United States: A Hat Tip To The Manufacturing, R&D And Electric Power Industries: California Bill Would Provide Income Tax Credits For Sales And Use And District Taxes Paid On Certain "Qualified Tangible Personal Property"

TAKEAWAYS

• California Assembly Bill 52 (AB 52) would provide corporation and personal income tax credits for local sales and use and district taxes paid on machinery and equipment primarily used in manufacturing, research and development, electric power generation or production, or electric power storage and distribution.
• The income tax credits provided by AB 52 would complement California's existing exemption from statewide sales and use taxes for machinery and equipment primarily used in such activities.
• AB 52 received unanimous approval in the California General Assembly and is now under consideration in the Senate, but it is unclear whether Governor Newsom would sign the bill into law.

On May 22, 2023, the California Assembly unanimously passed a bill that, if enacted, would provide a significant benefit to California businesses that make capital investments in manufacturing, research and development (R&D), and electric power machinery and equipment in California. The bill, Assembly Bill 52 (AB 52), would provide income tax credits in an amount equal to the sales and use and district taxes paid on qualified tangible personal property primarily used in manufacturing, R&D, and electric power generation or production, or storage and distribution. The credit would complement the existing partial sales and use tax exemption under California Revenue and Taxation Code (RTC) section 6377.1, effectively giving taxpayers with sufficient California income tax liability a full sales and use tax exemption on such qualified tangible personal property.

California's Existing Partial Exemption for Statewide Sales and Use Tax Paid on Qualified Tangible Personal Property

RTC section 6377.1 exempts from certain state sales and use taxes the sale of, and the storage, use or other consumption in California of, qualified tangible personal property primarily used in the following activities:

• Qualified tangible personal property purchased for use by a qualified person to be used primarily in any stage of the manufacturing, processing, refining, fabricating or recycling of tangible personal property;
• Qualified tangible personal property purchased for use by a qualified person to be used primarily in research and development;
• Qualified tangible personal property purchased for use by a qualified person to be used primarily to maintain, repair, measure or test any qualified tangible personal property described above;
• Qualified tangible personal property purchased for use by a contractor purchasing that property for use in the performance of a construction contract for the qualified person, that will use that property as an integral part of the manufacturing, processing, refining, fabricating or recycling process, the generation or production, or storage and distribution, of electric power, or as a research or storage facility for use in connection with those processes; and
• Qualified tangible personal property purchased for use by a qualified person to be used primarily in the generation or production, or storage and distribution, of electric power.

A qualified person may claim the partial exemption on up to $200 million of qualified tangible personal property purchased during any calendar year. The term "qualified tangible personal property" is defined broadly and includes machinery and equipment; equipment or devices used or required to operate, control, regulate or maintain the machinery; tangible personal property used in pollution control; and certain special purpose buildings and foundations. A company is a "qualified person" only if it is primarily engaged in the following lines of business described in the 2012 edition of the North American Industry Classification System: Codes 3111 through 3399 (relating to various types of manufacturing); Codes 221111 through 221118 (relating to various types of electric power generation); Code 221122 (relating to electric power distribution); and Code 541711 (relating to R&D in biotechnology or physical, engineering and life sciences other than biotechnology).

The exemption in RTC section 6377.1 is a partial exemption because it only applies to statewide, general-fund sales and use taxes, which are currently imposed at the collective rate of 3.975%. Subdivision (d) of the statute expressly provides that the exemption does not apply to certain other statewide taxes, local sales and use taxes imposed under the Bradley-Burns Uniform Local Sales and Use Tax Law, or district taxes imposed under the Transactions and Use Tax Law. Therefore, when the partial exemption applies, the sale or use of qualified tangible personal property is taxed at the rate of 3.3125%, plus the rate of any applicable district tax.

The existing RTC section 6377.1 partial exemption will sunset on July 1, 2030, unless it is extended by the California Legislature.

AB 52's New Income Tax Credits for Local Sales and Use and District Tax Paid on Qualified Tangible Personal Property

As AB 52's text notes, California has the highest state-level sales tax rate in the United States and the total combined rate, inclusive of local sales and use taxes and district taxes, can be as high as 10.75%. The partial sales and use tax exemption in RTC section 6377.1 provides some relief (abatement of 3.9375% of the total tax rate on qualified purchases), but even with the exemption California still lags well behind the roughly 40 states that offer full manufacturing exemptions.

AB 52 further notes that California's high taxes have prompted many manufacturing and R&D businesses to relocate their operations or direct their significant capital investments to other jurisdictions. Recognizing that these types of businesses are critical to California's economy and create high-wage jobs for California residents, the intent behind AB 52 is to eliminate California's existing competitive disadvantage by making economically whole those taxpayers who pay sales or use tax on qualified tangible personal property at the reduced rate under RTC section 6377.1.

For taxable years beginning on or after January 1, 2024 and ending before January 1, 2029, AB 52 would provide credits for both California corporation tax and personal income tax purposes that would flow directly from the amount of sales and use tax paid on qualified tangible personal property to which the partial sales and use tax exemption under RTC section 6377.1 applies.

As passed by the Assembly, AB 52 would create two separate credits under the Corporation Tax Law—one for sales tax reimbursement paid (i.e., sales tax the seller passes through to the buyer) and one for use tax paid:

AB 52 would create two similar credits under the Personal Income Tax Law for sales tax reimbursement and use tax paid that would apply against taxpayers' net tax.

In the case of both the personal income and corporation tax credits, to the extent the taxpayer would be allowed an income tax deduction for the sales tax reimbursement or use tax paid on the qualified tangible personal property, the deduction would be reduced by the amount of the credit allowed. In addition, if the credit exceeds the taxpayer's net tax, the excess could be carried forward up to eight years until exhausted.

The bill would authorize the California Franchise Tax Board to adopt regulations necessary or appropriate to carry out the purposes of the credit provisions.

What Comes Next

After receiving unanimous approval in the Assembly, AB 52 is now under consideration in the California Senate. If the Senate passes the bill before the Legislature adjourns on September 14, 2023, the bill will go to Governor Newsom.

The Governor has not discussed AB 52 publicly yet, but last September he vetoed a bill which would have replaced the partial sales and use tax exemption under RTC section 6377.1 with a full exemption. In his veto message, the Governor emphasized that he could not ask local governments to bear the substantial revenue loss that would have resulted from a full exemption. Unlike the vetoed bill, AB 52 would result in a revenue loss at the state level but not the local level. However, with California expected to experience a significant revenue shortfall for 2023 – 2024, it is unclear what the Governor will do with AB 52 if it passes the Senate. Still, if the Governor vetoes the bill, the Legislature could override the veto with a two-thirds vote in each house.

Should AB 52 become law, manufacturing, R&D and electric power businesses will need to carefully examine the bill's new credit provisions, existing income tax laws and their existing structures to ensure they will be able to fully realize the benefits of the new credits.

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