BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 450 N Street, Room 121 Sacramento, California REPORTER'S TRANSCRIPT JULY 13, 2010 ITEM B2 FRANCHISE AND PERSONAL INCOME TAX HEARING APPEAL OF ITEM B2a, FELIX LIN AND BETTY LIN (No. 477812) ITEM B2b, LINUS UPSON (No. 477846) and ITEM B2c, RAFAEL WEINSTEIN (No. 477868) 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: Chair 4 Jerome E. Horton 5 Vice-Chair 6 Barbara Alby Acting 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 Anthony Epolite 15 Equalization Staff: Appeals Division 16 Amy Kelly Appeals Division 17 18 For Franchise Tax Ann Hodges Board: Tax Counsel 19 Bill Hilson 20 Tax Counsel 21 For Appellant: Sheila Joyce Keller 22 Representative 23 Felix Lin Taxpayer 24 Linus Upson 25 Taxpayer 26 Rafael Weinstein Taxpayer 27 28 ---oOo--- 2 1 Sacramento, California 2 July 13, 2010 3 ---oOo--- 4 MS. YEE: Okay, Ms. Olson, our next oral 5 hearing. 6 MS. OLSON: Our next oral hearing is B2, Felix 7 Lin and Betty Lin; B2b, Linus Upson; and B2c, Rafael 8 Weinstein. 9 Board Proceedings has received contribution 10 disclosure forms from this afternoon's hearings from the 11 parties, agents and participants. All forms were 12 properly completed and signed. All parties, agents and 13 participants are on the Alpha listing provided to your 14 office. 15 Each person sitting at the table will be asked 16 to introduce themselves and if necessary their 17 affiliation with the taxpayer for the record. 18 Ten minutes is allocated for the taxpayer's 19 opening presentation followed by ten minutes for the 20 Franchise Tax Board's presentation and five minutes is 21 allocated to the taxpayer for rebuttal. 22 Ms. Yee. 23 MS. YEE: Thank you very much, Ms. Olson. 24 Okay, Members, we are on items B2a, b and c; 25 Felix and Betty Lin, Linus Upson and Rafael Weinstein. 26 Let me have Appeals introduce the matter. 27 MR. EPOLITE: Good afternoon, Madam Chairwoman 28 and Members of the Board. Anthony Epolite with the 3 1 Appeals Division. 2 The issue before the Board is whether 3 Appellants are entitled to exclude 50 percent of the 4 gain from the sell of AvantGo stock because the 5 corporation met the requirements to be considered 6 qualified small business stock. 7 MS. YEE: Okay. Thank you very much, 8 Mr. Epolite. Good afternoon. 9 MS. KELLERMAN: Good afternoon. My name is 10 Sheila Kellerman. I'm a C.P.A. in California. I've 11 been practicing for 25 years. 12 I'd like you to -- to introduce you to the 13 AvantGo founders. 14 MS. YEE: Okay. 15 MR. LIN: I'm Felix Lin. I was a founding CEO 16 for AvantGo. 17 MR. UPSON: Linus Upson. 18 MR. WEINSTEIN: Rafael Weinstein. 19 MS. YEE: Great. Thank you. Please proceed. 20 You have ten minutes. 21 MS. KELLERMAN: I've -- I've worked for -- for 22 many years with these gentlemen and will represent them 23 today. 24 MS. YEE: Okay. 25 MS. KELLERMAN: Our presentation today will 26 primarily focus on the issues raised by the Board staff 27 in the hearing summary. 28 The first issue is that the statutory 4 1 construction in relation to the meaning of the phrase 2 "total payroll expense attributable to employment." 3 The second issue is how many of qualifying 4 months within a holding period are to be determined for 5 purposes of meeting the 80 percent payroll test in this 6 section. 7 A third issue if we have time is -- that was 8 not raised in the staff summary, but which we'd like to 9 address is the respondent's hypothetical stated on page 10 14, footnote 8. 11 And finally we'll close our presentation with a 12 few words from Felix who will provide some background 13 information we believe you'll find essential in -- in 14 considering our appeals. 15 Included in today's exhibits are A, B and C. 16 Is -- one is a new case law, Quality Stores. B and C 17 relate to the new Federal Hire Act, which was intended 18 to incentivize employment across America. 19 So, in addition to the Federal requirements for 20 qualified small business stock treatment, California law 21 adds the active business requirement, which is defined 22 in part as during substantially all of the taxpayer's 23 holding period for the stock appellants meet the active 24 business requirement that no more than 20 percent of the 25 corporation's total payroll expense is attributable to 26 employment outside of California. 27 In the Cantor decision the Board weighed the 28 various arguments for the definition of substantially 5 1 all. 85 percent or 80 percent. And the gentleman 2 earlier today, Mr. Riley in the R & D presentation 3 defined it as 80 percent. 