011.9.
17)Provides that, in the 2016 awards cycle, the Committee shall
award authority to designate qualified equity investments to
qualified CDEs in the order applications are received by the
Committee.
18)Provides that, in the 2017 to 2020 award cycles, at least 60%
of the authority shall be awarded in the order applications
are received by the Committee.
19)Requires the Committee to award up to 40% of the authority in
the 2016 [sic] to 2020 award cycles to qualified CDEs on a
competitive basis using blind scoring and a review committee
comprised of community development finance practitioners.
20)Authorizes an approved applicant to transfer all or a portion
of its certified qualified equity investment authority to its
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controlling entity or any subsidiary qualified CDE of the
controlling entity, provided the applicant and the transferee
notify the Committee within 30 calendar days of such transfer.
The transferee shall be subject to the same rules,
requirements, and limitations applicable to the transferor.
21)Provides that a qualified CDE shall only make a qualified
low-income community investment that demonstrates a positive
revenue impact on the state over a 10-year period against the
aggregate tax credit utilization over the same 10-year period,
as specified.
22)Requires a qualified CDE that issues qualified equity
investments to submit a report to GO-Biz within the first five
business days after the first anniversary of the initial
credit allowance date that provides documentation as to the
investment of at least 85% of the purchase price in qualified
low-income community investments in qualified active
low-income community businesses in California.
23)Includes additional reporting requirements.
24)Provides that a taxpayer allowed a credit under the Program
for a qualified equity investment shall not be eligible for
any other state credit with respect to that investment.
25)Provides that GO-Biz and the Committee shall only make
authority awards in a calendar year in which the Legislature
appropriates funds in the California New Markets Tax Credit
Fund, which this bill creates.
26)Provides that this bill shall take immediate effect as a tax
levy.
27)Sunsets the credit provisions on December 1, 2028.
28)Declares that the provisions of this bill are severable.
EXISTING LAW:
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1)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.
2)Establishes the Committee, which has specified duties in
regard to tax credits for economic development.
3)Imposes an annual tax on the gross premiums of an insurer, as
defined, doing business in this state at specified rates.
4)Allows a credit equal to 20% of each qualified investment into
a community development financial institution that is
certified by the California Organized Investment Network
(COIN). The aggregate amount of qualified investments is
generally capped at $50 million for each calendar year. Thus,
the statewide total for all credits allowed under the program
is capped at $10 million per year (i.e., 20% of $50 million).
FISCAL EFFECT: The Franchise Tax Board estimates that this bill
would reduce General Fund (GF) revenues by $1.8 million in
fiscal year 2017-18, by $5.8 million in FY 2018-19, and by $11
million in FY 2019-20.
COMMENTS:
1)The author has provided the following statement in support of
this bill:
Although California demonstrates policy leadership in many
areas, including technology and innovation, environmental
stewardship, and top-tier trade partner [sic], California
remains short on one crucial piece. Issues related to
economic disparity have yet to be placed at the forefront
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of the state's agenda.
Addressing inequity rooted in race and geography requires
public policy solutions that bring market opportunity to
the level of the neighborhood and integrate low-income
neighborhoods within their regional economies. Markets
must be engaged on matters of economic and place-based
inequality if the state wishes to fully achieve its growth
and prosperity potential.
This measure proposes a program for delivering private
capital to very low-income neighborhoods in a manner that
incentivizes investors and empowers these communities in an
innovative way. While paralleling many of the federal
rules, the California New Markets Tax Credit represents the
next generation in attracting new private investment to the
state's most challenged low-income neighborhoods.
2)Proponents of this bill note the following:
AB 185 would help stimulate economic development by
offering a tax incentive to taxpayers that provide
investment for capital or loans to support businesses and
initiate projects in low-income areas. Numerous reports
indicate that a lack of capital stifles entrepreneurs and
impedes growth, leading to urban decay and economic
stagnation in small towns and rural communities.
The NMTC program addresses these problems by injecting
economic development into communities with
high-unemployment and poverty rates. The program requires
the private sector, not the government, to invest upfront
in California small businesses and keep those investments
for seven years, with the cost to the state in the form of
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future, delayed credits . . . .
Fourteen states already have state-level NMTC programs put
into place, with four states soon set to reauthorize their
programs. The results are clear: States that have enacted
similar legislation have developed a competitive advantage
by attracting investment dollars through their own NMTC
programs.
3)This bill is opposed by the California Tax Reform Association
(CTRA), which notes that "[t]he NMTC recently came under
fairly significant criticism from the [Government
Accountability Office] and, more interestingly, from Senator
Tom Coburn (R-Okla.), one of the most conservative of U.S.
