BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 1399 HEARING: 6/25/14
AUTHOR: Medina FISCAL: Yes
VERSION: 6/18/14 TAX LEVY: Yes
CONSULTANT: Grinnell
CALIFORNIA NEW MARKETS TAX CREDIT
Enacts the California New Markets Tax Credit.
Background and Existing Law
California law allows various income tax credits,
deductions, and sales and use tax exemptions to provide
incentives to compensate taxpayers that incur certain
expenses, such as child adoption, or to influence behavior,
including business practices and decisions, such as
research and development credits. The Legislature
typically enacts such tax incentives to encourage taxpayers
to do something that but for the tax credit, they would not
do. The Department of Finance is required to annually
publish a list of tax expenditures, currently totaling
around $50 billion per year.
I. CAEATFA's SB 71 Program. Housed in the office of the
State Treasurer, the California Alternative Energy and
Advanced Transportation Financing Authority (CAEATFA)
provides financing through conduit or revenue bonds, loan
guarantees, loan loss reserves and a sales and use tax
exemption for facilities that use alternative energy
sources and technologies. While the Legislature created
CAEATFA in 1980, it didn't do much until 2008, when
Governor Arnold Schwarzenegger and State Treasurer Bill
Lockyer announced that CAEATFA would use its existing
authority to grant sales and use tax exemption for normally
taxable manufacturing equipment purchased by Tesla Motors
under a sale-leaseback agreement. Subsequently, the
Legislature directed CAEATFA to administer sales and use
tax exemptions for manufacturers of renewable technology
(SB 71, Padilla, 2010), and advanced manufacturing (SB
1128, Padilla, 2012). CAEATFA is authorized to allocate
exemption up to $100 million annually to successful
applicants.
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II. Local Economic Development Reform. Last year, the
Legislature enacted AB 93 (Committee on Budget) and SB 90
(Committee on Budget and Fiscal Review), measures which
reformed California's economic development policies by
eliminating enterprise zones and other
geographically-targeted economic development areas, instead
allowing three new tax benefits:
Tax credits for wages paid by taxpayers to
qualified employees within former enterprise zones,
and other areas that suffer from high levels of
poverty and unemployment. The credit lasts from the
2014 taxable year until the 2019 taxable year.
A sales and use tax exemption on purchases of
manufacturing equipment made by taxpayers within
specific North American Industrial Classification
System codes, capped at $200 million annually per
taxpayer, effective July 1, 2014, and ending July 1,
2022. The exemption largely superseded the SB 71 and
SB 1186 programs, as they applied to almost all the
same taxpayers.
The California Competes Tax Credit, where the
California Competes Tax Credit Committee, also created
by the bill, can award various tax credits up to an
annually capped amount to taxpayers who apply. The
Committee is comprised of the Treasurer, the Director
of Finance, the Director of the Governor's Office of
Business and Economic Development (GO-BIZ), one
appointee of the Speaker of the Assembly, and one
appointee from the Senate Committee on Rules.
III. Federal New Markets Credit and California's CDFI
credit. Created in 2000, Federal law allows a new markets
tax credit for a taxpayer's investments in qualified
community development entities, the primary mission of
which must be serving or providing investment capital for
low-income communities or low-income persons, as certified
by the Secretary of the Treasury. The federal credit is
equal to 39% of the qualified equity investment and is
spread over seven years. The Community Development
Financial Institutions Fund allocated $777 million in
Federal New Markets Tax Credits to financial institutions
in California in 2013.
State law does not conform to the federal new markets
credit, but instead allows the Community Development
Financial Institution credit (CDFI), administered by the
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Department of Insurance (DOI) (AB 1520, Vincent, 1997).
Taxpayers may claim a credit against the Gross Premiums
Tax, Personal Income Tax, or Corporation Tax equal to 20%
of qualified investments in the form of non-interest
bearing deposits, loans, or equity investments of at least
$50,000 held for at least 60 months. Taxpayers can carry
over the credit for four years.
The credit was initially used only to reduce Personal
Income Tax, or Corporation Tax liabilities, but the
Legislature added a credit against the Gross Premiums Tax
in 1999, also administered by DOI (AB 157, Vincent). In
2002, the Legislature extended the credit until 2007 (SB
409, Vincent), again until 2012 (AB 2831, Ridley-Thomas,
2006), and once more until 2017 (AB 624, J. P�rez, 2011).
After many years of lack of demand for CDFI credits,
efforts by Insurance Commissioner Dave Jones led to
increased demand for the credits, which resulted in the
Legislature expanding the credit last year from $10 million
to $50 million (AB 32, J. P�rez).
