The Office of Tax Appeals is expected to rule by early 2026 on whether to impose sanctions on the California Department of Tax and Fee Administration and order the agency to pay an appellant’s legal fees due to its conduct during a tobacco excise tax appeal.
The OTA held a 90-minute oral hearing October 14 to hear from lawyers representing the CDTFA and the appellant, Starbuzz International Inc. The panel of three administrative law judges asked just two questions – both relating to entries in the taxpayer’s documentation of legal fees – and did not give any indication of how they will rule.
Starbuzz, represented by Marty Dakessian of Dakessian Law Ltd., argued that it was unreasonable for the CDTFA to petition for a rehearing in 2021 after the OTA unanimously granted his client’s appeal, and that the agency’s subsequent briefings constituted unreasonable actions warranting reimbursement of the taxpayer’s fees and expenses. The taxpayer additionally argued that the OTA should sanction the CDTFA for disparaging the ALJs who decided the appeal.
CDTFA attorney Stephen Smith argued that the fact that a second panel of OTA judges initially granted the petition for a rehearing is proof that the petition was reasonable, and that the CDTFA “has not engaged in sanctionable conduct.”
In the underlying appeal, two different panels of OTA administrative law judges concluded that Starbuzz, which makes flavored shisha for hookahs, is entitled to a refund of more than $2.8 million in overpaid taxes. The first panel decided the case on the merits and ordered the refund. The decision hinged on a review of the tobacco content of Starbuzz’s product, which contains molasses, flavorings, and tobacco. (The shisha sold by Starbuzz International Inc. and Starbuzz Tobacco Inc. contains 16 percent tobacco; the former California statute imposed a tax on products that contain more than 50 percent tobacco. The law was changed in 2017 to include shisha and other products made wholly or in part of tobacco, regardless of tobacco content, but the change was prospective and did not include the periods at issue in the appeal.)
The second OTA panel granted the CDTFA’s petition for rehearing on the grounds that it disagreed with the first panel’s legal reasoning. Starbuzz argued that the OTA exceeded the scope of its authority in granting the rehearing, and the company sued the OTA and the CDTFA to block the rehearing. After the parties settled the litigation, a third OTA panel agreed with Starbuzz, holding that the petition for rehearing was granted improperly. The third panel reinstated the original opinion and again ordered the CDTFA to pay Starbuzz the refund.
That did not end the dispute, however, as the CDTFA refused to issue the refund. Instead, the agency launched a reaudit after the OTA closed the case, raising issues relating to tax reimbursement that hadn’t been raised earlier.
Starbuzz sued to compel the CDTFA to issue the refund, noting that the OTA ruled in 2023 that the taxpayer’s “claims for refund are granted in full.” The Third District Court of Appeal sided with the CDTFA. Starbuzz has asked the California Supreme Court to review the case, arguing that under the doctrine of res judicata, the CDTFA was barred from raising new issues after the OTA ruled. CalTax sent an amicus letter to the court in support of the taxpayer’s request.
The latest OTA hearing did not touch on the litigation, but focused on the CDTFA’s actions during the OTA proceedings.
“This is a simple case, and while the issues presented are rather straightforward, the case is of great importance because it goes to the very heart of the OTA’s authority … and it’s about holding our taxing agencies accountable,” Dakessian said.
Under California law, a fee claim should be granted if the CDTFA has taken an unreasonable position and the fees claimed are reasonable. The law places the obligation on the CDTFA to justify that its position was reasonable.
Dakessian said the CDTFA took two unreasonable actions: Filing a “baseless petition for rehearing” and taking a position contrary to its own published guidance.
Smith argued that the petition for a rehearing was justified because the CDTFA “views the conclusion reached in the original opinion as wrong as a matter of statutory interpretation” and “contrary to electoral intent, which clearly demonstrates an intent to impose the tobacco tax on cancer-causing cigarettes and tobacco products in order to reduce tobacco related diseases and to fund public health efforts.”
