BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 5901 Green Valley Circle, Room 207 Culver City, California REPORTER'S TRANSCRIPT FEBRUARY 24, 2010 FINAL ACTIONS P. M. SESSION Reported by: Beverly D. Toms No. CSR 1662 1 1 2 P R E S E N T 3 4 For the Board Betty 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 Olson Chief, Board 14 Proceedings Division 15 16 ---oOo--- 17 18 19 20 21 22 23 24 25 26 27 28 2 1 ITEM C3 2 Culver City, California 3 February 24, 2010 4 ---oOO--- 5 MS. YEE: Let me ask, Ms. Olson, what is our 6 next matter? 7 MS. OLSON: Our next matter is the oral 8 hearings that were submitted. C1a, Elizabeth Wardley 9 Kwong, and C1b, Raymond Wah Kwong. 10 MS. YEE: Actually, those are -- 11 MS. OLSON: I apologize. That's twice today. 12 I'm so sorry. 13 MS. YEE: I believe it's C3 -- C3 and C -- 14 MS. OLSON: C3, L & S Restaurant, Inc. 15 MS. YEE: Okay. Members, we are on Item C3, 16 matter taken under submission, L & S Restaurant, 17 Incorporated. Is there a motion? 18 MR. HORTON: Yeah. Madam Chair, as I expressed 19 during the discussion, I was a little bit concerned that 20 the Department did not take a -- conduct a markup test 21 to substantiate that all of their subsequent decisions 22 was based on an -- an existing markup. 23 And I believe that we ought to -- and based on 24 a reconciliation of the Federal income tax returns to 25 the actual amount reported, which could not -- could 26 possibly have not given consideration to such things as 27 spoilage, theft and other adjustments that may have been 28 adjusted to Cost of Goods Sold or adjustments to the 3 1 income reflected on the Federal income tax returns. 2 Accordingly, in the absence of a markup test to 3 support one way or the other, I'd recommend some 4 adjustment, just don't know where. Maybe we can 5 consider splitting the two or maybe we consider maybe a 6 ten or -- ten percent adjustment for spoilage and 7 another ten percent adjustment for some sort of theft 8 that could have occurred, or loss that could have 9 occurred in another process beside the just general loss 10 of Cost of Goods Sold. 11 But I'd like to open it up for discussion from 12 the other Members. 13 MS. YEE: Okay. 14 MR. HORTON: That's kind of broad brush, if you 15 will. 16 MS. YEE: Thank you, Mr. Horton. And maybe a 17 question for Mr. Levine, what is typical when we make 18 allowances for theft and other losses? 19 MR. LEVINE: Well, I wouldn't say there's 20 anything typical. It would be good to have some 21 rationale. I mean, Mr. Horton had some rationale. 22 If you're going to make an adjustment, I don't 23 have anything to suggest. It was -- the Department did 24 use the figures for sales reported on the income tax 25 returns. If you're finding the Department shouldn't 26 have, that's one thing and making adjustments to 27 compensate for using wrong figures, but those were the 28 sales they reported. 4 1 MS. YEE: Right. 2 MR. LEVINE: And if right that already includes 3 the spillage and -- and theft and all because they're 4 only reporting the sales. They of course argue that 5 they should have reported less. 6 But, anyway -- 7 MR. HORTON: I mean, the Petitioner argued that 8 the amount reported on the Federal income tax return was 9 not reflective of their actual sales per -- per gross 10 receipts and taxable sales. And so, we as an agency 11 should have been able in my opinion to say yes or no to 12 that question, that we examine those particular sales, 13 that we make a determination that those sales in fact 14 were not taxable sales. And -- and I believe a markup 15 test and that we were able to support Cost of Goods 16 Sold, they're pretty extensive tests and the segregation 17 test to identify the actual Cost of Goods Sold. The 18 markup test would have just been the supporting 19 mechanism. 20 And the argument for accepting these gross 21 sales on the Federal income tax returns was the markup, 22 is that the markup was consistent with the average and 23 the norm. Subsequent testimony indicated that the 24 average and the norm did not reflect the change in 25 the -- in the market values. 