SB 64-RESEARCH AND DEVELOPMENT TAX CREDIT  2:32:07 PM CHAIR EGAN announced SB 64 to be up for consideration. CURTIS THAYER, Deputy Commissioner, Department of Commerce, Community and Economic Development (DCCED), thanked them for hearing SB 64. It establishes a 20 percent tax credit for qualified research and development (R&D) conducted by corporate taxpayers in Alaska. In effect the R&D tax credit would stimulate private sector investment, entrepreneurial activity and business expansion in the state while bringing opportunity and associated long-term benefits to the state's economy. This legislation will allow Alaska corporations to receive a 20 percent tax credit not to exceed $10 million per taxpayer per year. The payroll of the employees must take place in Alaska. To qualify for R&D activities it must meet the following requirements: -The purpose is discovering information -Information technology in nature, the application of which is intended to be useful in the development of a new or improved component of the taxpayer; all the activities constitute a process or experimentation. The experimentation is for qualifying activity or purpose. The bill would impose a reporting requirement on the Department of Revenue so the legislature and the public are aware of the fiscal impact and the economic benefits of the R&D credit to the state. MR. THAYER explained the way the credit would work is that a percentage of qualified R&D expenditures that exceed the average qualified R&D expenditures for three years immediately proceeding that year for which the credit is claimed. Unused credits will be carried forward for up to seven years after the expenditure for which the credit is 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 may not be claimed for expenditures that the corporation deducted in calculating its tax liability or for which it claimed a federal credit that has been apportioned to Alaska. Examples of activities that would qualify for these credits are the development of new and improved product processes and formulas; development of prototypes for models; building or improving manufacturing facilities; developing or improving software technologies; and development or application for patents. Activities that would not qualify are the exploration activity to assertion of the existence, location, extent or quality of any ore or mineral deposit; duplication of existing business components, surveys or studies such as market research; advertising. Routine data collection and research into social sciences, art or humanities would not qualify. 2:36:35 PM WANETTA AYERS, Director, Division of Economic Development, Department of Commerce, Community and Economic Development (DCCED), said she would amplify a couple of points that Mr. Thayer raised. She reiterated that this is modeled after an existing federal R&D tax credit that was established in 1981. It has been reauthorized 14 times and is currently authorized through 2011. There is a great deal of sentiment on a national level to have it reauthorized permanently. The Internal Revenue Code embodies a four-part test to determine what qualifies as research and development. The activity has to be technological in nature; there has to be some level of uncertainty, there has to be a process of experimentation, and it has to be for a permitted purpose. The idea is that there is some level of product or process innovation that will lead to newly commercialized activity or product. MS. AYERS said on the national level they may be hearing about the concept of the "innovation agenda." Recently the "America Competes Act" made a number of changes about how economic development is addressed on the federal level. Some key components of this are to accelerate the commercialization of new technologies, products, process and services. Within EDA they have established a new Office of Innovation and Entrepreneurship that is to foster innovation and the commercialization of new technologies, products, processes and services with the goal of promoting productivity and economic growth. She explained that President Obama characterized our nation's goal is to "out-build, out-innovate and out-education and out-hustle the rest of the world" so that we would be economic survivors. She said that 34 other U.S. states have some form of R&D tax credit or incentive. They don't want to necessarily "compete away" R&D activity from them, but to equalize the playing field. For every $5 increment in R&D expenditures, $1 would be credited back. SENATOR PASKVAN said in the last bill with tax credits they dealt with people from a specific industry, and he didn't see anyone in the R&D industry asking for this. He asked if they were working with anyone in particular. MS. AYERS replied the concept came out of the Council of Economic Advisors that provides advice to Commissioner Bell and the department. A number of members have seen the credit work in other states. A number of businesses could benefit, but they could not be here today. 2:41:04 PM JOHANNA BALES, Deputy Director, Tax Division, Department of Revenue (DOR) said the governor is interested in diversifying the state's economy and believes this is a step in the right direction. Maybe in a few years industries will be saying how great this credit is for them, just like the film incentive. SENATOR PASKVAN said the other bill had a cap for the incentive, but he saw $10 million per business here and he wanted to know the thought process behind it. MS. BALES responded that the process is different. The Film Office certifies those expenditures ahead of time and they have a general idea of what they are looking at to create a cap. When comparing it to other types of credits, it's very difficult to pigeonhole R&D expenditures for an entire group of corporate income taxpayers. For instance, they could cap it and then find out after three months that they have run out of money; this type of credit doesn't lend itself to the pre-approval process. SENATOR PASKVAN said he was trying to get an understanding of what 20 percent is now and what it would be three years from now. As he understands it now they get to deduct 100 percent of their expenditures; so do they get an additional 20 percent