Office of Tax Appeals

CDTFA Ignores OTA Ruling and Raises New Issue After Appeal Was Final, Taxpayer Asserts

OTA with State Seal

Months after the Office of Tax Appeals upheld the taxpayer’s unanimous victory in the Appeal of Starbuzz International Inc., the California Department of Tax and Fee Administration is refusing to comply with the decision and is violating the doctrine of res judicata by raising a new issue as a reason for denying a refund, the taxpayer’s attorney asserted this week.

The OTA’s ruling declared that “the CDTFA’s actions denying appellants’ claims for refund are reversed, and appellants’ claims for refund are granted in full.”

That final, clearly worded decision requires the CDTFA to immediately provide the refund that was in dispute, Attorney Marty Dakessian, of Dakessian Law Ltd., wrote in a June 28 letter to CDTFA Director Nicolas Maduros.

The letter states Starbuzz’s demand that the CDTFA “perform its ministerial duty by processing the refunds the OTA has granted,” and adds that “further and appropriate action” will be taken if the CDTFA does not indicate by the close of business today that it will “immediately and unconditionally process the refunds ordered by the OTA in the amount of $2,818,739, plus applicable interest.”

“After a nearly eight-year administrative tax dispute involving three OTA opinions, two OTA hearings, and a lawsuit, the OTA granted refunds of tobacco products tax to Starbuzz Tobacco Inc. and Starbuzz International Inc. … in the amount of $2,818,739,” Dakessian wrote. “During this extended controversy, the CDTFA fought relentlessly against Starbuzz’s refund claim based on its interpretation of the statutorily defined term ‘tobacco products’ – even going so far as to file a frivolous petition for rehearing. It did not prevail. But rather than respecting the rule of law and simply paying the $2,818,739 in refunds in compliance with the OTA’s order in favor of Starbuzz, the CDTFA has decided to defy that order and instead re-audit Starbuzz after the case has closed to determine if it may reduce the refunds granted by the OTA on a newly raised issue: that Starbuzz collected tax reimbursement.”

Dakessian wrote that the CDTFA’s action “is so clearly illegal under the doctrine of res judicata, that we thought there was some misunderstanding by the auditor as to the procedural posture of the case.”

After multiple discussions with CDTFA Chief Counsel Chris Schutz, Dakessian requested and received a meeting with Maduros to discuss the agency’s refusal to comply with the OTA’s ruling. At the conclusion of the videoconference meeting, Maduros requested that Dakessian present his client’s position in writing.

“On Monday, June 5, we provided you with a detailed nine-page letter explaining why the doctrine of res judicata barred CDTFA from attempting to raise new issues now that the OTA adjudication is final …,” Dakessian wrote in this week’s follow-up letter. “In that letter, we noted that CDTFA had ample opportunity to raise the issue of tax reimbursement at any point in time during the past eight years over which this controversy has spanned. We also noted the double standard that CDTFA seems to be implementing – it refuses to recognize the application of res judicata in this case, but it successfully asserted res judicata to defeat a taxpayer refund claim in a published OTA decision just six months earlier. Appeal of Achamak Trading, Inc.”

Dakessian said he also addressed the CDTFA’s assertation that tax reimbursement was collected, to show that the tax agency is incorrect.

“Although res judicata is dispositive of the matter, we thought it important to point out that CDTFA is also wrong on the tax reimbursement issue in hopes of bringing this matter to a close,” the attorney wrote.

On June 23, Dakessian was informed by Schutz that the CDTFA would not be issuing the refund and instead will proceed with its re-audit of the tax reimbursement issue.

The CDTFA said it believes res judicata does not apply because the issue of tax reimbursement was not an “affirmative defense.”

“I asked for legal authority to support CDTFA’s position and was not provided any,” Dakessian said. He added that res judicata requires that all issues that relate to a given tax period be raised by the parties in the same dispute, and there is no “tax reimbursement” exception.

“CDTFA was required to raise the issue when the controversy was active – not after it has concluded,” Dakessian wrote. “In addition to being legally untenable, CDTFA’s conduct is the latest in a series of actions that has shaken the faith of the taxpayer community in the new system put in place in 2017. … An important component of the tax system overhaul of 2017 was for taxpayers to feel secure in knowing that if they were successful at the OTA, then their matters would come to a close and the tax agencies that were party to the administrative appeals, such as CDTFA, would respect and abide by OTA’s decisions. … No taxpayer should ever want to adjudicate a matter at the OTA knowing that even if it prevails, the taxing agencies are free to ignore their decisions and can instead treat them as mere suggestions.”

The issue in the underlying appeal was California’s tobacco products excise tax, enacted by the voters through Proposition 99 of 1988 and amended by Revenue and Taxation Code section 30121(b), stating that: “Tobacco products includes, but is not limited to, all forms of cigars, smoking tobacco, chewing tobacco, snuff, and any other articles or products made of, or containing at least 50 percent, tobacco, but does not include cigarettes.”

The CDTFA imposed the excise tax on shisha – a hookah product containing molasses, flavorings, and approximately 16 percent tobacco – sold by Starbuzz Tobacco Inc. and Starbuzz International Inc. The taxpayer argued that under the statute as it read prior to April 1, 2017, when it was amended by Proposition 56 in 2016, shisha is not subject to the tax because the tobacco content is well below the 50 percent threshold.

In April 2021, a three-member panel of the OTA’s administrative law judges unanimously granted the taxpayer’s appeal, finding that because shisha contains less than 50 percent tobacco, it did not meet the definition of a “tobacco product” under state law. In September 2021, a new OTA panel – composed of one administrative law judge from the original panel and two new ALJs – granted the CDTFA’s petition for a rehearing in a split decision (with the original judge dissenting) and stated that “the findings expressed in the [original] opinion are contrary to the plain reading of the statute.” A new panel of administrative law judges heard arguments in January of this year and issued an opinion in March unanimously reinstating the original opinion.