BILL ANALYSIS �
AB 2045
Page 1
Date of Hearing: April 23, 2012
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 2045 (Perea) - As Amended: April 16, 2012
Majority vote. Fiscal committee.
SUBJECT : Emerging technology and biotechnology companies:
transfer of net operating losses.
SUMMARY : Creates a program to allow certain emerging technology
and biotechnology companies to transfer their net operating
losses (NOLs) to other companies, as specified, in exchange for
private financial assistance, as provided. Specifically, this
bill :
1)Authorizes the California State Treasurer (Treasurer), in
cooperation with the Franchise Tax Board (FTB), to establish a
"corporation business tax benefit certificate transfer
program" (Program) to allow new or expanding emerging
technology and biotechnology companies in California
(qualified companies) to transfer their unused NOLs to other
taxpayers in this state. Specifically, provides that:
a) Unused, but otherwise allowable, NOLs, as described in
Revenue and Taxation Code (R&TC) Section 17276.20 or
Section 24416.20, may be surrendered by a qualified company
for use by a taxpayer that is subject to the Corporation
Tax (CT) Law.
b) The tax benefits of the surrendered NOLs may be used by
the recipient taxpayer on a tax return filed pursuant the
CT Law.
c) The recipient taxpayer must provide "private financial
assistance" to aid in funding of costs incurred by the
qualified company.
d) The amount of the private financial assistance must
equal at least 80% of the amount of the surrendered NOLs.
e) The private financial assistance shall help with funding
expenses incurred in connection with the operation of a
qualified biotechnology company in California, including
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the expenses of fixed assets, such as the construction and
acquisition and development of real estate, materials,
start up, tenant fitout, working capital, salaries,
research and development expenditures, and any other
similar expenses.
2)Directs the Treasurer and FTB to review and approve
applications filed by a qualified company to surrender its
unused NOLs in exchange for private financial assistance.
3)Limits the total amount of transferable NOLs in any given
fiscal year to $60 million and requires the Treasurer, in
cooperation with the FTB, to allocate the amount of
surrendered NOLs as transferable NOLs, to ensure that the
total amount is within the $60 million limit, in the following
order:
a) An eligible applicant with $250,000 or less of
transferrable NOLs is authorized to surrender the entire
amount of NOLs.
b) An eligible applicant with more than $250,000 of
transferable NOLs is authorized to surrender a minimum of
$250,000 of its NOLs, plus a proportionately reduced amount
of the remaining NOLs.
4)Defines "amount of surrendered NOLs" as the amount of the NOL
multiplied by a qualified company's anticipated apportionment
factor, as determined by R&TC Section 25128 or Section
25128.5, for the taxable year in which the NOL is transferred
and subsequently multiplied by the rate of the franchise or
income tax, whichever is applicable.
5)Limits the amount of applicant's NOLs eligible for
transferable tax benefits to the NOLs that the applicant
requests and is eligible to surrender.
6)Provides that an otherwise qualified company is not eligible
to surrender its NOLs if the company:
a) Has demonstrated positive net operating income in any of
the two previous full years of ongoing operations, as
determined on its financial statements issued according to
generally accepted accounting standards endorsed by the
Financial Accounting Standards Board; or
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b) At least 50% of its stock is directly or indirectly
controlled or owned by another corporation that either:
i) Has demonstrated positive operating income in any of
the two previously full years of ongoing operations, as
evidenced by its financial statements, as specified; or,
ii) Is part of a consolidated group of affiliated
corporations that, in the aggregate, has demonstrated
positive net operating income in any of the two previous
full years of ongoing operations.
7)Limits the maximum lifetime value of surrendered NOLs that a
corporation is permitted to surrender to $15 million and
provides that applications to surrender NOLs must be received
on or before June 30 of each fiscal year.
8)Requires the Treasurer, in consultation with the FTB, to
establish rules for the recapture of all, or a portion, of the
amount of a tax certificate if the company that surrendered
the NOLs fails to use the private financial assistance, as
required, or fails to maintain a headquarters or a base of
operation in California during the five years following
receipt of the assistance. Provides an exception from the
recapture if the failure to maintain a headquarters or a base
of operation was due to the liquidation of the company.
