1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 APRIL 29, 2009 10 11 SALES AND USE TAX APPEAL HEARING 12 APPEAL OF 13 A REALTY PUBLICATIONS, INC. 14 NO. 343231, 373171, 379332,391653 (EH) 15 AGAINST PROPOSED ASSESSMENT OF 16 SALES AND USE TAX 17 18 19 20 21 22 23 24 25 Reported by: Juli Price Jackson 26 CSR No. 5214 27 28 1 1 2 P R E S E N T 3 For the Board Betty Yee of Equalization: Chair 4 Judy Chu 5 Vice-Chair 6 Bill Leonard Member 7 Michelle Steel 8 Member 9 Diane G. Olson, 10 Chief Board Proceedings 11 Division 12 For Board of David Levine 13 Equalization Staff: Staff Counsel 14 15 16 For Department: Scott Lambert 17 Hearing Representative 18 Robert Tucker Tax Counsel 19 20 Kevin Hanks Chief, Headquarters 21 Operations Division 22 23 For Petitioner: Paul Shimoff Attorney 24 Connor Wallmark 25 Cindy Hall 26 ---o0o--- 27 28 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 APRIL 29, 2009 4 ---oOo--- 5 MS. OLSON: And our first item on the agenda is 6 C3, A Realty Publications, Inc. 7 Board Proceedings has received contribution 8 disclosures forms for this afternoon's hearings from the 9 parties, agents and participants. All forms were 10 properly completed and signed. 11 We have two disqualifying contributions, C3, 12 Mr. Chiang has a disqualifying contributions and for 13 C7a and b, Ms. -- excuse me, Dr. Chu has a disqualifying 14 contribution. 15 Each person sitting at the table will be asked 16 to introduce themselves and, if necessary, their 17 affiliation with the taxpayer for the record. 18 Ten minutes is allocated for the taxpayer's 19 opening presentation; followed by ten minutes for the 20 Department's presentation and five minutes is allocated 21 to the taxpayer for rebuttal. 22 MR. SHIMOFF: Good afternoon. My name is Paul 23 Shimoff. 24 MS. YEE: Hold on, let me have Appeals 25 introduce your case. 26 MR. SHIMOFF: Thank you. 27 MS. YEE: And then we'll get to you. 28 Thank you. 3 1 Mr. Levine? 2 MR. LEVINE: It won't take long. 3 David Levine for the Appeals Division, good 4 afternoon, Madam Chair, Members. 5 The issues in these petitions of A Realty 6 Publications, Inc. are whether Petitioner was negligent 7 and whether the amnesty penalty should be relieved. 8 I note that the amnesty penalties are an 9 amnesty double negligence penalty and the amnesty 10 interest penalty. 11 If you find that Petitioner was not negligent, 12 then the amnesty double negligence penalty will 13 automatically be removed. 14 MS. YEE: Okay. Very well, thank you very 15 much. 16 Good afternoon. 17 MR. SHIMOFF: Good afternoon. My name is Paul 18 Shimoff. I'm an attorney on behalf of the Petitioner. 19 And to my left -- 20 MR. WALLMARK: My name is Connor Wallmark. 21 MS. HALL: And I'm Cindy Hall. 22 MS. YEE: Okay, very well. 23 MR. SHIMOFF: Connor is President, Cindy is 24 Treasurer. 25 MS. YEE: Okay, you have ten minutes for your 26 presentation. 27 MR. SHIMOFF: This may not even take ten 28 minutes. 4 1 MS. YEE: Okay. 2 MR. SHIMOFF: The Petitioner as correspondence 3 school. That is in dispute. They're regulated by the 4 Department of Consumer Affairs. They're recognized 5 under the private, post secondary and vocational 6 division. And they're also regulated by the Department 7 of Real Estate. 8 They provide correspondence courses for persons 9 involved in real estate licensing or relicensing. 10 That's not in dispute. 11 About ten years ago there was an audit. And 12 during that audit the State Boards reached the 13 conclusion or took the position, "Excuse me, you're 14 selling books. You're not providing a service." That 15 was the State's position. 16 Our position was, "No, we're providing a 17 service, not books. 18 After that first audit, which there were no 19 penalties imposed, the taxpayer, in retrospect and in 20 error, decided to settle with the State Board of 21 Equalization and conceded about 70 percent of the amount 22 of the tax -- 65 percent of the amount of tax. 23 He thought it was a good idea at the time. In 24 retrospect, it wasn't. 25 We now move forward. Before the first audit 26 was completed, just before it was completed, they 27 started -- they started a second audit. And that's the 28 genesis of the particular issue that we have now. 5 1 In the second audit they took the same 2 position, "You sell books." 3 Our position being, "No. We sell services." 4 And during the course of that audit, which went 5 on many, many years -- and a penalty was proposed, an 6 interest penalty was proposed at that time, the 7 Petitioner exercised its rights in order to petition and 8 say, "Excuse me, we don't believe this tax is 9 appropriate." 10 And, by the way, subsequent to that second 11 audit, other certain audit periods came on line, because 12 of the time, and during each of those other audit 13 periods, initially there was no negligence penalty -- no 14 penalty imposed. 