1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 CHIEF COUNSEL MATTERS 7 ITEM J 8 J1 REGULATION 4076 9 WHOLESALE COST OF TOBACCO PRODUCTS 10 11 12 REPORTER'S TRANSCRIPT 13 DECEMBER 16, 2009 14 15 16 17 18 19 20 21 22 23 24 Reported by: Juli Price Jackson 25 No. CSR 5214 26 27 28 1 1 2 P R E S E N T 3 4 For the Board Betty T. Yee of Equalization: Chair 5 Jerome E. Horton 6 Vice-Chair 7 Bill Leonard Member 8 Michelle Steel 9 Member 10 Marcy Jo Mandel Appearing for John 11 Chiang, State Controller (per Government Code 12 Section 7.9) 13 Diane G. Olson Chief, Board 14 Proceedings Division 15 16 17 ---oOo--- 18 For Staff: Carolee Johnstone Tax Counsel III 19 Robert Lambert 20 Assistant Chief Counsel 21 Randy Ferris Assistant Chief Counsel 22 23 Speaker: Dennis Loper 24 ---o0o--- 25 26 27 28 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 DECEMBER 16, 2009 4 ---oOo--- 5 MS. YEE: Okay. 6 MS. OLSON: So, our next item is J1, Regulation 7 4076, wholesale cost of tobacco products. 8 MS. YEE: Okay. 9 MS. OLSON: And we do have one speaker. 10 MS. YEE: Okay. Let me have the speaker come 11 forward. 12 Mr. Loper, are you here? 13 Okay. Why don't I have Mr. Lambert and 14 Ms. Johnstone introduce the matter and then we'll have 15 you speak? 16 MR. LOPER: Okay. 17 MS. YEE: Thank you. 18 MS. JOHNSTONE: Good morning, Madam Chair and 19 Members of the Board. I am Carolee Johnstone, Tax 20 Counsel III, in the Tax and Fees Division or Property 21 Programs of the Legal Department. 22 With me this morning is Bob Lambert of the 23 Assistant -- or the Assistant Chief Counsel of the 24 Litigation Division. 25 We request the Board's authorization to begin 26 the formal rulemaking process to adopt proposed 27 Regulation 4076, which proscribes the manner in which 28 the taxable wholesale cost of tobacco products shall be 3 1 calculated. 2 Assuming authorization is granted, we would 3 issue the Notice of Rulemaking and Initial Statement of 4 Reasons and schedule another public hearing for the 5 Board to consider and potentially adopt the proposed 6 regulation. 7 Mr. Lambert and I are prepared to answer any 8 questions you may have. 9 MS. YEE: Okay, thank you very much. 10 Mr. Loper? 11 ---o0o--- 12 DENNIS LOPER 13 ---o0o--- 14 MR. LOPER: Chairwoman Yee, Members of the 15 Board, I have talked with all of you or your staffs and, 16 as you know, we're extremely disappointed in the way 17 this rule came about and the fact that -- that generally 18 when we deal with Members of the Board and their 19 representatives, they -- usually when they are going 20 to do rulemaking or a new regulation seek the interested 21 parties out. 22 Particularly I remind you in October, when you 23 wanted to extend the cigarette tax stamp, Mr. Gau asked 24 me to appear and, funny, called me at least three times 25 before to make sure I would appear and sought us out. 26 This one I found just reading the Board agenda, 27 had no knowledge of it. And, frankly, I haven't had 28 time to really digest all of it. The one thing that I 4 1 do know is that -- that I'm extremely concerned about 2 the staff asking for sole discretion to set a tax, which 3 is -- which in this regulation. 4 And I find that something that, with the past 5 experiences we've had where we've had to litigate, one 6 of the last things I want to give is sole discretion to 7 the staff. 8 I'm -- I'm under the understanding that -- that 9 if this proceeds, that, Madam Chair, you're going to 10 recommend that we have interested parties go through and 11 a long process rather than expedited. And if that's the 12 case, we, you know, would withhold from opposing right 13 now. 14 But if I had my druthers, I'd ask them to start 15 all over again, starting with interested parties prior 16 to starting a regulation, particularly when it now 17 becomes probably the floor of discussions rather than 18 the ceiling. 19 So, with that, I'd ask you to consider that, 20 but I am extremely thankful that you have considered 21 forcing, at least, interested parties into the -- into 22 the mix. 23 And I am disappointed in the staff's actions. 24 Thank you. 25 MS. YEE: Thank you, Mr. Loper. 26 I think, given the concern that's been raised, 27 my thought here would be to try to have, I guess, a 28 little bit of a compromise, so it would be an expedited 5 1 interested parties meeting. 