January 05, 2011 | By Keith Martin in Washington, DC

CALIFORNIA said it does not intend to collect taxes on Treasury cash grants paid on renewable energy projects unless instructed to do otherwise by the courts.

The Franchise Tax Board made the announcement in a notice posted to its website on January 12.

A ballot initiative that the California voters passed in November had raised questions about whether the grants are taxable in California.

The US Treasury pays owners of new renewable energy projects 30% of the project cost after the projects are completed in place of tax credits for which the owners would have qualified for otherwise.

Grant recipients do not have to pay taxes on the grants at the federal level. The tax credits for which they substitute are not taxed either.

California, like most states, has its taxpayers start with a federal definition of taxable income and then make adjustments.

The state legislature must vote periodically to move forward the date through which the state conforms to how income is calculated at the federal level.

The Franchise Tax Board concluded in the fall 2009 that grants paid on renewable energy projects in California are subject to an 8.84% franchise tax because the grant program and a separate provision specifically exempting the grants from federal income taxes were enacted in February 2009, but the state had conformed at the time to how federal taxable income is calculated only through January 1, 2005. There is an assumption, even at the federal level, that anyone receiving money must report the amount as income.

The state legislature moved the conformity date forward to January 1, 2009 in April 2010—still not far enough because the Treasury cash grant program was not enacted until February 2009—but the bill, SB 401, specifically conformed to federal treatment on Treasury cash grants.

Proposition 26, approved by the voters in November, says that any “tax adopted” earlier in 2010 is “void 12 months after” November 3, 2010 unless reenacted by then by a two-thirds vote of both houses of the state legislature.

It is unclear whether SB 401 needs to be reenacted. After spending several weeks looking at the issues, Chadbourne concluded that “void 12 months after” means a bill remains good law until then and any change only applies after that date. It also concluded that SB 401 does not have to be reenacted. Two Chadbourne memos on the subject were shared with state officials before the Franchise Tax Board posted its guidance.

Separately, California Governor Jerry Brown released a budget plan on January 10 that would require companies doing business in the state to calculate the amount of income that is subject to tax in California based solely on the percentage of total sales the company has in the state compared to outside the state. The move is expected to increase tax collections by $468 million in fiscal 2011 and $942 million in 2012.

Companies pay income taxes not only at the federal level, but also in most states where they do business. State taxes are imposed only on the share of income that has its source in the particular state. Each state has its own approach to determine how much income was earned in that state. Many use a weighted average of the percentages of the company’s total sales, payroll and property in the state. However, the trend is for states to move to a single factor, usually sales.

Business groups have been urging California to allow optional use of a single sales factor. Brown said he saw no reason to make it optional.

He also wants to extend a temporary 1% increase in the state sales tax and a 0.25% increase in the corporate income tax rate that the legislature approved in February 2009 by another five years. The plan also calls for eliminating tax breaks for businesses that set up operations in low-income areas called “enterprise zones.”

Brown promised during the campaign last fall not to increase taxes without a direct vote by the voters. The state faces a $25.4 billion budget deficit in 2012. States are not allowed by their state constitutions to run deficits. Brown, a Democrat, also called for $12.5 billion in spending cuts.