15 The only time that penalty was imposed on the 16 later periods was in September of 2007, after the 17 Petitioner had exercised its right to contest the 18 dispute as to whether they were a correspondence school 19 selling books or services. And that, in itself, is 20 troublesome because what happened is initially they 21 didn't do it and they decided, well, you -- from our 22 perspective, you've exercised your rights to object, 23 we're going to now punish you. 24 Now, the end result of the last audit was that 25 the State conceded between 60 and 65 percent of its 26 position. And, so -- and, by the way, the taxpayers 27 paid all of the tax, paid all of the interest, that is 28 not in dispute -- but the taxpayer did everything it 6 1 could in order to try and educate the State as to what 2 its position was. 3 After the first audit it believed that it had 4 not properly identified on its invoices the items that 5 were taxable versus nontaxable. So, it undertook a task 6 to try and do that, to try and separately identify 7 registration, online services, postage, grading of 8 papers and things of that nature. It attempted to try 9 and comply with the breakdown of what was taxable versus 10 nontaxable. 11 The State, however, maintained the position it 12 really didn't matter. They just said, "You're a 13 correspondence -- excuse me, you're a bookseller." And, 14 ultimately, as the determination was finally made by the 15 State, the conclusion was, "No, you're not a 16 bookseller, you're a correspondence school. Some of 17 which you do have a book, which is part of this and you 18 should properly be taxed for the book." 19 We did reach an agreement about a year ago and 20 the State Board, by the way, did a fine job, they 21 finally got an auditor who listened, who looked, who did 22 the analysis and ultimately reached the conclusion that 23 about 30 percent of the price of the enrollment was, in 24 fact, allocated to the book, and for which the taxpayer 25 paid the tax, interest and is now complying and filing 26 its returns consistent with that fashion. 27 But the taxpayer does not agree and will not 28 agree that there is at any point that it's proper to 7 1 impose a penalty. It's tried to comply all long. It's 2 taken good efforts to do so. And it, in good faith, 3 disputed the position the State had taken. And the very 4 fact that the State ultimately conceded 60 or 65 percent 5 of that issue is pretty indicative of the fact that I 6 State was principally in error. 7 Neither penalty should be imposed. And just 8 from an administrative perspective, it's particularly 9 disturbing that the latter penalties, which were 10 originally imposed, were only imposed after -- after the 11 Petitioner undertook to dispute the underlying -- 12 underlying issue. 13 You should have been provided to you a week or 14 so ago a timeline and hopefully it's a colorful timeline 15 and, hopefully, it is descriptive enough so that you 16 understand what it says, but I'm certainly willing to 17 answer any questions that you may have concerning it. 18 MS. YEE: Okay. 19 MR. SHIMOFF: That's it. 20 MS. YEE: Okay. All right, you'll have five 21 minutes on rebuttal. 22 MR. SHIMOFF: Thank you. 23 MS. YEE: Department? 24 MR. LAMBERT: Good afternoon, Madam Chairwoman 25 and Members. 26 My name is Scott Lambert and I'll be 27 representing the Sales and Use Tax Department today. To 28 my right is Kevin Hanks, with the Sales and Use Tax 8 1 Department. And to Mr. Hanks' right is Robert Tucker 2 with the Legal Department. 3 Petitioner, a corporation, is a correspondence 4 school that offers continuing education courses for real 5 estate professionals. The Petitioner obtained a 6 seller's permit with a start date of November 1st, 1978. 7 Three audits have been conducted and three 8 additional determinations have been issued by our Return 9 Analysis Unit. 10 At issue here are the negligence penalty 11 applied to the second audit for the period July 1st, 12 2001 through December 31st, 2004 and the three 13 additional determinations for the periods January 1st, 14 2005 through March 31st, 2006, the second quarter 2006, 15 and the third quarter 2006. 16 In order to understand what has taken place, we 17 need to go back to the first audit. The first audit 18 ever period July 1st, 1998, to June 30, 2001. 19 Petitioner considered themselves the consumers 20 of books and lesson materials, which the Petitioner 21 refers to as self-study guides, and, therefore, paid tax 22 on the cost of those materials. The Department 23 considered the Petitioner to be the retailer of those 24 materials, which are tangible personal property, less 25 exempt charges, such as grading. 26 The Department notified the Petitioner during 27 October 2001, which was before the returns from the 28 second audit were due. The Department assessed tax on 9 1 the sales of the continuing education courses in the 2 audit. The Petitioner petitioned that audit. 3 A decision and recommendation was issued on 4 February 13th, 2003 which denied the Petitioner's 5 petition. In the decision and recommendation it was 6 written the issue of whether correspondence schools are 7 retailers or service enterprises is not new to the 8 Board. Historically the Board has made a distinction 9 between schools that provide classroom instruction and 10 correspondence schools that do not. 11 Tax applies to books and lesson materials 12 furnished to students in connection with correspondence 13 courses because the property, the books and lesson 14 materials, is considered significant in relation to the 15 services provided. Accordingly, correspondence schools 16 are regarded as the retailers of such property. 17 The corresponding section of the law was noted 18 and several annotations supporting these statements were 19 referenced and provided along with analysis of the 20 Department's position. 