BILL ANALYSIS �
AB 1818
Page 1
Date of Hearing: May 14, 2012
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 1818 (Perea) - As Amended: March 29, 2012
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Income tax credits: patent licensing.
SUMMARY : Allows an income tax credit to a qualified taxpayer in
an amount equal to an unspecified percentage of qualified
royalties paid by the taxpayer. Specifically, this bill :
1)Authorizes a tax credit, under both the Personal Income Tax
(PIT) and the Corporation Tax (CT) Laws, for taxable years
beginning on or after January 1, 2012, in an amount equal to
an unspecified percentage of the qualified royalties paid by a
qualified taxpayer during a taxable year.
2)Defines "qualified taxpayer" as a taxpayer that paid qualified
royalties during the taxable year and commercializes in
California the licensed patent, for which royalties were paid.
3)Defines "qualified royalties" as any royalties paid by a
qualified taxpayer for the use of a qualified patent through a
license agreement with the University of California (UC) or
another entity.
4)Defines "qualified patent" as a patent owned by the UC for an
invention where the research and development (R&D) for that
invention was funded, in whole or in part, by amounts eligible
for the R&D tax credit.
5)Provides that unused credit amounts may be carried over to
reduce the tax in the following years, until the credit is
exhausted.
6)Takes effect immediately as a tax levy.
EXISTING FEDERAL LAW :
1)Allows a R&D tax credit that is combined with several other
credits to form the general business credit. Does not apply
to any expenses paid or incurred after December 31, 2011.
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2)The R&D credit under the PIT Law is determined as the sum of
20% of the qualified research expenses incurred during the
taxable year that exceeds the base amount, as defined, and 20%
of the amount paid or incurred during the taxable year on
research undertaken by an energy research consortium. In
addition, corporate taxpayers are allowed a credit equal to
20% of expenses paid to fund basic research at universities
and certain nonprofit scientific research organizations.
3)Allows, prior to January 1, 2009, the Alternative Incremental
Credit method for calculating the R&D credit.
4)Prescribes certain requirements that must be met in order for
research expenses to qualify as eligible for the R&D credit.
EXISTING STATE LAW conforms to the federal R&D credit with the
following modifications:
1)The state R&D tax credit is not combined with other business
credits.
2)Research must be conducted in California.
3)The credit percentage for qualified research in California is
15% versus the 20% federal rate.
4)The credit percentage for basic research in California is
limited to corporations and is 24% versus the 20% federal
credit rate.
5)The percentages for the alternative incremental research
portion of the California R&D credit are 1.49%, 1.98%, and
2.48%.
FISCAL EFFECT : Unknown
COMMENTS :
1)Author's Statement . The author provides that following
statement in support of this bill:
"California has seen a sharp decline in the number of
manufacturing jobs. Between 2001 and 2011, the manufacturing
industry has lost 613,000 jobs, with many of them being
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outsourced to cheaper markets in other countries and states
with better tax incentives. The patent box would provide
California a significant opportunity to promote business
innovation for California and help market itself as a business
friendly environment.
"AB 1818 would require businesses to administer research and
development (R&D) at the University of California (UC) level
in order to qualify for the credit. The direct link with R&D
and UCs would encourage investment in our universities at a
time when private investment has decreased.
"Senator Feinstein will soon be introducing similar
legislation on the federal level. California should be the
first to lead that effort and build on its reputation as a
leading innovator.
"In the time the patent box has been used in other European
countries, it has already demonstrated the job creation
potential. For example, in the United Kingdom (UK),
GlaxoSmithKline, a pharmaceutical company, has invested $800
million to build a new manufacturing facility with the
potential to create 1,000 new jobs. According to the CEO of
the company, the decision behind the investment was based on
the new UK patent box policy which is set to be introduced in
2013. In order to build on California's reputation as a
leading innovator, we need to re-focus on attracting leading
companies to build and invest in this state.
"AB 1818 is needed to encourage business investments in
California that will promote innovation and create jobs."
2)Arguments in Support . The proponents of this bill argue that
AB 1818 would "incent emerging growth companies to
commercialize research performed in California public
universities, encouraging investment in research at a time of
tight funding for the state's public universities and
positioning the state to better convert its leadership in
research into the development of new job-creating products and
services." The proponents believe that "the Innovation Box
concept could represent a promising and creative policy lever
that could build on the tremendous talent resident in our
universities and better position California-based companies to
innovate and compete in the world economy." It is often that
"the transfer of viable research discoveries to the
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marketplace that can pose the greatest challenge to innovators
and entrepreneurs." The proponents assert that providing an
incentive for these efforts through "a tax credit on royalty
payments to the University?has the potential to spawn greater
investment in, and broader commercialization of, UC inventions
and discoveries." Thus, the proponents state that "AB 1818
provides a fresh, innovative approach that may enable the stat
to capture more of the growth of companies that start here."
3)What Is a "Patent" or "Innovation Box" ? A "patent box" simply
means a tax incentive that allows corporate income from the
sale of patented products to be taxed at a significantly lower
rate than other income. Literally, it is a box on the tax
form for a qualified taxpayer to check. An "innovation box"
is a similar tax incentive that provides a preferential tax
rate for income derived from commercialization of intangible
assets other than patents, such as for example, trade names,
brand names, copyrights, or technical know-how. A patent box
differs from an R&D credit. While a R&D credit is intended to
spur R&D activity, a patent or innovation box is put in place
to incentivize commercialization of innovations, rather than
just the conduct of R&D.
