HOUSE BILL NO. 118 "An Act relating to a tax credit for corporate income taxes paid for qualified research and development expenditures; and providing for an effective date." 1:42:58 PM Co-Chair Thomas MOVED to ADOPT a proposed committee substitute for HB 118, work draft 27-GH1951\B. Co-Chair Stoltze OBJECTED for purpose of discussion. JOE MICHEL, STAFF, REPRESENTATIVE BILL STOLTZE, explained changes to the proposed committee substitute. He observed that there were two changes on page 2, line 11: "apportioned to this state" and "AS 43.20.021" were deleted; and "this title was inserted. Co-Chair Stoltze WITHDREW his OBJECTION. There being NO further OBJECTION, proposed committee substitute for HB 118, work draft 27-GH1951\B was adopted. CURTIS THAYER, DEPUTY COMMISSIONER, DEPARTMENT OF COMMERCE, COMMUNITY AND ECONOMIC DEVELOPMENT, testified in support of HB 118. He observed that innovation can be an expensive, intricate and time-intensive enterprise. But it also could also spark a chain of investments in capital equipment, workers, and spillover activities in every economic sector. Nearly 40 other states had already recognized this by establishing a tax credit for research and development in addition to illustrated economic benefits the credit brings to those states. The tax credit also brought a competitive benefit advantage over Alaska. Mr. Thayer observed that House Bill 118 would address the issue by establishing a 20 percent tax credit for qualified research and development (R&D) conducted by corporate taxpayer in Alaska. In effect, the research and development tax credit would stimulate private-sector investment, entrepreneurial activity and business expansion in the state that would bring opportunity and sustainable long- term benefits to the state's economy. Mr. Thayer noted the HB 118 tax credit was modeled after the federal R&D established in 1981 and reauthorized fourteen times. The credit was reauthorized through 2011. Legislation was introduced to make the R&D tax credit permanent in order to help companies create good jobs while growing future productivity. Mr. Thayer explained that the legislation would allow Alaskan corporations to receive a 20% tax credit, not to exceed $10 million per taxpayer, per tax year. The research and development activities, or the payroll of the employees, must take place in Alaska. To qualify, research and development activities must meet the following: · The purpose is discovering information technological in nature; · The application of which is intended to be useful in the development of a new or improved component of the taxpayer; · Substantially all of the activities constitute a process of experimentation; and · The experimentation is for a qualifying activity or purpose. Mr. Thayer reviewed what would qualify: •Developing new or improved products, processes, or formulas; •Developing prototypes or models; •Building or improving manufacturing facilities; •Developing or improving software technologies; •Certification testing; and •Developing or applying for patents. Mr. Thayer reviewed what would not qualify: •Exploration activity to ascertain the existence, location, extent, or quality of any ore or mineral deposit; •Duplicating an existing business component; •Surveys and studies such as market research, advertising, and routine data collection; •Research in the social sciences, arts, or humanities; and •Anything for style, taste, cosmetic, or seasonal reasons. 1:48:13 PM Mr. Thayer gave examples of the type of credits that could occur. He referred to seafood processing waste disposal in fisheries. The EPA had restricted processing effluent. Research was needed to reduce sediment piles through process innovation, increased protein and by-product utilization. Tax credits meant research conducted in Alaska, jobs, vendor payments, increased experience, and capacity building in process and product innovation. He observed that some of the research was being down out-side of the state of Alaska for fish processing plants in the state of Alaska. Mr. Thayer reviewed potential tax credits for minerals, rare earth deposit processing. There was a need to customize the process for milling and recovery to use deposits to the fullest potential. More than 240 processes might be required to reach all components in a deposit. He observed the work was being done in Canada and maintained it should be done in Alaska. Mr. Thayer spoke to timber for use in architectural and building industries. To be specified for many building and architectural uses, species must have technical standards set for each product form. Mr. Thayer observed that there were 38 states with a form of R&D tax credit or incentive available. He clarified that credits were not stackable against other industries such as oil and gas within the title of the legislation. 