BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 450 N Street, Room 121 Sacramento, California REPORTER'S TRANSCRIPT JUNE 6, 2009 ITEM B1 FRANCHISE AND PERSONAL INCOME TAX HEARING APPEAL OF TAIHEIYO CEMENT, INC. (No. 332855) AGAINST PROPOSED ASSESSMENT OF ADDITIONAL TAX Reported by: Beverly D. Toms CSR No. 1662 1 1 2 P R E S E N T 3 For the Board Betty T. Yee of Equalization: Chairwoman 4 Judy Chu 5 Vice-Chair 6 Bill Leonard Member 7 Michelle Steel 8 Member 9 Marcy Jo Mandel Appearing for John Chiang 10 State Controller (per Government Code 11 Section 7.9) 12 Diane Olson Chief, Board 13 Proceedings Division 14 For Board of Lou Ambrose 15 Equalization Staff: Appeals Division 16 17 For Franchise Tax Ann Hodges 18 Board: Tax Counsel 19 Bill Hilson 20 Juan Mora 21 Jeanne Harriman 22 For Appellant: John Rucker 23 Representative 24 Fredrick Thomas Representative 25 Steve West 26 Representative 27 28 ---oOo--- 2 1 Sacramento, California 2 June 9, 2009 3 ---oOo--- 4 MS. OLSON: Our next item is B1, Teiheiyo 5 Cement, USA, Inc. 6 MS. YEE: Mr. Ambrose, I think that they want 7 put an additional chair right there. 8 MR. AMBROSE: Oh, I'm sorry. Okay, sure. 9 MS. YEE: Okay. Very well. Appeals. 10 MR. AMBROSE: This is a matter on rehearing. 11 It's the appeal of Teiheiyo Cement, USA, Incorporated. 12 And the sole issue before the Board is whether qualified 13 property within the meaning of Revenue and Taxation Code 14 Section 23612.2 includes both capitalized and expensed 15 property. 16 MS. YEE: Okay. Thank you very much. 17 Good morning, Gentlemen. Please state your 18 names for the record. You have ten minutes for your 19 presentation. 20 MR. RUCKER: Good morning, Madam Chairman and 21 Board Members. My name is John Rucker. 22 MR. WEST: My name is Steve West. 23 MR. THOMAS: My name is Fred Thomas. 24 MS. YEE: Okay. Please proceed. 25 MR. RUCKER: Okay. As stated, the issue before 26 the Board this morning is our client's entitlement to 27 the EZ Sales and Use Tax credit on machinery and 28 machinery parts used in its manufacturing process, which 3 1 were expensed for both Federal and State income tax 2 purposes. 3 By way of general background, our client took 4 this credit on its own initiative without the input of 5 any outside professional advice. Their tax and 6 financial in-house personnel basically read the statute, 7 the operative forms governing directions to the form and 8 reasonably -- reasonably concluded that the credit would 9 be applicable to its machinery and machinery parts used 10 in the manufacturing process. 11 Note that absent the statute form and 12 directions, no regulations, Chief Counsel rulings or 13 other authorities existed to -- at that time to 14 interpret the statute which appeared plain on its face. 15 From our client's perspective, this was an 16 issue of first impression. 17 By way of further background, the credit is 18 important to our client and the economics of its plant 19 operations. The cement plant at issue in Colton has 20 continuously operated there mostly seven days a week, 24 21 hours a day, since it was founded in 1981. 22 If you drive through Colton and surrounding 23 area where the plant is located, it -- it becomes very 24 apparent that it is a depressed area, no doubt precisely 25 of the type intended to be favorably impacted by the 26 State's enterprise zone legislation and related 27 initiatives intended to encourage investment. 28 The plant employs 100 employees and is one of 4 1 the pillars of the Colton community. During the audit 2 years the payroll was approximately $7 million annually. 3 Insofar as the procedural background is 4 concerned, the audit was commenced in 2003. The initial 5 work papers at the audit level allowed the credit. The 6 audit file was sent to Sacramento and then back down to 7 the field in the May-June of '04 time frame, at which 8 times revisions were made disallowing the credit on the 9 expensed parts. 10 Final revised work papers were issued in 11 December of 2004. And at that time NPAs -- NPAs shortly 12 followed. 13 We would like to note for the record that the 14 FTB's internal procedural manual -- manual, excuse me, 15 imposing for the first time a capitalization requirement 16 was revised in October of 2004, about the same time that 17 the NPAs were issued in this case. We don't know 18 whether that was coincidental or not, but that -- we 19 wanted to point that out for the record. And that's 20 contained in Exhibit C. 21 Due to the absence of authority on point in 22 this area, I wanted to touch briefly on the Legislative 23 history. As you know, the California economic 24 development and tax incentive framework was developed in 25 1984. At such time there was absolutely no 26 placed-in-service requirement embedded anywhere within 27 the enterprise zone tax regime. 28 In 1996, effective for years beginning 1-1-97 5 1 the statutory framework was revised. In Senate 2 Committee analysis, which accompanied the revisions it 3 is explained that the purpose of the revised EZ 4 legislation was to combine the most successful elements 5 of the enterprise zone and employment incentive area 6 programs into a single program with one set of 7 initiatives. 8 The Committee analysis further states that 9 having a unified program would enable California to be 10 more competitive with other states, the primary 11 objective of business attraction and job creation. 12 That was clear within the legislative history. 13 Accordingly, when the revisions to the EZ 14 program were made in 1996 are critically analyzed their 15 purpose is clear, to eliminate confusion and make the 16 available credits more accessible and more workable for 17 businesses, not less accessible. 18 Consistent with the Legislature's efforts to 19 make the credit more accessible to business, there 20 appears to be a clear purpose for the placed-in-service 21 language other than requiring the property to be 22 depreciable. 23 Specifically, the final version of the 1996 24 legislation provided that qualified property be 25 purchased and placed in service before the date the 26 enterprise zone expires is no longer binding or becomes 27 inoperative. 