BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 2218
                                                                  Page  1

          Date of Hearing:  May 1, 2006

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                 Johan Klehs, Chair

                AB 2218 (Torrico) - As Introduced:  February 22, 2006

          Majority vote.  Tax Levy.  Fiscal Committee.

           SUBJECT  :  Sales and Use Tax:  Exemption:  Manufacturing  
          Equipment

           SUMMARY  :   Creates a state sales and use tax (SUT) exemption  
          (5.25%) for purchases of manufacturing equipment for calendar  
          years beginning on or after January 1, 2007.  Specifically,  this  
          bill  :  

          1)States legislative intent to enact a Job Retention and  
            Economic Recovery Act that would provide for an exemption of  
            purchases of manufacturing equipment used in the manufacturing  
            process from the state sales and use taxes.

          2)Specifies that for calendar years beginning on or after  
            January 1, 2007, the following tangible personal property  
            (TPP) is exempt from SUT:

             a)   Purchased by a qualified person to be used primarily in  
               any stage of the manufacturing, processing, refining,  
               fabricating, or recycling of property.

             b)   Purchased by a contractor either as an agent of a  
               qualified person or for resale to a qualified person for  
               use in the performance of a construction contract for a  
               qualified person who will use TPP as an integral part of  
               the manufacturing, processing, refining, fabricating, or  
               recycling process, or as a research or storage facility for  
               use in connection with the manufacturing process.

          3)Provides that the exemption does not apply to TPP that is used  
            primarily in administration, general management, or marketing.

          4)Defines "fabricating" as making, building, creating,  
            producing, or assembling components or property to work in a  
            new or different manner.









                                                                  AB 2218
                                                                  Page  2

          5)Defines "manufacturing" as the activity of converting or  
            conditioning property by changing the form, composition,  
            quality, or character of the property for ultimate sale at  
            retail or use in the manufacturing of a product to be  
            ultimately sold at retail.  Manufacturing includes any  
            improvements to TPP that result in a greater service life or  
            greater functionality than that of the original property.

          6)Defines "primarily" as TPP used 50% or more of the time in an  
            activity described above.

          7)Defines "process" to mean the period beginning at the point at  
            which any raw materials are received by the qualified taxpayer  
            and introduced into the manufacturing, processing, refining,  
            fabricating, or recycling activity of the qualified taxpayer,  
            and ending at the point at which the qualified activity has  
            altered TPP to its completed form.  Raw materials are  
            considered to have been introduced into the process when the  
            raw materials are stored on the same premises where the  
            qualified activity is conducted.

          8)Defines "processing" as the physical application of the  
            materials and labor necessary to modify or change the  
            characteristics of property.

          9)Defines "qualified person" as a person who is engaged in those  
            lines of business described in Codes of the North American  
            Industrial Classification System (NAICS) Manual, 2002 edition,  
            and an affiliate of a qualified person, as specified.

          10)Defines "refining" as the process of converting a natural  
            resource to an intermediate or finished product.

          11)Specifies that TPP would not include:

             a)   Consumables with a normal useful life of less than one  
               year, except for fuels used in the manufacturing process;  
               and

             b)   Furniture, inventory, equipment used in the extraction  
               process, or equipment used to store finished products that  
               have completed the manufacturing process.

          12)Provides that "TPP" includes, but is not limited to,  
            machinery, equipment, devices, property used in pollution  








                                                                  AB 2218
                                                                  Page  3

            control that meets or exceeds state or local standards,  
            special purpose buildings, and fuels.

          13)Requires the purchaser to furnish the retailer with an  
            exemption certificate, containing the sales price of the  
            exempt machinery or equipment, and in accordance with  
            instructions and forms from the Board of Equalization (BOE).

          14)Does not apply to any tax levied by a county, city, or  
            district.

          15)Denies the exemption if the qualified property is removed  
            from California or from the exempt use within one year of the  
            date of purchase.  Provides for a recapture of the tax in this  
            case.

