EZ Policy Blog

Here is the August 2008 edition of the FTB’s “Tax News” newsletter.

Here is the July 2008 edition of the FTB’s “Tax News” newsletter.

From the April 2008 FTB Tax News publication:

The November 2007 issue of Tax News included an article regarding the State Board of Equalization (SBE) unpublished decision in the Appeal of Jessica McClintock. Specifically, that article stated that individuals with a documented barrier, as defined under the Job Training Partnership Act (JTPA) 10 percent exception category, could be considered qualified employees for purposes of the enterprise zone hiring credit.Based on information available at the time of the hearing, the SBE determined that “older worker” was a documented barrier for purposes of the JTPA 10 percent exception, regardless of the individual’s economic situation. Since then, Franchise Tax Board (FTB) has obtained Employment Development Department Directive 96-5 that provides program administration information to JTPA administrators, and discusses when an older worker is eligible for JTPA services. This Directive requires that an older worker must be both 55 years or older, and meet low-income guidelines.

FTB has presented this new information to the SBE and requested affirmation that for purposes of the enterprise zone hiring credit, “older worker” as a documented barrier also requires that the individual meet low-income guidelines. We will include information in Tax News on any future updates on this appeal.

Earlier Posts:

• Jessica McClintock - Part 1, August 30, 2007
• Jessica McClintock - Part 2, August 30, 2007
• CAEZ Conference - FTB Updates, October 30, 2007
• FTB on Jessica McClintock Implications, November 5, 2007

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

In its March 2008 “Tax News,” FTB is extolling the virtues of Enterprise Zones in an article called “Possible boost to California’s economy“:

Governor Arnold Schwarzenegger recently announced the conditional designation for eight Enterprise Zones statewide. The zones are East Los Angeles, Kings County, Oakland, Salinas Valley, San Joaquin County, Santa Ana, Siskiyou County, and West Sacramento.

The new designations will take the place of the eight zones set out in statute that are expiring over the next several months. Each zone designation is in effect for 15 years.

In his announcement, the Governor noted, “Enterprise Zones play a key role in revitalizing economically challenged parts of our state. By helping businesses create well-paying jobs, we empower communities to climb the economic ladder and build the state’s overall economy.”
…
In 2006, a report commissioned by the Department of Housing and Community Development (HCD) evaluated the success of Enterprise Zones in spurring economic recovery. The report showed that, on average, within Enterprise Zones between 1990-2000:

* Poverty rates declined 7.35 percent more than the rest of the state.
* Unemployment rates declined 1.2 percent more than the rest of the state.
* Household incomes increased 7.1 percent more than the rest of the state.
* Wage and salary income increased 3.5 percent more than the rest of the state.

In the next step in the designation process, the HCD will issue a conditional designation letter to each of the new zones, outlining conditions that must be met before final designation can be granted. Examples of conditions include a signed memorandum of understanding with HCD, which includes performance measures and benchmarks.

The text of the article quotes the governor as stating rather clearly that Enterprise Zones “play a key role” in boosting the economy, yet the FTB’s title uses the word “possible” in describing the economic benefit.  Interesting.

FTB has recently updated some sections of its Economic Development Areas Manual (EDAM) dealing with the Enterprise Zone credits.

A few weeks ago I reprinted a BNA article by Laura Mahoney discussing the appeal of Dicon v. FTB.   Mahoney contacted me today to alert me to a correction published in relation to that article:

A report on the Oct. 23 appeal of California court decision (Dicon Fiberoptics Inc. v. Franchise Tax Board, Cal. Ct. App., No. B202997), in 211 DTR K-2, 11/1/07, incorrectly stated the amount of credit denials or additional assessments the California Franchise Tax Board is expecting to issue in the process of auditing about 500 taxpayers who have claimed enterprise zone hiring credits. FTB estimated the total to be about $130 million, not $1 billion. As of Dec. 5, FTB estimated the total amount of credit denials and overstatements to be about $60 million, in light of a recent decision striking down the agency’s position that some credits involving economically disadvantaged employees were not allowable. The online version has been corrected.