9)Directs the Treasurer, in cooperation with the FTB, to review
and approve applications of corporate taxpayers to acquire
surrendered NOLs from companies in exchange for financial
assistance. Provides that the surrendered NOLs will be issued
in the form of corporation business tax benefit transfer
certificates.
10)Requires the company that wishes to surrender its NOLs to
certify that, as of the date of the exchange, it is operating
as a qualified company and has no current intention to cease
operating as such.
11)Provides that the Treasurer must require a taxpayer that
acquires a tax benefit certificate to enter into a written
agreement with the qualified company regarding the terms and
conditions of the private financial assistance and the
maintenance of a headquarters or a base of operation in
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California.
12)Specifies that any NOLs transferred pursuant to this program
to a taxpayer are allowed beginning on or after the first day
of the fourth taxable year after the date of issue of the
certificate, but only if the company that surrendered the NOLs
is still in business or has been acquired by another company.
13)Defines "biotechnology" as the continually expanding body of
fundamental knowledge about the functioning of biological
systems from the macro level to the molecular and subatomic
levels, as well as novel products, services, technologies, and
sub-technologies developed as a result of insights gained from
research advances that add to that body of fundamental
knowledge.
14)Defines "technology company" as an emerging corporation that
meets all of the following requirements:
a) Has its headquarters or base of operations in
California;
b) Owns, has filed for, or has a valid license to use
protected, proprietary intellectual property; and,
c) Employs some combination of highly educated or trained
managers and workers, or both, in California who use
sophisticated scientific research service or production
equipment, processes or knowledge to discover, develop,
test, transfer, or manufacture a product or service.
15)Defines a "biotechnology company" as an emerging corporation
that:
a) Has its headquarters or base of operations in this
state;
b) Owns, has filed for, or has a valid license to use
protected, proprietary intellectual property; and,
c) Is engaged in the research, development, production, or
provision of biotechnology for the purpose of developing or
providing products or processes for specific commercial or
public purposes, as provided.
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16)Defines "new or expanding" as a technology or biotechnology
company that, at the end of the calendar year prior to the
year in which the company applies for the NOL surrender, has
fewer than 225 employees in the United States, and (a) has at
least one full-time employee working in California if the
company has been incorporated for less than three years, (b)
five full-time employees if the company has been incorporated
for more than three years but less than five years, or (c) at
least 10 employees if the company has been incorporated for
more than five years.
17)Defines a "full-time employee" as any of the following:
a) A person employed by a new or expanding emerging
technology or biotechnology company for consideration for
at least 35 hours a week;
b) A person who renders any other standard of service
generally accepted by custom or practice as full-time
employment and whose wages are subject to withholding, as
required by Unemployment Insurance Code Division 6
(commencing with Section 13000);
c) A partner of a new or expanding emerging technology or
biotechnology company who works for the partnership other
than as an employee for at least 35 hours a week; or
d) A partner who works for the partnership other than as
employee and who renders any other standard of service
generally accepted by custom or practice as full-time
employment, and whose distributive share of income, gain,
loss, or deduction, or guaranteed payments are subject to
the payment of estimated taxes.
18)Provides that, in order to qualify as a "full-time employee,"
an employee shall receive from the company health benefits
under a group health plan, a health benefits plan, or a
specified policy or contract issued pursuant to the Insurance
Code.
19)Excludes from the definition of a "full-time employee" any
person who works as an independent contractor or on a
consulting basis.
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20)Provides that "group health plan" means an employee welfare
benefit plan, as defined in Title 1 of Section 3 of the
Employee Retirement Income Security Act of 1974, to the extent
that the plan provides medical care and including items and
services paid for as medical care to employees or their
dependents, as specified.
EXISTING FEDERAL LAW:
1)Allows a corporate taxpayer to carry forward a NOL for 20
years, or carry it back for two years, to reduce future or
past taxable income, as long as the corporation's legal
identity is maintained.
2)Does not allow a taxpayer to sell its NOLs to another
taxpayer.
3)Provides that, after certain asset acquisitions in which the
acquired corporation goes out of existence, the acquired
corporation's NOL carry forwards, generally, are inherited by
the acquiring corporation. However, in order to limit
tax-motivated acquisitions of loss corporations, the use of
those NOLs and other carry forwards may be subject to special
limitations. Acquired losses also include what is called an
"unrealized built-in loss", which is the amount of the value
of assets reported on the acquired corporation's books that
exceeds the fair market value of its assets immediately before
the corporation is acquired.
