United States

California: Report Discusses Recommendations for Increasing Utilization of Manufacturing and R&D Sales and Use Tax Exemption

Mar 20, 2017
From KPMG TaxWatch

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Recently, the California Taxpayer’s Association released a document exploring certain recommendations for improving utilization of the state’s partial sales and use tax exemption for manufacturing and R&D equipment, which was adopted in 2013. The partial exemption applies to purchases of qualified tangible personal property used primarily (more than 50 percent) in certain manufacturing, processing, biotechnology, and R&D activities. Currently, such equipment is exempt from 3.9375 percentage points of the tax. As required under California law, the State Board of Equalization (BOE) reported that for the 2014-15 and 2015-16 fiscal years, the amounts claimed under the partial exemption were $394 and $350 million less than the amounts that were expected to be claimed. This means that the exemption is significantly underutilized. The BOE report included options for the legislature to pursue to increase the use of the exemption, which were explored further by the California Taxpayer’s Association. One of the recommendations is to clarify the “useful life” requirement. Under current law, equipment eligible for the partial exemption must have a “useful life” of one year or more, and this is generally determined with reference to whether the equipment is treated as a capital expenditure on the taxpayer’s income tax return. The report recommends allowing taxpayers to substantiate the “useful life” criteria in other ways, such as by reference to either a warranty, a maintenance contract, or industry replacement standards of one year or more. The second recommendation is to expand eligibility for the exemption to taxpayers required to use three-factor apportionment for income/franchise tax purposes (i.e., taxpayers engaged in mining, extractive, agricultural, or banking and financial activities). Specifically, the report recommends allowing agricultural processing businesses to be eligible for the exemption. Another proposed change would extend the life of the exemption through 2030. Currently, the exemption is scheduled to sunset on July 1, 2022. The report notes that having a permanent or longer-term sales/use tax exemption for manufacturing and R&D equipment would help California compete with other states. The last recommendation is to extend the partial exemption to businesses engaged in the manufacture and generation of energy. These companies, while considered “manufacturers” under federal law, are precluded from taking advantage of the partial exemption because their activities do not fall within the qualifying NAICS codes. The report notes that allowing these businesses to benefit from the exemption will reduce utility costs and advance development of renewal-sourced energy production. There are two bills pending in the California legislature, Assembly Bill 600 and Senate Bill 600, that may be vehicles for implementing certain of these changes. Please stay tuned to TWIST for future updates.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.