Mahoney further informed me that the overwhelming majority of that adjustment was due to a math error and not the BOE decision in the Jessica McClintock case.

The new December “Tax News” newsletter from FTB appears to include some hints on how to prepare for an audit of your Enterprise Zone credits:

Establishing the right to a refund

While most claims for refund are made on a completed amended return with a sufficient level of support, we have recently been seeing an influx of claims that are not providing enough information for us to determine whether the taxpayer has established a right to the refund. Moreover, some taxpayers do not have information readily available when we request it.

We are reminding all taxpayers to include a sufficient level of support for their refund when they file their claims. This will expedite consideration of your clients’ claims, and refund processing. Sufficient support includes forms, calculations, or schedules used in determining the amount of refund, as well as detailed explanations for the change. For example, amended returns filed to claim an Enterprise Zone credit should include FTB Form 3805Z, Enterprise Zone Deduction and Credit Summary; Schedule Z, Computation of Credit Limitations – Enterprise Zone, and all worksheets referenced in the Form 3805Z.

Claims for refunds must be in writing, signed by the taxpayers or their agents, and must specify the grounds on which the claims are based. The taxpayer must also “affirmatively establish the right to a refund of the taxes by a preponderance of the evidence.” (Consolidated Accessories Corp. v. Franchise Tax Board (1984) 161 Cal.App.3d 1036, 1039; Paine v. State Bd. of Equalization (1982) 137 Cal.App.3d 438, 442; Honeywell, Inc. v. State Bd. of Equalization (1982) 128 Cal.App.3d 739, 744.)

In other words, the choice to file claims for refund obligate taxpayers with the burden to establish by a “preponderance of evidence” that they have the right to the claimed refund. When appropriate, we may request in writing that the taxpayer provide a completed amended return, and a sufficient level of support within a certain number of days. The claim may be denied if the information is not provided within the time requested.

Taxpayers should have documentation that supports their claim amount and basis readily available when they file their claims. For example, in a claim for refund to report an Enterprise Zone credit, documentation would include relevant accounting or financial records, such as payroll records, fixed assets journals, invoices, hiring credit vouchers, tax credit studies or other key documents required to substantiate the basis of the claim for refund. Making sure that your clients provide the right information at the time the claim is filed, and have the substantiating documentation readily available upon request, accelerates the resolution of all claims.

As reported in the Sacramento Bee, the Franchise Tax Board is holding a Taxpayer’s Bill of Rights public hearing this morning in Sacramento.  The meeting can be heard online via FTB’s website.

Once again Laura Mahoney of BNA treats us to a report on what’s happening in the California Enterprise Zone world. This time it’s a detailed article on the release of the new voucher form.

Reproduced with permission from Daily Tax Report, No. 218 (Nov. 13, 2007) p. H-3. Copyright 2007 by The Bureau of National Affairs, Inc. (800-372-1033) (http://www.bna.com)

HCD Application Form Available To Employers Seeking EZ Hiring Credit

SACRAMENTO, Calif.–The Department of Housing and Community Development Nov. 1 released a new, statewide application that employers must use to qualify for the hiring tax credit available in enterprise zones, and said the application must be used for all voucher applications beginning Jan. 1, 2008.

The new application is intended to provide uniformity between the 42 designated enterprise zones in the state, Frank Luera, chief of the HCD state enterprise and economic development section, told BNA Nov. 8. HCD issued the new application as a key part of revisions it has been making to the EZ program since it began administering the 20-year-old program in 2004, including new regulations governing EZs that took effect in January 2007.

Employers must use the new application forms to obtain hiring credit vouchers from local EZ administrators. At the same time, the EZs must all use a new certificate, or voucher, to document their approvals of applications. HCD issued the new forms because different EZs have been requiring different types of information and documentation from voucher applicants, Luera said.

