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Feb 1994

California tax update. (State & Local Taxation)

by Eisig, David

    Abstract- The California Legislature recently passed what Gov Pete Wilson considers the the most important tax bill in the state since Proposition 12. SB 671, which was passed on Sep 10, 1993, contains amendments to California's water's-edge combined reporting law. Although water's-edge combined reporting continues to be elective, SB 671 introduces new requirements replacing the domestic disclosure spreadsheet filing requirements, extends the water's-edge contract period by two years, and repeals the water's-edge election fee. Some of the bill's amendments affect the Bank of Corporation Income Tax, the Sales and Use Tax Law and the Personal Income Tax Law. The legislation will take affect on Jan 1, 1994. New water's-edge elections may have to be required.

Water's-Edge Amendments

* Water's-edge combined reporting remains elective. However, the domestic disclosure spreadsheet filing requirements were eliminated in favor of an information return identifying more than 20%-owned affiliates and the type of corporation (e.g., non-U.S., U.S., FSC). The information return is required if combined assets of the taxpayer and its affiliates exceed $200 million, regardless of whether a water's-edge election is made, and must be fried every three years.

* The water's-edge contract period is extended from five to seven years. The Franchise Tax Board's (FTB) ability to disregard an election is repealed, and significant penalties have been provided for failures to furnish information. New record keeping requirements have been added that also apply to worldwide combined report filers.

* The water's-edge election fee is repealed.

* The effective date is January 1, 1994, and any existing water's-edge election contracts under prior law still in effect are rescinded on the first day of the taxpayer's income tax year that begins on or after January 1, 1994. Therefore, it appears that new water's-edge elections will be required. It is unclear, however, whether a taxpayer that fried a domestic-disclosure spreadsheet for 1992 or 1993 will be required to file the new information return in 1994.

Credits, Exclusions, Deductions

Several tax credit provisions, exclusions from income, and deduction limitations also are included in the bill, such as:

* Meals and Entertainment. The bill conforms to Federal changes reducing business deductions for meals and entertainment from 80% to 50%, effective for income years beginning on or after January 1, 1994.

* Research and Development Tax Credit. The bill eliminates the "sunset" provision, and modified IRC Sec. 41(c)(5) for taxable years beginning on or after January 1, 1993, to take into account only those gross receipts from the sale of property held primarily for sale that is delivered or shipped within California, regardless of F.O.B. point or other conditions of sale. The bill also conforms to the amendments made by section 13112 of the Revenue Reconciliation Act of 1993 (Pub. L. No. 103-66) to IRC section 41 for taxable years beginning on or after January 1, 1994.

* Investment Tax Credit. The bill establishes a six percent tax credit for the cost of manufacturing equipment used in California and purchased on or after January 1, 1994. For fiscal-year taxpayers, purchases made after January 1, 1994, and before the beginning of the 1994 fiscal year are deemed to be paid or incurred in the taxpayer's 1994 fiscal year. No credit may be claimed on a taxpayer's 1994 return; rather, credits for pre-1995 purchases will be allowed on the 1995 return in addition to any amount of credit for 1995 purchases. The credit can be claimed against regular tax and alternative minimum tax. To be eligible for the credit, a taxpayer must be a "qualified person" (i.e., a person engaged in those lines of business described in Codes 2000 to 3999 of the Standard Industrial Classification Manual). The investment credit is not available if the taxpayer avails itself of the sales or use tax exemption for manufacturing property. The investment tax credit sunsets in 2001, unless 100,000 new manufacturing jobs are created.

Net-Operating-Loss Deduction

The net-operating-loss (NOL) carryover for corporations has survived another attack by the California legislation. A.B. 34 provides various amendments to California's NOL provisions, including the following:

* For taxable years beginning on or after January 1, 1993, the "sunset" date is eliminated, but the carryover period for NOLs incurred on or after January 1, 1987, has been reduced from 15 years to five years. With the exception of "new businesses" and "eligible taxpayers," the carryover amount, as under prior law, is generally 50% of the NOL generated.

* For taxable years beginning on or after January 1, 1994, 100% of an NOL of a "new business" (a business commencing operation on or after January 1, 1994, other than a trade or business used in any predecessor trade or business of the taxpayer or of a related taxpayer) incurred during the first three years of operation may be carried forward as follows:

-- eight years for an NOL attributable to the "new business'" first taxable year;

-- seven years for an NOL attributable to the second taxable year, and,

-- six years for an NOL attributable to the third taxable year.

* For taxable years beginning on or after January 1, 1994, 100% of an "eligible taxpayer's" NOLs may be carried forward for five taxable years. An eligible taxpayer is generally defined as a taxpayer with total receipts (gross income and cost of goods sold) of less than $1 million.

* For 1991 and 1992 (years in which NOL deductions were suspended), the bill provides that the carryforward period is extended. Also, for NOLs attributable to taxable years beginning on or after January 11 1987, and before January 1, 1994, a taxpayer in a Title II bankruptcy proceeding may carryover the NOL for ten years.

The California legislature has also passed S.B. 1176, a bill double- weighting the sales factor of the corporate income tax apportionment formula. Although characterized as revenue neutral, the double-weighted sales factor generally favors local business. In addition, it should be noted that this provision is effective January 1, 1993.

David Eisig, CPA, KPMG Peat Marwick

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