21 Petitioner filed the request for 22 reconsideration and the Appeals Division issued a 23 supplemental decision and recommendation on June 20th, 24 2003, which declined to make any changes to the 25 recommendation. 26 The matter was not heard by this Board. 27 Petitioner entered into an agreement with the Board of 28 Equalization Settlement Unit on March 24th, 2004. The 10 1 agreement was for the Petitioner to pay, in effect, 2 62 and a half percent of the liability. 3 The second audit, the one in contention here, 4 was started during February 2005. The Petitioner 5 changed the method of billing of their sales invoices 6 during that reporting -- during that audit period. 7 Petitioner's reporting, though, remained the same as 8 during the prior audit period. 9 Before I continue an explanation needs to be 10 made for the three billings made during the period 11 January 1st, 2005 to September 30th, 2006. During the 12 second audit the Riverside District office noted that 13 the Petitioner continued not to report the fair selling 14 price of the continuing education courses. The 15 Riverside office contacted the Headquarters Refund 16 Analysis Unit three separate times and asked them to 17 issue separate billings as Petitioner continued not to 18 report properly. 19 Unfortunately, the Return Analysis Unit did not 20 assess the negligence penalty for any of these billings. 21 This was not discovered until the Petitioner filed their 22 petition. When the oversight was discovered, an 23 increase letter, based on Section 6563 was issued and 24 the penalties were asserted. Also a negligence penalty 25 was properly not assessed on the first audit for all of 26 the following reasons: It was the Petitioner's first 27 audit; it was a fairly complicated area of the law; the 28 records were adequate; sales tax reimbursement was not 11 1 collected; and there was no negligence in preparing the 2 returns. 3 Negligence penalties were assessed on all 4 periods at issue here. There is no remaining negligence 5 penalty balance for the second quarter 2006 because the 6 Petitioner has paid the penalty. 7 Getting back to the second audit, the decision 8 and recommendation for this audit recommended that the 9 Department establish the fair retail selling price. The 10 Department concluded in a re-audit that about one-third 11 of Petitioner's charges for the continuing education 12 courses, after taking out items such as nontaxable labor 13 and shipping, are taxable. 14 Both the Department and Petitioner agreed on 15 the fair retail selling price. All tax interest has 16 been paid for all notice of determinations at issue 17 here. Therefore, the retail selling price is not at 18 issue. 19 What is at issue here is whether the Petitioner 20 reported -- what the Petitioner reported and when it was 21 reported. The Petitioner did not start reporting the 22 fair retail selling price until their first quarter 2008 23 sales and use tax returns. This was after the decision 24 and recommendation for the second audit, which is dated 25 December 5th, 2007. 26 Petitioner was instructed in the first audit by 27 both the Department and the Appeals section with their 28 decision and recommendation that the fair retail value 12 1 of the materials provided with the education courses 2 were taxable. 3 Petitioner disregarded the information provided 4 to them other than to separately itemize on the sales 5 invoice the shipping charge and part of the cost of 6 materials provided. 7 Petitioner continued reporting tax on the cost 8 of materials and made no attempt to report the fair 9 retail selling price. 10 After the second audit was started in February 11 2005, the Petitioner again was told that the fair retail 12 selling price should be reported as taxable. Again the 13 Petitioner did not attempt to change their reporting. 14 The negligence penalty's recommended because 15 the Petitioner failed to act in a reasonable manner and 16 not because they disagreed with the decision. 17 Petitioner basically entered into a settlement 18 agreement with the Board of Equalization for the first 19 audit period and then continued reporting in the same 20 manner as before. 21 Even though that first audit was resolved 22 through a settlement agreement, it is not reasonable to 23 believe that the issue would just go away on its own for 24 future reporting periods. Petitioner could not 25 reasonably believe that separately stating the cost of 26 shipping and part of the cost of the materials would be 27 sufficient to satisfy the reporting obligation. 28 Petitioner should have made an attempt to 13 1 establish the fair retail selling price of the 2 educational materials provided with their continuing 3 education courses. 4 The Department made every effort to notify the 5 Petitioner of their obligation to report properly. 6 In regards to amnesty, Petitioner was made 7 aware on March 22nd, 2005 that there was a tax 8 obligation for the second audit period. Petitioner 9 filed for amnesty but did not prepare returns or enter 10 into a payment arrangement. 11 Petitioner could have filed returns, paid the 12 tax liability and then filed a protective claim for 13 refund. Petitioner chose not to do this, knowing they 14 would held responsible for additional taxes, which would 15 result in amnesty-related penalties. Therefore, we 16 recommend that the petition be denied. 