For background on Dicon Fiberoptics v. FTB see these previous blog posts:

5/9/2007 “New Enterprise Zone Lawsuit.”
6/11/2007 “Dicon Fiberoptics v. FTB Update.”
7/17/2007 “Dicon Fiberoptics v. FTB Update 2.”
10/29/2007 “Dicon v. FTB Dismissed.”
11/13/07 “BNA: “Taxpayer Appeals Dismissal of Suit Challenging FTB’s Tax Credit Voucher Policy”.”

After the case was dismissed in Superior Court, Dicon filed an appeal in October 2007 which was eventually argued before the Court on January 27, 2009.  On May 7, 2009 the Appeals Court issued its decision which, on the one hand upholds FTB’s right to audit Enterprise Zone hiring credit vouchers, but, on the other hand, grants those vouchers a prima facie validity and places the burden of proof on FTB to overturn them.  The Court also sends the Dicon case back to Superior Court to allow Dicon to argue that FTB improperly rejected their vouchers and denied their refund claims.

I have posted a copy of the Court of Appeal’s decision here [PDF].

In its summation the Court wrote:

Dicon Fiberoptics, Inc., appeals from the trial court’s judgment sustaining without leave to amend the demurrer of the Franchise Tax Board to Dicon’s complaint seeking refund of a tax credit for employing disadvantaged workers. To receive the credit, Dicon submitted vouchers to the board certifying Dicon had employed disadvantaged workers. After auditing the vouchers, the board partially denied the tax credit to Dicon. Dicon contends the board has no legal authority to audit its vouchers, a contention we reject. We nevertheless conclude Dicon states a cause of action that the board exercised its audit power improperly, and therefore the trial court erred in sustaining the board’s demurrer. Accordingly, we reverse and remand.

After determining that the lower court inappropriately denied Dicon’s leave to amend their previous complaint, the Appeals Court addresses the main issue of FTB’s role in the auditing of vouchers:

The trial court’s error in sustaining FTB’s demurrer warrants reversal of the court’s judgment and remand for further proceedings. For the trial court’s and parties’ guidance after remand, we address the unanswered legal question looming over these proceedings: Does FTB’s authority to examine and audit tax returns permit FTB to reject a voucher issued by a local employment or social services agency? FTB answers “yes.” Dicon, in contrast, says a local agency’s decision is binding on FTB and answers “no.” Thus, according to Dicon, FTB must limit its review of vouchers to confirming Dicon in fact obtained the voucher from one of the local agencies identified in the statute; FTB may not, Dicon asserts, review the local agency’s underlying decision to issue the voucher. We hold vouchers are prima facie proof a worker is a “qualified employee,” but FTB may audit such vouchers. In such an audit, FTB bears the burden of rebutting the voucher’s prima facie value, typically by proving the worker did not meet the criteria to be a “qualified employee.” In trying to meet that burden, FTB may not rely on the employer’s failure to produce during the audit documents establishing a worker’s eligibility to the extent regulations governing the tax credit charge the enterprise zone, not the employer, with the obligation to maintain documents of workers’ eligibility.

So what is the Court’s conclusion? “We hold vouchers are prima facie proof a worker is a ‘qualified employee,’ but FTB may audit such vouchers.” But if FTB is barred from asking taxpayers for any underlying documentation, what would be the procedure for such an audit? Footnote 7 adds some additional information, but not necessarily more clarity:

We do not intend our holding today to restrict FTB’s audit powers, to limit the scope of the audits it conducts, or hamstring its authority to gather evidence relevant to the correctness of a tax return. Rather, we direct our holding to the weight FTB must give, in the absence of any other evidence, to vouchers during audits.

I think what the Court is getting at, or at least how it will likely be interpreted by FTB, is that in circumstances where FTB has knowledge of the existence of incorrect vouchering practices, they will use that evidence to justify the examination of additional documentation.

The discussion continues:

Although we hold FTB may audit a voucher, we conclude from the statutory framework governing vouchers that they are prima facie evidence an employee is a qualified worker. As prima facie evidence, a voucher shifts to FTB the burden of demonstrating an employee is not a qualified worker for which no voucher should have issued. We conclude FTB properly bears this burden for several reasons. First, an employer who submits a voucher to FTB has followed the statute?s requirements to (1) obtain a voucher from any one of several agencies identified in the statute, and (2) present the voucher to FTB. The employer’s compliance with the statute ought to count for something. Second, the documents supporting a worker’s certification as a “qualified employee” are not ordinarily within the employer’s custody and control, either when initially applying for a voucher from the local agency, or possibly years later during an FTB audit. Surveying the types of workers entitled to “qualified employee” status, we note that many categories involve disadvantaged workers for whom the impediments to employment involve conditions that are potentially embarrassing to a worker, such as limited literacy and criminal convictions. Documents proving such employment obstacles are not readily shared between worker and employer, especially not years later during an audit. Indeed, the statute does not require the employer to retain the documents supporting a worker’s designation of “qualified employee” and administrative regulations require only the Enterprise Zone manager to keep the documents.

Another reason to extend prima facie status to a local agency’s voucher is to promote the tax credit’s purpose of encouraging employers to hire disadvantaged workers. The employer ordinarily has some reassurance of receiving the credit if it knows after having received a voucher that FTB bears the burden of proving the voucher was unjustified. If FTB may reassess perhaps years later a worker’s status as a “qualified employee,” the employer has less confidence in receiving a credit, particularly if the employee no longer works for the employer. Reducing an employer’s confidence in receiving the tax credit is a disincentive to hiring a disadvantaged worker, thereby undermining the reason for the Enterprise Zone.

It is interesting to note the Court’s references to the vouchering regulations which were not in existence neither at the time Dicon received its vouchers nor at the time FTB performed its audit. This may be part of FTB’s basis for arguing that it did have reason to believe that the vouchers were improperly issued.

However, this last argument is particularly interesting as it takes into account the public policy implications of subsequent governmental intervention into the mechanics of a government program. Legislator’s might also do well to contemplate how proposing certain legislation can effect the confidence of the marketplace.