BILL ANALYSIS Ó
AB 437
Page 1
ASSEMBLY THIRD READING
AB
437 (Atkins)
As Amended May 28, 2015
2/3 vote
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|Committee |Votes |Ayes |Noes |
| | | | |
| | | | |
|----------------+------+-----------------------+------------------|
|Revenue & |9-0 |Ting, Brough, | |
|Taxation | |Dababneh, Gipson, | |
| | |Roger Hernández, | |
| | |Mullin, Patterson, | |
| | |Quirk, Wagner | |
| | | | |
|----------------+------+-----------------------+------------------|
|Appropriations |17-0 |Gomez, Bigelow, Bonta, | |
| | |Calderon, Chang, Daly, | |
| | |Eggman, Gallagher, | |
| | |Eduardo Garcia, | |
| | |Gordon, Holden, Jones, | |
| | |Quirk, Rendon, Wagner, | |
| | |Weber, Wood | |
| | | | |
| | | | |
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SUMMARY: Establishes a Research and Development-Small Business
Grant Program (Grant Program) providing grants, equal to a
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percentage of unused Research and Development credits, to
qualifying small business, as specified. Specifically, this bill:
1)Provides, on or after January 1, 2016, 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, 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,
2021, 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 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
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amount that is attributable to the taxable year in which a
credit is allowed, and available for carryover to the following
year. The FTB shall provide a certificate within 90 days 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
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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 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 (GO-Biz)
as an eligible qualified small business.
11)Provides for taxable years beginning on or after January 1,
2016, and before January 1, 2023, that gross income does not
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include a grant received by the Grant Program.
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,
2017, and before January 1, 2023, 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 Revenue
and Taxation Committee, which includes a list of grant
recipients for the previous calendar year and the grant amount
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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.
24)Provides that the grant shall remain in effect only until
January 1, 2023, and as of that date is repealed, unless a later
enacted statute, that is enacted before January 1, 2023, deletes
or extends that date.
FISCAL EFFECT: According to the Assembly Appropriations
Committee,
1)One-time General Fund (GF) costs of approximately $225,000 and
ongoing annual costs of approximately $525,000 to GO-Biz to
develop program and regulations, and ongoing administration;
significant GF costs to FTB and Controller to administer changes
to systems and procedures.
2)Estimated GF revenue decreases of $22 million, $27 million, and
$27 million in fiscal year (FY) 2015-16, FY 2016-17, and FY
2017-18, respectively.
COMMENTS:
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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 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)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%
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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.
3)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 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.
4)Purpose of the R&D Credit: There are various reasons why the
R&D credit was enacted at the federal and state level. First,
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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 United
States 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 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.
5)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
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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 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.
6)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 10% 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 15% of unused R&D credit
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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 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 3% 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.)
7)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
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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 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.
Analysis Prepared by:
Carlos Anguiano / REV. & TAX. / (916) 319-2098
FN: 0000695
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