BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 1500 HEARING: 8/16/12
AUTHOR: Pérez FISCAL: Yes
VERSION: 5/25/12 TAX LEVY: No
CONSULTANT: Miller
Makes the elective single sales factor apportionment
mandatory to fund the Middle Class Scholarship Program.
Background and Existing Law
I. Apportionment Formula . A multistate firm generates
profits based on its operations in many states, and has a
right under the U.S. Constitution to divide income between
these states for tax purposes, a process known as
"apportionment," to ensure that no state taxes more than
its fair share of that firm's income. The 1957 Uniform
Division of Income for Tax Purposes Act (UDITPA) created
the three-factor, double weighted apportionment framework
to capture the factors of production; specifically,
property to represent capital, payroll to represent labor,
and sales to represent market presence.
In 1966, California adopted UDITPA where each of the three
factors had an equal weight of one-third. In 1993,
California adopted a "double-weighted" formula, reducing
the formula's weights on both property and payroll from
33.3% to 25%, but increasing the weight on sales from
33.3% to 50%, thereby reducing that share of a the firm's
income apportioned to states where it employs relatively
more people and produces more goods in the state compared
to its sales. Under the change, a firm with all or most of
its production and payroll in California, but a smaller
share of its sales, benefits from the change, whereas a
firm that either employs few or no people or owns little to
no property here, but sells into California, pays more tax.
Many other states also changed the apportionment weights
in the 1980s and 1990s to induce firms to maintain or
relocate facilities and employees in the state.
Starting in 2011, California's apportionment formula allows
SB 1500 -- 5/25/12 -- Page 2
multi-state firms to annually choose either the above
apportionment formula or to use only its sales, commonly
known as the "single sales factor."
Each of the factors in the apportionment formula is a
fraction: the numerator is the value of the item in
California and the denominator is the value of the item
everywhere. The property factor generally includes all
tangible property owned or rented during the taxable year.
The payroll factor includes all forms of compensation paid
to employees. The sales factor includes all gross receipts
from the sale of tangible and intangible property.
Since 1993, the apportionment formula for most taxpayers
has been a three-factor double weighted formula consisting
of payroll, property and double weighted sales as
illustrated below.
---------------------------------------------------------
| Average | + |Average |+ |Californ|) | California |
|Californi| |Californ| (2x| ia | = |Apportionment|
| a | | ia | | Sales | | Formula |
|Property | |Payroll | | | | |
|---------+----+--------+------+--------+---+-------------|
| Average | |Average | | Total | | |
| Total | | Total | | Sales | | |
|Property | |Payroll | | | | |
---------------------------------------------------------
The only exceptions to this rule are four industries:
agriculture, extraction, including oil, savings and loan
and financial services. These four industries must use the
three factor formula without the double weighted sales
factor.
Beginning in 2011, as illustrated below, a qualified
business may elect to use a single sales factor based on
100 percent sales, instead of the three factor formula
described above. The industries listed above still do not
qualify for the single sales factor.
---------------------------
|Californi| = |California |
| a Sales | |Apportionmen|
| | | t Formula |
|---------+----+------------|
SB 1500 -- 5/25/12 -- Page 3
| Total | | |
| Sales | | |
---------------------------
II. Intangible Sourcing . As part of the budget agreement
of 2010 (SB 858, Committee on Budget & Fiscal Review,
2010), taxpayers electing the three-factor, double-weighted
sales formula must use the cost of performance method to
source sales of intangible items starting with the 2011
taxable year; taxpayers electing sales factor-only
apportionment of income must source the sales of
intangibles to California using the market rule.
Intangibles are everything that isn't "stuff", and include
all services, such as online stockbrokers and
telecommunications, and licenses to operate software
programs, among others.
Sales of Intangibles - "Costs of Performance ." A company
includes no revenue from its sales of intangibles to
California in the sales factor if the firm incurs a
plurality of the costs associated with developing these
products or services in another state; if the plurality
occurs in California, then the company includes all of its
sales in its California sales factor. For example, a
company that produces streaming video may spend $500,000 in
California and $520,000 in Oregon when developing the
service. The firm does not include any sales of its sales
of streaming video in this state in its California sales
factor, because it incurred most of its costs of
performance outside the state. Had the firm incurred most
of its costs of performance in California, the taxpayer
must include all of its sales of the video service in its
California sales factor.
