BILL ANALYSIS
AB 1719
Page 1
Date of Hearing: May 10, 2010
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Anthony J. Portantino, Chair
AB 1719 (Harkey) - As Amended: May 4, 2010
VOTE ONLY
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Sales and use tax (SUT) exemption: business equipment
SUMMARY : Creates a partial SUT exemption for specified business
equipment. Specifically, this bill :
1)Creates a SUT exemption for tangible personal property (TPP)
that is used by a:
a) "Qualified person" primarily in any stage of the
manufacturing, processing, refining, fabricating, or
recycling of property;
b) "Qualified person" primarily in research and
development;
c) "Qualified person" primarily to maintain, repair,
measure, or test any property described above; or,
d) Contractor in the performance of a construction contract
for a "qualified person" who will use the property as an
integral part of the manufacturing, processing, refining,
fabricating, or recycling of property, or as a research or
storage facility for use in connection with the
manufacturing process.
2)Defines TPP to include all of the following:
a) Machinery and equipment, including component parts and
contrivances such as belts, shafts, moving parts, and
operating structures;
b) All equipment or devices used or required to operate,
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control, regulate, or maintain the machinery including,
without limitation, computers, data processing equipment,
and computer software;
c) Special purpose buildings and foundations;
d) Property used in pollution control;
e) Fuels used or consumed in the manufacturing process;
and,
f) Property used in recycling.
3)Specifies that TPP does not include:
a) TPP used primarily in administration, general
management, or marketing;
b) Consumables with a normal useful life of less than one
year, except for fuels used in the manufacturing process;
or,
c) Furniture, inventory, and equipment used in the
extraction process, or equipment used to store finished
products that have completed the manufacturing process.
4)Defines a "qualified person" as any person that is both of the
following:
a) A new trade or business; and,
b) Engaged in those lines of business described in Codes
2011 to 3999, inclusive, of the Standard Industrial
Classification (SIC) Manual published by the United States
(U.S.) Office of Management and Budget, 1987 Edition.
i) In determining whether a trade or business activity
qualifies as a new trade or business, the following rules
shall apply:
(1) In cases where there is a purchase of an
existing trade or business, the trade or business
shall not be treated as a new business if the
aggregate fair market value of the acquired assets
used by a person in the conduct of his/her trade or
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business exceeds 20% of the aggregate fair market
value of the total assets of the trade or business
being conducted by such person;
(2) In cases where a person has been engaged in
one or more business activities in this state within
the preceding 36 months, and thereafter begins an
additional trade/business in the state, the additional
trade/business shall only be treated as a new business
if it is classified under a different division of the
SIC Manual published by the U.S. Office of Management
and Budget, 1987 Edition, than are any of the person's
current or prior trade or business activities in this
state;
(3) Where a person, including a "related person,"
is engaged in trade/business activities wholly outside
of this state and that person first commences doing
business in this state after December 31, 1993, the
trade/business activity shall be treated as a new
business;
(4) Defines "related person" as any person that is
related to that person under either Internal Revenue
Code (IRC) Sections 267 or 318; and,
(5) Defines "acquire" to include any gift,
inheritance, transfer incident to divorce, or any
other transfer, whether or not for consideration.
5)Specifies that a "qualified person" does not include any
person who has conducted business activities in a new trade or
business for three or more years.
6)Defines "primarily" as TPP used 50% or more of the time in an
activity that qualifies the taxpayer for the SUT exemption.
7)Defines "fabricating" as making, building, creating,
producing, or assembling components or property to work in a
new or different manner.
8)Defines "manufacturing" as the activity of converting or
conditioning property by changing the form, composition,
quality, or character of the property for ultimate sale at
retail or use in the manufacturing of a product to be
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ultimately sold at retail. Manufacturing includes any
improvements to TPP that result in a greater service life or
greater functionality than that of the original property.
9)Defines "process" to mean the period beginning at the point at
which any raw materials are received by the qualified taxpayer
and introduced into the manufacturing, processing, refining,
fabricating, or recycling activity of the qualified taxpayer
and ending at the point at which the qualified activity has
altered the TPP to its completed form. Raw materials are
considered introduced into the process when the raw materials
are stored on the same premises where the qualified activity
is conducted.
