Calif. Seeks Input on Clean Energy Equipment Tax Exemption

In connection with the IPM notice, the CDTFA has issued a discussion paper and proposed amendment language.^[3] The proposed amendments not only include language implementing expansion of the exemption to electric generation and distribution equipment, but also other favorable legislative changes that expand the exemption to include certain agricultural business equipment, retroactively expand the definition of useful life and extend the sunset date for the exemption through June 2030.

This article summarizes the sales and use tax exemption’s scope and qualifying requirements, the 2017 legislative changes to it, the CDTFA’s proposed amendments and why stakeholders may want to participate in the IPM process.

Introduction

California Code of Regulations Section 1525.4 provides the rules for implementing and applying the sales and use tax equipment exemption authorized by California Revenue and Taxation Code Section 6377.1. The exemption first became effective July 1, 2014, and was amended by two bills passed last summer and fall to expand and extend the exemption to further California’s long-standing effort to reduce greenhouse gases.^[4]

In general, the exemption applies to sales and purchases of “qualified tangible personal property” by a “qualified person.” As originally enacted, “qualified person” was largely limited to taxpayers primarily operating within the manufacturing sector and/or those engaged in research and development activities. The definition specifically excluded taxpayers primarily engaged in agricultural and extractive business activities, among others.

Section 6377.1 Prior to 2017 Amendments

Initially, the exemption applied only to the following:^[5]

1. Qualified tangible personal property purchased by a qualified person to be used primarily in any stage of the manufacturing, processing, refining, fabricating or recycling of tangible personal property, including packaging if required;
2. Qualified tangible personal property purchased for use by a qualified person to be used primarily in research and development;
3. Qualified tangible personal property purchased for use by a qualified person to be used primarily to maintain, repair, measure or test any qualified tangible personal property described under 1 or 2 above; and
4. Qualified tangible personal property purchased for use by a contractor purchasing that property for use in the performance of a construction contract for a qualified person that will use that property for statutorily specified purposes.

The term “qualified tangible personal property” for these purposes was defined to include the following:^[6]

1. Machinery and equipment, including component parts and contrivances such as belts, shafts, moving parts and operating structures;
2. Equipment or devices used or required to operate, control, regulate or maintain the machinery, including, but not limited to, computers, data-processing equipment and computer software, together with all repair and replacement parts with a useful life of one or more years;
3. Tangible personal property used in pollution control that meets established state or local standards; and
4. Special purpose buildings and foundations used as an integral part of the manufacturing, processing, refining, fabricating or recycling process, or that constitute a research or storage facility used during those processes. Buildings used solely for warehousing purposes after completion of those processes are not included.

The term “qualified person” for these purposes was defined to include persons primarily engaged in certain types of manufacturing, biotechnology research and development, or physical, engineering and life sciences research and development.^[7] The exemption expressly excluded certain trades or businesses conducting agricultural business, extractive business, savings and loan, banking or financial business activities.^[8]

2017 Amendments to Section 6377.1

Effective Jan. 1, 2018, the exemption includes an expanded definition of “qualified person” to include those engaged in the electric generation industry with particularly favorable treatment provided to persons engaged in renewable energy activities:^[9]

• Persons primarily engaged in electric power generation and methods of distribution activities, including renewable sources such as hydroelectric, solar, wind, geothermal and biomass, and conventional power sources such as nuclear and fossil fuels.
• Electric power establishments that primarily engage in either operating power distribution systems or operating as power brokers or agents.

The exemption also adds two key definitions that affect the expanded definition of “qualified person”:^[10]

• “Generation or production” means “the activity of making, producing, creating, or converting electric power from sources other than a conventional power source, as defined in section 2805 of the Public Utilities Code;” and
• “Storage and distribution” means “storing or distributing through the electric grid, but not transmission of, electric power to consumers regardless of source.”

Comment

The expanded definition of “qualified person” encompasses “conventional power sources,” such as power derived from nuclear energy, hydropower facilities and fossil fuels.

However, because the definition of “generation or production” specifically excludes conventional power sources, purchases of qualified tangible personal property will not be eligible for the tax exemption if used in the generation or production of electric power from conventional power sources.

In contrast, the definition of “storage and distribution” does not exclude electric power from conventional power sources. Thus, purchases of qualified tangible personal property used in the storage and distribution of electric power from conventional sources seem to be eligible for the exemption when purchased by a qualified person.

The changes to Section 6377.1 also expand the definition of “qualified person” to include those engaged in agricultural activities.^[11]

The changes to Section 6377.1 also expand the definition of “qualified tangible personal property” to encompass “special purpose buildings and foundations used as an integral part of the generation or production or storage and distribution of electric power.”^[12]

Finally, the changes to Section 6377.1 clarify the definition of “useful life.” To be eligible for the exemption, the property must have a “useful life” of more than one year. The CDTFA, in its interpretation of the originally enacted statute, limited this definition to mean only property capitalized and depreciated for income tax purposes.^[13] However, the legislative amendments now make clear that this means both specified depreciable and expensed property for income tax purposes.

