BILL ANALYSIS Ó AB 2518 Page 1 Date of Hearing: May 9, 2016 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Sebastian Ridley-Thomas, Chair AB 2518 (Gomez) - As Amended April 28, 2016 Majority vote. Tax levy. Fiscal committee. SUBJECT: Sales and use taxes: exemption: nonprofit corporation: building and construction supplies SUMMARY: Establishes a partial sales and use tax (SUT) exemption for building and construction supplies purchased for use by specified nonprofit corporations. Specifically, this bill: 1)Establishes a partial SUT exemption for building and construction supplies, materials, equipment, and machinery, and the parts thereof (collectively, "construction supplies"), that are purchased for use by a nonprofit corporation that is exempt from federal income taxation under Internal Revenue Code Section 501(c)(3) and that has received a welfare exemption under Revenue and Taxation Code (R&TC) Section 214.15 for construction and rehabilitation of properties in California sold to "persons and families of low income". AB 2518 Page 2 2)Defines "persons and families of low income" by reference to Health and Safety Code Section 50093. 3)Provides that, notwithstanding any provision of the Bradley-Burns Uniform Local SUT Law or the Transactions and Use Tax Law, the exemption shall not apply with respect to any tax levied by a county, city, or district pursuant to either of those laws. 4)Provides that the exemption shall not apply with respect to any tax levied pursuant to: a) R&TC Section 6051.2 or 6201.2; b) Section 35 and Section 36(f) of Article XIII of the California Constitution; or, c) R&TC Section 6051 or 6201 that is deposited in the State Treasury to the credit of the Local Revenue Fund 2011. 5)Contains a standard recapture provision. Specifically, if a purchaser certifies in writing to the seller that the construction supplies purchased without tax will be used in a manner entitling the seller to regard the gross receipts from the sale as exempt, and within one year from the date of purchase: (1) removes the construction supplies outside California, (2) converts the construction supplies for use not qualifying for the exemption, or (3) uses the construction supplies in a manner not qualifying for the exemption, the purchaser shall be liable for payment of the sales tax with applicable interest, as specified. AB 2518 Page 3 6)Takes immediate effect as a tax levy, but only becomes operative on the first day of the first calendar quarter commencing more than 180 days after this bill's effective date. 7)Automatically sunsets the exemption five years after its operative date. EXISTING LAW: 1)Imposes a sales tax on retailers for the privilege of selling tangible personal property (TPP), absent a specific exemption. The tax is based upon the retailer's gross receipts from TPP sales in this state. 2)Imposes a complimentary use tax on the storage, use, or other consumption of TPP purchased out-of-state and brought into California. The use tax is imposed on the purchaser; and unless the purchaser pays the use tax to an out-of-state retailer registered to collect California's use tax, the purchaser remains liable for the tax. The use tax is set at the same rate as the state's sales tax and must generally be remitted to the State Board of Equalization (BOE). 3)Provides that property is within the property tax exemption provided by Sections 4 and 5 of Article XIII of the California Constitution if that property is owned and operated by a nonprofit corporation, otherwise qualifying for the exemption under R&TC Section 214, that is organized and operated for the specific and primary purpose of building and rehabilitating single or multifamily residences for sale at cost to low-income families, with financing in the form of a zero interest rate loan and without regard to religion, race, national origin, or the sex of the head of household. AB 2518 Page 4 FISCAL EFFECT: The BOE estimates annual General Fund (GF) revenue losses of $175,000. COMMENTS: 1)The author has provided the following statement in support of this bill: As you already know, California is one of the most expensive places to live. Approximately 95 million American families suffer from housing problems including high cost burdens, overcrowding, and homelessness. One in three households spends more than 30 percent of their income on housing, and one in seven spends more than 50 percent. Local governments deal with overcrowding and congestion. Employers struggle to attract and retain the labor force that is so vital to their bottom line. Low- to moderate-income working families work longer hours, endure long commutes or cut back on basic necessities in order to pay for housing. AB 2518 Page 5 Affordable homeownership helps families, builds wealth, and strengthens communities by providing substantial economic benefits to the homeowner family, their neighborhood, and the economy. Several studies show potential benefits of homeownership to be: (1) Better education outcomes for children; (2) Lower community crime rates; (3) Less welfare dependency among households; (4) More household participation in civic affairs; (5) Better household health. It is the Assemblymember's goal to increase construction of affordable housing in California - AB 2518 is a modest step toward this goal. 2)The BOE notes the following in its staff analysis of this bill: a) Non-qualifying uses of items : "The proposed exemption will not apply if, within one year from the date of purchase, the nonprofit corporation uses the building supplies, equipment, and machinery in a manner not qualifying for the exemption, converts the building supplies, equipment, and machinery from an exempt use to a non-qualifying use, or removes the qualifying building supplies, equipment, and machinery from California. Similar sales and use tax exemptions specify that the qualifying items must be used primarily in the qualifying activity. These exemptions define 'primarily' as 50 percent or more AB 2518 Page 6 of the time. To administer this exemption consistent with similar sales and use tax exemptions, BOE staff recommends that the term 'primarily' be added to the bill. BOE staff will work with the author's office to address this concern." b) Partial exemptions complicate administration : "Currently, most sales and use tax exemptions are applied to the total applicable sales and use tax. However, several partial exemptions exist in which only the state tax portion (5.25%) of the sales and use tax rate is exempted, such as the farm equipment and teleproduction equipment exemptions. These