BILL ANALYSIS �
AB 1399
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GOVERNOR'S VETO
AB 1399 (Medina and V. Manuel P�rez)
As Amended August 22, 2014
2/3 vote
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|ASSEMBLY: | |(May 16, 2013) |SENATE: |35-0 |(August 27, 2014) |
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(vote not relevant)
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|COMMITTEE VOTE: |9-0 |(August 29, 2014) |RECOMMENDATION: |concur |
|(Rev. & Tax.) | | | | |
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Original Committee Reference: J., E.D. & E.
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|ASSEMBLY: |74-2 |(August 29, | | | |
| | |2014) | | | |
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SUMMARY : Establishes the California New Markets Tax Credit Program
(Program), with the stated purpose of stimulating private sector
investment in lower income communities, as specified.
The Senate amendments delete the Assembly version of this bill, and
instead:
1)Contain the following legislative findings:
a) While many areas of California have recovered from the
economic and community development impacts of the 2006
Financial Crisis and the 2010 global recession, Californians in
a number of communities and neighborhoods are still
experiencing their lingering effects. In some cases, this has
resulted in small and medium businesses in low-income areas
lacking sufficient access to capital and technical assistance.
Given that California has many needs and limited resources,
moneys from the private sector are necessary to fill this
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capital and investment gap.
b) Initially enacted in 2000, the Federal Government
established the New Markets Tax Credit (NMTC) Program, which
uses a market-based approach for expanding capital and
technical assistance to businesses in lower income communities.
The federal program is jointly administered by the Community
Development Financial Institutions Fund (CDFI Fund) and the
Internal Revenue Service. The NMTC Program allocates federal
tax incentives to community development entities (CDEs), which
they then use to attract private investors who contribute funds
that can be used to finance and invest in businesses and
develop real estate in low-income communities.
c) Through the 2013-14 funding round, the CDFI Fund had awarded
approximately $40 billion in NMTC in 836 awards including $3
billion in American Recovery and Investment Act of 2009 awards
and $1 billion of special allocation authority to be used for
the recovery and redevelopment of the Gulf Opportunity Zone.
d) The federal NMTC totals 39% of the original investment
amount in the CDE and is claimed over a period of seven years
(5% for each of the first three years, and 6% for each of the
remaining four years). Any investment by any taxpayer in the
CDE redeemed before the end of the seven-year period will be
recaptured.
e) Fourteen states in the United States (U.S.) have adopted
state programs using the NMTC model including Alabama, Florida,
Illinois, Nevada, and Oregon. While some of the programs
substantially mirror the federal program, others vary in both
the percentage of the credit and some of the policies that form
the foundation of the credit. One of the reasons cited for
establishing state-level programs is to make a state more
attractive to CDEs, which results in increasing the amount of
federal NMTCs being utilized in the state. Further, several
studies, including a January 1, 2011, case study by Pacific
Community Ventures, showed that for every dollar of foregone
tax revenue, the federal NMTC leverages $12 to $14 of private
investment.
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2)Require the California Alternative Energy and Advanced
Transportation Financing Authority (CAEATFA) to determine the
amount of the $100 million in exclusions not granted in the
assigned calendar year under Public Resources Code (PRC) Section
26011.8. An amount equal to that amount shall be granted in the
subsequent calendar year through the Program.
3)Require the California Competes Tax Credit Committee (Committee)
and the Governor's Office of Business and Economic Development
(GO-Biz) to administer the Program.
4)Allow, for taxable years beginning on or after January 1, 2015,
and before January 1, 2027, a credit in an amount determined in
accordance with Internal Revenue Code (IRC) Section 45D, as
modified. For a taxpayer holding a "qualified equity investment"
on that investment's "credit allowance date", the credit shall
equal a percentage of the amount paid to a "qualified CDE" for
such investment at its original issue. The applicable percentage
shall be:
a) Zero percent with respect to the first two "credit allowance
dates";
b) Seven percent with respect to the third "credit allowance
date"; and,
c) Eight percent with respect to the remainder of the "credit
allowance dates."
5)Modify the federal definition of a "qualified CDE" to include only
those qualified CDEs (and their subsidiaries) that have entered
into an allocation agreement with the CDFI Fund of the U.S.
Treasury Department, with respect to credits authorized by IRC
Section 45D, that includes California within the service area and
is dated on or after January 1, 2012.