For deposits to generate credits, CDFI must be certified by
the California Organized Investment Network (COIN), an
office in DOI, by demonstrating that it is a private
financial institution located in California, its primary
mission is community development, and that it lends in
urban, rural or reservation-based communities in
California. CDFIs may be banks, credit unions, or
non-regulated non-profit institutions organized to provide
private capital for community development or investing.
There are currently 27 CDFIs in California, down from 50 in
2011. CDFIs must use the proceeds of the investment for a
purpose that is consistent with its community development
mission and for the benefit of economically disadvantaged
communities and low-income people in California. COIN
generally allocates the credits on a first-come,
first-served basis; however, if COIN determines that the
total amount of investment will exceed the cap, it can
prioritize applications with investments that directly
benefit low-income persons, or prioritize affordable
housing, housing for veterans, and self-help housing ahead
of single-family housing. DOI or the Franchise Tax Board
(FTB) may recapture the credit within the 60 month period
if the taxpayer reduces or withdraws the investment.
Proposed Law
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Assembly Bill 1399 enacts a California New Markets Tax
Credit against the Gross Premiums Tax, Personal Income Tax
and Corporation Tax, administered by the California
Competes Tax Credit Committee, commencing in the 2015
taxable year, and ending in the 2027 taxable year. CAEATFA
must certify the amount of unallocated sales and use tax
exclusions under its $100 million cap in the calendar year;
the Committee can allocate up to that amount of New Markets
Tax Credits each calendar year, but not more than $40
million in credits annually. Any unused credits must be
returned to the Committee by March 1st and be available for
the Committee to reallocate in the following calendar year.
Taxpayers may claim a credit equal to 39% of the investment
in a qualified community development entity held for six
years, but must hold the equity investment on each credit
allowance date to claim the credit. The investment must be
obtained at original issue solely in exchange for cash,
substantially all of which is used by the community
development entity to make qualified investments. The
taxpayer can't claim a credit in the first year; instead,
the taxpayer may claim a credit equal to 7% in the second
year of the investment, 8% in the third year, and 8% in the
fourth, fifth, and sixth years. Taxpayers may carry over
the credit for six years.
To generate tax credits for investors, qualified entities
must:
Be domestic corporations or partnerships that have
as their primary mission serving, or providing
investment capital for, low-income communities and
low-income persons.
Have low-income persons be represented on the
corporation's governing or advisory board.
The measure also allows subsidiary community development
entities of an entity that meets the terms or a tax-exempt,
nonprofit corporation certified by the Committee as meeting
the terms above to qualify investors for the credit. The
Committee must establish guidelines to certify nonprofit
organizations under the bill, including reasonable
conditions on the certification, and may suspend or revoke
a certification after giving the organization notice and an
opportunity to be heard.
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The qualified entity must invest in a qualified low-income
community business for the investor to claim the credit
under the same terms as federal law. Entities may invest
funds in either equity investments of stock in a
corporation or capital interests in partnerships to qualify
investors for credits. If the business meets the below
tests at the time of the investment, the taxpayer can still
claim the credit. To qualify, a business must:
Derive at least 50% of total gross income from the
active conduct of a business in a low-income
community, as defined,
A substantial portion (40%) of the business's use
of tangible property and services performed by its
employees takes place in a low-income community in
California; however, the employment test only applies
if the entity holds a federal new markets tax credit;
instead, for those entities an investment in a
business qualified if the business uses 50% of its
property within any low-income community for any
taxable year.
Can't have more than 50% of its aggregate adjusted
bases of property attributable to collectibles, except
for collectibles held for sale in the ordinary course
of business, or nonqualified financial property.
The bill only allows operating businesses with fewer than
250 employees, which are located within a low-income
community at the time the investment is made to qualify,
but excludes businesses that derive, or attempt to derive,
15% or more of annual revenue from rental or sale of real
estate; however, the eligible business can be part of the
controlled group, or controlled by another business that
does derive more than 15% of its income from the rental or
sale of real estate if the second business is a primary
tenant.
Entities can invest in any of the following to generate
credits, similar to federal law:
Capital, equity investments, or loans to qualified
businesses,
Purchasing loans made by other qualified entities
in qualified businesses,
Financial counseling and other services according
to Treasury regulations,
Any equity investment or loan to another entity,
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Low-income community means census tracts:
In non-metropolitan areas, where median family
income does not exceed 80% of the greater of statewide
median income,
In metropolitan areas, where median family income
does not exceed 80% of the greater of statewide median
income, or metropolitan area median family income.
However, for purposes of the AB 1399 credit, when the
United States Census Bureau discontinues reporting median
family income on a census tract basis, GO-BIZ must use
census block group data from the American Community Survey
instead.
