BILL ANALYSIS �
AB 1911
Page 1
Date of Hearing: May 14, 2012
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 1911 (Donnelly) - As Amended: April 10, 2012
VOTE ONLY
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Sales and use taxes: exemption: manufacturing
SUMMARY : Establishes a partial sales and use tax (SUT)
exemption, beginning January 1, 2013, for specified
manufacturing equipment. Specifically, this bill :
1)Exempts qualified tangible personal property (TPP) used by a:
a) "Qualified person" primarily in any stage of the
manufacturing, processing, refining, fabricating, or
recycling of property; or,
b) Contractor in the performance of a construction contract
for a "qualified person" who will use the qualified TPP as
an integral part of the manufacturing, processing,
refining, fabricating, or recycling process, or as a
storage facility for use in connection with the
manufacturing process.
1) Defines qualified 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) 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
replacement parts with a useful life of one or more years;
c) Property used in pollution control, as specified;
d) Special purpose buildings and foundations, as specified;
and,
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e) Fuels used or consumed in the manufacturing process.
2)Specifies that qualified TPP does not include:
a) Consumables with a normal useful life of less than one
year, except for fuels used in the manufacturing process;
b) Furniture and inventory;
c) Equipment used in the extraction process or used to
store finished products that have completed the
manufacturing process; or,
d) TPP used primarily in administration, general
management, or marketing.
3)Defines a "qualified person" as any of the following:
a) A person engaged in those lines of business described in
Industry Groups 3111 to 3399, inclusive, or 5112 of the
North American Industry Classification System (NAICS)
published by the United States Office of Management and
Budget, 2012 edition; or,
b) An affiliate of a person described above, as specified.
4)Defines "fabricating" as making, building, creating,
producing, or assembling components or property to work in a
new or different manner.
5)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 qualified TPP that result in a greater service
life or greater functionality than that of the original
property.
6)Defines "primarily" to mean that qualified TPP is used 50% or
more of the time in an activity that qualifies the taxpayer
for the SUT exemption.
7)Defines "process" to mean the period beginning at the point at
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which raw materials are received by the qualified person and
introduced into the manufacturing, processing, refining,
fabricating, or recycling activity of the qualified person 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.
8)Defines "processing" as the physical application of the
materials and labor necessary to modify or change the
characteristics of property.
9)Defines "refining" as the process of converting a natural
resource to an intermediate or finished product.
10)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;
b) Under Revenue and Taxation Code (R&TC) Sections 6051.2,
6051.5, 6051.8, 6201.2, 6201.5 or 6201.8, or pursuant to
Section 35 of Article XIII of the California Constitution;
and,
c) Under R&TC Sections 6051 and 6201 that is deposited in
the State Treasury to the credit of the Local Revenue Fund
2011 pursuant to R&TC Sections 6051.15 and 6201.15.
11)Applies to leases of qualified TPP classified as "continuing
sales" and "continuing purchases" in accordance with R&TC
Sections 6006.1 and 6010.1. The SUT exemption shall apply to
rentals under such a lease provided the lessee is a qualified
person and the property is used in a qualified manner.
12)Takes immediate effect as a tax levy.
EXISTING LAW imposes a:
1)Sales tax on retailers for the privilege of selling TPP,
absent a specific exemption. The tax is based upon the
retailer's gross receipts from TPP sales in this state.
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2)Complementary use tax on the storage, use, or other
consumption in this state of TPP purchased from any retailer.
The use tax is imposed on the purchaser, and unless the
purchaser pays the use tax to a retailer registered to collect
the California use tax, the purchaser remains liable for the
tax, unless the use is exempted. The use tax is set at the
same rate as the state's sales tax and must be remitted to the
State Board of Equalization (BOE).
FISCAL EFFECT : The BOE estimates that this bill would reduce
general fund revenues by $355 million in fiscal year (FY)
2012-13, and by $770 million in FY 2013-14.
COMMENTS :
1)The author has provided the following statement in support of
this bill:
If California's tax code was relatively simple and there
were fewer arduous regulations on businesses, there would
be no need to offer these kinds of exemptions. The
problem, however, is the state has piled burden after
burden upon businesses, especially manufacturers, and
driven industries out of the state. This barrage has left
our economy in ruins during one of the worst economic
downturns we have seen in a generation. The only way to
restore hope in this state is to create an incentive that
will allow manufacturers to be welcomed back and allow them
to hire from one of the largest unemployment pools in the
country. History has shown that the only way this country
has recovered from previous depressions and downturns is by
getting businesses manufacturing again. We must remove the
barriers and allow this to take place in California.