26 Taxpayer himself indicated that there could 27 have been -- there was a reduction in the -- the overall 28 potential for profit in his operation as reflected by 5 1 the subsequent sale, even though there was a loss. 2 So, why don't I just throw a number out that 3 seems to -- that might be a little consistent, and the 4 argument would be is that presumably the Department is 5 correct that in a normal environment the markup would be 6 somewhere between 154 percent and 160. That given the 7 change in the economic environment it might be about a 8 20 percent reduction in the overall selling price of -- 9 on the average. At least that's what I've seen as a 10 consumer. Sometimes 50, sometimes 70 percent. So, I 11 think I'm being a little conservative. 12 MR. LEVINE: Not to be argumentative, but this 13 all preceded the economic collapse. This is while we 14 were sailing high and still fat and happy. 15 My recollection was it happened like in 2008. 16 At the beginning of 2008 the Republicans were going to 17 win the election and by the end of 2008 the economy had 18 tanked and -- and they lost. 19 MR. HORTON: Yes, but at this point I think -- 20 I think that the subsequent information relative to the 21 economy has proven that that was an artificial 22 presumption, that in fact the downturn in the economy 23 had occurred much earlier than that. It is the -- it 24 was the artificial creation of interest and debt that 25 allowed people to go out and do things that they -- 26 MR. LEVINE: As they say, the fundamentals were 27 undercut, but the confidence was there and people were 28 still buying. And this -- this restaurant may or may 6 1 not have been healthy. I have no idea and I didn't stop 2 by to take a look at it. But -- 3 MS. STEEL: But, actually -- 4 MR. HORTON: I mean -- let me just continue 5 along that lines. 6 MS. YEE: Yes, please. The -- here -- here are 7 the facts. The restaurant ultimately sold for $50,000. 8 They ultimately got out of business. They ultimately 9 walked away from this operation for the most part and 10 they may have convinced someone to go in and buy it for 11 a value that was greater than there was, but we didn't 12 make a determination. Even on the valuation of the 13 ultimate sale, we didn't determine the value of the 14 assets, the F&E, the goodwill, and tie those in. 15 So, this seems to be a business that was 16 declining, and than typically what happens when you're 17 trying to survive, you begin to go in and discount your 18 product. 19 Now what the period of time is, this is an 20 action subsequent, we're not -- we're not there, we're 21 not able to make that determination. And I mean if I 22 based it on my own experience, I mean I think the other 23 thing that they interjected was they actually began to 24 bake goods and prepare goods. So you got all this labor 25 that's associated with it, and in fact was that part of 26 the overall markup that was reflected of 160 percent. 27 I don't know that I would have walked in and 28 paid for -- in fact, now that I think about it, I can 7 1 actually look at -- we have Dunkin' Donuts in my 2 district, which is a very popular donut location. And 3 they're selling their donuts for the same price that 4 they were selling it 30 years ago -- 20 years ago. 5 Something like that. 6 Anyway, so that's just my thoughts. 7 MS. YEE: Okay. Ms. Steel. 8 MS. STEEL: Actually, the peti -- actually, 9 accountant said that there's no parking and there's a 10 deli and selling bakery items, that that was mostly to 11 go items. So, this markup that, you know, without doing 12 markup test that I don't think was really accurate 13 there. So I agree with Mr. Horton that, you know, we 14 have to range a little bit about the markup here. 15 MS. YEE: Mr. Horton, do you want to present a 16 motion? 17 MR. HORTON: I would -- see, I don't know how 18 to exactly frame the motion, but I would recommend a 20 19 percent adjustment to the markup and whatever that 20 amounts to, and rule in favor of the Department but 21 directions of a 20 percent markup. 22 MR. LEVINE: Can I make a suggestion, that you 23 just take -- you've expressed your reasons -- 24 MR. HORTON: Right. 25 MR. LEVINE: -- of why this is too high. 26 There is no markup because the Department 27 didn't use a markup. And we have the problem with the 28 taxpayer came up with cash -- with Z-tapes that -- that 8 1 contradicted their own argument about bank receipts. 