Annual Update on California’s Manufacturing Tax Incentives – 2003 Legislative Session
By Chris Micheli
I. Summary of Prior Law Changes
The purpose of this article is to provide perhaps the
final annual update on proposals and amendments to the statutes implementing
This year, however, the MIC and partial exemption are set to expire on December 31, 2003. While taxpayers may use credits carried over, no new credits may be generated after December 31. In addition, the partial exemption will no longer be available, even if a taxpayer’s three-year eligibility period has not expired.
Since the initial statutes
were enacted in 1993 (SB 671,
In 1995, legislative attempts to expand the statutes were unsuccessful. However, in 1996 (SB 38, Ch. 954), the MIC “special purpose buildings” and “small business” provisions were expanded. In addition, several technical changes were made. In 1997 (SB 1106, Ch. 604), only technical changes were made to the MIC statute.
In 1998 (AB 2798, Ch. 323), the MIC
definitions of “qualified taxpayer” and “qualified property” were expanded to
include software developers. In 1999 (SB
1229, Ch. 987), there were only technical amendments to the MIC statute. There also was an effort to expand the
statutes. In 2000, legislative attempts
to increase the MIC percentage and expand it to other industries were
unsuccessful.
Similarly, in 2001, there were several measures to
expand the MIC, none of which was successful.
However, (SB 1185,
Although unsuccessful, the following
measures to amend CRTC Sections 6377, 17053.49 and 23649 were considered by the
California Legislature during the 2003 Legislative Session:
|
Bill # / Author |
Description |
Status |
Sponsor |
|
AB
122 (Calderon) |
Would
extend sunset language in partial exemption and MIC to January 1, 2009 |
Held
on Assembly Appropriations Cmte Suspense File
(2-year bill) |
Author |
|
AB
651 (Corbett) |
Would
phase-out the MIC and phase-in a 7% tax credit based upon participation in
the Career Technical Education Campaign |
Held
on Assembly Rev & Tax Cmte Suspense File
(2-year bill) |
Author |
|
AB
1270 (Dutton) |
Would
expand the partial exemption and MIC to electrical power generation property
and taxpayers under SIC Code 4911 |
Not
heard in Assembly Rev & Tax Cmte (2-year bill) |
Author |
|
AB
1665 (Runner) |
Would
add telecommunications equipment to partial exemption; would remove the
limitation that only a “new trade or business” qualifies for the partial
exemption; would expand eligible taxpayers to include those in communications
industry; would allow a refund of the partial exemption for 2004-05 purchases
in 2006; would eliminate the sunset date for the partial exemption (but not
the MIC); would allow the partial exemption in addition to the MIC; would
eliminate the sales/use tax paid requirement in the MIC |
Not
heard in Assembly Rev & Tax Cmte (2-year bill) |
Author |
|
AB
1674 (Dutra and Nakano) |
Would
eliminate the sunset date for the partial exemption and MIC, thereby making them
permanent |
Held
on Assembly Rev & Tax Cmte Suspense File
(2-year bill) |
Author |
|
SB
2x (Poochigian and Ackerman) |
Would
eliminate the sunset date provision in the partial exemption and the MIC,
thereby making them permanent |
Held
on Senate Rev & Tax Cmte Suspense File (2-year
bill) |
Author |
|
SB
47 (Ackerman and Poochigian) |
Would
eliminate the sunset date provision in the partial exemption and the MIC,
thereby making them permanent |
Held
on Senate Rev & Tax Cmte Suspense File (2-year
bill) |
Author |
|
SB
137 (Morrow) |
Would
eliminate the sunset date provision in the partial exemption and the MIC,
thereby making them permanent; would increase the MIC from 6% to 8% |
Held
on Senate Rev & Tax Cmte Suspense File (2-year
bill) |
Author |
|
SB
454 (Vasconcellos) |
Would
extend the partial exemption and MIC sunsets to an unspecified date based
upon unspecified criteria |
Held
on Senate Rev & Tax Cmte Suspense File (2-year
bill) |
Author |
|
SB
1064 ( |
Would
revise as declaratory of existing law the MIC in-lieu refund statute (CRTC
Sec. 6902.2) effective for claims filed after 8/7/03 (prior version would
have made these changes retroactive) |
Enrolled
and to the Governor |
Author |
On January 10, 2003, Governor Davis proposed,
“clarifying” that the MIC is intended to apply to manufacturing activities as
specified in the SIC Manual. The intent of the Legislature in passing the
MIC legislation in 1993 was to provide an incentive for manufacturers to locate
in or remain in
“Nevertheless, the BOE recently approved
application of the MIC to in-store bakeries and delis. It is not clear
that BOE acted properly in granting this credit, in that their decision was in
conflict with a legally approved FTB regulation. This proposal would
reverse the BOE decision in favor of the FTB regulation limiting the
application of the MIC to manufacturing firms. If BOE did act improperly,
then the proposal would not be considered a 'tax increase'."