          16)Applies to leases of TPP up to a period of six years  
            beginning with commencement of the lease.  At the close of the  
            six-year period, lease receipts are subject to SUT without  
            exemption.

          17)Remains in effect for 10 calendar years.

           EXISTING LAW  :

          1)Imposes a tax on the gross receipts from the sale in  
            California, or the storage, use, or other consumption in this  
            state of TPP, and provides various exemptions from the tax.  

          2)Treats leases of TPP as continuing sales, and imposes sales  
            tax based on the lease payment.

          3)Does not provide special tax treatment for entities engaged in  
            manufacturing activities that make purchases of equipment and  
            other supplies.

           PRIOR STATE LAW  contained until January 1, 2004 various tax  
          incentives, referred to as the Manufacturer's Investment Credit  
          (MIC), to encourage investment in manufacturing equipment to be  
          used in California.  The MIC provided for an exemption from the  
          state share of SUT for purchases of manufacturing equipment, or  
          a credit against the personal income tax (PIT) or corporate tax  
          (CT) liability (equal to 6%) of the amount paid or incurred for  
          qualified property placed in service in California.   
          Specifically:








                                                                  AB 2218
                                                                  Page  4


          1)Defined a "qualified taxpayer" as any taxpayer engaged in the  
            manufacturing activities described in specific Standard  
            Industrial Classification (SIC) Manual Codes.

          2)Limited the availability of SUT exemption to a qualified  
            taxpayer engaged in a new trade or business, i.e., one that  
            has been conducted by the taxpayer for not more than 36  
            months.

          3)Defined "qualified property" as equipment used primarily for  
            manufacturing, refining, processing, fabricating, or  
            recycling; for research and development; for maintenance,  
            repair, measurement, or testing of qualified property; and,  
            for pollution control meeting state or federal standards.   
            Special purpose buildings were also included as qualified  
            property.

          4)Provided that the MIC was repealed on the later of January  
            2001 or on January 1 of the earliest subsequent year if total  
            manufacturing jobs in California, as determined by the  
            Employment Development Department (EDD) on the preceding  
            January 1, did not exceed the total manufacturing jobs in  
            California on January 1, 1994 by 100,000 jobs.

          FISCAL EFFECT  :  Board of Equalization (BOE) staff estimate an  
          annual revenue loss of $683 million.

           Proposition 98 Fiscal Effect  :  Based upon the anticipated Budget  
          for FY 2006-07, this bill will have no revenue impact on funding  
          for K-14 schools in FY 2006-07.  Committee staff estimate a  
          revenue loss to K-14 school funding of $369 million in FY  
          2007-08, and between $273 million and $410 million in FY  
          2008-09.

           COMMENTS  :   

           1)Background  :  Prior to January 1, 2004, California tax law  
            contained various tax incentives referred to as the MIC to  
            encourage investment in manufacturing equipment to be used in  
            California.  The MIC expired on January 1, 2004 pursuant to a  
            finding by EDD that total manufacturing jobs on the preceding  
            January 1 did not exceed the total manufacturing jobs in  
            California on January 1, 1994 by 100,000 jobs.









                                                                  AB 2218
                                                                  Page  5

             a)   The total employment in manufacturing for the years 1994  
               to 2002:

               ----------------------------------------------------------- 
              |Time Period        |Total              |Increase from      |
              |                   |Manufacturing      |January 1, 1994    |
              |                   |Employment         |                   |
              |-------------------+-------------------+-------------------|
              |January 1, 1994    |1,550,250          |N/A                |
              |-------------------+-------------------+-------------------|
              |January 1, 1995    |1,585,750          |  35,500           |
              |-------------------+-------------------+-------------------|
              |January 1, 1996    |1,642,350          |  92,100           |
              |-------------------+-------------------+-------------------|
              |January 1, 1997    |1,694,900          |144,650            |
              |-------------------+-------------------+-------------------|
              |January 1, 1998    |1,763,900          |213,650            |
              |-------------------+-------------------+-------------------|
              |January 1, 1999    |1,744,650          |194,400            |
              |-------------------+-------------------+-------------------|
              |January 1, 2000    |1,761,850          |211,600            |
              |-------------------+-------------------+-------------------|
              |January 1, 2001    |1,814,950          |264,700            |
              |-------------------+-------------------+-------------------|
              |January 1, 2002    |1,694,150          |143,900            |
               ----------------------------------------------------------- 

             b)   According to the Legislative Analyst's Office (LAO):

               i)     Most studies conducted on manufacturing jobs created  
                 by tax incentives show revenue reductions were greater  
                 than revenue increases.

