(a) In General. For purposes of Regulations 17053.49-1 through 17053.49-11, 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 17053.49-1 through 17053.49-11, 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, modification, or installation of qualified property, such amounts shall not be treated as qualified costs. In the case of any leasing transaction, Regulation 17053.49-6 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 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 $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 17250. 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 tax purposes under either Internal Revenue Code Sections 179 or 179A, 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 17252.5 (Enterprise Zone businesses), 24356.3 (Program Area businesses), 17266 (Los Angeles Revitalization Zone businesses), or 17268 (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 17053.49.

EXAMPLE 1: F, a qualified taxpayer, 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 income tax purposes to currently expense the entire cost of the stainless steel racks under Revenue and Taxation Code Section 17265 (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 17265 (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 17266 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 17252.5, 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 17252.5 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 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 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 17053.49-2.

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 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.