The Enterprise Zone Sales or Use Tax Credit (Part 2)

Filed in CPA Blog by on May 18, 2013
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Continued from Part 1 by May 20, 2013, By Robert Salazar, CPA – Tax Alliance Group, LLP


California Revenue and Taxation Code section 23612.2 provides banks or corporations operating in an enterprise zone an income tax credit for sales or use taxes paid. The credit is equal to the sales or use tax paid or incurred by the business for purchases of qualified property. Qualified property includes only machinery and machinery parts that are used for certain purposes.

In 1998, the sales or use tax credit statute was amended to expand the definition of qualified property to include data processing and communications equipment and motion picture manufacturing equipment. That expansion significantly increased the variety of equipment eligible for the sales or use tax credit. In fact, the main beneficiaries of the expansion were enterprise zone businesses in the technology and telecommunications sector because those types of businesses are constantly purchasing data processing and communications equipment.

Three Conditions that a Business Must Satisfy

Tax Savings for California Business Through Enterprise ZonesIncluded in the definition of qualified property are three conditions that businesses must satisfy. The first condition limits the cost of the qualified property that can be taken into account in any one year for purposes of claiming the credit to $ 20 million. The second condition requires that the qualified property be used exclusively in an enterprise zone. Banks or corporations that remove qualified property from an enterprise zone need to keep records indicating when the property was taken out of the zone. These types of records will prove useful in the event the Franchise Tax Board questions the exclusivity requirement because the sales or use tax credit statute does not have a recapture provision. Finally, the statute requires that the property be purchased and placed in service before the enterprise zone termination date.

Not surprisingly, California Revenue and Taxation Code section 23612.2 encourages businesses to purchase qualified property in California. If the qualified property is purchased outside California and a use tax has been paid, the credit will be disallowed if property of a comparable quality and price is available for purchase in California. Whether qualified property of a comparable quality and price is not timely available for purchase in California will depend on the facts and circumstances of the particular transaction. However, taxpayers purchasing computers or data processing equipment outside California should compile documentation showing why the equipment was purchased out of state.

Banks and corporations should also keep records of any unused credits. In the event the sales or use tax credit exceeds the tax for the income year, the amount of any credit not used may be carried over until it is exhausted. The credit must be applied first to the earliest income years possible. However, a bank or corporation electing to claim the credit is not entitled to increase the basis of the property by the amount of the sales or use tax paid.

Finally, the amount of the sales or use tax credit and the enterprise zone hiring credit, including any carryover amounts, cannot exceed the amount of tax that would be imposed on the taxpayer’s business income attributable to the enterprise zone. The taxpayer’s attributable income is determined by using a modified income apportionment rule with a two-factor formula. The two factors used are the property and payroll factors, and the denominator is the taxpayer’s California-source income instead of worldwide income.

A Substantial Savings Opportunity for California Businesses

In sum, the enterprise zone sales or use tax credit provides banks and corporations doing business in an enterprise zone a substantial savings opportunity. For taxpayers currently in an enterprise zone, each piece of machinery or machinery part purchased should be evaluated to determine whether it is qualified property. Businesses that do a good job of tracking their purchases will have an easier time determining whether the equipment falls within the definition of qualified property.

Next: The Enterprise Zone Hiring Credit

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