BILL ANALYSIS Ó
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|SENATE RULES COMMITTEE | AB 437|
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THIRD READING
Bill No: AB 437
Author: Atkins (D), et al.
Amended: 8/31/15 in Senate
Vote: 27
SENATE GOVERNANCE & FIN. COMMITTEE: 6-0, 7/8/15
AYES: Hertzberg, Nguyen, Beall, Hernandez, Lara, Pavley
NO VOTE RECORDED: Moorlach
SENATE APPROPRIATIONS COMMITTEE: 7-0, 8/27/15
AYES: Lara, Bates, Beall, Hill, Leyva, Mendoza, Nielsen
ASSEMBLY FLOOR: 79-0, 6/2/15 - See last page for vote
SUBJECT: Research and Development: Small Business Grant
Program
SOURCE: Author
DIGEST: This bill allows qualified small businesses to convert
excess research and development credits into cash.
ANALYSIS:
Existing law:
1)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
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decisions, such as motion picture production credit.
2)Allows taxpayers a nonrefundable research and development
credit designed to provide incentives for taxpayers to
increase their year-over-year spending on research and
development in modified conformity with federal law.
Taxpayers may carry forward credits to future taxable years
until exhausted.
3)Taxes businesses based on net income, so if a business
taxpayer's expenses exceed its gross receipts in a taxable
year, it doesn't pay income tax, in which case, it cannot make
use of a nonrefundable tax credit that year.
This bill:
1)Allows a qualified small business to convert into cash grants
10% of the value of research and development credits carried
over from the 2015 and 2016 taxable years to the 2017 year, or
15% for credits generated in the 2017 to 2022 taxable years,
remaining after reducing tax for the year to zero, beginning
on January 1, 2017. To qualify, small businesses must:
a) Have gross receipts of less than $5 million in the
taxable year,
b) Cannot be part of a combined reporting group of
corporations, and
c) Must have been in existence and filed income tax returns
for the two taxable years immediately preceding the taxable
year for which it applies for the grant.
1)Provides that grants aren't income for state tax purposes, and
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grants aren't available for transferred credits.
2)Creates a process for taxpayers to apply to the Franchise Tax
Board (FTB) when filing an original return electronically.
3)Requires FTB to allocate certificates for cash grants on a
first-come, first-served basis, unless more than one return is
received on the same day as authorized grant amounts expire,
in which case FTB allocates certificates on a pro rata basis.
FTB must allocate credits within 90 days of receiving the
application.
4)Requires FTB to allocate $100 million in credits for the 2017
calendar year, with not more than $50 million of that amount
for the 2015 and 2016 years, and $50 million each year
starting in 2018 and ending in 2024.
5)Directs the State Controller to pay the taxpayer upon receipt
of the certificate, and continuously appropriates funds from
the General Fund necessary to do so.
6)Requires the Controller to report to the Assembly Committee on
Revenue and Taxation and the Senate Committee on Governance
and Finance, or its successor, regarding the recipients of the
grants for the previous calendar year and the grant amount
each recipient received.
7)Makes conforming changes to reduce credit amounts by the
amount of the grant, among others.
8)Applies rules and definitions 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.
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Background
The Legislature typically enacts such tax incentives to
encourage taxpayers to do something that but for the tax credit,
they would not do. The Department of Finance is required to
annually publish a list of tax expenditures, currently totaling
around $51 billion per year.
Similar to federal law, California allows taxpayers a research
and development credit designed to provide incentives for
taxpayers to increase their year-over-year spending on research
and development. In 2011, the credit resulted in $1.77 billion
in foregone revenue, 95% of which is 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:
Qualify as expenses under Internal Revenue Code §174,
Must be undertaken for the purpose of discovering
information that is technological in nature,
Must 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,
Substantially all of the research activities must
constitute elements of a process of experimentation for a
qualified purpose.
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 a tax credit that year. Many California companies are in
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this situation, with products or services not yet ready for
market, but having spent funds on research expenses in the hopes
of developing it, yet in need of the capital necessary to
experiment further or start manufacturing a product. While
state 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
zero when appropriated by the Legislature (SB 80, Committee on
Budget and Fiscal Review, Chapter 21, Statutes of 2015).
Comments
AB 437 sets a significant precedent in state tax law by allowing
small businesses to convert tax credits into cash, accelerating
the taxpayer's ability to monetize the credits. As such, this
bill prioritizes these cash grants above all other state
spending, as moneys that the Controller must spend to provide
the grants comes out of the General Fund before the Legislature
appropriates what's left in the Budget Act. While the firms
that AB 437 would help with cash grants will likely claim the
credits against net income in the future, or transfer them to a
firm that subsequently acquires or merges with it, this bill
transfers the time value of money to the taxpayer at the expense
of the Legislature, who won't have those funds available today
for other state priorities such as education, health care, and
public safety. However, the Legislature will likely have more
funds in whichever years the taxpayer would've eventually
claimed the credit, and the business can put the grant funds to
work right away. Additionally, some of the firms that obtain AB
437 grants may never generate sufficient income, or go out of
business, before they could ever monetize the credit, in which
case this bill will result in a fiscal loss.
In recent years, the definition of "qualified research" has been
expanded to encompass products and services not generally
considered scientific. According to Citizens for Tax Justice,
some accounting firms advertise the credit to food service
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companies developing new or redesigning existing packaging,
while others market it for costs to make new soda machines.