4)Limits the amount of acquired losses that the acquiring
corporation may use to offset its income in the year of
acquisition and the following years �Internal Revenue Code
(IRC) Section 382]. Generally, the acquiring corporation may
use the acquired corporation's losses in the amount equal to
the value of the acquired corporation, measured by the value
of its stock immediately before the acquisition, multiplied by
the long-term tax exempt rate, a base interest rate computed
by the Internal Revenue Service.
EXISTING STATE LAW:
1)Conforms to the IRC either by reference to federal law as of a
"specified date" or by stand-alone language that mirrors the
federal provision. Currently, certain provisions of the
Personal Income Tax (PIT) Law and CT Law are conformed to the
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IRC as of January 1, 2009, unless otherwise provided. SB 401
(Wolk), Chapter 14, Statutes of 2010 was the last
California/federal conformity bill.
2)Allows taxpayers to carry forward NOLs for 20 years and
authorizes NOL two-year carrybacks beginning in the 2011
taxable year. �AB 1452 (Committee on Budget), Chapter 763,
Statutes of 2008].
FISCAL EFFECT : The FTB staff provided the General Fund
estimates of this bill:
------------------------------------------------
| Estimated Revenue Impact of AB 2045 |
|------------------------------------------------|
|For Taxable Years Beginning On Or After January |
| 1, 2013 |
|------------------------------------------------|
| Assumed Enactment After June 30, 2012 |
|------------------------------------------------|
| ($ in millions) |
------------------------------------------------
------------------------------------------------
|2012-1|2013-1|2014-1|2015-1|2016-1|2017-1|2018-1|
| 3 | 4 | 5 | 6 | 7 | 8 | 9 |
|------+------+------+------+------+------+------|
|-$0.02|-$0.06|-$0.04|-$0.02|-$2.40|-$5.00|-$5.40|
| | | | | | | |
------------------------------------------------
COMMENTS :
1)Author's Statement . The author states that AB 2045 "would
make it clear that California understands the importance of
supporting its local technology and biotechnology companies.
California was the nation's leading cyber state with 931,000
tech industry workers in 2010, more than twice as many as
second ranked Texas, and more than three times as many as
third ranked New York. Over 260,000 Californians were also
employed by the biotech industry in 2009 with an average
salary of $72,000 a year. These industries are significant
with improving the economic development in California by
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creating and maintaining high wage, high quality jobs.
"The cost of available funding for early stage companies can
be very high and possibly totally unavailable. Although the
net operating losses may be used to offset taxes once the
company becomes profitable, some of these companies are not be
able to reach profitability without additional sources of
capital. The Corporation Business Tax Benefit Certificate
Transfer (CBTBCT) program would be designed to help these new
and emerging companies to bridge this funding gap. The
additional funding is potentially critical to their survival
because it would allow them to turn their tax losses and
credits into cash to buy equipment or facilities, or for other
expenditures."
2)Arguments in Support . The proponents of this bill argue that
NOLs "are one the most valuable tools the State of California
has to remain competitive with other states in the life
science industry space, and this bill will allow small
companies to realize a monetization of those unused credits."
Early stage companies "face the challenge of a long (often
10-12 years) period of development before approval" and in the
current economic climate have even fewer options "to access
the tremendous capital needed to take a candidate from
discovery to approval." The proponents believe that AB 2045
"may give many of these young companies a lifeline while they
work to advance their candidates through the very difficult
period of early stage development."
3)NOLs: Background . Generally speaking, an NOL is the excess
of business deductions over gross income in a particular tax
year. In other words, an NOL is incurred when a business
taxpayer has negative taxable income. An NOL can be used to
obtain a refund for taxes paid in the past and/or to reduce
future tax obligations. The process of using an NOL to refund
previously paid taxes is known as an NOL carryback, whereas
the process of using an NOL to reduce future taxes is known as
a carry forward. Individuals, Subchapter C corporations,
estates and trusts and charitable organizations (with respect
to the unrelated business income tax) can benefit from NOLs.
Pass-through entities such as partnerships and Subchapter S
corporations do not benefit from the NOLs themselves, but
rather they pass through the benefit of the NOL to the
partners or shareholders, respectively.