Sales of Intangibles - "The Market Rule ." Under the
competitively-neutral market rule, all firms source these
sales based on the state in which the product or service is
ultimately used, so all firms report sales based on how
much they sell in the state, instead of where they invested
when developing the intangible item or service. Each
license for an operating system used on a California
personal computer would be included in the software firm's
California sales factor. In the example above, the firm
would include its sales of the video service to customers
in this state in its California sales factor.
SB 1500 -- 5/25/12 -- Page 4
The following chart summarizes California's history of both
apportionment and intangibles.
----------------------------------------------------------
| |1966 - |1993-2010 |2011 |
| |1992 | | |
|-------------+-----------+--------------+-----------------|
|Apportionment|3-factor |3-factor |Elective |
| |formula |formula |(3-factor |
| | |(double-weight|formula with |
| | |ed sales |double weighted |
| | |factor) |sales or single |
| | | |sales factor) |
|-------------+-----------+--------------+-----------------|
|Intangibles |Costs of |Costs of |Cost of |
| |performance|performance |performance if |
| | | |elect 3-factor; |
| | | |formula; market |
| | | |rule if single |
| | | |sales factor |
| | | |elected |
| | | | |
----------------------------------------------------------
Proposed Law
I. Apportionment Formula . As amended, this bill amends the
apportionment formula in two ways:
1. Single Sales Factor : This bill makes the single
sales factor apportionment formula mandatory for all
taxpayers except those in a qualified business
activity (extractive, agricultural, savings and loans,
and banks and financial services) for taxable years
beginning on or after January 1, 2011.
2. Elective Single Sales Factor . AB 1500 bill allows
taxpayers to choose the 3-factor formula only when it
results in a greater amount of tax owed before tax
credits are applied.
II. Intangible Sourcing. 50/50 market costs of
performance . SB 858 (Committee on Budget, 2010) requires
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that companies that elect single sales factor choose the
"market" rule and source all intangible property to this
state and taxpayers that elect to pay taxes under the
3-factor formula source intangible property to where the
goods originate. AB 1500 as amended allows cable companies
to choose either that have a "minimum investment" in this
state of $250 million or more, to assign 50% of their
intangible sales to "this state" under the sales factor and
50% of sales shall "not be assigned to this state Ýat
all]."
III. Middle Class Scholarship Program . AB 1501
establishes the Middle Class Scholarship Program, to be
administered by the California Student Aid Commission
(CSAC), beginning with the 2012-13 academic year, and
provides for a continuous appropriation for purposes of
funding the program, contingent upon the enactment of AB
1500 (Perez). The Middle Class Scholarship Program is a
program to provide scholarships for mandatory systemwide
fees at the UC and CSU; funds grants to cover fees, books,
and other educational costs at the CCC. AB 1501 is on the
suspense file in the Senate Appropriations Committee.
IV. Urgency . This bill takes effect immediately as an
urgency.
State Revenue Impact
According to the FTB, this bill will raise: $1.2 billion in
2012-13, $950 Million in 2013-14 and $1 billion in 2014-15.
Comments
1. Purpose of the bill . According to the author, "Since
the 2003-2004 school year, student fees at the California
State University have increased by 191 percent, from $2,046
to $5,970, and fees at the University of California have
increased by 145 percent since 2003-04, from $4,984 to
$12,192. Fees at our community colleges have also
increased substantially. Financial aid programs have
expanded to mitigate the impacts of fee increases for
lower-income families, but families who can't pay for
college out of pocket or who earn too much for financial
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aid grants are forced to take on a significant financial
burden, with many students assuming a staggering level of
debt.
The Middle Class Scholarship will apply to any student in a
CSU or UC whose family earns under $150,000 and does not
already have fees covered by financial aid. A typical UC
student, or their parents, will save approximately $8,200
per year, and a typical CSU student or their parents will
save approximately $4,000 per year. The Middle Class
Scholarship Act also provides $150 million for Community
Colleges to increase affordability there. Community college
students planning to transfer to UC or CSU will of course
also benefit from the reduced fees at those institutions.
