BILL ANALYSIS Ó AB 2334 Page 1 Date of Hearing: April 4, 2016 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Sebastian Ridley-Thomas, Chair AB 2334 (Mullin) - As Introduced February 18, 2016 Majority vote. Fiscal committee. Tax levy. SUBJECT: Alternative energy financing SUMMARY: Modifies the California Alternative Energy and Advanced Transportation Financing Authority (CAEATFA) Act to increase the annual amount of the sales and use tax (SUT) exclusion available for allocation by the CAEATFA and to extend the SUT exclusion to purchases of tangible personal property (TPP) by certain contractors, as provided. Specifically, this bill: 1)Extends the SUT exclusion to a lease or transfer of title of eligible TPP to any contractor for use in the performance of a construction contract for the participating party that will use that property as an integral part of the approved project (a "construction contract"). 2)Increases the annual amount of SUT exclusions available for AB 2334 Page 2 allocation to projects, including projects that involve specified construction contracts, as follows: a) For the 2016 calendar year, from $100 million to $575 million. b) For the 2017 calendar year and each calendar year thereafter, from $100 million to $350 million, plus any amounts unused or not granted from the previous calendar year. 3)Takes effect immediately as a tax levy. EXISTING LAW: 1)Authorizes CAEATFA to provide financial assistance to certain facilities that use alternative energy sources and technologies, develop advanced manufacturing, process recycled feedstock, or develop and commercialize advanced transportation technologies that conserve energy, reduce air pollution, and promote economic development and jobs. 2)Allows CAEATFA to provide eligible projects financial assistance in the form of a SUT exclusion on property used to process recycled feedstock or used for the "design, manufacture, production, or assembly" of advanced manufacturing, advanced transportation technologies, or alternative energy source products, components or system, as defined. 3)Requires a project to demonstrate that the benefits to the state from the project equals or exceeds the projected benefit to the participating party from the SUT exclusion. AB 2334 Page 3 4)Requires CAEATFA to provide 20-day notice to the Legislature, once the value of SUT exemptions approved by CAEATFA exceeds $100 million. The notification must be provided prior to granting additional approvals. 5)Repeals the CAEATFA's expanded authority to promote the use of advanced manufacturing and recycled feedstock as of January 1, 2021. 6)Imposes a sales tax on a retailer's gross receipts from the retail sale of tangible personal property (TPP) in this state, unless the sale is specifically exempt from taxation. It is presumed that gross receipts from a particular sale of TPP are subject to tax, unless the seller can establish either that the sale was not a retail transaction or that the sale is subject to an exemption. FISCAL EFFECT: Unknown COMMENTS: 1)Author's Statement . The author has provided the following statement in support of this bill: "AB 2334 increases the annual award cap of the California Alternative Energy and Advanced Transportation Authority (CAEATFA) sales and use tax exclusion (STE) from $100 million to $350 million and allows for rollover of unused funds from previous years, in addition to other small program changes. In doing so, AB 2334 gives CAEATFA the ability to further incentivize California-based jobs and manufacturing, while promoting clean technology and reducing pollution and energy consumption." 2)Arguments in Support . The sponsor of this bill states that, as of February 2016, the SUT exclusion program "reached its annual award cap and is currently oversubscribed. . . . AB 2334 Page 4 Oversubscription is due to increasing application numbers and to the large scale of awards to electric vehicle and aerospace companies." The sponsor argues, "[w]ith the program's 2016 cap already oversubscribed, projects that would have significant economic and environmental benefits to the state will not receive an award." 3)CAEATFA Program: Background . The California Alternative Energy Source Financing Authority was established in 1980, with an authorization of $200 million in revenue bonds to finance projects utilizing alternative or renewable energy sources, such as wind, solar, and cogeneration and geothermal. In 1994, the authority was renamed the "California Alternative Energy and Advanced Transportation Financing Authority" and its charge was expanded to include the financing of "advanced transportation" technologies. During the energy crisis of 2001, CAEATFA's authority was expanded again to provide financial assistance to public power entities, independent generators, and others for new and renewable energy sources. The CAEATFA board consists of five members: the Treasurer, Controller, Director of Finance, Chairperson of the Energy Commission, and President of the Public Utilities Commission. Generally, CAEATFA is authorized to provide financial assistance to approved projects via the issuance of bonds, loans, loan guarantees, and credit enhancements. CAEATFA may authorize up to $1 billion in revenue or prepayment bonds to fund projects. Over the last few years, CAEATFA has provided financial assistance through various programs, including qualified energy conservation bonds for projects that promote the use of alternative energy and energy efficiency in state, local and tribal government facilities, as well as clean renewable energy bonds for renewable energy projects. 