INSIDE SALT
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
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AB 2570: Déjà vu All over Again as California Attempts to Amend CFCA

by , and | Feb 24, 2020 | , , , ,

California’s Attorney General, Xavier Becerra, and Assembly Member Mark Stone have again advanced legislation that would amend the California False Claims Act (CFCA) to enlist private bounty hunters to go after California taxpayers. Becerra described the latest bill, AB 2570, as an additional tool to combat against “corporate cheats” whom Becerra claimed cost the state billions in lost revenue in 2019. Of course, the state already possesses an arsenal of tools to combat any underreporting: currently, the power to investigate cases of suspected tax fraud rests with the California Franchise Tax Board (FTB) and the California Department of Tax and Fee Administration (CDTFA). Thus, as many of the predecessor bill’s critics have adeptly noted, AB 2570 is more appropriately characterized as a “solution in search of a problem.”

The text of AB 2570 is almost identical to its predecessor, AB 1270, which failed to make it out of the legislature last year, and has likely given California’s business-savvy taxpayers a sense of dread-filled déjà vu. AB 1270 came under intense opposition last summer because, as seen in other states, allowing qui tam plaintiffs to initiate civil suits for state and local tax issues leads to abusive practices and undermines the goal of voluntary compliance in tax administration.

Like AB 1270, AB 2570 is replete with problematic provisions, including: (1) the imposition of a separate statute of limitations that will arguably trump any shorter limitations periods imposed by the Revenue & Taxation Code (See Cal. Gov’t Code § 12654(a) which permits claims under the CFCA to be pursued for up to 10 years after the date the violation was committed, compared to standard three or four years for tax audits); (2) a more lenient burden of proof for elements of an alleged violation; and, (3) extremely punitive damages—violators are subject to treble damages (i.e., three times the amount of the underreported tax, interest and penalties), an additional civil penalty of $5,500 to $11,000 for each violation, plus the costs of the civil action to recover the damages and penalties including attorney’s fees.

Unfortunately, private enforcement of state tax code violations has erupted over the past few years after whistleblowers in New York and Illinois purportedly have racked up multimillion dollar settlements as the result of such claims. If enacted, AB 2570 will open the floodgates to a slew of financially incentivized plaintiffs’ attorneys who are eager to enter the litigation lottery in hopes of winning a jackpot settlement payout from California’s taxpayers.

As discussed in our blog post from August 26, 2019, Vultures Circling as Bill to Expand California FCA to Tax Looms in Legislature, regarding AB 1270, when a false claims suit is filed by a private plaintiff (or relator) in a qui tam action, the recovered damages or settlement proceeds are divided between the state and the relator, with the relator permitted to recover up to 50% of the proceeds. See Cal. Gov’t Code § 12652(g)(3). Thus, this practice can be very lucrative for aggressive plaintiff’s attorneys.

Even [...]

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Vultures Circling as Bill to Expand California FCA to Tax Looms in Legislature

by , , and | Aug 26, 2019 | , , , ,

Legislators in Sacramento are mulling over one of the most (if not the most) troubling state and local tax bills of the past decade. AB 1270, introduced earlier this year and passed by the Assembly in late May, would amend the California False Claims Act (CFCA) to remove the “tax bar,” a prohibition that exists in the federal False Claims Act and the vast majority of states with similar laws.

If enacted, this bill will open the door for a cottage industry of financially driven plaintiffs’ lawyers to act as bounty hunters in the state and local tax arena. California taxpayers would be forced to defend themselves in high-stakes civil investigations and/or litigation—even when the Attorney General’s Office (AG) declines to intervene. As seen in other states, this racket leads to abusive practices and undermines the goal of voluntary compliance in tax administration. (more…)



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California Bill Would Remove Tax Bar to False Claims Act

by , and | May 1, 2019 | , ,

California legislators have recently introduced a bill, AB 1270, that would amend the False Claims Act (Act) to strike the tax bar. As introduced, the bill would amend the existing false claims statute in the state of California to expressly authorize tax-related false claims actions against a person whose reported taxable income, net income, or sales totaled $500,000 or more in to which the claim pertained, and the damages pleaded in the action total $200,000 or more. Also, “[t]he bill would authorize the Attorney General or the prosecuting authority, but not the qui tam plaintiff, to obtain otherwise confidential records relating to taxes, fees, or other obligations under the Revenue and Taxation Code. The bill would prohibit the disclosure of federal tax information to the Attorney General or the prosecuting authority without authorization from the Internal Revenue Service.”

