§ 17053.37-2. Definitions.

(a) Capitalized Labor. The term “capitalized labor” shall mean all costs of labor that are direct costs, as that term is used in Internal Revenue Code section 263A 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. For this purpose, labor encompasses full-time and part-time employees, as well as contract employees and independent contractors.

(1) Direct labor costs shall include all elements of compensation, such as basic compensation, overtime pay, vacation pay, holiday pay, sick leave pay (other than payments pursuant to a wage continuation plan under Internal Revenue Code section 105(d) as it existed prior to its repeal in 1983), shift differential, payroll taxes, and payments to a supplemental unemployment benefit plan, but shall not include any indirect labor costs.

(2) Indirect labor costs are costs that cannot be identified or associated with the construction, modification, or installation of specific items of qualified property. Indirect labor costs include, but are not limited to, training costs, officers' compensation, pension and other related costs, and employee benefit expenses (including payments pursuant to a wage continuation plan under Internal Revenue Code section 105(d) as it existed prior to its repeal in 1983).

(3) In determining whether direct costs of labor are properly allocable to the construction, modification, or installation of a specific item of qualified property, the qualified taxpayer shall be required to use the same method of allocation for California income and franchise tax purposes that the taxpayer used for federal income tax purposes under the uniform capitalization allocation rules specified in Treasury Regulation section 1.263A-1 (as in effect on the date Regulation 17053.37-2 is effective).

(b) Fabricating. The term “fabricating” shall mean the process of making, building, creating, producing, or assembling components or property to work or be useable in a new or different manner.

(c) Joint Strike Fighter. The term “Joint Strike Fighter” shall mean the next-generation air combat strike aircraft developed and produced under the Joint Strike Fighter program of the United States government.

(d) Initial Contract or Initial Subcontract. The term “initial contract” shall mean the contract awarded by the United States government to a prime contractor for any phase, including the Engineering and Manufacturing Development Phase, of the Joint Strike Fighter Program to produce the Joint Strike Fighter Aircraft. The term “initial subcontract” shall mean a contract between a prime contractor and any other contractor, or between two contractors where one of those contractors is under contract with the prime contractor or where the prime contractor or a contractor under contract with the prime contractor has consented to the contract in writing, to produce a product that is physically attached to or installed in a Joint Strike Fighter Aircraft under the initial contract.

(f) Manufacturing. The term “manufacturing” shall mean the process of converting or conditioning property by changing the form, composition, quality, or character of the property for ultimate use in a Joint Strike Fighter, and includes any improvements to tangible personal property that result in a greater service life or greater functionality than that of the original property. Tangible personal property shall be treated as having a greater service life if such property can be used for a longer period than such property could have been used prior to the conversion or conditioning of such property. Tangible personal property shall be treated as having greater functionality if it has been improved in such a manner that it can be used to perform new or different functions.

(g) Packaging. The term “packaging” shall mean to wrap, seal, box, or put together as a unit, but shall include only that portion of any wrapping, sealing, boxing, or putting together as a unit that is necessary to prepare the goods for delivery to and placement in the qualified taxpayer's finished goods inventory, or to prepare the goods so that they are suitable for delivery to and placement in finished goods inventory. Additional wrapping, sealing, boxing, or putting together as a unit, such as any wrapping, sealing, boxing, or putting together as a unit that is necessary to consolidate the finished goods prior to shipping or to protect them during transportation, shall not be treated as packaging.

(h) Placed in Service. The term “placed in service” shall mean the earliest taxable year in which either of the following occurs:

(1) under the depreciation method used by the qualified taxpayer for California tax purposes, the period for depreciation with respect to the qualified property commences; or

(2) the qualified property is placed in a condition or state of readiness and availability for a specifically assigned function. If qualified property meets the conditions of subsection (h)(2) of this regulation in any taxable year, it shall be considered placed in service in such year, notwithstanding that the period for depreciation with respect to the qualified property begins in a succeeding taxable year. For example, if under the qualified taxpayer's California depreciation practice such qualified property is accounted for in a multiple asset account and depreciation is computed under an averaging convention, or depreciation is computed under the completed contract method, the unit of production method, or the retirement method, then the qualified property is treated as in a condition or state of readiness and availability for a specifically assigned function. Specific examples where qualified property shall be considered in a condition or state of readiness and available for a specifically assigned function include (A) parts that are acquired and set aside during the taxable year for use as replacements for a particular item or items of qualified property in order to avoid operational time loss, (B) operational items of qualified property that are acquired for a specifically assigned function during the taxable year where it is not practicable to use such item of qualified property for its specifically assigned function in the qualified taxpayer's business until the following taxable year, and (C) qualified property acquired for a specifically assigned function that is operational but is still undergoing testing to eliminate any defects. Materials and parts acquired to be used in the construction of an item of qualified property shall not be considered in a condition or state of readiness and availability for a specifically assigned function.

(i) Product for Ultimate Use in a Joint Strike Fighter. The term “product for ultimate use in a Joint Strike Fighter” shall mean a product that is designed to be physically installed in or attached to a Joint Strike Fighter aircraft. The term “product for ultimate use in a Joint Strike Fighter” shall not include any product that is not designed to form a physical part of the Joint Strike Fighter aircraft. For this purpose, the term “product” shall include any pilot model or prototypes used in connection with the development of the product.

(j) Primarily. The term “primarily” shall mean that property is used 50 percent or more of the time in qualified activities. For purposes of the preceding sentence, the term “time” shall mean the total number of hours that the property is actually in use during the 12-month period immediately following the date the property is placed in service in this state. For example, if an item of property is used by a qualified taxpayer for a total of 100 hours for all uses during the 12-month period immediately following the date the property is placed in service in this state, then “primarily” used in qualified activities means at least 50 hours of the property's use is in qualified activities.

(k) Process. The term “process” shall mean the period beginning at the point at which any raw materials are received by the qualified taxpayer and introduced into the manufacturing, processing, or fabricating activity of the qualified taxpayer and ending at the point at which the manufacturing, processing, or fabricating activity of the qualified taxpayer has altered tangible personal property to its completed form, including packaging, if required. Raw materials will be considered to have been introduced into the process when the raw materials are stored on the same premises where the qualified taxpayer's manufacturing, processing, or fabricating activity is conducted. Raw materials that are stored on premises other than where the qualified taxpayer's manufacturing, processing, or fabricating activity is conducted, shall not be considered to have been introduced into the manufacturing, processing, or fabricating process.

( l ) Processing. The term “processing” shall mean the process of physically applying the materials and labor necessary to modify or change the characteristics of property.

(m) Qualified Activities. The term “qualified activities” shall mean activities engaged in by a qualified taxpayer that involve manufacturing, processing or fabricating a product for ultimate use in a Joint Strike Fighter.