2 But what I really want to do for the purposes 3 of today's discussion is to see, prior to that meeting, 4 if there are concerns other Members have so that we can 5 incorporate all of those into that discussion for that 6 first interested parties meeting. 7 Mr. Lambert? 8 MR. LAMBERT: I am just here if you want. 9 MS. YEE: Okay. Comments, Members? 10 Mr. Horton and then Ms. Mandel. 11 MR. HORTON: Madam Chair, I would just like to 12 have staff respond why did we circumvent, bypass the 13 public participation process? 14 MR. LAMBERT: The rulemaking process does not 15 provide for interested parties process. It's something 16 you can use when you want to use it. You're certainly 17 not required to use it. 18 We typically -- pardon me? 19 MS. YEE: Go ahead. 20 MS. MANDEL: But here the practice of the Board 21 for many years has been using the interested parties and 22 committee process to get the best possible, acceptable 23 product before we enter into the formal rulemaking 24 process. 25 And at times it's been done on an expedited 26 basis because of the needs for the particular programs. 27 So, I think the question really is, considering 28 what we normally do around here, and even, you know, 6 1 without an interested parties process, if it's something 2 where we know that there's basically one or two people 3 who really might have an interest in it, they, I think, 4 are consulted or alerted, as Mr. Loper mentioned, if we 5 were going to go straight into a formal rulemaking. 6 So, what was -- what was the reason why this 7 one just popped right onto the calendar as put it into 8 the formal rulemaking process? 9 MR. LAMBERT: Well, I'm probably the most 10 responsible for that, so I can address it probably as he 11 good as anyone. 12 Let me just tell you a number of things that 13 were in my mind when I asked that it be done this way. 14 One was it's not changing any staff position. 15 This is a well-known staff position reflected in this 16 regulation and industry knows and it's actually being 17 litigated. So, it's no surprise to industry. 18 Secondly, we have a situation, it's kind of, in 19 my mind, a little bit of an emergency with the wholesale 20 tobacco tax situation because -- let me give you an 21 example. 22 In this particular case I am referring to, 23 United States Tobacco, you had a company which for many 24 years had paid -- filed its returns as wholesale -- 25 wholesale cost of tobacco before discounts being the 26 price -- using its price list to third parties. 27 At some point it divided into two companies and 28 set up an artificial price between the two companies 7 1 that was 82 or 83 percent lower than what they sold to 2 third parties and said that price equals the wholesale 3 cost of tobacco. 4 We're litigating that point and I guess our 5 main, No. 1, we did a little better than that, we got 6 the discount reduced, but it's still a very substantial 7 discount, below what the actual cost is to third 8 parties. 9 Nevertheless, we think -- our litigating 10 position is that when you have a transfer price list to 11 third parties and yet you sell between affiliated 12 companies at a steep discount, that is a discount. 13 So, we want to prove discount by essentially 14 comparing the intercompany transfer price, less the 15 price they sell to third parties. We haven't been -- we 16 don't have a judgment yet, but it's difficult to 17 prove -- it's difficult to argue that without a 18 regulation, what the intention, we think of the statute 19 is, which is that the wholesale cost without discounts 20 is what is taxed. 21 If they're going to set up an intercompany 22 price that's much, much, much lower than what they sell 23 to third parties, we think -- and most charitably viewed 24 to the industry, it's purely done for tax avoidance. 25 Looked at another way you could say it's abusive. It's 26 certainly a loophole they're trying to create in the -- 27 because the statute language is very short and thin and 28 so it leaves a lot to interpretation. And we think it's 8 1 a tax gap issue. 2 So, we think that the better this is clarified 3 in a regulation, the sooner it's clarified and the more 4 clearest -- the sooner it's clarified, the better for 5 the State. And the sooner you are going to have a tax 6 that reflects what we believe to be the intention of the 7 legislature. 