28 Importantly, in our view, the placed-in-service 6 1 language appears in connection with this language 2 centered around zone expirations. We believe that in 3 view of the legislation to combine enterprise zones and 4 employment incentive areas it would be perfectly logical 5 and consistent with legislative intent to require that 6 the qualified property be placed in service prior to the 7 expiration of the zone. 8 Further, by using the language in the paragraph 9 addressing the $20 million qualified property 10 limitation, the language would have a clear budgetary 11 purpose -- purpose, as well. That is, it would prevent 12 taxpayers from stockpiling property and taking the 13 credit on property in excess of the $20 million annual 14 limitation. 15 So we feel that there's a clear legislative 16 purpose here apart from the property having to be placed 17 in service in view of the legislation which combined the 18 zones, increased the incentives and did various other -- 19 other things. 20 Additionally, when you -- when you look at the 21 briefing, much has been made of the double benefit. 22 That is allowing a credit with -- with respect to 23 expensed property. However, we feel that this issue is 24 a complete red herring. There is absolutely no double 25 benefit allowed since the Sales and Use Tax credit is 26 not part of the basis of the property. 27 So, whether the property is expensed, that is 28 recovered in one year, or whether it's capitalized and 7 1 recovered over a longer period of time, the Sales and 2 Use Tax credit is not expensed. And that was -- that 3 comes through in the legislative history where they're 4 concerned with -- with a potential double benefit. 5 Our -- our thought is that the timing of 6 deductions for Federal and State tax purposes is simply 7 a matching concept. That is, matching items of revenue 8 and expense to appropriately reflect income. 9 In our case, the parts at issue may be properly 10 expensed since the plant runs 24 hours a day, seven days 11 a week. If the plant operated eight hours a day, five 12 days a week, then under the FTB's view much of the 13 property would be eligible for the credit since it would 14 have a depreciable life of greater than one year. 15 We maintain that -- that for plant operational 16 characteristics to control the utilization of the credit 17 is untenable and inconsistent with the legislative 18 intent. 19 Moreover, it seems to us, if the "placed in 20 service" language were intended to impose a 21 capitalization requirement, then the Legislature would 22 have stated it directly, as it did in MIC legislation 23 and other legislation imposing a properly chargeable 24 tocapital account requirement. 25 Finally, we'd like to point out to the Board 26 that in the absence of any clear guidance imposing a 27 capitalization requirement we have attached in Exhibit C 28 those portions of the FTB's procedural manual that deal 8 1 with the economic development programs. 2 We've enclosed the three versions that would be 3 relevant to this dispute. The December '96 version. 4 The revised November 2000 version. And then the revised 5 October 2004 version. 6 Importantly, and as mentioned earlier, no clear 7 capitalization requirement is imposed until October of 8 2004, two months before the NPAs were issued to the 9 taxpayer. 10 In our case, the taxpayers calculated the 11 credit consistent with the prior versions of the 12 procedures manual, differentiating between manufacturing 13 machinery and parts, which are clearly eligible for the 14 credit, and excluding such items as oils, drill bits, 15 solvents and other consumables absorbed directly in the 16 manufacturing process and appropriately expensed for 17 Federal and State tax purposes. 18 So, in closing, as stated by your Board in the 19 Save Mart decision dealing with the MIC, we believe that 20 the enterprise zone sales and use tax statute should be 21 interpreted in favor of the taxpayer. In this case we 22 believe that it effectuates the purpose of -- of the 23 legislation. 24 And in this regard we'd like to close just by 25 by pointing to Exhibit A, which -- which you all should 26 have, which illustrates the very heavy manufacturing 27 intensive nature of the operations at the Colton plant 28 process which is continuous 24 hours a day, seven days a 9 1 week. And we'd like to note that the items for which 2 the -- which were qualified as qualified property under 3 the enterprise zone sales and use tax statute did not 4 consist of -- if consumable items such as specialized 5 blades and oils consumed in the manufacturing process, 6 rather these items were -- were manufacturing parts 7 critical and integral to the manufacturing process at 8 the plant. 9 MS. YEE: Okay. 10 MR. RUCKER: Questions. 11 MS. YEE: Okay. Any other comments at this 12 time? 13 Any other speakers wish to make comments at 14 this time? 15 MR. WEST: I would just note that it's 16 actually -- I think John may have said Exhibit A, and 17 the machinery -- examples of that machinery is actually 18 at Exhibit D. 19 MR. THOMAS: And also the plant's been 20 established since 1891 not 1991. 21 MR. RUCKER: Oh, I'm sorry. Yeah. 22 MR. THOMAS: It was established many hundreds 23 of years. It's been 1891 the plant's been out there and 24 running as a cement facility. 25 MS. YEE: Okay. Very well. Thank you very 26 much. You'll have time on rebuttal. 27 Franchise Tax Board. 28 MS. HODGES: Good morning, Madam Chairwoman and 10 1 Members of the Board. My name is Ann Hodges and I 2 represent the Franchise Tax Board. To my right is Bill 3 Hilson, Jeanne Harriman and Juan Mora, also representing 4 the Franchise Tax Board. 5 Your Board correctly determined that only sales 6 tax paid on property which has been capitalized is 7 eligible for the enterprise zone sales and use tax 8 credit. 9 In its petition for rehearing Appellant repeats 10 the same arguments which your Board has already 11 rejected. These arguments fall into three general 12 categories. First, the statute has always allowed and 13 currently does allow the credit for current expensed 14 assets. 