Under current California law, those making false or fraudulent claims to state or local governments can be liable to the state or locality for treble damages, including consequential damages, attorneys’ fees and a civil penalty of between $5,500 and $11,000 for each violation. The False Claims Act does not apply to claims made under the Revenue and Taxation Code.

In addition to repealing the exception for false claims made under the Revenue and Taxation code, the bill would expand the definition of “prosecuting authority” to include “counsel retained by a political subdivision to act on its behalf.” This opens a wide door to the use of contingent fee “bounty hunters” by localities for the prosecution of false tax claims.  The bill makes no provision for review of the allegedly false tax claims by any of the governmental agencies charged with interpretation of the Revenue and Tax Code, such as the Franchise Tax Board or the California Department of Tax and Fee Administration.

As we have seen in jurisdictions like New York and Illinois, opening the door to tax-related false claims can lead to significant headaches for taxpayers and usurp the authority of the state tax agency by involving profit-motivated private parties and the state Attorney General in tax enforcement decisions. Allowing private parties to intervene in the administration, interpretation or enforcement of the tax law commandeers the authority of the tax agency, compounded by the use by local governments of contingent-fee outside attorneys, creates uncertainty and can result in inequitable tax treatment. While many other problems exist with application of false claims to tax matters, those issues are beyond the scope of this blog.



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New California Office of Tax Appeals Discusses Emergency Regulations

by | Nov 15, 2017 | , , ,

The New California Office of Tax Appeals (OTA) on November 6, 2017, held an interested parties meeting in Sacramento to discuss the contents of a draft of emergency regulations to guide both income tax appeals from the California Franchise Tax Board and sales and use tax appeals from the California Department of Tax and Fee Appeals (CDTFA). The meeting was chaired by Kristen Kane, the newly appointed Chief Counsel and Acting Director of the OTA, and by Zack Morazzini, the Director and Chief Administrative Law Judge (ALJ) in the Office of Administrative Hearings.  Ms. Kane and Mr. Morazzini provided helpful insight on how the new OTA will operate, including the following:

  • The OTA is in the process of hiring 18 new ALJs.
  • Hearings will be held in Sacramento, Los Angeles and Fresno.
  • Hearings are expected to commence in late January, after a crash training program for the new ALJs.
  • Both Ms. Kane and Mr. Morazzini stressed the intention that the hearings be as informal and conversational as possible, bearing in mind that many, if not most, taxpayers will either appear pro per or be represented by non-attorneys.
  • Taxpayers will open the process by making a written submission, and the agencies will file a written brief in response. The procedures may be similar to the current practice before the State Board of Equalization, where the taxpayer submits a statement of facts and discussion of the law, and the facts as stated by the taxpayer are accepted unless the tax agency objects.
  • Where there is a disagreement on the facts, the burden will be on the taxpayer to come forward with supporting evidence.

In an informal discussion after the conclusion of the meeting, Mr. Morazzini said that the Office of Administrative Hearings is proud of their long and successful run at conducting fair hearings in many contexts with flexibility being a paramount concern. At least at the outset, there will be no written rules on the presentation of evidence. Mr. Morazzini said that the Administrative Procedures Act and, generally, the rules of evidence allow ALJs to fashion orders responsive to discovery requests by either or both of the taxpayer or the agency, as required under the circumstance. Either party will have the right to request a preliminary meeting with an ALJ, or the ALJ can order a preliminary meeting. The preliminary meeting is intended to be informal, and will give taxpayers the opportunity to request the production of documents, stipulations and admissions. Note that OTA anticipates that the preliminary meeting will be attended by only one ALJ, although A.B. 102, the authorizing legislation, calls for a panel of three ALJs.

