BILL ANALYSIS Ó
Senate Appropriations Committee Fiscal Summary
Senator Christine Kehoe, Chair
SB 116 (De Leon)
Hearing Date: 05/02/2011 Amended: 02/23/2011
Consultant: Mark McKenzie Policy Vote: G&F 6-3
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BILL SUMMARY: SB 116 would make the following changes to
apportionment formulas used to determine California taxable
income for specified multistate corporations:
Require specified corporations to use the "single sales
factor" apportionment formula for taxable years beginning on
or after January 1, 2011. This requirement would not apply to
the following business activities: agricultural, extractive,
savings and loans, and banking or financial services.
Repeal provisions that would allow a corporation to make an
annual election, beginning January 1, 2011, to use either the
single sales factor methodology or the traditional three
factor apportionment formula (payroll, property, and sales)
with double-weighted sales.
Require all corporations to use the "market rule" when
assigning sales of intangible goods to the state for purposes
of determining taxable income. All corporations would assign
sales from services to California to the extent the purchaser
derives benefit of the service in California, or the property
is used here.
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Fiscal Impact (in thousands)
Major Provisions 2011-12 2012-13 2013-14 Fund
Mandatory single-sales factor
apportionment (revenue gains) ($1,300,000)
($1,100,000) ($1,100,000) General
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STAFF COMMENTS:
The February 2009 state budget agreement included provisions
that revised the formula that multistate firms use to determine
the share of total income that is taxable in California (ABx3
15, Krekorian, and SBx3 15, Calderon). Previously, firms used a
weighted average of their California sales, property, and
payroll compared to its totals. Starting in 2011, firms may
choose to apportion using only the sales factor, which is
intended to encourage firms to locate payroll and property in
California. The Governor has proposed making the single sales
factor mandatory, rather than elective, as a part of his
2011-2012 budget. Both SB 79 (Budget and Fiscal Review
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Committee), which has been referred to the Assembly Budget
Committee, and AB 103 (Budget Committee), which is on the Senate
Floor, contain provisions similar to AB 116.
Apportionment Formula. A multistate firm generates profits
based on its operations in multiple states and has a right under
the U.S. Constitution to divide, or apportion, income among
those states for tax purposes to ensure that each state only
taxes its fair share of the firm's income. Since 1993, state
law has generally required multistate
firms to use a three factor formula to apportion income
associated with a company's payroll, property, and sales (with a
double-weighted sales factor) to California for purposes of
state taxation, except for companies that derive more than 50
percent of income from specified activities (extraction,
agriculture, savings and loan, and banks and financials). These
companies use the three factor formula but the sales factor is
not double-weighted. The double-weighted sales formula reduces
the 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 formula, a firm with all
or most of its production and payroll in California, but a
smaller share of its sales, benefits, 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 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, state law allows multistate firms to annually
choose between either the current three factor, double-weighted
sales apportionment formula or to use only its sales, while
ignoring property or payroll factors, commonly known as the
"single sales factor," to determine income apportioned to
California for purposes of taxation.
The recent Legislative Analyst's Office (LAO) report,
Reconsidering the Optional Single Sales Factor (May 26, 2010),
recommends 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 indicates that
the elective single sales factor allows the taxpayer to
essentially choose the tax it pays, creating an inequity
allowing taxpayers who operate in more than one state two
different ways to calculate their income. Multistate firms can
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choose the formula that will yield a lower tax each year, while
businesses that operate wholly inside California have no such
option. This disparate treatment puts the wholly in-state
businesses, as well as balanced multistate firms that would pay
roughly the same taxes under either formula, at a competitive
disadvantage to its multistate competitors that are primarily
based out of state, which tend to be larger companies.
Furthermore, since the single sales factor methodology is the
dominant apportionment formula among large states, making the
single sales factor mandatory in California would remove
incentives for firms to base operations elsewhere. To this
point, the LAO report notes that conformity with other large
states' apportionment formulas would prevent California firms
from being placed at a competitive disadvantage. While this
bill is intended to remove competitive barriers and encourage
investment in California, the state may lose some investments by
those firms that would have a higher tax liability as a result
of this bill to the extent that the benefits of current law
would encourage investment in California by those firms. Staff
notes that 24 other states have implemented or are in the
process of phasing in a single sales factor apportionment
methodology. Among these, 18 states require the use of a singe
sales factor and only Missouri allows an annual election of
either the single sales factor or the traditional three factor
formula
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." Intangible assets are not
considered tangible personal property, and include items and
services such as: online stockbrokers and telecommunications;
patents, trademarks, and copyrights; and licenses to operate
software programs. Under the "cost of performance" methodology,
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
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factor. 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.
SB 116 would eliminate the ability of multistate firms to
annually choose the apportionment formula that best suits its
circumstances, and instead requires these firms to use the
single sales factor methodology for taxable years on or after
January 1, 2011. The bill also requires all taxpayers that
assign sales of intangible goods to the state to use the "market
rule" to determine tax liability associated with intangibles.
The Franchise Tax Board estimates that the elimination of
elective rules, requiring multistate firms to apportion income
to California using the single sales factor methodology, and
requiring sales of intangibles to be sourced to the state using
the "market rule" would increase tax revenues by approximately
$1.3 billion in 2011-12, $1.1 billion in 2012-13, and $1.1
billion in 2013-14 and ongoing.
Staff notes that this bill would constitute a statutory change
resulting in a taxpayer paying a higher tax within the meaning
of Section 3 of Article XIIIA of the California Constitution
(Proposition 26 of 2010), thereby requiring the approval of
two-thirds of the membership of each house of the Legislature.