This proposal was never included in any pending
legislation in 2003.
Opponents
of the MIC made a number of arguments against extending the tax credit. When the MIC was being debated in the early
1990s, proponents presented detailed estimates that the credit would increase
manufacturing jobs by almost 400,000 by 2003.
Nothing like that has occurred.
And it is not surprising that jobs have not increased as a result of a
credit that is a subsidy for purchase of equipment that is in general intended
to substitute capital for labor – equipment that is intended to produce more product with a given number of employees.
The
MIC sunset based on employment data was intended as a rough measure of the
effectiveness of the credit. Some would
argue that the sunset worked, and terminated a demonstrably ineffective
credit. However, had we not fallen into
the current recession, the sunset would probably not have been triggered, and
the MIC would have continued; this casts doubt on the wisdom of a sunset
mechanism that measures total economic activity, rather than focusing on the
specific effect of the credit in question.
It
can further be argued that even though there is little evidence that the MIC
has had a directly positive impact on manufacturing employment, it has to some
degree offset some of the higher-than-average cost factors (housing, wages,
workers comp, traffic congestion, etc.) faced by manufacturers operating in
Lenny
Goldberg on behalf of the California Tax Reform Association wrote a letter of
opposition against all of the MIC extension bills. He wrote, “in short, the MIC should be
allowed to sunset because it has cost state taxpayers billions of dollars
without producing positive economic benefits in return.”
Specifically,
he wrote that CTRA opposes extending the MIC because: “(1) The MIC has failed to create the jobs
its proponents said it would. (2) The
MIC rewards economic activity that would take place anyway. (3) The MIC squanders taxpayer dollars that
could be put to much more productive uses.
(4) The MIC disproportionately benefits large corporations. (5) The MIC has been expanded to include
equipment the Legislature never intended to be covered by the credit. (6) The MIC favors capital investment at the
expense of human capital. (7) The MIC is
an administrative nightmare for both the FTB and company officials.”
The
Senate Revenue & Taxation Committee prepared a series of “amendments to
narrow application of the MIC.” These
were amendments drafted to SB 616 (Cedillo). However, the actual amendments were never
placed into the bill for consideration.
The information package prepared by the committee staff explained the
purpose of this section and described those amendments to the MIC statute 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 SIC 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% 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
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 Save Mart Supermarkets decision)
- 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) - 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) - 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) -
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 January 1, 2003, relating to the definition of a “qualified taxpayer”
accurately reflect the Legislature’s original intent with respect to the
definition of qualified taxpayer for purposes of the MIC law and are,
therefore, declaratory of existing law.
[So, this would give credence to the FTB’s regulation. Query:
Because the SBE’s Save Mart decision voided
the FTB’s QT regulation, it should not be in effect as of 1/1/03 and so is
there any effect of this section?]
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 SBE’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 January 1,
1994. [So, this would make these
amendments retroactive.]
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 reimbursable costs.
[So, this amendment would require following the FTB’s “look-through”
approach, which was rejected by the SBE 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 SBE in the Save Mart 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.]
The MIC is scheduled to sunset on January 1 of the
year following any year in which the January 1 manufacturing employment, less
aerospace, as determined by EDD, fails to exceed the comparable number for 1994
by at least 100,000. Generally circulated employment statistics have
shown that manufacturing employment has declined substantially in the past two
years.
However, the Employment Development Department
(EDD) appeared hesitant in making a determination that employment declined and
that, therefore, the MIC sunset has been triggered. On May 2, Senator Burton sent EDD Director
Michael Bernick a letter requesting EDD confirmation
of the relevant employment data, extracted from the EDD web site, for January
1, 1994 and January 1, 2003.
Mr. Bernick replied to
Senator Burton on May 20, 2003, essentially confirming the numbers, which show
that the 100,000 test fell short by 111,450 (i.e., January 1, 1994 = 1,524,350;
January 1, 2003 = 1,512,900). Thereafter,
the Senate legislative staff requested an oral opinion of Legislative Counsel
as to whether this letter from EDD constitutes a determination by EDD that
manufacturing employment did, indeed, fall short of the 100,000 test.
