BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 1391 - Yee
Amended: April 6, 2010
Hearing: May 12, 2010 Tax Levy Fiscal: Yes
SUMMARY: Requires Firms Claiming Existing Tax Credits to
Report to the Franchise Tax Board (FTB) Specified
Data; Requires Clawbacks of Future Tax Credits
for Firms Reporting Less Employment than the
Previous Year.
EXISTING LAW provides various tax credits designed to
provide incentives for taxpayers that incur certain
expenses, such as child adoption, or to influence behavior,
including business practices and decisions, such as
research and development credits and Geographically
Targeted Economic Development Area credits. The
Legislature typically enacts such tax incentives to
encourage taxpayers to do something but for the tax credit,
they would otherwise not do.
THIS BILL requires taxpayers doing business in the
state filing under either the Personal Income Tax or the
Corporation Tax that claim tax credits to submit annually
with the timely filed original return the following
information:
The number of full-time employees,
part-time employees, and temporary employees
The amount of tax credits claimed for
each tax credit.
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The number of full-time jobs, part-time
jobs, and temporary jobs created by the credit.
A list of occupations, job
classifications, and expected average wages for
the full-time jobs, part-time jobs, and temporary
jobs created by the credit.
A certification by the taxpayer that the
information is true and correct and contains no
knowing misrepresentation.
THIS BILL disallows any tax credit enacted on or after
January 1, 2011 for any taxpayer that has an annual net
decrease in full-time employees in any year, measured on a
full-time equivalent basis, by aggregating the total number
of full-time employees and dividing each employee's hours
worked in a year by 2,000. The credit shall be recaptured,
and the taxpayer shall be liable for any credits claimed on
previous returns. The bill provides that employees of
trades or businesses that are treated as related under
specified sections of the Internal Revenue Code shall be
treated as employed by a single taxpayer.
FISCAL EFFECT:
FTB states that the measure does not affect state
revenue because it does not apply to any currently
authorized tax credits.
COMMENTS:
A. Purpose of the Bill
According to the Author, "SB 1391 brings much needed
transparency and accountability to corporate tax
expenditures. This bill will allow the state to recoup, or
"clawback," any future tax expenditures given to a
corporation that fails to meet employment or investment
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commitments.
Specifically, this bill would require corporations to
annually submit to the Franchise Tax Board specified
information relating to how they used the tax credits they
received to retain or create jobs.
Corporations receiving tax expenditures will be
required to payback the entire amount of any assistance to
the state if the corporation has a net decrease in the
number of full-time employees.
Clawback provisions make tax expenditures more
effective, transparent, and accountable. This bill will
set clear expectations for corporations and guarantee that
the state's investment will yield measurable results in the
form of job retention and creation.
B. Taking it Back
California's key business tax credits, the Research
and Development Tax Credit and the Geographically Targeted
Economic Development Area Hiring Credit and Sales and Use
Tax Credit, are neither capped to a specified amount of
foregone revenue nor specifically allocated by a state
agency. If firms legitimately satisfy the conditions
necessary to claim the credit, such as increasing research
and development year-over-year or hiring a qualified worker
(with proper documentation), the firm claims the credit on
its return, thereby reducing its tax in the current tax
year, or carrying the credit over to be used against tax
due in a future year. Once granted, the state cannot
cancel the credit and make the firm repay the amount, a
procedure known as a claw back, if the firm followed the
law. In that way, California's key business tax
expenditures function similarly to entitlement programs,
but unlike spending programs, cannot be limited or
eliminated without 2/3 vote required by Section 3 of
Article XIIA of the State Constitution.
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Other states operate economic development programs by
application, and claw back incentives when companies leave
the state or decrease employment. Many firms must apply
for tax incentives, which the state awards up to an amount
specified in each state's budget, or sign memorandums of
understanding with the state. Next, the state requires
reports from firms to ensure that it meets specified
employment totals, wage amounts, and investment thresholds.
If the firm does not meet the targets, it must pay back
the entire value of the tax credit in some cases, sometime
with a penalty. A Chart from the organization "Good Jobs
First" details these provisions for 20 states.
SB 1391 brings California part of the way there.
First, it requires recipients of existing tax credits to
report specified information on its tax return, including
the number of its full-time employees, amount of tax
credits, and number of jobs created by tax credits,
although the assessment of a tax credit's job-creating
ability will be made entirely by the taxpayer. Secondly,
if the firm's employment declines in any year, then the
state recaptures the tax credit, and requires the taxpayer
to repay taxes previously offset by the credit, but only
for those credits yet to be authorized by the Legislature.
While SB 1391 is currently keyed a 2/3 vote because of a
legal ambiguity (See Comment E), should the measure seek to
clawback existing credits, the measure would require a 2/3
vote from each house of the Legislature to be enacted.
C. Beware the Jabberwock, My Son, the Jaws that Bite, the
Claws that Catch!
Martin Helmke, consultant to the Senate Revenue and
Taxation Committee for many years until his retirement in
2006, often cited poems as part of his analyses, including
Lewis Carroll's famous Jabberwocky, which evokes the image
of a scary monster. To many firms, SB 1391 may be
similarly perceived, because businesses factor in costs
offset by tax credits when calculating a return on
investment over a long period of investment, credits which
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SB 1391 may claw back someday if the firm's employment
declines. Clawing back tax credits will affect that return
on investment. Opponents state that the measure's focus on
jobs may not be appropriate because jobs are not the only
indicator of whether a credit works, as terminating a
secretary and hiring an applied researcher shows no net
increase in a firm's employment, but increases wages and
productivity. Additionally, had the Manufacturers'
Investment Credit sunset provision been indexed to
California's industrial output, as opposed to increasing
manufacturing jobs, it may still be in place today because
manufacturing equipment increases productivity, and often
serves as a substitute for employing a person.