4 The Board in Cantor concluded that 5 substantially means 80 percent or more. 6 Basic rules of statutory construction require 7 the Board to look at the precise words in the statute, 8 giving each word its usual and ordinary import and 9 significance. And keeping in mind the statutory purpose 10 of the qualified small business stock law, which is to 11 encourage small business to have an active business 12 within California by employing California employees. 13 The precise words that 80 percent or more of a 14 corporation's total payroll expense must be attributable 15 to employment in California. Payroll expense 16 attributable to employment does not include severance 17 payments because severance payments, while a component 18 of payroll expense, are not payments for services 19 performed but instead are payments for future 20 unemployment. 21 This is the definition of severance in the 22 Powell case, the Lisec case, the Quality Stores case in 23 Exhibit A today, and in the recent Hire Act in Exhibits 24 B and C provided to you today. 25 In addition, the Board's own Employment 26 Development Department also relies on this definition -- 27 on this definition and it is present on their web site. 28 Respondent claims that the plain language of 6 1 the section contains no such requirement that the 2 employee has to be currently providing services. We 3 assert that a company cannot meet an active business 4 requirement if employees are not providing services. 5 Exhibit C, the new Federal law just effective 6 is part of the Hire Act to incentivize employment in 7 which payroll tax forgiveness is allowed to employers 8 who hire new employees, provides on page 2, subsection 9 "d" -- sets forth language "wages with respect to 10 employment." 11 Further in the Joint Committee report, Exhibit 12 B, paragraph 1 on page 2, it repeats that the law 13 applies with respect to certain employment and then 14 states, "covered employment is limited to service 15 performed by a qualifying individual." 16 Much like this Hire Act the statutory purpose 17 of California's qualified small business stock law is to 18 encourage small business in California employing 19 California employees. In this case AvantGo was born in 20 California and grew to include operations in Chicago and 21 the UK but before, during and after its downsizing most 22 of its employees were in California. And for five of 23 seven years, more than 80 percent of the payroll was in 24 California. 25 The problem is that during the two years when 26 the company was downsizing and closing its Chicago and 27 UK operations it was forced to pay high severance costs 28 related to the termination of those operations. 7 1 Those -- that skewed the payroll numbers 2 outside of California in those years even though no work 3 attributable to employment was performed for that 4 severance pay. 5 Severance is a payroll expense but it is not a 6 payroll expense attributable to employment. Because 7 AvantGo did not pay severance for services performed it 8 paid severance attributable to unemployment of those 9 employees. 10 If severance expenses are removed from the 11 total payroll expense the Appellants meet the 88 percent 12 payroll in California test in all 67 months and in all 13 seven of the seven years, making the second issue not 14 relevant if you agree that severance pay is not payroll 15 attributable to employment. 16 However, the second issue is how do we 17 determine the qualifying months within the five year or 18 60-month minimum holding period, and it's the 19 Appellants' position that the payroll compares and must 20 be made on a monthly basis and that they should be given 21 credit for the period they did not meet the 80 percent 22 payroll test at least in proportion to actual employment 23 within those months within this State. 24 Respondent contends that the analysis must be 25 considered on a yearly basis and that Appellant should 26 be given no credit in any month of the calendar years it 27 did not meet the payroll -- payroll test. 28 I had written to point out an error in the 8 1 staff summary that I'd like to point out. 2 On page 17, lines 9 through 17 of the Board 3 hearing summary prepared by Mr. Epolite -- I hope I 4 pronounce it correctly, he presents an example of how 5 the Appellants' approach for determining the 80 percent 6 payroll for 2001 and 2002 should be evaluated. In his 7 example, a corporation has $100,000 of payroll expense 8 every month for a year, for a total of $1.2 million in 9 that year. 10 In the first six months, all $100,000 are 11 attributable to California employees. In the next six 12 months only 50,000 of the payroll is attributable to 13 California employees. 