AMENDMENTS
TO MIC STATUTE WOULD OVERTURN PRO-TAXPAYER RULINGS
By Chris
Micheli
Amendments being drafted for the manufacturers’
investment credit (MIC) statute would have the effect of overturning decisions
of the State Board of Equalization that favor taxpayers. The amendments were
before the Senate Revenue and Taxation Committee’s April 30 informational
hearing on the MIC.
As such, these amendments, if enacted into law, would
overturn the taxpayers’ victories in the SaveMart
Supermarkets, Bronco Wine Company, California Steel Industries, and Baxter
Healthcare MIC appeals. The only one not
affected is Milpitas Materials, which the taxpayer won on a 5-0 vote that
prevents bifurcation of MIC assets.
These amendments are quite substantive in
nature. Below is replicated the
description of the amendments used by the Senate Revenue and Taxation
Committee’s analysis, as well as the Legislative Counsel, and then an
examination of the actual language of the amendments as drafted to SB 616 (Cedillo).
The committee’s explanation of the purpose of these
amendments is as follows: “In recent
years, the Board of Equalization has acted to substantially broaden the
application of the MIC – arguably beyond what was intended by the Legislature
when the MIC was enacted. The attached
amendments would narrow the MIC with respect to":
·
Definition of a
qualified taxpayer (by providing that a taxpayer must be engaged in a line of
business “classified in,” rather than “described in,” a qualified Standard
Industrial Classification code activity);
·
Refer to
Internal Revenue Code Section 1245(a)(3)(A), rather than 1245(a) (so as to
clarify that qualifying property must be tangible personal property, rather
than fixtures such as wine tanks);
·
Provide that the
MIC is to be narrowly construed by the Board of Equalization, rather than
expansively construed;
·
Limit
capitalized labor cost of third-party construction contractors to 50 percent of
cost (to eliminate MIC applying to indirect labor costs when labor is provided
by third-party contractors);
·
Clarify
legislative intent that qualified property must not only be used in a specified
activity (manufacturing, R&D, etc.), but must also be used in the qualified
SIC code activity of the taxpayer;
·
Clarify that the
MIC would only apply to a portion of a building that qualifies as a “special
purpose,” and not to the entire building.
The Legislative Counsel’s Digest for the SB 616
amendments includes the following descriptions:
“This bill would clarify that in order to be eligible for the MIC, a
qualified taxpayer must be engaged in a business activity classified in the SIC
Code. This bill would clarify that the
term 'qualified property eligible for the credit' is limited to tangible
personal property and that, with respect to special purpose buildings, would
clarify that only that portion of a building that is used in the specified
activity constitutes qualified property.
This bill would also clarify that for purposes of the MIC,
only capitalized labor costs are eligible for the credit.”
Here is the troubling nature of these amendments
(as described by the Legislative Counsel's Digest): “This bill would declare that the amendments
made by this bill are clarifying changes that are declaratory of existing law
and that these amendments would be applied retroactively to January 1, 1994,
when the MIC was first authorized.”
One positive aspect is that the Legislative Counsel
recognizes that these amendments narrow the scope of the current MIC statute
and, therefore, raise revenues. As such,
these changes require a 2/3 majority vote for enactment, whereas an extension
of the MIC’s sunset date requires a majority vote.
The following is the actual proposed language as
drafted for SB 616 (with new language in italics, and prior language in
strikeout):
Qualified
Taxpayer Definition (overturning the
SaveMart Supermarkets decision) - CRTC Sections
17053.49 and 23649 subdivisions (b)(4) and (c)(1)
“…engaged in those lines of business described
classified in Codes 2011 to 3999,
inclusive, of the SIC Manual, 1987 edition.”
Qualified
Property Definition (making the
statute consistent with the Bronco Wine Company decision) - CRTC Sections
17053.49 and 23649 subdivisions (d)(1) and (d)(2)
“…tangible personal property that is defined in
Section 1245(a)(3)(A) of the IRC for
use by a qualified taxpayer in those lines of business described classified in Codes 2011 to 3999,
inclusive, of the SIC Manual, 1987 edition, and
that is primarily used for any of the following…”
Capitalized
Labor Definition (overturning the CA
Steel Industries and Baxter Healthcare decisions) - CRTC Sections 17053.49 and
23649 subdivision (d)(3)
“(3) The value amount of any capitalized labor costs that are directly allocable
to the construction or modification of property described in paragraphs (1) or
(2), or (4) as follows: (A) With respect to employee labor,
capitalized labor costs shall be limited to capitalized direct labor cost
within the meaning of Section 163A [sic] of the IRC and the regulations thereunder. (B) With respect to independent contract
labor, capitalized labor costs shall be limited to 50 percent of the labor
costs paid to the independent contractor.
For purposes of this subparagraph, “labor costs paid to the independent
contractor” means all amounts paid to an independent contractor with the
exclusion of those amounts paid to the independent contractor for overhead,
profit, materials, equipment, and any other reimbursable costs paid to the
independent contractor. These excluded
reimbursable costs shall only be eligible for the credit to the extent that the
amount paid otherwise satisfies the requirements of paragraph (1) of
subdivision (b).