15 Second, in the alternative, the addition of the 16 placed-in-service language added the capitalization 17 requirement. 18 And third, because respondent inconsistently 19 applied the capitalization requirement, Appellant should 20 be allowed the credit. 21 Previously you correctly determined that the 22 phrase "placed in service" in the specialized context of 23 a tax statute is used to describe capital assets not 24 current expensed assets. 25 Respondent pointed out that its research 26 revealed that the phrase "placed in service" appears 27 thousands of times in Federal and State tax statutes, 28 regulations, case law and tax articles. However, 11 1 Appellant only cited six instances where this phrase 2 referenced current expensed assets. 3 With regard to the second argument, your Board 4 also correctly determined that the capitalization 5 requirement existed prior to the phrase "placed in 6 service" being added to the statute. 7 The relevant Legislative history confirmed that 8 this addition was a clarification rather than a change 9 in policy when it stated that the new sales tax credit 10 was the same as the former sales tax credit. 11 This statutory limitation was evident before 12 the 1997 edition of the phrase "placed in service" for 13 the following reasons. In general, there is a policy in 14 matters of taxation of prohibiting double deductions for 15 the same item. For all years relevant to this appeal, 16 the enterprise zone sales and use tax credit statute 17 applied this general policy against double deductions by 18 specifically prohibiting a double benefit for capital 19 assets in the statute. 20 The statute, however, contained no such 21 specific prohibition with respect to current expensed 22 assets. The absence of that prohibition was not an 23 implied grant of a right to permit taxpayers to double 24 dip or to claim both a business expense deduction and a 25 tax credit for treating such acquisitions as current 26 expensed assets. 27 The absence of that prohibition was due to the 28 simple fact that the credit was not available on current 12 1 expensed assets. As such, there was no need to 2 specifically prohibit the double deduction for current 3 expensed assets. 4 In its third argument, Appellant has asserted 5 that FTB inconsistently applied the capitalization 6 requirement. As proof of that assertion, Appellant's 7 representative states that Respondent knowingly allowed 8 the credit for current expensed assets to another 9 taxpayer identified as Quebecor. In support of this 10 assertion, Appellant's representative has provided 11 copies of schedules which it states were to -- provided 12 to the Quebecor auditor who made the determination to 13 allow the credit. 14 I have with me today Juan Mora, the Quebecor 15 auditor who made the determination on the enterprise 16 zone sales and use tax credit, who if asked would say 17 that these documents were not given to him during the 18 audit. And, furthermore, he would tell you that if they 19 had been given to him, they would have been in the audit 20 file. 21 The Board should have a copy of my response to 22 the SBE regarding these documents in which I state that 23 Respondent did a page-by-page review of the Quebecor 24 audit file and did not find these schedules in the file. 25 What Respondent did find is that the Quebecor 26 auditor looked at the sales and use tax credit claimed 27 and requested the relevant information, including 28 schedules identifying the property purchased and sales 13 1 tax paid. 2 In response to these requests, Quebecor 3 provided three sets of schedules. One set related 4 to LARZ assets and was not relevant. The other two sets 5 of schedules specifically state that the assets upon 6 which Quebecor was claiming the credit were in fact 7 capital assets and contained no reference to the assets 8 having been current expensed assets. 9 As a double check of the propriety of the 10 claim, Juan cross-referenced the amounts claimed on tax 11 returns and schedules with the BOE Use Tax reports and 12 made a determination that the claim was appropriate. 13 The grant of the claim does not appear to have 14 been influenced in any way by the schedule saying some 15 of the assets were current expensed assets because they 16 were not in the file. 17 Finally, I also have with me today Jeanne 18 Harriman, who is a former Audit Manager of the 19 enterprise zone program, who if asked would tell you 20 that FTB's policy has always been that the sales and use 21 tax credit is not available for current expensed assets. 22 Finally, with regard to the EDAM. It has 23 always been entirely consistent with the capitalization 24 requirement. All versions contains reference to basis 25 and depreciation which is understood to reference 26 capital assets. 27 The manuals are update -- are written to 28 provide the best guidance at the time and are updated 14 1 as necessary to provide clarifications. 2 In conclusion, to the extent there is an 3 explanation for the statute, it is that the law favors 4 long-term investments in enterprise zones by allowing a 5 larger tax benefit in the form of a credit for the sales 6 tax paid on capital assets in comparison to a deduction 7 for sales tax paid on current expensed assets. 8 MS. YEE: Very well. Thank you very much. 9 Others from the Franchise Tax Board wish to make any 10 comment at this time? 11 Okay, thank you. You have five minutes on 12 rebuttal, gentlemen. 13 MR. RUCKER: Yeah, firstly, insofar as the 14 EDAMs are concerned, and again this is in the exhibit, 15 but the word "capitalized", capitalization requirement, 16 appears in the October 2004 revisions. Okay. The 17 legislation that we're talking about is -- the enactment 18 of the enterprise zone sales and use tax credit was 19 1984. Significant consolidation and amendment in 1997. 20 And then here the term "capitalization" appears in 2004. 21 And it's clear -- and then they use the same 22 language in the EDAM that they've used in MIC -- in the 23 prior MIC legislation. That is that the costs need to 24 be properly chargeable to capital account. Nowhere in 25 any of the legislative history does -- does that phrase 26 appear, costs properly chargeable to a capital account. 