BILL ANALYSIS SB 15 X3 Page 1 ( Without Reference to File ) SENATE THIRD READING SB 15 X3 (Calderon) As Amended February 14, 2009 Majority vote. Tax levy SENATE VOTE: Vote not relevant SUMMARY : Enacts the fiscal stimulus revenue provisions of the 2009-10 Special Session Budget Agreement. Specifically, this bill : 1)Provides a temporary tax incentive to small businesses to hire full-time employees. This bill, for taxable years beginning on or after January 1, 2009, allows a qualified employer to claim an income tax credit of $3,000 for each additional full-time employee hired by the employer during the taxable year. The credit will be subject to a cap, as explained below. The amount of credit is prorated if the employee works fewer than 12 months during the employer's tax year. The credit is only available to a business that has 20 or fewer employees on the first day of the taxable year. The credit is allowed only if it is claimed by the employer on a timely filed original return received by the Franchise Tax Board (FTB) on or before any cut-off date established by the FTB. The cut-off date for claiming the credit will be the last day of the calendar quarter within which the FTB estimates that the aggregate amount of credit claimed pursuant to this bill, under both the Personal Income Tax and the Corporation Tax laws, will have reached $400 million. The FTB is required to notify taxpayers periodically by posting a notice on its website regarding the amount of the credit claimed on returns received by the board. Credits claimed prior to the cut-off date, that exceed the qualified employer's tax liability in that year, may be carried over to reduce the tax in the following eight taxable years, if necessary. 2)Allows most multi-state businesses to apportion income to California using only their percentage of sales in California as an alternative to using the current apportionment methodology, which averages a business's proportion of sales, property, and payroll in California (with the sales factor SB 15 X3 Page 2 double-weighted). This provision will be effective starting in tax year 2011 and is permanent. Businesses that derive more than 50% of their gross receipts from agriculture, extractive business, savings and loans, or banks and financial activities currently are limited to a single-weighted sales factor and will continue to use three-factor apportionment. This measure also includes provisions that the ability to apportion based solely on the sales factor will reduce California taxes for firms with significant employment and property in the state, but most of whose sales are outside the state. The estimated annual revenue loss will be approximately $700 million, eventually growing to $1.5 billion. The measure also includes the following provisions necessary to clarify and appropriately apply apportionment of business income using only sales: a) Economic Nexus. Since sales is the easiest factor for firms to manipulate for tax purposes (by choosing the location of the transaction or setting up shell buyers, for example). The bill amends Revenue and Taxation Code Section 23101 to clarify and specify that companies that operate in the state or make sales in the state are doing business in California and subject to California tax. The amendment also includes de minimus exemptions. However, because of federal law, nexus does not currently, and would not under this measure, extend to companies whose only connection is that they sell tangible property in the state; b) Clarifies the Term Gross Receipts. As used in the calculation of the sales factor, this term will include all gross amounts received for goods or services, or for use of property to produce business income, but will explicitly exclude purely financial corporate transactions (such as corporate Treasury function or hedging transactions to reduce the taxpayer's risk on its own operations); c) Clarifies Treatment of Unitary Groups. Requires the sales factor to include all sales of a unitary group (the Finnegan rule) and to include sales of the group that are not subject to apportionment to any other state (known as the "throwback" rule). This prevents gaming by structuring sales among related entities or manipulating the location of sales to places without tax; and; SB 15 X3 Page 3 d) Apportions Sales of Services Based on the Extent of Benefit Provided in California. This provision provides fair treatment of companies that provides accounting, engineering, or any other services. Currently, the location at which the service is performed is used in the calculation of the sales factor. The measure also provides similar treatment for sales of intangible property. 3)Establishes a motion picture production tax credit. The measure requires the California Film Commission (CFC) to administer a motion picture production tax credit allocation and certification program: a) Qualifying taxpayers would claim the credit on their tax return filed with the Franchise Tax Board (FTB) under either the Personal Income Tax or Corporation Tax. Taxpayers will first apply to the CFC for a credit allocation, based on a projected project budget. Upon receiving an allocation, the project must be completed within 30 months. The taxpayer must then provide the CFC with verification of completion and documentation of actual qualifying expenditures. Based on that information, the CFC will issue the taxpayer a credit certificate up to the amount of the original allocation; b) The tax credit is equal to 20% of the qualified expenditures attributable to the production of a qualified motion picture, or 25% of the qualified expenditures attributable to the production of a television series that relocated to California, or an independent film, which is defined as a film with a budget between $1 million and $10 million produced by a non-publicly traded company which is not more than 25% owned by publicly traded companies. Qualified motion pictures must be produced for general distribution to the public, and include feature films with budgets between $1 million and $75 million; Movies of the Week with a minimum budget of $500,000, and new television series with a minimum production budget of $1 million. To be eligible, 75% of the production days must take place within California or 75% of the production budget is incurred for payment for services performed within the state and the purchase or rental of property used within the state. The credit would not be available for commercial advertising, music videos, motion pictures for SB 15 X3 Page 4 noncommercial use, news and public events programs, talk shows, game shows, reality programming, documentaries, and pornographic films; c) The bill specifies that the commission will allocate $100 million of credit authorizations each year during the period 2009-10 through 2013-14 on a first-come, first-served basis, with 10% of the allocation reserved for independent films. Any unallocated amounts and any allocation amounts in excess of certified credits may be carries over and reallocated by the commission; and, d) Taxpayers may use certified credits in a number of ways. They may claim it directly, they may assign it to another member of their unitary group, they may sell the credits to other taxpayers, or they may elect to apply the credit against their sales and use tax liability. 