BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 1373 - Leno
As Introduced February 19, 2010
Hearing: April 28, 2010 Tax Levy Fiscal: Yes
SUMMARY: Reclassifies Paving Contractors as Retailers
instead of Consumers under the Sales and Use Tax
Law.
EXISTING LAW requires every person engaging in or
conducting business in California as a sell of tangible
personal property (TPP) to apply for a seller's permit for
each place of business.
State Board of Equalization (BOE) Regulation 1521
provides guidance to contractors about construction
contracts, materials, fixtures, machinery, and equipment,
among other topics. Under Regulation 1521:
A Construction Contractor is a person who agrees to
perform and performs a construction contract, including
specialty and subcontractors.
Materials are construction materials and components,
and other TPP incorporated, attached, or affixed to real
property which, when combined other TPP, "loses its
identity to become and integral and inseparable part of the
real property". Materials include bricks, doors, electric
wiring, roofing, tile, and windows to name a few.
Contractors pay the sales and use tax on materials when
they are purchased. Contractors collect and remit the
sales tax when fixtures are sold. With materials,
contractors are customers, and generally are not required
to get a seller's permit from the BOE.
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Fixtures are accessory to a building and do not lose
their identities when installed. Fixtures include air
conditioning units, burglar alarms, cabinets, electric
generators, and refrigerators. With fixtures, contractors
are sellers. For example, contractors who sell elevators
must obtain a seller's permit and collect and remit the
appropriate sales tax.
Contractors that manufacture and install fixtures pay
tax based on its "cost price," or the price which it sells
similar fixtures in similar quantities. If no comparable
sales exist, the contractor calculates the cost price based
on amounts stated in price lists, bid sheets, or other
records of the contractor.
Currently, paving contractors are considered
construction contractors that install materials, and are
considered consumers under the Sales and Use Tax Law under
Regulation 1521.
THIS BILL reclassifies paving contractors as retailers
under the Sales and Use Tax Law. The gross receipts from
the retail sale of the materials shall be included in the
measure of tax. The gross receipts shall be determined by:
The price at which the contractor sells
similar materials in similar quantities ready for
installation by other contractors.
If the contractor does not sell similar
materials in similar quantities ready for
installation by other contractors, the price
shall be deemed to be the amount stated in price
lists, bid sheets, or other records of the
contractor.
THIS BILL defines "paving construction contracts" as a
construction contract to erect, construct, alter, or repair
streets, highways, sidewalks, driveways, curbs, gutters,
parking lots, or other similar structures. As a tax levy,
the measure takes immediate effect.
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FISCAL EFFECT:
According to the Board of Equalization, SB 1373
results in revenue gains of $8.3 million in 2010-11, and
$17.5 million annually thereafter. BOE also notes that by
increasing sales and use tax liability, SB 1373 will
diminish profits subject to Personal Income Tax and the
Corporation Tax. A Franchise Tax Board estimate of those
effects is pending.
COMMENTS:
A. Purpose of the Bill
SB 1373 changes the Sales and Use Tax law that
currently works to the disadvantage of thousands of paving
construction contractors who pay sales tax on asphalt,
sand, gravel, Portland cement, and related materials that
are used in the performance of construction contracts.
Large paving and construction firms often produce concrete
and paving materials by excavating rock, sand and gravel
from their own property, and therefore pay no tax to the
state at this stage of the transaction. Thousands of
smaller contractors, however, have to pay sales tax on the
materials they will be using in the construction work,
rather than on the gross receipts resulting from the sale
of the materials they used in the construction contract.
This disadvantages thousands of paving contractors in the
state that do not manufacture their own concrete because it
requires them to include their sales tax costs when bidding
on contracts, which often results in a higher bid than one
submitted by a large vertically integrated paving company.
SB 1373 changes the designation of a paving
construction contractor from a purchaser to a retail seller
of the materials used in the construction contract. It
also provides a mechanism for determining the gross
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receipts from the retail sale so that the appropriate gross
receipts tax can be collected instead. In that way, it
will help smaller businesses compete effectively with the
large concrete and paving companies on construction
contracts without any loss of tax revenues to the state.
B. Where the Rubber Meets the Road
The central question of SB 1373 is whether
vertically-integrated firms which mine aggregate to
manufacture paving materials that are subsequently used by
that firm to satisfy its construction contracts have a
competitive advantage over smaller firms which must buy
paving materials from manufacturers to satisfy its
construction contracts. The vertically-integrated firm
does not pay sales tax when it transfers the material from
the left hand of its mining and manufacturing operations to
the right hand of its construction contractor. The smaller
firm must pay sales tax when it purchases the material
because it is considered a consumer of the material under
Regulation 1521. Supporters indicate that this tax
advantage allows vertically-integrated firms a considerable
cost advantage when bidding on contracts, thereby
diminishing the chances that smaller contractors will win
the contract, although opponents point to recent bids where
both vertically-integrated and non vertically-integrated
firms won projects.