2)Proponents of this measure state:
For nearly a century, California was a global leader in
manufacturing, but the state lost 613,000 manufacturing
jobs between 2001 and 2011, according to data from the
California Employment Development Department. While most
of these jobs were lost during the national manufacturing
recession, the Milken Institute study, "Manufacturing 2.0,"
reports that California's manufacturing base declined
faster than the nation as a whole because of the state's
onerous regulatory climate and its high taxes. This trend
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also applies to other business sectors that often cite
California's high tax burden as one of the primary reasons
for relocating to other states.
The Milken Institute estimates that a 5-cent reduction of
the sales tax on manufacturing equipment purchases would
create 500,000 total jobs over a 10-year period, with
144,000 of those jobs in the manufacturing sector, and
bring in $459 million in new revenues to the state.
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 elective single sales factor and other
corporation tax breaks (e.g. loss carry-backs) in a
revenue-neutral manner. We also object to the credit for
the use of fuels in the manufacturing process, and arguably
the language defining manufacturing is too broad. However,
even if these problems were remedied, this bill should only
move forward if other issues in the corporation tax are
addressed to cover the revenue loss.
4)The BOE has provided the following comments in its staff
analysis of this bill:
a) "What types of entities are included in Codes 3111 to
3399 and 5112 ? Codes 3111 to 3399 include all
establishments primarily engaged in manufacturing
activities. This includes manufacturers in the aerospace
sector, food and beverage, tobacco, textiles and apparel,
wood and paper products, pharmaceuticals, chemicals,
fertilizers, plastics and rubber, paint and coatings,
printing, glass, cement and concrete product, metal
fabrication and machinery, transportation and related, and
computer and electronic product, and miscellaneous
manufacturing.
"Code 5112 is comprised of establishments primarily engaged
in computer software publishing or publishing and
reproduction. Software publishing establishments carry out
the functions necessary for producing and distributing
computer software, such as designing, providing
documentation, assisting in installation, and providing
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support services to software purchasers. The software
publishing industry produces and distributes information,
but usually it "publishes" or distributes its information
by non-printed methods such as by CD-ROM's, preloaded
software included in the sale of new computers, or through
electronic distribution over the Internet.
b) Administrative and technical concerns :
i) "In defining "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
the sales and use tax manufacturing equipment exemption
previously.
ii) "Another issue relates to the proposed definitions
for the types of property included and excluded from the
proposed exemption. For example, on page 4, lines 14 and
15, and lines 31 and 32, the bill refers to the items
having a useful life of one year or more (or less than
one year). In order to lessen potential audit disputes,
the bill should contain some mechanism for determining
the useful life. Perhaps some reference to the provision
in the California income tax laws for depreciating assets
should be incorporated into the bill.
iii) "Subdivision (c) would require a purchaser to
furnish an exemption certificate to the retailer and the
retailer to subsequently furnish the BOE with a copy of
the exemption certificate (this provision was in the
former Section 6377). This provision will require the
BOE to store copies of each exemption certificate taken
by a retailer, which is a cumbersome process for BOE
staff. To address this concern, staff suggests that the
bill be amended to require the retailer to retain a copy
of each exemption certificate and make it available to
the BOE for examination upon request. Staff can assist
the author's office in drafting this proposed amendment.
c) "The term "property" needs clarifying . The term
"property," which is used throughout proposed Section
6377.5, needs clarifying since, as currently drafted, the
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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
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."