1:50:08 PM ALAN JOHNSTON, WEDBUSH SECURITIES, ANCHORAGE, testified in support of the legislation. He noted he had been in the investment business for 35 years and stressed the importance of the legislation. He emphasized the importance of raising aspirations that R&D could occur in Alaska. 1:51:44 PM DAN WHITE, ASSOCIATE VICE CHANCELLOR, RESEARCH, UNIVERSITY OF ALASKA, FAIRBANKS, spoke in support of the legislation and stressed the importance of moving research and development from the university into the private sector. moving R&D to the private sector was seen as a critical element of economic development in Alaska, especially in engineering. Businesses would gain competitive advantage in national and global markets from applied research conducted and licensed by the University of Alaska, Fairbanks. He concluded that HB 118 would provide a significant incentive to business to take advantage of emerging opportunities and contribute to the university's mission. The legislation would build a bridge between the university and the private sector that would lead to job growth and diversification for the state. 1:53:38 PM Representative Guttenberg noted that seasonal items would not apply and pointed out that "seasonal" could apply to agriculture, fishing, or timber; and questioned the definition. Mr. Thayer offered to provide a definition under the tax code. Co-Chair Stoltze asked for further clarification regarding agricultural seasonal definitions. Mr. Thayer observed that agricultural items would qualify. He pointed out that the peony market was a product of the university's research. 1:57:03 PM Representative Gara recalled concerns that state money would not displace federal funds. He asked the federal tax rate. Mr. Thayer explained businesses could not claim both a state and federal tax credit on the same percentage. Mr. Thayer explained that the 20 percent tax credit for qualified research and development that exceeded the average qualified research and development expenditures as defined in 26 U.S.C 41(d) (Internal Revenue Code) for the three years immediately preceding the year in which the credit was claimed. Unused credits might be carried forward for up to seven years after the expenditure for which the credit was claimed. In order to prevent a corporate taxpayer from claiming more than one benefit for a single expenditure, the bill would also provide that a credit could not be claimed for expenditures the corporation deducted in calculating its tax liability, or for any other credit, including any federal credits, that had been apportioned to the state and claimed under the current Alaska Net Income Tax Act. Representative Gara asked what would occur in a case where there was a 22 percent state credit and an 18 percent federal credit and questioned if the state would pay the extra 2 percent or the entire credit. He reiterated his request for the federal tax rate. 1:59:19 PM Representative Guttenberg reiterated his question: What agricultural products qualify that would not be seasonal. BRUCE TANGEMAN, DEPUTY COMMISSIONER, TAX DIVISION, DEPARTMENT OF REVENUE (via teleconference), could not respond but promised to provide the information. Representative Gara asked the federal tax rate and if it would be replaced with state credits. Mr. Tangeman stated he would provide the information. Co-Chair Stoltze noted the bill would be held in order to allow the Department of Revenue time to research answers to the member's questions. 2:01:17 PM Representative Gara concluded that businesses could take the state or federal tax credit and restated his previous scenario. He thought the state would pay the entire tax if its tax credit was higher than the federal rate. Representative Gara noted a comprehensive system of deductions and credits under 43.55 oil and gas tax established under Alaska's Clear and Equitable Share (ACES). He did not see the prohibition for adding these credits to the proposed R&D tax credit. He wanted further assurance that the tax could not be taken in addition to the ACES credit. 2:03:00 PM Representative Neuman asked equipment and facilities would be allowed if they supported a new product or technology. Mr. Thayer affirmed that they would be covered as long as the business was a taxpayer to the state of Alaska and it supported new technology to bring something to market; it would qualify if it had not been done before. He clarified the credit would apply for developing and proving the technologies or building or improving manufacturing facilities to add or enhance a product. 