14 He then asserts that we -- our argument would 15 be that it's 75 percent would be attributable to 16 employment within California; the first six months at 17 100 percent, second six months at 50 percent, it results 18 in 75 percent. 19 He then goes on to say, which the sentence 20 reads, "Respondent would conclude that the corporation 21 met the 80 percent payroll test for six months out of 22 the year." That's not true. Since it's 75 percent for 23 the whole year Respondent would say that in that example 24 the payroll test was met in zero months out of that 25 year. 26 It -- we agree with -- that his presumption is 27 entirely reasonable but the -- to the contrary, because 28 Respondent assumes that there's zero payroll in 9 1 California attributable to employment in California in 2 any month in 2001 and 2002, even though the Schedule R 3 shows that it was at least 68 percent and 75 percent in 4 those years. 5 There's some important points. In order to 6 further the purpose of the statute to encourage small 7 business in California, Respondent cannot be permitted 8 to assume zero payroll in the two of the seven years. 9 Keep in mind the purpose of this payroll test 10 is to determine if the company is an active business 11 within California. There is no question it was an 12 active business within California for every one of the 13 months during the holding period. 14 The vast majority of company employees were 15 showing up every workday in California during that 16 24-month period just as they were in the rest of the 17 67-month period. 18 Appellants' monthly proportional analysis makes 19 sense and is fair as opposed to a year in evaluating 20 that AvantGo is an active business within California. 21 If you consider the very purpose of the Schedule R 22 apportionment table on which the Respondent relies it -- 23 it comes up with an average of activity within 24 California such that a company that has worldwide 25 operations, it would be reasonable to assume that based 26 on this analysis of this average that that's how much 27 would be subject to tax within the State of California. 28 Instead, Respondent zeroes out two entire years 10 1 and why shouldn't that same average be applicable to -- 2 to these Appellants for payroll purposes? 3 For five of the seven years more than 80 4 percent of payroll was in California. And in two years 5 100 percent was in California. It makes no sense to 6 fail the active business test by zeroing out two entire 7 years only because the fell -- the payroll fell below 80 8 percent on Schedule R. 9 The issue not raised in the staff -- staff 10 summary but which Appellants would like to respond to is 11 the hypothetical on page 14. It asserts that 12 Appellants' propose they would qualify if one entire 13 year in a five-year holding period the company had no 14 payroll in California. We propose no such thing. The 15 hypothetical is wrong. Not only is it speculative, but 16 it's not applicable because the company had payroll in 17 every single month during the holding period within 18 California. 19 We might assert that if the -- if given that 20 example, that hypothetical with four years of payroll, 21 there would probably be in year five 12 months of 22 severance. Because we would then based on a 23 technicality meet that payroll test would the Respondent 24 then say that we're an active business in year five? I 25 don't think anyone would say that. 26 MS. OLSON: Time has expired. 27 MS. KELLERMAN: Thank you. 28 MS. YEE: Ms. Kellerman, let us give you time 11 1 on rebuttal. I'm sure we're going to delve into this in 2 quite some detail. Okay. 3 MS. KELLERMAN: Thanks. 4 MS. YEE: Franchise Tax Board. 5 MS. HODGES: Good afternoon, Madam Chairwoman 6 and Members of the Board. My name is Ann Hodges and I 7 represent the Franchise Tax Board. 8 To my right is Bill Hilson, also representing 9 the Franchise Tax Board. 10 At issue in this appeal is the qualified small 11 business stock incentive which allows shareholders to 12 exclude 50 percent of the gain from the sale of 13 qualified small business stock. 14 The Legislature modeled the California small 15 business stock provisions after the Federal qualified 16 small business stock provisions, but also added specific 17 requirements designed to ensure that shareholder 18 investments were made in California. 