Commentary, State Budget

Budget Proposal Attacks Independence of Office Tax Appeals

Bart Baer x

By CalTax Chief Tax Counsel Bart Baer

One of Governor Gavin Newsom’s recently proposed business tax increases stands out for reasons beyond the impact it would have on employers and the economy. In addition to accounting for $1.9 billion of the governor’s $18 billion in tax hikes, it attacks the independence of the state’s Office of Tax Appeals by retroactively overturning an OTA ruling. Unfortunately, this bad idea also was included in the legislative leadership’s budget proposal released this week.

Some background is important. The OTA was created by the “Taxpayer Transparency and Fairness Act” of 2017, which stated: “Taxpayers deserve to have appeals considered by an independent, objective panel with sufficient expertise and a sole focus on tax issues. Any appeals forum must issue decisions in a transparent fashion, relying on well-established precedents in tax law, providing open public access and choice of representation, and building a record that both taxpayers and tax administration agencies can rely upon.”

Taxpayers were wary. Previously, appeals were decided by elected officials who were accountable to the voters. In contrast, the OTA’s director is a political appointee. Concerns increased when the OTA began hiring judges and 13 of the first 14 had worked for California tax agencies.

Some concerns were mitigated as the office diversified its pool of judges with more hiring from the private sector, but the OTA has proven to be a tough forum for appellants. For example, the 63 opinions released by the OTA in May include just one in which the taxpayer completely prevailed – consistent with how the OTA has ruled since its creation.

So, when the OTA grants an appeal, you can be sure the taxpayer presented a detailed argument with the law firmly on its side.

Such was the case when the OTA granted the Appeal of Microsoft, concerning California’s tax treatment of dividends from foreign subsidiaries.

We won’t get lost in the weeds, but essentially, the taxpayer asserted that the entire amount of the foreign dividends it received should be included in the formula that determines how much of the company’s income earned worldwide is taxable in California. This position is consistent with the plain language of the relevant statutes, legislative history, and legal authorities.

In 2023, a panel of three OTA judges unanimously agreed with the taxpayer. The Franchise Tax Board petitioned for a rehearing, and in February another three-member panel (with one holdover from the original) unanimously reaffirmed the decision.

That should be the end of the story, not the beginning of a new chapter. The taxpayer should receive a refund (California requires taxpayers to pay before appealing or litigating most issues), and others should be able to rely on the ruling, so they won’t have to spend time and money re-arguing the same issues against the FTB’s relentless lawyers.

The question of whether the decision will be precedential hasn’t been settled, but Newsom is attempting to make it moot. His budget includes provisions to overturn the OTA’s well-reasoned decision and declare the FTB’s rejected arguments victorious.

The governor and legislative leaders describe this as an “apportionment fix” to “clarify existing law.” In fact, it’s a retroactive change in law – in a budget bill, so the motivation is obvious.

The proposal doesn’t reflect the intent of the legislators and governor who wrote the law in 1966 – before Newsom and 65 percent of our current lawmakers were born. The OTA’s judges thoroughly considered legislative history and intent, and found that the provisions now in Newsom’s proposal are not in existing law.

Taxpayers who are forced to overpay taxes and fight for refunds, manage to overcome the tax agencies’ presumption of correctness, and win a favorable decision from a notoriously tough appeals board should not face the additional hurdle of after-the-fact legislative changes designed to allow the state to keep their money.

Using the Legislature and budget process to overturn OTA decisions would undermine the OTA’s authority and create an atmosphere in which lawmakers could seek to retroactively change any decision they disagree with – potentially based on revenue or political considerations rather than correct application of the law.

There are many ways to describe this type of governmental behavior, but “taxpayer fairness” isn’t one of them. Lawmakers should reject the governor’s proposal.