27 So, in terms of what their policy was, there is 28 no General Counsel ruling, there's been no regulations. 15 1 When you read the -- the forms, the forms are clear, the 2 credit applies to manufacturing parts. So I would 3 question exactly what -- you know, who had knowledge 4 of -- of their long-standing policy. Certainly it seems 5 like the EDAMs would be the best documentation and 6 representation of their policy. 7 And, additionally, the prior EDAMs, the ones 8 that were in place prior to the revision in October of 9 2004, in -- the way that I read them they -- they 10 distinguish between manufacturing parts and other items 11 that are consumed in the manufacturing process. The 12 consumables. Solvents, oil. You know, those -- bolts, 13 nuts, specialized blades that are, you know, constantly 14 replacing, consumed, that may, you know, happen to be 15 expensed under 162 are not eligible for the credit. 16 That -- that's clear. 17 In our case we have major machinery parts that 18 are operated within the plant 24 hours a day, seven days 19 a week that -- you know, are -- have to be replaced. 20 Sometimes twice a year, sometimes three times a year. 21 If those -- if the plant operated eight hours a day five 22 days a week, under the FTB -- these view, they would 23 be -- it would be okay to take the credit with respect 24 to those items. 25 The other point, on the no double deductions, 26 it's important to understand this because this is a 27 complete disconnect between us and the FTB. Is -- is 28 this a complete red herring of -- of an issue? 16 1 The ability to take a double deduction refers 2 to the ability to deduct the sales and use tax in 3 addition to recovering the life -- recovering the cost 4 of the property. In no case is a Sales and Use Tax ever 5 deducted. It's not included in the base -- basis of the 6 property and for expensed property there's no current 7 deduction with respect to the Sales or Use tax. 8 So I don't -- there -- there is a complete 9 disconnect there and I would love to know what -- what 10 the explanation there is because, again, the definition 11 of "qualified property" is clear. There's no double -- 12 absolutely no double benefit. 13 And if -- and in the FTB's own publications on 14 this, for example 179 expensed property, property that 15 you normally would depreciate over a number of years, 16 where you can expense it over one year, for example, 17 it -- it's clear that you can take the credit on that 18 type of -- of property. So they don't view it as a 19 double benefit in that context. 20 So, again, you know, we -- we feel that if 21 these EDAMs are carefully looked at, the legislative 22 history is looked at, the -- the qualitative and 23 quantitative nature of the parts that were expensed on 24 the taxpayer's facts, that the taxpayer is absolutely 25 entitled to these credits. 26 The last point, on the Quebecor audit, we were 27 not directly involved in that audit. I can tell you 28 that the refunds were filed based upon expensed parts. 17 1 I talked to the person in our group who ran the audit, 2 Pam Davis, was a Senior FTB auditor. She's now V. P. of 3 Tax at Watson Pharmaceuticals. She had the auditors up 4 at the plant. They -- they had a plant tour. 5 As far as I understand it met with the 6 controller, looked at the G. L. It's -- it's kind of -- 7 I mean, we don't have firsthand knowledge of what 8 transpired, but at the end of the day for what it's 9 worth, the credit was granted with respect to certain 10 machinery parts that were expensed. 11 But -- but I -- you know, it would be our view 12 that -- that, you know, your decision should be made on 13 the parts of the record that, you know, we have in front 14 of you, which include the EDAMs and the other items 15 we've spoken to today. 16 MS. YEE: Okay. Thank you very much. 17 MR. WEST: About -- one more comment in regards 18 to basis. Section 24912 of the California Revenue and 19 Tax Code said the basis of property shall be the cost of 20 property. So, basis and -- and cost, which has been one 21 of the big items that have been thrown around here, are 22 basically identical terms in regards to definition. And 23 they don't necessarily drive what type of property it 24 is. That actual -- that base -- that discussion then is 25 used in regards to how you determine taxable gain or 26 loss on disposition of property. 27 So it's not necessarily a driving term that 28 specifically forces you into one type of asset or the 18 1 other. 2 MS. YEE: Very well. Thank you very much. 3 Questions or comments, Members? 4 Let me start, if I could. To the Franchise Tax 5 Board, there's been a lot of reliance placed by the 6 Appellants on these various versions of the EDAMs. 7 Can you kind of run through the chronology for 8 us in terms of the changes and from your perspective why 9 they were made in each of the subsequent versions? 10 MS. HODGES: Well, I -- if I'm understanding 11 correctly, the only change I think he's pointing out is 12 the 2004. 13 MR. RUCKER: That was the -- the wording in the 14 first two changed a little bit but the significant 15 change -- 16 MS. YEE: The significant one is the 2004. 17 MR. RUCKER: -- is October of 2004. 18 MS. HODGES: Periodically we review the manuals 19 and if we determine there's a need for clarity or 20 clarification, we will update them. If -- and that to 21 my understanding is what happened here. I have no 22 information that there was a particular impetus for that 23 change. 24 And Jeanne Harriman, who is here with me, would 25 like to add something. 26 MS. HARRIMAN: Good morning. Yes, I've been 27 working with enterprise zones since 1995, and our first 28 manual was published in 1996 as a result of the team 19 1 that I was leading at that point in time. 2 Typically we look at any issue in the 3 situation, the enterprise zone, and determine what sort 4 of guidance that we can give the public, as well as our 5 staff. The manuals are used for both purposes. 6 So what we did is we convened various teams on 7 various issues and issued the first EDAM in 1996 looking 8 at all the incentives and focusing on the laws that 9 existed today. 