19 One such requirement which is at issue in this 20 appeal is that for substantially all of a shareholder's 21 holding period 80 percent of the corporation's payroll 22 expense must be attributable to employment in 23 California. 24 It is well settled by your Board that it is the 25 shareholder's burden to establish entitlement to items 26 reported on the return. However, because the Franchise 27 Tax Board has access to a corporation's reporting of 28 payroll on its income tax returns, during qualified 12 1 small business stock audits it routinely obtains and 2 examines this information to assist shareholders in 3 meeting this burden. 4 In this case when AvantGo's payroll reporting 5 on its income tax return was examined it was determined 6 that for 64 percent of Appellants' holding period 7 AvantGo met the requirement that 80 percent of its 8 payroll expense is attributable to California. 9 Because not even Appellants are arguing that 64 10 percent is substantially all Respondent disallowed the 11 exclusion. 12 Appellants reference the two-year period of 13 2001 and 2002 when approximately 34 United Kingdom 14 employees, 4 Chicago employees and 200 California 15 employees were terminated by AvantGo. They argue that 16 any payroll expenses associated with the termination of 17 these employees should be removed from the payroll 18 factor. Appellants contend that if these expenses are 19 removed AvantGo's -- the percentage of AvantGo's payroll 20 would increase from 75 percent to 80 percent in 21 California. 22 However, Appellants -- Appellants' arguments 23 fail for the following reasons; The statute at issue 24 specifically requires that 80 percent of a corporation's 25 payroll expense be attributable to employment in 26 California. 27 Appellants admit that for income tax purposes 28 severance pay is properly treated as income to the 13 1 employee and a deductible expense for the employer. 2 On page 9 of Appellants' reply brief they state 3 that. It is common practice to include all forms of 4 compensation including severance and other termination 5 costs as payroll expenses on a company income tax 6 return. The severance and other costs are included 7 because they are taxable to the employee and the company 8 takes a corresponding deduction for amounts on its tax 9 returns. 10 Notwithstanding this admission and the fact 11 that this is an income tax dispute, Appellants argue 12 that certain cases that treat severance arrangements as 13 something other than wages for unemployment insurance 14 purposes should control this dispute. 15 However, these cases themselves do not stand 16 for the proposition that severance pay is something 17 other than income to the employee or a business expense 18 deduction to the employer. What these cases do is 19 nothing more than ease the hardship being encountered by 20 a newly laid off employee by exempting severance from 21 payroll taxes. They do not stand for the proposition 22 that severance pay is not income to the employee and a 23 deductible expense to the corporation. 24 Furthermore, assuming arguendo that you should 25 remove termination expenses from the payroll factor 26 Appellants have not done the math to demonstrate that 27 the removal would increase the percentage of payroll 28 attributable to California to 80 percent. 14 1 Furthermore, any attempts to do the math are 2 hindered by the fact that there is not sufficient 3 information available to conclusively determine the 4 amounts of severance included in AvantGo's payroll 5 factor. 6 Because Respondent's determination was based on 7 actual amounts of payroll reported by AvantGo, it should 8 be upheld. 9 MS. YEE: Thank you, Ms. Hodges. You have five 10 minutes on rebuttal, Ms. Kellerman. 11 MS. KELLERMAN: The -- there's no question that 12 severance is a payroll expense, and that it's an income 13 to the employee and it's deductible by the corporation. 14 That's not -- it has nothing to do with the statute that 15 says that 80 -- 80 percent of the payroll expense must 16 be attributable to employment. That is entirely the 17 argument. 18 We -- we also have -- we have determined -- 19 well, first of all, it was determined in each of the 20 cases including in the new Hire Act that the -- that 21 payroll expense has to be attributable to -- to current 22 employment, and not to -- you know, to severance. 23 If -- if the argument was that just because 24 they can deduct it on payroll expense on their tax 25 return, and a person should be entitled to an Hire Act 26 credit for people that they fired is ludicrous. 