BILL ANALYSIS Ó
AB 437
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Date of Hearing: April 27, 2015
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Philip Ting, Chair
AB 437
Atkins - As Amended April 13, 2015
SUSPENSE
2/3rd vote. Fiscal committee.
SUBJECT: Research and Development: Small Business Grant
Program
SUMMARY: Establishes a Research and Development-Small Business
Grant Program (Grant Program) providing grants, equal to a
percentage of unused Research and Development credits, to
qualifying small business, as specified. Specifically, this
bill:
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1)Provides, on or after January 1, 2016, and before January 1,
2021, that a qualified small business may apply for and
receive a one-time grant in an amount equal to 10% of the
excess credit amount that is attributable to taxable years
beginning on or after January 1, 2014, and before January 1,
2016, available for carryover into taxable years beginning on
or after January 1, 2016.
2)Requires, in order to receive a one-time grant, a qualified
small business, or partner, or "S" corporation shareholder of
a qualified small business to apply for the grant on a timely
filed original return. The return must be filed with the
Franchise Tax Board (FTB) using electronic technology in a
form and manner prescribed by the FTB for the taxable year
beginning on or after January 1, 2015. The application must
indicate the amount equal to 10% of the excess credit that is
attributable to taxable years beginning on or after January 1,
2014, and before January 1, 2016. The FTB shall provide a
certificate within 90 days of receiving the application.
3)Provides, on or after January 1, 2016, and before January 1,
2025, that a qualified small business may annually apply for a
grant in an amount equal to 15% of the excess credit amount
attributable to the taxable year in which the credit is
allowed.
4)Requires, in order to receive a grant, a qualified small
business, partner, or "S" corporation shareholder, as
applicable, to apply for the grant on a timely field original
return. The return must be field with the FTB using
electronic technology in a form and manner prescribed by the
FTB for each taxable year beginning on or after January 1,
2016. The return must indicate the amount equal to 15% of any
excess credit accrued for that taxable year and available for
carryover to the following taxable year in which the credit is
allowed. The FTB shall provide a certificate within 30 days
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of receiving the return.
5)Provides that, under the Personal Income Tax (PIT) Law, for
taxable years beginning on or after January 1, 2016, in the
case where the FTB has issued a certificate for a grant, the
following shall apply:
a) The excess credit amount that may be carried over by a
taxpayer shall be reduced by the amount reflected on a
certificate issued by the FTB;
b) In the case of a pass-thru entity, the amount of credit
that may be passed through shall be reduced by the amount
reflected on a certificate issued by the FTB;
c) Defines a "pass-thru entity" as a partnership or "S"
corporation; and,
d) If a credit allowed is less than the amount of the
credit that provided the basis for a grant, the amount of
the grant attributable to the credit not allowed shall be
treated as a deficiency.
6)Provides that, under the Corporation Tax (CT) Law, for taxable
years beginning on or after January 1, 2016, in the case where
the FTB has issued a certificate for a grant, the following
shall apply:
a) The excess credit amount that may be carried over by a
taxpayer shall be reduced by the amount reflected on a
certificate issued by the FTB;
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b) In the case of a pass-thru entity, the amount of credit
that may be passed through to a partner shall be reduced by
the amount reflected on a certificate issued by the FTB;
c) Defines a "pass-thru entity" as a partnership; and,
d) If a credit allowed is less than the amount of the
credit that provided the basis for a grant, the amount of
the grant attributable to the credit not allowed shall be
treated as a deficiency.
7)Defines a "qualified small business" as a taxpayer that was
allowed a California Research Credit under the PIT or CT Law
and has gross receipts of $5 million or less for the taxable
year.
8)Provides that a qualified small business may not be an
affiliated corporation that is treated as a member of a
combined reporting group.
9)Provides that no grant may be awarded with respect to a credit
that may be assigned.
10)Provides the qualified small business to be certified by the
Governor's Office of Business and Economic Development as an
eligible qualified small business.
