The Center of the California Enterprise Zone Information Universe


BNA’s Laura Mahoney on the California Competes Credit

As always, Laura Mahoney provides detailed clarity on California’s tax incentive programs:

Demand for a new tax credit aimed at business expansion in California continues to outstrip supply as state regulators iron out details for awarding the credit and recouping it if businesses don’t live up to their promises.

About 250 businesses asked for $289 million in credits from a pool of $75 million to be awarded by the Governor’s Office of Business and Economic Development (GO-Biz) April 16. It’s the third application round since the program was created in 2013, and the application window closed Feb. 2.

In the first two rounds, 400 companies asked for $500 million in credits from a pool of $29 million awarded to 29 companies in June 2014, and 286 companies asked for $329 million from a pool of $31 million awarded to 56 companies in January 2015.

A total of $151.1 million is available in the 2014-15 fiscal year, with one more round of applications and award of the final $31.1 million scheduled for June 18. In the next fiscal year, $200 million will be available for the credit.

In exchange for the credit, companies commit to creating and retaining jobs, and investing in equipment, intellectual property and other business development tools. It helps if they plan to invest in areas with high poverty and unemployment rates.
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BNA Incentives Watch on California Competes

BNA’s “Incentive Watch” on the next round of California Competes credit and the ongoing legal controversy regarding regulating consulting fees:

As the deadline looms for another round of California Competes tax credit applications, demand is certainly going to outpace the supply of available credits. With recently issued final regulations for the credit, taxpayers have new considerations in submitting their applications, including a divisive requirement that applicants must disclose contingency fee arrangements.

The California Competes tax credit, first available to taxpayers in 2014, is aimed at fostering business relocation and expansion in California, and replaces the Enterprise Zone Tax Credit in California, which has been phased out. It gives credits to businesses based on several criteria, including job creation. For the most recent application period that closed Feb. 2, the California Competes program received 253 applications, requesting a total of $289 million. Unfortunately for applicants, the Governor’s Office of Business and Economic Development (GO-Biz) will only award $75 million in tax credits during the February application period. California will also award $31.1 million in credits, plus any unallocated funds from previous applications periods, for the final round of applications, which are being accepted starting March 9.

In the January application round, GO-Biz received 286 applications requesting $329 million in credits. Ultimately, 56 companies received $31 million in tax credits. This brought the total amount of credits awarded through the program up to $60 million.

In February, final regulations governing the California Competes credit took effect. Although the final regulations are similar to emergency regulations adopted last year, there are a few changes, including a provision that allows companies to apply for the credit multiple times, provided they meet additional investment and employment requirements.

One of the more controversial regulations is the requirements regarding contingency fee arrangements between applicants and third parties that prepare the credit application. Not only are applicants required to disclose these fee arrangements, but the arrangements will be reviewed by GO-Biz to ensure that fees are reasonable. This regulation led to a lawsuit by Ryan LLC, a tax services firm headquartered in Dallas, Texas, challenging the contingency fee disclosure requirements.

This is not the first time that California has tried to restrict contingency fees. According to the complaint in the Ryan case, California has twice introduced legislation that restricts contingency fee arrangements in tax-related matters, but neither was enacted into law. On the federal level, the DC District Court, in Ridgely v. Lew, invalidated the I.R.S. Circular 230 contingency fee ban on tax practitioners.

The Ryan complaint alleges that GO-Biz abused their rulemaking powers by adopting regulations which conflict with California law. The complaint alleges that California law specifies the factors used in determining which businesses receive California Competes credits and that consideration of the contingency fee arrangement imposes an additional condition on tax credit applicants. California issued an answer to the complaint on Feb. 20.


California Bill Would Provide Small Businesses With Cash Grant For Unused R&D Tax Credits

AB 437, sponsored by California Assembly Speaker Toni Atkins, would provide businesses with less than $5 million in gross receipts to receive a cash grant for between 10 and 15 percent of any unused R&D tax credits.

According to the Sacramento Business Journal:

Under the existing California Research Tax Credit, businesses can reduce their taxes through if they incur certain types of research-related expenses. However, data from the Franchise Tax Board show a majority of the tax credits available to small businesses go unused because the business does not have enough taxable liabilities.

Assembly Bill 437 would allow businesses with revenues of $5 million or less to cash out 10 percent of all R&D tax credits received in 2014 and 2015, and reinvest the money into research and development. Beginning in 2016, businesses would be able to cash out 15 percent of their tax credits.


IRS Authorizes Retroactive WOTC Transition Relief

In March of 2013, because of Congress’ retroactive authorization of the WOTC program, the IRS allowed a brief period of “transition relief” to allow taxpayers to file WOTC applications for employees hired in 2012 retroactively. Normally, the WOTC program requires that applications be submitted within 28-days of an employee’s start date.