27 It's -- it's very clear that all of this is to 28 incentivize employment within California. There is no 15 1 argument on the fact that there's -- it's part of 2 payroll expense you can deduct it or it's part of income 3 you include it, I don't see how that applies to this 4 case at all. 5 The other issue is that we have not done the 6 math. We have done the math. It is included in the 7 hearing summary. I can find the page. 8 MR. LIN: While she's taking a look at that, 9 I'd like to take a minute just to make a few comments. 10 I was the founding CEO of AvantGo. And I've known both 11 Linus and Rafael, we've been friends and worked together 12 for more than 15 years. 13 Together we started three software companies 14 here in California and we generated hundreds of jobs for 15 Californians. 16 In 1997 we started AvantGo and than to -- to 17 this day AvantGo continues to employ Californians here. 18 From the day we started working together on AvantGo in 19 Rafael's living room to the day that AvantGo was 20 acquired by Sybase, five and a half years later, more 21 than 85 percent of our employees were based in our 22 Silicon Valley headquarters. 23 With the exception of relatively few lonely 24 sales reps who worked out of their home offices, every 25 one of our employees reported to work every day for 26 those five and a half years here in California. 27 There's no question that from the time we 28 started the company until the economic downturn in 2001 16 1 we had the bulk of our employees in California, we were 2 qualified as small business, and we met the payroll 3 test. 4 Following the layoffs in 2002 again we met the 5 payroll test and we were a qualified small business. 6 Now, during those two difficult years in 2001 7 and 2002 we saved a disproportionate number of jobs here 8 in California. We went from 85 percent of our employees 9 working in California to 92 percent of our employees 10 working here in California. 11 So if we met the payroll test before and met 12 the payroll test after, it seems shocking that somehow 13 we wouldn't meet the payroll test when we're 14 consolidating jobs here in California. The only way 15 that you can explain that is the fact that in the UK, 16 for example, it costs us five times as much to lay off 17 an employee doing equal work. 18 We pay 11 weeks of severance to somebody here 19 in California. But to keep that job we lay off somebody 20 in the UK and pay 22 weeks of employ -- of severance. 21 So, when you count severance, which is not 22 payment for employment, payment for losing your job, 23 when you count that as employment you can skew the 24 numbers that we fail the test. Okay. 25 If you agree with the Respondent's assertion, 26 right, what we should have done to maintain our QSB 27 status -- what we could have done and should have done 28 is to lay off 20 more people in California and keep 20 17 1 more jobs in London. And if we had done that we 2 wouldn't be here today. That doesn't really make any 3 sense to me. And I think really violates both the 4 letter and spirit of the QSB statute. 5 MS. YEE: Thank you. Ms. -- Ms. Kellerman, 6 please. 7 MS. KELLERMAN: Yes. On page 7 of the -- of 8 the summary brief we have indicated we've quantified the 9 termination costs and the (inaudible) payroll expense 10 we've recalculated what the Schedule R would look like 11 if you pulled out the termination costs. 12 At one point Respondent indicated that the -- 13 the termination within California would need to be $9 14 million per her calculation. Unfortunately, there is no 15 more than 2.4 million in total severance cost, so that's 16 impossible. 17 MR. LIN: The 2.4 million in severance comes 18 from numbers that were reported in a variety of places, 19 10Q statements as well as public announcements. If you 20 actually look at total severance of $2.4 million and you 21 exclude the severance from total payroll numbers that 22 were reported in our filings, California payroll would 23 be 13.4 million, non-California payroll would be 3.2 24 million for a total of 13 -- 16.6. 25 In that -- in those numbers 81 percent of that 26 payroll expense is California. Okay. 27 MS. OLSON: Time has expired. 28 MS. KELLERMAN: Okay. 18 1 MS. YEE: Okay. Thank you very much. Let me 2 open it up for questions and I know we'll be delving 3 into this. 4 Questions, Members? Ms. Steel, please. 5 MS. STEEL: So, you reported severance pay as a 6 payroll? 