EZ Policy Blog

Reproduced with permission from Daily Tax Report, No. 46 (Mar. 10, 2008), p. H-3. Copyright 2008 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com:

A cement manufacturer March 3 asked the State Board of Equalization to reconsider its Feb. 1 decision in which SBOE disallowed enterprise zone tax credits for machinery parts because they were expensed instead of capitalized, but backtracked on adopting a formal opinion that would have set a precedent for other similar cases (Appeal of Taiheiyo Cement USA Inc., No. 332855, petition for rehearing filed 3/3/08).

Jess B. Penilla, director of the Multistate Tax Services Group with Deloitte & Touche in Los Angeles, told BNA March 5 he filed a petition for rehearing with SBOE on behalf of Taiheiyo Cement USA Inc., which is seeking almost $2 million in sales and use tax credits for its plant in Riverside County.

If the board had adopted a precedent-setting formal opinion in the case Feb. 1, it would have marked the first time an adopted opinion included a formal dissent. The two Republicans on the board, Bill Leonard and Michelle Steel, strongly disagreed with the three Democrats on the board who voted to sustain the Franchise Tax Board’s position in the case, and sought to use new SBOE rules to include their dissent in the opinion.

But one of the three Democrats, Deputy Controller Marcy Jo Mandel representing State Controller John Chiang, would not vote for the opinion during the Feb. 1 board discussion. Without Mandel’s vote, neither the majority nor the dissenting opinion could be adopted.

Board Asked for Opinion in September

Mandel had previously voted with the two other Democrats, Judy Chu and Betty Yee, to sustain FTB and seek a formal opinion when the board first considered the Taiheiyo case in September (181 DTR H-3, 09/19/07). In September, the board said it wanted to consider adopting a formal opinion that could be cited as precedent because other, similar cases were pending.

But at the Jan. 31-Feb. 1 board meeting at which it considered adopting the opinion, Mandel said she would not be voting for it.

“The formal opinion may or may not reflect all the reasons why we may have voted that day [Sept. 11],” Mandel also said of the opinion SBOE staff presented to the board for adoption.

Mandel also said the controller does not believe many other cases will be coming before the board, and the issues in the case do not warrant a formal opinion.

The board voted 4-1 Jan. 31 to adopt the opinion and the dissent, with Mandel being the only vote against it, but the board rescinded that vote Feb. 1 after staff members advised them that at least three members needed to be signatories to the opinion. Because Leonard and Steel would be signatories on the dissenting opinion, the votes in favor of the opinion from Yee and Chu were not enough to adopt it.

The board then voted 3-2 to sustain the FTB in the case without adopting a formal opinion.

Leonard, who was attempting to adopt a dissenting opinion for the first time at the board, said he was frustrated that Mandel’s decision not to vote for the majority opinion meant the dissent would also go unadopted.

“Your motion is denying me the right to have my opinion published,” Leonard said to Mandel. “That’s contrary to informing the taxpayers of our opinion.”

Ruling Applies Only to Taiheiyo

Without the formal opinion, the board’s decision applies only to Taiheiyo, and with its petition for rehearing the company is continuing to argue the underlying tax policy disagreement between it and the state.

Central to the case is the meaning of the term “placed in service,” and how it applies to machinery parts that Taiheiyo bought and used within one year. The Revenue and Taxation Code does not contain an explicit requirement that property be capitalized to be eligible for the EZ sales and use tax credit, so FTB and the company came up with opposing views on the issue. So far, SBOE has agreed with FTB.

Taiheiyo, the parent company of Portland Cement, operates the Riverside County plant 24 hours a day, seven days a week. At issue are tax credits it claimed for tax years 1998 and 1999, including carryover credits generated in tax years 1990 through 1996.

Taiheiyo said it maintained a constant inventory of the parts because of continuous operations at the plant, where parts that may typically last three years wore out within one year. The company expensed these parts in the year they were purchased and used. Even though the credit is generally allowed for equipment that is capitalized, or depreciated over several years, the lack of an explicit exclusion for expensed parts in RTC in the context of when an item is “placed in service” allows the credit to apply to expensed property, the company argued.