4)CAEATFA's SUT Exclusion Program . CAEATFA is also allowed to AB 2334 Page 5 provide a SUT exclusion for certain specified projects. The first SUT exclusion was granted to Tesla in 2009. Shortly thereafter, SB 71 (Padilla), Chapter 10, Statutes of 2010, expanded the SUT exclusion to apply to purchases of equipment used for the design, manufacture, production, or assembly of "advanced transportation technologies" and "alternative source" products, components, or systems. Alternative source products include cogeneration technology; energy conservation; and solar, biomass, wind, geothermal, specified hydro-electric, or any other energy efficient technologies that reduce the use of fossil and nuclear fuels. In 2012, SB 1128 (Padilla), Chapter 677, Statutes of 2012 added "advanced manufacturing" to the list of eligible projects. Consequently, the SUT exclusion program was enlarged to include "advanced manufacturing" projects. SB 1128 also placed a $100 million cap on the amount of the SUT exclusion that may be awarded in a calendar year. In 2013, AB 1422 (Jobs, Economic Development and the Economy), Chapter 540, Statutes of 2013, revised the definition of "participating party" for purposes of the SUT exclusion to include out-of-state and overseas entities. AB 1422 allowed an otherwise qualified out-of-state entity to apply for financial assistance and the SUT exclusion. The entity, however, must commit and demonstrate that it will be opening a manufacturing facility in California. Finally, in 2015, AB 199 (Eggman), Chapter 768, Statutes of 2015, further modified the SUT exclusion program to include manufacturing projects that either process or utilize "recycled feedstock." The expanded program is due to sunset on January 1, 2021. 5)CAEATFA's Application Process for SUT Exclusion . California provides several tax incentives designed to encourage socially AB 2334 Page 6 beneficial behavior, such as an increase in low-income housing, research and development activity, and overall economic activity. A major policy concern when enacting a tax incentive program is the possibility of rewarding behavior that would have occurred in the absence of the subsidy, known as "deadweight loss". The possibility of rewarding, instead of incentivizing, behavior has become an accepted reality for almost all tax incentive programs. The Legislature has attempted to address this problem by creating tax incentives programs that require potential beneficiaries to undergo a rigorous application process to ensure, on a case-by-case basis, that the state receives the desired benefit. One of the prime examples of such programs is the SUT exclusion administered by the CAEATFA. The CAEATFA has established a lengthy application process to ensure the efficient use of state resources by requiring each applicant to demonstrate a benefit to the state before an award may be granted. Before a SUT exclusion may be awarded, CAEATFA is required to determine the eligibility of an individual project based on a number of factors relating to the reduction in greenhouse gases and the creation of manufacturing jobs. Specifically, when evaluating an application, CAEATFA must consider the extent to which the project develops manufacturing facilities located in California; the extent to which the project will create new, permanent jobs in California; the extent to which the project results in a reduction of greenhouse gases; the unemployment rate in the area in which the project will be located; and any other factors that CAEATFA deems appropriate in accordance with this program, among other criteria. Most important among the factors is the requirement that applicants demonstrate a "net benefit" to the state. Known as the "net benefits" test, this test quantifies the fiscal and environmental benefits of the proposed project to ensure that the state receives a benefit beyond the cost of the SUT exclusion and is one of the most important factors that CAEATFA considers when awarding the exclusion. In this manner, the test attempts to address the "dead-weight" problem found within every subsidy. Projects approved for the exclusion receive a full exemption AB 2334 Page 7 from the state and local portions of the SUT. The full SUT rate ranges from 7.5% to 10%, with a statewide average of 8.42%. Once the exclusion has been granted, applicants are allowed three years to use the award but can request extensions from the CAEATFA Board. Amounts awarded in previous years, but not yet utilized, may not be recaptured by the CAEATFA. In November 2015, CAEATFA suspended acceptance of new applications due to the proposed program revisions and the development of the regulations to implement AB 199. Currently, $25 million of the 2016 annual amount remains unallocated. 6)What Does this Bill Do ? This bill proposes to modify the existing CAEFTA program to: (a) increase the aggregate award amount available to eligible applicants in each calendar year, starting with 2017; (b) allow a rollover of unallocated funds to the following calendar year; and, (c) extend the SUT exclusion to a project where a contractor leases or purchases TPP for use in the performance of a construction contract for the participating party, as provided. With respect to the award amount, this bill would increase the cap from $100 million to $575 million (which includes unused funds from 2010-2014 calendar years) for the 2016 calendar year and to $350 million for the 2017 calendar year and each year thereafter. It appears that, of these amounts, at least $100 million plus any previously unallocated or unused amounts must be allocated each calendar year, beginning with the 2017 calendar year, exclusively to projects other than the specified construction contracts. 