BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 5901 Green Valley Circle Culver City, California REPORTER'S TRANSCRIPT APRIL 29, 2009 SALES AND USE TAX APPEALS HEARINGS CLAIM FOR REFUND filed by D. R. SYSTEMS, INC. (Case No. 381450 FH ) Reported by: Beverly D. Toms CSR No. 1662 1 1 2 P R E S E N T 3 4 For the Board Betty T. Yee of Equalization: Chair 5 Judy Chu 6 Vice-Chair 7 Bill Leonard Member 8 Michelle Steel 9 Member 10 Marcy Jo Mandel Appearing for John Chiang 11 State Controller (per Government Code 12 Section 7.9) 13 Diane Olson Chief, Board Proceedings 14 Division 15 For Board of David Levine 16 Equalization Staff: Tax Counsel IV 17 Chris Schutz 18 Tax Counsel 19 Robert Tucker Legal Department 20 Kevin Hanks 21 Sales and Use Tax Department 22 For Petitioner: Scott Savary 23 Attorney at Law 24 Charles Zuckerman Representative 25 26 ---OOO--- 27 28 2 1 Culver City, California 2 April 29, 2009 3 ---oOo--- 4 MS. OLSON: Our next item is C1, D & R 5 Systems, Inc. 6 MS. YEE: Good morning, Mr. Levine. 7 MR. LEVINE: Good morning. Madam Chair, 8 Members, David Levine for the Appeals Division. 9 The issues in this claim of D. R. Systems, Inc. 10 are whether a letter that mentions an overpayment is 11 part of a request for relief of a penalty without asking 12 for a refund constitutes a valid claim, and if so, 13 whether a refund is warranted. 14 MS. YEE: Okay. Very well. Thank you. 15 Good morning, gentlemen. 16 MR. SAVARY: Good morning. 17 MS. YEE: Please introduce yourselves for the 18 record. You have ten minutes for your presentation. 19 MR. SAVARY: Thank you very much, Members of 20 the Board. My name is Scott Savary and I'm here on 21 behalf of D. R. Systems. 22 MS. YEE: Okay. 23 MR. ZUCKERMAN: My name is Charles Zuckerman. 24 I'm the Chief Financial Officer of D. R. Systems. 25 MS. YEE: Great. Thank you. Please proceed. 26 MR. SAVARY: Thank you. I think it would be 27 appropriate to start with a brief history of -- of how 28 we -- how we came here today. And I think everybody is 3 1 up to speed on -- on that history, but I never heard so 2 make sure we're all on the same page. 3 The time frame at issue for -- for our 4 discussion today is the second and third quarters of 5 2002. And the amount of refund claimed for those 6 time -- for those two quarters is $283,410.80. 7 There has been a claim for refund for periods 8 subsequent to the second and third quarter of '02 and 9 those amounts have been allowed and refunded along with 10 a payment of interest. 11 The question -- well, after it was discovered 12 that there was a -- a credit in the third quarter of 13 2004 that credit was applied to a return that was filed 14 by the taxpayer. The amount was essentially disallowed 15 and -- and a penalty was -- was assessed. 16 That fact is of paramount importance to our 17 discussion here and I'll read you the law later, but the 18 fact that that amount was -- was applied to the return 19 and than a penalty was assessed and then later waived 20 is -- is important on the question of notice. 21 One of the prime issues that I'll be dealing 22 with when I discuss the law that's applicable for a 23 claim for refund is whether or not the FTB was on notice 24 of the existence of the claim for refund. i.e., were 25 they aware that there was an amount of money sought by 26 the taxpayer as a result of an overpayment, within the 27 applicable time period. 28 Clearly, as of the third quarter of 2004 the 4 1 FTB was aware that there was an amount claimed by the 2 taxpayer in the amount of $283,000. 3 A penalty was assessed and then the pivotal 4 letter of January 7, 2005 was written wherein it was 5 discussed. The 2005 letter -- everybody I believe has 6 had an opportunity to review that letter -- quite 7 clearly and quite bluntly states in terms that are 8 really not ambiguous that there's a large credit balance 9 due to us from the State for sales tax. When we combine 10 the prior year with the current year, our credit balance 11 changed. In no uncertain terms this letter is saying 12 you, the State, owe me, the taxpayer, money. It could 13 not be more straightforward. It could not be ambiguous 14 in any way, shape or form. 15 In order to properly apply the facts which I 16 don't really believe are disputed here that, a, there 17 was a credit taken, the credit was disallowed, a penalty 18 was assessed and then a subsequent letter was written to 19 the State asking for acknowledgement of the fact that 20 money was indeed owed to the taxpayer; one then needs to 21 look at the law. 22 The position contrary has -- has been that 23 this -- this January 7, '05 letter does not amount to a 24 claim for refund. And I think the analysis that I'm 25 going to go through briefly of -- of the statutes and 26 the case law discusses really what is the purpose of 27 writing a claim for refund. 28 The governing sections that we're going to deal 5 1 with, the Tax Code Section 6904 and then the California 2 Code of Regulations 5232 essentially indicates that in 3 order to make a claim for refund one must write a 4 letter, identify the reporting period, the amount if 5 known, provide your contact info and specify the grounds 6 upon which the claim is founded. 7 Why? Why does the Code require those items? 8 For no other reason than to put the Board on notice of 9 the -- of the request for a claim. Not Board, I'm 10 sorry, the FTB on notice of -- of the claim. 11 The Preston case, which I'm sure the Board is 12 familiar with, cites to the case of Whorten versus the 13 Franchise Tax Board, 68 Cal. App. 4th, 961, 977, for 14 that very premise. That the whole point of this statute 15 is to make sure the FTB is on notice of the existence of 16 this claim. To suggest that these two distinct events, 17 this January '05 letter and the taking of the credit in 18 the third quarter of '04 combined with the subsequent 19 review, the waiver of penalty for the taking of the 20 credit of the third quarter of 2004, did not amount to 21 sufficient notice on the part of the FTB is a -- a 22 disingenuous interpretation of both the facts and the 23 law and would suggest -- it would be hard to swallow the 24 FTB to suggest that they were unaware of the existence 25 of the credit at that point. 