There has been speculation that since Congress once again authorized WOTC for the year that has passed, IRS would provide a similar transition relief in 2015 for employees hired in 2014. Today, we received IRS Notice 2015-13 which does just that.

The Notice says, in part:

Because the Act extended the WOTC retroactively for 2014 for members of targeted groups, employers need additional time to comply with the requirements of § 51(d)(13)(A). Accordingly, a taxable employer that hired a member of a targeted group (as defined in §§ 51(d)(2) through (10)), or a qualified tax-exempt organization that hired a qualified veteran described in § 51(d)(3), on or after January 1, 2014, and before January 1, 2015, will be considered to have satisfied the requirements of § 51(d)(13)(A)(ii) if it submits the completed Form 8850 to the appropriate DLA to request certification not later than April 30, 2015.


Ways and Means Committee Passes Permanent R&D Credit

The Ways and Means Committee today passed H.R. 880 making the R&D tax credit permanent.

A similar bill was passed by the House last year, and despite the President calling for the same policy,* has little chance of passage on its own.

*Pages 49-50


California Competes Credit Updates

GO-Biz updated its FAQ for the California Competes Credit on Feb. 6.

Among the changes is an updated table of investment to tax credit ratios that were accepted into the second round:

Gobiz_ratio_150206

In addition, final regulations were approved on 2/5/2015, and a final Statement of Reasons was posted to the website as well.


GO-Biz Received 253 Applications for Latest Round of California Competes Tax Credit

California’s GO-Biz just sent out the following press release:

Sacramento, Calif. – Building on the state’s effort to help businesses expand and create new jobs, the Governor’s Office of Business and Economic Development (GO-Biz) today announced that it received a total of 253 applications with a combined tax credit request of $289 million for the most recent California Competes Tax Credit application period which closed on February 2, 2015.

This fiscal year, GO-Biz is authorized to award $151.1 million in tax credits of which 25% ($37.7 million) is reserved for small businesses. GO-Biz made the first allocation of $31 million on January 15 and is scheduled to make additional awards on April 16, 2015 ($75 million) and June 18, 2015 ($31.1 million plus any unallocated amounts from the previous application periods).

GO-Biz evaluates the most competitive applications based on the factors required by statute, including total jobs created, total investment, average wage, economic impact, strategic importance and more. By April 6, 2015, GO-Biz will post on the California Competes website a list of the applicants recommended for an award. The final decision on whether to award a tax credit is made by the California Competes Tax Credit Committee at a meeting scheduled for April 16, 2015.


Paul Ryan Wants to Deal With Extenders Early

According to Politico:

Chairman Paul Ryan during the [Ways and Means Committee] hearing said he wants to pass extenders earlier this year rather than waiting until the end of the year and making everyone frantic about whether they’ll be continued.


President’s Fiscal Year 2016 Budget Calls for Permanent, Expanded WOTC

The Department of the Treasury’s document, “General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals,” on pages 51-53, explains the President’s budget proposal regarding WOTC and the Indian Employment Credit:

Reasons for Change

The Indian employment credit and the WOTC have been extended numerous times, but extension has often been retroactive or near the expiration date. This pattern leads to uncertainty for employers regarding the availability of the credit and may limit the incentive the credits provide for employers to employ individuals from the targeted groups. To improve the effectiveness of the credits, both credits should be made permanent. Disabled veterans may pursue educational and other training opportunities after release or discharge from military service before entering the civilian workforce, yet few who pursue such education or training would be likely to complete it within the one-year period in which they would remain qualified for the WOTC under current law. The Administration believes that such education and training is beneficial and that disabled veterans who pursue such opportunities should remain a qualified veteran for the purpose of the WOTC until six months after the education or training is completed.
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WOTC Amendment to the Hire More Heroes Act

The Senate Finance Committee will consider today H.R. 22, the Hire More Heroes Act. H.R. 22 was passed by the House to exempt veterans from being taken into account for purposes of determining the employers to which the employer mandate applies under the Patient Protection and Affordable Care Act.

In the Senate Finance Committee Senators Portman and Cardin have submitted the following amendment to extend WOTC and add a new category:

Short Title: Extend and Expand the Work Opportunity Tax Credit

Description of Amendment: The Work Opportunity Tax Credit (WOTC) provides a tax credit between $1,200 and $9,600 per employee for hiring and retaining members of vulnerable groups.

Eligible groups currently include: veterans, TANF, SNAP, and SSI recipients, ex-felons, the disabled, and summer youth employees. WOTC expired on December 31, 2014. This amendment would extend WOTC through December 31, 2015 and would allow an employer hiring someone who has exhausted their 26 weeks of regular unemployment benefits to be eligible for a 40 percent credit on the first $6,000 of wages paid that first year, or a maximum credit of $2,400 per employee.


