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. ----------------------------------------------------------------- | | | | | | ----------------------------------------------------------------- |--------------------------------+--------------------------------| | | | |Version: July 13, 2015 |Policy Vote: GOV. & F. 6 - 0 | | | | |--------------------------------+--------------------------------| | | | |Urgency: No |Mandate: No | | | | |--------------------------------+--------------------------------| | | | |Hearing Date: August 17, 2015 |Consultant: Robert Ingenito | | | | ----------------------------------------------------------------- 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. AB 437 (Atkins) Page 1 of ? 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 AB 437 (Atkins) Page 2 of ? 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. AB 437 (Atkins) Page 3 of ? 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. -- END --