4) Takes immediate effect as a tax levy. FISCAL EFFECT : As shown in the table below, this bill would result in an estimated General Fund revenue loss of $2.5 billion over the five-year period from 2008-09 through 2012-13, with additional and growing losses in subsequent years. Revenue Impact of SB 15 X3 (Millions of dollars) --------------------------------------------------------- | Tax | Effective |2008-0|2009-1|2010-11|2011-12|2012-1| |Provisio| Date |9 |0 | | |3 | | n | | | | | | | |--------+-----------+------+------+-------+-------+------| |Elective|Permanent | $0| $0| -$50| -$650| -$750| | single |beginning | | | | | | |sales |in tax | | | | | | | |year 2011 | | | | | | |--------+-----------+------+------+-------+-------+------| |Film |Allocated | | | -60| -175| -120| |credit |2009-10 | | | | | | | |through | | | | | | | |2013-14, | | | | | | | |claimed | | | | | | SB 15 X3 Page 5 | |beginning | | | | | | | |in 2011 | | | | | | | |tax year | | | | | | |--------+-----------+------+------+-------+-------+------| |Hiring |Tax years | -15| -330| -50| -25| -15| |credit |2009 and | | | | | | | |2010 | | | | | | |--------+-----------+------+------+-------+-------+------| |Total | | -$15| -$330| -$160| -$850|-$885 | --------------------------------------------------------- To the extent that these tax provisions have positive effects on employment and investment, a portion of these revenue losses may be offset. COMMENTS : 1)Small business jobs credit. a) Existing state law provides four distinct programs offering tax incentives to taxpayers that employ qualified individuals within geographically targeted economic development areas (Enterprise Zones, Local Agency Military Base Recovery Areas, Manufacturing Enhancement Areas, and Targeted Tax Areas). Specifically, state law provides employers a hiring credit equal to 50% of qualified wages in the first year of employment, 40% in the second year, 30% in the third year, 20% in the fourth year, and 10% in the fifth year. Federal law, in turn, provides a "work opportunity credit" for wages paid by employers who hire from certain targeted groups of hard-to-employ individuals. Generally, the federal credit is equal to 40% of the first $6,000 in qualified wages paid to each member of a targeted group during the first year of employment. b) This measure creates a temporary tax credit of $3,000 for each new full-time job created by a business with 20 or fewer employees. In this way, it differs significantly from the state hiring credits described above. First, the proposed credit is specifically limited to small businesses (those with 20 or fewer employees). Second, the credit is available statewide and is not limited to employers located in specific geographic regions. Third, the credit is not contingent upon hiring employees from certain targeted SB 15 X3 Page 6 groups. Finally, the credit is specifically tied to net job creation. Proponents of similar hiring credits argue that the credits promote economic development by encouraging businesses to hire. Opponents, on the other hand, argue that these credits have little or no impact on hiring decisions and simply provide a tax break for hiring individuals that would be hired without the credit, while failing to address the issue of job retention. 2)Business Income Apportionment. California may only tax a portion of the income earned by businesses that also operate in other states (or nations) in addition to California. That amount is determined by an apportionment formula. California currently uses a three-factor formula that is based on the proportion of a company's sales, payroll, and property that is located in California. For example, if one-third of a company's sales, one-third of its payroll, and one-third of its property are in California, then one-third of its total earnings are subject to California Corporation Tax. a) Double-Weighted Sales Factor. For most types of businesses, the sales factor is double-weighted-given twice the importance of the other two factors. For example, assume that a company has 75% of its property and of its payroll in California, but only makes 10% of its sales in this state. Under equal weighting of the three factors, 53.3% of this company's income would be subject to California tax, but the double-weighted sales factor reduces this to 42.5%. Double-weighting of the sales factor does not apply to businesses in agriculture, extractive industries (e.g., oil and as producers), or banks or other financial businesses. b) Companies with substantial employment and facilities in California, but which primarily sell their products nationally or internationally argue that the current apportionment method penalizes them for expanding in California by increasing their California tax apportionment, but rewards them for expanding outside the state because doing so reduces their California property and payroll factors without necessarily changing their sales factor. In particular, California high-tech and biotech companies have made this argument. The argument has gained weight as approximately 20 other states have SB 15 X3 Page 7 converted to using sales as the only apportionment factor (called the "Single Sales Factor" approach). c) This Bill Addresses the Issue by Establishing Sales as the Sole Apportionment Factor (Single Sales Factor) for California. The change would be effective starting with the 2011 tax year. This change will reduce taxes for companies that have significant payroll and facilities in California, but make the bulk of their sales outside the state. Companies doing business only in California will see no change in their taxes. Companies that have few employees or facilities in California, but that make substantial sales here will pay more tax. The overall impact will be a revenue loss to the General Fund. Over time, proponents would argue, this loss may be offset by additional revenue from employment and property due to improved business retention, expansion and location in the state. Around 20 states have now adopted single-sales-factor apportionment (or something similar). 3)The motion picture production credit language includes a provision that any reduction in the $100 million annual credit authorization provided to the CFC shall be deemed a tax increase under Article XIIIA of the California Constitution. Analysis Prepared by :Daniel Rabovsky / BUDGET / (916) 319-2099 FN: 0000135