[S]enators . . . ." The CTRA points to a report by Senator
Coburn that apparently noted:
Many banks have set up their own CDEs in order to receive
tax credit allocations from the Treasury, making them both
the recipient of the tax credits and the lender. Many of
the top CDEs receiving tax credit allocations are
subsidiaries of major banks including Bank of America, JP
Morgan Chase, Wachovia (now Wells Fargo), and SunTrust
banks."
The CTRA continues by noting, "In other words, this program
appears to be just another tax-incentive program for which
there is no evidence that it will work as intended, work
proportional to the cost, or work in lieu of other programs
costing the same or less that might work better."
4)The FTB notes the following policy concern in its analysis of
this bill:
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This bill would allow a taxpayer to obtain combined federal
and state credits equal to 74 percent of the investment
even in cases where the federal credit alone would make the
CA Development Entity's low-income community investment
economically feasible. Consequently, the author may wish
to provide that a specified degree of economic necessity is
present before the CA Development Entity may market the
state credit.
5)Committee Staff Comments
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).
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. While this affords taxpayers greater financial
predictability, 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,
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irrespective of their efficacy or cost, without a
supermajority vote.
c) What would this bill do ? This bill would enact a new
tax expenditure program modeled after the federal NMTC,
with the stated purpose of stimulating private sector
investment in lower income communities.
d) The federal NMTC : Congress established the federal NMTC
program as part of the Community Renewal Tax Relief Act of
2000 to encourage investment in low-income communities that
have traditionally lacked access to capital. The federal
NMTC program provides taxpayers (e.g., individual
investors, financial institutions, corporations, etc.) with
a credit for investing in economically distressed
communities. Specifically, the credit is allowed for a
taxpayer's qualified equity investment in a CDE, which must
be a corporation or partnership. The CDE's primary mission
must be serving, or providing investment capital for,
low-income communities or low-income persons, as certified
by the Secretary of the Treasury. The taxpayer's federal
NMTC totals 39% of the qualified equity investment made in
the CDE, but is spread over a seven-year period as follows:
i) A 5% credit for the year the qualified equity
investment is purchased and for the first two years
thereafter (i.e., 15% for the first three years); and,
ii) A 6% credit for years four through seven (i.e., 24%
for the subsequent four years).
In recent years, private investors have claimed more than $1
billion in NMTCs annually.
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The federal NMTC program is administered by the CDFI Fund
within the U.S. Treasury. The CDFI Fund allocates tax
credit authority to CDEs that apply for and obtain
allocations. These CDEs, in turn, enable private investors
to obtain credits in exchange for equity investments with
the CDEs. The CDEs then invest the raised capital in
qualified low-income community investments, which include
investments in operating businesses and residential,
commercial, and industrial projects. While the range of
projects financed by CDEs varies, roughly 50% of NMTC
investments have been used for commercial real estate
projects.
The FTB notes that the federal NMTC expired on December 31,
2014, but is generally expected to be extended.
e) How would the Program differ from the federal NMTC ? The
Program would differ from the federal NMTC in numerous
respects, including the following:
i) Different credit percentages over the seven-year
period : While the proposed state credit, like the
federal credit, totals 39% of the taxpayer's investment
in a qualified CDE, the state credit would be spread out
over the seven-year period as follows:
(1) Zero percent for the year the investment is
purchased and the following year (i.e., 0% for the
first two years);
(2) A 7% credit for the third year; and,
(3) An 8% credit for years four through seven
(i.e., 32% for the subsequent four years).
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It is Committee staff's understanding that this
"back-loading" of the credit percentages is designed to
reduce the Program's upfront cost to the GF.
i) Modified definition of a qualified active low-income
community business : This bill modifies the definition of
a "qualified active low-income community business" in
several respects. For example, under federal law, a
substantial portion of the services performed for such a
business by its employees must be performed in a
low-income community. This bill arguably dilutes that
requirement for "service-based" qualified active
low-income community businesses. Specifically, this bill
allows the services of employees of a service-based
business to be performed outside the low-income
community. The business would, however, be required to
lease or own real property in the low-income community
for the operation of its business. Nevertheless, the
Committee may wish to consider whether this weakening of
federal safeguards is warranted in this bill.
In some respects, however, this bill's definition of a
"qualified active low-income community business" is more
restrictive than the federal definition. For example,
under this bill, any business that derives 15% or more of
its annual revenue from the rental or sale of real estate
would generally be excluded from the definition. In
addition, the state definition is limited to businesses
that, at the time the initial investment is made, have
250 or fewer employees.
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f) Does California have any similar tax credit programs ?