After the Committee grants notice and offers a six month
cure period, the Committee must recapture credits whenever:
A recapture occurs for a federal New Markets
Credit, but the state recapture must be proportional
to the federal recapture,
The entity redeems or makes principal repayment on
the investment prior to the seventh anniversary, but
the state recapture must be proportionate to the
amount of the investment redeemed or repaid,
The entity fails to invest an amount equal to 85%
of the investments' purchase price in qualified
low-income community investments in California within
12 months of the issuance until the last credit date.
Entities can avoid recapture if they reinvest an
amount equal to the capital returned in another
qualified investment within 12 months. Periodic
interest amounts paid from loans made to qualified
businesses count toward the reinvestment requirement
if the amounts are reinvested by the end of the
calendar year in a qualified investment. Amounts need
not be reinvested in the sixth or seventh year.
Recaptured credits can be available for allocation the year
after recapture. However, they must first be granted pro
rata to applicants who had allocations limited by the $40
million annual cap.
The bill disconnects federal basis adjustments, so taxes on
future capital gains will be reduced for taxpayers
receiving investments under the bill.
The Committee can issue guidelines necessary to carry out
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the purposes of this section not subject to the
Administrative Procedures Act; however, the guidelines
shall not disqualify investments for the single reason that
other forms of public or private incentives exist. The
Committee must establish reasonable fees that apply for
allocation, and use the revenue to defray the cost of the
program. The fees must reasonably correspond with the
value of the services provided by the entity.
The Committee must adopt an allocation process that:
Creates an equitable distribution process that
ensures low-income communities have an opportunity to
benefit from the program,
Set minimum organizational capacity standards that
applicants must meet to receive an allocation of
credits,
Provides for the annual return of unused credits.
The Committee must begin accepting applications on March
15, 2015, and allocate credits at least twice per year
until 2019. The bill also spells out a specific process
for the Committee to deem applications complete, and
request additional information. The Committee has 20 days
to decide to grant the application in whole or in part
after deeming it complete. The Committee must award
credits in the order they receive applications.
In the first year, the Committee must allocate credits
solely to entities that also have federal credits. For the
next three years, at least 60% of credits must be awarded
to entities that also have federal credits. The committee
must award credits to entities without federal new markets
tax credits on a competitive basis with priority given to
rural, urban, and suburban applications that can
demonstrate that the credits will allow the entity to
undertake qualified low-income community investments in an
area that has been historically underserved, newly
established businesses, and real estate development that
results in the greatest benefit to the largest number of
lower income individuals. The bill also sets forth a
process for the Committee to certify applicant investments.
Approved applicants can transfer credits to controlling
entities or subsidiaries, providing they notify the
Committee. The bill delineates the process by which an
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entity or transferee issues the investment; enacts a
process to notify the Committee of the issuance; receipt of
cash; and qualified investment, and provides that
certifications lapse if the entity doesn't receive cash and
make the qualified investment within 60 days. The entity
must reapply for certification, and cannot issue the
investment. Lapsed certifications revert to the Committee
for reallocation.
Entities must report the names of individuals who can claim
credits based on investments in that entity. The entity
must report to the Committee within five days of the first
anniversary of the credit allowance date, and within 60
days from the beginning of each calendar year thereafter
that provides documentation of the purchase price of the
investments, with specified contents. The Committee must
annually report on its website the information provided in
the reports, and on the geographic distribution of the
credits.
FTB can issue rules and regulations necessary to implement
the program, and can have any documentation held by the
Committee
AB 1399 states that the purpose of the credit is to
stimulate private sector investment in lower income
communities by providing a tax incentive to qualified
community and economic development entities that can be
leveraged by the entity to attract private sector
investment that in turn will be deployed by providing
financing and technical assistance to small and medium size
businesses and the development of commercial, industrial,
and community development projects, including, but not
limited to, facilities for nonprofit service organizations,
light manufacturing, and mixed-use and transit-oriented
development. The measure also makes legislative findings
and declarations supporting its purposes.
State Revenue Impact
Pending.
Comments
1. Purpose of the bill . According to the author, "Small
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businesses create jobs in our communities and are key
economic drivers within California's $2 trillion economy.
Central to their success is accessing debt and equity
financing. Small businesses rely on adequate short-term
(working capital) and long-term debt, as well as, equity
financing to build and expand facilities, purchase new
equipment, replenish inventories, and market their
services. While financial institutions routinely extend
working capital and long-term debt to larger businesses,
smaller size businesses located in historically underserved
areas are often bypassed. AB 1399 creates a $200 million
state New Markets Tax Credit Program for the purpose of
attracting federal New Market Tax Credit activities in
order to stimulate economic development and investment in
lower income areas of California. For a $200 million
investment, these lower income communities will gain access
to over $500 million in capital."
