BILL ANALYSIS Ó
AB 437
Page 1
CONCURRENCE IN SENATE AMENDMENTS
AB
437 (Atkins)
As Amended August 31, 2015
2/3 vote
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|ASSEMBLY: | 79-0 |(June 2, 2015) |SENATE: | 32-0 |(September 1, |
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Original Committee Reference: REV. & TAX.
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.
The Senate amendments:
1)Delay the operative date by one year.
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2)Require the State Controller to also provide the report to the
Committee on Governance and Finance, or its successor.
3)Delete the requirement that the Governor's Office of Business
and Economic Development (GO-Biz) certify that the taxpayer is
a qualified small business and meets all requirements.
4)Require a "qualified small business" to be organized as one of
the following business entities:
a) Corporation;
b) Partnership;
c) Limited Partnership; or,
d) Limited Liability Company, whether classified as a
corporation, partnership, or disregarded as a separate
entity.
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5)Require a "qualified small business" to be in existence and
have filed income tax returns for the two taxable years
preceding the taxable year for which the taxpayer applies for
a grant.
AS PASSED BY THE ASSEMBLY, this bill:
1)Provided, 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)Required, 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)Provided, 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)Required, in order to receive a grant, a qualified small
business to apply for the grant on a timely field original
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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 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)Provided 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)Provided 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:
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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 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)Defined 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)Provided that a qualified small business may not be an
affiliated corporation that is treated as a member of a
combined reporting group.
9)Provided that no grant may be awarded with respect to a credit
that may be assigned.
10)Provided the qualified small business to be certified by the
GO-Biz as an eligible qualified small business.
11)Provided for taxable years beginning on or after January 1,
2016, and before January 1, 2023, that gross income does not
include a grant received by the Grant Program.
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12)Defined gross receipts as having the same meaning as provided
for under Internal Revenue Code (IRC) Section 41(c)(7).
13)Required the FTB to allocate the certified amounts based on
the aggregate applicable amount for the calendar year in which
the certificate is issued.
14)Provided 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)Provided 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)Required 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)Provided 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.
18)Provided the following for pass-thru entities:
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a) Defined a "pass-thru entity" as a partnership or "S"
corporation under the PIT, and as a partnership under the
CT.
b) Required 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) Required the FTB to issue a certificate to the
partnership or "S" corporation with respect to taxable
years on or after January 1, 2016.
d) Provided that a certificate shall not be issued to an
"S" corporation with respect to the credit allowed under
the CT California Research Credit.
19)Required 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)Provided that grants are continuously appropriated from the
General Fund.
21)Required 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
each recipient received.
22)Required, on or after January 1, 2016, that GO-Biz, upon
application by the taxpayer, to certify that the taxpayer
meets all the requirements of a qualified small business.
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23)Provided 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)Provided 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 Senate Appropriations
Committee:
1)The FTB estimates that the previous version of this bill would
result in General Fund revenue losses of $22 million in
2015-16, and $27 million in 2016-17. By delaying the
implementation date one year, the revenue impacts would
themselves be delayed by one year, and would likely be of
similar magnitude.
2)The FTB estimates that this 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 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 state in proportion to the amount of the
research and development tax credits they have
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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% 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
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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,
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
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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 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
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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
2015 and 2016. Going forward, the Grant Program will provide
qualifying small businesses with a grant equal to 15% 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
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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 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.
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Analysis Prepared by:
Carlos Anguiano / REV. & TAX. / (916) 319-2098
FN:
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