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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.

Negotiated Agreements

The businesses receiving the credit negotiate contracts with GO-Biz that set minimum employee compensation and retention periods, specify the period over which the credit will be distributed and include a provision allowing the state to recapture the credit amounts if the business fails to meet its commitments.

As they review the latest round of applications, GO-Biz officials are working under permanent regulations governing the program that took effect Feb. 5 to replace temporary regulations adopted Feb. 20, 2014, on an emergency basis. The regulations explain how the credit works, including definitions, the application and review process, and information that applicants must provide.

The final version of the regulations makes a few minor changes from the emergency regulations in place for the past year. One of the changes specifies that companies can apply for and win the credit multiple times, but each time they will be evaluated based on new commitments for investment and pay to workers in California. The change makes it clear that an applicant can’t be awarded a credit for activities that were part of a previous California Competes award and contract with GO-Biz.

Fee Arrangements at Issue

The final regulations also require applicants to assert that absent the credit award they “may” terminate or relocate employees, rather than “will” terminate or relocate. The change addresses concerns from publicly traded companies that stating they “will” relocate would run afoul of obligations they have to the Securities and Exchange Commission and shareholders.

GO-Biz rejected requests to change the regulations to be less restrictive toward contingency fee arrangements between applicants and consultants, attorneys, tax practitioners, or others who help prepare their credit applications. The regulations allow GO-Biz to request information about fee arrangements, and specify that such fees “must result in a fee that is less than or equal to the product of the number of hours of service provided to the applicant and a reasonable hourly rate for such services.”

Ryan LLC sued GO-Biz in August, alleging the restrictions on contingency fee arrangements exceed the office’s authority and illegally regulate fee arrangements between private parties. The lawsuit is pending in Sacramento County Superior Court (Ryan LLC v. Governor’s Office of Bus. and Econ. Dev., Cal. Super. Ct., No. 34-2014-00167988, 1/23/15).

Counter to Intent, GO-Biz Says

The California Society of Certified Public Accountants asked Go-Biz to change the regulations to affirm the office’s authority to reject excessive fees in the rare instances they occur without discouraging CPAs and others from accepting work on a contingency fee basis.

In comments explaining why it rejected the California Society of CPAs’ suggestion, Go-Biz said the changes would contradict the intent of the law creating the program, which is to ensure it is a model of transparency and accountability, and that it uses taxpayer dollars effectively.

“Allowing finite tax credits to be redirected to excessively high consultant fees is counter to the intent of this program’s authorizing statutes,” Go-Biz said.

At a Feb. 19 public meeting, staff members of the Franchise Tax Board explained in more detail the agency’s role in reviewing, but not auditing, the books and records of those winning the credit. The discussion at the meeting was the first guidance about the agency’s role since it issued a notice in November outlining its procedures under the new credit program.

Recapturing Credit

The FTB must review the books and records of all businesses receiving the credit that have more than $2 million in annual gross receipts to determine if they have met the milestones for employment, wages and investment required under their contracts with the state. The agency has the option to do the same for businesses with less than $2 million in gross receipts.

The tax agency is open to the types of information a company can provide to show it has met its milestones, the FTB staff members told meeting attendees. Examples would be payroll records, leases and rental agreements, intellectual property patents or applications, building plans and construction documentation, invoices and lists of depreciable assets.

If the FTB determines that a business has a material breach of its contract, either through failure to timely provide information for review, a material omission or incorrect information, or failure to meet milestones for employment, wages or investment, the agency will notify GO-Biz. It will be up to the five-member Go-Biz California Competes Tax Credit Committee to make a final decision whether businesses must pay back the credit due to a breach.

Self-Certification

For its part, GO-Biz is providing worksheets that credit recipients must use to self-certify that they have met their milestones. Once GO-Biz approves the self-certification, a business can claim the credit on its return for the year it received the credit.

The FTB review will come sometime later, and if the agency finds the business has breached its contract, the business must report the “recapture” of the credit on its return for the year. If the company doesn’t include the recapture on its return, the FTB will send a bill.

Companies can’t appeal a decision by the GO-Biz committee to recapture the credit, FTB and GO-Biz officials told attendees. However, once they pay the credit back to the state they can file a claim for refund with the FTB, GO-Biz Deputy Director Will Koch said.

In response to questions from attendees about the overlap between audits and credit reviews, the FTB representatives said agency staff reviewing the books and records for California Competes credits will be in a separate unit from those who perform audits.

“We’re not looking to open up another audit,” Tax Counsel Kristin Kane said. “If you think they’re asking for information for other reasons, you can ask why.”

If the businesses believe the information requests aren’t germane to the credit review, they should ask to speak with the reviewer’s supervisor, Kane said.

The California Competes credit is one of three tax incentives that replaced the enterprise zone tax credit program under a 2013 economic development package from Gov. Jerry Brown (D). A sales and use tax exemption for purchases of manufacturing equipment and a credit for hiring some types of employees in certain areas of the state are also available.

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