BILL ANALYSIS Ó AB 544 Page 1 Date of Hearing: May 27, 2015 ASSEMBLY COMMITTEE ON APPROPRIATIONS Jimmy Gomez, Chair AB 544 (Mullin) - As Amended May 20, 2015 ----------------------------------------------------------------- |Policy |Revenue and Taxation |Vote:|9 - 0 | |Committee: | | | | | | | | | | | | | | ----------------------------------------------------------------- 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: AB 544 Page 2 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. AB 544 Page 3 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 AB 544 Page 4 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 AB 544 Page 5 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. AB 544 Page 6 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 AB 544 Page 7