California Code of Regulations › Title 18 - Public Revenues › Division 3 - Franchise Tax Board › Chapter 3.5 - Bank and Corporation Tax › Subchapter 3 - Corporation Income Tax › Article 3 - Tax Credits › Section 23637-4 - Qualified Costs

Current through Register 2024 Notice Reg. No. 28, July 12, 2024
Qualified Costs -- (See Regulation 23637-0 for Table of
						Contents.)
(a) In General. For
					 purposes of Regulations 23637-1 through 23637-11, inclusive, the term
					 "qualified costs" includes any costs paid or incurred by a qualified taxpayer
					 for the construction, reconstruction, or acquisition of qualified property on
					 or after January 1, 2001, and before January 1, 2006, provided that California
					 sales or use tax has been paid, directly or indirectly, on such costs (except
					 for costs paid or incurred for capitalized labor), and such costs are properly
					 chargeable to the qualified taxpayer's capital account. However, the term
					 "qualified costs" does not include the amount of any California sales or use
					 tax paid, directly or indirectly, by the qualified taxpayer.
(b) California Sales and Use Tax Payment
					 Requirement. In order for costs to be treated as qualified costs, California
					 sales or use tax must be paid, directly or indirectly as a separately stated
					 contract amount or as determined from the books and records of the qualified
					 taxpayer, with respect to the qualified property. For purposes of Regulations
					 23637-1 through 23637-11, inclusive, the requirement that California sales or
					 use tax be paid prior to claiming the JSF Property Credit shall be deemed
					 satisfied as of the date the California sales or use tax is due and payable
					 under Part 1 (commencing with section
					 6001) of Division 2 of the Revenue
					 and Taxation Code. In the case of any costs paid or incurred by the qualified
					 taxpayer upon which California sales or use tax has not been paid (except in
					 the case of amounts properly treated as capitalized direct labor for the
					 construction, modification, or installation of qualified property), such
					 amounts shall not be treated as qualified costs. In the case of any leasing
					 transaction, Regulation 23637-6 contains special rules applicable to the
					 California sales and use tax payment requirement.
EXAMPLE 1: D, a qualified taxpayer, purchases three
						hydraulic turbines from B, a California manufacturer of hydraulic turbines, for
						$500 to be used in D's manufacturing facility in Escondido. Under the terms of
						the purchase contract, B agrees to install the turbines at D's manufacturing
						facility by affixing them to the facility's concrete floor for an additional
						$100. Assume $36 of the $100 installation charge constitutes direct labor costs
						paid by B to its employees under Internal Revenue Code section
						263 A. B charges and collects from
						D $40 in California sales tax under the contract ($500 X 8%), with the $100 in
						installation charges being separately stated in the purchase contract and for
						purposes of this example are assumed to be exempt from California sales and use
						tax. Under these facts, D has $536 in qualified costs ($500 in costs upon which
						California sales tax was paid and $36 in capitalized direct labor costs, but
						excluding the $40 in sales tax).
EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except
						that instead of D purchasing the turbines from B, D enters into a "fixed-price,
						turn-key" contract with C, the terms of which require D to pay C a total of
						$640 upon delivery and installation of the turbines in D's manufacturing
						facility. C, instead of delivering a resale certificate to B, pays $40 ($500 X
						8%) in California sales tax to B on its purchase of the turbines. Under C's
						contract with D, the $40 California sales tax paid by C is a separately stated
						item. Under these facts, since the sales tax was separately stated in D's
						contract with C and paid by C on behalf of D, D is treated as having satisfied
						the California sales tax payment requirement. However, since $40 of the total
						contract price represents the sales tax paid indirectly by D, the amount of D's
						qualified costs is $536 ($500 for the turbines plus $36 in capitalized direct
						labor costs, but excluding the $40 in sales tax).