“If the department could have sought judicial review of the original opinion, it would have,” Smith added. “And the department is confident that any court of law would have found that shisha tobacco is a tobacco product. … But because the department cannot file suit in superior court, its only recourse was to file a PFR.”
“’Contrary to law’ means that the opinion was unsupported by any substantial evidence,” Dakessian said. “… It is not a dispute over the quality or nature of the reasoning behind the opinion, but whether or not the opinion can or cannot be valid according to the law. … Rehashing previous arguments, complaints over the quality of the reasoning, just wanting to take another bite at the apple – these are not acceptable reasons for filing a petition for rehearing. And that’s exactly what the CDTFA did here. It simply rehashed its arguments from the first proceedings. It didn’t even attempt to identify what contrary to law meant. … And then if that weren’t bad enough, then they rehashed the arguments a third time in the rehearing proceedings by the third panel.”
On the issue of the CDTFA’s guidance, Dakessian told the OTA: “The CDTFA argued that the statute was clear and unambiguous. They said it during the oral hearing [for the petition for rehearing]. … But what does their published guidance say? The exact opposite. … Their own published guidance says that section 30121 can be interpreted in two ways. What are those two ways? Their view and our view. Yet we wasted a lot of time during the hearing process, during the rehearing process on this issue of ambiguity of the statute. … Agencies are not allowed to do this. They’re not allowed to contravene their own published guidance. That is a garden-variety example of an unreasonable position.”
Smith argued that the reference to ambiguity was in a backup letter to an annotation, and that even though that letter is available on the agency’s public website, the annotation in its entirety supports the CDTFA’s position and is the text that meets the legal definition of what can be cited as published guidance.
Starbuzz is seeking legal costs from the day the company retained Dakessian through the day the third OTA panel granted the claims in full a second time. The CDTFA argued that no legal costs should be reimbursed, but said that if the OTA disagrees, it should dramatically reduce the requested hourly rates and the period for which reimbursement would be warranted.
On the issue of sanctions, Dakessian said the CDTFA “has said some really, really objectionable things, in our view, as it relates to the first panel.”
“Sanctions are warranted because they impugn the integrity of the first OTA panel,” Dakessian said. “… Whenever an attorney questions the integrity of a judicial officer, that is prima facie grounds for sanctions. That is not allowed. That is not okay. … The CDTFA in its petition for rehearing says that the decision by the first panel was constructed to support a specific outcome. … This made it through the review process of the CDTFA and made it into a brief.”
The CDTFA additionally said the first panel arrived at “an absurd result” and used a “misleading” case citation, Dakessian noted.
“The sanctity of these proceedings is important for taxpayers,” Dakessian argued. “… What happened was wrong, and someone needs to answer for it.”
Smith argued that the CDTFA did nothing wrong.
“The department has been critical of the analysis contained in the original opinion, but the criticism was limited to the analysis itself,” Smith said. “The department never attacked the integrity of OTA, as claimants assert. Moreover, OTA’s authority to issue sanctions relates to conduct that interferes with the orderly resolution of the appeals. Written advocacy contained within briefs does not interfere with the adjudicative proceedings and is therefore outside the scope of the types of conduct OTA is authorized to sanction.”
The latter argument drew a sharp rebuke from Dakessian.
“What we did not hear from my counterpart was an apology,” Dakessian said. “… He didn’t apologize to the panel for the obviously disrespectful comments that were made in the petition for rehearing. Instead, in what is just sort of symptomatic with this case, he denied that the OTA had the authority to issue sanctions. That’s where they went. No circumspection, no saying, ‘You know what, maybe we could have said it differently.’ … Instead, what they did was try to argue that the OTA didn’t have the authority to issue sanctions because the disrespectful conduct was in briefing and not during the course of an oral proceeding. That’s wrong and that’s not what the authorities say.”
The OTA said it will issue a written decision to the parties within 100 days of the hearing.