Employers who receive vouchers from local EZ administrators must provide copies of them to the Franchise Tax Board when claiming the credits. FTB has increased its scrutiny of the vouchers in the past four years, based on concerns that many EZs were issuing the vouchers improperly. FTB has audited, or is in the process of auditing, 500 taxpayers and expects to deny about $1 billion in claimed EZ hiring credits.

The State Board of Equalization has issued three decisions in the past year on EZ credit disputes between employers and FTB, and two employers have sued FTB disputing its authority to audit the vouchers (211 DTR K-2, 11/1/07 ).

Fewer Audits Expected

FTB expects that it will be much less likely to audit hiring credits claimed under the new regulations using the new application, spokeswoman Susan Maples told BNA Nov. 9. The new regulations address FTB’s concerns about the EZ program by requiring that all EZs operate under the same procedures and policies, and clearly stating the types of documentation necessary to secure a voucher.

Under the EZ program, employers receive a tax credit of up to $34,000 per qualified employee hired in one of 42 zones in the state. The zones are designated by the legislature as areas facing economic hardships such as high unemployment and significant job losses due to downturns in specific industries.

Eligible new employees must fall into one of 17 categories–for example those who are unemployed and are not likely to find work similar to their previous employment, or displaced homemakers who no longer have access to the income on which they depend.

HCD delayed its release of the new voucher application, originally set for August, because legislators were interested in adding some questions to the form that would help them gather data to measure the effectiveness of the EZs. However, because HCD could not require applicants to answer the questions envisioned, the data gathered would have had limited value, Luera said.

The new form does not ask for new types of information or documentation, but requires basic information about the employer and the employee, including the eligibility category to which the employee belongs. Employers must submit the application along with the necessary documentation, depending on the eligibility category, to the EZ for review.

New Rules Apply Now

In a Nov. 1 memo to EZ coordinators, Luera said although the zones and employers can use their old forms until Jan. 1, 2008, they must now comply with the rules imposed by the new forms and include the information specified on it.

Luera told BNA that HCD also has begun posting its decisions on appeals from employers when they disagree with an EZ that has denied its voucher application. HCD has just begun reviewing appeals from employers under a new process established in the regulations.

HCD recently posted its first appeal decision, in which it overturned an EZ’s denial of an application based on a one-day discrepancy between the employee’s date of hire on the voucher application and the employer’s federal employment eligibility form, Form I-9.

By Laura Mahoney

Below I am reprinting the fine article written by Laura Mahoney of BNA regarding the status of the Dicon v. FTB case I discussed earlier. The article appeared in BNA’s “Daily Tax Report” on 11/1/2007 and was titled “Taxpayer Appeals Dismissal of Suit Challenging FTB’s Tax Credit Voucher Policy.”

Reproduced with permission from Daily Tax Report, No. 211 (Nov. 1, 2007) pp. K-2 - K-3. Copyright 2007 by The Bureau of National Affairs, Inc. (800-372-1033) (http://www.bna.com)

SACRAMENTO, Calif.–A corporate taxpayer Oct. 23 appealed a trial court judge’s decision to dismiss its case against the Franchise Tax Board in which the company claims the board does not have the authority to audit tax credit vouchers it received from local government agencies for hiring workers in designated enterprise zones (Dicon Fiberoptics Inc. v. Franchise Tax Board, Cal. Ct. App., No. B202997, notice of appeal filed 10/23/07).

In a case of first impression, Los Angeles County Superior Court Judge Mel Red Recana Oct. 3 formally dismissed the lawsuit filed by Dicon Fiberoptics Inc. almost two months after sustaining FTB’s demurrer to the company’s complaint.

The company’s appeal makes it the lead case challenging a 2003 change in FTB policy through which the agency is auditing 500 taxpayers and expects to deny about $1 billion in claimed EZ hiring credits.

In sustaining FTB’s demurrer Aug. 17, Recana said he agreed with FTB’s argument that it may, under the Revenue and Taxation Code, “for purposes of administering its duties, including ascertaining the correctness of any return, demand taxpayers to provide information or make available for examination or copying any books, papers, or other data which may be relevant to that purpose.”