Eight nations - Belgium, China, France, Ireland, Luxembourg, the
Netherlands, Spain and Switzerland - have enacted patent box
regimes. The United Kingdom is set to implement its patent
box policy in 2013 with a 10% tax rate on income generated
from patented products, in contrast to its regular rate of
26%. The United States does not have any similar tax
incentive, although Senator Feinstein is working on
legislation to create a federal patent box regime. The
legislation is expected to be introduced in the next few
months.
4)Potential Benefits of a Patent Box Regime in California .
According to Robert Atkinson, President and Founder of the
Information Technology and Innovation Foundation, the economic
theory behind a patent or innovation box regime is based on
the recognition of the fact that the process of innovation is
subject to multiple market failures and is much more global
and footloose now. (See, e.g., R. Atkinson, Patent Boxes:
Innovation in Tax Policy and Tax Policy for Innovation, p. 4).
Innovation requires substantial risk, in part because the
"time lag between R&D investments and a successful commercial
production introduction is often considerable." (Id., p. 6).
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Furthermore, intellectual property is highly mobile and could
be easily migrated to a low-tax jurisdiction. For example,
many high-tech businesses in California choose to conduct
their R&D in California but commercialize the resulting
innovations in another state or country. Thus, commercial
activity from successful R&D does not necessarily occur in the
same place where the R&D was conducted. In other words, the
R&D tax credit alone is insufficient for a state or a country
to be globally competitive, and a patent box incentive is
needed to transform R&D into economic growth in the state or
country.
As suggested by Mr. Atkinson at this Committee's hearing
"California's High-Tech Sector: Promoting Job Creation and
Innovation Through Sound Tax Policy" on December 5, 2011, a
successful patent box regime should be designed in a way that
links the incentive to conduct R&D and production of the
patented product in California. Such a tax incentive would
spur the creation of more innovation-based jobs, including
manufacturing jobs, in California more than a regular patent
box regime. Notably, Dr. Atkinson emphasized three key issues
that must be considered in designing a patent box in
California. First of all, California should consider
implementing a patent box rate that is at least half of the
regular corporate tax rate of 8.84%. Secondly, the definition
of "qualifying income" should not be overly restrictive since
some industries, such as software, do not rely as much on
patents to protect intellectual property. For example, the
Netherlands created an innovation box system where income from
innovation-based products qualifies for the lower rate, not
just income from patented products. Finally, it is important
to establish a policy link between the lower rate and
production in California by requiring that patented products
are developed and produced in state. Given the nature of
global supply chains, Dr. Atkinson recommended that a share of
the profits be taxed at a lower rate based on the share of
total R&D and production that is performed in California. In
his opinion, this approach would provide flexibility as well
as an incentive to produce R&D and products in the state.
5)What Does This Bill Do ? AB 1818 sets out to accomplish two
goals. It seeks to encourage companies to increase their R&D
activity at the UC and to commercialize in California the
patented products resulting from that activity. This bill
does not create a "patent box" regime per se. Instead, it
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establishes a credit in an amount equal to a percentage of the
royalty payments made by a qualified taxpayer - the taxpayer
that commercializes the licensed patent in California - during
a taxable year. Qualified royalties are defined as any
royalties paid for the use of a qualified patent through a
license agreement with the UC or other entity (i.e. an
original licensor). In other words, the credit is structured
in a way that requires a firm to invest in qualified research
at the UC first, at the time when state funding for UC is
decreasing. Then, if and when the research results in a
patented product, the UC will grant an exclusive license to
the firm that will have to commercialize the product in
California in order to be eligible for the proposed credit.
This bill also contemplates a situation where the original
licensor may decide to sub-license the right to develop the
patented product to another firm. In that case, the
sub-licensor will be eligible for the credit as long as it
commercializes the product in California. Thus, AB 1818 is
intended to link privately-funded R&D done by the UC with the
commercialization of the resulting product in California.
6)R&D Funding at the UC. In the 2010-11 fiscal year, the UC's
direct research expenditures totaled $4.44 billion, of which
50% were funded by the federal contracts and grants, 23% by
private gifts and grants, including corporate and nonprofit
entities, and 12% by the State & UC general funds.
Approximately $207 million of research expenditures came from
corporate entities and $7 million came from individuals. In
the same fiscal year, the UC received $16.9 million in royalty
income from California companies (excluding royalties from
plant varieties), $5 million in royalty income from
Californian plant nurseries (as a result of plant varieties),
and $6.9 million from non-California companies.
7)The Limited Incentive . Under this bill, a patent must be
commercialized in California in order to qualify a taxpayer
for the credit. However, as noted above, the nature of global
supply chains would significantly limit the use of the tax
incentive for firms that are willing to locate a significant
portion of their production in California but also have to
produce some overseas. The author may wish to consider
utilizing a pro rata approach, whereby a credit amount is
prorated in the case of a product that is partly made outside
of California. In such a case, the eligible credit amount may
be based on the share of production that was performed in
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California.
8)Franchise Tax board's (FTB) Implementation Concerns. In its
analysis, the FTB staff notes that this bill:
a) Does not require qualified taxpayers to maintain the
production of the product for any defined minimum amount of
time. As such, this bill would allow a taxpayer to begin
production in California and then transfer the production
out of state without any consequences, such as a recapture
of the used credits.
b) Would allow for an unlimited carryover period, which
would require the FTB to retain the carryover on the tax
forms indefinitely. Experience, however, shows that
credits typically are exhausted within eight years of being
earned.
9)Proposed Amendments . The author is planning to present
amendments to AB 1818 at this Committee's hearing on May 14,
2012. The amendments will specify the percentage of royalty
payments to be used to determine a credit amount, define the
term "commercialize," and address other concerns raised by the
FTB staff in its analysis of this bill.
REGISTERED SUPPORT / OPPOSITION :
Support
TechNet
Central Valley Business Incubator
University of California
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098