26 The Preston case, as I alluded to earlier, 25 27 California 4th, 197 discusses the obligation to 28 interpret a claim for refund broadly. The language that 6 1 I think is most telling in Preston is the language that 2 indicates that unstated contentions clearly implied from 3 contentions expressly raised in a claim for refund are 4 sufficiently stated. 5 In this situation what you have is a letter 6 referencing a credit. It's expressly stated in this 7 letter you, the FTB, or you, the State, owe me, the 8 taxpayer, money. And then there's a discussion about 9 the fact that two or three months earlier a credit had 10 been asked for. 11 That implied contention that that $283,000 12 credit had been previously sought is precisely what 13 Preston allows. There's a specific demand or specific 14 statement that the taxpayer is owed money by the State. 15 And then there's a reference to additional information 16 that's already in the possession of the State indicating 17 that, yes, we have known about this -- this request for 18 a credit. 19 The additional language in Preston indicates 20 that where contentions are intertwined with the 21 contentions expressly raised, they may be considered. 22 In this situation you cannot separate what happened in 23 the third quarter of '04 from what happened in January 7 24 of '05 when this letter was written. They're -- they're 25 inseparable. And once the Franchise Tax Board realizes 26 that they have an issue, a claim, a credit that's owed 27 to the taxpayer, they are on notice of the claim for 28 refund and the issue that we're here for today really 7 1 becomes -- it becomes a non-issue. 2 The suggestion to the contrary, that this was 3 simply a waiver -- a request for a waiver of penalties, 4 there's no authority to suggest that it cannot be a 5 waiver -- a claimed waiver and a request for a refund at 6 the same time. There's no indication that this letter 7 does not represent both of those. 8 There is a language in -- in the middle of this 9 saying that the taxpayer appreciates the consideration 10 of the State in waiving penalties and interest. That's 11 five or six words out of the entire letter. 12 It's my understanding that the penalty waiver 13 generally requires the use of a -- a form. This was 14 submitted in the form of a letter. 15 I think the next -- next question that's -- 16 that's going to be raised is the -- the sufficiency of 17 the notice in Exhibit A, in the January 7, '05 letter. 18 And I -- and I put in my brief, and I'm sure the Board 19 Members have had an opportunity to review this, that 20 what constitutes specificity or sufficient specificity 21 is not defined in the statute. It's not defined in the 22 regulations, and it's not defined in -- in the tax code, 23 in 6904. 24 And because it is not defined, what constitutes 25 sufficient specificity, because that's not defined, it 26 creates an ambiguity. It is not clear from a reading of 27 the statue what constitutes specificity. 28 It doesn't say that you have to do A, B, C and 8 1 D. It just says specify the grounds. 2 The grounds here are quite clear. There was a 3 problem back in '02. There was an individual who was a 4 prior controller, not Mr. Zuckerman, who didn't do her 5 job very well. An audit was run and had been run 6 through this period of time, through 2004, and these 7 errors discovered. Now the credit balance is due and 8 owing. 9 This is argued -- 10 MS. OLSON: Time has expired. 11 MR. SAVARY: Oh. 12 MS. YEE: Please, finish your thought. 13 MR. SAVARY: My last thought was that the -- 14 the case law I cited, which is the Edison California 15 Stores versus McCauligan (phonetic), 30 Cal. 2d at 476, 16 stands for the proposition that any ambiguity in the 17 statutes, in the Tax Code, needs to be resolved against 18 the State, in the favor of the taxpayer. 19 What constitutes sufficient specificity in this 20 situation is ambiguous. And that's -- that was the 21 point I wanted to make. 22 MS. YEE: Okay. 23 MR. SAVARY: I appreciate you giving me extra 24 time for that. 25 MS. YEE: All right. Before I go to the 26 Department, I presume that your references to the 27 Franchise Tax Board were -- 28 MR. SAVARY: State Tax Board. 9 1 MS. YEE: -- really -- 2 MR. SAVARY: State Board of Equalization. 3 MS. YEE: Equalization. Okay. Thank you. 4 MR. SAVARY: I -- I apologize. 5 MS. YEE: Okay. Department. 6 MR. SCHUTZ: Madam Chair and Members of the 7 Board, I'm Chris Schutz from the Legal Department. 8 To my right is Bob Tucker also from the Legal 9 Department. And to his right is Kevin Hanks from the 10 Sales and Use Tax Department. We will be representing 11 the Department today. 12 Here the claim for refund for second quarter 13 and third quarter 2003 should be denied because for 14 these periods claimant did not file a timely claim for 15 refund. 16 Specifically, as applicable here, under Rev. 17 and Tax Code 6902 a claim for refund cannot be granted 18 unless a claim is filed with the Board within three 19 years from the last day of the month following the close 20 of the quarterly period for which overpayment was made. 21 This means that absent a waiver of limitations 22 in place by claimant, claimant would have needed to file 23 a claim for refund before the end of October 2005. 24 Here claimant filed a claim for refund on May 12, 2006 25 which claimant concedes was not timely for second 26 quarter and third quarter 2002. The failure to file a 27 timely claim for refund constitutes a waiver of any 28 demand against the Board on account of overpayment. 10 1 Instead, as you heard from claimant, he's claiming that 2 a letter sent on January 7, 2005, which requested 3 abatement of a penalty applied for failing to make a 4 prepayment for third quarter 2004 was also a claim for 5 refund that covered second, third quarter 2002. 