Dispute Over Documentation, Scope of Authority

The judge agreed with FTB, which argued that Dicon failed to state a cause of action because the board is not required by law to accept the EZ hiring credit vouchers, issued by local vouchering agencies, and has the authority to require Dicon to provide documentation to support the $1.1 million in claimed credits before allowing them.

Dicon, based in Richmond, Calif., argued that state law giving local agencies the authority to issue the EZ hiring credit vouchers requires only that the taxpayer receiving the voucher provide a copy to FTB. The agency exceeded its authority when it demanded documentation that Dicon was not required to keep once it received the voucher from the local agency, and that was outside Dicon’s possession, custody, and control, according to the company.

Recana rejected Dicon’s argument, saying FTB properly denied the credits after the company did not provide documentation it requested.

At a hearing on the case in August before he sustained the demurrer, Recana suggested to lawyers for FTB and Dicon that they take the case to the Court of Appeal because it is the lead case on the issue. “What’s important is that we have good guidance from the court of appeal,” Recana said, according to a court transcript of the hearing.

Dicon filed its appeal Oct. 23 in the California Court of Appeal, Second District, in Los Angeles. Marty Dakessian, an attorney in Glendale, Calif., representing Dicon, declined to comment to BNA Oct. 31 on the case except to say he disagrees with Recana’s dismissal.

Other Voucher Cases

A spokeswoman for FTB also declined to comment because the case is pending.

Dicon filed its lawsuit in May, five months after the State Board of Equalization issued a formal opinion in a dispute between FTB and Deluxe Corp. on the same issue of whether FTB can examine EZ hiring credit vouchers. SBOE ruled in favor of FTB, saying both tax agencies have the authority to “look behind” the vouchers issued by local agencies (243 DTR H-2, 12/19/06 ). Dakessian represented Deluxe in that case.

Deluxe Corp. also has filed a lawsuit in state trial court challenging FTB’s ruling in that case (Deluxe Corp. v. California Franchise Tax Board, No. CGC 07-462305). A trial is scheduled for April 21, 2008. Deluxe is represented by Amy Silverstein and Edwin Antolin of Silverstein & Pomerantz in San Francisco.

The Deluxe case was the first to reach SBOE on appeal as a result of a change in FTB policy in 2003. From 1994 until 2003, FTB issued EZ tax credits without questioning the vouchers. But the agency changed its policy after a 2003 state audit of the Oakland EZ showed that many hiring credit vouchers may have been issued improperly.

As a result, FTB has audited or is in the process of auditing more than 500 taxpayers on the question of the EZ hiring credit, and expects to deny about $1 billion in credits.

Several other cases have reached SBOE on appeal, and the board ruled most recently in August and September in two other cases involving different enterprise zones credit issues (158 DTR H-1, 8/16/07 ; 181 DTR H-3, 9/19/07 ).

By Laura Mahoney

The FTB “Tax News” publication we had been anticipating since Oct. 31 has just been published to the FTB website. It contains this information about the implications of the Jessica McClintock appeal at BOE:

An employer who meets certain requirements may claim an enterprise zone hiring credit. (See R&TC Sections 17053.74 and 23622.7.) One of these requirements is that the employer hires a “qualified employee.” An individual who is eligible for the Job Training Partnership Act (JTPA) public assistance program may be considered a “qualified employee” for purposes of the enterprise zone hiring credit. The JTPA, which expired June 30, 2000, provided training and job placement assistance for qualified individuals who faced significant barriers to employment and suffered an economic disadvantage. The JTPA program also provided that 10 percent of its funds could be used to enroll individuals into the JTPA program if they suffered a barrier to employment but had no corresponding economic disadvantage.

On August 14, 2007, the Board of Equalization held in an unpublished decision, Appeal of Jessica McClintock, that individuals who had a documented barrier as defined under the JTPA 10 percent exception category could be considered qualified employees for purposes of the enterprise zone hiring credit. Accordingly, vouchers issued for employees hired on or before June 30, 2000, under this eligibility category with a documented employment barrier will be accepted as valid vouchers.