"Without this clarification, the bill would not only
complicate administration of the statute, but also would
potentially open the door for aggressive litigation from
the providers of services, utilities, and intangibles,
possibly resulting in significant revenue losses to the
state far beyond what the Legislature intended. While
arguments for such greater scope seem unreasonable and
overbroad, clarification now would help preclude
unanticipated future issues and problems.
d) "Partial exemptions complicate administration of the
tax . Currently, most sales and use tax exemptions apply to
the total applicable sales and use tax. However, there are
currently five partial exemptions in California law, where
only the state tax portion (5.25%: General Fund (3.9375%),
Fiscal Recovery Fund (0.25%), and Local Revenue Fund 2011
(1.0625%)) of the state and local sales and use tax rate is
exempted. These five partial tax exemptions include: (1)
farm equipment and machinery, (2) diesel fuel used for
farming and food processing, (3) teleproduction and
postproduction equipment, (4) timber harvesting equipment
and machinery, and (5) racehorse breeding stock. These
partial tax exemptions are difficult for both retailers and
the BOE. They complicate return preparation and return
processing. And errors on returns attributable to these
partial exemptions occur frequently, which result in
additional return processing workload for the BOE.
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"This measure proposes a 3.9375% exemption (General Fund
only), which would create a new exemption category, since
current law does not have any partial exemptions other than
a 5.25% exemption. This would require a revision to the
sales and use tax return and result in a new, separate
computation on the return. Some retailers would have to
segregate in their records sales subject to the 3.9375%
exemption (proposed by this bill), 5.25% exemption, sales
with a full exemption (such as a sale for resale or a sale
in interstate commerce), and sales that are fully taxable.
This would add a new level of complexity, which would
create a corresponding increase in errors in reporting the
tax to the BOE. This increase in errors would further
complicate the BOE's administration of the sales and use
tax law and complicate reporting obligations of retailers."
5)Committee Staff Comments :
a) Is the proposed SUT exemption for manufacturing
equipment good tax policy? Businesses currently pay about
one-third of the state's SUT. A business pays SUT when it
is considered to be the final consumer of TPP. Any SUT
paid by a business will, however, be factored into the
prices it charges for goods, which, in turn, may be subject
to taxation. This results in end consumers paying a tax on
a tax (i.e., pyramiding), making the overall tax system
less transparent. Requiring businesses to pay SUT on their
manufacturing equipment also increases the cost of
production in California, placing the state at a
competitive disadvantage vis-�-vis other states that
provide exemptions for certain manufacturing equipment.
Thus, nearly all economists and tax experts agree that
taxing manufacturing equipment represents poor tax policy.
Indeed, during this Committee's March 23, 2009
informational hearing on "Tax Policy in a Time of Economic
Crisis," presenters unanimously agreed that it would make
sense to eliminate the SUT on most business purchases.
Such a change, however, should likely be considered in the
context of the state's overall tax structure. A SUT
exemption would obviously result in a significant reduction
of state revenues. For this reason, 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
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in revenues accompanying a manufacturing exemption.
b) Would a manufacturing exemption lead to job growth?
While a manufacturing exemption represents sound tax
policy, past experience suggests that it, by itself, may
not lead to large scale job creation. Prior to January 1,
2004, California had a similar tax incentive known as the
Manufacturers' Investment Credit (MIC), which was enacted
in response to the state's economic downturn during the
late 80s and early 90s. During this period, 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) determined 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 manufacturing
employment was 35,150.
c) Defining useful life. As noted by the BOE, this bill
specifies that qualified 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 and objective
standard for determining the useful life of an item.
d) Notification requirement. AB 1911 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 1911 does not provide a method for notifying BOE. Short
of an audit, BOE would have no means of learning of the
liability.
e) Related legislation. Committee staff notes the
following related bills introduced in the 2011-12
legislative session:
i) AB 303 (Knight) would have established a partial SUT
exemption for specified business equipment. AB 303 died
in the Assembly Appropriations Committee.
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ii) AB 979 (Silva) would have established a partial SUT
exemption, beginning January 1, 2012, for specified
business equipment. AB 979 died in this Committee.
iii) AB 1057 (Olsen) would have established a partial SUT
exemption for specified business equipment. AB 1057 died
in this Committee.
iv) AB 1972 (Huber) would establish a SUT exemption for
specified business equipment. AB 1972 is set to be taken
up by this Committee along with this bill.
REGISTERED SUPPORT / OPPOSITION :
Support
George Runner, Member, Board of Equalization
California Chamber of Commerce
California Manufacturers & Technology Association
California Taxpayers Association
Oxnard Chamber of Commerce
Southwest California Legislative Council
Opposition
American Federation of State, County and Municipal Employees,
AFL-CIO
California Federation of Teachers
California Tax Reform Association
Analysis Prepared by : M. David Ruff / REV. & TAX. / (916)
319-2098