EXAMPLE 3: Assume the same facts as in EXAMPLE 2, except
						that D's contract with C does not separately state the amount of California
						sales tax paid by C. However, D's books and records substantiate that C paid
						California sales tax on behalf of D and that the total contract price of $640
						is broken down between $500 for the turbines, $40 in California sales tax, and
						$100 in installation charges. Under these facts, the result is the same as in
						EXAMPLE 2 since the amount of California sales tax treated as being paid
						indirectly by D can be determined from D's books and records.
(c) Capitalization Requirement. In order for
					 costs to be treated as qualified costs, they must be amounts properly
					 chargeable to the capital account of the qualified taxpayer. Amounts shall be
					 treated as properly chargeable to capital account if under the qualified
					 taxpayer's method of tax accounting they are properly includible in the
					 qualified taxpayer's basis for computing depreciation on the qualified property
					 under Revenue and Taxation Code section
					 24353.
					 However, any amounts not required to be included in the qualified taxpayer's
					 basis for depreciation purposes shall not be treated as qualified costs. For
					 example, Internal Revenue Code section
					 179 provides that amounts for
					 which an election is made under that section to currently deduct such amounts
					 are "not chargeable to capital account." Thus, any amounts for which a
					 qualified taxpayer makes an election to currently expense for California income
					 or franchise tax purposes under either Internal Revenue Code sections
					 179 or
					 179 A, or amounts for which a
					 qualified taxpayer makes an election for California purposes to currently
					 expense under Internal Revenue Code section
					 179 -type provisions such as
					 Revenue and Taxation Code sections
					 24356.6
					 (Targeted Tax Area businesses), 24356.7 (Enterprise Zone businesses), or
					 24356.8 (Local Agency Military Base Recovery Area businesses), are treated as
					 amounts that are not properly chargeable to capital account. In addition, any
					 costs paid or incurred for property with a useful life of less than one year
					 which may properly be expensed under Internal Revenue Code section
					 162 would be treated as amounts
					 not properly chargeable to capital account. Although costs that are not
					 properly chargeable to capital account are not treated as qualified costs, the
					 portion of the cost of any item of qualified property that is properly
					 chargeable to capital account (such as, for example, the amount in excess of
					 what may be currently deducted under Internal Revenue Code section
					 179) may be a qualified cost under
					 Revenue and Taxation Code section
					 23637.
EXAMPLE 1: F, a qualified taxpayer which is a California
						S corporation, purchases 50 stainless steel racks for $900 from G for use in
						F's production line in Palmdale. F pays $72 ($900 X 8%) in California sales tax
						on the purchase. F makes an election for California franchise tax purposes to
						currently expense the entire cost of the stainless steel racks under Revenue
						and Taxation Code section
						23802,
						subsection (f)(1) (Internal Revenue Code section
						179). Under these facts, the $900
						paid by F for the stainless steel racks would not be treated as a qualified
						cost since the $900 is not properly chargeable to F's capital account under
						Revenue and Taxation Code section
						23802,
						subsection (f)(1) (Internal Revenue Code section
						179).
EXAMPLE 2: H, a qualified taxpayer doing business in the
						Fresno Enterprise Zone, purchases a drill press for $25 from I, and pays $2 (8%
						of $25) in California sales tax on the purchase. H makes an election under
						Revenue and Taxation Code section
						24356.7
						to expense 40% of the cost of the drill press. Under these facts, $10 of the
						$25 paid by H would not be treated as a qualified cost since the $10 is not
						properly chargeable to H's capital account.
(d) Capitalized Labor Costs. For costs paid
					 or incurred by the qualified taxpayer for capitalized labor, the requirement
					 that California sales or use tax be paid in order for the costs to be treated
					 as qualified costs shall not apply. The qualified taxpayer shall have the
					 burden of establishing the amount of any cost paid or incurred for capitalized
					 labor that is a direct labor cost, as that term is used in Internal Revenue
					 Code section
					 263 A and defined in the
					 regulations thereunder, that can be identified or associated with and are
					 properly allocable to the construction, modification, or installation of any
					 item of qualified property. This burden may, for example, ordinarily be
					 satisfied by either an invoice, supported by the books and records of the
					 qualified taxpayer, that separately states the amount of capitalized direct
					 labor for qualified property acquired by purchase or, in the case of
					 self-constructed qualified property, from books and records of the qualified
					 taxpayer that establish the amount of capitalized direct labor for the
					 construction of the item of qualified property.