10)Defines "processing" as the physical application of the
materials and labor necessary to modify or change the
characteristics of property.
11)Defines "refining" as the process of converting a natural
resource to an intermediate or finished product.
12)Defines "research and development" as those activities that
are described in IRC Section 174 or in any regulation
thereunder.
13)Provides that the exemption shall not apply with respect to
any tax levied by a county, city, or district under the
Bradley-Burns Uniform Local SUT Law or the Transactions and
Use Tax Law.
14)Applies to leases of TPP classified as "continuing sales" and
"continuing purchases" in accordance with Revenue and Taxation
Code (R&TC) Sections 6006.1 and 6010.1. The SUT exemption:
a) Shall apply to rentals under such a lease provided the
lessee is a qualified person and the property is used in a
qualified manner; and,
b) Will only be available for six years from the date of
commencement of the lease. At the close of the six-year
period, lease receipts are subject to SUT without
exemption.
15)Goes into immediate effect as a tax levy. The SUT exemption
provided shall not apply to any tax levied under R&TC Sections
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6051.2, 6051.5, 6201.2, and 6201.5, or pursuant to Section 35
of Article XIII of the California Constitution, on or after
January 1, 2011.
16)Sunsets on January 1, 2017.
EXISTING LAW imposes a sales tax on retailers measured by the
gross receipts from the sale of TPP sold at retail in this
state, or a use tax on the storage, use, or other consumption in
this state of TPP purchased from a retailer for storage, use, or
other consumption in this state.
FISCAL EFFECT : The Board of Equalization (BOE) estimates
General Fund revenue losses of $1.8 million in fiscal year (FY)
2010-11, and $3.1 million in FY 2011-2012.
COMMENTS :
1)The author states that, "Existing law does not allow for tax
exemptions on the sale of, storage of, use of and other
consumption of business equipment. Amidst crippling
unemployment, low investor confidence and a decline of Main
Street businesses, California needs to show its commitment to
recovery via tax relief for the hardworking entrepreneurs of
our state."
2)Proponents of this bill state that a SUT exemption would
provide relief from the high cost of doing business in the
state. Specifically, proponents argue that a SUT exemption
would encourage new machinery and equipment purchases, and
foster business and job growth. Proponents also support this
bill because it eliminates the double taxation of both the
business input and the final goods sold to customers.
3)Opponents of this bill state that a SUT exemption is the wrong
policy during an economic crisis that has devastated the
state's budget. California corporations receive $14.5 billion
in tax exemptions with little oversight or accountability by
the state. These are funds that are not available to fill the
budget gap and prevent cuts to social services, education, and
infrastructure projects.
4)Committee Staff Comments
a) Is the proposed SUT exemption for business inputs good
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tax policy? Businesses pay about one-third of the state's
SUT. The SUT is paid when a business is considered to be
the final consumer of a tangible item. The tax paid for a
tangible item is then incorporated into the cost of
consumer products, which the consumer then pays taxes on,
leading to double taxation. During this Committee's March
23, 2009 informational hearing on "Tax Policy in a Time of
Economic Crisis," presenters unanimously agreed that it
would be good tax policy to eliminate the SUT on most
business purchases. Such a change, however, should be
considered in light of the overall tax structure. As
noted, a SUT exemption would reduce sales tax revenue. Dr.
Charles McClure, a Senior Fellow with the Hoover Institute,
stated during the Committee's March 23 hearing that the SUT
base should be expanded and the rate increased to
compensate for the loss in revenue. However, such changes
in the tax structure may not be necessary since this bill
only applies to new businesses.
b) Will the SUT exemption lead to job growth? Prior to
January 1, 2004, California had a similar tax incentive
known as the Manufacturer's Incentive Credit (MIC). The
MIC was created in response to the state's economic
downturn during the late 80's and early 90's. During this
time, the state lost about 300,000 jobs and had a 45%
reduction in aerospace alone. The MIC expired on January
1, 2004 after the Employment Development Department (EDD)
found that jobs on the preceding January 1 did not exceed
the total manufacturing jobs in California on January 1,
1994 by more than 100,000. EDD stated that from January 1,
1994 to January 1, 2002, the total net increase in
manufacturing employment was 35,150.
c) Implementation. This bill is almost identical to a
repealed provision exempting equipment under former R&TC
Section 6377. The BOE has existing regulations for such an
exemption and would be able to apply these regulations to
AB 1719.
d) Defining Useful Life. This bill provides that TPP does
not include consumables with a normal useful life of less
than one year. This bill, however, does not provide any
guidance on how normal useful life is to be measured.