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Under federal law, nearly every taxpayer is allowed to carry
back an NOL from a trade or business to apply as a deduction
against income in prior taxable years. Generally, NOLs can be
carried back to the two years preceding the loss year and then
forward to the 20 years following the loss year. Recently,
the federal carryback period was extended from two to five
years for 2008 and 2009 NOLs. California mostly conforms to
the federal law for NOLs and recently authorized NOL carry
backs beginning in the 2011 tax year. For NOLs generated in
the 2011 taxable year, taxpayers may carry back 50% of the
loss to the 2009 and 2010 taxable years. For NOLs generated
in the 2012 taxable year, taxpayers may carry back 75% of the
loss to the 2010 and 2011 taxable years. For NOLs generated
in the 2013 taxable year and thereafter, taxpayers may carry
back 100% of the loss to the 2011 taxable year and thereafter.
The basic rationale for allowing losses to be carried forward
and back flows from recognition that businesses are
established with the goal of making a profit over a business
cycle rather than in any particular year. Economic theory
demonstrates that a suitably long period for NOL deductions
helps to smooth out income and taxes paid over a business
cycle, thereby allowing a business to make efficient decisions
regarding financing and investment. For example, consider two
firms, one with a $100 loss in year one and a $300 gain in
year two, the second with a $100 gain in each year. Without a
NOL deduction, over the two years, the first firm would report
$300 taxable income, while the second would report $200, even
though each had $200 net income. �Department of Finance
(DOF), Annual Tax Expenditure Report, 2008-09].
The NOL deduction levels the playing field for firms with
volatile and steady income and is not considered a tax
expenditure by the DOF. Similarly, the federal Joint
Committee on Taxation does not view NOL carrybacks or
carryforwards as tax expenditures. It's assumed that the
general limits on the number of years that such losses may be
carried back or forward were chosen for reasons of
administrative convenience and compliance concerns and
represent normal income tax law.
4)Transfers of NOLs Under Existing Law . Neither federal nor
state law allows taxpayers to sell NOLs and severely restrict
the taxpayers' ability to transfer NOLs. IRC Section 382,
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originally added to the IRC in 1954 and completely re-written
in 1986, was enacted to limit tax-motivated acquisitions of
loss corporations. Prior to the enactment of IRC Section 382,
corporations with large losses were attractive to buyers with
large taxable income simply because the acquired corporation's
losses could be used to reduce the buyer's taxable income and,
effectively, the cost of acquisition. The limitations
currently in place preclude a buyer from using the NOLs and
built-in losses of the acquired entity at a rate that is
faster than the rate at which the acquired corporation could
have used them if it had sold its assets and invested the
proceeds in tax-exempt governmental obligations. Built-in
losses are also subject to special limitations because they
are economically equivalent to pre-acquisition NOL carry
forwards. If "built-in losses were not subject to
limitations, taxpayers could reduce or eliminate the impact of
the general rules by causing a loss corporation (following an
ownership change) to recognize its built-in losses free of the
special limitations" and "then invest the proceeds in assets
similar to the assets sold." (General Explanation of the Tax
Reform Act of 1986, Joint Committee on Taxation, p. 298, May
4, 1987). The purpose of this IRC Section 382 limitation is
to make losses a neutral factor in a corporate acquisition.
5)The Proposed Transfers of NOLs. AB 2045 would allow small
biotechnology and technology companies to transfer unused NOLs
to other unaffiliated companies in exchange for private
financial assistance. The program would be administered by
the Treasurer, in cooperation with the FTB. The total amount
of transferable NOLs in any given year would be capped at $60
million. AB 2045 would apply only to small companies, i.e.
companies that employ fewer than 225 employees in the United
States. In addition, to qualify as eligible, a company has to
employ at least one full-time person in California, if the
company has been incorporated for more than three years, at
least five full-time employees, if the company has been
incorporated for more than three more but fewer than five
years, and at least 10 full-time employees if the company has
been incorporated for more than five years. Any NOLs
transferred pursuant to AB 2045 would be allowed to a taxpayer
beginning on or after the first day of the fourth taxable year
after the date of issue of the corporation business tax
benefit certificate. This bill also conditions the usage of
the acquired NOLs on the existence of the company that
transferred those NOLs. If the transferor is no longer in
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business or has not been acquired by another company, the
transferred NOLs will have no value. Overall, the proposed
program is patterned after the New Jersey corporation business
tax benefit certificate transfer program and is very limited.
