The following is Laura Mahoney’s article for BNA on the Dicon v. FTB decision.
Reproduced with permission from Daily Tax Report, 81 DTR K-1 (Apr. 27, 2012). Copyright 2012 by The Bureau of National Affairs, Inc (800-372-1033) <http://www.bna.com>
Dicon Fiberoptics v. Franchise Tax Board, Cal., No. S173860, 4/26/2012
Key Holding: FTB has authority to audit tax credit vouchers that local governments issue to employers in enterprise zones.
Key Takeaway: Burden of proof remains with taxpayer to show that FTB’s denial of enterprise zone credit was incorrect.
By Laura Mahoney
SACRAMENTO, Calif.—In a win for the Franchise Tax Board, the California Supreme Court unanimously said April 26 that FTB has the authority to audit the validity of tax credit vouchers that local governments issue for hiring qualified workers in enterprise zones (Dicon Fiberoptics v. Franchise Tax Board, Cal., No. S173860, 4/26/2012).
The seven justices reversed a state appellate court ruling from 2009 (Dicon Fiberoptics Inc. v. Franchise Tax Board, 92 Cal. Rptr. 3d 902 (Ct. App. 2009); 88 DTR K-2, 5/11/09), and rejected arguments from Dicon Fiberoptics Inc. that the EZ tax credit vouchers issued by local agencies are valid on their face, and FTB has the burden to show the credits should be invalid.
In a 22-page opinion, the court repeatedly cited FTB’s authority under the Revenue and Taxation Code to review returns and require taxpayers to provide information necessary to determine the correct amount of tax.
FTB’s authority places the burden of proof on the taxpayer, and the tax agency is not bound by the determination of a local officer or administrative agency, the court said. The statute establishing the EZ program does not trump FTB’s authority.
“Although obtaining a voucher is necessary for an employer to claim a hiring credit, the statute does not say that doing so shall be sufficient and conclusive in every case,” the court said. “The Enterprise Zone Act was enacted against a backdrop of the general statutes conferring broad power on the FTB as well as our precedents placing the burden of proof on the taxpayer.”
Case Stems From 2006 SBOE Ruling
At issue was $1.1 million Dicon claimed in 2001 for hiring disadvantaged workers who qualified the company for credit under the EZ program. FTB granted $2 million in EZ credits for the 2001 tax year but rejected another $1.1 million in credits, and Dicon sued after FTB refused its request for a refund.
The case was one of first impression, and was filed in 2007 to challenge a 2006 ruling from the State Board of Equalization that upheld FTB’s authority to audit EZ vouchers (In re Appeal of Deluxe Corp., No. 297128, Dec. 12, 2006; 243 DTR H-2, 12/19/06).
“The court’s decision affirms FTB’s role in ensuring the integrity of tax credit programs,” SBOE Member Betty Yee (D), who voted in favor of FTB in Deluxe, told BNA April 26. “This decision provides necessary guidance in response to questions that have arisen with respect to the quality of the vouchers. Ultimately, the court came to the same conclusion as the Board did in the Deluxe case in 2006.”
An FTB spokeswoman told BNA the tax agency declined to comment on the ruling.
An attorney for Dicon, Marty Dakessian with Reed Smith in Los Angeles, told BNA the ruling does not change Dicon’s entitlement to the credits because they are well documented. Dicon expects to win at the trial court level on FTB’s denial of the credits.
The court recognized that several of Dicon’s arguments and interpretations of law were reasonable and strong, Dakessian said. Dicon’s loss “is based on a very stringent standard of review—whereby the court states it must accept the FTB’s interpretation if it is merely reasonable (even if our interpretation is more reasonable),” Dakessian said in an email to BNA.
“In the end, the Supreme Court’s decision is further evidence of the strong institutional bias in favor of the state and protecting the [fiscal condition] and an indication of what taxpayers face in connection with refund actions in general and the specifically bargained for benefits in connection with the EZ program in particular,” Dakessian said.
Lower Court’s ‘Middle Ground’ Rejected
The Supreme Court rejected what it called “a middle ground” the appellate court had taken in its 2009 ruling, in which it said FTB has the authority to audit vouchers issued by local EZ authorities to employers, but the agency must meet the burden of rebutting a voucher’s prima facie validity.
The court said FTB has a reasonable approach to the voucher process, which complements its own audit process and provides another level of review. FTB said in its briefs that it is not required, nor does it intend, to audit every voucher in every case. Given budgetary constraints, review is likely to occur only “in cases where FTB has information that vouchers may have been improperly issued,” the court quoted from FTB’s briefs.
The court also noted FTB’s argument that at the time the vouchers were issued to Dicon, the vouchering process had several weaknesses including the lack of statutory or regulatory requirements for documentation necessary to obtain a voucher. Many of those weaknesses were address through new regulations issued in 2006.
“[I]t is not unreasonable for the FTB to require a taxpayer to prove that a worker meets the statutory definition of a qualified employee when the FTB lacks confidence in a voucher’s accuracy,” the court said. “We can address situations in which the FTB is alleged to have acted arbitrarily or unreasonably if and when they arise.”
Dicon’s Strongest Point Not Strong Enough
The court rejected several arguments from Dicon, including what it called Dicon’s strongest point raised—that the statutory incentive for hiring disadvantaged workers would be diluted by exposing enterprise zone employers to the risk that the agency certification determinations might be undone years later by FTB auditors simply because the FTB disagrees with discretionary determinations made by the certifying agencies.
The California Taxpayers Association also argued this point in a friend-of-the-court brief, saying taxpayers will not take advantage of tax incentives if they prove to be unpredictable.
Although the legislative history of the 1994 EZ law is not decisive, it is not unreasonable to assume the Legislature added the voucher certification scheme to work in addition to FTB’s audit authority and not to supplant it, the court said.
“Although Dicon is correct that the hiring incentive would be incrementally stronger if a certification were prima facie (or conclusive) evidence that a worker is a qualified employee, the corresponding risk of abuse would be greater as well,” the court said.
Justice Goodwin Liu wrote the unanimous opinion for the court.