6)Modify the federal definition of a "qualified active low-income
community business" as follows:
a) Allows the services of employees of a service-based
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qualified active low-income community business to be performed
outside the low-income community. "A service-based qualified
active low-income community business" is defined as a business
that primarily earns revenue through providing intangible
products and services and leases or owns real property in the
low-income community that is used for the operation of the
business;
b) A qualified active low-income community business shall not
include any business that derives, or projects to derive, 15%
or more of its annual revenue from the rental or sale of real
estate, subject to certain exceptions;
c) A qualified active low-income community business shall only
include a business that, at the time the initial investment is
made, has 250 or fewer employees and is located in one or more
California low-income communities;
d) A qualified active low-income community business shall only
include a business located in specified census tracts based on
poverty and unemployment rates;
e) A qualified active low-income community business shall not
include any business that operates or derives revenues from the
operation of a country club, gaming establishment, massage
parlor, liquor store, or golf course;
f) A qualified active low-income community business shall not
include a sexually oriented business, as defined; and,
g) A qualified active low-income community business shall not
include a charter school.
7)Provide that the aggregate amount of qualified equity investments
that may be allocated in any calendar year under the Program shall
be an amount based upon any unused portion of the $100 million in
exclusions, authorized under Revenue and Taxation Code Section
6010.8, as determined by CAEATFA and reported to the Committee,
not to exceed an amount based upon a credit of $40 million.
8)Require the Committee to limit the allocation of investments that
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may be designated to a cumulative total amount based on credits of
no more than $200 million.
9)Require GO-Biz to establish a process for the recapture of
credits. Specifically modifies federal law to add the following
events triggering a credit recapture:
a) The qualified CDE fails to invest at least 15% of the
qualified equity investment in a qualified low-income community
business in consultation or partnership with either of the
following:
i) A qualified CDE that has not received a federal NMTC
allocation on or after January 1, 2012, as specified; or,
ii) A nonprofit organization certified by GO-Biz, as
specified.
b) The qualified CDE made an investment without performing a
revenue impact assessment that satisfies this bill's
requirements.
10)Provide that enforcement of each of the recapture provisions
shall be subject to a six-month cure period. Specifically,
recapture shall not occur until the qualified CDE gives notice of
potential noncompliance to GO-Biz and is afforded six months to
cure the noncompliance.
11)Provide that in cases where a qualified CDE fails to send the
required notice of potential noncompliance or GO-Biz has
information from the annual report or other sources indicating
that the entity is in potential noncompliance, GO-Biz shall send
the notice, and the date GO-Biz sends the notice shall begin the
six-month cure period.
12)Provide that if a qualified CDE makes a capital or equity
investment or a loan with respect to a qualified low-income
building under the state Low-Income Housing Tax Credit Program,
the investment or loan is not a qualified low-income community
investment under the Program.
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13)Require GO-Biz to adopt guidelines necessary or appropriate to
carry out its responsibilities with respect to the allocation of
the qualified equity investments and recapture of credit. The
adoption of these guidelines shall not be subject to the
rulemaking provisions of the Administrative Procedure Act
(Government Code Section 11340 et seq.).
14)Require GO-Biz to establish and impose reasonable fees upon
entities that apply for an allocation that, in the aggregate,
defray the cost of reviewing applications.
15)Require GO-Biz to adopt an allocation process that does all of
the following:
a) Creates an equitable distribution process that ensures that
low-income community populations across the state are engaged
and have an opportunity to benefit from the Program;
b) Sets minimum organizational capacity standards that
applicants must meet to receive an allocation, as specified;
c) Considers the qualified CDE's prior qualified low-income
community investments under IRC Section 45D;
d) Considers the qualified CDE's prior qualified low-income
community investments under the Program;
e) Does not require the qualified CDE to identify the qualified
active low-income community businesses in which the qualified
CDE will invest in an application for qualified equity
investment allocation; and,
f) Does not disqualify a low-income community investment for
the single reason that public or private incentives, loans,
equity investments, technical assistance, or other forms of
support have been or continue to be provided.
16)Provide that GO-Biz shall begin accepting applications on or
before May 15, 2015, and shall award authority to designate
qualified equity investments annually through 2019, to the extent
that allocations are available under PRC Section 26011.9.
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17)Provide that, in the 2015 awards cycle, the Committee shall award
authority to designate qualified equity investments to qualified
CDEs in the order applications are received by the Committee.
18)Provide that, in the 2016 to 2019 award cycles, at least 60% of
the authority shall be awarded in the order applications are
received by the Committee.
19)Require the Committee to award up to 40% of the authority in the
2016 to 2019 award cycles to qualified CDEs on a competitive basis
using blind scoring and a review committee comprised of community
development finance practitioners.
