Office of Tax Appeals

February Opinions Include One Precedential Case


The Office of Tax Appeals released 30 opinions February 7, including one pending precedential opinion upholding the Franchise Tax Board’s position in a dispute over the business income of an S corporation headquartered in North Carolina (the Appeal of Amarr Company).

Amarr is headquartered in North Carolina, manufactures garage doors in Kansas and North Carolina, and sells the doors throughout the United States, including in California. The company sells its products through distribution centers, including several located in California.

The transaction at the heart of the dispute occurred in November 2013, when the appellants, as sellers, entered into a stock sale transaction with a third party. The purchase agreement for the sale transaction indicated that in return for all the outstanding stock in Amarr, the buyers paid an initial fixed purchase price and agreed to make deferred contingent earnout payments totaling up to $50 million if Amarr’s earnings exceeded certain thresholds during the three years immediately following the transaction. The actual payments ended up totaling $33 million.

The FTB determined that because the 2013 return was Amarr’s final California tax return, the company should have accelerated the reporting of deferred installment gain. Additionally, the FTB determined that under Regulation section 25137(c)(1)(A), the sale was a substantial and occasional sale. As a result, FTB concluded that Amarr should have excluded the fixed portion of the sale amount from the sales factor. Based on these determinations, the FTB proposed to add $31,364,828 of installment income to Amarr’s business income and remove the fixed portion of the sale amount from the sales factor.

The taxpayers argued that while Amarr was no longer an S corporation after the sale, it continued California business operations as a C corporation and continued to be subject to California tax. Therefore, they argued, the accelerated reporting was not required. The OTA rejected this argument, noting that the parties had elected to treat the stock sale as an asset sale under Internal Revenue Code section 338(h)(10), and once that election was made, the corporation must be treated as if it sold its assets, liquidated, and ceased to exist.

The taxpayers also argued that the fair market value of the earnout payments was much less than calculated by the FTB, and could be $0. The OTA opined that the taxpayers did not meet their burden of proving that the FTB’s calculations were erroneous.

In its unanimous 21-page opinion supporting the FTB, the OTA ruled that the unreported installment gain should be accelerated for inclusion in taxable income for the 2013 short tax year, the income from the deemed asset sale relating to intangibles such as goodwill constitutes business income, and the gross receipts from the deemed asset sale should be excluded from the sales factor as receipts arising from a substantial and occasional sale.

In other noteworthy cases:

Fraud Penalties Imposed on Businesses That Underreported Taxable Sales. Two appeals involved the California Department of Tax and Fee Administration’s imposition of the fraud penalty against taxpayers who underreported their taxable sales, illustrating the aggressive anti-fraud measures that are available and frequently used under existing state law.

The Appeal of Z. Andesha, Z. Rashid, and R. Rashid involved taxpayers who operated a restaurant in Fremont. The CDTFA found that the restaurant’s credit card receipts for January 2009 through December 2010 totaled $1,157,669, while the owners reported total sales of only $697,424 for the same period. “Even without considering appellant’s cash sales, we note that appellant chose not to report $460,245 of its credit card sales,” the OTA wrote.

The OTA concluded that the CDTFA “provided clear and convincing evidence of fraud.”

The OTA explained: “The evidence we find most persuasive is the substantial underreporting, throughout the audit period, along with a failure to request assistance in reporting or record keeping from its accountant or CPA; appellant’s failure to report 40 percent of its credit card sales, as evidenced by credit card receipts; and the absence of a plausible explanation for the substantial understatement of reported taxable sales.”

In the Appeal of International Truck & Trailer Services Inc., the taxpayer operated a business repairing truck tractors and trailers in Fontana from February 2012 through June 2016. The business also included “taxable sales of parts for both truck tractors and trailers,” according to the OTA’s opinion.

Upon audit, the CDTFA found that the taxpayer had unreported taxable sales totaling $520,178 for the audit period. The OTA concluded that no adjustment to the unreported taxable sales figure was warranted, and also found that “CDTFA has shown by clear and convincing evidence that appellant knowingly operated without a seller’s permit for the purpose of evading taxes.”

FTB Concedes Interest Abatement for Unreasonable Delays. In two appeals, the FTB agreed to abate interest for long periods in which the tax agency took no action.

In the Appeal of R. Michovich and D. Micovic, the OTA ruled for the FTB on the primary issue of whether a proposed assessment was barred by the statute of limitations, but explained in a footnote that the FTB “determined that two years would have been a reasonable amount of time for it to resolve appellants’ protest and thus conceded interest that had accrued from February 4, 2015 (two years after FTB received appellants’ protest), through December 31, 2020 (the date of the NOA).”

Similarly, in the Appeal of A. Ogamba and C. Ogamba, the FTB prevailed on the underlying issues but conceded during the appeal to abate interest for the period December 16, 2016, to December 9, 2020. The FTB “considered the overall length of the appeal, including appellants’ federal appeal of their tax liabilities in the United States Tax Court, and determined that 48 months was the reasonable amount of time needed to resolve appellants’ protest,” the OTA wrote.