BILL ANALYSIS                                                                                                                                                                                                    



                                                                     AB 544


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          Date of Hearing:  May 27, 2015


                        ASSEMBLY COMMITTEE ON APPROPRIATIONS


                                 Jimmy Gomez, Chair


          AB  
          544 (Mullin) - As Amended May 20, 2015


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          |Policy       |Revenue and Taxation           |Vote:|9 - 0        |
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          Urgency:  Yes State Mandated Local Program:  NoReimbursable:  No


          SUMMARY:


          This bill conforms California tax law with respect to the  
          research and development credit, for taxable years beginning on  
          or after January 1, 2016, to January 1, 2021, to the federal  
          alternative simplified credit (ASC), and repeals the alternative  
          incremental credit, and conforms to recent federal changes  
          related to acquisitions, dispositions, and aggregations.   
          Specifically, the bill conforms to the federal law relating to  
          the alternative simplified credit, except as follows:












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          1)The credit for incremental qualified research expenses over  
            50% of the average qualified research expenses for the  
            previous three years is 7% (instead of the federal 14%).





          2)The credit for qualified research expenses where the taxpayer  
            does not have qualified research expenses in any of the  
            previous three years is 4.5% (instead of the federal 6%).





          The bill provides that an election to use the ASC would apply to  
          all succeeding taxable years unless revoked with the consent of  
          the Franchise Tax Board (FTB); and conforms to federal law  
          relating to the inclusion of qualified research expenses and  
          gross receipts of an acquired person and aggregation of  
          expenditures.


          FISCAL EFFECT:


          1)Insignificant cost to FTB to implement the exclusion.





          2)Estimated GF revenue decreases of $17 million, $60 million,  
            and $75 million in FY 2015-16, FY 2016-17, and FY 2017-18,  
            respectively.










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          COMMENTS:


          1)Purpose.  According to the author, California has long been a  
            global leader in research and development (R&D), and to  
            safeguard the growth of R&D in this state, the tax code should  
            offer additional incentives for R&D investment.  The author  
            asserts the current R&D tax credit dates to a 1987 federal  
            law, but since that time the federal law changed while the  
            California credit remained the same.  The author believes  
            discrepancies between the two laws burdens research firms as  
            they must maintain different accounting for the two credits.





            Supporters, including Hewlett-Packard, argue the ASC proposed  
            in this bill is a simpler and superior method of calculating  
            the R&D tax credit, and shifts the focus to R&D conducted in  
            relatively recent years.  Supporters contend the current  
            method can result in unintended or strategic consequences,  
            such as significant disparities in credits among competitors  
            based on activity conducted decades ago, and increased credits  
            when revenue-generating activity is shifted out of state.





          2)The R&D Tax Credit.  The R&D tax credit is designed to achieve  
            two goals: (i) increase the total amount of R&D activity,  
            which results in enhanced productivity and economic growth,  
            and (ii) encourage taxpayers to conduct R&D in the location  
            where the credit is given.  California's high and permanent  
            R&D tax credit currently provides a strong incentive for  








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            private businesses to conduct R&D in this state.  Unlike many  
            other tax incentives, the R&D tax credit does not reward past  
            behavior, but can only be claimed for incremental increases in  
            the taxpayer's research activity.





            The California R&D tax credit leads to increased R&D activity  
            and jobs in this state, which may be more desirable than jobs  
            in other industries.  One of the advantages to the state, as  
            explained by FTB, comes through economies of agglomeration -  
            the benefits that inure to several firms located in close  
            proximity.  This agglomeration facilitates production and  
            development efficiencies by allowing greater specialization  
            among the firms.  Businesses not directly engaged in R&D  
            activities may also benefit from the presence of firms with  
            extensive R&D activities.





            Unlike the federal R&D tax credit, however, the benefits of  
            enhanced productivity and technology cannot be confined to the  
            state of California, and in this way the California R&D tax  
            credit subsidizes advances and efficiencies that help people  
            and firms outside this state.  In effect, the "public good"  
            created through increased R&D is shared throughout the world  
            but paid for by California taxpayers.





          3)Alternative Simplified Credit.  Unlike the incremental method,  
            which relies on a tiered system of average annual gross  
            receipts, the ASC allows a credit for a percentage of research  








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            expenses (14% under federal law) that exceed 50% of the  
            average research costs for the three preceding taxable years.   
            By conforming to the ASC, taxpayers will be less likely to  
            make mistakes and FTB will find it easier to conduct an audit.





          4)Tax Credit vs. Direct Subsidy.  Several scholars have  
            suggested that direct investment in R&D activities can  
            stimulate a greater amount of activity, and can help create  
            equally high, if not higher, numbers of R&D related jobs in  
            the relevant geographic area than tax credits.  Direct  
            investment also has the advantage of potentially benefitting  
            all firms, particularly smaller firms, since the R&D credit is  
            only useful to firms that have or will have taxable profits  
            with which to offset against the credit.  On the other hand,  
            direct R&D subsidies can have the unintended effect of  
            increasing the cost of R&D inputs - primarily highly-skilled  
            labor - causing the overall increase in R&D expenditure to  
            produce higher wages instead of increased productivity and  
            technology.





            Given one of the primary justifications for a state R&D tax  
            credit is the creation of desirable jobs, the high cost of  
            increasing the R&D credit, and the ample opportunities to  
            invest in California's leading technology firms and  
            universities, it may be worth considering whether the amounts  
            spent by this bill would be better invested directly in R&D  
            activity instead of distributed via a tax credit.












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          5)Related and Prior Legislation.





             a)   AB 437 (Atkins) of this session creates a $50 million  
               per year R&D grant program for small businesses.  AB 437 is  
               currently awaits hearing on the Suspense File of this  
               committee.





             b)   AB 2330 (Mullin) of last year was nearly identical to  
               this bill, and was held on the Suspense File of this  
               committee.








          Analysis Prepared by:Joel Tashjian / APPR. / (916)  
          319-2081












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