Additionally, recent decisions from the State Board of
Equalization have expanded the kinds of products that qualify as
research expenditures. In the recent appeal of Pacific Coast
Building Products, BOE overturned FTB's denial of research and
development Credits for normal manufacturing equipment used to
make building products, which the company claimed on amended
returns generated by a tax credit study of the company's
operations despite any documentation of experimentation.
In 2005, the Federal Reserve Bank of San Francisco studied
California's research and development (R&D) credit, and found
that it was both effective in increasing R&D in the state, and
does so by drawing away research and development that would've
taken place in other states that lack a credit ("Beggar Thy
Neighbor? The In-State, Out-of-State, and Aggregate Effects of
R&D Tax Credits." Daniel J. Wilson, August, 2007). However,
the Legislative Analyst Office (LAO) recommended reducing the
state's credit or phasing it out over time, because measuring
the credit's benefits are not enough to offset its substantial
revenue loss.
The United States Tax Court ruled in 2015 that tax credits where
the state allows taxpayers to claim a credit without paying tax
are considered grants, and therefore taxable income for federal
purposes in Maines v. Commissioner, 144 T.C. No. 8. As such, AB
437 will allow qualified small businesses to obtain cash grants
in-lieu of credits, but these businesses will have to include
the grant amount in income for federal purposes. However,
because this bill includes an explicit exclusion, grant amounts
won't be included for California purposes.
FISCAL EFFECT: Appropriation: Yes Fiscal
Com.:YesLocal: No
According to the Senate Appropriations Committee, the FTB
estimates that the previous version of this bill will result in
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General Fund revenue losses of $22 million in 2015-16, and $27
million in 2016-17. Recent amendments delay the implementation
date one year, so the revenue impacts would themselves be
delayed by one year, and would likely be of similar magnitude.
FTB estimates that this bill will result in one-time General
Fund administrative costs of $664,000, related to the creation
of the grant program. Ongoing costs will be $344,000 annually,
beginning 2017-18.
SUPPORT: (Verified8/28/15)
BIOCOM
California Asian Chamber of Commerce
California Association for Microenterprise Opportunity
California Chamber of Commerce
California Healthcare Institute
California Life3 Sciences Association
California Metals Coalition
Flex Tech Alliance
National Federation of Independent Business
SEMI
Small Business California
OPPOSITION: (Verified8/28/15)
California Tax Reform Association
ARGUMENTS IN SUPPORT: According to the author, "AB 437 allows
small businesses to receive a grant from the state in proportion
to the amount of research and development tax credits they have
earned. This will allow small businesses to reinvest real
dollars in further research and development projects as well as
business expansion. According to data from the FTB, for
taxpayers that have $1 million - $10 million in gross receipts
there was $100 million in tax credits were generated. Of that
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amount, $87 million of those credits were not used. This data
shows that often small and medium sized companies are able to
earn the tax credits but not able to use them and reinvest those
resources in to more R&D efforts because they don't have enough
taxable liabilities. 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. This
will allow small businesses to reinvest in further research and
development projects. 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."
ARGUMENTS IN OPPOSITION: According to the California Tax
Reform Association, "After corporations successfully petitioned
the Board of Equalization for refunds for unused Manufacturers'
Investment Credits, the Legislature explicitly ensured that
business tax breaks are nonrefundable. That policy was
overwhelmingly agreed upon by the Legislature and Governor and
AB 437 sets back that important concept. California currently
allows credits to be carried forward 20 years, recognizing the
long lead time that some of these products may take; however,
turning these into refundable credits effectively makes
California an investor in all of these research efforts, whether
they have future value or not. Unlike other cash investors the
state gets no direct return. This bill effectively provides
grants to companies with no review or control, whether they have
a viable product or one that will ultimately fail. This is not
a case of choosing winners and losers - rather, it is one of
providing grants irrespective of success or failure. Taxpayers
should not be required to subsidize bad ideas by turning the
zero tax liability from no-profit companies into a grant program
without any review or criteria."
ASSEMBLY FLOOR: 79-0, 6/2/15
AYES: Achadjian, Alejo, Travis Allen, Baker, Bigelow, Bloom,
Bonilla, Bonta, Brough, Brown, Burke, Calderon, Campos, Chang,
Chau, Chiu, Chu, Cooley, Cooper, Dababneh, Dahle, Daly, Dodd,
Eggman, Frazier, Beth Gaines, Gallagher, Cristina Garcia,
Eduardo Garcia, Gatto, Gipson, Gomez, Gonzalez, Gordon, Gray,
Grove, Hadley, Harper, Roger Hernández, Holden, Irwin, Jones,
Jones-Sawyer, Kim, Lackey, Levine, Linder, Lopez, Low,
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Maienschein, Mathis, Mayes, McCarty, Medina, Melendez, Mullin,
Nazarian, Obernolte, O'Donnell, Olsen, Patterson, Perea,
Quirk, Rendon, Ridley-Thomas, Rodriguez, Salas, Santiago,
Steinorth, Mark Stone, Thurmond, Ting, Wagner, Waldron, Weber,
Wilk, Williams, Wood, Atkins
NO VOTE RECORDED: Chávez
Prepared by:Colin Grinnell / GOV. & F. / (916) 651-4119
8/31/15 8:54:51
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