BILL ANALYSIS Ó
AB 2647
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Date of Hearing: May 9, 2016
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Sebastian Ridley-Thomas, Chair
AB 2647
(Eduardo Garcia) - As Amended April 12, 2016
Majority vote. Tax levy. Fiscal committee.
SUBJECT: Income taxation: insurance taxation: credits:
California New Markets Tax Credit
SUMMARY: Establishes the California New Markets Tax Credit
(NMTC) Program (Program), with the stated purpose of stimulating
private sector investment in lower income communities, as
specified. Specifically, this bill:
1)Contains the following legislative findings:
a) While many areas of California have recovered from the
economic and community development impacts of the 2006
Financial Crisis and the 2010 global recession,
Californians in a number of communities and neighborhoods
are still experiencing their lingering effects. In some
cases, this has resulted in small and medium businesses in
low-income areas lacking sufficient access to capital and
technical assistance. Given that California has many needs
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and limited resources, moneys from the private sector are
necessary to fill this capital and investment gap.
b) Initially enacted in 2000, the Federal Government
established the NMTC Program, which uses a market-based
approach for expanding capital and technical assistance to
businesses in lower income communities. The federal
program is jointly administered by the Community
Development Financial Institutions Fund (CDFI Fund) and the
Internal Revenue Service. The Program allocates federal
tax incentives to community development entities (CDEs),
which they then use to attract private investors who
contribute funds that can be used to finance and invest in
businesses and develop real estate in low-income
communities.
c) Through the 2013-14 funding round, the CDFI Fund had
awarded approximately $40 billion in NMTC in 836 awards
including $3 billion in American Recovery and Investment
Act of 2009 awards and $1 billion of special allocation
authority to be used for the recovery and redevelopment of
the Gulf Opportunity Zone.
d) The federal NMTC totals 39% of the original investment
amount in the CDE and is claimed over a period of seven
years (5% for each of the first three years, and 6% for
each of the remaining four years). Any investment by any
taxpayer in the CDE redeemed before the end of the
seven-year period will be recaptured.
e) Fourteen states in the United States (U.S.) have adopted
state programs using the NMTC model including Alabama,
Florida, Illinois, Nevada, and Oregon. While some of the
programs substantially mirror the federal program, others
vary in both the percentage of the credit and some of the
policies that form the foundation of the credit. One of
the reasons cited for establishing state-level programs is
to make a state more attractive to CDEs, which results in
increasing the amount of federal NMTCs being utilized in
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the state. Further, several studies, including a January
1, 2011, case study by Pacific Community Ventures, showed
that for every dollar of foregone tax revenue, the federal
NMTC leverages $12 to $14 of private investment.
2)Provides that the Program shall be administered by the
Responsible Tax Credit Administrator (RTCA), as designated by
the Governor.
3)Allows, for taxable years beginning on or after January 1,
2017, and before January 1, 2022, a credit in an amount
determined in accordance with Internal Revenue Code (IRC)
Section 45D, as modified. For a taxpayer holding a "qualified
equity investment" on that investment's "credit allowance
date," the credit shall equal a percentage of the amount paid
to a "qualified CDE" for such investment at its original
issue. The applicable percentage shall be:
a) Zero percent with respect to the first two "credit
allowance dates";
b) Seven percent with respect to the third "credit
allowance date"; and,
c) Eight percent with respect to the remainder of the
"credit allowance dates".
4)Modifies the federal definition of a "qualified CDE" to
include only those qualified CDEs (and their subsidiaries)
that have entered into an allocation agreement with the CDFI
Fund of the U.S. Treasury Department, with respect to credits
authorized by IRC Section 45D, that includes California within
the service area and is dated on or after January 1, 2012.
5)Modifies the federal definition of a "qualified active
low-income community business" as follows:
a) A qualified active low-income community business shall
not include any business that derives, or projects to
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derive, 15% or more of its annual revenue from the rental
or sale of real estate, subject to certain exceptions;
b) A qualified active low-income community business shall
only include a business that, at the time the initial
investment is made, has 250 or fewer employees and is
located in one or more California low-income communities,
subject to certain exceptions;
c) A qualified active low-income community business shall
only include a business located in specified census tracts
based on poverty and unemployment rates;
d) A qualified active low-income community business shall
not include any business that operates or derives revenues
from the operation of a country club, gaming establishment,
massage parlor, liquor store, or golf course;
e) A qualified active low-income community business shall
not include a sexually oriented business, as defined; and,
f) A qualified active low-income community business shall
not include a charter school.