partial exemptions are difficult for both retailers and the BOE, and complicate return preparation and processing. Moreover, errors attributable to these partial exemptions occur frequently. This results in additional return processing workload for the BOE." 3)This bill is supported by Habitat for Humanity, which notes the following: AB 2518 would exempt Habitat for Humanity from the state portion of sales and use tax when purchasing building and construction supplies, materials, equipment, machinery, and related parts for construction of low-income housing. Habitat for Humanity (Habitat) brings homeownership opportunities to low income and very low income families who are unable to obtain conventional home financing and desire a permanent residence compared to a rental unit. In most cases, prospective Habitat homeowner families make a $500 down payment and they contribute 500 hours of "sweat equity" on the construction of their home. Because Habitat houses are built using donations of land, material, labor AB 2518 Page 7 and government funding subsidies, like rental units, they are kept affordable. 4)Committee staff comments: a) What is a "tax expenditure" ? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, U.S. Treasury officials began arguing that these features of the tax law should be referred to as "expenditures" since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each (in the form of foregone revenues). b) 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, it should also be noted that, once enacted, it takes a two-thirds vote to rescind an existing tax expenditure absent a sunset date. This effectively results in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of their efficacy or cost, without a supermajority vote. c) An overview of the SUT Law : California's SUT Law imposes a sales tax on retailers for the privilege of selling TPP, absent a specific exemption. The tax is based upon a retailer's gross receipts from TPP sales in California. The SUT Law also imposes a mirror "use tax" on the storage, use, or other consumption of TPP purchased AB 2518 Page 8 out-of-state and brought into California. The use tax is imposed on the purchaser, and unless the purchaser pays the use tax to an out-of-state retailer registered to collect California's use tax, the purchaser remains liable for the tax. The use tax is set at the same rate as the state's sales tax and must generally be remitted to the BOE. The SUT represents the state's second largest source of GF revenues. Nevertheless, the past 60 years have seen a dramatic reduction in the state's reliance on the SUT and a corresponding increase in its reliance on personal income tax revenues. In fiscal year (FY) 2014-15, SUT revenues were estimated to comprise 23% of the state's GF revenues, down from nearly 60% in FY 1950-51. d) What accounts for the state's reduced reliance on SUT revenues ? The SUT Law was enacted in a very different era. In the 1930s, California's economy was largely dominated by manufacturing, and residents mostly bought and sold tangible goods. Thus, in establishing the base for a new consumption tax, it made sense to impose the tax on sales of TPP, defined as personal property that may be "seen, weighed, measured, felt, or touched." Over the past 80 years, however, California's economy has seen dramatic growth in the service and information sectors, resulting in a significant erosion of the SUT base. For example, the Commission on the 21st Century Economy noted that spending on taxable goods represented 34.6% of personal income in 2008, down from 55.4% in 1980. As a result, tax experts and economists from across the political spectrum argue that California should expand its SUT base. It could be argued that, while well-intentioned, additional SUT exemptions further erode an already shrinking SUT base. This, in turn, increases fiscal pressures to maintain or even increase California's relatively high SUT rate. High AB 2518 Page 9 rates arguably promote non-compliance and encourage out-of-state purchases, placing California retailers at a competitive disadvantage. High rates also risk impacting consumer decision-making, which runs counter to widely accepted principles of sound tax policy. e) What would this bill do ? This bill would provide a partial SUT exemption for construction supplies purchased for use by specified nonprofit corporations exempt from federal income taxation under IRC Section 501(c)(3). Specifically, to receive the benefit of the exemption, the nonprofit would need to have received a property tax welfare exemption under R&TC Section 214.15. In addition, the supplies would need to be used for constructing and rehabilitating properties in California sold to low-income families. The BOE notes that the exemption would apply both to items consumed or used by the nonprofit to construct the low-income housing and to items that are physically incorporated into the housing. f) To whom would this bill apply ? The BOE notes that, according to the California Department of Housing and Community Development and the California Housing Finance Agency, there are only a few nonprofit organizations that construct housing for sale to low-income families with zero-percent financing. For example, the Habitat for Humanity program constructs and rehabilitates homes for sale to such families, and provides long-term, zero-percent financing. g) Defining the scope of eligible property : This bill's current list of TPP potentially eligible for the SUT exemption is remarkably broad. Specifically, the exemption applies to "building and construction supplies, materials, equipment, and machinery" along with the parts thereof. Such items could include items actually incorporated into AB 2518 Page 10 the housing, such as lumber, flooring, paint, tile, and lighting fixtures. In addition, the terms could be read expansively to include other TPP used to construct the housing, but not actually incorporated into the housing, such as electric generators, bulldozers, backhoe loaders, cranes, and even pick-up trucks. If the author's intent is to limit the exemption to materials actually incorporated into low-income housing, appropriate amendments should be taken to make this intent clear. In addition, the author may wish to clarify whether computers and office supplies used in administrative and management activities would also qualify for the proposed exemption. REGISTERED SUPPORT / OPPOSITION: Support Habitat for Humanity Opposition None on file Analysis Prepared by:M. David Ruff / REV. & TAX. / (916) 319-2098 AB 2518 Page 11