Reps Pascrell and Reed Reintroduce Bill to Add Long-Term Unemployed Category to WOTC

PolitickerNJ.com reports:

U.S. Reps. Bill Pascrell, Jr. (D-NJ) and Tom Reed (R-NY), both members of the House Ways and Means Committee, today announced the reintroduction of H.R.481, the Long-term Unemployed Hiring Incentive Act, legislation that would extend the successful Work Opportunity Tax Credit program to make companies that hire long-term unemployed individuals eligible for a tax credit of up to $2400. Similar legislation was introduced in the last Congress, and the legislation was approved by the Senate Finance Committee in S. 2260, the Expiring Provisions Improvement Reform and Efficiency (EXPIRE) Act.
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Did the State of the Union Make Tax Reform Less Likely?

Politico’s “Morning Tax” has an interesting collection of links indicating that the consensus is that the President’s State of the Union address hurt the possibility of getting tax reform done:

SOTU DAY TWO FLY-AROUND: GLASS IS HALF EMPTY ON TAX REFORM. The day after Obama gave his State of the Union address, most tax wonks, reporters and newspaper editorials said the president’s speech — specifically his calls for tax hikes on the rich to make new cuts for the middle class — only crippled the prospects of tax reform. Read: 1.) MarketWatch: “The prospects for an overhaul of the tax code just got dimmer.” (http://on.mktw.net/1xzVhn2) 2.) “The tax reform gap between Obama and the GOP is widening,” Howard Gleckman for TaxVox (http://bit.ly/1yI9PW1). 3.) The Hill: “Obama’s decision to pitch tax changes for individuals in his [SOTU] address has only complicated the chances for tax reform.” (http://bit.ly/1yJStXg.) 4.) “Obama Tax Agenda Widens Partisan Gulf as He Seeks Redistribution,” Bloomberg (http://bloom.bg/1L1vzAT).


FTB To Hold Interested Parties Meeting On California Competes Credit

The California FTB will hold an interested parties meeting on February 19, 2015 to discuss the requirement in the new California Competes Tax Credit that FTB review the books of taxpayers awarded the credit. From the announcement:

Topic

On November 7, 2014, the Franchise Tax Board issued FTB Notice 2014-02 to inform taxpayers of the procedures the department will use as guidelines to review the books and records of those taxpayers that are awarded a California Competes Tax Credit by the Governor’s Office of Business and Economic Development (GO-Biz) in accordance with Revenue and Taxation Code sections 17059.2 and 23689.

Purpose:

To explain the review procedures and open a dialogue as to what types of information and records may be available and used to show compliance with the contract milestones. Discussion topics include:

1. An overview of the review procedures and key features
2. Discussion of contract milestones and record keeping
a. Increase in employment and compensation levels/Employment Records Available
b. Project Investment/Records Available
3. Timing for first reviews
4. Wrap up and Q & A


Obama Administration Calling For Closing “Loopholes” and Making R&D Tax Credit Permanent

While President Obama did not specifically address tax policy in his State of the Union address on Tuesday night, on Wednesday morning, Treasury Secretary Jack Lew presented the administration’s outlook at the Brookings Institution. Among his remarks, he said:

Let me now turn to the specific components of the President’s framework for reform. The President’s proposal for a new business tax system has five pillars that represent an attempt to chart a bipartisan path forward.

First, we need to lower rates and close wasteful loopholes. This will make our business tax system competitive, fundamentally fair, and fiscally responsible. The President’s plan eliminates dozens of tax breaks and loopholes, and without adding to our deficits, reduces the current top corporate tax rate from 35 percent to 28 percent. This rate is in line with our trading partners, and it will help encourage investment in the United States. As we broaden the tax base, we can also create more certainty and make the system simpler and more efficient. And, we believe there is bipartisan support to move forward on this.

Second, we need to build on the resurgence of manufacturing in the United States. A vibrant U.S. manufacturing sector is fundamental to our capacity to remain innovative and competitive, and it is an important source of good-paying jobs for America’s workers. That is why the President’s plan makes it even more attractive for manufacturers to build and expand here rather than overseas. It lowers tax rates for domestic manufacturing to 25 percent. And it takes manufacturing incentives — including the Research and Experimentation Tax Credit — and makes them permanent. The Research and Experimentation Tax Credit jumpstarts private investment in research and technology, and it propels innovations that spark new jobs, new industries, and new breakthroughs in engineering and production. And this is another area of broad bipartisan support.

Here is the video of the speech and discussion:


R&D Update – Software – New Proposed Regulations Released

On Friday, January 16, 2015, the Treasury and IRS released proposed regulations (REG-153656-03) governing the R&D tax credit as it regards the development of computer software.