11)Provides for taxable years beginning on or after January 1,
2016, and before January 1, 2025, that gross income does not
include a grant received by the Grant Program.
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12)Defines gross receipts as having the same meaning as provided
for under Internal Revenue Code (IRC) Section 41(c)(7).
13)Requires the FTB to allocate the certified amounts based on
the aggregate applicable amount for the calendar year in which
the certificate is issued.
14)Provides that the aggregate applicable amount that may be
certified for the calendar year beginning January 1, 2016,
shall be $100 million, not to exceed $50 million for each
taxable year beginning January 1, 2014 and January 1, 2015.
15)Provides that the aggregate applicable amount shall not
exceed $50 million each calendar year beginning on or after
January 1, 2016, and before January 1, 2026, regardless of
taxable year to which the grant relates.
16)Requires the FTB to allocate the certificates to the
qualified small business, or partnership or "S" corporation,
on a first-come-first-serve basis, determined by the date the
taxpayer's original tax return is received by the FTB. If two
or more returns are received on the same day and the amount of
credit remaining to be allocated is insufficient to be
allocated fully to each, the credit remaining shall be
allocated to those qualified small businesses on a pro rata
basis.
17)Provides that the FTB shall determine the date an application
or return is received. The determination as to the date an
application or return is received or whether the application
or return has been timely filed may not be reviewed in any
administrative or judicial proceeding.
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18)Provides the following for pass-thru entities:
a) Defines a "pass-thru entity" as a partnership or "S"
corporation under the PIT, and as a partnership under the
CT.
b) Requires the FTB to issue a certificate to the qualified
small business, partners, or "S" corporation shareholders
with respect to grants for taxable years beginning on or
after January 1, 2014, and before January 1, 2016.
c) Requires the FTB to issue a certificate to the
partnership or "S" corporation with respect to taxable
years on or after January 1, 2016.
d) Provides that a certificate shall not be issued to an
"S" corporation with respect to the credit allowed under
the CT California Research Credit.
19)Requires the Controller, upon receipt of a certificate issued
to a qualified small business, partner, or "S" corporation
shareholder, to pay the qualified small business the grant
amount indicated on the certificate.
20)Provides that grants are continuously appropriated from the
General Fund.
21)Requires the Controller, on or before January 1, 2017, and
each January 1 thereafter, to issue a report to the Assembly
Committee on Revenue and Taxation, which includes a list of
grant recipients for the previous calendar year and the grant
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amount each recipient received.
22)Requires, on or after January 1, 2016, that the Governor's
Office of Business and Economic Development, upon application
by the taxpayer, to certify that the taxpayer meets all the
requirements of a qualified small business.
23)Provides that the FTB may prescribe rules, guidelines, or
procedures necessary or appropriate to carry out the purposes
of this division, including any guidelines regarding the
allocation of the certificates issued.
EXISTING FEDERAL LAW:
1)Allows taxpayers engaged in a trade or business to deduct all
of the ordinary and necessary business expenses incurred.
2)Allows a R&D tax credit that is combined with several other
credits to form the general business credit. The R&D credit
is designed to encourage companies to increase their R&D
activities.
3)Specifies that the R&D credit is equal to 20% of the qualified
research expenses that exceed the base year amount, as
defined, plus 20% of the amount paid or incurred during the
taxable year on research undertaken by an energy research
consortium.
4)Defines "base year amount" as the product of the average
annual gross receipt of the taxpayer for the four taxable
years preceding the taxable year the credit is earned times a
fixed percentage, but under no circumstances may the base year
amount be less than 50% of the qualified research for the
taxable year.
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5)Authorizes an additional credit to corporate taxpayers equal
to 20% of expenses paid to fund "basic research" at
universities and certain nonprofit scientific research
organizations.
6)States that a taxpayer was allowed, prior to January 1, 2009,
to elect an alternative incremental research credit for
determining its R&D credit. The federal percentages are 3%,
4%, and 5%.
7)Allows an alternative simplified credit equal to 14% of
research expenses that exceed 50% of the average research
costs for the three preceding taxable year.