17 MS. YEE: Thank you very much. 18 You have five minutes on rebuttal. 19 MR. SHIMOFF: The real question is fair -- the 20 State has indicated that the taxpayer failed to identify 21 fair selling price. We never failed to identify. We 22 had a difference of opinion as to what it should be. 23 The State's position had always been that 24 100 percent of -- virtually 100 percent of everything we 25 sold was subject to tax. Our position was no, that's 26 not right. 27 What the State wants us to do is say -- agree 28 with them, pay all of the tax -- I don't know where we 14 1 get the money -- pay all of the tax and file a claim for 2 refund. That's not fair to the taxpayer. 3 When you have a legitimate dispute where you 4 have reasonable basis to -- to contest the value, the 5 fair market value of an item, you should have the 6 opportunity to go through the process, which ultimately 7 we did and ultimately we had fine agreed resolution in 8 2008. 9 The taxpayer provided the State Board on an 10 ongoing basis with information as to what the fair value 11 of the books should be. The State refused to accept 12 anything we had provided. 13 And it was only when we had one very 14 knowledgeable, capable member of the State Board in the 15 audit look at it and listen to us that we finally got 16 the matter resolved. 17 And that's why there is no tax now due. All 18 the tax has been paid and all the interest has been 19 paid. 20 What ultimately happened is fair and the 21 taxpayer is now in compliance. What the taxpayer did in 22 the past was try and educate at State as to the fair 23 selling price. 24 The amnesty issue is pretty much the same. The 25 State wants us to pay an extraordinary amount of money 26 for taxes and then file a claim for refund. This is in 27 an audit period where the State has already acknowledged 28 that they were wrong to the extent of two-thirds of the 15 1 dollars that they claimed were owed are wrong, and yet 2 they wanted us to pay 100 percent of the tax. 3 And the taxpayer said, "This is not -- we 4 shouldn't have to do this pause they're wrong." And 5 ultimately the agreement that was reached concluded 6 that. 7 So, it would be inequitable to cause the 8 taxpayer to be forced to pay the tax under these 9 circumstances. Taxpayer's acted reasonably, attempted 10 every chance it could be to get their attention and have 11 them look at it reasonably. They failed to do so. 12 MS. YEE: Thank you very much. 13 Would either of you like to make comments at 14 this point? 15 Okay, thank you very much. 16 Questions or comments? 17 Dr. Chu and then Ms. Steel. 18 DR. CHU: Well, you had a dispute about the 19 amount of tax to be paid, but you actually didn't pay 20 any tax during this audit period and yet there were 21 three occasions where the Department was indicating that 22 you had -- that you owed tax. 23 And that was on October 2001, when the 24 Department discussed this matter with you and then 25 February 20 -- no, January 2002, where there was the 26 Department's report of field audit. And then there's 27 February 2003 where there was the decision and 28 recommendation upholding the Department's audit 16 1 findings. So, you have three occasions where it's told 2 to you that you owe tax, but you didn't pay any tax 3 whatsoever. 4 MR. SHIMOFF: Dr. Chu, if you received a letter 5 from the Internal Revenue Service in the mail that said 6 that owe tax, you have a number of choices. You can 7 agree -- "Well, I guess I owe the tax," or you can go 8 through the administrative process to dispute it. 9 What the taxpayer did is receive a letter 10 saying, "We believe you owe tax." This is a proposed 11 tax on the first audit. That issue was not even 12 resolved until '03. The audit for 0 -- the audit for 13 '01, for the period ended in June of '01, was not 14 resolved until February of '03, I believe, May of '03. 15 You had many years in between where we're going through 16 the administrative process. 17 By the way, the taxpayer, from the time the 18 second audit occurred, did pay tax two different times. 19 There were tax payments made on an ongoing basis in 20 anticipation that there would be, ultimately, a 21 resolution. 22 The taxpayer paid -- about two years ago paid a 23 large sum of money and then about a year later paid 24 another large sum of money, in anticipation that they 25 realized that, "We're going to have a resolution of 26 this, we need to get this tax paid." So, they did pay a 27 tax. 28 And they did not ignore the State Board in any 17 1 fashion. If you look in the records, you'll find there 2 is two different sets of our checks, payments being 3 made. 4 DR. CHU: Department, could you -- how do you 5 respond to that? 6 MR. LAMBERT: What he said? 7 DR. CHU: Yeah, because it was my understanding 8 that the negligence penalty is being implemented because 9 there was no tax that was paid during this time period. 