6)Technology Business Tax Certificate Transfer Program: The New
Jersey Experience . In 1995, New Jersey (NJ) created a program
- the NJ Technology Business tax Certificate Transfer Program
- authorizing new and emerging technology and biotechnology
companies in NJ to transfer their unused research and
development (R&D) tax credits, as well as unused NOLs, to
other unaffiliated corporations doing business in the state.
These tax benefits may be acquired and used by the
unaffiliated corporations in exchange for private financial
assistance to the qualifying technology and biotechnology
companies. The NJ Program is very similar to one created by
AB 2045, although the California program would not allow a
sale of R&D tax credits.
In 2010, the NJ Institute of Technology conducted an evaluation
of the NJ Program to determine the program effectiveness. The
study found that the primary goal of the program - creation of
high wage and high quality jobs in NJ in a cost-effective
manner - was achieved but only for biotechnology companies.
The study concluded that, while "technology companies are an
important opportunity for job creation in New Jersey, other
programs like direct grants to promising startups, support of
the business incubator networks, and co-investment in startups
through the Edison Innovation Fund would be a more effective
way to generate and maintain significant technology employment
in New Jersey." (New Jersey's Science & Technology
University, Program Evaluation: New Jersey Technology Business
Tax Certificate Transfer Program, p. 2). The study also
states that "the cost of the tax transfers is less than the
benefit of the NJ income tax revenues generated by the
beneficiary companies." (Ibid.) The authors of the study made
several recommendations to improve the effectiveness of the
almost 20-year old program but concluded that it should be
continued only for biotechnology companies. They also
suggested an amendment to the program to incorporate issuance
of warrant to NJ in connection with the authorization of
credits and a provision for a discounted direct state buyback
of the issued credits.
7)Implementation Concerns . The FTB has identified several
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implementation issues.
a) The bill should include provisions in the R&TC in order
to allow the use of corporation business tax benefit
certificates to reduce the taxpayer's taxable income, as if
it was an NOL generated by the taxpayer or to apply the
amount of tax benefit against the taxpayer's tax liability
(like a credit).
b) The bill fails to provide guidance for the approval of
acquirers, other than requiring acquirers to enter into a
written agreement with the transferor. It is unclear if
the acquirer can request the certificates of a specific
corporation or not. The language should clarify the
process.
c) The bill provides for the surrender of NOLs generated
under PIT Law (individuals, partnerships and limited
liability corporations). Those NOLs become NOLs at the
partner/member level, which could lead to some
partners/members surrendering and some not surrendering
their NOLs. This would be difficult to track and
administer. A potential solution would be to limit the
surrender to corporate NOLs only.
d) The bill is silent on a number of issues, such as the
deductibility of the acquisition costs or whether the
transferor would have income as a result of receiving the
required financial assistance. These issues were addressed
in the language for the assignments of credits within a
combined reporting group and would need to be included in
the language of this bill in order for FTB to administer
the bill.
e) At the time of surrendering their NOLs, most taxpayers
will, most likely, not have had their NOLs audited by the
FTB. As a result, when the NOL is audited, most likely
several years later, the audit findings could affect the
allocation of the $60 million cap for that tax year.
Technically, FTB would have to re-evaluate the calculation
and provide the new information to the Treasurer. This
would make the administration very difficult to do as the
allocation of the capped amount would change as audit
cycles are completed. An allocation process similar to the
allocation process for the movie credit (first in line
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approach) would be a much more effective method.
8)Committee staff notes that it is not clear whether a qualified
recipient of the unused NOLs is precluded from reselling the
NOLs remaining after four years to another qualified taxpayer,
provided that the general statute of limitations for that NOL
is still open. The author may wish to consider amending this
bill to clarify the tax treatment of the NOL remainder, if
any.
9)Related Legislation .
AB 1147 (Mullin), introduced in the 2007-08 Legislative session,
would have allowed certain corporations to sell their unused
NOLs. AB 1147 was held under submission in this Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
BIOCOM
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098