8)Specifies that, in order to qualify for the R&D credit,
research expenses must qualify as an expense or be subject to
amortization, be conducted in the U.S. and be paid by the
taxpayer.
9)Provides that "qualified research" is research that is:
a) Undertaken to discover information that is technological
in nature;
b) Primarily involves experimentation related to quality or
to a new or improved function or performance; and,
c) Its application will be useful in developing new or
improved business components for the taxpayer.
EXISTING STATE LAW:
1)Allows various tax credits designed to either provide tax
relief for taxpayers who incur certain expenses or to
influence taxpayers' behavior.
2)Conforms California to the federal R&D credit but with the
following modifications:
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a) The state R&D credit is not combined with other business
credits.
b) Both "qualified research" and "basic research" must be
undertaken in California.
c) The credit percentage for increasing qualified research
activities in California is 15%.
3)Provides an alternative credit of 24% (versus the 20% federal
credit) for "basic research", available for "C" corporations
only.
4)Sets the percentages for the alternative incremental research
portion of the credit lower than those of the federal credit.
5)Allows the R&D credit, which is permanent, for taxable years
beginning on or after January 1, 1987.
6)Allows taxpayers that are members of a combined reporting
group to make a one-time irrevocable assignment of eligible
credits to another member. However, the assigned credits may
be utilized to reduce tax only for taxable years beginning on
or after January 1, 2010.
FISCAL EFFECT: The Franchise Tax Board estimate General Fund
revenue loss of $22 million in fiscal year (FY) 2015-16, $27
million in FY 2016-17, and $27 million in FY 2017-18.
COMMENTS:
1)Author's Statement : The author has provided the following
statement in support of this bill:
AB 437 allows small businesses to receive a grant from the
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state in proportion to the amount of the research and
development tax credits they have earned. Research and
Development Tax Credits (R & D) were created in California
back in 1987 to put more dollars in the wallets of
innovative businesses - money businesses used to create new
jobs, and expand product lines. However, data from the
Franchise Tax Board shows that often small and medium sized
companies are able to earn the R &D tax credits but not
able to receive their monetary benefit because these
businesses don't have enough taxable liabilities. These
startups have the potential of being the next big thing but
without some way of monetizing earned R&D tax credits, they
may never reach their full potential. AB 437 is not a
reimbursable credit. It is a grant program which uses the
R & D tax credit to determine how much investment the state
should provide the small business. Specifically, the bill
authorizes eligible businesses to receive a grant for 15%
of the credits generated starting in 2016. The bill also
allows a two year look back period for which small business
can receive a grant for 10% of all tax credits received in
2014 and 2015.
2)Arguments in Support : The National Federation of Independent
Business states that this bill "is a very important means of
helping to reenergize creativity and entrepreneurism in our
state and letting small businesses know that our leaders are
committed to success and expansion on Main Street. This
legislation establishes the Research and Development-Small
Business Grant Program, which would provide qualified small
businesses, as defined, grants in amounts equal to either 10%
or 15% of any unused credit amount allowed to the small
business for specified years under the credit described above.
This legislation is responsible, positive policy that helps
to encourage businesses - small businesses - think big and
take their ideas to the next level, and that there is a
financial reward out of the gate to inspire them to realize
their dreams and create jobs."
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3)Arguments in Opposition : The California Tax Reform
Association states that "[w]ith regard to the research and
development credit, the Legislature has made sure -
particularly for bio-tech companies - that those credits can
be carried forward for 20 years, recognizing the long lead
time that some of these products may take. However, turning
these into refundable credits effectively makes California
taxpayers an investor in all of these research efforts,
whether they have future value or not."
4)R&D Credit Background : California enacted the credit for
research expenses in 1987 as part of two general federal tax
conformity bills [AB 1172 (Klehs), Chapter 1138, Statutes of
1987; and SB 572 (Garamendi), Chapter 1139, Statutes of 1987.]