2:05:08 PM Vice-chair Fairclough observed that page 2 lines 5 and 6 provided for a seven-year credit carry forward and asked why a past tax liability would be allowed for seven years. Mr. Thayer explained that the provision was modeled after federal tax legislation. Vice-chair Fairclough referred to page 2, line 9. She shared concerns that the state deduction would be taken in lieu of another deduction [federal] and questioned if there should be a requirement to go forward on the other deduction. Vice-chair Fairclough observed the national and global recession and questioned what other states were doing in terms of R&D tax credits. 2:07:09 PM Representative Gara referred to subsections (c) and (d) on page 2: (c) If the tax credit under this section exceeds the taxpayer's tax liability after other tax credits are taken under this chapter for the year in which the expenditure is incurred, the excess of the tax credit over the liability may be carried forward for up to seven years. If an unused credit is carried forward to a tax year from an earlier year, the credit arising in the earliest year is applied first against the tax liability for the year. (d) A person may not claim a credit under this section for qualified research and development expenditures that were deducted in the calculation of tax liability under AS 43.20.011(e) or for which any other credit, including any federal credit, has been apportioned to this state and claimed under AS 43.20.021. Representative Gara thought that the above sections conflicted. He thought that they implied that credits were stackable to 100 percent. Mr. Thayer responded that the committee substitute would effectively prohibit stacking. He maintained that the legislation prohibited a company from claiming R&D tax credits against corporate income tax if the expense used in calculating the R&D was used to claim a credit against taxes due on other types under Title 43. Testimony in previous committees during the 2011 session expressed concern that a company subject to both corporate income tax and oil and gas production tax could receive a credit against both taxes for the same expense. The committee substitute assured that the company could only take a credit against one tax type for those expenses. Representative Gara reiterated his concerns. Mr. Thayer noted that an oil company or subsidiary that does R&D on heavy or viscous retrieval would qualify as long as there was no other tax credit received; the credit would not apply once production was begun. 2:09:23 PM Representative Gara provided a scenario based on a company invested in heavy oil technology that received a deduction of their tax rate, which could be 40 percent. He suggested that the legislation would not prevent the company from getting a tax credit on top of the deduction. Mr. Thayer reiterated that the legislation refers back to the bill title, which indicated that credits would only pay for qualified research and development expenditures. He maintained that they could not take both. Representative Gara argued that the legislation spoke to tax credits not deducts, which were separate under the oil and gas [tax] code. Mr. Tangeman clarified that it could not be used as a tax credit if it were used as a deduction and pointed to Section (d), page 2, line 8: A person may not claim a credit under this section for qualified research and development expenditures that were deducted in the calculation of tax liability under AS 43.20.011(e). 2:11:24 PM Representative Gara agreed with the intent but noted that AS 43.20.011(e) referred to the nine percent state corporate tax, not the oil and gas tax. Mr. Tangeman felt that Section (d) was clear and maintained that the intent was not to allow stacking. Representative Gara suggested an amendment was needed for clarification that the credit could not be stacked on credits and deductions taken under AS 43.55, oil and gas tax. 2:13:22 PM Representative Neuman asked what discussions had occurred regarding transferable and non-transferable credits. He observed that transfers had been enacted to assist smaller companies with working capital. He recognized that the state was still "on the hook" for 100 percent, but suggested they be transferrable. Mr. Thayer noted that only the film incentive program had transferrable tax credits. He observed issues surrounding how credits would be transferred and evaluated. Film industry tax credits sell between 80 to 90 cents on a dollar. Smaller companies would not have a tax liability to the state. The credit would be aimed at large companies that had the ability to do a lot of R&D in the state. Mr. Tangeman agreed that the intent was not to be transferable and the seven year provision would allow smaller corporations to have time to realize the tax liability. Co-Chair Stoltze closed public testimony. HB 118 was HEARD and HELD in Committee for further consideration. 2:17:41 PM AT EASE 2:25:42 PM RECONVENED