Legislative Counsel agreed that the letter does
constitute the statutorily required determination, for lack of anything to the
contrary. Counsel then conferred with FTB legal staff, which is of the
view that if Legislative Counsel accepts the EDD letter as the statutory determination,
then so does FTB. The result is that the MIC is repealed by its own terms
on January 1, 2004, and the cost to a qualified taxpayer of qualified property
acquired, constructed or reconstructed on or after that date is not a qualified
cost.
Finally, the Senate legislative staff received a
written Legislative Counsel opinion (#13964, dated June 17, 2003) that EDD has
"determined and reported to the Legislature that the total manufacturing
employment in this state on January 1, 2003 did not exceed by 100,000 jobs the
total manufacturing employment in this state on January 1, 1994.
Accordingly, we further conclude that Sections 6377, 17053.49 and 23649 of the
Revenue and Taxation Code are repealed by their own terms on January 1,
2004...."
On September 3, 2003, the California Legislative
Counsel issued a 15-page legal opinion (#18456) to Senate President pro tempore
John Burton concerning the manufacturers' investment credit (MIC) and the State
Board of Equalization (SBE) decision in Appeal of Save Mart Supermarkets
& Subsidiary (2002-SBE-002). Senator Burton asked (a)
whether the SBE has the authority to hold that a regulation adopted by the
Franchise Tax Board (FTB) is invalid, and (b) whether a court also would hold
that the regulation at issue in the Save Mart decision is invalid.
The Legislative Counsel opinion
reviews the MIC law and its definition of "qualified taxpayer" (see
California Revenue & Taxation Code Section 23649(c)). The opinion
then proceeds to discuss the Save Mart decision rendered by the
SBE. Thereafter, the Legislative Counsel opinion addresses the two issues
raised by Senator Burton.
Concerning the authority of the SBE
to invalid an FTB regulation, the Legislative Counsel opined that the power of
the SBE to hear and determine income and franchise tax appeals is conferred by
statute (See CRTC Sections 19047 and 19333), and not by the Constitution.
Nothing in state law confers any authority on the SBE to hold that a regulation
adopted by the FTB is invalid.
Moreover,
Finally, the Legislative Counsel
opined that the "disparity" that expressly allows taxpayers the right
to trial de novo in a superior court, while providing no comparable
authority to the FTB is inconsistent with the concept of fair and equitable
judicial proceeding where all parties are treated equally, and "thus
further supports the conclusion that the SBE does not act in a judicial
capacity in interpreting a franchise and income tax regulation."
As a result of this discussion, the Legislative
Counsel concluded that the SBE, when acting in an appellate capacity with
respect to decisions of the FTB, does not have the authority to hold that a
regulation adopted by the FTB is invalid.
Concerning the interpretation of whether a court
would hold the FTB's MIC Regulation is an invalid interpretation of CRTC
Section 23649, the Legislative Counsel reviewed the statutory language and the
FTB's regulatory language concerning the definition of a "qualified
taxpayer," and cases dealing with statutory construction. Essentially, the opinion notes that an administrative regulation is
not valid or effective unless it is consistent, and not in conflict, with the
authorizing statute. The Legislative Counsel also discussed the
California Supreme Court's decision in Yamaha Corp. of America v. State
Board of Equalization (1998) 19 Cal.4th 1.
The opinion determined that the "primary
issue" in determining the validity of the MIC Regulation is whether a line
of business "described in" certain SIC Codes means a line of business
that is "classified in" one of the specified SIC Codes. The
FTB's interpretation is that qualified taxpayers are limited to those
"classified in" the specified SIC Codes.
According to the
Legislative Counsel, a "reasonable, commonsense construction of the term
'described in' means 'classified in'." Otherwise, there would
be no reason to refer in CRTC Section 23649 to specified
SIC Codes. Moreover, a "broad construction" of the term
'described in' does not lead to wise policy, but rather to mischief or
absurdity.
Finally, the Legislative Counsel opinion cites FTB revenue estimates that those estimates
were based upon the assumption that "described in" certain SIC Codes
means to be "classified in" those same codes. As a result, a
court would give considerable weight to the FTB's regulatory interpretation of
CRTC Section 23649. Therefore, the Legislative Counsel is of the opinion
that a court would hold that the FTB's MIC Regulation is valid.
While the MIC and partial exemption
statutes will expire at the end of 2003, there will be an extensive effort to
reinstate these two valuable manufacturing incentives. Over 275,000 manufacturing jobs in
Chris
Micheli is an attorney and registered lobbyist for the
Sacramento governmental relations firm of Carpenter Snodgrass & Associates
(916/447-2251). He served as the lead
lobbyist on the original MIC and partial exemption statutes while serving as
General Counsel to the