The original credit percentage was 8% of qualified research
expenses. Since that time, the California R&D credit rate was
amended several times and finally was increased from 12% to
15% in 2000 [AB 511 (Alquist), Chapter 107, Statutes of 2000.]
The alternative incremental computation of the R&D credit was
adopted in 1997 [AB 1042 (Wayne), Chapter 613, Statutes of
1997] and was subsequently amended to reflect the changes to
the California research credit percentage [AB 2798 (Machado),
Chapter 323, Statutes of 1998]. Unlike the federal R&D
credit, the California R&D credit is permanent.
5)The Scope of the California R&D Credit . The California R&D
credit is very similar to the federal R&D credit and is
generally available with respect to incremental increases in
qualified research. "Qualified research expenses" eligible
for the credit consist of in-house expenses for wages and
supplies attributable to that research, certain time-sharing
costs for computer use, and 65% of the contract research
expenses. However, "qualified research expenses" include 100%
of amounts paid by the taxpayer to an eligible small business,
university, or federal laboratory for qualified energy
research. Under California law, qualified research includes
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only research conducted in California.
Under the regular credit, the amount of the California R&D
credit equals to the sum of: (a) 15% of the amount by which
the taxpayer's qualified research expenses for a taxable year
exceed its "base amount for that year", and (b) 15% of the
taxpayer's expenditures on research undertaken by an energy
research consortium (the so-called 'energy research credit').
The energy research credit applies to all qualified
expenditures, not just those in excess of a base amount. In
addition, corporate taxpayers are also allowed a credit of 24%
(in contrast to 20% allowed under federal law) of expenses
paid to fund basic research at universities and certain
nonprofit scientific research organizations.
6)Purpose of the R&D Credit : There are various reasons why the
R&D credit was enacted at the federal and state level. First,
the R&D credit is intended to reduce the after-tax cost of R&D
investments, which is expected to lead to an increase in R&D
activity and to encourage taxpayers to conduct R&D in the U.S.
rather than in another country. Similarly, the California R&D
credit is designed to increase R&D activity and to encourage
manufacturing related to R&D to be undertaken in California
rather than elsewhere. The California's R&D credit provides a
powerful incentive for firms to conduct R&D in California
because of its high credit percentages that exceed that of
other states. The creation of additional R&D economic
activity in California is arguably more desirable than
increased economic activity from other industries. Additional
economic activity in California also allows other local
businesses to adopt innovations more rapidly than innovations
developed elsewhere. As explained by the FTB, the advantage
to California "may come through something economists call
economies of agglomeration," which can be described as the
benefits several firms receive when locating in close
proximity. (California Income Tax Expenditures, Compendium of
Individual Provisions, Updated December 2009, FTB.)
Specifically, the cost of production may significantly decline
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because there is a greater chance for specialization and
division of labor. If this is the case, many California
businesses, not just those receiving this credit, will gain an
advantage over their rivals in other states.
7)Why subsidize R&D ? Positive externalities are benefits
resulting from an economic activity that are enjoyed by third
parties, a benefit not received directly by the seller or the
buyer. California's R&D credit creates a number of positive
externalities such as reducing the costs of other firms'
innovative activity and providing newer, better, and less
expensive products to the market. (Bronwyn Hall and Marta
Wosinka, The California R&D Tax Credit: Description, History,
and Economic Analysis, June 1999.) For example, research
conducted by a bio company may lead to the new medication,
which can increase sales, but the benefits may also include an
overall healthier population. Because the bio company does
not necessarily receive a direct benefit from having a
healthier population, it may limit itself from conducting
additional R&D even though a greater amount of research would
be better for society.