The Middle Class Scholarship is funded by closing
California's "elective" single sales factor loophole. Right
now out-of-state corporations get to choose their own
formula for the taxes they owe in California. And the
fewer jobs they have in California, the bigger their tax
break.
Closing the "elective" single sales factor loophole would
put California in line with the tax policies of a mix of 15
red and blue states, including Michigan, Texas, New Jersey,
New York, South Carolina, Georgia, Wisconsin, Indiana,
Illinois, Iowa, Nebraska, Colorado, Oregon, Minnesota, and
Maine. In fact, only three other states allow out-of-state
corporations to choose which tax formula they prefer.
In 2009, changes to corporate tax law were made that,
beginning in 2011, shifted from the "three factor formula"
(which considers location of sales, property, and payroll)
to the "single sales factor" (which considers only location
of sales). Governor Schwarzenegger used budget
negotiations to insist that the change be optional, so that
out-of-state corporations with little California property
and small California payrolls but high sales could take
advantage of this "elective" loophole and use the three
factor formula and avoid California taxes.
In 2010, the non-partisan Legislative Analyst's Office
(LAO) recommended closing the "elective" single sales
factor loophole stating it would generate revenue from
out-of-state corporations while allowing California-based
firms to continue their reduced their tax bills. The report
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recommended that "the state require all firms to use the
single sales factor, which would help the state's
competitiveness while limiting the cost to the budget."
The LAO report went on to state that "California has been
criticized at times for having high costs of doing
business. The single sales factor would reduce those costs
for mobile firms who sell into national or world markets
and are more of a flight risk than firms who sell only into
the California market."
On a bipartisan two-thirds basis, the California State
Assembly voted in 2011 to close the single sales factor
loophole. Given the targeted nature of Middle Class
Scholarship Act and the substantial benefit it provides to
California families, it should also garner support as the
appropriate use of the $1 billion in revenue generated from
closing the "elective" single sales factor loophole.
In 2011 Governor Brown stated that closing the "elective"
single sales loophole is "a critical step in making sure
the state does everything it can to support local job
creation." Writing in the Los Angeles Times, veteran
columnist George Skelton stated, "here's a no-brainer
opportunity to encourage job-creation and collect a pile of
money" and noted closing the "elective" single sales factor
loophole would remove a disincentive for business expansion
in California."
2. Don't tax me . Groups that oppose this bill state that
no matter the "noble cause" or the justification, a
mandatory single sales factor is a tax increase that will
hurt business. Cal-Tax states that "recent political
debates have misconstrued the elective single sales factor
(SSF) as benefitting out-of-state companies to the
detriment of in-state entities. The reality is that
elective SSF helps companies domiciled both in-state and
out-of-state, that have employees, property and sales in
this state." Kimberly-Clark opposes this bill even though
it has supported a mandatory single sales factor in other
states. The company points out, hover, that California has
the biggest market and states that have adopted the
mandatory single sales apportionment, business is united in
its support. Furthermore, Kimberly-Clark points to the
different costs of doing business with heavy products and
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equipment such as it uses with high transportation costs
and digital, high-tech equipment with relatively little
transportation cost.
3. Let them pay more . This bill allows only one group of
taxpayers to choose between the single sales factor and the
4-factor formula: those businesses that would pay more
under the 4-factor formula before the application of any
tax credits. The provision allows companies that, before
the application of credits, would pay the same or more
under the 4-factor formula to choose to pay taxes under
that method. This so-called "Silicon Valley Fix," with no
specific support, is intended to allow some companies to
show their shareholders that they can fully utilize their
available credits. The FTB estimates no additional cost or
revenue loss associated with this change. For example, if
a company owed $1 million in taxes, before credits, under
the 4-factor formula and $2 million under single sales
factor, that company would have no option to elect. If,
however, the company owed $4 million under the 4-factor
method and $2 million under the single sales method, the
company would be able to elect 4-factor so as to be able to
show shareholders that the credits, which often may only be
monetized for 8 years according to accounting rules, still
have viability because they may still use them under the
higher tax scenario. The Committee may wish to (1) if it
makes sense to still allow some form of election to further
complicate the state's tax system and (2) consider if
provides shareholders with full information if the taxpayer
never intends to use the 4-factor formula for
apportionment.
