A Look at the FTB’s Guidance on Claiming the MIC in California
The purpose of this article is to review the Franchise Tax Board’s manuals on California’s manufacturers’ investment credit (MIC). It is based upon the FTB’s Multistate Audit Technique Manual Section 9120, as well as FTB Publication 1113.
“To stimulate employment in California, the State Legislature enacted three provisions to alleviate the basic sales tax for manufacturing companies on purchases of manufacturing equipment.” Qualified taxpayers may claim a 6% credit against tax under California Revenue & Taxation Code (CRTC) § 23649.
Generally, a "qualified taxpayer" is allowed the MIC for "qualified costs" paid or incurred for "qualified property" that is placed in service in California on or after January 1, 1994. All three tests must be met for the taxpayer to claim the credit.
A "qualified taxpayer" is any taxpayer that is engaged in an activity described in Division D (Manufacturing) of the Standard Industrial Classification (SIC) Manual, 1987 edition (SIC Codes 2011- 3999) or activities related to computer programming services or computer software design (SIC Codes 7371 – 7373). A qualified taxpayer may be an individual, partnership, corporation, S corporation, or limited liability company (LLC).
A taxpayer with multiple business activities that are treated as "establishments" under the SIC Manual will be a qualified taxpayer if any one of its activities falls within SIC Codes 2011-3999 or 7371-7373. Examples of whether an activity constitutes an "establishment" can be found in FTB Regulation 23649-3. The MIC is available to pass-through entities (partnerships, S corporations, and LLCs).
Note: Until CRTC § 23649 is amended, the SIC Manual will continue to be used for purposes of the MIC, rather than the NAICS Manual, which was issued in 1997.
In general, "qualified costs" include any capitalized costs paid or incurred by a qualified taxpayer for the construction, reconstruction or acquisition of qualified property. The costs must be properly includable in the taxpayer's depreciable basis of the property. Except for capitalized labor costs, qualified costs are an amount upon which California sales and use tax has been paid (directly or indirectly).
Capitalized labor costs for the construction or modification of qualified property may also qualify for the MIC, provided they meet the definition of "direct" labor costs under the federal uniform capitalization (UNICAP) rules. Direct costs of labor include wages, overtime pay, vacation, payroll taxes, and sick pay (see IRC Section 263A), but do NOT include training costs, officer’s compensation, pension and other related costs, and employee benefit expenses.
Note: For guidelines regarding when engineering and design services will be considered direct capitalized labor costs, see FTB Notice 98-1. For guidelines regarding when payments to third-party contractors will be considered direct capitalized labor costs, see FTB Notice 2000-1.
"Qualified property" refers to new or used IRC § 1245(a) tangible personal property or off-the-shelf computer software upon which sales or use tax has been paid. Because only tangible personal property qualifies for the credit, Regulation 23649-5(b)(2) interprets the IRC § 1245(a) requirement to mean that only property described in IRC § 1245(a)(3)(A) qualifies for the MIC.
For SIC Code 2911, qualified property also includes other tangible property that is defined in IRC § 1245(a)(3)(B), such as outdoor permanent industrial structures. This property is primarily used in petroleum refining for the production of "reformulated gasoline" or "oxygenated gasoline."
Another exception to the general IRC § 1245(a) tangible personal property requirement is for special purpose buildings and foundations, but only for taxpayers that are engaged in manufacturing activities that fall within certain SIC codes (generally related to computer or office equipment; electronic components; biotech or biopharmaceutical activities; space satellites and communications satellites and equipment; or, semiconductor equipment).
Specifically excluded from the definition of qualified property is furniture, equipment used for warehousing or extraction purposes, inventory, or property used in administration, general management or marketing.
To be “qualified property,” at least 50% of the property's use must be in an activity that involves manufacturing, processing, refining, fabricating, recycling, research and development, or pollution control; or maintaining, repairing, measuring or testing of any other qualified property. The business activity must fall within SIC Codes 2011-3999.
A qualified taxpayer who leases qualified property may claim the MIC so long as the lessor paid California sales or use tax when it acquired the property. The lessor may not claim the MIC. The normal "qualified cost" rules do not apply to lessees.
Instead, under an operating (or true) lease, the lessee may generally claim the MIC based upon the purchase price amount on which the lessor paid sales or use tax, plus any capitalized labor costs related to the lessor's construction or modification of the property.
If the lease is a "finance" or "capital" lease for sales and use tax purposes, then the rules applicable to an acquisition will generally apply in calculating the qualified costs of the lessee. These general rules are subject to a few exceptions and refinements depending upon the type of lease and how the transaction is structured.
The total cost of property eligible for the credit must be reduced by the amount of sales or use tax paid on the property. However, the basis of qualified property for which the MIC is claimed is not required to be reduced by the amount of the credit.
There is no annual limit on the MIC. However, the credit may not reduce the minimum franchise tax imposed on corporations and certain other entities. The MIC may not reduce the built-in gains tax or the excess net passive income tax imposed on some S corporations; or the limited liability company (LLC) gross receipts fee.
Also, the credit may not reduce alternative minimum tax, but may reduce the "regular" California tax below the tentative minimum tax. Generally, the credit can be carried forward for eight years, while small businesses can carry the credit forward for ten years. The MIC may not be transferred or allocated to an affiliated taxpayer or a member of a unitary group.
If the property upon which the credit is claimed is disposed of within one year or less from the date the property was first placed in service in California, the credit must be recaptured. Disposition includes removal of the property from California, use of the property primarily in a nonqualified activity, and transfer or sale of the property to an unrelated party.
Chris Micheli is an attorney and registered lobbyist for the Sacramento governmental relations firm of Carpenter Snodgrass & Associates (916/447-2251), where he specializes in tax legislative matters.