The following barriers to employment were recognized under the JTPA Program.

* Addict.
* Alcoholic.
* Basic skills deficient.
* Cash welfare recipient.
* Disabled individuals.
* Displaced homemaker.
* Homeless.
* Limited English language proficiency.
* Offender.
* Older worker.
* Pregnant/parenting youth.
* School dropout.
* Veteran.

The requirements of each of these barriers are set forth within the JTPA statutes and regulations including common documentation used to verify these barriers.

“Tax News” also includes a detailed explanation of how to understand the implications of AB 1550 with regard to the new Enterprise Zones.

CAEZ was lucky enough to have Jeanne Harriman of the FTB available throughout their recent conference. As far as Enterprise Zones go, she’s the closest thing we have to a rock star. The following are some highlights:

1. In September, the Board of Equalization heard the appeal of Taiheiyo Cement and found in favor of the FTB. An official ruling will be issued in the near future. The case dealt with EZ Sales or Use credit and the correct application of “placed in service.” Listen to the audio of the hearing by clicking that little, blue “play” button.
2. FTB will issue a “Tax News” article on October 31 discussing the ramifications of the BOE decision in the Jessica McClintock appeal (see earlier blog posts here and here).
3. Currently pending with the BOE is the appeal of URS Corp. which will deal with documentation requirements for dislocated worker vouchers.
4. Also pending at BOE is an Enterprise Zone Net Interest Deduction case involving Farmers & Merchants Bank.
5. The Economic Development Areas Manual sections on Enterprise Zone will be updated by December.
6. Regarding the 8886 issue, Jeanne conceded, based on arguments previously made here, that it would have been better had they simply asked taxpayers to mail the forms to a P.O. Box rather than to the aggressively frightening Abusive Tax Shelter Unit. However, even though making Enterprise Zone credits an exception seems to be under consideration, it doesn’t sound likely that will happen this year.

One of the updates we received from FTB at the recent CAEZ Conference was that the case of Dicon Fiberoptics Inc. v. FTB (discussed previously here, here and here) was dismissed by the Los Angeles County Superior Court Judge on October 3, 2007. On October 11th Dicon notified the court that they would appeal to the Court of Appeal, Second Appellate District. Attached to that notice is a transcript of the hearing held in Superior Court on August 6th.

The whole transcript is very interesting and neatly summarizes the basic argument for both the Dicon case as well as the Deluxe case that the FTB does not have the statutory authority to override an Enterprise Zone hiring tax credit voucher once issued by a local agency. I’ll reproduce part of the transcript here to show the Court’s reaction to FTB’s argument as well as the judge’s recommendation that this case be sent up to the Court of Appeals (Mr. Freeman is the counsel for Dicon Fiberoptics and Mr. Richelson is the counsel for FTB):

The Court: Okay. Now, how was the statute worded? Why you arrived at this conclusion that they, the local agency, has the final word?

Mr. Freeman: It’s because — the revenue and tax code 23622.7, subpart (c) says that the taxpayer’s required to do the following: “To obtain from,” — and it lists a number of agencies that it’s supposed to obtain a certification from, including — it says, “obtain from the EDD, as permitted by federal law, the local county or city” agencies responsible for the administration of various programs a certification that provides that a qualified employee meets the eligibility requirements specified above in the statute. And the second requirement is that the taxpayer retain a copy of the certification and provide it upon request to the Franchise Tax Board. The only requirement of the taxpayer is to get a certification and to submit it. The only agency that is authorized to make a determination as to whether the employee is qualified are the agencies that are listed. There are a number of local agencies that are listed in that paragraph. It doesn’t say that the Franchise Tax Board can trump their local agency’s decision, which is what would happen if they were able to exercise review over a highly discretionary decision. And that’s also critically important because the legislation was changed in 1994. It used to be that the decision as to whether an employee was qualified was a very black and white test. Either the employee was a participant in certain listed programs or the employee was not listed. The employee was — if the employee was not a participant in the listed programs, the employee would not be — would not be qualified. In 94, the legislature broadened the standard and said the employee doesn’t have to actually be a participant. The employee needs to be eligible for participation. And these local agencies who can certify have the expertise to applying the discretionary standards as to whether the employee is eligible. That involves things like is it likely that this employee would get a job within the area from another employer if his employer–

The Court: What are these local agencies?