A recent article in Tax Notes by Cara Griffith
discusses the perception of firms to states and
municipalities seeking to clawback tax credits given
current fiscal difficulties:
In response to public concern over the length of the
recession and the handling of public funds, many
states have reportedly become aggressive in including
and enforcing clawback provisions in tax credit and
incentive packages. In essence, a clawback provision
permits state officials to rescind the benefits of the
deal if the business doesn't uphold its end of the
bargain. Although enforcement of clawbacks depends
largely on the state, with some states more aggressive
than others, businesses should not assume that if they
will be unable to meet the terms of the agreement,
they will lose all the benefits.
[Ali] Master [a partner and national director of
business incentives and credits, state and local tax,
at Ernst & Young LLP], said that if a company
negotiates a credit or incentive on the basis that it
will create a specific number of jobs and then finds
that circumstances have changed and it will be unable
to meet that goal, it might walk away. But while
renegotiation of the benefit will be harder in the
current environment than in the past, it is possible.
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"States don't want the deal to look like a failure any
more than the company does," Master said, particularly
if the state made a prominent announcement of the deal
and the jobs that were expected to be created in the
state.
Powell likewise said, "The pushback from states is a
bit of form over substance. States will watch their
dollars, but they want to work with companies to get
jobs and investment inside their borders. And as a
result, states will work with businesses on compliance
with and the terms of the package, provided companies
approach them early."
D. Stretching Out
Forcing employers to pay back tax credits directly
affects a firm's bottom line; companies generally factor
tax credits into profitability calculations when investing
in a business over the long term. Additionally, firms can
reduce employment for many reasons, such as lack of access
to capital, changes in demand for its products or services,
or general economic changes, not just reducing in-state
property and payroll to relocate in jurisdictions with
lower taxes, and fewer labor and environmental protections.
SB 1391 requires clawbacks of all future tax credits
whenever employment falls below the total from the prior
year, a very specific measurement, but one that could apply
a very strict penalty for any negative employment change in
any one year. While the measure only applies to tax
credits as yet created, and not existing tax benefits such
as Research and Development Credits, is a one-year
employment loss the appropriate event to trigger such a
harsh penalty? A firm's employment over a longer period of
time would better demonstrate its long-term level of
investment in the state. The Committee may wish to
consider amending SB 1391 to elongate the period of time to
measure employment change to a rolling three year period
instead of an annual year-over-year measurement, with claw
backs beginning in the 2013 tax year after three tax years
of reporting after the bill's effective date (2010, 2011,
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and 2012 taxable years).
E. Dirt Under the Nails
Committee Staff and the Franchise Tax Board recommend
the following amendment to SB 1391:
Reduce the information required to be included with
the taxpayer's original income tax return to 1) the
number of full-time, part-time, and temporary
employees in the State for the current and preceding
taxable year, and 2) the number of full-time,
part-time, and temporary jobs created by the tax
credit.
Provide that the information included by the
taxpayer on the return would be in a form and manner
as required by the forms and instructions prescribed
by the Franchise Tax Board.
Give the Franchise Tax Board (FTB) authority to
issue rules, procedures, guidelines and regulations
necessary to implement this provision.
Provide that for personal income tax purposes, only
business credits would be subject to disallowance
under this bill.
Revise the phrase "full-time employee" and "annual
full-time employee" to "full-time equivalent employee"
to be consistent with the calculation that determines
if a credit is disallowed.
Correct the reference to "tax" under Corporation
Tax Law.
Provide that the amount of credits recaptured would
include interest computed from the due date of the
return of each taxable year in which the credit was
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claimed to the date of the payment of the recaptured
credits.
Provide definitions for "business credit,"
"full-time employee," "part-time employee," and
"temporary employee."
Clarify that the FTB has the authority to audit the
information provided by the taxpayer.
Delete the measure's reference to "previous"
credits to clarify the ambiguity resulting in
Legislative Counsel keying the measure a 2/3 vote.
Support and Opposition
Support: California Nurses Association (sponsor),
California Labor Federation, UFCW 1428, California Alliance
for retired Americans, Napa Solano Building Trades Council,
San Mateo Building Trades Council, Plumbers and
Steamfitters Local 159, International Longshore and
Warehouse Union Local 6 and Local 94, Northern California
District Council - International Longshore and Warehouse
Union, Ironworkers Local Local 118, Local 155, and Local
377, American Federation of Teachers Local 1521,
International Association of Theatrical and Stage
Employees, California Federation of Teachers, CalPIRG,
California Church Impact, Alliance of Californians for
Community Empowerment (ACCE), California Tax Reform
Association, California Professional Firefighters, American
Federation of State, County, and Municipal Employees,
AFL-CIO, Service Employees International Union, California
Teamsters Public Affairs Council, United Food and
Commercial Workers Western States Council, California
Conference Board of the Amalgamated Transit Union,
California Conference of Machinists, Unite-HERE
International Union, Health Access California, Western
Center on Law and Poverty, Sierra Club California,
California Hunger Action Coalition,
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Oppose:California Chamber of Commerce, California
Bankers Association, California Aerospace and Technology
Association, California Taxpayers Association, California
Manufacturers and Technology Association, TechAmerica,
California Grocers Association, BIOCOM
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Consultant: Colin Grinnell