6 I note that a claim for refund at a minimum 7 must be in writing and must state the specific grounds 8 upon which the claim is founded. 9 This January 7, 2005 letter does not meet the 10 standard and thus does not constitute a claim for 11 refund. Because it does not state specific grounds upon 12 which it is founded and it does not provide even the 13 minimum amount of information necessary to put the Board 14 on notice that claimant was requesting a claim for 15 refund. 16 Specifically it states, "During the current 17 year we have been performing a self audit of revenue and 18 sales tax. We reviewed the books from 2000 -- second 19 quarter -- 2001 through 2003. During July 2004 we 20 showed a large credit balance due to us from the State 21 for sales tax. When we combined the prior year with the 22 current year our credit balance changed. We are 23 currently completely reconciled and have backup to show 24 the process we went through to clean up our books and 25 records." 26 From there the letter goes on to request that a 27 prepayment penalty and interest be waived and stated 28 that -- stating the actual sales during the first 11 1 prepayment period, July 2004, which was $19,000 -- a 2 little bit more than $19,000. 3 Thus the letter merely states that the claimant 4 had a credit balance for a prepayment period but that 5 balance changed and now it's reconciled. Thus nothing 6 in the letter is expressing that a refund is due 7 claimant. Additionally, on the third quarter 2004 8 return, which I've provided a copy of, claimant does not 9 show that he's due a credit for any past periods, but 10 instead shows that it owed an additional $94,000 in tax, 11 which it paid on October 27, 2004 timely and that it 12 made a prepayment, which it did, of $53,000. 13 Accordingly, the January 7, 2005 letter cannot 14 be construed as a claim for refund for the second and 15 third quarter of 2002, and the claim for refund should 16 be denied. 17 I have just a couple quick notes with regard to 18 claimant's statement. First, claimant says that, well, 19 that -- that letter is for 28 -- $283,000 of 20 overpayment. But at the most it would have been the 21 $19,000 that it didn't make the prepayment for that it 22 says it should have made a prepayment for for July. So 23 the entire amount that that could even have been 24 considered a claim for refund for was only $19,000. 25 And additionally, if -- if claimant is saying 26 that it considered when a penalty was assessed that its 27 claim for refund was disallowed, it didn't follow up 28 for -- for over a year on that, you would have thought 12 1 that if it thought it was a claim for refund that was 2 being disallowed it would have immediately had followed 3 up and said, "Well, why did you disallow my claim for 4 refund?" 5 But this -- this issue didn't come up again. 6 In fact, it paid the interest that was assessed because 7 it was a failure to file a prepayment. It paid the $300 8 in interest that was assessed on that and this issue 9 didn't come up again until the end of 2005. So, over a 10 year later. 11 With that, if you have any questions I'd be 12 happy to answer them. 13 MS. YEE: Okay. Thank you -- thank you very 14 much. You have five minutes on rebuttal. 15 MR. ZUCKERMAN: Can I respond to him -- 16 MS. YEE: Please, Mr. Zuckerman. 17 MR. ZUCKERMAN: -- personally? 18 First off, when you're reconciling accounts and 19 you have a credit balance there's a large amount of 20 money in there. If it has a credit balance it's not 21 zero. So it's not equal. 22 Secondly, when he's referring to the return, in 23 the body of a return the credit was in the return 24 reducing a total amount that was due to the State. So, 25 it was in the return and spread out among the various 26 districts. So it was taken in that return, this credit 27 balance that -- that would eventually bring our books 28 back to zero or in balance without a credit balance. 13 1 So, it was taken in the 2004 return. When the auditor 2 showed up to audit all the prior returns he disallowed 3 that whole refund at that time. 4 So, I think it's disingenuous for him to say 5 that since he wasn't the auditor, he wasn't the person 6 that came and he doesn't know all the facts that were in 7 that return and the total amount of the credit that was 8 taken and then disallowed at the time of the audit. 9 MS. YEE: Okay. Mr. Savary. 10 MR. SAVARY: Thank you. I think the -- I think 11 we need to focus on -- on what the requirement is for a 12 claim of refund and whether or not those -- those -- 13 those basic requirements were met here. 14 It's -- it's clear that each of the elements 15 for the claim for refund have been met. What happened 16 after, you know, that's -- there's a subsequent audit 17 done and the information that is solicited then results 18 in a -- a large refund to the taxpayer. 19 This is clearly a -- a claim for refund. It 20 basically says, "You owe us money," and I don't know how 21 much more blunt it could be. There's a credit balance 22 due to us. What more would this Board want? If 23 somebody owes you money, you say, "Hey, you owe me 24 money." Oop, you didn't say the word "refund", is 25 that -- is that what we're down to here? Are we 26 splitting hairs on language about whether the word 27 "refund" or the word "credit balance due to us from the 28 State" is present? Is that really the purpose of the 14 1 statute? 2 No. The purpose of the statute is to create 3 notice. And once notice is created, and you can use the 4 contents of the specific refund claim and anything that 5 can be interpreted -- anything that's intertwined with 6 the letter itself. 7 So, yes, you can reference the returns from 8 '04. And at that point notice is established, and to 9 suggest that there was not notice of a large credit 10 balance due in the amount of $283,000 as of January 7, 11 2005 is just -- it's just not the case. 12 So if there's any questions I'd be happy to -- 13 MS. YEE: Thank you very much. Ms. Steel. 