If an inequity exists, the secondary policy question
is whether reclassifying pavement contractors as retailers
under the Sales and Use Tax Law undercorrects, corrects, or
overcorrects the inequity described above. Reclassifying
all pavement contractors ensures that all bidders are
treated the same when bidding regardless of whether they
mine and manufacture the paving material or they purchase
it; the cost of the sales tax is reflected in the bids of
all parties. Opponents claim that vertically integrated
firms pay property tax on the construction materials,
payroll taxes for mining and manufacturing workers, and
excise taxes on fuel necessary as part of the manufacturing
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process, but aren't these prices already imputed into the
pavement material price? If so, SB 1373's fix provides the
appropriate remedy.
C. Upsetting the Applecart?
Equity considerations aside, SB 1373 would provide a
statutory carve-out for one part of the construction
industry, paving contractors, providing a separate
treatment than all other contractors that would continue to
be subject to Regulation 1521. Opponents argue that they
would have to collect and remit sales taxes in a completely
different manner than they have been accustomed to since
the inception of Regulation 1521 in 1939, asserting that
the change could lead to administrative difficulties in
calculating the base of the tax. While the economy is now
significantly different that the year in which the BOE
enacted the regulation, and change is never in and of
itself a bad thing, what is unique about the paving
industry that merits different rules than all other
construction contractors? Are there other parts of the
construction industry in which the sales tax treatment of
vertical integrated firms creates inequities in the bid
process? While SB 1371's solution may or may not be
favorable to the paving industry as a whole, the Committee
may wish to consider the precedent of SB 1373 where paving
contractors furnishing materials would be considered
retailers, and all other construction contractors would be
considered consumers.
D. Rattled by the Rush
Committee Staff and the BOE recommend the following
amendments:
First, because changing tax collection
methodology can take time, the measure should be
amended to specify an enactment date of the first
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day of the first calendar quarter commencing more
than ninety days after the effective date of the
act. The measure should also apply to fixed
price contracts enter into prior to that
effective date.
Second, the measure specifies that the
gross receipts of the sales shall be the price at
which the contractor sells similar materials in
similar quantities. If that price cannot be
discovered, then the prices shall be deemed to be
the amount stated in price lists, bid sheets, or
other records of the contractor the materials.
Regulation 1521 offers a third fall-back in case
neither of the previous two systems can determine
the appropriate price. Since SB 1373 carves
paving contractors out of the regulation, the
back-stop may prove useful. The measure should
be amended to include the following at the end of
the section:
"If the sale price cannot be established in the
above manner and the fixture is manufactured by
the contractor, the cost price shall be deemed to
be the aggregate of the following:
[1] Cost of materials, including such items as
freight-in and import duties,
[2] Direct labor, including fringe benefits and
payroll taxes,
[3] Specific factory costs attributable to the
fixture,
[4] Any manufacturer's excise tax,
[5] Pro rata share of all overhead attributable
to the manufacture of the fixture, and
[6] Reasonable profit from the manufacturing
operations which, in the absence of evidence to
the contrary, shall be deemed to be 5 percent of
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the sum of the preceding factors.
Jobsite fabrication labor and its prorated share
of manufacturing overhead must be included in the
sale price of the fixture. Jobsite fabrication
labor includes assembly labor performed prior to
attachment of a component or a fixture to a
structure or other real property."
Support and Opposition
Support:Betty Yee, Chairwoman, State Board of
Equalization, Angus Asphalt, Inc., ABC Construction
Company, Inc., Emmett's Excavation, Inc., Hazard
Construction Company, Universal Asphalt Company, Inc., Cass
Construction, Inc., California Metals Coalition, Small
Business Majority, Oakland Metropolitan Chamber of
Commerce, South San Francisco Chamber of Commerce, Vulcan
Materials Company, Kammerer & Company, Southern California
Contractors Association, Construction Industry Legislative
Council, Small Manufacturers Association, Small Business
California, Delta Construction Company, Ghilotti Bros.,
Inc., San Francisco Small Business Commission, RGW
Construction, Inc., E.E. Lueck Construction, Inc., Andreini
Bros., Inc., California Metal Coalition,
Plumbing-Heating-Cooling Contractors of California, C.F.
Archibald Paving, Inc., Bay Cities Paving and Grading,
Inc., Bill's Sweeping Service, Inc., Sierra Asphalt, Inc.,
A.M. Stephens Construction Co., Inc., NTK Construction,
Inc., Ace Asphalt, JB Bostick Company, R.A. Nemetz
Construction Co., Inc., Collet Construction Co., Inc., Half
Moon Bay Grading and Paving, Inc., Hutchins Paving and
Engineering, Inc., American Asphalt Repair and Resurfacing
Co., Inc., Flowline Contractors, Inc., Cal-Neva
Construction Services, Inc., Spa and Pool Industry
Education Council (Spec)
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Oppose:Granite Rock Company, Granite Construction,
Inc., California Construction and Industrial Materials
Association
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Consultant: Colin Grinnell