BILL ANALYSIS
AB 1935
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Date of Hearing: May 3, 2010
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Anthony J. Portantino, Chair
AB 1935 (De Leon) - As Introduced: February 17, 2010
2/3 vote. Tax levy. Fiscal committee.
SUBJECT : Corporation tax: mandatory single sales factor.
SUMMARY : Repeals the provision that allows a corporate taxpayer
to make an annual election, for taxable years beginning on or
after January 1, 2011, to use either a single sales factor (SSF)
or a double-weighted sales factor formula in apportioning its
business income to California. Specifically, this bill :
1)Requires corporate taxpayers, except those that derive more
than 50% of their gross receipts from conducting an
agricultural, extractive, savings and loan, or banking or
financial business activity, to use the SSF formula in
apportioning its income to California.
2)Takes effect immediately as a tax levy but is operative for
taxable years beginning on or after January 1, 2011.
EXISTING STATE LAW :
1)The Corporation Tax (CT) Law imposes an annual tax on
corporations measured by income sourced to California, unless
otherwise exempted. Generally, for corporations operating
both in and outside of the state, income sourced to California
is determined on a worldwide basis applying the unitary method
of taxation. The unitary method combines the income of
affiliated corporations that are members of a unitary business
and apportions the combined income to California based upon
the average of four factors (the property factor, the payroll
factor, and two sales factors). Each of these factors is a
fraction the numerator of which is the value of the item in
California and the denominator of which is the value of the
item elsewhere. This four-factor formula identifies the
relative levels of business activity in the state and
apportions the combined income to California using the
determined share of California business activity.
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2)For taxable years beginning on or after January 1, 2011,
certain corporate taxpayers may make an annual election to
apportion its income to California using an SSF apportionment
formula. The election must be made on a timely filed original
return in the manner and form prescribed by the Franchise Tax
Board (FTB). However, taxpayers that derive more than 50% of
gross business receipts from conducting a "qualified business
activity" are required to use a three-factor, single-weighted
sales apportionment formula. A "qualified business activity"
is defined as an agricultural, extractive, savings and loan,
and banking or financial business activity. Thus, those
taxpayers are prohibited from electing the SSF apportionment
formula.
3)The CT includes the franchise tax, the corporate income tax,
and the bank tax. The regular CT rate is 8.84%, and the bank
tax rate is 10.84%. In addition, an "S" corporation, which is
a "pass-through" entity, is subject to a reduced rate of tax
at 1.5%.
FISCAL EFFECT : The FTB staff estimates that this bill will
result in an annual gain of $135 million in fiscal year (FY)
2010-11, $450 million in FY 2011-12, $600 million in FY 2012-13,
and $550 million in FY 2013-14.
COMMENTS :
1)Author's Statement . The author states that, "As our state's
economy struggles to rebound from the worst financial crisis
since the Great Depression and sky-rocketing unemployment
rates, we need to be proactive in encouraging the investment
of more jobs here in California.
"Towards this end, I believe we need to revise current tax law
to require the universal application of the "single sales
factor" in the calculation of taxes owed by corporations to
the state. Under existing law, corporations will soon have
the ability to choose whether to utilize this new method or
the long-standing three-factor formula; allowing this option
will unfairly benefit companies that move or base the bulk of
their operations out-of-state.
"In making the use of the single sales factor mandatory instead
of elective, this legislative proposal will save the state
upwards of $600 million/year in desperately-needed tax revenue
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- we simply cannot afford to continue to reward corporations
that move jobs and operations out-of-state."
2)Arguments in Support . The proponents of this bill argue that,
as "a matter of tax policy, it does not make sense to give
businesses the option to elect either single-sales factor or
the previous 3-factor formula" since the election "would
provide [businesses] with the lowest tax bill" and would allow
them "to attribute more losses to California in bad years,"
thus further reducing tax liability in California. The
proponents believe that the repeal of the "elective" component
of the SSF "would remove the competitive advantage that
out-of-state corporations have over California employers" and
would "prevent further devastating cuts to education, health
care, and other vital safety net services." Finally, the
proponents state that this bill would encourage greater job
investment in California and would stop rewarding corporations
that move jobs and operations out of state.
3)Arguments in Opposition . The opponents of this bill argue
that "[t]he elective nature of the single sales factor was put
into place in February 2009 to avoid creating "winners and
losers" by enacting the new tax provisions designed to
stimulate jobs and investment in California." The opponents
state that the repeal of the elective single sales factor may
hurt California employers since some taxpayers that choose the
four-factor formula under an elective system may have
substantial amounts of jobs and investment in California.
Furthermore, "a mandatory single sales factor would discourage
retailers selling tangible goods from locating stores in
California if they have comparatively larger amounts of
property and payroll in other states." Finally, the opponents
conclude that "allowing businesses to choose the best formula
to operate, employ and sell in the state charts the greatest
path towards California's economic recovery" and that
"requiring the new apportionment methodology to be mandatory
is nothing short of a massive tax increase on an existing
group of taxpayers already contributing to the California
economy through one of the highest corporate tax rates in the
country."
