The Office of Tax Appeals posted 45 opinions to its website October 5, including three pending precedential cases. All of the precedent-setting cases involve taxes administered by the California Department of Tax and Fee Administration, and all were decided unanimously in favor of the tax agency.
The pending precedential cases:
- The Appeal of Micelle Laboratories Inc., a complicated appeal involving the sale of a business that manufactured nutritional supplements, and the value of machinery, consumable supplies and other assets transferred to the purchaser, Herbalife International of America Inc. The CDTFA issued a notice of determination for more than $430 million in tax, plus interest, for the period of July 1, 2007, through August 21, 2009.
Among other things, the taxpayer sought relief of interest for a period of more than three years based on a claim that the CDTFA acted unreasonably and unnecessarily delayed resolution of the dispute.
“The law allows CDTFA to grant interest relief ‘in its discretion,’ provided certain elements are met,” the OTA wrote. “There is no statutory right to interest relief. As such, in these circumstances OTA will generally not second-guess the standard timeframes determined by CDTFA for purposes of granting discretionary interest relief, and will instead defer to CDTFA’s decision absent evidence of an abuse of discretion. It does not appear, from the record, that CDTFA has abused its discretion in deciding what periods were eligible for interest relief.”
- The Appeal of Image 2000, involving the question of whether the taxpayers relied on written advice from the CDTFA regarding sales tax on copier parts and toner.
After a 2015 audit, the CDTFA alleged that the taxpayer failed to properly report or pay tax on repair and replacement parts furnished under optional maintenance contracts, and ink and toner furnished in connection with the separately stated per-page charges.
In prior audits, the CDTFA determined that the business was liable for tax measured by its cost of repair parts furnished in connection with its maintenance contracts. The taxpayer’s total cost price for all repair parts was 10 percent of the total charges to its customers. The taxpayer continued to use the 10 percent ratio, arguing that it was relying on the CDTFA’s written advice from three prior audits.
The OTA sided with the CDTFA, writing, “There is no evidence in the available audit work papers that CDTFA ever advised appellant that it could report using a taxable ratio of 10 percent in perpetuity, regardless of appellant’s actual taxable measure (i.e., cost price of repair parts).”
The OTA also unanimously denied the taxpayer’s petition for rehearing.
- The Appeal of Snowflake Factory LLC, involving a dispute over where and when an airplane was purchased, and whether the current owner of the plane owes California use tax for the transaction. “The parties … agree that the aircraft was located in California on January 27, 2015, and in Oregon on February 10, 2015, and that the sale and purchase occurred on one of these two dates,” the OTA wrote.
The OTA found that the plane was purchased when the current owner obtained title to the aircraft on January 27 in exchange for consideration of $1 million. The panel rejected the owner’s claim that the sale did not occur until weeks later when the company obtained possession of the plane in Oregon.
The OTA also denied the taxpayer’s petition for rehearing.
In other noteworthy opinions:
OTA Lacks Jurisdiction to Help Taxpayer Whose Funds Were Wrongly Seized. In the Appeal of A. Gozukara, the OTA wrote that “there is no dispute as to the tax liability amount and person responsible for the tax,” nor that the CDTFA seized $141,298 from the wrong person thanks to a lien on property solely owned by the responsible person’s former spouse.
“At all relevant times, appellant was not liable for any unpaid sales or use taxes administered by CDTFA,” the opinion states. “At all relevant times … appellant’s ex-spouse … was personally liable for the unpaid taxes of Urban Automotive Group, LLC in the amount of $79,833 tax, plus accrued interest, and penalties of $7,983.30.”
This did not translate to a win for the appellant, however.
“OTA does not have jurisdiction to consider whether a taxpayer is entitled to a remedy for CDTFA’s actual or alleged violation of any substantive or procedural right, unless the violation affects the adequacy of a notice, the validity of an action from which a timely appeal was made, or the amount at issue in the appeal …,” the opinion states. “Although appellant appealed an adverse [CDTFA] Appeals Bureau decision, the issue in the appeal does not involve a dispute as to a tax liability. Instead, appellant is asserting that CDTFA’s levy was improper because appellant was the sole owner of the levied property and not the tax debtor. This argument does not affect the adequacy of a Notice of Determination, the validity of any action from which a timely appeal was made, or the amount at issue in the appeal. … Thus, the sole issue in this appeal is related to CDTFA’s collection activities, which is explicitly excluded from OTA’s jurisdiction.”
The appellant anticipated this result, and stated in her arguments that she filed the appeal simply to exhaust all administrative remedies before pursuing the matter in court.
Dissenting Judge Faults FTB’s Use of Mortgage Interest to Estimate Income. The Appeal of J. Navar challenged the Franchise Tax Board’s method of determining taxable income for a taxpayer who did not file a California income tax return for tax year 2015.
The FTB received information from a financial institution attributing mortgage interest payments to the taxpayer, and this information triggered the FTB’s assumption that the taxpayer might have a California filing requirement.
Using a 6:1 ratio of income to mortgage interest paid, the FTB estimated total income of $229,788, and proposed to assess tax, a late-filing penalty and interest.
