“The composition of the legislature has become a bit more — I won’t say friendly to business — but at least a bit more educated on the pushes and pulls from other states, as far as their aggressiveness in trying to attract companies, and so I think the legislature is beginning to come to a realization that California has to be at least competitive in some aspects with some of the other states.”
California Lawmakers Mull Extending Biotech Net Loss 'Carry-Forward' from 10 to 20 Years
California lawmakers are looking to double from 10 to 20 years the amount of time that biotech companies can carry forward tax deductions on their net operating losses, after concluding the change will advance the state’s life sciences industry at minimal cost to the state.
A bill extending the “carry-forward” period, Assembly Bill 1370, has moved to the state Senate after it passed the state Assembly last month. Though a hearing date had yet to be scheduled at deadline, the state Senate is expected to refer the bill to its revenue and taxation committee for review shortly, Assembly Speaker Pro Tempore Sally Lieber (D-Mountain View) told BioRegion News last week.
“We’re very hopeful that we can get this through this year,” Lieber said in an interview. “We consider this a pretty modest step to getting California in line with some other states that have been very successful in attracting and keeping biotech in their states.”
According to the Biotechnology Industry Organization, 30 states have carry-forward periods of at least 15 years. Proponents argue California’s current 10 year period needs to be lengthened because companies need more than a decade to conclude the clinical trials and other US Food and Drug Administration requirements to getting new drugs on the market.
California’s legislature allows lawmakers from the house to advance bills before the Senate, with no Senate sponsor needed until the bill gets before the full Senate for discussion and a vote.
The bill’s clearance in the Assembly is further than the measure progressed through the legislature last year, when it was part of a broader biotech bill that died in committee. Since then, Lieber said, the measure was split into separate bills for its two provisions — one extending the carry-forward period to 20 years, the other a measure allowing biotech companies to sell unused net operating losses. The latter is the purpose of Assembly Bill 1147, introduced by Assembly member Gene Mullin (D-South San Francisco), who chairs the Assembly’s Select Committee on Biotechnology.
That bill allows companies to sell unused net operating losses after Jan. 1, 2008, to buyers to use starting on or after Jan. 1, 2010, at 75 percent or more of their tax value amount.
Qualified sellers are defined as California-based bioscience companies that have spent at least half their expenses on R&D, have not had positive net income from product sales any of the previous five years, and have raised 400 percent of the tax value of the proposed net operating loss sale from public or private funding sources in the previous 24 months. Sellers can exclude any revenues from the sale of unused net operating losses from their gross income.
Qualified tax credit buyers are bioscience companies employing 500 or more employees in California. Buyers can only use the net operating losses they purchase as a deduction from gross income derived from bioscience products, and must start using the net operating losses they purchase within five years.
Mullin’s bill is pending in the Assembly revenue and taxation committee.
Minimal Loss for the State
Lieber’s carry-forward bill could be applied by companies “engaged in biopharmaceutical business activities or other biotechnology business activities that are described in Codes 325411 to 325414, inclusive, and 541710 of the North American Industry Classification System,” and that have not received FDA product approval.
Code 325411 covers medicinal and botanical manufacturing. Other NAICS codes eligible for the carry-forward are 325412 (pharmaceutical preparation manufacturing), 325413 (in vitro diagnostic substance manufacturing), 325414 (biological product manufacturing, except diagnostic manufacturing) and 541710 (research and development in the physical, engineering and life sciences).
The carry-forward would apply only to net operating losses incurred by biotech and biopharma companies on or after Jan. 1, 2008, through Dec. 31, 2027.
As a result, the state would not lose money until the 2019-2020 fiscal year, when California would lose a projected $300,000 based on a state Franchise Tax Board estimate that $6 million in net operating losses set to expire that fiscal year would instead be carried forward.
That loss is a far cry from the $30 million California was projected to lose under the combined bill, reflecting almost entirely the proposed sale of NOL credits.
“Because of our budget situation in California, I think the underlying fear was that companies would really take advantage of the credits,” Lieber said.
After passing a $128.4 billion budget last year where expenses topped revenues by $4.1 billion, state lawmakers spent the past six months scrambling to plug a more than $5 billion deficit for the fiscal year started July 1, before lawmakers came to terms on a $140 billion spending plan.
The budget approved by the state’s Budget Conference Committee was smaller than the $143 billion budget Gov. Arnold Schwarzenegger submitted in January, let alone a revised $145 billion plan the governor introduced in May. While lawmakers insist the budget is balanced, Legislative Analyst Elizabeth Hill, the state’s top fiscal advisor to the Legislature, has projected California would face a more than $5 billion budget shortfall in the 2008-09 fiscal year and deficits of more than $3 billion every fiscal year through 2010-2011.