10 MR. LAMBERT: Well, that's correct, Dr. Chu. 11 They did not file for amnesty. And they were notified 12 before amnesty, on March 22nd of '05, which allowed them 13 until March 31st of '05 to file for that. 14 So, they could have had the penalty removed 15 during that time and they declined to do that. And, in 16 fact, they did file for amnesty, but didn't follow it 17 up. 18 What would have been reasonable was for them to 19 make an estimate of what they believed was the fair 20 retail selling price of those -- of those products, but 21 they did not do that. 22 So, they didn't -- we did go back and assert 23 later the negligence penalty once we found out that we 24 had overlooked it from our Return Analysis Unit, as I 25 had mentioned. There was an oversight because they 26 looked at the returns and then just disallowed the 27 deductions that they took on line 10F. And, so, there 28 was an error on the Department's fault -- I would say an 18 1 oversight in that particular area. 2 But we've gone back and adjusted that and there 3 has been a penalty applied to each one of the individual 4 periods. 5 MR. SHIMOFF: Once again we must distinguish, 6 the taxpayer made two significant payments. I can't 7 tell you the exact date and it was not, certainly, in 8 the initial period. 9 Once the taxpayer realized that there was going 10 to be a fair selling price determination, it made a 11 estimated payment. When it realized that the estimate 12 that they had made was insufficient, they made another 13 payment. And you'll find there is two major payments 14 made -- it might have been the end of '96 or '97, 15 somewhere in there, and I assume the transcript of 16 account -- 17 MR. LAMBERT: There was a payment of $58,000 in 18 December 26th of '06 and then there were various 19 payments -- well, various payments that were made at 20 that time. 21 DR. CHU: But that was past the audit period. 22 MR. LAMBERT: Well, that's correct, yeah. It 23 was outside -- it was not during the audit period, it 24 was outside of that. 25 MR. SHIMOFF: During, however -- during the 26 time period which we were administratively appealing the 27 matter. We were still administratively appealing it, 28 yet we still made a payment. And we made another 19 1 significant payment -- you'll find, I believe, a larger 2 payment about a year later. 3 MS. YEE: Ms. Steel? 4 MS. STEEL: Well, some of Dr. Chu's question 5 was mine too, but at the same time, that 1998 to 2001 6 audit was done by May of 2003. 7 So, when you imposed a negligence penalty on, 8 you know, July '01 to December '04, was not fair to the 9 taxpayers then. 10 MR. LAMBERT: Well, they were -- 11 MS. STEEL: Because they didn't get any 12 decision yet until that time. 13 MR. LAMBERT: Well, I understand that. 14 We had notified them in October of 2001 that 15 there was an error there. We gave them the working 16 papers in January of 2002. 17 And then they also had another opportunity to 18 remove those penalties by filing for amnesty. And we 19 again told them then, on March 22nd of 2005, that they 20 could file for amnesty and those penalties would all go 21 away. 22 So, they didn't take any of those avenues in 23 order to remove the penalty. 24 MS. STEEL: Could you answer that? 25 MR. SHIMOFF: The position the State has is 26 that we -- "We believe you're wrong. Pay all of the tax 27 now." 28 That's the position they've taken. 20 1 MS. STEEL: All tax agencies are doing that. 2 MR. SHIMOFF: Our position was, "We don't 3 believe we're wrong. We want to exercise our 4 administrative rights to educate you as to why we 5 believe you were wrong." 6 And ultimately I think we prevailed because 7 they conceded two-thirds of it. And it's -- it would be 8 easy in a clinical context to say, "Well, we told them 9 they were wrong, they should have just agreed with us. 10 They should have just paid the tax." 11 That's offensive when you have a valid reason 12 not to pay it and a valid reason to dispute it. 13 And I would say to the State, "Why didn't they 14 wait until we had this matter fully resolved?" 15 MS. STEEL: To the Department, when do we 16 impose a negligence penalty to the taxpayers? 17 MR. LAMBERT: When did we? 18 MS. STEEL: Yeah. 19 MR. LAMBERT: Well, the first time is when the 20 second audit was determined. And then on -- I can get 21 that date, it was January 26th of '06. 22 And then the second time that we imposed it 23 was -- it was sometime during September -- I believe it 24 was September 17th, 2007 is when we inserted the 25 increase to add the penalty for the three determinations 26 that were issued by the Return Analysis Unit. 27 MR. SHIMOFF: Ms. Steel, I think your analysis 28 is correct with respect to the first major penalty 21 1 imposed. We did not have a resolution until '03. 2 And yet they want us to somehow magically 3 believe that we should have gone back and done something 4 on the last three audit periods. 5 Although they are saying, "This is what 6 happened," from our perspective we got -- had no 7 negligence penalty when those proposed notices came out. 8 The only time the negligence penalties were 9 then asserted is after we had exerted our opportunity 10 for administrative appeal and then they came back and 11 said they were going to impose them. 12 MS. YEE: Okay, other questions or comments? 13 MR. LEONARD: Yes, ma'am? 14 MS. YEE: Mr. Leonard? 15 MR. LEONARD: Similar line on two points. One 16 is that I appreciate your admitting that there was a 17 Department oversight and in your opinion the negligence 18 penalty should have been imposed earlier when the field 19 asked for it. 20 Nevertheless, it looks really bad if it's not 21 imposed until the taxpayer files an appeal. It does 22 look like a punishment for pursuing your rights as a 23 citizen. 