Administrative Law Judges Andrea Long and Alberto Rosas opined that the FTB’s estimate was “reasonable and rational,” and thus passed the test for shifting the burden of proof to the taxpayer. “After the burden of proof shifted, appellant did not establish that the proposed assessment was erroneous,” Long and Rosas wrote.
Administrative Law Judge Jeffrey Margolis wrote a separate opinion to concur in the result but express concerns about the reliance on mortgage interest studies to estimate income.
“Those studies indicate that respondent’s review of millions of returns showed that there was (at least) a 6:1 ratio between the amount of total income reported on a return and the amount of mortgage interest claimed on a Schedule A,” Margolis wrote. “However, the Forms 1098 at issue in this appeal appear to have been issued with respect to investment and/or commercial properties. That interest would be reported on Schedule E (or Schedule C), not Schedule A. [The FTB] has not shown that its studies apply to interest claimed with respect to interest that is reportable on Schedules E and C. Accordingly, respondent’s studies are not sufficient to make the requisite showing in this appeal that its determination is supported by a rational basis and was not arbitrary and excessive in amount.”
However, Margolis opined that the FTB “remedied this defect by introducing evidence at the hearing showing that appellant sold California property for a gross sales price of $550,000 during the year at issue,” which provided a rational basis to estimate income.
“Appellant was offered the opportunity to provide information that his gain from the sale of this property was less than $550,000, but he refused to avail himself of that opportunity,” Margolis added.
FTB Failed to Exercise Reasonable Diligence, OTA Rules. In the Appeal of Gallagher Enterprises, the OTA ruled that the FTB improperly imposed its “demand penalty” for five tax years when it mailed demand letters to the wrong address.
It is “inexplicable” that the FTB continued to send letters to a Placerville address several years after determining that an El Dorado address was the most current address for the taxpayer, the OTA opined. The FTB “failed to exercise reasonable diligence by looking into its own computer system for the last known address,” the OTA added.
On many other issues, however, the FTB prevailed. The appeal involved a C corporation seeking refunds for multiple tax years dating back to 1991. The OTA’s opinion explains the corporation was established in 1972, and was suspended by the state in 1983 due to failure to file tax returns. The current operator of the corporation described it as a family business founded by his grandparents that lapsed after their deaths in 1986 and 1990. The corporate status was revived in 2018 after the grandson paid the outstanding tax liabilities, filed late returns for the 1991 through 2017 tax years, then sought refunds of disputed amounts. The taxpayer also requested abatement of amnesty penalties for the 1991 through 2002 tax years, but the OTA ruled that it does not have jurisdiction to review the penalties.
FTB Improperly Imposed Demand Penalty, OTA Rules. The Appeal of R. Hense and P. Hense is the latest opinion finding that the FTB improperly imposed the demand penalty.
Revenue and Taxation Code section 19133 provides that if a taxpayer fails to file a return upon notice and demand by FTB, the FTB may impose a penalty of 25 percent of the amount of tax assessed, unless the failure is due to reasonable cause and not willful neglect. Regulation section 19133 provides that for individuals, the demand penalty will be imposed only if the following two conditions are satisfied: the taxpayer fails to timely respond to a current demand for tax return in the manner prescribed, and the FTB has proposed an assessment of tax after the taxpayer failed to timely respond to a request or demand for a tax return “at any time during the four-taxable-year period preceding the taxable year for which the current Demand for Tax Return is issued.”
For many years, the FTB has been imposing the demand penalty for years that fall outside the stated four-year period, the OTA has opined in several opinions over the last two years.
“Here, to properly impose the demand penalty for the 2014 tax year, FTB’s regulation requires that FTB have issued an NPA for a prior tax year on a date anytime between January 1, 2010, through December 31, 2013. This threshold requirement has not been met in this case,” the OTA’s majority wrote.
ALJ Richard Tay dissented, opining that “FTB’s interpretation of the regulation is reasonable and comports with the intent of the regulation.”
The FTB petitioned for a rehearing, but the petition was denied in a 2-1 decision, with Tay again dissenting.
Taxpayers Lose Appeal but Gain Major Concession. The taxpayers in the Appeal of Earle A. Malm and Evelyn A. Malm were largely unsuccessful, but did gain a major concession from the FTB during the appeal.
The OTA upheld tax, interest and accuracy penalties, finding that the taxpayers did not prove material participation in a rental business’ activities, and thus were not entitled to deduct claimed ordinary losses or net real estate losses against their nonpassive income.
During the oral hearing and post-hearing briefing, however, the FTB conceded that the appellants are entitled to a reported Internal Revenue Code section 1231 loss of $588,490 for tax year 2010, resulting in lower tax, penalties and interest.
The oral hearing was held April 30, 2019. At the conclusion of the hearing, the OTA closed the record. However, the OTA reopened the record July 9, 2019, vacated the original submission date, and requested post-hearing briefs. The parties filed post-hearing briefs and the OTA closed the record September 27, 2019.
The taxpayers petitioned for a rehearing, but the petition was denied unanimously.