2. Tradeoffs . Tax benefits generally do two things:
First, they reward behavior that would have occurred
without the tax benefit, so-called "deadweight loss." Some
investors will invest in low-income community businesses
because they think they will earn a return better than
alternatives, not because of a tax credit. In these
instances, the state receives no marginal benefit, and
transfers wealth from purposes it would otherwise spend
money on for government purposes to the investor. Second,
the bill may generate economic activity resulting from
investments that wouldn't have occurred but for the credit;
the incentive will provide sufficient incentive for an
investor to invest in qualified entity, who in turn invests
to a qualified business in a low-income area. A successful
tax credit would lead to more economic activity at the
margin than its deadweight loss, but no tax credit has yet
conclusively demonstrated that its benefits outweigh its
costs.
Additionally, enacting a new tax benefit requires cuts in
spending or higher taxes to match the amount of foregone
revenue resulting from AB 1399. Tax credits do not pay for
themselves: the state's last effort of "dynamic revenue
analysis" indicates that while dynamic effects are
definitely present and visible, their effects are generally
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relatively modest.<1>
3. Are tax credits the right tool ? California's
Manufacturers' Investment Credit sunset when manufacturing
jobs didn't meet employment targets, the home purchase tax
credit didn't lead to more construction employment, and the
Legislature recently repealed geographically-targeted
economic development areas, like enterprise zones, after
years of failing to boost employment or reduce poverty in
areas. While AB 1399 uses tax credits to subsidize
investments, tax credits may not be the best option;
instead, the Legislature could increase local economic
development funds increase public employment, or add funds
to existing business assistance programs in low-income
areas. The Committee may wish to consider whether tax
credits are the best tool to direct investments in
low-income areas.
4. Overlap ? AB 1399 enacts a state new markets tax
credit; however, it overlaps with other tax credit
programs. First, the federal new markets tax credit has
been very active in the state. AB 1399 partially requires
the Committee to direct state new markets credits to
entities that already have federal ones, and while new
state credits could draw more investment into low-income
areas, it's unclear that the marginal benefit of adding
state credits on top of federal credits is a superior use
of the state's resources. Second, the Legislature recently
increased the amount of investments COIN can certify for
the CDFI credit, which operates very similarly to AB 1399's
credit. Additionally, the Legislature adopted wholesale
reform to its local economic development policies last
year. The Committee may wish to consider the space AB
1399's credit would fill in the state's economic
development portfolio.
5. We're one, but we're not the same . When the
Legislature enacts a capped and allocated tax benefit, it
doesn't put money into an account to fund tax credits;
instead, the Department of Finance subtracts the expected
effects of tax benefits from future revenue estimates. AB
1399 adopts a novel approach to funding its credit. When
the Legislature extended CAEATFA's programs to include
-------------------------
<1>
"Whatever Happened to Dynamic Revenue Analysis in
California?" John David Vasche, prepared for the
Federation of Tax Administrators, September, 2006.
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advanced manufacturing, it capped an unlimited authority to
allocate sales and use tax exclusions to $100 million
annually. Last year, the economic development reform
initiative largely superseded CAEATFA's program by
providing a state-only sales and use tax exemption for a
broader class of industries, thereby curtailing interest.
Today's CAEATFA applicants are largely biogas facilities,
or firms covered by the economic development initiative who
want the additional local share of the sales and use tax
excluded. AB 1399 relies on the annual difference between
the amount of exclusions CAEATFA grants and its annual cap,
up to $40 million per year. However, the Department of
Finance indicates that AB 1399 would result in revenue
losses to the state, because it estimated revenue losses
for CAEATFA were less than $100 million anyway, and it
already accounted for the decreased interest in CAEATFA
programs as part of last year's economic development
reforms.
6. Targeting : To better target benefits, the Committee
could amend AB 1399 to:
Require, as part of the state-only definition for
qualified low-income community business, that some
portion of the 250 employees to be employed in the
low-income community,
Lower income thresholds for "low-income community"
to direct credits towards incomes with less income,
Exclude businesses in a commonly controlled group
with more than 15% from real estate,
Reapply basis adjustment.
Assembly Actions
Assembly Floor 70-0
Assembly Appropriations 17-0
Assembly Jobs, Economic Development and the Economy9-0
Support and Opposition (06/19/14)
Support : Advantage Capital Partners; Association of
California Life and Health Insurance Companies; League of
California Cities.
Opposition : None
AB 1399 - 6/18/14 -- PageL
received.