10 Typically, when we issue a manual we will 11 substantially parallel language that is also used in the 12 statute or existing regs, simply for the purpose that we 13 make sure that we get clear guidance out to our staff, 14 but we also don't run afoul of underground regulation 15 issues. 16 So in 1996 when we issued this first guidance 17 we did reference the use of basis which the statute did, 18 as well. And we did reference specifically that 19 depreciation could not be also taken on this same item 20 that was subjected to the credit and allowed. 21 As we move forward and passage of time we run 22 across situations because we get questions from 23 practitioners or we have audit examples where we find 24 that our manuals are unclear. Okay. 25 And we also have law changes. So both those 26 situations will generate an update to a manual, and 27 you've seen as we go through this in 1998 manuals were 28 updated and again in 2000 -- I think the manual 2004, as 20 1 well. The manual was updated to provide either clarity 2 or to reference new law situations in that. 3 In each of the EDAM that have been provided you 4 see the continuity of the reference to basis and 5 depreciation not being allowed for these particular 6 items where the Sales or Use Tax credit was granted. 7 And then in 2004 again because of the 8 situations with perhaps statute changes or more 9 experience with the manufacturer's investment type 10 credit we felt more comfortable putting guidance out for 11 the enterprise zone credit with perhaps more specific 12 statements in regards to capitalized basis. 13 And, yes, you do see the reference now in the 14 statute to placed in service, which came in in 1997. 15 So, again, the -- we -- I don't consider that 16 the EDAMs are inconsistent in their guidance to our 17 staff as how we handled this, or -- or the taxpayers to 18 rely on. We provided the best guidance that we were 19 able to do at the time we issued those respective 20 manuals. 21 MS. YEE: Okay. Thank you. Other questions? 22 Dr. Chu. 23 DR. CHU: Well, to the Appellants, you seem to 24 rely upon these two credit statutes, the MIC and the 25 joint strike for -- strike force credit in support of 26 the position that the Legislature could have put forth a 27 capitalization requirement if it was required. 28 However, it seems to me that the language of 21 1 these two subsequent tax credits are -- are similar to 2 the EZ tax credit because these statutes refer to the 3 qualified cost of -- the qualified cost of qualified 4 property. And then they require that the cost would be 5 properly chargeable to the capital account. Whereas the 6 original statute only provides the credit for purchases 7 of qualified property. 8 So the language there is somewhat similar. But 9 actually what I wanted to ask is you say that the 10 Legislature could have set forth the capitalization 11 requirement. 12 I could actually ask the opposite, if the 13 Legislature wanted to allow both capitalization and 14 expensed assets to be deducted at the same time, they 15 could have written that in. Why didn't they? 16 They could have written that into statute. 17 MR. THOMAS: Well, I think that the statute, 18 you know, contains a definition of qualified property. 19 And, you know, in terms of determining which types of 20 property, whether current or expensed, you know, would 21 qualify for the sales and use tax credit, you know, 22 that -- that's the definition you would look to, you 23 know, that grants the credit for machinery and machinery 24 parts, you know, used in fabricating and manufacturing, 25 et cetera. 26 You know, once you satisfied that definition I 27 think, you know, you're entitled to the credit unless 28 there's some limitation placed on it. 22 1 So, I think -- I don't think that it would 2 grant the right to take the credit on an expensed asset. 3 I think, you know, more likely what you would see is a 4 requirement, now that you've determined that the 5 property qualifies, you would have to limit it somehow. 6 MR. WEST: And in -- in our case we feel the 7 limit areas is the -- is the information that was -- or 8 the placed-in-service language was put into the statute 9 to deal with the $20 million annual limitation, which 10 was probably a budgetary type constraint as we 11 discussed. And then also the ability to load a zone up 12 with qualified property prior to its expiration. 13 So we think that that's not an additional 14 defining type item, but strictly ties to a limited or a 15 budgetary type issue and a over-zealous type loading up 16 of a zone for qualified assets or qualified property 17 which is already defined up above prior to the 18 acquisition of the zone. 19 DR. CHU: Well, you're doing it by inference 20 and I don't see an explicit item in the statute which 21 says that you can allow both capitalization and the 22 expensed assets to be -- to be used at the same time. 23 And in my opinion there hasn't been much change 24 in the argument since the last time this appeal came up. 25 The question here that you're posing is whether 26 qualified property for purposes of the EZ credit 27 includes only capitalized assets or includes both 28 capitalized currently -- and currently expensed assets. 23 1 And of course you're arguing for the latter based on the 2 fact that first the two subsequent credit statutes 3 expressly limited those credits to costs associated with 4 capitalized assets and the Legislature knew how to write 5 such a limitation but chose not to do so. 6 And, secondly, that the capitalization 7 requirement was added in 1997 when the phrase "placed in 8 service" was added. 9 And on the first issue about -- about the fact 10 that it was not expressly put into the statutes, I 11 really have to look at the original purpose of the 12 statute was to encourage -- which was to encourage 13 economic development in distressed areas of the state 14 and to encourage long-term private sector capital 15 investments because it's essential to business growth. 