8 MS. YEE: And, I think, Mr. Lambert, I don't 9 know that anyone disputes kind of the goal that we're 10 pursuing here. 11 But certainly the process and I think there's 12 probably, as you say, there is lots of room for 13 interpretation. And our customary practice has been to 14 pursue the rulemaking process with interested parties. 15 One of the things I was disappointed in seeing 16 was that the information that was even provided for this 17 particular agenda item didn't even spell out a timeline 18 for the APA process without interested parties meetings. 19 So, it kind of kept everyone in the dark about 20 what would -- how it would proceed. There would be 21 still an opportunity for public comment -- 22 MR. LAMBERT: Certainly. 23 MS. YEE: -- but we don't know when or the 24 public doesn't know when. 25 MR. LAMBERT: Well, it would be -- presumably, 26 it would be -- 27 MS. YEE: No, I mean -- 28 MR. LAMBERT: -- if the -- yeah. 9 1 MS. YEE: -- yeah, I'm just saying it wasn't 2 kind of spelled out. 3 So, I am sympathetic to kind of the process 4 concerns -- 5 MR. LAMBERT: Surely. 6 MS. YEE: -- that have been raised. 7 Understanding that there is a need to do this, 8 and -- but also wanting to have the best, most robust 9 outcome that we can get, I would like to suggest that we 10 have an expedited interested parties process. It could 11 be scheduled for sometime in January. 12 But I also want to take the opportunity to see 13 if there other concerns that Members want to raise for 14 that purpose. 15 MS. MANDEL: Can I just ask another question? 16 MS. YEE: Ms. Mandel? 17 MS. MANDEL: What's -- since this relates to 18 the setting of the tax rate, what's the next -- when's 19 the next time that the Board sets this tax rate? 20 And what's your contemplation that you were 21 looking to get this reg in place for the next -- 22 MR. LAMBERT: It doesn't have any effect on the 23 tax rate. 24 MS. MANDEL: Oh, not on the tax rate? Okay. 25 MR. LOPER: May I? 26 MR. LAMBERT: It's just clarifying what he 27 means by wholesale cost, especially when you have 28 related party transactions where they don't seem to 10 1 reflect what they're selling to unrelated third 2 parties. 3 MS. MANDEL: Isn't determining wholesale cost 4 part of what goes into calculating the rate? 5 MS. JOHNSTONE: The rate is imposed or is 6 calculated -- the rate is imposed on the wholesale cost. 7 MS. MANDEL: Oh, on the wholesale cost. 8 MR. LAMBERT: But it has -- 9 MS. JOHNSTONE: They report the wholesale cost, 10 then times the rate is what the tax is. 11 MR. LAMBERT: This -- this reg has nothing to 12 do with the rate. 13 MS. MANDEL: Okay. 14 MR. LAMBERT: It just has -- mainly -- 15 MS. MANDEL: It's just we're seeing all these 16 different formulas. 17 MR. LAMBERT: -- it mainly addresses definition 18 of wholesale costs with discounts when you have 19 interrelated party transactions, which are much lower 20 than what they sell to third parties for. 21 MR. LOPER: If I may just have one second? 22 MS. YEE: Mr. Loper, then Mr. Horton, 23 Ms. Steel. 24 MR. LOPER: And, I'm sorry, but -- 25 MS. YEE: That's okay. 26 MR. LOPER: -- I am not sure that Mr. Lambert 27 fairly represented the position of the distributors. 28 First of all, we were not parties to the 11 1 litigation. 2 And, second, I -- industry -- he's using in a 3 very broad brush. I represent the distribution 4 committee for -- community for which this regulation is 5 also imposed upon. 6 And, so, it's not nearly as simple as he would 7 like to bring it to. 8 MS. YEE: Yeah. 9 MR. LOPER: And that's why I asked for -- and I 10 would really argue against an expedited process if they 11 don't have an understanding of who they're imposing 12 regulations on. 13 MS. YEE: What is the desired time frame of 14 actually having a regulation in place? 15 MR. LAMBERT: The sooner, the better. 16 MS. YEE: Well, no, is there a drop dead time? 17 MR. LAMBERT: No, but I think we'd like to have 18 it resolved by the early spring -- march, April. 19 MS. YEE: Okay. Mr. Horton, then let me 20 formulate some follow-up questions. 21 Mr. Horton, then Ms. Steel. 22 MR. HORTON: Yeah. You know, I worked on this 23 quite a bit while in the legislature and authored 24 several pieces of legislation related to this. 25 And one of the things that I found that I don't 26 think I could have done it without the interested 27 parties participating. It was a laborious process. I 28 mean, a lot of people came to the table, a lot of 12 1 different issues. 