News and Insights

California Phases Out Enterprise Zones, Creates New Sales Tax Exemption

Tax Development Jul 09, 2013

California is phasing out its Enterprise Zone Program (“Program”) and replacing it with three new tax incentives, including a statewide sales tax exemption for some manufacturers and biotechnology companies. The changes were authorized by Assembly Bill 93 (“AB 93”), which passed the state Senate on June 25, 2013 and was approved by the Assembly on June 27, 2013. The bill was signed Thursday, July 11, 2013 by Governor Jerry Brown, who had earlier issued a statement calling AB 93 “a big bipartisan win for California businesses and working people. AB 93 will help grow our economy and create good manufacturing jobs.” On July 3, 2013, the Assembly passed Senate Bill 90 (“SB 90”), which further refined some of the changes that had been adopted in AB 93. Governor Brown also signed it on Thursday, July 11, 2013.

The Program provided businesses operating in designated enterprise zones with certain tax preferences under both the state corporations tax and personal income tax, including an income tax credit for sales tax paid on certain business purchases, hiring credits, net interest deductions, business expense deductions, and net operating loss deductions. AB 93 eliminates the Program effective January 1, 2014, subject to the following:

  • Unused sales or use tax credits may be carried forward for ten years.
  • Unused hiring credits may be carried forward for up to ten years or through December 2023.
  • The net interest deduction may be applied to interest received before January 1, 2014. The deduction will expire for taxable years beginning on or after January 1, 2014, and officially withdrawn on December 1, 2014.

State funds committed to the Program are to be redirected into the following new tax incentive programs:

State Sales Tax Exemption

A statewide state sales and use tax exemption applicable to equipment procured by businesses engaged in manufacturing or biotechnology research and development (R&D) will replace the Program’s sales tax credit. Eligible companies include manufacturers in aerospace, textiles, pharmaceuticals, printing, and food, as well as biotechnology research and experimental development activities in agriculture, electronics, environmental biology, botany, computers, chemistry, food, fisheries, forestry, geology, health, mathematics, medicine, oceanography, pharmacy, physics, veterinary, and other allied fields. Extractive industries are not eligible for the exemption.

Beginning on July 1, 2014, qualifying businesses can exclude the first $200 million of eligible purchases per year from the state portion of the sales and use tax.

  • The $200 million cap on the exemption applies per combined reporting group.
  • Eligible purchases include:
    • Machinery and equipment, including component parts.
    • Devices used or required to operate, control, regulate, or maintain the machinery.
    • Pollution control items.
    • Special purpose buildings and foundations that are an integral part of the process or that constitute a research or storage facility used during the process (excludes warehousing).
  • The exemption applies to rentals payable under leases classified as “continuing sales” or “continuing purchases” in accordance to California Revenue & Taxation Code Sections 6006.1 and 6010.1.
  • Qualified tangible items must be used at least 50% of the time by the purchaser in any stage of manufacturing or R&D and have a useful life in excess of one year.
  • An exemption certificate must be provided to the retailer.

The exemption will sunset on July 1, 2022. This provision was contained in a clean-up bill, SB 90, which passed on July 3, 2013.

Manufacturing, including processing, refining, fabricating, or recycling, begins when raw materials are received and introduced into the process and ends when a tangible item is altered to its complete form, including packaging. It also includes any improvements to a tangible item that result in a greater service life or greater functionality than that of the original item.

The definition of R&D is consistent with the federal definition under Section 174, IRC or any regulations thereunder.

Hiring Credit

AB 93 retains the hiring credit but significantly tightens eligibility requirements, effective January 1, 2014.

  • Areas eligible for the credit include those located within the designated census tract or areas within the state’s current 40 enterprise zones, including local agency military base recovery areas. Wages must be between $12 per hour to $28 per hour, which equates to 150% to 350% of the current minimum wage. However, in certain designated pilot areas, wages must be at least $10 per hour, according to a change made by SB 90. The current program required a wage of up to $12 per hour.
  • The credit is to be calculated at a maximum of 35% of wages each year for up to a total of seven years. Currently, the calculation is based on 50% of wages the first year, declining 10% each year for five years.
  • The maximum credit per employee is $56,000, an increase from the current maximum of $36,000.
  • Employee must work 35 hours or more per week. Currently, the Program permits part-time employees.
  • There are only four categories of qualifying employees. (Previously, the Program had multiple categories.)
    • Persons unemployed for at least six months.
    • Veterans.
    • Persons receiving public assistance or Earned Income Tax Credit.
    • Ex-offenders.
  • Credit applies to net increase in annual statewide jobs only; unlike the current program, replacement jobs are not eligible.
  • Credits can only be claimed on timely filed original returns. The Program currently permits participants to amend returns.
  • Temporary help agencies, retailers, restaurants, and drinking establishments, as defined by the NAICS codes, are not eligible. Small businesses are excluded from this exception. In SB 90, California lawmakers also added “sexually oriented businesses” to the list of ineligible businesses.
  • Businesses moving intrastate into an eligible area are required to provide an “offer of transfer” to its employees with comparable compensation.
  • Small businesses are allowed 25% of the hiring credit, if all program requirements are met. A small business is defined as a trade or business with aggregate receipts, less returns and allowances, of less than $2 million during the previous tax year.
  • The credit expires as of January 1, 2021.

Investment Tax Credit

AB 93 also creates a new investment tax credit to be awarded by a newly established California Competes Tax Credit Committee (“Committee”) based on a competitive application process. Competitive criteria will include the following:

  • Number of jobs to be created or retained by the business in the state.
  • Compensation paid or proposed to be paid to employees, including wages and fringe benefits.
  • Amount of investment made in the state.
  • Extent of unemployment in the area in which the taxpayer’s project or business is proposed or located.
  • Incentives available to the taxpayer in California, including incentives from the state, local government, and other entities.
  • Incentives available to the taxpayer in other states.
  • Duration of the proposed project and the duration the taxpayer commits to remain in the state.
  • Overall economic impact in the state of the taxpayer’s project or business.
  • Strategic importance of the taxpayer’s project or the business to the state, region, or locality.
  • Opportunity for future growth and expansion in the state by the taxpayer’s business.
  • Extent to which the anticipated benefit to the state exceeds the projected benefit to the taxpayer from the tax credit.

The Governor’s Office of Business and Economic Development (“GO-Biz”) will negotiate agreements with applying businesses for approval by the Committee. The aggregate amount of the credit allocated to any one taxpayer can be no more than 20%. Priority will be given to projects located or proposed to be located in an area of high unemployment or poverty. Small businesses are allowed 25% of the investment credit, if all program requirements are met.

The new tax credit will be effective January 1, 2014 and ends January 1, 2025. Program funds will be allocated beginning July 1, 2013 for the 2013-2014 fiscal year. Recapture will occur if a business fails to fulfill the terms of an agreement. Information regarding all awards will be publicly available on the GO-Biz website.