14 MS. STEEL: To -- to BOE, that how can they 15 make more clear on the letter that they -- that we show 16 the large credit balance due to us from the State for 17 sales tax? They made it very clear there, that's the 18 first thing. 19 And second thing is when they filed the tax 20 return they deducted for less taxpayer -- estimate tax 21 for $53,000. And on BOE procedure when they deduct that 22 amount then you are not sure that we supposed to follow 23 up with phone calls to the taxpayers. 24 So what was going on there, that when they 25 deducted the $53,000 for estimated tax? 26 MR. SCHUTZ: That was a prepayment that they 27 made -- 28 MS. STEEL: Right. 15 1 MR. SCHUTZ: -- that went against the total tax 2 for that quarter. So it was -- they paid and it was -- 3 it was actually the second prepayment of $53,000 that 4 they made, that was deducted from the -- the quarterly 5 amount that they ultimately ended up owing. 6 So, that was something that we accepted, they 7 made a payment. 8 MS. STEEL: Was it a prepayment or was that you 9 were deducting that from the over tax payment? 10 MR. ZUCKERMAN: It was -- that payment was a 11 prepayment taking into consideration the credit balance. 12 So, the amount of tax owed was -- was a lot more. In 13 other words, if -- if we didn't take the credit -- if we 14 didn't take the credit on that return we would have of 15 been prepaying a lot more than $53,000. We would have 16 been -- 17 MR. SCHUTZ: Yeah, when -- when they had to 18 file their -- their quarterly return by October they 19 would have had to pay S147,000 at that time instead of 20 the 94,000 that they did pay. We require taxpayers that 21 generate over a certain amount of sales tax to make 22 prepayments. 23 MS. STEEL: So they paid only $53,000 instead 24 of that they supposed to pay over $90,000? 25 MR. SCHUTZ: They made a prepayment of $53,000 26 and then when they filed their quarterly return they 27 paid $94,000. So, they did pay the whole -- total 28 amount that they stated they owed on their third quarter 16 1 2004 return. 2 What the claimant is saying is that -- and what 3 claimant didn't do initially was they needed to make two 4 prepayments. They only made one prepayment. We applied 5 a penalty -- they were supposed to really make a 6 prepayment for the -- the first period, which is the 7 July 2004. They didn't do so, and we applied a penalty. 8 They said, "Well, we only -- we should have 9 made a payment for $19,000. We didn't do so. We abated 10 the penalty but just applied credit interest. And that 11 was the purpose of the letter, is to request abatement 12 for not timely making a prepayment. 13 MS. STEEL: Okay. Then let's go back to the 14 letter. How can you -- taxpayers can make it very clear 15 there they have to write a refund or -- 16 MR. SCHUTZ: Well, it says during July 2004, 17 which was the first prepayment period, -- 18 MS. STEEL: Right. 19 MR. SCHUTZ: -- they said we had a large 20 credit. But when we -- we reconciled it and we didn't 21 have a -- well, then the credit changed, without saying 22 well, what that credit amount was, if it was even a 23 credit amount, it -- it almost looks like it ended up 24 maybe they had a -- a credit amount for -- 25 MS. STEEL: You just assume that it looks like. 26 MR. SCHUTZ: -- for July for 2000 --- 27 MS. STEEL: You have to check it. Right? On 28 BOE. 17 1 Mr. Tucker, it seems like you had a lot of 2 questions to him so, you know, you were writing there. 3 So -- 4 MR. TUCKER: One of the things that concerns me 5 is that he made the statement that they took self help 6 on a subsequent return. If they took self help on a 7 subsequent return -- 8 MS. STEEL: What does that mean, exactly? 9 MR. TUCKER: It means what he said is on a 10 later return he took an amount that he believed that 11 credit was and adjusted his return to take into account 12 the credit that he thought he was due. He didn't -- he 13 didn't specifically say, "This is a credit that I'm 14 owed," he -- it appears from what he said that he 15 adjusted it into a return either using some other 16 claimed non-taxable transaction. 17 MR. SCHUTZ: Right. 18 MR. TUCKER: If he did that, then this wasn't 19 intended as a claim for refund because if it had been 20 intended as a claim for refund you would have gotten it 21 twice. And I don't think that's what he intended to do. 22 MS. STEEL: How they got -- how they can get 23 twice? 24 MR. TUCKER: Well, because he already took it 25 by adjusting a return and reconciling -- as he refers to 26 it, reconciling for the credit without explicitly 27 stating that on your return. 28 MS. STEEL: Because they knew that they 18 1 overpaid it. 2 MR. TUCKER: Right. 3 MS. STEEL: That's why they were doing it. 4 MR. TUCKER: Exactly. So, he did that on that 5 return without letting the BOE know because it was 6 claimed that some other -- 7 MS. STEEL: But when BOE was not sure that you 8 guys always contact taxpayer, is that why this -- 9 MR. SCHUTZ: How we would have done it is on 10 his return he claimed ten million in gross sales. And 11 he claimed eight million in non-taxable sales. If you 12 look at page 2 of the return it's -- it's claimed as 13 interstate and foreign commerce sales. 14 Now, he would have had to either lower his 15 gross from -- from a different amount, to lower it to 16 ten million, which we wouldn't have been able to tell 17 from the return, itself, or claimed more -- the credit 18 as interstate commerce sales, which we wouldn't have 19 been able to tell from the return, itself. 20 Now, what -- what Mr. Tucker is saying -- 21 MS. STEEL: You are -- just -- let's just go 22 back. So you don't have any papers that we don't have 23 any extra documents that you can explain that why? 24 MR. SCHUTZ: Not for gross -- for gross 25 receipts. I mean, this is their -- what they're 26 reporting as gross receipts with -- is a specific -- 27 their total sales. And the eight million is -- is an -- 28 interstate commerce sales. 