BILL ANALYSIS                                                                                                                                                                                                    Ó



          SENATE COMMITTEE ON APPROPRIATIONS
                             Senator Ricardo Lara, Chair
                            2015 - 2016  Regular  Session

          AB 437 (Atkins) - Research and Development: Small Business Grant  
          Program.
          
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          |Version: July 13, 2015          |Policy Vote: GOV. & F. 6 - 0    |
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          |Urgency: No                     |Mandate: No                     |
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          |Hearing Date: August 17, 2015   |Consultant: Robert Ingenito     |
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          This bill meets the criteria for referral to the Suspense File.




          Bill  
          Summary: AB 437 would permit qualified small businesses to  
          convert research and development credits into cash grants.


          Fiscal  
          Impact: 
                 The Franchise Tax Board (FTB) estimates that this bill  
               would result in General Fund revenue losses of $22 million  
               in 2015-16, $27 million in 2016-17 and 2017-18.

                 FTB estimates that the bill would result in one-time  
               General Fund administrative costs of $664,000, related to  
               the creation of the grant program. Ongoing costs would be  
               $344,000 annually, beginning in 2016-17.  









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          Background: California law allows various income tax credits, deductions,  
          and sales and use tax exemptions to provide incentives to  
          compensate taxpayers that incur certain expenses, such as child  
          adoption, or to influence behavior, including business practices  
          and decisions, such as motion picture production credits.  The  
          Legislature typically enacts such tax incentives to encourage  
          taxpayers to do something they would not do on the natural. 
          Similar to federal law, California allows taxpayers a research  
          and development (R&D) credit designed to provide incentives for  
          taxpayers to increase their year-over-year spending on R&D. In  
          2011, the credit resulted in $1.8 billion in foregone revenue,  
          95 percent of which was attributable to firms with more than $1  
          billion in annual gross receipts. To qualify for the credit,  
          research expenses must be conducted in California, and (1)  
          qualify as expenses under federal law, (2) be undertaken for the  
          purpose of discovering information that is technological in  
          nature, (3) be undertaken for the purpose of discovering  
          information the application of which is intended to be useful in  
          the development of a new or improved business component of the  
          taxpayer, and (4) be the case that substantially all of the  
          research activities must constitute elements of a process of  
          experimentation for a qualified purpose.


          The R&D credit increases as the taxpayer incrementally grows  
          research expenditures over a comparable base-year period.  To  
          calculate the credit, taxpayers multiply the credit rate  
          (generally 15 percent) by the amount by which their current year  
          research expenditures exceeds the "base amount," as specified.


          If a business taxpayer's expenses exceed its gross receipts in a  
          taxable year, it doesn't pay income tax, so it cannot make use  
          of the tax credit that year. Many California companies are in  
          this situation, with products or services not yet ready for  
          market, but having spent funds on research in the hopes of  
          developing it, yet it need of the capital necessary to  
          experiment further or start manufacturing a product.  While  
          current law allows taxpayers to carry forward most credits to a  
          specified number of taxable years, the only refundable tax  
          credit is the newly-enacted Earned Income Tax Credit, which  
          allows taxpayers to receive a refund equal to the difference  
          left over after using the credit to reduce the tax due below  








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          zero when appropriated by the Legislature (SB 80, Committee on  
          Budget and Fiscal Review, 2015).




          Proposed Law:  
           This bill would allow a qualified small business to convert  
          into cash grants 10 percent of the value of R&D credits carried  
          over from the 2014 and 2015 taxable years to the 2016 year, or  
          15 percent for credits generated in the 2016 to 2021 taxable  
          years. The measure also would provide that its grants are not  
          taxable income for California purposes.  
          Taxpayers apply for grants by timely filing an original return  
          with FTB, who allocates them on a first-come, first-served  
          basis. FTB can allocate $100 million in credits for the 2016 tax  
          year, with not more than $50 million of that amount for the 2014  
          and 2015 years, and $50 million each year starting in 2017 and  
          ending in 2023.  FTB can only allocate credits to taxpayers (1)  
          with less than $5 million in gross receipts in the taxable year  
          using the Internal Revenue Code's (not California's) definition,  
          and (2) who are not members of combined group of corporations  
          for tax purposes.


          FTB must provide taxpayers with certificates within 90 days of  
          receiving the return with the application.  Taxpayers cannot  
          share grants under the authority to share credits within unitary  
          or combined groups of corporations. The bill directs the  
          Controller to pay the taxpayer upon receipt of the certificate,  
          and continuously appropriates funds from the General Fund  
          necessary to do so.  The Controller must report to the  
          Legislature, as specified, regarding the recipients of the  
          grants for the previous calendar year and the grant amount each  
          recipient received.


          The measure applies rules for pass through entities, treats as a  
          deficiency any grant amount the taxpayer subsequently claims as  
          a credit, and allows FTB to issue any rules and regulations  
          necessary to implement the credit.  The bill also makes  
          technical and conforming changes, and sunsets on January 1,  
          2023.  









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          Staff  
          Comments: Using 2012 tax return data, it was determined that  
          companies with $5 million or less in gross receipts generated  
          approximately $130 million of R&D credits that were not used to  
          offset tax liabilities. This amount was reduced by approximately  
          50 percent to account for companies who do not meet the  
          definition of a qualified small business as defined in this  
          bill. Using the Department of Finance's economic model, FTB grew  
          this amount to calculate a 2014 and 2015 R&D unused credit  
          balance totaling $160 million that would be available beginning  
          in 2016 for eligible taxpayers to receive a grant. FTB assumed  
          that the number of taxpayers applying for the R&D grant would  
          double over a 5-year period. The increase in the number of  
          taxpayers that would apply for the R&D grant includes  
          non-filers, startups, disregarded entities, and other pass-thru  
          entities currently conducting R&D activity yet not reporting the  
          credit on their return because the entity has no tax liability.  
          The applicable percentage of the grant as provided in this bill  
          was then applied. For taxable year 2015, FTB anticipates that  
          $30 million in grant requests would be made.
          FTB estimates that the bill would result in costs of $664,000 to  
          develop an application process for electronic filing and  
          services, grant certification, database development and testing,  
          and a noticing system to allow for a new grant program. In order  
          to meet the 90-day certification process, these costs assume the  
          taxpayer would be required to e-file their return (including a  
          grant application).  Additionally, the cost assumes a volume of  
          approximately 5,000 returns per year, based on a credit  
          allocation of $50 million dollars per fiscal year.  Beginning in  
          2016-17, ongoing costs would be $344,000 annually.  


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