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California’s New Office of Tax Appeals Issues Preliminary Draft of Procedural Rules that Is Silent on Discovery Matters

by | Nov 1, 2017 | , , ,

As part of Governor Jerry Brown’s 2017 budget bill, the California State Board of Equalization (SBE) was stripped of its functions that had been authorized by statute, leaving principally property tax matters deriving from the state constitution. Sales and use tax and fee functions were moved to a newly created California Department of Tax and Fee Administration (CDTFA). Jurisdiction to hear appeals from the Franchise Tax Board (FTB) as well as appeals in sales and use tax and fee matters from CDTFA was vested in a new Office of Tax Appeals (OTA), to become effective January 1, 2018. The OTA is scurrying to adopt rules before opening for business on January 1, 2018. It recently released an early draft of what will become emergency regulations. An informal public discussion meeting of the draft has been scheduled for November 6, 2017, in Sacramento. (more…)



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California FTB Schedules Interested Parties Meeting on Short Notice to Discuss Issues in the Regulations on Sourcing Income from Services and Intangibles

by | Jan 5, 2017 | , ,

The California Franchise Tax Board has scheduled an Interested Parties Meeting to discuss proposed changes to its apportionment regulations. Several years ago, when the statute called for sourcing receipts from services and intangibles at the location of income producing activity, based on cost of performance, the FTB, after a series on interested parties meetings, adopted new regulation 25137-14 sourcing receipts for mutual fund service providers and asset management service providers not at the location of the service provider, but at location of customers.  That was good news for California service providers and bad news for out-of-state service providers.

The FTB scheduled on December 22, 2016 an Interested Parties Meeting for January 20, 2017 to discuss a series of issues arising under the new market- based sourcing regulations. A Discussion Topic Paper (attached) was issued on January 3, 2017, and included (1) draft examples of souring income from asset management fees, (2) a discussion of “reasonable approximation”, including who makes that reasonable approximation, (3) clarification of the term “benefit of a service” in several contexts, including timing, government contracts, R&D contracts and patent sales, (4) dividend assignment, (5) a freight forwarding example, (6) interest received from a business entity borrower and (7) marketing intangibles.

The FTB takes these Interested Parties Meetings seriously.  Taxpayers should pay immediate attention to whether any of these issues are of significance to them, and consider participating.



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Digital Tax Update – Local Edition

by , and | Oct 20, 2016 | , , , , , , , ,

After the highly publicized administrative lease transaction and amusement tax expansions in Chicago last year, more cities around the country are taking steps to impose transaction taxes on the sale or rental of digital content. Unlike tax expansion efforts at the state level (such as the law recently passed in Pennsylvania), which have almost all been tackled legislatively, the local governments are addressing the issue without clear legislative authority by issuing administrative guidance and taking aggressive positions on audit. As the local tax threat facing digital providers turns from an isolated incident to a nationwide trend, we wanted to highlight some of the more significant local tax developments currently on our radar.

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Unclaimed Property Litigation Update – Spring 2016

by , and | May 16, 2016 | , , , ,

Litigation over unclaimed property rules and obligations continues to accelerate. The first quarter of 2016 brought developments in several cases, including a much-watched contest over merchandise credits and a new battle between the states over which state gets the money.

California Merchandise Credits Not Subject to Remittance as Unclaimed Property; Implicit Application of Derivative Rights Doctrine Prevails

On March 4, 2016, a California superior court held in Bed Bath & Beyond, Inc. v John Chiang that unredeemed merchandise return certificates (certificates) issued by Bed Bath & Beyond (BB&B) to tis California customers are exempt “gift certificates” under the California Unclaimed Property Law—and not “intangible personal property” under the California catch-all provision. Like many retail stores, BB&B provides the certificates as credits to customers who return items without a receipt. While the certificates may be redeemed for merchandise at BB&B or one of its affiliates, they cannot be redeemed for cash. BB&B took the position that it mistakenly reported and remitted the unclaimed certificates from 2004 to 2012 and filed a refund claim with the California State Controller’s Office (Controller) in 2013 for the full amount remitted during that time period (amounting to over $1.8 million). The Controller denied the claim, and BB&B proceeded to sue John Chiang, both individually and in his official capacity as former California state controller. The relief sought by BB&B was the full refund request, plus interest. (more…)



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California FTB to Discuss Apportionment of Combined Group Income

by | Mar 24, 2016 | , , ,

The California Franchise Tax Board (FTB) will hold a second Interested Parties Meeting at their office in Rancho Cordova on April 20, 2016, dealing with the apportionment of income for combined reporting groups with both financial and non-financial members.  The Notice of Interested Parties meeting provides a description of the sourcing methods used in other states and solicits comments on four specific proposals.