7)Oversubscription: What is the Problem ? According to CAEATFA, a very diverse group of applicants are applying for the same funds. Last year, CAETFA had a high number of applications requesting an allocation of the SUT exclusion, and the existing cap of $100 million was quickly reached. With the expansion of the CAETFA program to include projects that AB 2334 Page 8 process or utilize recycled feedstock, the number of SUT exclusion applications is expected to increase even more. During this Committee's informational hearing on February 22, 2016, the Executive Director of CAEFTA testified that the increased demand for the funds may be due to continued economic recovery, newly added categories of eligible projects and a number of applications requesting large SUT exclusion amounts. While historically small projects requesting less than $2.1 million in SUT exclusions comprised almost 75% of approved applications, in recent years CAEFTA has approved a number of applications for large projects with more than $20 million in SUT exclusions, such as for example, the ones submitted by Tesla, Atieva, Lockheed, Space X, and Solyndra. Existing law does not impose a cap on the amount that a company may request in SUT exclusions, nor does existing law prioritize certain types of projects. Thus, applications involving large projects may utilize a considerable portion of the allowable $100 million cap, leaving no funds for smaller projects. Furthermore, the CAEFTA does not have the authority to utilize the unclaimed awards. Finally, CAEFTA may not award any amounts that remain unallocated in a particular calendar year in the following years. In other words, the un-awarded SUT exclusion amounts simply disappear. The author believes that allowing a rollover of unallocated funds to the following calendar year and substantially increasing the annual SUT exclusion cap would help projects that would have significant economic and environmental benefits to the state. 8)Partial SUT Exemption for Purchases of Manufacturing and R&D Equipment . In 2013, Governor Brown signed AB 93 (Committee on Budget), Chapter 69, Statutes of 2013, which reformed California's economic development policies. The new law eliminated enterprise zones and other geographically targeted economic development areas and, instead, created three new tax benefits: (a) a temporary tax credit for wages paid by AB 2334 Page 9 taxpayers to qualified employees within former enterprise zones, and other areas that suffer from high levels of poverty and unemployment; (b) a temporary SUT exemption on purchases of manufacturing equipment made by qualified taxpayers, capped at $200 million annually per taxpayer; and, (c) the California Competes Tax Credit program. Existing law limits the total annual amount of these three tax incentives to $750 million. With the passage of AB 93, sales and leases of certain manufacturing and R&D equipment may now qualify for the temporary SUT partial exemption. The partial exemption rate is currently set at 4.1875%, which means that sales of qualifying property sold to a qualified person are taxed at a rate of 3.3125% (7.5% current statewide tax rate minus 4.1875% partial exemption rate), plus any applicable district taxes. The exemption is available for purchases made until July 1, 2022. The program is generally self-certified, with little oversight from the State Board of Equalization (BOE). The program was created in such a way as to allow the partial SUT exemption to be taken immediately, without complicated forms and procedures. Unlike CAEATFA's SUT exclusion, the partial SUT exemption does not necessarily attempt to encourage or incentivize beneficial behavior. Instead, the partial SUT exemption attempts to reduce the distortion from the imposition of a tax on a tax, otherwise known as "pyramiding". When manufacturers pay a SUT on tangible personal property, the tax is incorporated into the cost of a consumer product, often leading to double taxation. Ideally, taxes should only be levied once because pyramiding may cause consumers to favor goods and services provided by a single company instead of those that require multiple production steps. 9)The Interaction of the Partial SUT Exemption and the CAEFTA SUT Exclusion . To a large degree, the CAEATFA SUT program overlaps with the partial SUT exemption for manufacturing and AB 2334 Page 10 R&D equipment. Thus, unless a project includes a purchase of manufacturing or R&D equipment worth more than $200 million, the purchase may qualify for the partial SUT exemption, which requires no application or allocation. However, as noted above, the partial SUT exemption provides tax relief only for the state portion of the SUT. When the partial SUT exemption was enacted, the BOE estimated that General Fund revenue would decrease annually by more than $600 million ($637 million in fiscal year (FY) 2014-15 and $681 million in FY 2015-16). However, the most recent data demonstrates that the exemption is currently underutilized. The total exemption amount claimed in FY 2014-15 was $91.2 million; in the first four months of FY 2015-16, the amount was only $77.2 million. The underutilization problem may be due to complexities of the program and/or may be attributed to the conditional nature of the SUT exemption, where only a certain type of property and purchasers qualify for the exemption. It may be argued that the partial nature of the exemption, where some amount of SUT still needs to be collected by the vendor, also contributes to the underutilization problem. Meanwhile, the CAEATFA exclusion program has been oversubscribed. Although the program has no per-purchaser limit, it is subject to the overall annual cap of $100 million and most likely will be oversubscribed in 2016 and 2017. In the absence of legislative intent, it is unclear which types of projects should receive priority. The CAEATFA