4. Have we met before? There have been various attempts
to impose a mandatory single sales factor since the
Legislature approved an elective apportionment formula in
February 2009:
In January, 2011, Governor Brown's proposed
removing the ability for firms to choose which
apportionment formula because he claimed it lead to
paying the lowest tax.
In September 2011, the Governor supported AB 40X
(Fuentes) which proposed mandatory single sales factor
and used the revenue to (1) reduce the corporate tax
rate; (2) exclude the first $50,000 of positive income
under the personal income tax; (3) reduce the minimum
franchise tax from $800 to $750; (4) increase the
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standard deduction by 27%. The bill is in the Senate
Rules Committee.
SB 116 (deLeon) proposed a mandatory single sales
factor first coupled with an education credit and
partial sales and use tax exemption in July and later
identical to AB 40X (Fuentes). SB 116 died on the
Senate floor.
In January 2012, Governor Brown again proposed that
the state adopt a mandatory single sales factor, not
as part of the budget, and suggested he would create a
jobs program to spend the money raised.
SB 1505 (DeSaulnier) also requires the state adopt
a mandatory single sales factor and uses the revenue
for Veteran's programs across the state under the
"Keeping Our Promises" Act. SB 1505 was held in the
Senate Committee on Veteran's Affairs without
recommendation.
Proposition 39, the "California Clean Energy Jobs
Act," is an initiative sponsored by Tom Steyer that
will appear on the November, 2012 ballot. Beginning
on January 1, 2013, the initiative proposes imposing a
mandatory single sales factor on California
corporations and uses half of the revenue
($550,000,000) for the Job Creation Fund over a period
of five years. Money from this fund will be used to
fund projects that will create jobs in California,
improve its energy efficiency, and expand its clean
energy production. Retrofitting schools and public
facilities to be more energy efficient, job training
in the clean energy sector, and nourishing
public-private partnerships to promote job creation
and clean energy expansion are examples of possible
projects. The other half of the funds go to the
General Fund. The Committee heard this initiative on
August 8th. If both this bill and the initiative
pass, the initiative would chapter out AB 1500 but AB
1500 which imposes mandatory single sales factor
immediately would remain law until November 6, 2012.
5. Dr. Frankenstein's Creation . As Edward Kleinbard,
former chief of staff to the Joint Committee on Taxation,
recently wrote: "The tax system is a window into the soul
of our society, because we use tax law as our principal
tool of industrial policy, wage support and income
redistribution. Our tax structure tells more about what we
as a society believe to be fundamentally fair than does any
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other aspect of government." Applying this quote to
California's tax law leads to the conclusion that
California is one of the most taxpayer-friendly states in
the nation, and one that provides unique benefits to
out-of-state firms, in stark contrast to its history of
treating all multistate corporations equally. When
California adopted the elective single sales factor in
2009, it departed from every other state save Missouri by
allowing taxpayers to choose to use the old formula if it
resulted in a lower tax in any given year. Allowing firms
with more property and payroll to benefit from the old
formula negates the incentive for them to move more
property and payroll to California, thereby reducing the
share of its income it has to apportion to other three
factor states. Additionally, an out-of-state firm that
mostly or exclusively sells intangibles that apportions
under the three-factor, double weighted formula and
allocates intangibles under the cost of performance rule,
yielding a sales factor close to or equal to zero, enjoys a
competitive advantage over a California firm electing
single sales factor and allocates intangibles under the
market rule because it cannot reduce its sales factor below
the percentage of its sales in California.
The measure applies the market rule to all taxpayers,
except for cable companies which would have to allocate
half of its sales based on that percentage of its sales in
California compared to its total sales if it met qualified
investment targets. Generally, tax systems should apply
the same rules to all taxpayers instead of creating
specific rules for certain industries. Also, cable
companies primarily invest in California to serve customer
demand, and have consistently avoided California with its
discretionary investments, resulting in its opposition to
the market rule and support for the cost of performance
method. This so-called cable fix has been in all the bills
related to single sales factor and is also included in the
previous bills listed above as well as the Proposition 39.