2 I mean, I commend you for the goals and 3 objectives, but without the participation and the input 4 of those who are impacted by the actions of this agency, 5 I'm not even prepared to take it under consideration. 6 Even though I probably could give you some -- some 7 valued input, but it would be a little premature without 8 having the benefit of all of those who will be impacted 9 by this action to at least share their thoughts. 10 So, I'm almost of a mind to unwind the wheel, 11 but with your testimony and the need to expedite it, you 12 know, I'm prepared to be supportive of some process that 13 incorporates the public participation, the input of the 14 of the -- those who are within the industry who will be 15 impacted by this act of the Board. 16 MR. LAMBERT: Certainly. 17 MS. YEE: Thank you, Mr. Horton. 18 Ms. Steel? 19 MS. STEEL: This issue is in the court right 20 now. 21 And do you know how long it's going to take to 22 come out? 23 MR. LAMBERT: We don't have a judgment yet, so, 24 I couldn't possibly predict exactly how long it will 25 take. 26 It will be quite a while. 27 MS. STEEL: So, you said you wanted this 28 regulation has to be done as soon as possible. 13 1 But after we have regulations, after court 2 decision comes out, then what happens? 3 MR. LAMBERT: Well, the statute that provides 4 for the promulgation of regulations in the Special Taxes 5 automatically makes them retroactive. 6 So, if -- if the regulation is final before 7 there is an Appellate Court decision, we could, at 8 least, ask the Appellate Court to take judicial notice 9 of it and apply the clarifications from the regulation 10 to that case. That's how it applies to that case. 11 But this -- this regulation is not just for 12 this particular lawsuit. It's what we perceive to be 13 a -- kind of a general problem now. It's cropping up 14 with respect to the statute. 15 And the, you know, tax administrative staff is 16 -- is to look for issues arising with statutes which are 17 very kind of bare bones and try to interpret them in 18 regulations. 19 So, we see it as kind of something that we need 20 to do regardless of this case or not. But it would be 21 nice to be able to apply -- to ask that the Appellate 22 Court take judicial notice of this and apply this 23 retroactively under our statute, given that we're asking 24 that it just merely clarify a longterm staff 25 interpretation. 26 MS. STEEL: You know what, I think I'm very 27 concerned about the recrafting the regulation based on 28 issues that, you know, from one member of the industry 14 1 because, you know, our process here and practice was 2 that we always go out and interested parties and we try 3 to bring other industries ideas first. 4 And, actually, I was surprised when I was 5 looking at this too because we are not going through 6 what we used to practice, but just suddenly comes out 7 and then you wanted the publication first and then, you 8 know, then go through. 9 This is -- I don't think this is really acceptable 10 for me. 11 MS. YEE: Okay, thank you, Ms. Steel. 12 Any other comments, Members? 13 Well, I think, Mr. Lambert, you may have just 14 made your own case about the need to go to an interested 15 parties meeting to the extent that we're looking at this 16 to potentially be more broad than just the case at hand. 17 MR. LAMBERT: That's true. 18 MS. YEE: So -- and knowing that there is kind 19 of a pending case, I really, really would encourage you 20 to confer with, certainly, Mr. Loper -- ahead of even 21 the interested parties meeting that I hope will be 22 scheduled for sometime in January -- and reach out to 23 other interests as well. 24 But -- and I -- we can see whether we can work 25 diligently towards your spring timeline. But, frankly, 26 if all of the issues and concerns aren't addressed 27 during that one interested parties, we are going to 28 probably look to have you continue to work with the 15 1 interests until we get some resolution and agreement. 2 MR. LAMBERT: It's a possibility we won't have 3 agreement, but I'll try my best. 4 MS. YEE: Okay, yeah. And maybe just kind of 5 getting a headstart -- 6 MR. LAMBERT: Certainly. 7 MS. YEE: -- in the sense of what people's 8 concerns are. 9 Communication is always a good thing. 10 Other questions, Members? 11 Do you need a -- is that adequate direction or 12 do you want a motion? 