2 But -- so we have that problem, but if you 3 think this is too high, I would suggest you -- I know -- 4 we all know you're picking a number out of the air, 5 but -- 6 MR. HORTON: Right. 7 MR. LEVINE: -- it's because we don't have 8 records and you're doing your best to be accurate. 9 Whatever figure we get is not going to be accurate. 10 If you think this is 20 percent too high, or 11 whatever you think this is too high, I would suggest you 12 just make a direct -- a motion for a direct amount, 13 whether it's $7,000 or 6,000 or reduce it by 10 or 20 14 percent. 15 MR. HORTON: I don't think I -- I wouldn't 16 necessarily go that far. I mean, I would sort of 17 characterize this as a markup situation and say direct 18 staff to reduce the markup to a markup that was more 19 reflective of -- give an adjustment to Cost of Goods 20 Sold or -- strike that, I can -- as a reconciliation. 21 MR. LEVINE: But that's -- if they use a 22 markup, my recollection, maybe I'm wrong, but I think 23 that they did the calculation of the markup based on FIT 24 records. So if you're going to -- 25 MR. HORTON: But, I mean -- but here's where I 26 am. I don't believe that we've -- we've substantiated 27 that if -- the Federal income tax records were accurate. 28 And because we didn't do the testing in order to do so. 9 1 I do believe that we've been able to substantiate that 2 Cost of Goods were accurate and that the markup that the 3 taxpayer had established was inaccurate, which is 60 4 percent. 5 And so now we're faced with an inaccurate 6 markup of 67 percent and a markup that was not -- a 7 selling price compared to Cost of Goods Sold, which 8 yielded a markup of 154 to 160 percent, which was not 9 substantiated by the Department, it was just arbitrarily 10 accepted. Which is the right thing to do when 11 everything else is impeached. But had we did some sort 12 of a testing we might have found that the markup is 13 somewhere in between the two and therein and of itself 14 caused us to do additional testing. 15 As the example that I provided, if they had 16 reported on their Federal income tax returns a sales 17 figure that yielded a full hundred percent markup, then 18 the logic would have been the invert. Is that well, 19 that can't be true so something must be wrong with Cost 20 of Goods Sold or something must be wrong with the 21 reported total sales. And would have caused us to do 22 additional testing. 23 I'm suggesting that when we reconcile -- when 24 we do a cost of living analysis, or we do alternative 25 testing other than looking at the actual records, that 26 we -- to the extent possible that we do the 27 additional -- do a markup test if we can or do 28 additional testing that substantiates that alternative 10 1 testing. 2 So -- but I'm not prepared to just arbitrarily 3 reduce the amount without that logic being supportive of 4 that action. 5 MR. LEONARD: Do you want a 30-30-30 to have 6 them calculate that and come back to you, Mr. Horton? 7 MR. LEVINE: The Cost of Goods that would be 8 marked up is on the income tax returns. So, we don't -- 9 we have a -- I think -- to be honest, I think whatever 10 you do, that's what you're doing. And sometimes that's 11 the right answer. Sometimes there's no better 12 information except your feel that this is too high and 13 it's -- like in the old days Ernie Dronenberg would make 14 a recommendation that in my -- "Based on my 23 years of 15 auditing" -- you were an auditor, you can make this 16 motion -- "Based on my 23 years of auditing experience, 17 I think it's too high." Klehs would say, "It's 24." 18 And -- and then he would make the 19 recommendation. And sometimes that's what -- that is 20 what you have to go on here. We're -- we're -- the 21 Department took these numbers, looked at other things, 22 did calculations and determined that the numbers on the 23 original tax return were as good as it gets and then 24 they did a segregation test to calculate the taxable 25 measure. 26 Whatever numbers you're picking, we're using 27 numbers that are subject to doubt. However you do it, 28 we come up to the same thing where you're -- whatever 11 1 adjustment you make, you're making an arbitrary 2 adjustment based on the facts that you heard. 3 MR. HORTON: Here -- here's an argument. 