4)Background: Apportionment Formulas . Under California's CT
law, multistate or multinational businesses must apportion
their income among the jurisdictions in which they do
business. California may only tax a portion of the income
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earned by businesses that operate in other states (or
nations), in addition to California. That amount is
determined by an apportionment formula. Prior to January 1,
1993, California used a three-factor formula that was based on
the proportion of a company's sales, payroll, and property
that is located in California. For example, if one-third of a
company's sales, one-third of its payroll, and one-third of
its property are located in California, then one-third of its
total earnings are subject to California tax under CT law.
a) Double-Weighted Sales Factor . After January 1, 1993,
California adopted a formula in which the sales factor is
double-weighted - given twice the importance of the other
two factors. For example, if a company has 75% of its
property and of its payroll in California, but only 10% of
its sales in this state, then 53.3% of its income would be
subject to California tax under equal weighting of the
three factors. The double-weighted sales factor would
reduce the apportionment percentage to 42.5%.
Double-weighting of the sales factor does not apply to
businesses that derive more than 50% of their gross
receipts from agricultural, extractive (e.g., oil and as
producers), or banking or other financial activities. Those
companies must still use the equally weighted three-factor
formula to apportion their worldwide income.
b) SSF . In 2009, a component of the 2009-10 budget package
gave multistate and multinational corporations an
additional option for apportioning their business income to
California [AB x3 15 (Krekorian), Chapter 10, Statutes of
2009, and SB x3 15 (Calderon), Chapter 17, Statutes of
2009]. The new legislation allows multi-state businesses
to apportion their business income to California using only
their percentage of sales in California, as an alternative
to using the current double-weighted apportionment
methodology. This so-called "SSF" option becomes effective
for the 2011 tax year and is permanent. However,
businesses that derive more than 50% of their gross
receipts from agriculture, extractive business, savings and
loans, or banks and financial activities will continue be
limited to a single-weighted sales factor and will be
required to use the same three-factor apportionment
formula.
c) The Reason for Change . For a long time, businesses with
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substantial employment and facilities in California that
primarily sell their products nationally or internationally
argued that the three- or four-factor apportionment method
penalizes them for expanding in California. They pointed
out that any increase in their payroll and/or property in
California would result in an increase of their tax
liability in California under the three- factor
apportionment formula. Conversely, any decrease in their
California property and/or payroll factors, without any
change to their sales factor, would result in a reduction
of their California tax liability. Many California
high-tech and biotech companies made the argument that the
three-factor formula rewarded businesses for expanding
outside the state.
The enactment of the SSF provision was welcomed by companies
that have significant payroll and facilities in California,
but make the bulk of their sales outside the state because
the election of the SSF apportionment formula would, most
likely, reduce their California taxes. Companies doing
business only in California will see no change in their
taxes. On the other hand, companies that have few
employees or facilities in California, but make substantial
sales here, may pay more tax under the SSF apportionment
formula. To alleviate the tax burden on those companies
and to avoid creating "winners and losers," the Legislature
included a provision that allows taxpayers to make an
annual election to choose between the SSF and a
double-weighted formula for the apportionment of their
business income to California. As a result, taxpayers that
have a relatively high amount of sales in California, most
likely, will elect the four-factor formula as long as they
have property and payroll in California and elsewhere.
When the elective SSF provision was enacted in 2010, its
overall impact was estimated to be a revenue loss to the
General Fund. The anticipated annual revenue loss is
approximately $700 million, eventually growing to $1.5
billion. Over time, proponents argued, this loss will be
offset by additional revenue from employment and property
due to improved business retention, expansion and location
in the state.
5)An Overview of the SSF Apportionment Regime in Other States .
In the last few years, several states have changed their
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apportionment formulas to an SSF, eliminating the property and
payroll factors entirely, and, effective for tax year 2011,
over 20 states will allow an SSF apportionment formula.
However, most states will only allow manufacturers or other
identified industries to use the SSF formula. Furthermore,
some states require taxpayers to invest in the state (e.g.,
Kansas) or file an annual information report with the tax
agency (e.g., Maryland) in order to utilize the SSF formula.
Finally, no state, but Missouri and California so far, allows
a corporate taxpayer to elect between the SSF and a
traditional three-factor apportionment formula on an annual
basis.
6)Elective SSF and Missouri's Experience . By the end of 1995,
five states had enacted a SSF formula but the State of
Missouri was the only one that has allowed businesses to
choose between the SSF formula and the traditional
three-factor formula on annual basis. If the theory behind
the economic benefits of elective SSF were correct, then "a
state like Missouri should perform especially well since no
corporation pays more income tax when [single sales factor] is
an election rather than a requirement." (Michael Cassidy and
Sara Okos, Single-Sales Factor: An Economic Development Tool
That Isn't, The Commonwealth Institute, September 2008). But
the available data shows that Missouri was one of the 27
corporate income tax states that lost 63,000 manufacturing
jobs from 1979 to 2000, even though it has had a SSF in place
for decades. (M. Mazerov, The "Single Sales Factor" Formula
for State Corporate Taxes: A Boon to Economic Development or
a Costly Giveaway? September 1, 2005, p. 7). Furthermore,
Missouri's manufacturing job performance since 2001 "has
actually been below the median for the nation, with over
35,000 lost jobs." (See, e.g., M. Cassidy and S. Okos).