program had been in place for many years prior to the enactment of the partial SUT exemption. It is unknown whether the underutilization of one program has contributed to the oversubscription for the other program or whether there is any connection between the two programs. However, in light of AB 2334 Page 11 the underutilization of the partial SUT exemption and oversubscription of the CAEATFA program, the Committee may consider restructuring the CAEATFA program to prioritize certain projects, in addition to allowing the recapture of allocated funds and rollover of unallocated funds. Furthermore, as an alternative to the proposed increase in the $100 million cap, the Committee may also consider authorizing CAEATFA to exempt only the local portion of the SUT in the case of projects that otherwise meet the eligibility requirements for the partial SUT exemption. 10)Construction Contracts: Definition of "Sale" or "Purchase. " In 2012, SB 1128 revised R&TC Section 6010.8, which authorizes the SUT exclusion to allow a "participating party" to purchase or lease qualified TPP directly from the seller, removing the need for CAEATFA to act as an intermediary. The term "participating party" means, among others, a person, federal or state agency, city or county, state college or university, school district or other political entity engaged in the business or operations in the state, whether for profit or non-profit, that applies for financial assistance from the CAEATFA for the purpose of implementing a project. Prior to 2013, in order to qualify for the exemption, the participating party had to purchase the property without payment of tax and then resell the equipment to CAEATFA. The transfer was excluded from the SUT as a transfer from a participating party to CAEATFA. The participating party and CAEATFA would then enter into a lease agreement and upon complete installation of the TPP, ownership of that property would be transferred from the CAEATFA to the participating party. Alternatively, CAEATFA was able to purchase the specified equipment on behalf of the participating party, financing the purchase through a bond or loan, and the participating party would lease the equipment from CAEATFA. As the purchaser of the equipment, the CAEATFA paid no sales tax on the purchase, nor was it required to collect the use tax on the lease receipts. SB 1128 simplified these AB 2334 Page 12 complicated sale-lease transactions that are not feasible for business reasons by providing that a lease or transfer of TPP constituting a "project" under the SB 71 Program to a participating party is neither a "sale" nor "use" and, thus, is exempt from the SUT. This bill proposes to simplify sale-lease transactions further for certain construction contracts. According to CAEFTA, the main purpose of this modification is to streamline the application of the SUT exclusion for contractors and subcontractors. Existing law only covers transfers of title of TPP property to the participating party, not a contractor or subcontractor performing the work on the eligible project. Thus, only the participating party may issue a certificate to the retailers for the purchases of materials, fixtures, machinery, equipment or other TPP. Although a contractor may be able to utilize the SUT exclusion in certain circumstances, the process to ensure that the contractor is eligible to claim the exclusion when purchasing TPP is complicated and cumbersome. Construction contractors and participating parties must follow specific procedures when providing exemption certificates to suppliers and preparing contractual agreements. Essentially, a construction contract must be structured in a way, per BOE's instructions, that allows the title to materials to be transferred from the vendor selling TPP directly to the participating party. In some instances, a contractor may not be able to use the SUT exclusion because the participating party has become eligible for the exclusion after a contract was performed. Usually, CAEATFA directs applicants to the BOE for advice regarding the use of contractors since the BOE is responsible for administering the SUT law. To simplify the process, this bill proposes to amend the existing definition of "sale" and "purchase" in Section 6010.8 to allow any contractor to claim the SUT exclusion when the contractor purchases TPP for use in the performance of a construction contract for the participating party. This provision would only apply if the participating party will use the TPP as an integral part of AB 2334 Page 13 the approved project. It seems that while increasing the overall annual allocation amount for the SUT exclusion, this bill would require that at least $100 million be awarded annually to projects other than projects involving the abovementioned leases and purchases of TPP by contractors. Stated differently, this bill would create two categories of projects: projects that will become eligible for the SUT exclusion award only after the effective date of this bill and projects that are already eligible under existing law. Although unclear, it appears that the overall annual allocation amount will depend on the type of projects eligible for the awards. 11)Related Legislation . AB 1683 (Eggman) is similar to this bill. AB 1683, among other things, would increase the annual amount of SUT exclusions available for annual allocations to projects to $200 million. AB 1683 will be heard by this Committee today. REGISTERED SUPPORT / OPPOSITION: Support John Chiang, Treasurer, State of California (Sponsor) Proterra Motiv California Against Waste AB 2334 Page 14 California Manufacturers and Technology Association Opposition None on file Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916) 319-2098