If the Legislature intended to restrict the definition of qualified property to capitalized assets under the EZ statute, it could have done so, the company argued. Lawmakers have explicitly made such distinctions in other statutes, such as a now-expired law that created a manufacturers investment credit similar to the EZ credit.

Opinion Spells Out Reasoning

The unadopted opinion, provided to BNA by Leonard’s office, spells out in more detail FTB’s arguments and the reasoning behind SBOE’s agreement with it. SBOE agreed with FTB’s argument that parts must be depreciated to be eligible for the credit, based on examination of the legislative history and legal meaning of “placed in service.”

Although the term sometimes refers informally to current expense assets, the specific legal meaning of “placed in service” refers to the date that capitalized assets are in the condition or state of readiness or availability, and the date that depreciation of the capital asset is first allowable.

SBOE concluded that the Legislature’s use of “placed in service” in the law indicates its intent to restrict the definition of qualified property to capitalized assets.

Further, RTC Section 23612.2(e) prohibits the taxpayer from taking a credit for sales or use tax paid and adding that tax to the basis of qualified property, according to FTB’s arguments summarized in the unadopted opinion. The reference to “basis” in the law refers to capitalized assets and prevents taxpayers from receiving both a deduction and a credit for purchase of a capital asset. The law prevents no such double benefit for expensed assets.

Therefore, FTB argued, the prohibition on adding sales or use tax to the basis of qualified property is further evidence that the Legislature intended to restrict the credit to capitalized assets.

SBOE also agreed with FTB’s argument that, if it allowed the EZ credit for current expense assets, taxpayers would be able to “double dip” by deducting the cost of the asset against its net income, excluding sales tax paid, and then receive a credit for the tax on the same asset. On the other hand, capital assets are not currently deductible.

“Such an interpretation would favor currently expensed assets over capitalized assets, creating an incentive for taxpayers to find ways to expense property that otherwise ought to be capitalized, “the unadopted opinion said.

Taxpayers Cannot Research Intent, Dissent Says

In their dissent, Leonard and Steel said the plain language of RTC reveals no requirement that property be capitalized to be eligible for the credit. The taxpayer cannot be expected to research legislative history to speculate about legislative intent in order to use the credit, especially when published guidance available in the years in question gave no reason for Taiheiyo to suspect the law was ambiguous, they said.

“[Taiheiyo] has meticulously followed the statutory language and published guidance in pursuing the EZ SUT credit,” the dissent said. “The State of California can demand no more than that from any taxpayer.”

The dissenters argued that the types of parts at issue would normally be capitalized, but were not because of the unusually demanding way in which they were used. “Even if some legislators had silently intended to limit the enterprise zone sales and use tax credit to capital assets, the machinery parts at issue here were likely to have been the sort of assets that they had in mind,” the dissent said.

Leonard and Steel said the term “placed in service” is not used in the EZ SUT provisions of the state tax law to distinguish between certain types of property, but is used only to limit the tax credit to $20 million a year, and to limit the credit to property in use before the expiration of an EZ designation. The distinction between capital assets and expensed assets is not made.

Term Not in Use During Years at Issue

Further, they argued that “placed in service” was not added to the state law until 1997, which is after the time that most of the credits in the appeal were earned and therefore should not apply.

The dissent also faulted FTB’s argument that the term “basis” in the law can only refer to capital assets. FTB’s argument ignores the fact that all property has a basis that is used to calculate gain when property is sold.

“There is simply no foundation to the assertion that the term ‘basis’ can only be used in reference to capitalized assets, even if the term is frequently used in that context,” the dissent said. “We should affirm that ‘basis’ is a general term that applies equally to expensed assets and capital assets (and to any other conceivable thing that can be sold). [FTB’s] fears about double benefits will only materialize if we adopt [FTB’s] incorrect view that ‘qualified property’ is limited to capitalized assets.”

SBOE will review Taiheiyo’s petition for rehearing, which must include reasons for the request such as arguments that the board made in error of law in reaching its decision or that newly discovered evidence is available. If SBOE denies the petition, the taxpayer has exhausted its administrative remedies and may file suit in state trial court.

By Laura Mahoney