20)Authorize an approved applicant to transfer all or a portion of
its certified qualified equity investment authority to its
controlling entity or any subsidiary qualified CDE of the
controlling entity, provided the applicant and the transferee
notify the Committee within 30 calendar days of such transfer.
The transferee shall be subject to the same rules, requirements,
and limitations applicable to the transferor.
21)Provide that a qualified CDE shall only make a qualified
low-income community investment that demonstrates a positive
revenue impact on the state over a 10-year period against the
aggregate tax credit utilization over the same 10-year period, as
specified.
22)Require a qualified CDE that issues qualified equity investments
to submit a report to GO-Biz within the first five business days
after the first anniversary of the initial credit allowance date
that provides documentation as to the investment of at least 85%
of the purchase price in qualified low-income community
investments in qualified active low-income community businesses in
California.
23)Include additional reporting requirements.
24)Provide that a taxpayer allowed a credit under the Program for a
qualified equity investment shall not be eligible for any other
state credit with respect to that investment.
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25)Provide that GO-Biz and the Committee shall only make authority
awards in a calendar year in which the Legislature appropriates
funds in the California New Markets Tax Credit Fund, which this
bill creates.
26)Provide that this bill shall take immediate effect as a tax levy.
27)Sunset the credit provisions on December 1, 2028.
28)Declare that the provisions of this bill are severable.
EXISTING LAW :
1)Allows various tax credits under both the Personal Income Tax Law
and the Corporation Tax Law. These credits are generally designed
to encourage socially beneficial behavior or to provide relief to
taxpayers who incur specified expenses.
2)Establishes the Committee, which has specified duties in regard to
tax credits for economic development.
3)Imposes an annual tax on the gross premiums of an insurer, as
defined, doing business in this state at specified rates.
4)Allows a credit equal to 20% of each qualified investment into a
community development financial institution that is certified by
the California Organized Investment Network (COIN). The aggregate
amount of qualified investments is generally capped at $50 million
for each calendar year. Thus, the statewide total for all credits
allowed under the program is capped at $10 million per year (i.e.,
20% of $50 million).
AS PASSED BY THE ASSEMBLY , this bill authorized GO-Biz, and its
director, to expend specified economic development funds previously
administered by the Business, Transportation and Housing Agency.
FISCAL EFFECT : According to the Senate Appropriations Committee
(assuming future legislative action implements the NMTC Program):
1)The Franchise Tax Board (FTB) indicates that this bill will result
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in a General Fund revenue loss of $1.6 million in 2016-17, $5.7
million in 2017-18, and $10 million in 2018-19.
2)The FTB will incur costs of $131,000 in 2015-16 for IT programming
changes, and $13,000 on-going annually thereafter (General Fund).
3)GO-Biz estimates that it will require 11 positions and $1.3
million annually to administer the program, for compliance
monitoring, program administration and enforcement (General Fund).
COMMENTS : The author has provided the following statement in
support of this bill:
Small 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.
What is a "tax expenditure"? Existing law provides various credits,
deductions, exclusions, and exemptions for particular taxpayer
groups. In the late 1960s, U.S. Treasury officials began arguing
that these features of the tax law should be referred to as
"expenditures" since they are generally enacted to accomplish some
governmental purpose and there is a determinable cost associated
with each (in the form of foregone revenues).
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How is a tax expenditure different from a direct expenditure? As
the Department of Finance notes in its annual Tax Expenditure
Report, there are several key differences between tax expenditures
and direct expenditures. First, tax expenditures are reviewed less
frequently than direct expenditures once they are put in place.
This can offer taxpayers greater certainty, but it can also result
in tax expenditures remaining a part of the tax code without
demonstrating any public benefit. Second, there is generally no
control over the amount of revenue losses associated with any given
tax expenditure. Finally, it should also be noted that, once
enacted, it takes a two-thirds vote to rescind an existing tax
expenditure absent a sunset date. This effectively results in a
"one-way ratchet" whereby tax expenditures can be conferred by
majority vote, but cannot be rescinded, irrespective of their
efficacy, without a supermajority vote.
This bill: This bill would enact a new tax expenditure program
modeled after the federal NMTC, with the stated purpose of
stimulating private sector investment in lower income communities.
The federal NMTC: Congress established the federal NMTC program as
part of the Community Renewal Tax Relief Act of 2000 to encourage
investment in low-income communities that have traditionally lacked
access to capital. The federal NMTC program provides taxpayers
(e.g., individual investors, financial institutions, corporations,
etc.) a credit for investing in economically distressed communities.