24 I don't know how you get out of it. But I 25 would -- I would really caution that behavior. And I -- 26 our goals are to have less hearings here and more 27 agreements and settlements and I think you almost forced 28 taxpayers, when the negligence is thrown on that late, 22 1 "I've got nothing to lose now by going ahead with the 2 appeal." 3 And here we're today not on the tax at all. 4 So, just -- you got to find a better way to administer 5 that. 6 The second one, do you concur with the 7 taxpayer's point that it was early '03 when they had the 8 choice to either appeal or to agree that they owed extra 9 tax? 10 Do you agree with that time frame? 11 MR. LAMBERT: Yeah, when they entered into 12 settlement, I mean -- 13 MR. SHIMOFF: Yeah, May 24th, '04. 14 MS. YEE: Well, Mr. Shimoff, hold on. 15 MR. LEONARD: I'm asking the Department. 16 MS. YEE: Mr. Leonard is asking the Department. 17 MR. LAMBERT: They signed a letter for 18 settlement in October of '03. 19 MR. LEONARD: October? 20 MR. LAMBERT: That was ultimately accepted in 21 '04. 22 MR. LEONARD: Okay. But the date in which the 23 taxpayer said, "I owe some extra money," was October of 24 '03? 25 MR. LAMBERT: Yes. 26 MR. LEONARD: Wouldn't it be better to impose 27 the negligence penalty starting that date forward until 28 the first quarter of '08 when they paid according to 23 1 that -- they paid off all current quarters according to 2 that settlement formula, as well as the prior quarters? 3 Do you see what I'm saying? I'm trying to 4 figure out -- because I see part of your point. You 5 tell the taxpayer, "This isn't the way it works." They 6 don't agree. And you go through the usual process and 7 you finally come to some resolution which, like it or 8 not, they agree, "I owe more." From that point on they 9 don't pay the extra tax that -- that's negligent. 10 But prior to that it's -- it's not negligence 11 as long as you still think you are right and you are 12 still making an argument about it. 13 MR. HANKS: I can appreciate your comment and I 14 agree with you. 15 I think what the District was thinking is 16 they're mindful, though, of the first audit period where 17 the District staff did not recommend the penalty 18 specifically because of the complex area of the law -- 19 MR. LEONARD: Sure. 20 MR. HANKS: -- that we're dealing with -- 21 MR. LEONARD: Which hasn't changed. 22 MR HANKS: -- which hasn't changed. 23 And, so, I think they were mindful of that. 24 But then following that audit, I think at that 25 point, what the District is understanding is that the 26 Petitioner should have known that there was some 27 responsibility to report fair market value and they 28 didn't do that following that -- that first audit 24 1 period. 2 There was no change whatsoever -- 3 MR. LEONARD: Sure. 4 MR. HANKS: -- in the reporting. 5 And, so, I think that's the complication here 6 and that's why the District believes that the penalty 7 applies. 8 MR. LEONARD: The problem is if I were running 9 a school like this, that anybody can sell the book, it's 10 my services that kind of make my business profitable, I 11 think my argument would be, 12 "I bought the book. I paid California sales 13 tax on the book. I am now reselling it, 14 according to the Department. I say the markup 15 is zero." 16 The Department says, "Pick a number," I hope it 17 was somewhat less retail was your markup of a typical 18 retail operation, but then that's where the settlement 19 discussions took place is that there was a reasonable 20 markup that was above zero and less than a separate book 21 store. 22 And -- but until that number is agreed upon and 23 reached, which sounds like it was the settlement date of 24 October '03, I think the taxpayer would -- would have a 25 problem paying -- filing a return that showed something 26 above their position and the settlement discussions. 27 I don't know what they were and they're 28 probably not disclosable, but if the taxpayer went in 25 1 the whole period saying, 2 "Okay, I owe a tax on the resale, but my markup 3 was zero, so, I'm -- I'm deducting the tax I 4 paid and I'm charging the customer the tax and 5 it's zero." 6 If that's their position going into it, I think 7 they'd hold to it until they signed the settlement 8 agreement. 9 Isn't that -- I am trying to figure out when -- 10 when they should have really known. You're asserting 11 they should have known back in the first audit period -- 12 MR. HANKS: Correct. 13 MR. LAMBERT: Correct. 14 MR. LEONARD: -- because you told them so. 15 MR. HANKS: Right. 16 MR. LEONARD: The taxpayers do have a right to 17 dispute and disagree. 18 And this one, it's -- since they never alleged 19 that it was for resale and they paid tax on their end of 20 the purchase, I assume we've got 75, 80, 90 percent of 21 the tax already in their returns, depending on what the 22 markup was ultimately agreed to. 23 MR. LAMBERT: I don't believe that to be the 24 case. 25 MR. LEONARD: So, you're saying there was 26 100 percent markup is what you argued for? 27 MR. LAMBERT. Ultimately how it turned out, 28 yeah. 26 1 MR. LEONARD: There was 100 percent mark up on 2 their purchase price? 3 MR. LAMBERT: Yeah. 4 MR. LEONARD: Wow, so, you do get them like a 5 regular book store? 6 MR. LAMBERT: Yeah, well, we did -- yeah. 7 MR. LEONARD: Okay. So, they got -- you got 50 8 percent of the money already, years ago? 9 And you're just talking about the second 50? 