4 Here's an argument -- I mean, here's a -- here's a 5 statement that might work, is that I would move that we 6 provide the taxpayer a 20 percent adjustment to the 7 amounts reported on the Federal income tax returns in 8 order to reflect sales included that would not be 9 subject to tax based on the fact that the resulting 10 markup is considered -- was not substantiated and 11 considered to be not representative in this case. How 12 about that? It's long, but it gets me where I need to 13 be. 14 MS. YEE: Okay. A motion by Mr. Horton. Is 15 there a second? 16 For purposes of discussion -- 17 MR. LEONARD: I'll second. I have a question, 18 though. 19 MS. YEE: Mr. Leonard, please. 20 MR. LEONARD: Is it your purpose, Mr. Horton, 21 to accomplish a 20 percent reduction in the proposed tax 22 return -- redetermination? Because if it is, I'd ask 23 you kind of turn the motion around, make it easier for 24 staff, we're going to reduce the tax 20 percent because 25 we believe that there's a 20 percent error in the way 26 that the gross income -- the Federal income tax returns 27 were compared to the Sales Tax reports. 28 MR. LEVINE: Otherwise, I can't do these 12 1 numbers in my head, and I'm an auditor. 2 MR. HORTON: All right. 3 MR. LEVINE: But this could result in a refund. 4 MR. HORTON: No, I would -- 5 MR. LEVINE: Because of -- you're taking -- 6 MR. HORTON: That works, as well. 7 MS. YEE: Okay. 8 MR. HORTON: That works, as well. 9 MS. YEE: You want to -- you want to -- 10 MR. LEVINE: Because you've got the explanation 11 for it. 12 MR. LEONARD: I'm happy to second that. 13 MR. HORTON: Okay. 14 MS. YEE: Okay. 15 MR. HORTON: That works. 16 MS. YEE: All right, good. 17 MR. LEVINE: So, just so I'm clear -- 18 MR. HORTON: By the way, I had no idea I could 19 just split the baby here. 20 MR. LEONARD: Go talk to Dronenberg. 21 MR. LEVINE: Three -- three votes, you can 22 split the baby. 23 MR. HORTON: All right. You know -- 24 MR. LEVINE: In Property Tax, though -- 25 MR. LEONARD: -- used to do it all the time. 26 MR. LEVINE: In Property Tax I understand 27 you're not supposed to add things together, it makes it 28 harder to defend. But here -- 13 1 MR. LEONARD: I seen it done in Property Tax. 2 MS. MANDEL: He has -- he has a -- you know, he 3 stated his factual basis -- 4 MR. LEVINE: I think this explains it, so -- 5 just so I understand the number, it's a reduction to the 6 deficiency of 20 percent for this reason. 7 MR. HORTON: Yes. 8 MR. LEVINE: Okay. 9 MS. YEE: Okay. Very well. We have a motion 10 by Mr. Horton, second by Mr. Leonard. 11 Without objection, that motion carries. 12 Thank you. 13 ---oOo--- 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 14 1 ITEM C4. 2 MS. OLSON: The next item is C4, Team Dennis 3 Conner Corporation. 4 MS. YEE: Okay, we're on item C4, Team Dennis 5 Conner Corporation. Is there a motion? 6 MR. HORTON: You know, based on my 21 years of 7 experience -- 8 MR. LEONARD: 22. 9 MR. HORTON: 22, by the way. 10 MR. LEVINE: Sailing experience. It's got to 11 be sailing experience. 12 MS. YEE: Yes, Mr. Horton. 13 MR. HORTON: No, I'm just kidding. Just 14 kidding. 15 MR. LEVINE: This is one you really can't split 16 the baby. 17 MS. YEE: Yes. 18 MR. HORTON: Yeah, I know. I know. 19 MR. LEONARD: No, I was going to ask Mr. Levine 20 if -- if -- if the training consists of mandatory 21 classes by qualified instructors -- 22 MR. LEVINE: Beals, but they have no kitchen. 23 MR. LEONARD: All expensive. I thought Mr. 24 Tucker might have an answer. 25 MR. HORTON: Yeah. 26 MS. YEE: Well, let me put a motion on the 27 table to adopt the staff recommendation. Is there a 28 second? 15 1 MR. HORTON: Yeah, I would -- I would second 2 that. And the reason is, is that it appears that the 3 intended purpose is to -- was to acquire this property 4 for use here in California. The subsequent use -- 5 subsequently outside the State was primarily in order to 6 conduct the race. And the commerce activity, even 7 though it was commerce, it was not primarily associated 8 with the -- with the -- with the marketing of the 9 product and the marketing associated with it, but not 10 the boat in and of itself or even the sail -- sailboat 11 for that -- that matter. 