Specifically, the credit is allowed for a taxpayer's qualified
equity investment in a CDE, which must be a corporation or
partnership. The CDE's primary mission must be serving, or
providing investment capital for, low-income communities or
low-income persons, as certified by the Secretary of the Treasury.
The taxpayer's federal NMTC totals 39% of the qualified equity
investment made in the CDE, but is spread over a seven-year period
as follows:
a) A 5% credit for the year the qualified equity investment is
purchased and for the first two years thereafter (i.e., 15% for
the first three years); and,
b) A 6% credit for years four through seven (i.e., 24% for the
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subsequent four years).
In recent years, private investors have claimed more than $1 billion
in NMTCs annually.
The federal NMTC program is administered by the CDFI Fund within the
U.S. Treasury. The CDFI Fund allocates tax credit authority to CDEs
that apply for and obtain allocations.<1> These CDEs, in turn,
enable private investors to obtain credits in exchange for equity
investments with the CDEs. The CDEs then invest the raised capital
in qualified low-income community investments, which include
investments in operating businesses and residential, commercial, and
industrial projects. While the range of projects financed by CDEs
varies, roughly 50% of NMTC investments have been used for
commercial real estate projects.
The federal NMTC program expired in 2013, but legislation has been
introduced to extend it, and the President requested a permanent
extension in his FY 2015 budget proposal.
How would the Program differ from the federal NMTC? The Program
would differ from the federal NMTC in numerous respects, including
the following:
a) Different credit percentages over the seven-year period:
While the proposed state credit, like the federal credit,
totals 39% of the taxpayer's investment in a qualified CDE, the
state credit would be spread out over the seven-year period as
follows:
i) Zero percent for the year the investment is purchased
and the following year (i.e., 0% for the first two years);
ii) A 7% credit for the third year; and,
iii) An 8% credit for years four through seven (i.e., 32% for
the subsequent four years).
It is Committee staff's understanding that this "back-loading"
of the credit percentages is designed to reduce the Program's
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<1> In the 11 allocation rounds since 2003, the CDFI Fund has made
allocations to CDEs totaling $40 billion.
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upfront cost to the GF.
b) Modified definition of a qualified active low-income
community business: This bill modifies the definition of a
"qualified active low-income community business" in several
respects. For example, under federal law, a substantial
portion of the services performed for such a business by its
employees must be performed in a low-income community. This
bill arguably dilutes that requirement for "service-based"
qualified active low-income community businesses.
Specifically, this bill allows the services of employees of a
service-based business to be performed outside the low-income
community. The business would, however, be required to lease
or own real property in the low-income community for the
operation of its business.
In some respects, however, this bill's definition of a
"qualified active low-income community business" is more
restrictive than the federal definition. For example, under
this bill, any business that derives 15% or more of its annual
revenue from the rental or sale of real estate would generally
be excluded from the definition. In addition, the state
definition is limited to businesses that, at the time the
initial investment is made, have 250 or fewer employees.
Does California have any similar tax credit programs? While
California does not conform to the federal NMTC, state law does
allow a 20% credit for each "qualified investment" in a CDFI
certified by COIN. The aggregate amount of qualified investments is
generally capped at $50 million for each calendar year.<2> Thus,
the statewide total for all credits allowed under the program is
capped at $10 million per year (i.e., 20% of $50 million). Unlike
the federal NMTC, the "qualified investment" in the CDFI must be at
least $50,000, be for a minimum duration of 60 months, and may
consist of either an equity investment or a deposit or loan that
does not earn interest.
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<2> State law provides that if the aggregate amount of qualified
investments made in a calendar year is less than $50 million, the
difference may be carried over to the next year, and any succeeding
year during which the credit remains in effect, and added to the
aggregate amount authorized for those years.
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Existing law defines a "CDFI", in turn, as a private financial
institution located in California that has community development as
its primary mission, and that lends in urban, rural, or
reservation-based communities in this state. Specifically, a "CDFI"
may be a community development bank, a community development loan
fund, a community development credit union, a microenterprise fund,
a community development corporation-based lender, or a community
development venture fund.
The existence of California's stand-alone CDFI tax credit raises
some interesting issues. Namely, California already has a tax
credit program specifically designed to encourage private investment
in underserved markets. Given this fact, does it makes sense to
establish a second tax credit program with the same goal? If this
bill were enacted in its present form, California would have two
similar tax credit programs, administered by two separate entities,
with an unclear level of coordination between the two.