credit? MS. BALES answered no; if they take the credit they can't also take the expenditure. They can't get both. She explained that they are hoping to attract new corporate income tax payers, because the only time they would get the credit is if the R&D activity actually increases in the state. So, if you are someone who is already conducting R&D activity in the state and you increase it this year, you will get a credit for 20 percent of that increase. But if you are someone who has never operated here, your base is going to be zero. So, any new R&D you do, you would get 20 percent of all expenses. SENATOR GIESSEL said Ms. Bales frequently talks about corporations, and asked if this credit would also apply to an individual. MS. BALES answered no; just corporations. Individuals don't pay an income tax in Alaska. SENATOR GIESSEL said she was thinking about Alaska Aerospace Corporation that wants to attract some corporations to Alaska to do some launches. If those corporations are doing some innovative research, would they qualify for this kind of tax credit? MS. BALES answered they may if they meet the qualifications. 2:46:38 PM SENATOR MENARD said it dawned on her that grandfathering in this case is a negative, because if a company already invested and is already going, it won't be given the same credit. MS. BALES said you could look at it that way, but established companies have been able to enjoy the federal tax credit which Alaska does apportion to their corporate income tax. The intent of this legislation is to increase the activity that is happening right now, if they can partner with those that are already here and also bring new industry to Alaska. 2:48:02 PM SENATOR PASKVAN said he assumed a company doing R&D would be deducting the payrolls, rents and all their costs on its federal income taxes, and then they get the credit component. So, if they can't take the deduction and only take the expense, how would that work? MS. BALES explained that in the calculation of state tax, Alaska starts with federal taxable income. They would be required to add those expenses back, so it would increase their taxable income. Then they would be allowed to take a 20 percent credit but only for those expenses they added back in. So, all of their R&D expenses would be allowed to be deducted. Depending on the tax bracket a taxpayer is in and how they are operating, it might be more beneficial for them to take the deductions and the federal credit that passes through versus the Alaska credit. Generally speaking, credits are more favorable because they are dollar for dollar. She added that Alaska has a 9.4 percent top corporate income tax rate versus a 20 percent tax credit dollar per dollar. To be honest, she said, this is a fairly innocuous credit, and they will see how it works before doing anything else. 2:50:20 PM SENATOR MENARD asked what other states do not have a state income tax. MS. BALES answered Nevada, Wyoming, Florida, South Dakota and Washington. SENATOR GIESSEL asked why the mineral industry gets no credit for R&D. MS. BALES explained that this legislation basically piggybacks the qualifications under federal law and that is stipulated in federal law. SENATOR GIESSEL asked how the credits would work with the petroleum industry and R&D in processing heavy oil since it's an innovative unknown. 2:53:10 PM MS. BALES replied if that activity would qualify under federal law, it would qualify here as well. She said they would like to present an amendment. SENATOR PASKVAN said he was still struggling with understanding the recalculation of gross income under the federal tax, calculate an Alaska percentage and then apply 20 percent of this limited number as a credit, and asked if any other state does that. MS. BALES replied that the state does this with several other programs as well; for instance, the education tax credit where one is also not allowed to take the contribution deduction if the credit is taken. So, they start with the federal tax and add back that contribution amount. Then they are allowed to take the education credit. There are other modifications to federal taxable income that happen, as well, for differences in federal and state income tax. SENATOR PASKVAN said he was still trying to understand what the numbers would be and what they would mean. MS. BALES added this is a corporate income tax that is widely used in most other states. Most corporations are well aware of it, and that is why they have a large tax staff. SENATOR PASKVAN said he wanted to know if this promotes the attorney's industry more than the R&D industry. MS. BALES explained that it is truly just a line item on a return that gets added back and recalculated. It is done frequently and most taxpayers are set up to deal with these kinds of anomalies. MS. BALES said she had an amendment that deletes all of (e) on page 2, lines 12-25 and insert new language. 2:57:41 PM SENATOR PASKVAN moved to adopt conceptual Amendment 1.  CONCEPTUAL AMENDMENT 1  TO: SB 64 BY: The Department of Revenue Page 2, line 12: delete "names" insert "number" Page 2, line 16: after "credit." insert "The department may only report this information if three or more taxpayers claimed the credit in the prior year." The subsection would then read: "(e) Each year, the department shall report the number [NAMES] of taxpayers who claimed credits under this section in the prior year, the total cumulative amount of credits granted to all taxpayers under this section for the prior tax year, and the total cumulative number of employees conducting the research and development for which all taxpayers claim the credit. The department may only report this information if three or more taxpayers claimed the credit in the prior year." SENATOR DAVIS objected for discussion purposes. She asked why the amendment is needed. MS. BALES responded that the department does not generally disclose tax information, especially when talking about R&D which could be proprietary. Language would also identify taxpayers and the level of activity they are doing could be disconcerting and actually make them not want to participate in this program. The new language would protect that confidentiality. CHAIR EGAN said SB 64 would be held for further work.