10 And I guess I'd like to distinguish the 11 negligence penalties between the periods that they 12 hadn't agreed to that and didn't -- didn't respect that 13 judgment as to whether or not that was taxable at that 14 markup level and the date at which they did agree to it 15 and that was the number they should have charged and 16 reported from then on. 17 And is it October '03? Is that the "They 18 should have known better" date? 19 MR. LAMBERT: Well, I mean, they entered into 20 an agreement. They signed the settlement agreement in 21 October of '03. 22 MR. LEONARD: Okay. 23 MR. LAMBERT: But they did receive a D & R, a 24 decision and recommendation, from the Board of 25 Equalization. 26 MR. LEONARD: Which they could have appealed to 27 this Board? 28 MR. LAMBERT: Which they could have, yeah. 27 1 In fact, they did. 2 MR. LEONARD: So, their appeal -- I'm saying 3 when their -- when they either exhausted their appeal 4 rights or they decided to not fight any longer is the 5 closure date? 6 The D & R, by itself, doesn't tell me that 7 unless they wrote you guys a check, which they didn't 8 do. 9 MR. LAMBERT: No. 10 MR. LEONARD: They took the next step, not to 11 appeal to us but asked for settlement on it. 12 MR. HANKS: Right. Except that I think I would 13 add too, that we had the District indicating to the 14 Petitioner that they needed to report fair market value 15 on the sale of the educational materials. 16 So, a zero percent markup wouldn't represent a 17 fair market value. 18 And I think the Appeals Division more or less 19 agreed with that determination with their issuance of 20 the first decision and recommendation. 21 So, I think they agreed also that Petitioner 22 needed to report fair market value on the price, that it 23 wasn't satisfactory for them to purchase the items tax 24 paid. 25 MR. LEONARD: The Department's position has 26 been consistent. I am trying to figure out when the 27 taxpayer either agreed to it, concurred with it or 28 settled with it. 28 1 And it sounds like October of '03? 2 MR. LAMBERT: That's when they -- 3 MR. LEONARD: I mean, there's no dispute in my 4 mind the taxpayer knew there was a problem from '01 on. 5 MR. HANKS: Correct. 6 MR. LEONARD: Maybe even earlier, for all that 7 matter, but was just disagreeing with the government's 8 interpretation of the law. 9 So, I would -- Madam Chair, I would suggest we 10 come to agree to divide the question on negligence 11 between this October '03 period, before and after. 12 MS. YEE: Well, I guess I have a different take 13 on it. 14 To the extent that we knew that that was the 15 question in dispute in the prior audit, I would have 16 expected that there would have been some -- 17 MR. LEONARD: This is the settlement of the 18 prior audit, it's October of -- 19 MS. YEE: No, I understand that, but -- 20 MR. LEONARD: -- well -- 21 MS. YEE: -- but we knew what the issue was in 22 dispute. 23 MR. LEONARD: Right. 24 MS. YEE: And yet there still continued to be 25 no allocation of any portion of the lump sum charged 26 towards the fair market value. 27 I mean not even a de minimus amount. I mean, 28 had there been any attempt to do that rather than to 29 1 fully -- 2 MR. LAMBERT: They did separately itemize on 3 their sales invoice an amount for shipping and also what 4 they considered, I believe, to be the fair value of the 5 materials that they handed out. 6 But at first -- and they did not charge sales 7 tax on that amount. 8 At the first -- during the first audit their 9 contention was is that, "The cost of the materials that 10 we hand out is $5." 11 And then when they separately itemized, it was 12 $3.50. So, it was even below what the actual cost was 13 and they didn't charge sales tax reimbursement on that 14 and just continued to report tax on cost. 15 And that happened in September of '03. 16 MS. YEE: Okay. Mr. Shimoff? 17 MR. SHIMOFF: Let's distinguish, as Mr. Leonard 18 has, the two -- the two periods which are pretty -- 19 pretty interesting. 20 During the first audit, taxpayer ultimately 21 settled in the 24th of March of '04, that's the 24th or 22 25th of March of '04. 23 Until that point, taxpayer had maintained a 24 position that they were correct, the government was 25 incorrect. 26 The taxpayer, as I indicated in my opening 27 remarks, in retrospect, made a terrible mistake in 28 entering into a settlement with the State Board. They 30 1 thought, 2 "Let's just get rid of it, we'll resolve it." 3 But the taxpayer, in good faith, believed the 4 problem was not as articulated by the State Board. They 5 thought they had failed to properly identify the taxable 6 versus nontaxable. The problem was in the invoices, 7 that's where they thought the problem was. 8 So, they started changing their invoices to 9 properly identify and they thought, 10 "Gee, we didn't just break things out before, 11 now that we've broken things out, now we've 12 identified the taxable versus nontaxable." 13 And, so, they thought by taking that action 14 they had, in fact, complied with what was needed. 15 Then they go into the second audit period, 16 which -- which didn't even begin until -- or wasn't even 17 resolved until '05. They're going through the second 18 audit period and they're trying to figure out, 19 "How do we change? How can we make sure we're 20 in compliance?" 