EXAMPLE 1: G, a qualified taxpayer, purchases a machine
						that is qualified property from X for $500. The price of the machine includes
						$50 in separately stated shipping charges. X collects California sales tax of
						$34 (8% of $450) from G, with the shipping charges assumed to be exempt from
						California sales and use tax. Upon receipt of the machine, G incurs an
						additional $50 in capitalized direct labor costs to have G's employees install
						the machine in G's manufacturing facility in Riverside, and $25 in training
						costs to train G's personnel to properly operate the machine. Under these
						facts, only the cost of the machine upon which California sales tax was paid
						($450), plus the capitalized direct labor installation costs ($50), would be
						treated as qualified costs. The $50 paid for shipping charges is not a
						qualified cost since no California sales tax was paid on such amounts, nor are
						the shipping charges treated as capitalized direct labor costs. The $25
						incurred by G in training costs is not a qualified cost since training costs
						are indirect labor costs under subsection (a)(2) of Regulation
						23637-2.
EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except
						that the $50 in freight charges are not separately stated and X collects $40
						(8% of $500) in California sales tax from G. Under these facts, the cost of the
						machine, including the freight charges, upon which California sales tax was
						paid ($500), plus the capitalized direct labor installation costs ($50), would
						be treated as qualified costs.
EXAMPLE 3: J, a qualified taxpayer, purchases an extended
						warranty contract on qualified property. J's extended warranty contract
						provides that all unscheduled maintenance and repairs will be performed at no
						cost by the seller or its agent. Assume that the costs of the extended warranty
						contract are exempt from California sales and use tax. Under these facts, the
						extended warranty contract is not treated as a capitalized direct labor cost
						since it is not for the construction, modification, or installation of
						qualified property. As a result, the costs paid for the extended warranty
						contract are not qualified costs.
EXAMPLE 4: K, a qualified taxpayer, purchases a machine
						that is qualified property and then uses its own employees to install and
						modify the machine, including necessary adjustments, alignments and
						"debugging," so that the machine will properly run K's assembly line. Under
						these facts, assuming that K properly capitalizes for California tax purposes
						its direct labor costs for installing and modifying the machine, the labor
						costs are treated as capitalized direct labor costs and are thus qualified
						costs.
EXAMPLE 5: L, a qualified taxpayer, purchases a
						comprehensive insurance policy on an item of qualified property. L may not
						include the premiums for the insurance policy as qualified costs because the
						insurance policy covers risk of loss, and is not a capitalized direct labor
						cost that is associated with the construction, modification or installation of
						qualified property.
(1) Capitalized
					 Labor Costs Under Third-Party Contracts. Only capitalized direct labor costs,
					 as that term is used in Internal Revenue Code section
					 263 A and defined in the
					 regulations thereunder, that can be identified or associated with and are
					 properly allocable to the construction, modification, or installation of
					 specific items of qualified property, constitute qualified costs for purposes
					 of the JSF Property Credit. For capitalized labor costs paid or incurred by a
					 qualified taxpayer to a third-party contractor for the construction,
					 modification or installation of qualified property, a qualified taxpayer is
					 only allowed to include as qualified costs those direct labor costs that the
					 qualified taxpayer could include if the qualified taxpayer had itself
					 constructed the qualified property using its own employees. To determine
					 whether the labor costs can be included as capitalized direct labor costs for
					 the JSF Property Credit, the qualified taxpayer is required to look through its
					 contract with the third party and put itself in the shoes of the third party
					 for purposes of computing qualified costs.