Mr. Freeman: well, there are a number of them. And these are basically the local agencies that are responsible for all of these jobs programs and related programs. For instance, I’ll read it to you to give you some idea.

The Court: Yes.

Mr. Freeman: (reading) “Obtain from the Employment Development Department” — that’s the State Department — “as permitted by federal law, the local, county or city Job Training Partnership Act administrative entity, the local GAIN Office or Social Services Agency, or the local government administering the enterprise zone, a certification that provides that a qualified employee meets the eligibility requirements…” So the idea is that you have a number of local agencies who are responsible for administering these programs. They’re the ones with the expertise as to whether somebody meets the requirements for those programs.

The Court: I understand. I’ve read the pleadings. You’re saying their word is the final word.

Mr. Freeman: their word is the final word. And it’s just basically applying the expressio unius. If this was subject to de novo review, if the discretionary determination was subject to that kind of review by the Franchise Tax Board, there would be an indication of it in the statute. It would be simple to do. Instead, the statute expressly delegates to these non-taxing authorities the decision.

The court: But I thought that the legislature should have said, “And we’re aware that the FTB is the taxing authority. However, we have now given the full power or the authority to make this determination and such determination is not subject to review.” But I think that’s not — that is absent from the statute.

Mr. Freeman: Well, two things. One, the carve-out for the local agencies is narrow. It is simply to determine whether a voucher — it’s to certify that the employees are qualified. There could be objective reasons for denying the tax credit, such as the FTB does an audit and determines that the business is not located within the proper confines of the enterprise zone. But making that key decision, it’s an express delegation.

The Court: Okay.

Mr. Freeman: There’s no need to – there’s no need to say — to expressly say, “We delegate authority — we, the legislature, delegate authority to the local agencies.”

The Court: So I take it that the key to this issue really is for the court to make that determination.

Mr. Freeman: Yes.

The Court: Okay. Can I hear – I’m sorry, folks. I have a jury trial at 9:45, so I have to — go ahead, please. Now we are hearing from the Attorney General.

Mr. Richelson: First, I’ll answer the court’s last question directly. That is the issue. Looked at this way, the plaintiff is asking you to imply in the statute the words that the voucher is conclusive proof to tax credit.

The Court: That’s what I’m hearing.

Mr. Richelson: Right. Then they are asking you to imply that because the statute doesn’t say, “And the Franchise Tax Board can audit you,” that the Board’s general authority is negated by implication. So you have two implications, creating a third implication. If you’re talking about — if we talk about judicial legislation, that seems to be it. You’re asking to imply words which create then implied lack of words to revoke the Board’s specific and important power. I just don’t think that makes it. I just don’t think that gets you there, particularly when the case law is clear, federal and state, that exemptions are strictly construed. and if you strictly construe the exemptions, you’re not going to imply words into the statute and then say, “because of those words, we’re going to imply that the board’s power is taken away.” It just doesn’t follow. Next, your honor, I don’t hear anybody saying that the Board can’t audit for fraud. I mean if the Board can’t audit — if the Board can’t audit for fraud, that’s a third implication that they’re asking you to make. But if the Board can audit for fraud, then it’s clear that the statute is not conclusive proof of the exemption. He also says that this is highly discretionary. But there are many highly discretionary functions that agencies do that can be reviewed by the Court for abuse of discretion. And to the extent that we’re talking about discretion, while some sections may have discretion, some of the findings that the vouchering agency makes is to determine if the qualified employee’s commencement of employment with the taxpayer was a person eligible for services under the Job Training Partnership Act. I don’t see the discretion there. “Immediately preceding the qualified employee’s commencement of employment with the taxpayer was a person eligible to be a voluntary or mandatory registrant under the Greater Avenues for Independence Act.” Don’t think that that’s the kind of discretion plaintiff is trying to have you believe exists.