6)Provides that the aggregate amount of qualified equity
investments that may be allocated in any calendar year under
the Program shall be $40 million per calendar year.
7)Modifies federal law relating to events triggering a credit
recapture, as specified.
8)Provides that enforcement of each of the recapture provisions
shall be subject to a six-month cure period.
9)Requires RTCA to adopt guidelines necessary or appropriate to
carry out its responsibilities with respect to the allocation,
monitoring, and management of the tax credit Program.
10)Requires RTCA to establish and impose reasonable fees upon
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entities that apply for an allocation that, in the aggregate,
defray the cost of reviewing applications.
11)Requires RTCA to adopt an allocation process that does all of
the following:
a) Creates an equitable distribution process that ensures
that low-income community populations across the state have
an opportunity to benefit from the Program;
b) Sets minimum organizational capacity standards that
applicants must meet to receive an allocation, as
specified;
c) Considers the qualified CDE's prior qualified low-income
community investments under IRC Section 45D; and,
d) Considers the qualified CDE's prior qualified low-income
community investments under the Program.
12)Provides that RTCA shall begin accepting applications on or
before May 15, 2017, and shall award authority to designate
qualified equity investments annually through 2021.
13)Provides that, in the 2017 awards cycle, the RTCA shall award
authority to designate qualified equity investments to
qualified CDEs in the order applications are received by the
RTCA.
14)Provides that, in the 2018 to 2021 award cycles, at least 60%
of the authority shall be awarded in the order applications
are received by the RTCA.
15)Requires the RTCA to award up to 40% of the authority in the
2018 to 2021 award cycles to qualified CDEs on a competitive
basis using blind scoring and a review committee comprised of
community development finance practitioners.
16)Authorizes an approved applicant to transfer all or a portion
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of its certified qualified equity investment authority to its
controlling entity or any subsidiary qualified CDE of the
controlling entity, provided the applicant and the transferee
notify the RTCA within 30 calendar days of such transfer. The
transferee shall be subject to the same rules, requirements,
and limitations applicable to the transferor.
17)Requires a qualified CDE that issues qualified equity
investments to submit a report to RTCA that provides
documentation as to the investment of at least 85% of the
funds being deployed within one year in qualified low-income
community investments in qualified active low-income community
businesses located in California.
18)Includes additional reporting requirements.
19)Provides that a taxpayer allowed a credit under the Program
for a qualified equity investment shall not be eligible for
any other state credit with respect to that investment.
20)Provides that the credit shall only be allowed for those
taxable years for which moneys are appropriated to RTCA to
administer the credit, as specified.
21)Provides that this bill shall take immediate effect as a tax
levy.
22)Sunsets the credit provisions on December 1, 2022.
23)Declares that the provisions of this bill are severable.
EXISTING LAW:
1)Allows various tax credits under both the Personal Income Tax
Law and the Corporation Tax Law. These credits are generally
designed to encourage socially beneficial behavior or to
provide relief to taxpayers who incur specified expenses.
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2)Imposes an annual tax on the gross premiums of an insurer, as
defined, doing business in this state at specified rates.
3)Allows a credit equal to 20% of each qualified investment into
a community development financial institution that is
certified by the California Organized Investment Network
(COIN). The aggregate amount of qualified investments is
generally capped at $50 million for each calendar year. Thus,
the statewide total for all credits allowed under the program
is capped at $10 million per year (i.e., 20% of $50 million).
FISCAL EFFECT: The Franchise Tax Board (FTB) estimates that
this bill would reduce General Fund (GF) revenues by $1.5
million in fiscal year (FY) 2018-19, by $4.6 million in FY
2019-20, and by $7.9 million in FY 2020-21.
COMMENTS:
1)The author has provided the following statement in support of
this bill:
Although California demonstrates policy leadership
regarding the future of its economy in areas that emphasize
our state's role as a technology giant, a leader in
environmental sustainability, a significant participant in
global supply chains, and as a driver for middle-skill
workforce development, California remains short on one
crucial piece. California's increasing income inequality
remains noticeably outside the scope of the state's primary
economic development programs. Addressing the state's
growing disparities among different geographic regions and
population groups requires public policy solutions that
bring market opportunity to the neighborhood level and
establish access points for these low-income neighborhoods
to become more integrated with their regional and state
economies. This measure proposes a program for delivering
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private capital to very low-income neighborhoods in a
manner that incentivizes investors and empowers these
communities in an innovative way.