EXAMPLE: H, a qualified taxpayer, contracts with I for
						$100 to have a machine that is qualified property modified to increase its
						per-unit output. Assume that the labor costs associated with the modification
						are exempt from California sales and use tax. Assume also that $45 of the $100
						contract constitutes direct labor costs paid by I to its employees under
						Internal Revenue Code section
						263 A and the regulations
						thereunder. Although H does not pay California sales or use tax on the
						modification work, H may include in its qualified costs a portion of the costs
						of modifying the machine since $45 of the $100 is properly treated as a
						capitalized direct labor cost for the modification of qualified property. H
						must "look-through" the contract with I so that only those costs that
						constitute capitalized direct labor costs with respect to payments made by I to
						its employees shall constitute direct labor costs with respect to H.
(a) Qualified Costs Paid or Incurred Pursuant
					 to Binding Contracts. For any qualified property constructed, reconstructed, or
					 acquired by the qualified taxpayer (or any person related to the qualified
					 taxpayer within the meaning of Internal Revenue Code sections
					 267 or
					 707) pursuant to a binding
					 contract in existence on or prior to January 1, 2001, costs paid pursuant to
					 that contract shall be subject to allocation under the rules in this
					 subsection.
(1) Allocation of Costs Actually
					 Paid Prior to January 1, 2001. In any case where a qualified taxpayer has
					 actually paid amounts (including, without limitation, contractual deposits and
					 option payments) prior to January 1, 2001, under a binding contract, any such
					 amounts shall not be treated as qualified costs. However, if under any binding
					 contract a qualified taxpayer has paid amounts both before and after January 1,
					 2001, then the amounts actually paid after December 31, 2000, to the extent
					 properly allocable to the construction, reconstruction, or acquisition of
					 qualified property, shall be treated as qualified costs. In the case of any
					 contract that was binding on January 1, 2001, under the terms of which a
					 qualified taxpayer will acquire both qualified property and non-qualified
					 property, and the qualified taxpayer has actually paid amounts both before and
					 after January 1, 2001, then the amounts paid prior to January 1, 2001, and the
					 amounts paid after December 31, 2000, must be allocated between the qualified
					 property and the non-qualified property in proportion to the actual amounts
					 paid prior to January 1, 2001, and the total contract price.
(2) Binding Contract Bid Amount Reduced by
					 Credit. In no event shall the allocation provided in this subsection be allowed
					 unless the bid that was the basis of the binding contract in existence on or
					 prior to January 1, 2001, was reduced by the amount of the JSF Property Credit
					 allowable as required by Revenue and Taxation Code section
					 23637, subsection (i)(2), and
					 Regulation 23637-7.
EXAMPLE 1: On October 1, 2000, M, a qualified taxpayer,
						executes a contract to purchase five machines and ten computers that are
						qualified property for a total of $100 (plus applicable California sales tax).
						M will use the qualified property to complete a subcontract where the bid
						amount was reduced by the amount of the JSF Property Credit allowable. Under
						the terms of the contract, M is required to make a non-refundable $20 deposit
						upon execution of the contract and pay the remaining $80 upon delivery of the
						machines and computers. On May 1, 2001, the machines and computers are
						delivered and M pays the remaining $80 due under the contract. Under these
						facts, the $20 actually paid by M in 2000 will not be treated as a qualified
						cost, but the remaining $80 paid in 2001 will be treated as a qualified
						cost.
EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except
						that the computers are not qualified property because M intends to use them for
						general administrative purposes. The computers represent $20 of the total $100
						contract price. Under these facts, since M is purchasing both qualified
						property and non-qualified property under a binding contract, the $20 paid
						prior to January 1, 2001, and the $80 paid after December 31, 2000, must be
						allocated between the machines and the computers. Since the cost of the
						machines represent 80% of the total contract price ($80/$100), and $20 was
						actually paid prior to January 1, 2001, $16 (80% of $20) of the total $80 paid
						for the machines is treated as having been paid prior to January 1, 2001, and
						is thus not treated as a qualified cost. However, the remaining $64 ($80-$16)
						paid for the machines is treated as a qualified cost.