19 1 If we had questions for -- about this when we 2 audited them, certainly we would go back and look at the 3 records at that point. But on just a return we don't 4 require them to -- to provide all their bills of lading 5 to -- to prove up all their interstate and foreign 6 commerce sales. 7 So we don't have anything additional. What -- 8 what Mr. Tucker is saying is if -- if -- if taxpayer is 9 saying, well, we took it either by -- by reducing our 10 gross receipts or increasing our claimed interstate 11 commerce sales, and then we sent this letter in asking 12 for a refund, they would have gotten the refund twice. 13 One, because we didn't know about it until it would have 14 been audited and then, two, on this refund letter. 15 That's what -- what Mr. Tucker is saying, that -- that 16 it's almost like if -- if what taxpayer is saying is 17 true then it would be like claiming the refund twice. 18 MR. ZUCKERMAN: The requirement -- 19 MS. YEE: Hold on one second. I'll let you 20 respond. Ms. Steel. 21 MS. STEEL: Could you respond that, because how 22 can you claiming twice? 23 MR. ZUCKERMAN: I'm not -- 24 MS. STEEL: I'm not really clear about. 25 MR. ZUCKERMAN: I'm not requesting a -- a 26 refund twice. I'm in the process of trying to reconcile 27 prior years. And as you reconcile one year the credit 28 balance will change. And as you do the first year you 20 1 can get to the second year. And when you're doing the 2 second year the balance is going to change again. 3 So, there's no requirement to -- to -- to say 4 how much of a refund or what the credit is. You just 5 have to notify that there's a credit or a refund out 6 there and hopefully at some time in the future you can 7 figure out what that dollar amount is. 8 And there's no dispute about what the dollar 9 amount is. We're arguing about whether a credit 10 balance -- 11 MS. STEEL: That letter -- 12 MR. SCHUTZ: -- is a refund or not. No one is 13 trying to take money from them. We're -- we're 14 collecting money for the State and we're giving that 15 money to the State. 16 We shouldn't be obligated to give the State 17 more money than what we collected from the customers in 18 California. 19 MS. STEEL: I agree. 20 MR. ZUCKERMAN: And no one is paying us to 21 collect that money for the State. 22 MS. YEE: Okay. And I think from Ms. Steel's 23 questions what -- what's clear is that the -- what's 24 reflected on the return falls short of trying to 25 reconcile the -- what 283,000 that's in the -- that's 26 the total of the claimed -- 27 MR. ZUCKERMAN: That's correct. 28 MS. YEE: -- overpayment. So -- 21 1 MR. ZUCKERMAN: There's obviously a lot going 2 on with the -- 3 MS. YEE: Yeah. 4 MR. ZUCKERMAN: -- corporation at this time -- 5 MS. YEE: Okay. 6 MR. ZUCKERMAN: -- and there's a lot of 7 reconciliations going on. The prior controller 8 embezzled. There's five years of stuff to clean up and, 9 you know, I only arrive in January of '05. 10 So I'm -- excuse me, January of '04. 11 MS. YEE: Okay. No. But -- but I -- I think 12 just for both sides, I mean the -- the return is not 13 going to be kind of dispositive of -- of how to account 14 for the entire amount of the -- 15 MR. ZUCKERMAN: That's correct. 16 MS. YEE: -- the over-payment. 17 I guess a question to follow up on Ms. Steel's 18 question, where is it laid out in terms of what the 19 specific requirements are for a claim for refund? 20 MR. SCHUTZ: In 6904, which I -- I quoted, it 21 says that it must be -- a claim must be in writing and 22 must state the specific grounds upon which the claim is 23 founded. 24 We also have in our rules for tax appeals 25 Regulation 5232, explaining the general contents for a 26 claim for refund. I'd be happy to read that to you. 27 MS. YEE: Okay. And -- 28 MR. ZUCKERMAN: Can I respond to that? 22 1 MS. YEE: Briefly, because I want -- 2 MR. ZUCKERMAN: I'll be very brief, trust me. 3 So, this letter is in writing. Okay. 4 MS. YEE: Yes. 5 MR. ZUCKERMAN: And it says the grounds are 6 prior audits for prior years 2001 and 2003. 7 MS. YEE: Okay. But I think it does fall short 8 with respect to -- I mean, grounds to me suggests 9 further information about the reasons for why the 10 overpayments kind of are there. So, it -- I mean, if 11 you look at the return then you look at the letter, it 12 still doesn't try to -- it doesn't -- together don't 13 even try to tie everything together in whole. 14 But, anyway, I think both are deficient. 15 Mr. Leonard. 16 MR. LEONARD: Thank you, Madam Chair. To the 17 Department, you -- you make a good case that in this 18 kind of overlap of timing between this letter and the 19 return that applied credits that if they'd been 20 processed independently the possibility of a -- of a 21 double refund, a credit and a refund of the same dollars 22 could have occurred. 23 At the same time, the situation we're in now is 24 that you're benefiting twice. You're getting to keep 25 money that you don't deserve. 26 And I don't like that result as much as I don't 27 like the other result. So, it -- you're telling -- I'm 28 wrong? 23 1 MR. HANKS: Actually, I would -- I would 2 add that -- 3 MR. LEONARD: How am I wrong? 4 MR. HANKS: I would add that the amounts 5 actually that -- that the Petitioner is indicating that 6 they over-reported are amount of sales tax reimbursement 7 that they've collected from their customers. 8 MR. LEONARD: Right. 9 MR. HANKS: So, to the extent that tax 10 reimbursement has been collected and -- and paid to us, 11 those were amounts that they had collected from their 12 customers that -- 13 MR. LEONARD: Right. 14 MR. HANKS: -- then were -- were paid to us. 15 MR. LEONARD: And -- and to the extent that 16 they're exempt and the customer deserves a refund we're 17 keeping the money. We're not allowing that to happen. 18 So, let me -- I thought the dollars were not in 19 dispute. It's -- it's more the technical timing of when 20 they should have been asked for. 21 MR. SCHUTZ: As a -- as a clarification, the 22 amount that was claimed is not in dispute, but we would 23 still need to go and verify -- 24 MR. LEONARD: Oh, absolutely. Which is my -- 25 my next question. This letter is -- is admittedly 26 deficient in terms of an explicit claim for refund. 