The revenue loss (incorporated into the revenue above) to
the cable company carve out is $20 million 2012-13, $34
million in 2013-14 and $35 million in 2014-15.
6. Gillette vs. FTB . In July, the Governor signed AB 1015
which confirms that current law with respect to
apportionment of corporation income is pursuant to an
original return, repeals all provisions related to the
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Multistate Tax Compact, and adopts non-inference language
regarding this action. This bill was in response to a
court case Gillette vs. FTB and involved the ability of
Gillette to elect to use the apportionment method contained
within the multistate tax compact which did not double
weight sales. The court issued a decision on July 24th
which was later vacated. The case is pending at the Court
of Appeal.
Support and Opposition (8/15/12)
Support : AFSCME; AFT Local 1931; Alhambra Unified School
District Board of Education; Associated Students of Chico
State; Associated Students of Sacramento State; Associated
Students of University of California; Associated Students
of UCD; Associated Students of UCM; Associated Students of
UCSD; Associated Students of Ventura College; BayBio;
BIOCOM; CA Communities United Institute; CA Community
Colleges Chancellor's Office; CA Conference Board of the
Amalgamated Transit Union; CA Conference of Machinists; CA
Faculty Association; CA Hospital Association; CA Labor
Federation; CA Medical Association; CA Professional
Firefighters; CA State Association of Electrical Workers;
CA State Conference of the NAACP; CA State Pipe Trades
Council; CA Teachers Association; CA YouthBuild Coalition;
California State Student Association; California State
University; Centinella Valley Union School District; Cisco;
City of Berkeley; City of Carson; City of Long Beach; City
of Sacramento; Coalition of CA Utility Employees; Congress
of CA Seniors; Controller Wendy Greuel; Councilmember
Richard Alarcón, 7th District; Councilmember Joe Buscaino,
15th District; Councilmember Tony Cardenas, 6th District;
Councilmember Eric Garcetti, 13th District; Councilmember
Dr. Robert Garcia, 1st District; Councilmember Jose Huizar,
14th District; Councilmember Paul Koretz, 5th District;
Councilmember Paul Krekorian, 2nd District; Councilmember
Steven Neal, 9th District; Councilmember Bill Rosendahl,
11th District; Councilmember Herb Wesson, 10th District;
Councilmember Dennis Zine, 3rd District; Engineers and
Scientists of CA, IEPTE Local 20; Equality California;
Faculty Association of Rancho Santiago Community College
District; Hacienda La Puente Unified School District;
Inglewood Unified School District; International Longshore
and Warehouse Union Southern California District Council;
SB 1500 -- 5/25/12 -- Page 12
International Longshore and Warehouse Union; International
Union of Elevator Constructors; Jockeys' Guild; LA City
Council (12-0); LA County Democratic Party; LA County
Sheriff's Department; LA County Sheriff Lee Baca; LA Labor
Fed; LAUSD; LAUSD School Board Member Nury Martinez; LAUSD
Superintendent Deasy's office; Los Rios Community College
District; Mayor Antonio R. Villaraigosa; Montebello Unified
School District Board of Education ; National Police Clergy
Council; Professional Engineers in CA Government;
Professional and Technical Engineers, IEPTE Local 21;
Qualcomm; Region VI Student Senate for Community Colleges;
Sacramento County Board of Supervisors; San Francisco Youth
Commission; Santa Barbara County Supervisor, Salud
Carbajal-1st District; Santa Monica/Malibu Unified School
District; Santiago Canyon College Associated Student
Government; Shasta College Student Senate; Student Senate
for California Community Colleges; Teamsters; Tri-Counties
Central Labor Council; UAW Local 2865; UAW Local 4123; UAW
Local 5810; UC Riverside Graduate Student Association; UFCW
Western States Council; UNITE-HERE, AFL-CIO; University of
California; University of California Student Association;
Western Association for College Admission Counseling;
Western States Council of Sheet Metal Workers
Opposition : Alliance of Automobile Manufacturers; CA Asian
Pacific Chamber of Commerce; CA Chamber of Commerce;
California Manufacturers & Technology Association; CalTax;
Chrysler; General Motors; Howard Jarvis Taxpayers
Association; International Paper; Kimberly-Clark; Procter &
Gamble; Southwest California Legislative Council