12 It's just hard to -- to reach for me that this 13 was interstate commerce or used for the transportation 14 of goods and product. So -- 15 MS. YEE: Okay. Thank you, Mr. Horton. 16 MR. LEONARD: Madam -- 17 MS. YEE: Mr. Leonard and then Ms. Steel. 18 MR. LEONARD: I do have a serious to Mr. 19 Levine. I -- remind me, there was something in some of 20 the previous cases on RVs that were purchased in 21 California, taken out but immediately brought back in 22 because there was a mechanical defect and there was a 23 warranty repair. And I thought the -- the clock stopped 24 for that, but it may have been for the 90-day or -- how 25 does -- how does that example of repair under warranty 26 compare with the tied up at dock while waiting for the 27 new mast to come in and -- 28 MR. LEVINE: That was, I believe, by statute 16 1 operative after this period. I don't know if it covers 2 vessels. But they're just vehicles -- or vehicles, 3 vessels, aircraft. But it's -- as I recall it's an 4 exception when, as you say, the -- the property is 5 outside California and it excludes time it comes back 6 for warranty repairs. 7 This is -- this has got two things wrong with 8 it. It's gone the wrong way. What they -- what was 9 damaged was sent out rather than coming in, and the main 10 thing stayed here. Not for warranty repairs. It was 11 because of repairs. It's certainly connected. It was 12 not operational because the mast was gone, but -- 13 MR. LEONARD: Well, I assume the mast was 14 installed here, though, so part of the -- part of the 15 warranty work was here. 16 MR. LEVINE: Okay. Well, that -- that would be 17 true, but that still wouldn't come within this exception 18 which is basically someone has it out. The only time 19 the RV -- it's like I think a 30-day. So, it comes in, 20 it's repaired within a certain period and that period is 21 excluded. This was over 30 days and the boat was not 22 here solely for the warranty repair. 23 So -- 24 MS. MANDEL: And that's why -- 25 MR. LEVINE: And it's after this period. It 26 doesn't apply. 27 MS. MANDEL: And that --- that was what I was 28 asking about and they said the statute came later, 17 1 right? 2 MS. YEE: Yes. 3 MR. LEONARD: I'm -- 4 MR. LEVINE: It has to do with the 12-month and 5 then that was modified because people were saying, well, 6 12 months and then I have warranty repairs. So they 7 modified the statute. I believe that's how it worked. 8 MR. LEONARD: Okay. Thank you. 9 MS. YEE: Okay. 10 MR. LEONARD: Thank you, Madam Chair. 11 MS. YEE: All right. We have a motion by Yee, 12 second by Horton to adopt the staff recommendation. 13 Please call the roll. 14 MS. OLSON: Madam Chair. 15 MS. YEE: Aye. 16 MS. OLSON: Mr. Leonard. 17 MR. LEONARD: Aye. 18 MS. OLSON: Ms. Steel. 19 MS. STEEL: No. 20 MS. OLSON: Mr. Horton. 21 MR. HORTON: Aye. 22 MS. OLSON: Ms. Mandel. 23 MS. MANDEL: Aye. I think they made a valiant 24 effort to save a failed exclusion and they made some 25 interesting arguments, but ultimately aye. 26 MR. LEVINE: And a valiant effort to bring the 27 cup home, but -- 28 MS. MANDEL: Okay. 18 1 MS. YEE: Yes. 2 MS. OLSON: Motion carries. 3 MR. HORTON: There you go. 4 ---oOo--- 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 19 1 ITEM C6 . 2 MS. OLSON: Our final case for today is C6, 3 Betty Jo Hobart (sic) and it was a waived appearance. 4 MR. LEVINE: And we have a revised 5 recommendation to grant. The -- the determination was 6 not issued before the Statute of Limitations had passed. 7 MS. MANDEL: So moved. 8 MR. LEONARD: So -- so, second. 9 MS. YEE: Motion by Ms. Mandel to adopt the 10 revised staff recommendation. Second by Mr. Leonard. 11 Without objection, that motion carries. 12 Does that conclude our business, Ms. Olson? 13 MS. OLSON: That concludes our business. 14 MS. YEE: Very well. Thank you, Members, very 15 much. Thank you, staff. And we are adjourned. 16 ---oOo--- 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, BEVERLY D. TOMS, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 February 24, 2010 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 20 13 pages constitute a complete and accurate transcription 14 of the shorthand writing. 15 16 Dated: March 4, 2010. 17 18 19 20 ____________________________ 21 BEVERLY D. TOMS 22 Hearing Reporter 23 24 25 26 27 28 21