2)This bill is supported by the Los Angeles County Economic
Development Corporation, which notes the following:
As Southern California's premier economic development
leadership organization, we have seen first-hand how the
federal NMTC program serves as a catalyst for investment in
low-income communities that may otherwise not occur.
Unfortunately, the federal NMTC program, which was recently
extended five years through 2019 at its current level of
$3.5 billion per annum, is not underwritten with enough
credit allocation authority to tackle the critical need in
many of California's very low-income communities,
especially here locally in L.A. County, where there are
over 300 census tracts (with approximately 1.3 million
residents) that qualify as severely economically
distressed. Indeed, almost 240 applications, requesting a
combined $17.6 billion in allocation authority, were
received from community development entities under the 2015
round of the federal NMTC program; this is more than five
times in authority available (i.e., $3.5 billion) for the
2015 round.
3)This bill is opposed by the California Tax Reform Association,
which notes the following:
We believe that the federal New Markets Tax Credit has been
effective, and the state also has the COIN program, which
has provided for effective investment in CDFIs. As the FTB
analysis notes, the combined program could provide credits
up to 74%. We question the need to replicate tax benefit
programs which are already in operation and addressing
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low-income communities.
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. While this affords taxpayers greater financial
predictability, it can also result in tax expenditures
remaining a part of the tax code without demonstrating any
public benefit. 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) What would this bill do ? This bill would enact a new
tax expenditure program modeled after the federal NMTC,
with the stated purpose of stimulating private sector
investment in lower-income communities.
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d) The federal NMTC : Congress established the federal NMTC
program as part of the Community Renewal Tax Relief Act of
2000 to encourage investment in low-income communities that
have traditionally lacked access to capital. The federal
NMTC program provides taxpayers (e.g., individual
investors, financial institutions, corporations, etc.) with
a credit for investing in economically distressed
communities. Specifically, the credit is allowed for a
taxpayer's qualified equity investment in a CDE, which must
be a corporation or partnership. The CDE's primary mission
must be serving, or providing investment capital for,
low-income communities or low-income persons, as certified
by the Secretary of the Treasury. The taxpayer's federal
NMTC totals 39% of the qualified equity investment made in
the CDE, but is spread over a seven-year period as follows:
i) A 5% credit for the year the qualified equity
investment is purchased and for the first two years
thereafter (i.e., 15% for the first three years); and,
ii) A 6% credit for years four through seven (i.e., 24%
for the subsequent four years).
In recent years, private investors have claimed more than $1
billion in NMTCs annually.
The federal NMTC program is administered by the CDFI Fund
within the U.S. Treasury. The CDFI Fund allocates tax
credit authority to CDEs that apply for and obtain
allocations. These CDEs, in turn, enable private investors
to obtain credits in exchange for equity investments with
the CDEs. The CDEs then invest the raised capital in
qualified low-income community investments, which include
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investments in operating businesses and residential,
commercial, and industrial projects. While the range of
projects financed by CDEs varies, roughly 50% of NMTC
investments have been used for commercial real estate
projects.
e) How would the Program differ from the federal NMTC ? The
Program would differ from the federal NMTC in numerous
respects, including the following:
i) Different credit percentages over the seven-year
period : While the proposed state credit, like the
federal credit, totals 39% of the taxpayer's investment
in a qualified CDE, the state credit would be spread out
over the seven-year period as follows:
(1) Zero percent for the year the investment is
purchased and the following year (i.e., 0% for the
first two years);
(2) A 7% credit for the third year; and,
(3) An 8% credit for years four through seven
(i.e., 32% for the subsequent four years).
It is Committee staff's understanding that this
"back-loading" of the credit percentages is designed to
reduce the Program's upfront cost to the GF.
i) Modified definition of a qualified active low-income
community business : In some respects, this bill's
definition of a "qualified active low-income community
business" is more restrictive than the federal
definition. For example, under this bill, any business
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that derives 15% or more of its annual revenue from the
rental or sale of real estate would generally be excluded
from the definition. In addition, the state definition
is limited to businesses that, at the time the initial
investment is made, have 250 or fewer employees.
f) Does California have any similar tax credit programs ?
While California does not conform to the federal NMTC,
state law does allow a 20% credit for each "qualified
investment" in a CDFI certified by COIN. The aggregate
amount of qualified investments is generally capped at $50
million for each calendar year.<1> Thus, the statewide
total for all credits allowed under the program is capped
at $10 million per year (i.e., 20% of $50 million). Unlike
the federal NMTC, the "qualified investment" in the CDFI
must be at least $50,000; be for a minimum duration of 60
months; and may consist of either an equity investment or a
deposit or loan that does not earn interest.
