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 23649-4 - Qualified Costs

Current through Register 2024 Notice Reg. No. 28, July 12, 2024
(See Section
						23649-0 for Table of
						Contents.)
(a)
In
					 General
. For purposes of Regulations 23649-1 through 23649-11,
					 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, 1994, 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 23649-1 through 23649-11, inclusive, the requirement that
					 California sales or use tax be paid prior to claiming the MIC 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 labor directly allocable to
					 the construction, such amounts shall not be treated as qualified costs. In the
					 case of any leasing transaction, Regulation 23649-6 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, which is dated February
						15, 1994, B agrees to install the turbines at D's manufacturing facility by
						affixing them to the facility's concrete floor for an additional $100. B
						charges and collects from D $40 in California sales tax under the contract
						($500 X 8%), with the $100 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 $600 in qualified
						costs ($500 in costs upon which California sales tax was paid and $100 in
						capitalized labor, 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 $600 ($500 for the turbines plus $100 in
						capitalized labor, 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 purpose 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
					 24356.2
					 (Enterprise Zone businesses), 24356.3 (Program Area businesses), 24356.4 (Los
					 Angeles Revitalization 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 Section
					 179 of the Internal Revenue Code)
					 may be a qualified cost under Revenue and Taxation Code Section
					 23649.
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 cheese production line in Santa Cruz. 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(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(f)(1)
						(Internal Revenue Code Section
						179).
EXAMPLE 2
: H, a qualified taxpayer doing
						business in the Los Angeles Revitalization Zone, purchases a commercial baking
						oven 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
						24356.4
						to expense the entire cost of the oven. Under these facts, the $25 paid by H
						would not be treated as a qualified cost since the $25 is not properly
						chargeable to H's capital account.
EXAMPLE 3
: Assume the same facts as in
						EXAMPLE 2, except that H is instead doing business in the Fresno enterprise
						zone. Under the provisions of Revenue and Taxation Code Section
						24356.2,
						H elects to expense $10 of the cost of the oven. Under these facts, H may treat
						only $15 of the total $25 paid for the oven as a qualified cost since the $10
						being expensed under Revenue and Taxation Code Section
						24356.2
						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 directly 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
					 directly allocable capitalized labor on 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 labor that
					 is directly allocable to the construction of the item of qualified property.
EXAMPLE 1
: G, a qualified taxpayer,
						purchases a machine that is qualified properly 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 directly allocable capitalized 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 directly allocable 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 directly allocable capitalized
						labor. The $25 incurred by G in training costs is not a qualified cost since
						training costs are indirect labor costs under subsection (c)(2) of regulation
						23649-2.
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 directly allocable installation costs
						($50), would be treated as qualified costs.
EXAMPLE 3
: 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. Although H does
						not pay California sales or use tax on the modification work, H may include in
						its qualified costs the costs of modifying the machine since the $100 is
						properly treated as a capitalized labor cost that is directly allocable to the
						modification of qualified property.
EXAMPLE 4
: 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 directly
						allocable capitalized 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 5
: 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, then the
						direct labor costs are treated as directly allocable capitalized labor costs
						and are thus qualified costs.
EXAMPLE 6
: 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 directly
						allocable capitalized labor cost that is associated with the construction,
						modification or installation of qualified property.
(e)
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, 1994, 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, 1994.
In any case where a qualified
					 taxpayer has actually paid amounts (including, without limitation, contractual
					 deposits and option payments) prior to January 1, 1994, 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, 1994, then the amounts actually paid after December 31,
					 1993, 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, 1994, 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, 1994, then the amounts paid prior to January
					 1, 1994 and the amounts paid after December 31, 1993, must be allocated between
					 the qualified property and the non-qualified property in proportion to the
					 actual amounts paid prior to January 1, 1994, and the total contract price.
EXAMPLE 1
: On October 1, 1993, 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). 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, 1994, 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 1993 will not be
						treated as a qualified cost, but the remaining $80 paid in 1994 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 nonqualified property under a binding
						contract, the $20 paid prior to January 1, 1994, and the $80 paid after
						December 31, 1993, 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, 1994, $16 (80% of
						$20) of the total $80 paid for the machines is treated as having been paid
						prior to January 1, 1994, 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.
(2)
Binding
					 Contracts.
For purposes of Regulations 23649-1 through 23649-11,
					 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 an engine to power a printing press would be a
					 binding contract only for the engine, not for the entire printing press.
EXAMPLE 1
: X, a qualified taxpayer,
						enters into a written contract with Y on August 15, 1993, under which X agrees
						to purchase 10 machines for $150 for delivery on December 1, 1994. Under the
						terms of the contract, X is required to make a nonrefundable 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, 1994.
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, 1994, since X's potential damages under the contract are less than
						5% of the total contract price ($5/$150, or 3.3%).
(3)
Successor or Replacement
					 Contracts
. Any contract entered into on or after January 1, 1994, that
					 is a successor or replacement contract to a contract that was binding prior to
					 January 1, 1994, shall be treated as a binding contract in existence prior to
					 January 1, 1994, 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, 1994, 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, 1994.
EXAMPLE 1
: On December 15, 1993, 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, 1993. On February 15, 1994, 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, 1994, contract is treated as a replacement
						contract to the December 15, 1993, contract, and the $10 deposit made by P on
						December 20, 1993, 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, 1994, 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, 1994, is not treated as a
						qualified cost.
EXAMPLE 4
: On November 1, 1993, 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, 1993. On March 1, 1994, 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, 1994, contract is treated as a replacement
						contract to the November 1, 1993, 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, 1994, contract. The $10 deposit actually
						paid prior to January 1, 1994, 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, 1994,
						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.
(4)
Option
					 Contract
s. For purposes of Regulations 23649-1 through 23649-11,
					 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, 1994, 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, 1993, F, a
						qualified taxpayer, pays $150 to G for the right to purchase G's manufacturing
						facility in Stockton for a total contract price of $900 (less the amount paid
						for the option) at any time prior to May 1, 1995. Under the terms of the
						option, the $150 is not refundable in the event F does not exercise its option.
						On January 15, 1995, F exercises its option to purchase G's manufacturing
						facility 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
						ten percent (10%) of the fixed option price upon cancellation or non-exercise
						of the option, the option is treated as a binding contract and the $150 paid by
						F prior to January 1, 1994, 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 ten percent (10%) of the fixed option
						price.
(5)
Conditional Contracts.
A contract shall be treated as binding
					 notwithstanding the fact that the contract is subject to a condition.
EXAMPLE
: On December 1, 1993, 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, 1993, with the balance to be paid on January 30, 1994.
						However, T's obligations under the contract are expressly conditioned upon the
						completion of T's new manufacturing facility in Compton. Despite this
						condition, the contract is treated as a binding contract in existence on or
						prior to January 1, 1994.