Comment

For taxpayers that treated tangible personal property as deductible for income tax purposes on or after July 1, 2014, and continuing through Jan. 1, 2018, such taxpayers may be entitled to a refund and/or cancellation of an outstanding or unpaid deficiency if the deductible treatment was consistent with the clarifying revisions to “useful life” in Section 6377.1.^[14]

Importantly, taxpayers who qualify will only be entitled to a cancellation or refund if a written request is sent to the CDTFA by June 30, 2018.^[15]

The CDTFA’s Proposed Regulatory Project and the Value of Stakeholder Participation in the IPM

On March 13, 2018, the CDTFA issued a notice for its IPM scheduled for April 11, 2018, inviting stakeholders to discuss its proposed regulatory project and present any additional suggestions or comments.^[16] California regulations, including regulatory amendments, are developed and enacted through a rulemaking process. That process includes formal, required public notice and input, but can also include open meetings, like the CDTFA’s IPM, designed to gather public input when the administrative agency is engaged in preliminary rulemaking activities. These informal meetings allow stakeholders to participate in the creation of and revisions to regulations. Participation in the process is extremely important, but often overlooked by stakeholders. It provides a unique opportunity to influence and shape law directly.

In this case, stakeholder participation is especially important because the CDTFA’s proposed regulatory amendments, as currently drafted, only make conforming revisions to incorporate the legislative changes to Section 6377.1.^[17] In other words, the CDTFA has not suggested any amendments that provide guidance beyond the language that already exists in the statutory language.

For stakeholders who believe the CDTFA should be providing more substantive guidance in the regulation regarding the application of the new statutory amendments, including more examples or detailed definitions, the IPM process is designed to elicit that type of input for consideration by the CDTFA. This process can take many forms, including suggesting additional general or specific regulatory language, suggesting examples, objecting to or supporting regulatory language or examples suggested by other stakeholders or the CDTFA, or even voicing that no regulatory amendments should be made at all. Stakeholders can participate in this process and have their positions considered by attending the CDTFA’s April 11, 2018, IPM and/or by submitting written comments to the CDTFA by April 27, 2018.

_{[1] California Revenue and Taxation Code Section 6377.1 is a partial exemption with a current rate of 3.9375 percent resulting in taxation at a rate of 3.3125 percent plus applicable district taxes. The section is frequently referred to as the “partial sales and use tax exemption for certain manufacturing and research and development equipment.”}

_{[2] The CDTFA is charged with administering California’s Sales and Use Tax Law.}

_{[3] See CDTFA, Discussion Paper on Proposed Amendments to Regulation 1525.4, Manufacturing and Research & Development Equipment (Mar. 13, 2018), available at: https://www.cdtfa.ca.gov/taxes-and-fees/1525-4-DP-Web.pdf (CDTFA Regulation 1525.4 Discussion Paper).}

_{[4] Stats. 2017, c. 135 (AB 398) and Stats. 2017, c. 252 (AB 131).}

_{[5] Cal. Rev. & Tax. Code § 6377.1(a) prior to 2017 amendments.}

_{[6] Cal. Rev. & Tax. Code § 6377.1(b)(7)(A) prior to 2017 amendments.}

_{[7] Cal. Rev. & Tax. Code § 6377.1(b)(6)(A) prior to 2017 amendments.}

_{[8] Cal. Rev. & Tax. Code § 6377.1(b)(6)(B) prior to 2017 amendments.}

_{[9] CDTFA Regulation 1525.4 Discussion Paper, p. 6; Cal. Rev. & Tax. Code § 6377.1(b)(8)(A)(ii).}

_{[10] CDTFA Regulation 1525.4 Discussion Paper, p. 6; Cal. Rev. & Tax. Code § 6377.1(b)(3), (12).}

_{[11] CDTFA Regulation 1525.4 Discussion Paper, p. 6; Cal. Rev. & Tax. Code § 6377.1(b)(8)(B)(ii).}

_{[12] CDTFA Regulation 1525.4 Discussion Paper, p. 7; Cal. Rev. & Tax. Code § 6377.1(b)(9)(A)(iv)(II).}

_{[13] CDTFA, Tax Guide for Manufacturing and Research & Development Equipment Exemption, Industry Topics, Useful Life, available at: https://www.cdtfa.ca.gov/industry/manufacturing-exemptions.htm#Topics.}

_{[14] Cal. Rev. & Tax. Code § 6377.1(b)(13)(B).}

_{[15] Cal. Rev. & Tax. Code § 6377.1(b)(13)(B).}

_{[16] See CDTFA Interested Parties Meeting Notice, March 13, 2018.}

_{[17] CDTFA Regulation 1525.4 Discussion Paper, Exhibit 1, pp. 1-15.}