16 And the intent was to ensure that there be long-term 17 investments therefore in the form of machinery and 18 machinery parts. 19 But I find it hard to believe that the 20 Legislature would have actually intended that taxpayers 21 get the double benefit in the same year, that they could 22 claim a deduction for the full cost of the property and 23 then receive a credit against its tax liability for the 24 sales tax paid. 25 And on the second issue, the 1997 revisions, I 26 don't believe that by adding the word "placed in 27 service" that it actually changes the substance of the 28 1984 statute. Apparently the change was intended to 24 1 qualify that -- to -- to clarify that qualified 2 property actually be placed into service and -- and 3 actually that it's used and not that it was just sitting 4 in a storeroom. 5 But it still seems to imply that it is capital 6 equipment that -- that must be in existence -- that the 7 purchase of the capital equipment must be the 8 fundamental element in order to get the EZ credit, 9 but -- 10 MR. RUCKER: Yeah, again -- again, the double 11 benefit concept we just -- there's a disconnect between 12 us and the FTB on that, because the -- the concept of 13 whether you have a machinery part and if the machinery 14 part is -- is consumed in one year because the plant 15 operates 24 days -- 24 hours a day, seven days a week, 16 and you happen to recover the cost in a year versus 17 three years, that -- that's a cost recovery concept that 18 is completely independent of the benefit received by 19 taking Sales and Use Tax credit against the cost of the 20 property. 21 So, you have a matching of income and expense, 22 a timing issue, with respect to -- to covering -- 23 recovering depreciation deductions which in our view is 24 completely independent and separate from the definition 25 of qualified property. The definition of qualified 26 property is clear. The plain language of the statute 27 says machinery and machinery parts. 28 So our view is that, you know, as I mentioned, 25 1 I don't believe the operating characteristics of the 2 plant, whether a part -- again referring to the exhibit, 3 is consumed within a year or within three years or 4 within five years should control the incidence of the 5 credit. 6 I believe that, again, when you look at the 7 statute you look at the forms, you look at the 8 directions to the forms, that the -- that the purpose is 9 clear. You've got a definition of qualified property on 10 the one hand, which is one concept, and then you have 11 the matching of income and expense which is the 12 depreciation or expense of an item, which is completely 13 different. It's an accounting principle concept. 14 There's absolutely no double benefit that we 15 see anywhere in what the taxpayer did here. 16 And then as far as the EDAMs are concerned, I 17 believe that, you know, a fair -- if this was the FTB's 18 long-standing policy, why didn't they just come out and 19 say so, in -- in the EDAMs. The EDAMs in -- in our mind 20 argue the EDAMs is they make a distinction between those 21 types of expense items, oils, lubricants, drill blades, 22 that are consumed directly in the manufacturing process 23 that are incidental to the process. And clearly you 24 can't take the credit with respect to those items. 25 You can, however, in all versions of the -- of 26 the EDAMS it clearly says machinery -- machinery and 27 machinery parts. And that's -- when -- when the audit 28 here was conducted, our client went through the GL in a 26 1 great deal of -- of detail, and -- and threw out what 2 was unrelate -- what it thought was -- was not at all 3 connected to the definition of machinery or machinery 4 parts. 5 So, solvents, lubricants, all that type of 6 thing -- all that type of thing, which is incidental to 7 the manufacturing process, no credit was taken with 8 respect to that. It was simply the machinery, the 9 machinery parts. 10 So, again, the double deduction issue is, in 11 our view, a total and complete red herring and, you 12 know, we just don't see it. 13 MR. WEST: And one other item in regards to the 14 164(a), which is the -- which is the double deduction 15 part of it that deals with whether you do or you don't 16 add sales tax to the cost or basis of property, that 17 applies equally to whether I have an item that's going 18 to be expensed in a current period or that it's going to 19 be depreciated. Either way the sales tax is going to be 20 removed from -- at that point in time for the benefit to 21 the taxpayer. 22 So if it's a $110 item with $10 worth of sales 23 tax, whether I expense it, it will be a limit to $100. 24 If I depreciate it over three years it's going to be 33 25 and a third dollars over three years. 26 But either way, the $10 is not going to be 27 there. So it's not a -- a double dip and it's clear 28 that I'm not allowed to include that in the cost or 27 1 basis of my property which the taxpayer did -- not do. 2 DR. CHU: I'm curious because these arguments 3 sound so similar to -- to the last time we had this 4 hearing. What -- what is new in terms of the arguments? 5 MR. RUCKER: Well, the -- the client engagement 6 team has changed since -- you know, we did read the 7 brief. I think these arguments we -- we delved much 8 more deeply into the legislative history and I think 9 have given reasonable interpretations of what placed in 10 service could mean in this context. 11 When you have zones that are -- are being 12 two -- two major programs that are being combined and 13 simplified to make the credit more accessible to 14 taxpayers, you know, I think there was a -- probably 15 a -- a concern that -- in certain zones were expiring, 16 there was no authority to extend certain zones. And I'm 17 reading a little bit between the lines here, but I think 18 there's a clear purpose to -- to make sure the taxpayers 19 had -- had the property, whether it was capitalized or 20 expensed, in service prior to the -- the expiration of 21 the zone. 22 And, you know, that seems more in line with the 23 legislative history in my mind than tying it directly 24 to -- to depreciation. 