Because the normal useful life of one item may vary
depending on the type of industry, this bill should
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reference a clear objective standard for determining the
useful life of an item.
e) Notification Requirement. AB 1719 includes a provision
eliminating the SUT exemption if the purchased property is
removed from California, is converted in a manner not
qualifying for the exemption, or is used in a manner not
qualifying for the exemption. This bill allows BOE to
collect taxes not paid if any of the above occurs, but AB
1719 does not provide a method for notifying BOE. Short of
an audit, BOE would have no means of learning of the
liability.
f) Suggested Technical Amendments.
i) Committee staff recommends changing "1993" to "2010"
on page 5, line 4. The December 31, 1993 year is in
reference to R&TC Section 6377 and its original date of
enactment. The year should be changed in order to
reflect the new date of enactment.
ii) On page 5, line 34, replace "(10)" with "(11)".
5)BOE Comments:
a) As a tax levy, this bill would take effect immediately.
However, subdivision (e)(2) provides that the exemption
shall not apply to certain state and local taxes (Fiscal
Recovery Fund, Local Revenue Fund, and Local Public Safety
Fund), on or after January 1, 2011. By having this
provision operative January 1, 2011, the exemption would
apply to these taxes for the period when this bill takes
effect through December 31, 2010. Then, starting January
1, 2011, the exemption would not apply. Because the author
intends for the tax exemption to apply only to general fund
taxes and to become operative January 1, 2011, the language
should be changed in order to reflect "on and after January
1, 2011" immediately after "(a)" on page 2, line 3.
b) The BOE administered regulations for former R&TC Section
6377, which was almost identical to this bill. The BOE,
however, takes issue with this bill's definition of a
"qualified person." BOE recommends that this bill define a
"qualified person" as an entity primarily engaged in the
activities described in the referenced code sections.
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c) Like the former R&TC Section 6377, this bill references
the SIC codes for purposes of qualifying entities.
However, the SIC codes have been replaced by the North
American Industry Classification System (NAICS), which
should be used to reference the manufacturing activities
the author intends to be included within the scope of the
exemption. In order to convert the SIC codes to NAICS, the
following changes should be made:
i) Subdivision (b)(6)(B): Engaged in those lines of
business described in Codes 2011 to 3999 3111 to 3399 ,
inclusive, of the Standard Industrial Classification
Manual North American Industry Classification System
published by the United States Office of Management and
Budget, 1987 2007 edition.
ii) Page 4, lines 35 - 36: strike out "Standard
Industrial Classification Manual" and insert "North
American Industry Classification System"
iii) Page 4, Line 37: strike out "1987" and insert
"2007"
6)Related Legislation. There have been several bills introduced
in the current legislative session that would provide a
similar tax exemption for certain TPP:
AB 1812 (Silva) would provide a partial SUT exemption,
beginning January 1, 2011, for specified TPP. AB 1812 is
pending on the Assembly R&T Committee suspense file, set to be
heard on May 10, 2010.
AB 2280 (Miller) would provide a complete SUT exemption for
all manufacturing equipment. AB 2280 is pending on the
Assembly R&T Committee suspense file, set to be heard on May
10, 2010.
AB 2640 (Arambula) would, among other tings, allow an income
tax credit for the SUT paid by a qualified taxpayer for
qualified property. AB 2640 is currently pending on this
Committee's suspense file.
SB 1053 (Runner) would provide a partial SUT exemption for TPP
used in manufacturing and qualified research and development
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activities by manufacturers and software publishers and
affiliates. SB 1053 is pending on the Senate Revenue and
Taxation Committee suspense file.
REGISTERED SUPPORT / OPPOSITION :
Support
BIOCOM
BAYBIO
California Manufacturers & Technology Association
California Aerospace & Technology Association
California Taxpayers' Association
TechAmerica
Opposition
California Federation of Teachers
California Labor Federation
California Tax Reform Association
Analysis Prepared by : Carlos Anguiano / M. David Ruff / REV. &
TAX. / (916) 319-2098