EXAMPLE 3: Assume the same facts as in EXAMPLE 1, except
						that the qualified taxpayer did not reduce the amount of the bid that formed
						the basis of the subcontract by the amount of the JSF Property Credit
						allowable. Under these facts, M is not entitled to any credit since the bid
						amount was not reduced by the amount of the JSF Property Credit
						allowable.
(3) Binding
					 Contracts. For purposes of Regulations 23637-1 through 23637-11, inclusive, a
					 contract shall be treated as binding where the contract is enforceable under
					 state law against the qualified taxpayer (or any related party within the
					 meaning of Internal Revenue Code sections
					 267 or
					 707) and the amount of potential
					 damages (whether by an express liquidated damages provision or otherwise) for
					 which the qualified taxpayer may be liable upon cancellation or breach of the
					 contract would equal or exceed five percent (5%) of the total contract price.
					 However, a contract to acquire a component part of a larger item of property
					 shall only be treated as a binding contract to acquire such component part and
					 shall not be treated as a binding contract to acquire the larger item of
					 property under the general rule for binding contracts. For example, a written
					 binding contract to acquire a motor to power a drill press would be a binding
					 contract only for the motor, not for the entire drill press.
EXAMPLE 1: X, a qualified taxpayer, enters into a written
						contract with Y on August 15, 2000, under which X agrees to purchase 10
						machines for $150 for delivery on December 1, 2001. Under the terms of the
						contract, X is required to make a non-refundable deposit of $10 upon execution
						of the contract. Under these facts, since X's potential damages upon
						cancellation or breach of the contract equal or exceed 5% of the total contract
						price ($10/$150, or 6.7%), X's contract with Y is treated as a binding contract
						in existence on or prior to January 1, 2001.
EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except
						that Y is required to refund half of X's $10 deposit in the event X cancels the
						contract. Assume further that X's potential damages to Y upon breach of the
						contract are limited by a liquidated damages provision to the $5 of X's deposit
						that Y is not required to refund to X. Under these facts, X's contract is not
						treated as a binding contract in existence on or prior to January 1, 2001,
						since X's potential damages under the contract are less than 5% of the total
						contract price ($5/$150, or 3.3%).
(4) Successor or Replacement Contracts. Any
					 contract entered into on or after January 1, 2001, that is a successor or
					 replacement contract to a contract that was binding prior to January 1, 2001,
					 shall be treated as a binding contract in existence prior to January 1, 2001,
					 and shall be subject to the same rules described in this section applicable to
					 binding contracts generally. However, if a successor or replacement contract is
					 entered into on or after January 1, 2001, and the subject of the successor or
					 replacement contract relates both to amounts to be paid or incurred for the
					 construction, reconstruction, or acquisition of qualified property described in
					 the original binding contract and to amounts to be paid or incurred for the
					 construction, reconstruction, or acquisition of qualified property not
					 described in the original binding contract, then the portion of those amounts
					 described in the successor or replacement contract that were not described in
					 the original binding contract shall not be treated as costs paid or incurred
					 pursuant to a binding contract in existence prior to January 1, 2001.
EXAMPLE 1: On December 15, 2000, P, a qualified taxpayer,
						enters into a binding contract with Q to purchase three drill presses that are
						qualified property for a total contract price of $50. Under the terms of the
						contract, P makes a non-refundable $10 deposit to Q on December 20, 2000. On
						February 15, 2001, P and Q mutually agree to rescind the original contract and
						simultaneously execute a new contract under which P requests minor
						modifications to the specifications for the drill presses. Under the new
						contract, the total contract price is increased to $55 to compensate Q for Q's
						additional costs of modifying the specifications for the drill presses. Under
						these facts, the February 15, 2001, contract is treated as a replacement
						contract to the December 15, 2000, contract, and the $10 deposit made by P on
						December 20, 2000, is not treated as a qualified cost.
EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except
						that upon rescission of the original contract Q refunds P's $10 deposit. Under
						the terms of the new contract P is legally obligated to make a non-refundable
						deposit of $15 to Q within 30 days of the execution of the contract. Under
						these facts, the new contract is still treated as a replacement contract.