25 So, it seems to me when I looked at the file, 26 looked at the briefing, you know, that's one -- one 27 argument. I think -- I don't recall that these EDAMs 28 had been discussed. I think you can read these EDAMs 28 1 entirely consistent with what the taxpayer did. 2 And then the other thing is we took a plant 3 tour. When -- when the new client service engagement 4 team came on the account we took a tour of the plant to 5 really get our arms around, okay, well, what is this 6 that's being expensed? And that's why we wanted to put 7 together the -- you know, the -- the color pictures that 8 you have that really shows that these are not -- these 9 aren't lubricants. They aren't oils. They're -- 10 they're not specialized drill bits, as -- as I mentioned 11 in the EDAM. These -- these are tangible pieces of 12 equipment that are critical to the operation of the 13 plant. And we think precisely fit within the definition 14 of machinery and machinery parts. 15 MS. YEE: Other questions? Mr. Leonard. 16 MR. LEONARD: Thank you very much. It seems 17 this whole debate about current expensed or depreciation 18 is -- is a bit off point, that the Legislature wanted to 19 give a sales tax credit. The original proposal was to 20 repeal the sales tax on manufacturing equipment like 21 virtually every other state with the sales tax already 22 does for its manufacturers. 23 That was decided to be probably too expensive 24 and too big a shift and unfortunately it was narrowed to 25 be a sales tax partial credit within certain zones in 26 the State. But the underlying purpose was still the 27 same, to focus on the -- the benefit of eliminating some 28 portion of the sales tax for manufacturers who purchase 29 1 qualified property. 2 Whether they use it up in some period of time 3 is really not relevant to the fact that they bought it, 4 they paid for it, they paid the sales tax. Their 5 competitors in other states never did. 6 So that -- that's a different issue. The 7 question is whether it's qualified property and I 8 remember the debate was we didn't want to give the 9 credit for all the other personal property that 10 companies buy. 11 As already -- you've mentioned fluids and 12 things like that. But paper and everything else was 13 just -- just seen as -- as too large a -- a credit 14 grant. 15 So, there's -- the idea -- the extent that 16 we're forcing them all to pay sales tax on manufacturing 17 equipment, there's always a double benefit to relieve 18 that. There's the one benefit of the partial credit of 19 the sales tax and there's the continuing income tax 20 benefit that expenses of a business are allowed to be 21 expensed by being deducted in calculating net profit. 22 Whether it's a depreciated expense line or a current 23 expense line, the result is the same, everything spent 24 by the company to run their business is taken off the -- 25 the line to calculate the net profit. 26 So the question before us, and that's why these 27 photographs and some better description I think are 28 enlightening the Board, is is this qualified 30 1 manufacturing equipment. If it is, the credit is 2 earned, the partial sales tax refund is -- is earned as 3 the law said, and as FTB has allowed in similarly 4 situated properties in other manufacturing concerns. 5 The purpose of the law I think was achieved in 6 that in this zone this company kept its business going 7 more hours a day in a week than most others do, and kept 8 employment higher than it might otherwise have been. 9 I'm assuming given what I've heard about the competition 10 in this industry with the -- with overseas imports of 11 cement, that getting a net profit out of these 12 operations is very difficult. And I'm assuming that 13 this -- this may have been pretty close to the -- the 14 difference between scaling back the facility, shutting 15 down the operation or some type of entrenchment and 16 profitability to keep it going as much as -- as it did. 17 So, it achieved the purpose of the law to the 18 credit of workers of California. It did it in a 19 reasonable cost because the credit's only a partial 20 credit for the purchases and it is limited to -- to 21 manufacturing equipment. 22 So, I'm -- that to me is what's new, is the 23 better investigation of what was being bought and why it 24 was -- it was manufacturing equipment for the purpose of 25 this operation. 26 MS. YEE: Thank you, Mr. Leonard. Other 27 questions? 28 Ms. Mandel. 31 1 MS. MANDEL: Yeah, I just have a question for 2 Franchise Tax Board. Typically and -- taxpayer's 3 representative described it in a long fashion, but 4 typically when we talk about that some -- a taxpayer is 5 getting a double benefit and they shouldn't get a double 6 benefit, and that comes up a lot -- in the credit 7 context it comes up all the time in the FTB bill 8 analyses where legislators are proposing a credit for 9 something but they have failed to restrict the deduction 10 of -- of the same thing. It's where get a deduction for 11 the exact same thing you're claiming the credit for. 12 Here they're claiming a credit for the sales 13 tax and they're saying that they did not expense the 14 sales tax. And you're talking about deducting the 15 actual underlying cost of the machinery prior to the 16 addition of sales tax, which would have been deductible, 17 as well, had they deducted the sales tax. 18 So if you're gonna -- if you're going -- if 19 they did not deduct the sales tax on a return and they 20 took a credit for it, and you're rejecting the credit, 21 did you give them through the audit process a deduction 22 for the sales tax that they did not deduct? 23 Because otherwise then you're giving them no 24 benefit for the sales tax. Do you know? 25 MS. HODGES: I don't know -- typically the 26 sales tax -- okay, are you talking about the current 27 expensed assets? 28 MS. MANDEL: Correct. 32 1 MS. HODGES: Okay. 2 MS. MANDEL: They're saying that because of the 3 restriction on adding sales tax to basis when you take 4 the credit, that they did not -- 5 MS. HODGES: Okay, I understand. 