Mr. Freeman: May I respond, Your Honor?

The Court: He’s not finished

Mr. Freeman: I’m sorry.

Mr. Richelson: And I think we just go back – the one other point, Your Honor, is there are many statutes that require certain things to get an exemption or to get proof of an amount to be included on your tax. In all of those sections, Your Honor, there is no specific statement that says that — talking about an audit one way or the other. When you accept a resale permit for — in lieu of sales tax, it doesn’t say the resale permit can’t be audited. And there is no implication that because it doesn’t say the resale certificate can be audited, that it can’t be audited. I think you just — I think you get back to the Court’s original question. You’re asking to imply the words “conclusive proof,” which then gets you to Plaintiff’s theory that because the words “you can audit” aren’t in the statute, the implication is that the Board’s general authority is negated. I think that’s implication on implication on implication. It doesn’t get you there generally and certainly doesn’t get you there when you strictly construe an exemption.

The Court: I’m going to hear your word, whatever you have to say, but I think — are there going to be future claims for refunds similar to your — what you’re asking now, counsel for the plaintiff?

Mr. Freeman: You mean are there going to be — I’m sorry, similar claims by –

The Court: Yes.

Mr. Freeman: — Other plaintiffs?

The Court: Right.

Mr. Freeman: Well, I assume that this would be a precedent — this case is dealing with an issue of statutory interpretation.

The Court: Right, that’s why I was thinking that if you still would like to argue, I’ll listen. But I’ll take this under submission. And maybe, however I go, you should take it up.

Mr. Richelson: I think so, your honor. If I could add a little more to your question.

The Court: Yeah.

Mr. Richelson: It is our understanding this is one of the biggest things before the Board.

The Court: Right.

Mr. Richelson: And that lined up behind — there’s one other case in litigation — we, I think, are the lead case right now — where I had a case in San Francisco.

The Court: This is the lead case.

Mr. Richelson: This is the lead case right now.

The Court: So we’ll take it up however I go.

Mr. Richelson: Right. You can make the law, Your Honor.

The Court: I hope it’s not a reversal on my part. But who cares. What’s important is we have good guidance from the Court of Appeal. Go ahead, sir.

Mr. Freeman: I just want to add a couple things, Your Honor, because I know you’re going to be taking this under submission.

The Court: Yes, sir.

Mr. Freeman: The same provision that I read earlier about what are the local agencies that are going to make this decision, in the same paragraph, that paragraph ends with “The Department of Housing and Community Development shall develop regulations governing the issuance of certificates by local governments pursuant to Government Code 7086.” Now, notice who is issuing the regulations that are guiding the determination about whether an employee is qualified? It’s not the Franchise Tax Board because they don’t have any expertise. It’s the Department of Housing and Community Development. So the notion that a discretionary decision can be made in one stage — you have regulations, you have an express delegation of authority, and then all of a sudden you have the Franchise Tax Board coming in without expertise and saying, “Oh, we want to make our own decision.” And it could be years later. There could be documents that are not available. I also want to point out something that I understand the government could either confirm or deny this, but my understanding is that the practice is that if a voucher — if a certification is rejected at the local level, the FTB will not consider any kind of appeal. Their position is, “That is a decision that is made by the local authorities, and even though you, the taxpayer, claim that you should have gotten a voucher, you should have been certified, we are not going to reconsider a decision denying that made by the local agency.” Well, that implies a certain interpretation of the statute by their conduct, which is that they are not in the business of second-guessing the local agencies.

The Court: Okay.

Mr. Richelson: Thank you, Your Honor.

Mr. Freeman: Thank you, Your Honor.

The Court: Thank you, folks.

(The above proceedings were concluded.)