27 However, it's -- it's a tremendously explicit notice 28 that the taxpayer was claiming some kind of credit 24 1 balance and that should have been an alert to the 2 Department to review the -- the returns referred to, to 3 see what they were you talking about. 4 We should not -- we should not carry credit 5 balances at the State of California. And -- and to the 6 extent that we do and we don't quickly address them, we 7 give rise to encouraging taxpayers under the table to do 8 the self help thing, which I don't know if it's 9 explicitly outlawed yet or -- I know -- I know, Mr. 10 Hanks, you're working with field. In some districts 11 it's okay on audit; in other districts it's totally 12 forbidden. 13 So I'm not sure where we are on the whole self 14 help thing, but if I were reading that letter and 15 processing the penalty waiver on the thing, for them to 16 assert that they had some, you know, six figure credit 17 balance, would have been alert to pull the return and, 18 you know, what are you talking about? Is showing the 19 return a request for information? Are you asking for a 20 refund because you're going to document these 21 out-of-state sales? Or what are you talking about? 22 And it sounds like no action was taken on that 23 paragraph of the 2005 letter at all. 24 MR. HANKS: Mr. Leonard, I -- I shared your 25 concerns when -- when I read the Petitioner's letter and 26 I looked in the file and I noted that actually some 27 correspondence had taken place between the Board and the 28 taxpayer -- 25 1 MR. LEONARD: Okay. 2 MR. HANKS: -- with respect to some overpaid 3 prepayments that they had made previously. And what the 4 Board staff did was recognize the -- the overpayments 5 and suggested that those overpayments be applied to 6 other periods. 7 So those -- those were taken care of. 8 MR. LEONARD: So, the self help idea came from 9 the Department this time? 10 MR. HANKS: Those -- 11 MR. LEONARD: Okay. 12 MR. HANKS: That was taken care of separately 13 but that's -- that's distinct from -- from this 14 situation. 15 Now, when this letter came in, however, and 16 especially when it references this return, our return 17 analysis folks would have looked at this and noted that 18 there isn't a credit reported on -- on this return. The 19 Petitioner is -- taxpayer is reporting -- 20 MR. HANKS: Wouldn't that have triggered a 21 response to that paragraph of the letter, say, "What are 22 you talking about?" 23 MR. HANKS: Not necessarily. What it -- what 24 it did was -- was trigger whether or not they should be 25 relieved of penalties, which is addressed in -- in the 26 content of -- of their letter, which the -- the 27 Department did. But then -- 28 MR. LEONARD: Right, but wasn't -- weren't -- 26 1 wouldn't the basis for relief of penalties be partly 2 based on the fact that there was a -- there was a -- the 3 Department recognized there was a credit balance? 4 I know there's other reasons to relieve 5 penalties, but one big one is I've overpaid. So -- 6 MR. HANKS: No, the issue relative to -- to 7 that penalty was that the Petitioner had made a late 8 prepayment. So they hadn't made an overpayment, so 9 there was no credit that -- that was reported -- 10 MR. LEONARD: I thought they made a -- the 11 Department -- they made a partial prepayment and the 12 Department wanted more. And they believe they made the 13 partial repayment (sic) recognizing there was a credit 14 balance that they -- they could access. 15 MR. SCHUTZ: No, they -- they only made one 16 prepayment. They needed to make two prepayments. The 17 one prepayment they did make was for $53,000. In the 18 letter they say, well, our -- our activity for July, 19 which is the period -- July 2004, which is the period 20 that they needed to make another prepayment was only 21 $19,000. 22 So they're saying, well, we didn't make that 23 $19,000 prepayment; we did make a prepayment of $53,000. 24 And then they did pay the entire amount of 25 liability that was shown on their return. So, there was 26 no credit -- if they would have shown, look, in that 27 prepayment column we're taking, you know, $283,000 as 28 what our -- our credit was due, then that would have 27 1 alerted us. But there was -- 2 MR. LEONARD: But that's my point. The letter 3 refers to a credit balance. That alone should have 4 alerted you to some different perspective of -- of the 5 return. 6 MR. SCHUTZ: I can only say it says in July 7 2004 there was a credit balance, and then there -- and 8 then it was coupled with something else and it was 9 changed. So there's -- there's no clear at the end of 10 it if there was any credit balance or not. 11 If -- clearly, it seems like the taxpayer meant 12 that there was still a credit balance owing, but it was 13 just not clear whether -- 14 MR. LEONARD: If there was a credit balance at 15 one point and there was no refund paid, then a 16 reasonable person would assume that they had undertaken 17 some kind of self help with that credit balance. Or 18 they're asking for a refund. 19 I mean, there's -- there's kind of only two 20 possibilities reading that letter. 21 MR. HANKS: But there isn't a credit balance 22 with respect to that quarter. So there is -- 23 MR. LEONARD: Which would have triggered an 24 inquiry, what are you talking about? 25 MR. HANKS: Well, we -- 26 MR. LEONARD: It seems like there should be 27 more reaction to this letter than -- than just looking 28 at a prepayment penalty and interest issue. 28 1 MR. SAVARY: I think it's important to note 2 that when -- the letter goes on to say, "When you 3 combine the prior year with the current year the credit 4 balance changed." 5 So, it -- it wasn't limited to just that 6 quarter. 7 MR. LEONARD: So it was also alert in the 8 letter that self help was being utilized. 