While California does not conform to the federal NMTC,
state law does allow a 20% credit for each "qualified
investment" in a CDFI certified by COIN. The aggregate
amount of qualified investments is generally capped at $50
million for each calendar year.<1> Thus, the statewide
total for all credits allowed under the program is capped
at $10 million per year (i.e., 20% of $50 million). Unlike
the federal NMTC, the "qualified investment" in the CDFI
must be at least $50,000; be for a minimum duration of 60
months; and may consist of either an equity investment or a
deposit or loan that does not earn interest.
Existing law defines a "CDFI," in turn, as a private financial
institution located in California that has community development
as its primary mission, and that lends in urban, rural, or
reservation-based California communities. Specifically, a
"CDFI" may be a community development bank, a community
development loan fund, a community development credit union, a
microenterprise fund, a community development corporation-based
lender, or a community development venture fund.
The existence of California's stand-alone CDFI tax credit raises
some interesting issues. Namely, California already has a tax
credit program specifically designed to encourage private
investment in underserved markets. Given this fact, does it
makes sense to establish a second tax credit program with the
---------------------------
<1> State law provides that if the aggregate amount of qualified
investments made in a calendar year is less than $50 million,
the difference may be carried over to the next year, and any
succeeding year during which the credit remains in effect, and
added to the aggregate amount authorized for those years.
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same goal? If this bill were enacted in its present form,
California would have two similar tax credit programs,
administered by two separate entities, with an unclear level of
coordination between the two.
g) Government Accountability Office report : A recent
report issued by the U.S. Government Accountability Office
(GAO) found that better controls and data are needed to
ensure the effectiveness of the federal NMTC program.
Specifically, the report noted that the financial
structures of NMTC investments have become increasingly
complex and less transparent over time. This increased
complexity, in turn, was attributed to the combining of the
NMTC with other federal, state, and local government funds.
The GAO's survey of CDEs determined that approximately 62%
of NMTC projects received other federal, state, or local
government support from 2010 to 2012. The report
acknowledged that combining public financing from multiple
sources can fund projects that would otherwise not be
economically viable. At the same time, however, this
combination raises questions about whether the subsidies
are unnecessarily duplicative. In addition, the report
found that "in some cases the complexity of the structures
may be masking rates of return for NMTC investors that are
above market rates." The GAO specifically pointed to a
U.S. Treasury report that found an investor apparently
earning a 24% rate of return, which is significantly above
market rates. In that case, the investor leveraged the
NMTC by using other public funds to increase the base for
claiming the credit. The report found that the U.S.
Treasury does not currently have controls to limit the risk
of unnecessary duplication in government subsidies or above
market rates of return. The report found that "[w]ithout
such guidance and controls the impact of the NMTC program
on low-income communities could be diluted." The GAO also
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found that the data on equity remaining in low-income
community businesses after the seven-year credit period
were unreliable because, in part, reporting instructions
are unclear. Similarly, data on NMTC project failure rates
were unavailable.
Thus, the GAO recommended that the U.S. Treasury issue further
guidance on how other government programs can be combined with
NMTCs. The GAO also recommended the implementation of adequate
controls to limit the risks of unnecessary duplication and
above-market rates of return. Finally, the GAO also recommended
the collection of more complete and accurate data on, among
other things, the equity remaining in businesses after seven
years, along with loan performance.
h) Governor's veto : This bill is nearly identical to AB
1399 (Medina), of the 2013-14 Regular Session. Governor
Brown vetoed AB 1399 with the following message:
This bill creates a new markets tax credit that will cost
- over time - $200 million.
I certainly endorse programs that result in private
investments to help low income areas, but a bill to spend
this much should be considered with other priorities
during the annual budget.
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i) Technical amendments : The FTB has suggested technical
amendments in its staff analysis of this bill.
j) Double referral : This bill was double-referred to the
Assembly Committee on Jobs, Economic Development, and the
Economy. This bill passed that committee on April 29,
2015, by a vote of 8 to 0. For additional discussion of
this bill, please refer to that committee's analysis.
REGISTERED SUPPORT / OPPOSITION:
Support
Advantage Capital Partners
California Association for Local Economic Development
California Association for Micro Enterprise Opportunity
California Bankers Association
California Communities United Institute
California Urban Partnership
Capital Impact Partners
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City of Indian Wells
City of Lakewood
City of Thousand Oaks
Enhanced Capital
Enhanced Capital Partners
Fresno Community Development Financial Institution
Fresno Economic Opportunities Commission
Genesis LA Economic Growth Corporation
League of California Cities
Los Angeles County Economic Development Corporation
Northern California Community Loan Fund
Opportunity Fund
Orange County Business Council
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Regional Economic Association Leaders of California
Small Business California
TELACU
Opposition
The California Tax Reform Association
Analysis Prepared by:M. David Ruff / REV. & TAX. / (916)
319-2098