The proposed regulations:

1. Clarify the definition of internal use software (IUS);

2. Retain and modify the single product and production process exceptions to IUS;

3. Modify the significant economic risk prong of the high threshold of innovation test applicable to IUS;

4. Provide examples illustrating the process of experimentation requirement as it pertains to software development; and

5. Withdraw Announcement 2004-9.

I. IUS DEFINITION

1. General and Administrative Software: IUS is defined as software developed for use in general or administrative functions that facilitates or supports the conduct of the taxpayer’s trade or business. General and administrative functions include financial management/recordkeeping, HR management, and support services (such as data processing or facilities services) intended to cover back office functions that a taxpayer would have regardless of industry.

2. Computer and Noncomputer Distinction Eliminated: The proposed regulations eliminate the distinction between software developed to deliver computer and noncomputer services.

3. IUS Presumption Eliminated: Software developed for sale, lease or license is still presumed to be external use software. However, software that is not held for sale, lease or license is no longer automatically presumed to be IUS.

4. Dual Function Software Presumed to be IUS: Dual function software (i.e., used by the taxpayer and third parties) is presumed to be IUS. The burden of proof is on the taxpayer to identify the external use portion (and the associated QREs). If the taxpayer cannot identify the non-IUS portion, there is a safe harbor provision allowing the taxpayer to claim 25% of the costs if the external use portion is reasonably anticipated to constitute 10% of the system’s total use.

5. Software Enabling Third Party Interaction: Software that enables a taxpayer to interact with third parties or allows third parties to interact with the taxpayer’s systems does not solely benefit the taxpayer, and thus should not be considered IUS. However, third parties do not include any persons that use the software to support a taxpayer’s general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business.

6. Taxpayer Intent Controls: Whether software is developed for internal use depends on the intent of the taxpayer and the facts and circumstances at the beginning of software development. For example, if a taxpayer initially develops software for internal use but later makes improvements to the software with the intent to sell, lease or license the improved software or to allow third parties to initiate functions or review data, the improvements can be considered separate and will not be deemed IUS. Alternatively, if a taxpayer originally develops software to sell, lease or license or to interact with third parties, but later makes improvements for internal use, the former activities will be considered non-IUS while the latter will be considered separate and deemed IUS.

II. IUS EXCEPTIONS: SINGLE PRODUCT AND PRODUCTION PROCESS

1. Single Product Exception Retained: The proposed regulations retain the exception that computer software and hardware developed as a single product used directly by the taxpayer in providing services in the taxpayer’s trade or business is not considered IUS.

2. Production Process Exception Clarified: Software that is developed for use in a production process is not IUS. However, computer software supporting the delivery of goods or services to third parties is not part of a production process and would not fall within this exception. Nonetheless, such software development would not be IUS to the extent that the software enables a taxpayer to interact with third parties or allows third parties to initiate functions or review data.

III. HIGH THRESHOLD OF INNOVATION TEST

1. Elimination of Unique or Novel Requirement: Under the proposed regulations, the high threshold of innovation test requires the following:

(i) Innovative: Software is considered innovative if it would result in a reduction in cost, improvement in speed, or other measurable improvement, that is substantial and economically significant. (The innovative requirement no longer requires that the software be (1) unique or novel, and (2) intended to differ in a significant and inventive way from prior software implementations or methods.)

(ii) Significant Economic Risk: The taxpayer commits substantial resources to the project, and there is substantial technical uncertainty. Substantial technical uncertainty is defined as uncertainty of capability or uncertainty of methodology. Appropriateness of design uncertainty is not sufficient to meet this requirement. Thus, the level of risk required is higher than that required to meet uncertainty under I.R.C. § 174 and the four-part test.

(iii) Commercial Availability: No commercially available software provides the necessary functionality without modification that would satisfy the first two requirements.

IV. PROCESS OF EXPERIMENTATION

1. Examples under Treas. Regs. § 1.41-4(a): The proposed regulations add six examples to Treas. Regs. § 1.41-4(a) to illustrate what constitutes a process of experimentation for software development.

V. EFFECTIVE DATES

1. The proposed regulations will be prospective only, applicable for tax years ending on or after the date final regulations are published in the Federal Register.

2. The IRS will not challenge return positions consistent with the proposed regulations for tax years ending on or after January 20, 2015.

3. Consistent with FedEx Corporation v. United States of America, 108 AFTR 2d 2011-5669 (W.D.Tenn. Mar 28, 2011), denying reconsideration of 103 AFTR 2d 2009-2722, 2009-1 USTC paragraph 50,435 (W.D.Tenn. 2009), for tax years ending before January 20, 2015, taxpayers may choose to follow all of the internal-use software provisions in the 2001 final regulations (without applying the “discovery test”) or the 2001 proposed regulations. The IRS has withdrawn its advance notice of proposed rulemaking issued on January 2, 2004.

The proposed regulations are generally taxpayer favorable and may afford new opportunities for taxpayers to reevaluate their software development expenses for eligibility under I.R.C. § 41.


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