In a supply and demand model, the supply curve can be thought
of as marginal cost and the demand curve can be thought of as
marginal benefit. Equilibrium is reached where the marginal
cost equals marginal benefit. Everything to the left of the
equilibrium point and between the marginal benefit and
marginal cost curves is a benefit to society because the
marginal benefit is greater than the marginal cost. However,
in terms of R&D, the marginal benefit curve of a firm
investing in research may not necessarily capture the positive
externalities received by society. Because of this, a company
may choose to curtail R&D investment. Ideally, society would
want the private marginal benefit curve to be the same as
society's marginal benefit curve. The disparity can be
thought of as a "market failure" because the amount of
research conducted by individual firms is less than what is
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needed to capture the additional marginal benefits enjoyed by
society. This disparity could be remedied by providing a
subsidy to a researching firm. The subsidy will lower the
cost of production and increasing the amount of research
conducted by a firm. The subsidy works so long as investment
is increased up to the point where the marginal social benefit
equals marginal cost. Assuming current investment in research
is less than the optimal level, providing a grant based on a
percentage of unused R&D credit can provide a larger benefit
to society than the cost of the subsidy.
8)Grant Program : This bill establishes a Grant Program to
provide grants to qualifying small businesses with unused R&D
credit. During the first year of enactment, the Grant Program
will provide a qualifying small business with a grant equal to
ten percent of all unused R&D tax credits earned for taxable
years 2014 and 2015. Going forward, the Grant Program will
provide qualifying small businesses with a grant equal to
fifteen percent of unused R&D credit earned during the taxable
year. By creating a grant program instead of a utilizing the
current R&D tax credit, companies with little or no tax
liability to offset would be able to monetize at least a
portion of unused R&D tax credits.
As explained above, subsidizing R&D, in this case through a
grant program, works so long as investment in research is
increased up to the point where the marginal social benefit
equals marginal cost. According to the Joint Committee on
Taxation, "[T]here is evidence that the current level of
research undertaken in the United States, and worldwide, is
too little to maximize society's well-being." (Joint
Committee on Taxation, Description of Revenue Provisions
Contained in the President's Fiscal Year 2010 Budget Proposal,
Part Two: Business Tax Provisions, JCS-3-09, p. 11.) This is
especially true for smaller companies, such as those
contemplated within this bill, that receive little or no
benefit from the existing R&D tax credit program. As
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explained by FTB, for 2012 companies with gross receipts
between $1 and $10 million generated a total of $100 million
in R&D tax credits. Eighty-seven million dollars' worth of
credits were earned by companies that were completely unable
to utilize the credit. The remaining $13 million worth of
credits were earned by companies that were only able to
utilize $3 million of earned credit. The remaining $10
million will need to be carried forward. In total, companies
with gross receipts between $1 and $10 million were only able
to utilize three percent of the R&D tax credits earned. The
bulk of R&D tax credits are earned by large companies.
According to FTB's most recent annual income tax expenditure
report, companies with gross receipts of more than $1 billion
claimed a total of $1.7 billion in R&D credits, or 95.5% of
all credits allowed. (California Income Tax Expenditures,
Compendium of Individual Provisions, 2011, FTB.)
9)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. Second, there is
generally no control over the amount of revenue losses
associated with any given tax expenditure. Finally, once
enacted, it takes a two-thirds vote to rescind an existing tax
expenditure absent a sunset date. The Grant Program is a
hybrid of both a tax and a direct expenditure. The State
Controller is required, upon receiving a certificate issued by
the FTB, to pay the qualified small business the grant amount
indicated on the certificate. Additionally, grant amounts
paid to the qualifying small business are calculated based on
earned R&D tax credit, and the amount of grant paid reduces
the amount of excess credit the qualifying small business can
carryforward by the amount reflected on the certificate.
Because of the tax implications, a two-thirds vote is required
in order to rescind the Grant Program. Even though the Grant
Program contains a sunset date, the length of time allowed
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before the Grant Program sunsets is much longer than has
generally been allowed by this Committee when considering
other tax expenditures in the past. For this reason, the
Committee may wish to consider reducing the sunset provision
to five-years.
REGISTERED SUPPORT / OPPOSITION:
Support
Baybio
Biocom
California Asian Pacific Chamber of Commerce
California Healthcare Institute
California Metals Coalition
National Federation of Independent Business
Small Business California
Opposition
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California Tax Reform Association
Analysis Prepared by:Carlos Anguiano / REV. & TAX. / (916)
319-2098