9 MR. HANKS: Well, and to the extent that that 10 was occurring, the Board recognized Petitioner had 11 overpaid certain prepayments previously and that the 12 Board did allow them to apply those prepayments to 13 subsequent quarters' liabilities. 14 MR. LEONARD: So that the person reading that 15 letter then made an assumption that these applications 16 of credit balances to -- to later periods would somehow 17 work out evenly and therefore there was no claim for 18 refund. 19 MR. HANKS: Correct. And they would have -- 20 they would have assumed, and I'm just assuming that this 21 is what they were thinking -- 22 MR. LEONARD: Payment was disallowed on audit, 23 right? 24 MR. SAVARY: That's correct. 25 MR. LEONARD: It was disallowed on audit, so 26 that put -- that put the credit balance back to a 27 positive number and -- for prior periods. I don't know, 28 maybe they're outside of the audit. Maybe that's part 29 1 of the problem. 2 But shouldn't the auditor in their audit notes 3 have said that by disallowing this for this period, I'm 4 recreating a credit balance for prior periods? 5 MR. HANKS: Actually, the audit period did not 6 include this period. 7 MR. LEONARD: I -- I understand that. 8 MR. SCHUTZ: The audit period -- 9 MR. LEONARD: But shouldn't the auditor have 10 noted that? 11 MR. SCHUTZ: What -- what he's saying is -- is 12 that it was disallowed, is that for three -- third 13 quarter 2004 it -- it appears, although it's not clear 14 from the audit, why -- specifically how -- how things 15 were disallowed. Whether or not it was taken from the 16 under-reported -- and what I mean by that is whether or 17 not they under-reported gross receipts for third quarter 18 2004 or they over-reported the amount of non-taxable 19 sales for 2004. There was an amount of, I think, 20 $600,000 in measure that was under-reported for 2004. 21 Whether it was because of, again, non-taxable 22 sales or -- or not reporting the entire amount of gross 23 receipts, but that's something we couldn't have seen 24 from the face of the third quarter 2004 return. 25 MR. LEONARD: But the auditor could have? 26 MR. SCHUTZ: When -- when it was audited, yes, 27 but that was -- that was several years later. 28 MS. YEE: Much later. 30 1 MR. TUCKER: The statute had already expired at 2 that time. 3 MR. SCHUTZ: Yeah, and the statute -- the 4 statute for 2 -- for 2Q '02 -- '02 and 3Q '02 had 5 already expired, by the start of the audit. 6 MR. LEONARD: Did the auditor know that by that 7 decision they were creating a credit balance for a 8 closed period and thereby the State enriching themselves 9 unduly? 10 MR. HANKS: The auditor wouldn't have been 11 mindful of -- of what occurred in -- in those prior 12 periods because that person wouldn't have been looking 13 at -- at those periods. 14 MR. SCHUTZ: Right, that it was disallowing 15 basically self help. 16 MR. LEONARD: But by disallowing self help, you 17 know you have to go back to prior periods. I mean, I -- 18 MR. SCHUTZ: They would have been outside the 19 Statute of Limitations by -- by the point the audit -- 20 MR. LEONARD: I understand that. But the 21 auditor would have known that by disallowing that you 22 were creating a credit balance in prior periods. 23 MR. SCHUTZ: Assuming that he knew that the 24 understatement was because of self help. 25 MR. LEONARD: Yeah, I'm making that assumption. 26 I think that -- it sounds like that should have -- 27 anybody should have been able to figure that out. 28 MR. ZUCKERMAN: Can I -- 31 1 MR. LEONARD: And that the company could have 2 told the auditor that's -- that's exactly what we're 3 doing. 4 I guess, let me ask you. When you -- were you 5 there for this audit? 6 MR. ZUCKERMAN: I was there. Can I -- can I 7 just -- 8 MR. LEONARD: When the disallowance took place 9 did -- did you discuss with the auditor that that 10 recreated a credit balance in prior periods? 11 MR. ZUCKERMAN: I did, and keep in mind that -- 12 that D. R. Systems has been audited a number of times 13 since 1992. 14 MR. LEONARD: Sure. 15 MR. ZUCKERMAN: And the prior audit went from a 16 period to December 31 of 2001. So, the next audit 17 period should have been December 1, 2002 through 18 a period. 19 And so, the reason why the State Board auditor 20 audited 2002 is because that's where it picked up from 21 the prior audit. And that's why the actual dollar 22 amount of the refund is actually known, because the 23 auditor did do the work. 24 MR. LEONARD: Thank you all. I'll stop for a 25 while. 26 MS. YEE: Okay. 27 Mr. Levine, did you have some comment? You've 28 been waiting patiently. 32 1 MR. LEVINE: I don't remember what it was. 2 MS. YEE: Okay. All right. 3 Actually, I have a question for you. What is 4 our current policy relative to self help refunds? 5 MR. LEVINE: You can't do self help. The -- 6 the problem with self help, which is exemplified here, 7 is it's buried in the return. And the return analysis 8 staff cannot check the return for -- for validity of 9 self help because it's buried in information that needs 10 to be audited. 11 Had it been an increase in the claimed 12 prepayment, I'm not sure what the Department does, but I 13 assume, as I think Ms. Steel was getting to, was that 14 the staff would compare the amount shown on the claimed 15 credit with the amount actually paid and that should 16 match. And if it doesn't, that should trigger 17 something -- a further review. 18 But where the claimed prepayment amount matches 19 what was actually paid, that's the one place that can be 20 checked because we have that information. But we don't 21 have -- as the Department was saying, we don't have 22 the -- the gross receipts and we don't have the claimed 23 exemptions, and that's not where the claim belongs. 24 MS. STEEL: But, Mr. Levine, when they were not 25 sure exact amount, how they going to do the tax return 26 with the exact amount, that how much they supposed to 27 get credited the first? 28 And second, the letter say that 2001 to 2003, 33 1 that books from 2001 through 2003 they said large credit 2 balance due. So they already assume that they already 3 asked for the refund at that point. 