6 MS. MANDEL: -- currently expense the sales 7 tax. They only currently expensed, you know, the 8 $50,000, whatever that they paid -- that was the 9 price -- purchase price for -- 10 MS. HODGES: I don't think we did just because 11 my understanding was they wanted to wait to see what the 12 outcome of the process was before they amended any 13 returns to claim additional deduction they might be 14 entitled to. 15 If you -- if you look at Jeff Pania's 16 (phonetic) brief -- in the appeal letter there's a 17 footnote that says that there needs to be -- if the -- 18 if he doesn't win the appeal they would have to make 19 adjustments to account for just the types of things 20 you're talking about. 21 MS. MANDEL: So if -- if -- this is a refund 22 claim because there was sufficient -- there was so 23 much -- sufficient credit to -- and a refund claim on 24 the original term because they had paid in to the system 25 more than their bottom line tax after credit would have 26 been. 27 MS. HODGES: Yes. 28 MS. MANDEL: So, if -- if -- if there's a -- if 33 1 there's a -- Mr. Ambrose, if there's a -- I mean -- if 2 there's a ruling against them on the credit, they should 3 get the sales tax deduction. 4 MR. AMBROSE: You know, I would think so. 5 MR. WEST: The -- I think the actual tax was 6 paid because of the amnesty penalties that related to 7 these years. So they actually paid the full amount of 8 the tax outside amnesty. 9 But -- so all the tax has been paid. 10 MS. MANDEL: No, I -- yeah, my concern is if -- 11 if you were to -- if you were to lose on the issue of 12 credit, because there's been all this talk about the 13 double deduction which I understand what you're saying, 14 that usually we say that the double deduction, they're 15 not -- they're not -- the taxpayer's represented that 16 they are not -- did not deduct the sales tax for which 17 they are seeking a credit. 18 If they don't get the credit and the case is 19 here, they don't get the credit -- 20 MS. HODGES: Ms. Mandel -- 21 MS. MANDEL: Yeah. 22 MS. HODGES: I have Jeanne Harriman -- 23 MS. MANDEL: Do you know? 24 MS. HARRIMAN: I don't know in this particular 25 case and as far as the audit procedures in this 26 situation, when we run across a taxpayer who hasn't 27 taken the sales or use tax credit for expensed items and 28 we've disallowed, it is our procedure to allow them the 34 1 deduction for the sales tax if they have not already 2 done so. So -- and our review staff as well as our 3 audit staff are -- are aware of that. So if our audit 4 staff fails to catch it, our review staff would. 5 MS. MANDEL: And -- well, that just seems that 6 that would be something that we would have to make -- if 7 they don't get the credit that that would be something 8 somehow we'd have to make sure that they -- calculate -- 9 I mean they may still have some level of refund if it's 10 not in the underlying NPAs or whatever they paid through 11 amnesty. 12 Amy, do you have a -- did you have a comment on 13 it? 14 Oh, you're just waving to him. 15 Okay. All right, but that -- that's my general 16 understanding of -- of when someone gets a double 17 benefit and when FTB argues against it. So, why is FTB 18 saying there's a double benefit if they did not deduct 19 the sales tax and are claiming a credit for the same 20 item? 21 MS. HODGES: I may not have been clear. What I 22 said is the statute doesn't prohibit a double benefit. 23 I -- I didn't mean to imply that the taxpayer actually 24 took a double benefit in this case. 25 MS. MANDEL: And you think -- you think that it 26 does not prohibit a double benefit because not adding 27 sales tax to basis you think is also restricted to 28 capital assets that basis is not at all relevant to 35 1 every single asset? 2 MS. HODGES: That is correct. That reference 3 is to Section 164, which says you can't add basic -- you 4 can't add sales tax to cost. The cost -- 5 MS. MANDEL: Cannot? 6 MS. HODGES: Cannot. Or you -- yes, the 7 Section 164 that says you can't deduct sales tax 8 currently but you can add it to the cost of a -- of an 9 item. 10 But when we added the prohibition in our 11 statute we chose to use the word "basis" instead of 12 "cost," and I think there was a deliberate reason for 13 that, and that was because the statute was limited to 14 capital assets and basis in that context has most use 15 and meaning in reference to capital assets. 16 MS. MANDEL: When you say added it to our 17 statute, which one are you talking about? The EZ 18 statute or the -- 19 MS. HODGES: The Sales and Use Tax. 20 MS. MANDEL: -- the 164 -- 21 MS. HODGES: I'm talking about the prohibition 22 in the EZ sales and use tax credit statute, which says 23 that you can't add sales tax to basis, by reference to 24 Section 164. 25 MR. THOMAS: In regards to that, again Section 26 24912 says that basis of property shall be the cost of 27 property. And 164 said you could not add sales tax, but 28 that you had to add sales tax to the cost of property. 36 1 Instead of deduct it. 2 MR. AMBROSE: Ms. Mandel, I was just informed 3 by Ms. Kelly that -- that adjustment that -- would be 4 made if it hadn't been -- you know, sales tax hadn't 5 been deducted on the original return, she's informed me 6 that that's something that we would put in the letter 7 decision to clarify that -- just what you were 8 explaining. 9 MS. MANDEL: Okay. 10 MS. YEE: Okay. Other questions or comments, 11 Members? 12 Hearing none, is there a motion? 13 DR. CHU: Move to take the matter under 14 submission. 15 MS. YEE: Motion by Dr. Chu to take this matter 16 under submission. 17 Is there a second? 18 MS. MANDEL: Second. 19 MS. YEE: Second by Ms. Mandel. 20 Without objection that motion carries. 21 Thank you very much, gentlemen. 22 MR. RUCKER: Thank you. 23 MS. YEE: We will discuss your matter later. 24 MR. RUCKER: Thank you for your time. 25 ---oOo--- 26 27 28 37 1 REPORTER'SCERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, BEVERLY D. TOMS, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 June 9, 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 37 13 pages constitute a complete and accurate transcription 14 of the shorthand writing. 15 16 Dated: June 30, 2009. 17 18 19 ____________________________ 20 BEVERLY D. TOMS 21 Hearing Reporter 22 23 24 25 26 27 28 38