13 MR. LAMBERT: Well, I would ask Mr. Loper to 14 respond to me in e-mail or a letter with exactly what 15 his concerns are, when he's had the opportunity to read 16 the proposed draft. 17 That would probably be a good place to start. 18 MS. YEE: Mr. Horton? 19 MR. HORTON: Madam Chair, I mean I agree that 20 that might be a good place to start. 21 I don't necessarily want us to isolate this to 22 a Mr. Loper issue, so -- 23 MR. LAMBERT: Well, no, there's an interested 24 parties process, but I mean, if you want to get a 25 headstart on it, that might be a way to go since he's 26 the lobbyist for the distributors. 27 MR. HORTON: Well, I personally am not going to 28 direct anyone to -- I mean, I think once -- in part of 16 1 starting the interested parties, we ought to reach out 2 to everyone to participate -- 3 MR. LAMBERT: We will. 4 MR. HORTON: -- and as soon as possible. 5 So, what might occur is that in addition to 6 Mr. Loper, there are a number of other individuals who 7 represent this industry. So, maybe we can have a 8 preliminary meeting with all of them involved. 9 I mean, there is an inherent danger of just 10 isolating, you know, one industry or one particular 11 individual. 12 So, it was just a thought. But I'm not 13 prepared to -- 14 MR. LAMBERT: It's just a request, actually, 15 before the meeting so we know what he's thinking. 16 MR. HORTON: Well, let me -- let me say it -- 17 let me say it a different way. 18 I mean, I really believe that we could close 19 this out and that the two of you, on the way down the 20 aisle, could kind of say, "Let's get together and let's 21 talk about it." 22 I don't really think that we have to formalize, 23 you know, a discussion between the two of you. And 24 therein of itself may be the genesis of the issue and 25 the problem. 26 So, what I would advocate is that the two of 27 you get together and sing "Koombiyah" and work it out. 28 That's what I would do. 17 1 MR. LAMBERT: Certainly. 2 MS. YEE: All right. 3 MR. LAMBERT: And I would extend the invitation 4 to Mr. Loper to contact me with when and where he would 5 like to meet. 6 MS. YEE: Okay. 7 Any other comments, Members? 8 Mr. Loper? 9 MR. LOPER: I will do what I can do to try to 10 help you as fast as we can. 11 MS. YEE: Okay. 12 MR. LOPER: I would hope that Mr. Lambert 13 recognizes that the holidays are upon us. 14 MS. YEE: Yes, they are. 15 And if you'll continue to just give us kind of 16 progress reports as to how we're proceeding? 17 MR. LAMBERT: Yes, we will. 18 MS. YEE: Okay, great. 19 Thank you very much. 20 MR. LOPER: Thank you. 21 MS. YEE: Okay, next matter? 22 MS. OLSON: Our next matter is J2, Regulation 23 4903, Innocent Spouse. 24 MR. LEONARD: Madam Chair? 25 MS. YEE: Yes, Mr. Leonard? 26 Excuse me, Miss Olson. 27 MR. LEONARD: What was -- what was our action? 28 MS. YEE: It was actually direction back to 18 1 Mr. Lambert for an expedited interested parties 2 meeting sometime in January, but to begin conferring 3 with the interested -- 4 MR. LEONARD: Do they need our direction to 5 start one? Can they start one on their own? 6 MS. YEE: We -- I believe we just gave it, but 7 without -- did you want a motion formally? 8 MR. LEONARD: Well, and the process itself, my 9 memory on interested parties is there -- there is 10 someone in our staff that sort of is the watchdog of 11 interested parties process, to make sure the meetings 12 are noticed legally and all that. 13 And it's not necessarily the unit that's 14 proposing the regulation. 15 MS. YEE: No, no, and this -- 16 MR. LEONARD: I'm wondering who's in charge of 17 this? 18 MS. MANDEL: That would be a Business Tax 19 Committee -- 20 MS. YEE: Business Tax Committee, right? 21 MS. MANDEL: -- process, right? 22 MS. YEE: BTC staff, yes. 23 Mr. Ferris? 24 MR. FERRIS: The Tax and Fee Programs Division 25 will work with the BTC team and the Sales and Use Tax 26 Department to coordinate with the Chair about it. 27 MS. YEE: Okay. 28 MR. LEONARD: All right, good. That helps. 19 1 Thank you for helping my understanding. 2 MS. YEE: Thank you. 3 ---o0o--- 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 20 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 DECEMBER 16, 2009 I recorded verbatim, in shorthand, to 10 the 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 20 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: December 23, 2009 17 18 19 20 21 ____________________________ 22 JULI PRICE JACKSON 23 Hearing Reporter 24 25 26 27 28 21