4 They're letting Board of Equalization knows 5 that, yes, you owe us taxes at that point. 6 MR. LEVINE: Had that really been true in my 7 view we wouldn't have had a -- this letter wouldn't have 8 been sent immediately after the return that -- and I'm 9 not sure I understood, but what I thought Petitioner was 10 saying -- claimant was saying is that it took some or 11 all of the very amount in question here buried in its 12 return. It did the self help and then it's filing this 13 document. 14 And after the fact, again my view -- after the 15 fact saying it was a claim for refund but it thought it 16 had already received the benefit of the credit because 17 it was in the return and it did not know until the 18 audit -- later when the auditor went through, audited 19 and said, oh, this doesn't match. You did self help. 20 You can't do that. 21 It's not until then that claimant realized that 22 it was not going to get the benefit of the credit it 23 claimed by way of its returns. 24 And I think that's what the Department was 25 saying about this letter, how could this be a claim for 26 refund when claimant already thought that it had claimed 27 the refund. 28 The whole point of the claim for refund is to 34 1 actually say, "Give me a refund, and here's why I 2 claimed" -- "I didn't claim all the resales I was 3 entitled to." Or "I didn't claim all the exempt 4 interstate commerce sales I was entitled to." 5 Had -- had the Department understood this to be 6 a claim without that reason my understanding, what I 7 normally see is they write the taxpayer back and say, 8 "I've got your claim for refund but you haven't stated 9 grounds. You need to state grounds. We'll give you" -- 10 I don' know how much time they give, but they say, 11 "Write me another letter and tell me why you think you 12 overpaid tax." 13 MS. STEEL: Right. But we never followed 14 through that. 15 MR. LEONARD: They didn't do that. 16 MR. LEVINE: No, because the Department person 17 who reviewed this didn't see this as a claim for refund. 18 MS. YEE: Right. 19 MR. LEVINE: I assume that's why. 20 MR. HANKS: So that -- that is -- 21 MS. YEE: Mr. Hanks. 22 MR. HANKS: That is accurate. Ms. Steel, I 23 wanted to -- to point out, too, in terms of procedures 24 what happens and what Petitioner was involved in is 25 filing a subsequent claim for refund for a subsequent 26 period. This was in April of 2007. Petitioner writes 27 to us and says, "During the fourth quarter of '06 we 28 self reported Use Tax in error. We charged and paid 35 1 sales tax on an invoice that was for software only, not 2 hardware. Here's the revised return for that quarter. 3 We're requesting a refund of $28,000." 4 That's -- that's typically the -- the form of 5 the claims for refund that are filed with -- with the 6 Board. And then we respond a month later and of course 7 acknowledge that letter and indicate to the Petitioner, 8 "We acknowledge receiving your claim for refund for this 9 period. We're requesting that" -- "that you document 10 the amounts that you've paid in" -- "in error and please 11 provide us with copies of original sales invoices, 12 purchase invoices and associated documentation. 13 So that's the typical correspondence that -- 14 that would have occurred had this been treated as a 15 valid claim for refund. Petitioner would have 16 immediately been written by our Return Analysis section. 17 They would have written them within a month's time. 18 MS. STEEL: But when we receive any letters 19 from the taxpayers there is a reason, don't we supposed 20 to follow that procedure? That, you know, you are not 21 sure. You cannot just dismiss this letter that this is 22 not for refund, that we supposed to have another 23 procedure that what does this mean. And can you let us 24 know that, you know, why you -- I mean, why you overpaid 25 and why that huge balance -- credit balance from the 26 sales taxes. We supposed to do that, to let taxpayers 27 know that you need another letter to follow up. 28 But we never did that, from our -- 36 1 MR. HANKS: I think that we did follow up. 2 MS. STEEL: So when we didn't do that and then 3 taxpayer thought that they already gave us the warning 4 that, yes, you owe us a refund. 5 MR. HANKS: Ms. Steel, I -- we did follow up. 6 With respect to this letter what we did is interpret 7 it -- 8 MS. STEEL: That was 2007. 9 MR. HANKS: Yes, we -- we interpreted that 10 letter as -- 11 MS. STEEL: But this letter was not 2007. 12 MR. HANKS: -- as a request for relief. 13 MS. STEEL: It's January 2005. 14 MR. HANKS: Correct. Correct. With respect to 15 the -- the January of '05 letter. 16 We did follow up with respect to that letter. 17 But we interpreted that to mean that Petitioner was -- 18 was wanting relief of -- of penalties for that quarter. 19 MS. YEE: Okay. 20 MR. HANKS: We addressed that -- that issue. 21 MS. YEE: Yeah, okay. Let me see if there are 22 other questions or comments from Members. 23 Okay. Hearing none, is there a motion? 24 DR. CHU: Move to take the matter under 25 submission. 26 MS. MANDEL: Second. 27 MS. YEE: Motion by Dr. Chu to take this matter 28 under submission. Seconded by Ms. Mandel. 37 1 Without objection, that motion carries. 2 Thank you, gentlemen. 3 MR. SAVARY: Thank you very much. 4 MS. YEE: We will discuss your matter later 5 this afternoon. 6 ---oOo--- 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 38 1 . 2 REPORTER'S CERTIFICATE 3 4 State of California ) 5 ) ss 6 County of Sacramento ) 7 8 I, BEVERLY D. TOMS, Hearing Reporter for the 9 California State Board of Equalization certify that on 10 April 29, 2009 I recorded verbatim, in shorthand, to the 11 best of my ability, the proceedings in the 12 above-entitled hearing; that I transcribed the shorthand 13 writing into typewriting; and that the preceding 38 14 pages constitute a complete and accurate transcription 15 of the shorthand writing. 16 17 Dated: May 11, 2009. 18 19 20 ____________________________ 21 BEVERLY D. TOMS 22 Hearing Reporter 23 24 25 26 27 28 39