The current statute and regulations, applied literally, in effect assign the majority of combined income of bank(s) and broker-dealer(s) to the location of the bank(s) or broker-dealer(s) and its customers.  This can produce an issue worth many hundreds of millions of dollars to the bank or broker dealer.  We understand that the California FTB has issued ad hoc Notices of Proposed Assessment to some taxpayers based on a distortion theory; some of these cases have gone to the Settlement Bureau, where both the FTB and the taxpayers have settled and executed confidentiality agreements.

The FTB takes these Interested Parties Meetings very seriously.  They have an unusual format in that there is not a record of who said what, the goal being to have a full and frank discussion on a non-attribution basis. An early example of collaboration between the FTB and interested parties produced what is now Reg. 25137-10.  Before the regulation, many years ago Sears argued that it was not engaged in a unitary business with a finance company subsidiary.  Sears lost in the trial court on that issue, but the court also held that Sears was entitled to include intangible personal property in the property factor, and the situs of that property was Illinois, resulting in a refund for Sears. Regulation 25137-10 represented an effort to harmonize the income-producing character of intangible personal property with tangible property in the property factor, and the outcome was that intangible property would be included in the property factor at 20 percent of face value. This regulation and the bank regulation 25137-4.2 provide the current regulatory basis for modification of the statutory formula where high volume, low profit activity is combined with other activity in a combined return, but Reg. 24137-10 only applies where the principal business activity of the combined group is not financial.

Taxpayers should follow these regulatory activities carefully, as evidenced by the adoption of a regulation a few years ago on sourcing income of mutual fund service providers, which was favorable to California-based taxpayers. The statute provided for sourcing income from services at the location of income-producing activities, measured by cost of performance. The adopted regulation instead provides for a form of market sourcing.



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California Supreme Court Denies BOE Petition for Review in Lucent Technologies

by , and | Jan 26, 2016 | , , , , , ,

Last week, the California Supreme Court denied the State Board of Equalization’s (BOE’s) petition for review in Lucent Technologies, Inc. v. State Bd. of Equalization, No. S230657 (petition for review denied Jan. 20, 2016). This comes just months after the California Court of Appeals held against the BOE and ordered it to pay Lucent’s $25 million sales tax refund. As explained in more detail below, the denial finalizes the favorable precedent of the Court of Appeals in Nortel Networks Inc. v. State Bd. of Equalization, 191 Cal. App. 4th 1259, 119 Cal. Rptr. 3d 905 (2011)—representing a monumental victory for a broad range of taxpayers in California and opening the door for significant refund opportunities. Moreover, the California Supreme Court’s denial affirms the Court of Appeals decision that the BOE’s position was not substantially justified and the taxpayer was entitled to reasonable litigation costs of over $2.6 million.

Background

Lucent and AT&T (collectively Lucent) are and were global suppliers of products and services supporting, among other things, landline and wireless telephone services, the internet, and other public and private data, voice and multimedia communications networks using terrestrial and wireless technologies. Lucent manufactured and sold switching equipment (switches) to their telephone customers, which allowed the customers to provide telephone calling and other services to the end customers. The switches required software, provided on storage media, to operate. Lucent designed the software (both switch-specific and generic) that runs the switches they sell, which was copyrighted because it is an original work of authorship that has been fixed onto tapes. The software also embodies, implements and enables at least one of 18 different patents held by Lucent.

Between January 1, 1995, and September 30, 2000, Lucent entered into contracts with nine different telephone companies to: (1) sell them one or more switches; (2) provide the instructions on how to install and run those switches; (3) develop and produce a copy of the software necessary to operate those switches; and (4) grant the companies the right to copy the software onto their switch’s hard drive and thereafter to use the software (which necessarily results in the software being copied into the switch’s operating memory). Lucent gave the telephone companies the software by sending them magnetic tapes or CDs containing the software. Lucent’s placement of the software onto the tapes or discs, like the addition of any data to such physical media, physically altered those media. The telephone companies paid Lucent over $300 million for a copy of the software and for the licenses to copy and use that software on their switches.

The BOE assessed sales tax on the full amount of the licensing fees paid under the contracts between Lucent and its telephone company customers. Lucent paid the assessment and sued the BOE for a sales tax refund attributable to the software and licenses to copy and use that software at the trial court. The parties filed cross-motions for summary judgment on Lucent’s refund claims, and the Los Angeles [...]

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