Existing law defines a "CDFI," in turn, as a private financial
institution located in California that has community development
as its primary mission, and that lends in urban, rural, or
reservation-based California communities. Specifically, a
"CDFI" may be a community development bank, a community
development loan fund, a community development credit union, a
microenterprise fund, a community development corporation-based
lender, or a community development venture fund.
---------------------------
<1> State law provides that if the aggregate amount of qualified
investments made in a calendar year is less than $50 million,
the difference may be carried over to the next year, and any
succeeding year during which the credit remains in effect, and
added to the aggregate amount authorized for those years.
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The existence of California's stand-alone CDFI tax credit raises
some interesting issues. Namely, California already has a tax
credit program specifically designed to encourage private
investment in underserved markets. Given this fact, does it
makes sense to establish a second tax credit program with the
same goal? If this bill were enacted in its present form,
California would have two similar tax credit programs,
administered by two separate entities, with an unclear level of
coordination between the two.
g) Government Accountability Office report : A recent
report issued by the U.S. Government Accountability Office
(GAO) found that better controls and data are needed to
ensure the effectiveness of the federal NMTC program.
Specifically, the report noted that the financial
structures of NMTC investments have become increasingly
complex and less transparent over time. This increased
complexity, in turn, was attributed to the combining of the
NMTC with other federal, state, and local government funds.
The GAO's survey of CDEs determined that approximately 62%
of NMTC projects received other federal, state, or local
government support from 2010 to 2012. The report
acknowledged that combining public financing from multiple
sources can fund projects that would otherwise not be
economically viable. At the same time, however, this
combination raises questions about whether the subsidies
are unnecessarily duplicative. In addition, the report
found that "in some cases the complexity of the structures
may be masking rates of return for NMTC investors that are
above market rates." The GAO specifically pointed to a
U.S. Treasury report that found an investor apparently
earning a 24% rate of return, which is significantly above
market rates. In that case, the investor leveraged the
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NMTC by using other public funds to increase the base for
claiming the credit. The report found that the U.S.
Treasury does not currently have controls to limit the risk
of unnecessary duplication in government subsidies or above
market rates of return. The report found that "[w]ithout
such guidance and controls the impact of the NMTC program
on low-income communities could be diluted." The GAO also
found that the data on equity remaining in low-income
community businesses after the seven-year credit period
were unreliable because, in part, reporting instructions
are unclear. Similarly, data on NMTC project failure rates
were unavailable.
Thus, the GAO recommended that the U.S. Treasury issue further
guidance on how other government programs can be combined with
NMTCs. The GAO also recommended the implementation of adequate
controls to limit the risks of unnecessary duplication and
above-market rates of return. Finally, the GAO also recommended
the collection of more complete and accurate data on, among
other things, the equity remaining in businesses after seven
years, along with loan performance.
h) Bringing intent and language together : The author's
office has indicated its intent to authorize annually
qualified equity investment authority sufficient to
generate $40 million in tax credits (taken over the
applicable 7-year period). This bill's current language,
however, provides for an annual allocation of qualified
equity investments of $40 million per calendar year. The
tax credit, however, is based upon a percentage of
qualified equity investments, and thus, under the current
bill, the aggregate value of credits would be significantly
lower than the author intends.
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i) Governor's veto : This bill is similar to AB 1399
(Medina), of the 2013-14 Regular Session. Governor Brown
vetoed AB 1399 with the following message:
This bill creates a new markets tax credit that will cost
- over time - $200 million.
I certainly endorse programs that result in private
investments to help low income areas, but a bill to spend
this much should be considered with other priorities
during the annual budget.
j) Technical amendments : The author is currently working
with the FTB to resolve potential technical issues with
this bill. The author, with the assistance of Legislative
Counsel, has provided bill language addressing certain
technical issues, which the FTB is currently reviewing.
The author has committed to taking whatever amendments are
necessary to ensure the bill is operational, including in
the areas of oversight and monitoring.
aa) Double referral : This bill was double-referred to the
Assembly Committee on Jobs, Economic Development, and the
Economy. This bill passed that committee on April 5, 2016,
by a vote of 9 to 0. For additional discussion of this
bill, please refer to that committee's analysis.
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REGISTERED SUPPORT / OPPOSITION:
Support
Los Angeles County Economic Development Corporation
Opposition
California Tax Reform Association
Analysis Prepared by:M. David Ruff / REV. & TAX. / (916)
319-2098