BILL ANALYSIS �
AB 303
Page 1
Date of Hearing: April 4, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 303 (Knight) - As Introduced: February 9, 2011
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Sales and use taxes: exemption: business equipment
SUMMARY : Establishes a partial sales and use tax (SUT)
exemption for specified business equipment. Specifically, this
bill :
1)Establishes 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 process, 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,
control, regulate, or maintain the machinery including,
without limitation, computers, data processing equipment,
and computer software, together with all repair and
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replacement parts with a useful life of one or more years;
c) Property used in pollution control;
d) Special purpose buildings and foundations, as specified;
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 31
to 33, inclusive, of the North American Industry
Classification System (NAICS) published by the United
States Office of Management and Budget, 2007 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
business exceeds 20% of the aggregate fair market
value of the total assets of the trade or business
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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
NAICS, 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 the effective date of
this bill, 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
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.
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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:
a) By a county, city, or district under the Bradley-Burns
Uniform Local SUT Law or the Transactions and Use Tax Law;
and,
b) Under Revenue and Taxation Code (R&TC) Sections 6051.2,
6051.5, 6201.2, and 6201.5, or pursuant to Section 35 of
Article XIII of the California Constitution.
14)Applies to leases of TPP classified as "continuing sales" and
"continuing purchases" in accordance with 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.
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15)Goes into immediate effect as a tax levy.
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 State Board of Equalization (BOE) estimates
revenue losses of $3.6 million in fiscal year (FY) 2011-12, $3.8
million in FY 2012-13, and $4.1 million in FY 2013-14.
COMMENTS :
1)The author has provided the following statement in support of
this bill:
Assembly Bill 303 seeks to address the challenging business
environment in California. With over 2.3 million
Californians jobless (as of February 2011), something must
be done to keep people working and businesses out of the
red. Increased investment in research and development,
allows businesses to remain competitive and employ working
individuals.
Forbes Magazine recently laid out a map of businesses
relocating across the nation. California, by far, showed
the most businesses 'leaving' the state. California's
businesses are struggling to keep out of the red due to the
overextended tax burdens and regulations that government
has placed on their day to day business. A simple tax
exemption for companies conducting research and development
will allow businesses to stay afloat in this global economy
and not add to our already crippling unemployment rates.
Assembly Bill 303 will help alleviate the high costs of
doing business in this state.
2)Proponents state:
The high cost of doing business in California has already
seen many manufacturers expand or shift operations to other
states. In several instances, other states provide both a
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sales tax exemption and investment tax credits to encourage
manufacturing investment in their state. AB 303 would
provide manufacturers some relief from the high cost of
doing business in the state, which according to the Milken
Institute's annual study is currently over 23% higher than
the national average.
3)Opponents state:
Our primary concern with this bill is substantial revenue
loss. As a matter of tax policy, we understand the
argument in part, and would suggest that this policy
substitute for single sales factor and other corporation
tax breaks (e.g. loss carry-backs) in a revenue-neutral
manner. We also question the exemption for research
property, insofar as research and development already
receives tax credits which are the highest of any state in
the country.
4)BOE notes the following in its staff analysis of this bill:
a) "In defining �a] "qualified person," it is recommended
that the bill require that the qualifying entity be
primarily engaged in the activities described in the
referenced codes. This is an important issue and one that
generated many disputes when the BOE administered Section
6377 previously. BOE staff is willing to work with the
author's office in drafting amendments."
b) "As a tax levy, the provisions of the bill would become
effective immediately. However, since retailers generally
rely on receiving an "official notice" of tax law changes
from the BOE before implementing a law change, it is
recommended that a delayed operative date be incorporated
into the bill in order for the BOE to give proper advance
notice."
c) "The term "property," which is used throughout proposed
Section 6377, needs clarifying. As currently drafted, the
bill would exempt sales of tangible personal property
purchased by a qualified person for use in the
manufacturing, fabrication, processing, etc., of
"property." Traditionally, when the Legislature addresses
the manufacturing of property, it means the traditional
manufacturing of tangible personal property, not the
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creation of intangibles or the provision of services and
utilities. To the extent that the bill does not expressly
limit such term to the manufacturing or fabricating of
tangible personal property, then it may be asserted that it
has left open the door to unintended arguments that it
includes the creation of intangible property or the
provision of services and utilities. To avoid any
unintended consequences in administering the proposed
exemption, we suggest that the term "property" be replaced
with "tangible personal property.""
5)Committee Staff Comments :
a) Is the proposed SUT exemption for business purchases
good 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
fundamental 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 enacted 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
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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 303.
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
reference a clear objective standard for determining the
useful life of an item.
e) Notification Requirement. AB 303 includes a provision
eliminating the SUT exemption if the purchased property is
removed from California or converted to a non-exempt use
within one year of the purchase date. This bill allows BOE
to collect taxes not paid if any of the above occurs, but
AB 303 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 Amendment : On page 5, line 28,
replace "(10)" with "(11)".
1)Related Legislation. Several bills were introduced in the
2009-10 Legislative Session to provide a similar tax exemption
for certain TPP:
a) AB 1719 (Harkey) contained provisions nearly identical
to this bill. AB 1719 was held in this Committee.
b) AB 1812 (Silva) would have provided a partial SUT
exemption, beginning January 1, 2011, for specified TPP.
AB 1812 was held in this Committee.
c) AB 2280 (Miller) would have provided a complete SUT
exemption for all manufacturing equipment. AB 2280 was
held in this Committee.
d) SB 1053 (Runner) would have provided a partial SUT
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exemption for TPP used in manufacturing and qualified
research and development activities by manufacturers and
software publishers and affiliates. SB 1053 was held in
the Senate Committee on Revenue and Taxation.
REGISTERED SUPPORT / OPPOSITION :
Support
California Aerospace Technology Association
California Manufacturers & Technology Association
California Taxpayers Association
Opposition
California Tax Reform Association
Analysis Prepared by : M. David Ruff / REV. & TAX. / (916)
319-2098