21 The object was never not to pay the proper 22 amount of tax. They thought they had paid the proper 23 amount of tax. 24 The object was always, 25 "Let's change the invoice to do it properly." 26 The ultimate resolution, which -- as we can 27 look back wonderfully in retrospect, is the proper 28 resolution. 31 1 The State Board -- we provided information to 2 the State Board and said, 3 "Look, we think our position is correct. They 4 ultimately went from a position where they're 5 100 percent correct to where they're only a 6 third correct." 7 They took on a logical -- they finally got an 8 auditor who would listen to us and look at the facts. 9 The very fact that it took so many years for the State 10 to finally agree they were wrong is troublesome. 11 The very fact that we are here today fighting 12 against a penalty that we've told the State all along, 13 "You shouldn't impose this at 100 cents on the 14 dollar, this is wrong." 15 The very fact that it's taken this many years, 16 we should not be punished for. The State has no -- has 17 immunity for having taken the position they've taken, 18 which they have now acknowledged is incorrect -- at 19 least to the extent of two-thirds of it. 20 Yet they're not punished, we are. 21 MS. YEE: Let me just ask a question of the 22 Department, following on that. 23 So, the basis for the reduction of the measure 24 following the re-audit was -- 25 MR. LAMBERT: There were labor charges that 26 were not associated with the sale of tangible personal 27 property. And we went through and identified those -- 28 those charges. And those were removed from the lump sum 32 1 billing that they had for the course. 2 So, ultimately when it came out, it was -- it 3 was about one-third, it was -- depending on the type of 4 course, but it ranged from -- there was three different 5 types of courses. It was 34, 35 and 36 percent. So -- 6 MR. SHIMOFF: Interesting, Ms. Yee. 7 The service's position at the beginning of all 8 of these audits was, 9 "You -- you are selling books, that's what 10 you're going to get charged on. That's a 11 modest little $5 amount. You're selling a 12 book." 13 Our position is, 14 "No, we provide a service. There's are all of 15 the services we provide." 16 We've got 14 employees, 13 of those are 17 providing the service, We have one person who actually 18 takes care of the books -- that manages the books. 19 We're a service. And, so, the fact that they 20 come, in all of these years it's taken us this long and 21 this hard to get them to finally be educated as to what 22 we do, and they finally agree is significant, for which 23 the taxpayer's finally very appreciative. 24 So, the proper tax could have been paid and the 25 proper interest has been paid. 26 But the penalty is wrong. It's wrong to punish 27 a taxpayer who's attempted all of these years in good 28 faith to try to change the way in which they do their 33 1 business, to try to reflect the proper amount of tax. 2 And then it's wrong when the State finally 3 comes in and acknowledges, 4 "You know, I know we had this position for all 5 these years, but now we've been enlightened, 6 now we agree two-thirds of our position is 7 wrong. But we still want you to pay a 8 penalty. 9 And, by the way, a lot of that penalty, gee, 10 you know, we're only going to impose during -- 11 during the period of the administrative 12 appeal." 13 It's wrong. It sends the wrong message 14 philosophically. To this client it certainly sends the 15 wrong economic message. 16 But philosophically it has a terrible chilling 17 effect on anybody trying to bring a petition, trying to 18 dispute the matter with the State. 19 The State's position was always, they're right, 20 they're right, they're right. 21 "And, by gosh, you better pay this tax, pay 22 this tax now. Maybe we'll give you some money 23 back if you file a claim for refund." 24 The taxpayer should not be obligated to be 25 bullied in that fashion and be treated in that fashion. 26 MS. YEE: Okay. Other questions, Members? 27 Hearing none, is there a motion? 28 DR. CHU: Move to take the matter under 34 1 submission. 2 MS. YEE: Okay, motion by -- 3 MR. SHIMOFF: Well, could you -- could we ask, 4 please -- 5 MS. YEE: Mr. Shimoff -- 6 MR. SHIMOFF: Ms. Yee? 7 MS. YEE: Yes? 8 MR. SHIMOFF: The taxpayer's dealt with this 9 for many years. The taxpayer would like to have a 10 resolution of this matter if possible today. 11 MS. YEE: Okay. We have a motion by Dr. Chu to 12 take this matter under submission. 13 Is there a second? 14 I'll second that motion. 15 Without objection, that motion carries. 16 Thank you very much. 17 MR. SHIMOFF: Thank you. 18 MS. YEE: We'll discuss your matter later today 19 and send you a written notice of our decision. 20 MR. SHIMOFF: Thank you. 21 ---o0o--- 22 23 24 25 26 27 28 35 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, JULI PRICE JACKSON Hearing Reporter for the 8 California State Board of Equalization certify that on 9 April 29, 2009 I recorded verbatim, in shorthand, to the 10 best of my ability, the proceedings in the 11 above-entitled hearing; that I transcribed the shorthand 12 writing into typewriting; and that the preceding pages 1 13 through 35 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: August 17, 2009 17 18 19 ____________________________ 20 JULI PRICE JACKSON 21 Hearing Reporter 22 23 24 25 26 27 28 36