               ii)    Industry representatives noted that a SUT exemption  
                 is preferable to an income tax credit, since it would be  
                 less complicated to calculate, result in less  
                 administrative work and auditing, and not be limited only  
                 to firms with taxable income. LAO noted that a partial  
                 exemption of the state SUT may even be preferable in some  
                 respects to an income tax credit as provided under the  
                 previous MIC.

          1)Committee staff note several implementation and policy  
            concerns with this bill.  Specifically:









                                                                  AB 2218
                                                                  Page  6

             a)   It does not contain specific NAICS codes in the  
               definition of "qualified person", thereby allowing any type  
               of business to qualify for the exemption.  It is  
               recommended the codes be specified to limit this bill to  
               specific types of businesses.  However, Committee staff  
               note that BOE included only those businesses classified as  
               manufacturers (NAICS codes 31-33) in their revenue  
               calculation.

             b)   Long-term leases of qualifying property would not enjoy  
               the same tax privileges that this bill would provide to  
               actual purchasers of the same property, as the exemption  
               for specified leases of qualified property is limited to a  
               six-year period.

             c)   This bill does not require the manufacturer to notify  
               BOE if the property is removed from California or converted  
               from an exempt use within one year, and there is currently  
               no means, other than an audit, through which BOE would  
               learn of the new sales tax liability.

             d)   There is no mechanism specified for determining an  
               item's "useful life".

             e)   This bill contains legislative intent to enact a Job  
               Retention and Economic Recovery Act; however, there is no  
               further reference to jobs nor is there a job retention or  
               creation requirement attached to this SUT exemption.

          2)Proponents cite the need for California to compete with  
            incentivized opportunities in other states, as California is  
            one of the only states that taxes manufacturing equipment with  
            no credit or exemption.

          3)Opponents state that a portion of the exemption and credit  
            will go to companies which would have made the same  
            investments, regardless of the tax incentive, as they operate  
            in market-oriented industries.  Opponents urge the author to  
            amend the bill to limit it to specific types of businesses.

          4)Several bills have been introduced in this legislative session  
            that would reinstate the expired exemption for specific  
            manufacturing or research and development property.  AB 2395  
            (Villines), pending in this committee and set to be heard May  
            8, 2006, would provide a SUT for TPP purchased for use by  








                                                                  AB 2218
                                                                  Page  7

            manufacturers that have "gross aggregate gross assets" used in  
            manufacturing that do not exceed $5 million.  SB 1291  
            (Alquist), currently pending in Senate Revenue and Taxation  
            Committee, would provide a SUT for purchases used by entities  
            engaged in manufacturing, research and development, software  
            production, and printing, and for semiconductor, biotechnology  
            and pharmaceuticals cleanrooms and equipments.  SB 1643  
            (Runner), currently pending in Senate Revenue and Taxation  
            Committee, would allow a SUT for TPP used by new manufacturers  
            and computer programmers in the manufacturing, processing,  
            refining, fabricating, or recycling of property.

           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          AeA
          BIOCOM
          California Chamber of Commerce
          California Healthcare Institute
          California Manufacturers & Technology Association (Sponsor)
          California Taxpayers' Association
          Intel Corporation
          Lockheed Martin Space Systems
          Silicon Valley Leadership Group

           Opposition 
          
          California Tax Reform Association
           
          Analysis Prepared by  :  Sabrina Landreth / REV. & TAX. / (916)  
          319-2098