Additional economic development tools currently available: Just
last year, California dramatically restructured its tax-based
economic development strategy. Specifically, the state phased out
the oft-criticized Enterprise Zone program and replaced it with
three new tools. First, the state adopted a new hiring credit
designed to increase employment in former Enterprise Zones and areas
with high unemployment and poverty. Second, the state authorized
GO-Biz to allocate credits based on specified factors, including the
number of jobs the taxpayer will create or retain, and the extent of
unemployment or poverty in the area in which the taxpayer's project
or business is proposed or located. Finally, the state enacted a
sales and use tax exemption for purchases of manufacturing equipment
made by specified taxpayers.
Government Accountability Office report: A recent report issued by
the U.S. Government Accountability Office (GAO) found that better
controls and data are needed to ensure the effectiveness of the
federal NMTC program. Specifically, the report noted that the
financial structures of NMTC investments have become increasingly
complex and less transparent over time. This increased complexity,
in turn, was attributed to the combining of the NMTC with other
federal, state, and local government funds. The GAO's survey of
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CDEs determined that approximately 62% of NMTC projects received
other federal, state, or local government support from 2010 to 2012.
The report acknowledged that combining public financing from
multiple sources can fund projects that would otherwise not be
economically viable. At the same time, however, this combination
raises questions about whether the subsidies are unnecessarily
duplicative. In addition, the report found that, "in some cases the
complexity of the structures may be masking rates of return for NMTC
investors that are above market rates." The GAO specifically
pointed to a U.S. Treasury report that found an investor apparently
earning a 24% rate of return, which is significantly above market
rates. In that case, the investor leveraged the NMTC by using other
public funds to increase the base for claiming the credit. The
report found that the U.S. Treasury does not currently have controls
to limit the risk of unnecessary duplication in government subsidies
or above market rates of return. The report found that, "[w]ithout
such guidance and controls the impact of the NMTC program on
low-income communities could be diluted." The GAO also found that
the data on equity remaining in low-income community businesses
after the seven-year credit period were unreliable because, in part,
reporting instructions are unclear. Similarly, data on NMTC project
failure rates were unavailable.
Thus, the GAO recommended that the U.S. Treasury issue further
guidance on how other government programs can be combined with
NMTCs. The GAO also recommended the implementation of adequate
controls to limit the risks of unnecessary duplication and
above-market rates of return. Finally, the GAO also recommended the
collection of more complete and accurate data on, among other
things, the equity remaining in businesses after seven years, along
with loan performance.
Proposed credit percentages: As noted above, the proposed state
credit, like the federal credit, totals 39% of the taxpayer's
investment in a qualified CDE. Thus, this bill would allow a
taxpayer to obtain combined federal and state credits equal to 78%
of the taxpayer's investment, even in cases where the federal credit
alone would be sufficient to render a low-income community
investment economically feasible. Thus, this credit may, in some
cases, reward taxpayer behavior that would have taken place even
without a state subsidy, resulting in so-called "deadweight loss."
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FTB legal concerns: The FTB notes the following in its staff
analysis of this bill:
This bill would restrict the NMTC to investments in
California. This bill could raise constitutional
concerns under the Commerce Clause of the United States
Constitution because it could appear to improperly
favor in-state activity over out-of-state activity. On
August 28, 2012, (Cutler v. Franchise Tax Board), the
Court of Appeal issued a unanimous opinion holding that
California's Qualified Small Business Stock statutes
were unconstitutional. Specifically, the Court of
Appeal held that the statutory scheme's requirement of
a large California presence in order to qualify for an
investment incentive discriminated against interstate
commerce, and therefore violated the federal dormant
commerce clause. While no court decision has yet
invalidated, as a general matter, state income tax
credits that provide an incentive for in-state
activity, i.e., property placed in service in the
state, employees employed in the state, etc., targeted
tax credits such as the NMTC in California may be
subject to constitutional challenge.
Federal law allows states to impose a
non-discriminatory franchise tax on federal securities.
This bill would allow a credit for investment in
entities that make loans to entities engaged in a trade
or business in low-income communities. The credit
provides an indirect subsidy by encouraging these loans
over investments in federal securities and providing
more favorable tax benefits for making the loan instead
of holding federal securities. As a result, this tax
benefit could be considered to result in discrimination
against investments in federal securities and thus a
violation of the federal prohibition of discriminatory
state taxation of federal securities.
GOVERNOR'S VETO MESSAGE :
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"This bill creates a new markets tax credit that will cost -- over
time -- $200 million.
"I certainly endorse programs that result in private investments to
help low income areas, but a bill to spend this much should be
considered with other priorities during the annual budget."
Analysis Prepared by : M. David Ruff / REV. & TAX. / (916)
319-2098
FN: 0005691