						Despite Q's refund to P, $10 of the total $15 deposit made by P under the new
						contract is properly treated as having been actually paid prior to January 1,
						2001, and will not be treated as a qualified cost.
EXAMPLE 3: Assume the same facts as in EXAMPLE 1, except
						that under the new contract P agrees to purchase five drill presses instead of
						the three drill presses under the original contract. The total contract price
						for the new contract is increased to $85. Under these facts, the new contract
						is still treated as a replacement contract with respect to the three drill
						presses which were the subject of the original contract, and the $10 actually
						paid by P prior to January 1, 2001, is not treated as a qualified cost.
EXAMPLE 4: On November 1, 2000, R, a qualified taxpayer,
						enters into a binding contract with S to purchase two machines for $10 each and
						five computers for $2 each, for a total contract price of $30. Assume that the
						machines are qualified property, but since R will use the computers in its
						general administrative office, the computers are not qualified property. Under
						the terms of the contract, R makes a non-refundable $10 deposit to S on
						November 5,2000. On March 1, 2001, R and S mutually agree to rescind the
						original contract and simultaneously execute a new contract under which R
						agrees to purchase three machines and five computers for $40. Under these
						facts, the March 1, 2001, contract is treated as a replacement contract to the
						November 1, 2000, contract to the extent of the two machines and the five
						computers, but is not treated as a replacement contract as to the third machine
						added by the March 1, 2001, contract. The $10 deposit actually paid prior to
						January 1, 2001, is not treated as a qualified cost. However, none of this $10
						deposit amount is required to be allocated to the third machine for purposes of
						allocating the total contract price between the qualified property and the
						non-qualified property because the March 1, 2001, contract is not treated as a
						binding contract under this section as to the third machine, so that the entire
						$10 cost of the third machine is a qualified cost.
(5) Option Contracts. For purposes of
					 Regulations 23637-1 through 23637-11, inclusive, in any case where a qualified
					 taxpayer (or any related party within the meaning of Internal Revenue Code
					 sections 267 or
					 707) had an option to acquire
					 qualified property on or prior to January 1, 2001, the option shall generally
					 be treated as a binding contract. However, if the option holder would be
					 required to forfeit an amount that is less than ten percent (10%) of the fixed
					 option price upon cancellation or non-exercise of the option, then the option
					 shall not be treated as a binding contract.
EXAMPLE 1: On May 1, 2000, F, a qualified taxpayer, pays
						$150 to G for the right to purchase G's aluminum die-casting equipment for a
						total contract price of $900 (including the amount paid for the option) at any
						time prior to May 1, 2002. Under the terms of the option, the $150 is not
						refundable in the event F does not exercise its option. On January 15, 2002, F
						exercises its option to purchase G's casting equipment and delivers the
						remaining $750 due to G under the terms of the option. Since the option holder
						would have been required to forfeit more than 10% of the fixed option price
						upon cancellation or non-exercise of the option ($150/900, or 17%), the option
						is treated as a binding contract and the $150 paid by F prior to January 1,
						2001, is not treated as a qualified cost.
EXAMPLE 2: Assume the same facts as in EXAMPLE 1, except
						that F pays only $80 for the option and is not obligated to forfeit any
						additional monies to G in the event F chooses not to exercise the option. Under
						these facts, the option is not treated as a binding contract since the maximum
						amount that F would be required to forfeit under the option contract is less
						than 10% of the fixed option price ($80/900, or 9%).
(6) Conditional Contracts. A contract shall
					 be treated as binding notwithstanding the fact that the contract is subject to
					 a condition.
EXAMPLE: On December 1, 2000, T, a qualified taxpayer,
						enters into a contract to purchase seven machines that are qualified property.
						The contract provides for a twenty percent (20%) down payment on December 1,
						2000, with the balance to be paid on January 30, 2001. However, T's obligations
						under the contract are expressly conditioned upon the completion of T's new
						manufacturing facility in Palmdale. Despite this condition, the contract is
						treated as a binding contract in existence on or prior to January 1,
						2001.