Finally, according to Site Selection Magazine, 71 facilities,
valued at $700 million or more were placed in states with
corporation income taxes from 1995 through 2004. Arguably,
because out-of-state corporations may elect whether or not to
use the SSF formula in Missouri to their benefit, those
corporations are in a better position to invest in that state
than they would have been under the mandatory SSF formula.
However, the State of Missouri failed to capture a single one
of these major plant locations or expansions, even though it
is a relatively low tax state compared to other states. In
2005, Missouri's corporate income tax ranked 46th in the
nation (four states do not levy a corporation income tax)
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(Morgan Quitno, "2007 State Rankings Book," page 325) but the
State of Missouri does not have a particularly impressive
long-term record for attracting or creating jobs, which is an
indication that an elective SSF is "unlikely to live up to its
billing as a potent economic development incentive." (M.
Mazerov, p. 7).
It appears, judging by the Missouri's experience, that the
elective nature of the SSF does not act as an economic
development tool, even though it removes any impediments to
out-of-state corporations to invest in-state. Although
corporations accept tax breaks gladly if states offer them,
they ultimately locate their investments and employees where
fundamental business considerations demand.
7)Is Elective SSF Justified on Policy Grounds ? Even if one
assumes that an elective SSF is an effective economic
development tool, the question still remains as to whether
allowing a taxpayer to choose how much tax it wants to pay
each year is sound tax policy. Under the elective system,
businesses will naturally choose, on an annual basis,
whichever method reduces their tax liability. An elective SSF
formula is a tax expenditure that contains no requirement to
invest or to create jobs in the state, no accountability
measures, no paper trail for the state to review, and no
records about outcomes at any specific company or industry.
Furthermore, an elective SSF regime provides a fertile soil
for creative tax planning, especially in light of other recent
legislation that allows corporate taxpayers to carryforward
California's net operating loss (NOL) to 20 years with a
phased in two-year carryback and to share business tax credits
with the members of a combined reporting group. For example,
for a company with sales outside of California, but property
and payroll located in the state, electing the SSF
apportionment formula should, generally, result in a reduction
of the California apportionment factor and, consequently,
California taxable income. However, if the same company, in a
particular year, generates losses instead of profits, it would
elect the double-weighted formula in order to apportion a
greater amount of losses to California for purposes of
offsetting its California tax liabilities in the future or
claiming a refund for the last two taxable years. In other
words, an elective SSF provides multistate and multinational
corporate taxpayers with an opportunity, i.e. an "election,"
to choose how much tax they like to pay to the state in a
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particular tax year. This election is one of a kind. The
only other election allowed to corporate taxpayers is an
election between two reporting methods: worldwide combined
reporting and a reporting on a "water's-edge" basis. However,
even the "water's-edge" election is binding for a seven-year
period.
When the three-factor apportionment formula was first developed
between 1955 and 1957 and later adopted by various states, it
was considered the only reasonable and fair system to ensure
that multinational companies are not taxed unduly by the
states in which they do business. At the same time, if
adopted by all the states, the three-factor formula would,
arguably, guarantee that 100% of corporate income is taxed.
In contrast, if all states were to enact legislation to allow
an elective SSF formula, corporations would elect the SSF
formula in states where they have relatively large portions of
their payroll and property, while choosing the alternative
formula in states where they have a relatively large portion
of their sales. As a result, the total amount of income
apportioned to all states will be less than the amount of
income the corporation earned nationally. (FTB, California
Income Tax Expenditures, Report, December 2009, p. 28).
The California's elective SSF regime represents an attempt to
accomplish a public policy objective - alleviate the tax
burden on out-of-state companies - that would be more
efficiently addressed through direct outlay of state funds or
through more targeted tax incentives that include certain
accountability measures.
8)Related Legislation .
SB x6 18 (Steinberg), introduced in the 6th Extraordinary
Session, among other things, repeals the elective nature of
the SFF, and thus requires each apportioning trade or
business, except certain businesses, to apportion business
income by using the SSF formula.
REGISTERED SUPPORT / OPPOSITION :
Support
United Firefighters of Los Angeles City
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National Association of Social Workers, California Chapter
California Tax Reform Association
California Immigrant Policy Center
The American Federation of State, County and Municipal Employees
(AFSCME), AFL-CIO
The Service Employees International Union (SEIU)
Opposition
California Manufacturers & Technology Association
California Chamber of Commerce
California Taxpayers' Association
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098