Schwarzenegger’s administration insists it is on the right track since the state’s operating deficit for 2007-08 has shrunk from the $16.5 billion projected when he took office in 2003.
Past years’ budget problems prompted California to suspend its carry-forward of net operating losses in 2002 and 2003. The state reinstated the carry-forward in 2004.
“If we’re saying let’s structure things so that companies can’t take advantage of us, and if they do it’s going to be too costly to us, it seems like gaming the system a little bit,” Lieber said in the interview.
Lieber said the improved prospects this year for extending the carry-forward reflect not only its uncoupling from the proposed credit sale, but some increased lobbying by biotechs as well.
She credited two of the state’s major regional biotech industry associations, BayBio based in San Francisco and BIOCOM based in San Diego — as well as the decision by heads of several companies to testify in favor of the revised bill during committee hearings earlier this year.
Among those executives were George Scangos, president and CEO of Exelixis, a South San Francisco developer of small-molecule therapeutics to treat cancer and other diseases; and Gail Maderis, president and CEO of FivePrime Therapeutics, a protein therapeutics discovery and development company in San Francisco’s Mission Bay.
Neither executive returned telephone messages from BioRegion News.
Jimmy Jackson, BIOCOM’s vice president of public policy, said in an interview that the carry-forward bill’s success this year shows state lawmakers are more receptive to the views of the life sciences industry than in recent years.
“The composition of the legislature has become a bit more — I won’t say friendly to business — but at least a bit more educated on the pushes and pulls from other states, as far as their aggressiveness in trying to attract companies, and so I think the legislature is beginning to come to a realization that California has to be at least competitive in some aspects with some of the other states,” Jackson said.
He noted the bill would be similar to a carry-forward biotechs can use toward federal taxes.
Tax Formula Under Review
The carry-forward bill is one of two bills being watched closely by California biotech groups this year.
Life science industry groups had joined with general business groups in supporting Assembly Bill 1591, a measure to change how businesses calculate their taxes, with the goal of reducing what they owe the state. Assembly member Fiona Ma (D-San Francisco) introduced the measure, with Mullen joining Assembly members Kevin de Leon (D-Los Angeles) and Bonnie Garcia (D-El Centro) as co-authors.
The measure creates a formula for calculating taxes owed to California: Multiply business income by a fraction consisting of property tax plus payroll tax plus twice the sales generated, and divide that number by four. The fraction, and thus the tax, can be reduced each time a company spends $250 million or more on any or all of the following:
For each $250 million spent on one or more of those factors, one additional sales factor is added to the top of the fraction while the number on the bottom is increased by one.
However, companies have the option of calculating their taxes the same way they do now — through a four-factor formula consisting of one payroll factor, one property factor, and a double-weighted sales factor.
“That actually dissuades people from having large numbers of employees in California, because you’re getting dinged for the fact that you’re hiring Californians in your taxes,” Jackson of BIOCOM said.
The hyper-weighted tax bill has been “under discussion now and actually in very, very serious negotiations” by lawmakers, he added. The measure is before the revenue and taxation committee.
The bill also sets a higher tax for banks, financial businesses, savings and loans, and businesses carrying out agricultural or “extractive” business activities by requiring them to divide by three their property taxes plus payroll tax plus twice the sales generated, that fraction multiplied by business income.
The bill applies to income generated on or after Jan. 1, 2008, through Dec. 31, 2021.
The sales factor bill has been before lawmakers for at least four years. An earlier version, Jackson said, would have created a single sales factor that would have based corporate income taxes solely on sales.
The measure has been opposed by the California Budget Project, a nonprofit group that advocates for policies intended to benefit low- and moderate-income residents, which has argued the state can ill afford the change.
“It would cost the state more than a billion dollars which it doesn’t have,” Jean Ross, executive director of the California Budget Project, told BioRegion News. “Even if we had a good budget year, with the hyper-weighted sales factor, I think it leaves the door open for a lot of manipulation.”
The Franchise Tax Board has projected the change in tax calculation formulas would cost California $550 million in 2007-08, $1.3 billion in FY 2008-09 and $1.95 billion in FY 2009-10.
“Historically, you would think that when you’re facing a multi-billion-dollar shortfall, legislators would be reluctant to cut taxes, although we haven’t always been able to rely on that fact in California,” Ross added.