Special
Purpose Buildings Definition
(overturning the Baxter Healthcare decision) - CRTC Sections 17053.49 and 23649
subdivisions (d)(4), striking out (d)(4)(B), and
amending (d)(4)(C)(i), (ii), and (iii)
(4): “In the
case of any qualified taxpayer engaged in manufacturing activities described
in those lines of business classified
in SIC Code 357 or 367, those activities related to biotechnology described
in those lines of business classified
in SIC Code 8731, those activities related to biopharmaceutical establishments
only that are described classified
in SIC Codes 2833 to 2836, inclusive, those activities related to space
vehicles and parts described in
those lines of business classified in SIC Codes 3761 to 3769, inclusive,
those activities related to space satellites and communications satellites and
equipment described in those lines
of business classified in SIC Codes 3663 and 3812 (but only with respect to
“qualified property” that is placed in service on or after January 1, 1996), or
those activities related to semiconductor equipment manufacturing described
in those lines of business classified
in SIC Code 3559….”
(4)(B): entire
subdivision is struck out
(4)(C)(i): “…special purpose building and foundation
means only a building and the foundation immediately underlying the
building or a portion of a building and
the foundation immediately underlying that portion of a building, that is
specifically designed…”
(4)(C)(ii): “A
building, or a portion thereof, is
specifically designed and constructed or modified for a qualified purpose if the special purpose machinery and equipment
require the construction of building improvements to create a controlled
environment, with respect to special air, humidity, dust, or bacterial
requirements, and the special purpose nature of the machinery and equipment can
only be achieved in the controlled environment, and it is not economical to
design and construct…” [So, this
means that only “clean rooms” would qualify as the FTB has unsuccessfully
argued.]
(4)(C)(iii):
“For purposes of clause (i) and clause (vi), a building, or a
portion thereof, is used exclusively for a qualified purpose only if its
use does not include a use for which it was not specifically designed and
constructed or modified. Incidental use
of a building, or a portion thereof,
for nonqualified purposes does not preclude the building, or a portion thereof, from being a special purpose building…”
Section 4 of the bill: (a) The amendments to the definition of a
“qualified taxpayer” in subdivision (c) made by this act are intended by the
Legislature to be declaratory of existing law and shall be operative for
taxable years beginning on or after January 1, 1994, and shall expressly apply
to any pending claim for refund that is not final as of ____. [So, for any pending claims for refund, as
well as for any original returns to be filed, the QT definition changes will be
retroactive in effect.] (b) The
Legislature declares that the regulations of the FTB in effect on
Section 5 of the bill: (a) The amendments to the definition of the
term “qualified property” in subdivision (d) made by this act, other than the
amendments made to subdivision (d)(3) [concerning capitalized labor] are
intended by the Legislature to be declaratory of existing law and shall be
operative for taxable years beginning on or after January 1, 1994. [So, this section would also be retroactive.] (b) The Legislature declares that the federal
law, as reflected in the case of Whiteco
Industries, Inc. v. Commissioner (1975) 65 T.C. 664, is to be
applied in determining the meaning of the term “tangible personal property” for
purposes of subdivision (d). [So, this
would codify the BOE’s Bronco Winery decision.] (c) These amendments to subdivision (b) of
Section 6377 and subdivision (d) of the MIC statute further clarify the
Legislature’s original intent, that for purposes of those sections, the term
“qualified property” is limited to property of a qualified taxpayer that is
used by that taxpayer in an activity that is in a line of business classified
in Division D of the SIC Manual and that is primarily used for a particular
purpose or in a particular activity.
[So, this section is intended to narrow the MIC further.] (d) The Legislature further declares that the
amendments to subdivision (d) that define a “special purpose building and
foundation” clarify that only that portion of a building, including the
foundation of that portion of the building, constitutes a special purpose
building will qualify for the credit.
[So, this would have the effect of denying the MIC for an entire
building.] (e) It is the intent of the
Legislature that the amendments to subdivision (d) referenced in this section
all accurately reflect the Legislature’s original intent with respect to the
determination of property that constitutes “qualified property” and therefore
are declaratory of existing law and shall be operative for taxable years
beginning on or after
Section 6 of the bill: (a) The amendments made to subdivision (d)(3) by this act with respect to “capitalized labor costs”
shall be applied to taxable years beginning on or after January 1, 2004. [So, this is the one amendment that would not
be retroactive in effect.] (b) It is the
intent of the Legislature that the amendments adding subdivision (d)(3)(B)
shall be construed to require a qualified taxpayer to obtain the necessary
information from an independent contractor to identify the amount of the
payments made to the independent contractor that represent labor costs and the
amounts of payments that represent excluded reimburseable
costs. [So, this amendment would require
following the FTB’s “look-through” approach, which was rejected by the BOE in
the CSI decision.] (c) It is the intent
of the Legislature that no inference be drawn in connection with any matter
governed by subdivision (d)(3) for any taxable year beginning before January 1,
2004, with respect to the amendments made by this act. [So, this would limit the applicability of
these changes to prospective.]
Section 7 of the bill: (a) The Legislature declares that tax deductions,
exclusions, and credits are a matter of Legislative grace embodied in
statute. [This would codify several
appellate court decisions that mean the Legislature can change tax incentive
statutes whenever they want.] (b) It is
the intent of the Legislature that the MIC should be strictly construed. [This would reverse a finding by the BOE in
the SaveMart and CSI decisions that the MIC should be
“liberally construed in favor of the taxpayer,” an approach agreed to by the
FTB’s legal counsel.]
These amendments have yet to be made to SB 616 (Cedillo). In addition, that bill has not been set for
a hearing in the policy committee at this time.
Chris Micheli, Esq., of Carpenter
Snodgrass & Associates in Sacramento, specializes in tax matters and has
authored numerous articles and reports on the manufacturers’ investment credit. cmicheli@carpentersnodgrass.com