BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 1505 HEARING: 4/11/12
AUTHOR: DeSaulnier FISCAL: Yes
VERSION: 4/9/12 TAX LEVY: No
CONSULTANT: Miller
Makes the elective single sales factor apportionment
mandatory and creates the "Keep our Promises Act" for
veterans in this State.
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.
SB 1505 -- 4/9/11 -- Page 2
Starting in 2011, California's apportionment formula allows
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 1505 -- 4/9/11 -- 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 1505 -- 4/9/11 -- 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 . SB 1505 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
SB 1505 -- 4/9/11 -- Page 5
performance . SB 858 (Committee on Budget, 2010) requires
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. SB 1505 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 property to "this state" under the market
rule and 50% shall "not be assigned to this state."
III. Veteran's Proposal. SB 1505 proposes using the funds
generated by the imposition of mandatory single sales
factor on existing and new programs within the Department
of Veterans Affairs in a continuously appropriated "Keep
our Promised Fund." This bill provides that the funds in
the Keep Our Promises Fund would supplant the General Fund
revenues appropriated to the Department of Veterans Affairs
and requires specified additional allocations by the
Department of Veterans Affairs regarding veterans' homes,
small business loans for veterans, and the Veterans'
Assistance Grant Program, which would be created by this
bill. Many of these items do not yet have a specified
budget allocation but are blank in the bill.
State Revenue Impact
According to the FTB, this bill will raise: $1.2 billion in
2012-14, $950 Million in 2014-15 and $1 billion in 2014-15.
Comments
1. Purpose of the bill . According to the author,
"California has more veterans than any State in the
country. Over 2 million veterans live in the state, with
37,000 more returning from overseas every year. Naturally,
after serving in high combat areas, veterans need
assistance adjusting to civilian life. However, because of
strained budgets, the federal and state government has
continually failed to respond quickly and effectively to
the most needy and deserving in the community.
Many veterans suffer from untreated mental and physical
disorders that prevent them from becoming productive
SB 1505 -- 4/9/11 -- Page 6
members of society. For example, from 2002 to 2003 there
was a 232% increase in post-traumatic stress disorder
(PTSD) in veterans born after 1972. Despite these rising
numbers, the U.S. Department of Veterans Affairs (VA) does
not have the resources to provide adequate care to the
overwhelming need for mental health care.
In response, veterans sued the federal government for
failing to provide adequate mental health care, among other
services. Last year, the U.S. Court of Appeals for the 9th
Circuit ruled in favor of the veterans, concluding that we
must "fulfill our country's obligation to care for those
who have protected us."
In addition, veterans often have difficulty sustaining
consistent employment and regularly maintain upwards of a
20% unemployment rate--the highest of any group in the
state. While the state has many existing state and
nonprofit veterans' organizations focused on providing
transition employment services, perpetual budgetary
problems have strained their budgets, preventing them from
helping all that need it.
Lastly, veterans have disproportionate rates of
homelessness. Although accurate counts are impossible to
come by, the US Departments of Housing and Urban
Development and Veterans Affairs estimate that over 67,000
veterans are homeless on any given night. In Los Angeles
alone, over 7,400 veterans have nowhere to live. In order
to address this problem, the Federal and State VA has begun
the construction of many affordable housing projects for
veterans, including 150 rooms in Redding and 300 in Fresno.
However, because of constant budgetary problems, the State
does not have the resources to staff these homes, and many
are in danger of falling into disrepair.
Veterans are heroes and should be treated accordingly. The
California Keep Our Promises Act is a reflection of the
states abiding commitment to Californians who have
courageously served our country. By creating a constant
funding stream to the Department of Veterans Affairs, and
providing special grants to fund non-governmental
organizations who serve veterans, SB 1505 will provide the
support and assistance for those soldiers who have fought
so hard to protect all of us."
SB 1505 -- 4/9/11 -- Page 7
2. Don't tax me . Two groups that oppose this tax cite
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 that in 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
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
3-factor formula: those businesses that would pay more
under the 3-factor formula before the application of any
tax credits. This so-called "Silicon Valley Fix," with no
specific support, is intended to allow some companies need
this option in order to fully utilize their available
credits. The FTB estimates no additional cost or revenue
loss associated with this change. 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 there is a possibility that taxpayers would
still pay less under less under the 3-factor formula
because of the availability of credits which the
calculation in this bill does not consider.
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
SB 1505 -- 4/9/11 -- Page 8
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
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)
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.
AB 1500 (P�rez) also requires the state adopt a
mandatory single sales factor and uses all revenue for
the Middle Class Scholarship Fund which would allocate
the revenue to increase the affordability of higher
education. The bill is awaiting hearing in the
Assembly Revenue & Taxation Committee.
The "California Clean Energy Jobs Act," is an
initiative sponsored by Tom Steyer, collecting
signatures for placement on the November, 2012 ballot.
The initiative proposes imposing a mandatory single
sales factor on California corporation 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.
5. Dr. Frankenstein's Creation . As Edward Kleibard,
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
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
SB 1505 -- 4/9/11 -- Page 9
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 treat should
apply the same rules to all taxpayers. 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. The Committee may wish to consider why a separate
set of rules should apply to cable companies.
6. Blakity Blank . This bill allocates funds to various
existing and new programs within the Department of
Veteran's Affairs but does not specify any amounts. As
this bill will be heard in the Senate Veteran's Affairs
committee should it get out of this committee, the author
will address these blanks there.
Support and Opposition (4/5/11)
� Support : Gordon P. Erspamer, Morrison and Forester.
SB 1505 -- 4/9/11 -- Page 10
Opposition : Alliance of Automobile Manufacturers,
California Asian Pacific Chamber of Commerce, California
Chamber of Commerce, California Manufacturing & Technology
Association, California Taxpayers Association, Chrysler,
General Motors, International Paper, Kimberly- Clark
Corporation, Howard Jarvis Taxpayer's Association, Procter
& Gamble.