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 Construction Contractors That Make
Its Own Aggregate Materials as Retailers for
Sales and Use Tax Purpose.
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. With materials, contractors are
customers, and generally are not required to get a seller's
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permit from the BOE.
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; they collect and remit the sales tax when
fixtures are sold. For example, contractors who sell
elevators must obtain a seller's permit and collect and
remit the appropriate sales tax based on the sales price of
the elevator.
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.
Some items, such as cabinets, occupy a middle ground
based on the percentage of the product manufactured before
being installed into real property. When these products
are manufactured by one party, and installed by a
contractor, the contractor is treated as a retailer of
fixtures. The same holds if 90% of the total direct cost
of all labor and materials is incurred prior to installing
the cabinet onto realty. However, when a contractor
predominantly makes the product on-site, he or she is
considered a consumer of materials.
Currently, both vertically integrated and non
vertically-integrated 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 contractors that fabricate,
manufacture, process or produce any aggregate-based
materials that the contractor permanently incorporates into
a construction project as a retailer under the Sales and
Use Tax Law. The measure states that a taxpayer reusing or
recycling aggregate-based materials that originate from the
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site of the construction project, or using fill dirt or
sand materials that are transported to the construction
site that are not purchased by the contractor, and that are
not crushed, blended, or processes triggers the
reclassification. Gross receipts from the deemed retail
sale of the aggregate-based materials shall be included in
the measure of the taxes, and 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 applies to contracts awarded on or after
April 1, 2011.
FISCAL EFFECT:
According to the Board of Equalization, the February
19, 2010 version of SB 1373 resulted in revenue gains of
$8.3 million in 2010-11, and $17.5 million annually
thereafter. FTB estimates that about 10% of the sales and
use tax gain will be offset by lower bases for the personal
income tax and corporation tax because of lower profits
from the firms that would be considered retailers under SB
1373. BOE indicates that this version of SB 1373 will not
result in a substantively different revenue effect.
COMMENTS:
A. Purpose of the Bill
SB 1373 changes the Sales and Use Tax law that
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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
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 that
are subsequently used by that firm to satisfy its
construction contracts have a competitive advantage over
smaller firms which must pay sales and use tax when buying
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
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the right hand of its construction contractor; no sale
takes place because tangible personal property is not being
transferred from one person to another. 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 which are almost
always awarded to the low bidder, thereby diminishing the
chances that smaller contractors will win the contract.
Opponents point to recent bids where both
vertically-integrated and non vertically-integrated firms
won projects.
C. Rocks and Pebbles
If an inequity exists, the secondary policy question
is whether reclassifying only those contractors that
produce its own aggregate-based materials 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. However, SB 1373 only goes part of the way:
reclassifying only those vertically-integrated contractors
as retailers when the rest of the industry would retain its
classification as consumers. While obtaining a resale
certificate and paying sales tax as a retailer is more
complex and administratively burdensome, does correcting
one inequity by enacting differential treatment remedy the
problem or simply create another one? While the June 2,
2010 version eliminates the distinction within the smaller
universe of paving contractors by treating aggregate
materials more similarly to cabinets, wouldn't a more
direct way of ensuring equity be to classify all paving
contractors as retailers? The Committee may wish to
consider amending SB 1373 to classify all paving
contractors as retailers.
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D. Upsetting the Applecart?
SB 1373 would provide a statutory carve-out for
vertically-integrated contractors that manufacture its own
aggregate which is subsequently used by the same firm in a
construction contract. Only those contractors, amongst the
entire all other contractors would be legally considered
retailers while others continue to be subject to
distinctions within Regulation 1521. Opponents argue that
they would be subject to new reporting requirements, and
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. Opponents also
argue that the change could lead to administrative
difficulties in calculating the base of the tax because
paving materials can vary in price due to fluctuating input
costs and the distance from the quarry to the construction
site.
E. Hammer and Chisel
The February 19, 2010 version of SB 1373 stated that
those paving contractors that fabricate, manufacture,
process, or produce materials used in paving contractors
would be considered retailers under the sales and use tax
law. The version of the bill the Committee hears today
make a subtle, but important change. Instead of deeming
one type of business model that of a retailer, this bill
states that a contractor that produces fabricates,
manufacturers, or processes any aggregate-based material in
the performance of a construction contract be considered a
retailer. This change expands the universe of products
used and contracts performed that would change the way
sales and use taxes are applied or not; not just paving
contracts would trigger a contractor being a retailer, now
any construction contract where the contractor uses
aggregate materials does. Also, by changing to a
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distinction based on the use of the materials, this version
of SB 1373 moves the law closer to that which applies to
cabinets, where contractors that incur a large share of the
cost off-site, then complete the finished product on-site,
become retailers. However, it is unclear whether 90% of
the cost to perform construction contracts is attributable
to the mining of the aggregate materials necessary to
perform the contract as must be the case with cabinets.
F. Rattled by the Rush
Committee Staff and the BOE recommend the following
amendments:
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
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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
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,
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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)
Oppose:Granite Rock Company, Granite Construction,
Inc., California Construction and Industrial Materials
Association
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Consultant: Colin Grinnell