The California State Court of Appeals agreed with the FTB’s narrow interpretation of Enterprise Zone Sales/Use Tax Credit laws when it sided with the FTB against Taiheiyo Cement U.S.A. this week. Taiheiyo had sued the FTB for nearly $5 million in refunds of taxes, interest and penalties paid as well as declaratory relief. Most importantly, the taxpayer wished for the Court to find that the FTB could not impose on taxpayers its interpretation that only “capitalized assets” were eligible for Enterprise Zone sales/use tax credits.
The fundamental issue debated was whether sales and use tax credits are available for “currently expensed assets”. These items have a useful life of less than one year, as opposed to “capital assets which have a useful life of over one year. Taiheiyo argued that under the plain language of the code, taxpayers should be able to capture a sales and use tax credit for “qualified property, whether expensed or depreciated”. If the property is expensed then that means that the entire cost of the item was expensed in the current year. If it was depreciated, then of course the cost or basis in the asset was spread out over its useful life. Taxpayers argued that since the code allowed for credits on “expensed” property that this included non-capitalized assets, or items purchased that had a useful life of less than one year.
The Appeals court rested its decision on a broader investigation of the legislative history of the law and the reading of the statute in its entirety finding that “qualified property” was what the Internal Revenue Code referred to as “Section 1245 property” which is property that is “placed in service” and has a “basis”, i.e. “capital assets”.
The broader issue is whether or not tax rules that are considered vague, regarding tax credits and deductions should be interpreted against taxpayers. Citing to numerous other opinions, the Court chose to expressly remind taxpayers of the ruling in Krumpotich v. FTB. (1994) 26 Cal.App.4th 1667 that stated “the extent of allowable deductions is dependent exclusively on legislative grace and does not turn upon equitable considerations”. In other words, the taxpayer is reminded that only as a result of the kindness of the legislation, does the taxpayer receive the benefit of a tax credit and with that in mind the “grace” should not be taken advantage of, through an expansive interpretation that favors the taxpayers.
In that regard, the Court found that because the broader legislative guidelines regarding “qualified property” used terms such as “basis” and “placed in service”, which are generally restricted to “capitalized assets” the Court found references to qualified property were therefore meant to mean “capitalized assets”. While the taxpayer argued that the initial language of the statute was clear, the FTB felt that the language of that specific statute required an interpretation that incorporated other sources such as legislative history and references within the Internal Revenue Code. Unfortunately for Taiheiyo, the Court agreed. Although the taxpayer made a compelling argument that “placed in service” was a term that simply referred to the timing of when the property would be used, the Court rejected it on the basis of the connection between these concepts and “capitalized assets”.