7 MS. KELLERMAN: Yes. 8 MS. STEEL: On the tax return. How that 9 counted if -- can they do other ways to do it when they 10 do the tax report, severance pay as something other than 11 payroll taxes? Right now that that's the problem we 12 have right now. Severance pay -- 13 MS. HODGES: For income tax purposes it's -- 14 it's commonly pay -- severance pay is commonly treated 15 as a business expense or a payroll expense. 16 MS. STEEL: So it is payroll -- it's -- that's 17 what you are saying? 18 MS. HODGES: For income purposes. The other 19 code sections and materials they were citing pertained 20 only to payroll taxes. Funding things like Social 21 Security or Unemployment Insurance, et cetera. 22 But for income tax purposes severance pay is 23 considered -- 24 MS. STEEL: Has to be from payroll. 25 MS. HODGES: It is a payroll -- 26 MS. STEEL: It was reported as a payroll tax. 27 MS. HODGES: -- expense and commonly included 28 in the Schedule R numbers. If you know what I mean by 19 1 Schedule R. I can explain that. 2 MS. KELLERMAN: But the -- the statute doesn't 3 say total payroll expense. It says total payroll 4 expense attributable to employment. 5 MS. STEEL: But severance pay -- 6 MS. KELLERMAN: And that's the discussion. 7 MS. STEEL: -- went to -- dismiss the 8 employees -- 9 MS. KELLERMAN: Right. 10 MS. STEEL: -- that you pay. So, it's -- you 11 know, you can go either way. I mean, I was reading this 12 case is that, you know, severance pay is a payroll 13 taxes, because you are giving somebody -- did you take 14 taxes out when you give severance pay? 15 MS. KELLERMAN: Severance pay is subject to 16 tax. 17 MS. STEEL: So you take the payroll -- 18 MS. KELLERMAN: Uh-huh. 19 MS. STEEL: Okay. 20 MS. KELLERMAN: It is included -- it's commonly 21 included in total payroll expense -- 22 MS. STEEL: Right. Right. 23 MS. KELLERMAN: -- as would be the gain on the 24 stock options that people would exercise when they were 25 terminated. So that would serve to further inflate the 26 total payroll expense. 27 MS. MANDEL: Question. 28 MS. YEE: Ms. Mandel, please. 20 1 MS. MANDEL: As I understand the arguments, for 2 the payroll test for the qualified small business stock 3 exclusion it -- the statutory language is payroll 4 attributable to employment in California. What 5 Franchise Tax Board is looking at to determine payroll 6 is -- and -- and it's -- it's a matter of convenience 7 and a matter of courtesy and a matter of -- you know, 8 how you've been doing it, is the payroll factor for 9 apportionment purposes on the Schedule R of the 10 corporate return. And because severance pay is 11 compensation and compensation is includable in the 12 employee's income, it's deductible, it's part of the 13 payroll factor because the payroll factor is defined as 14 compensation figures, it goes into the payroll factor 15 for apportionment purposes. 16 For purposes of Social Security or Unemployment 17 Insurance where those taxes are based on wages, there's 18 case law that says different things are wages and things 19 that might be paid whether out of a settlement or other 20 things from employers, something may be wages and it may 21 not be wages. And what the taxpayers have put on is 22 information of severance pay for those -- purposes of 23 those taxes are not wages and the reason they're not 24 wages is they're saying they're not attributable to the 25 employment, it's not like back pay. Back pay 26 settlements will be considered wages. But they're 27 still -- the severance pay is still compensation. 28 What the taxpayers are arguing and I haven't 21 1 really heard from Franchise Tax Board, Franchise Tax 2 Board looks at the corporate payroll factor, and that's 3 a -- that's an easy thing to do. The payroll factor 4 being based by statutory language on compensation. 5 Taxpayer's point is that the statutory language 6 for this provision is payroll -- payroll expense not 7 being further defined, but payroll expense attributable 8 to employment in California. 9 When -- when Franchise Tax Board short titles 10 it when they're talking you say payroll expense in 11 California, but their focus is it's payroll expense 12 attributable to employment in California and their point 13 is they think that when the Legislature used those words 14 they used those words to try to be specific about 15 something. 16 The Legislature didn't draft a statute that 17 referred you to look at the corporate payroll factor 18 under 25 whatever it is -- 25 something, in the -- you 19 know, in the apportionment and allocation provision. 20 So, is there something -- what is it that backs 21 up the Franchise Tax Board's position that you should 22 read payroll attributable to employment in California 23 to -- to mean the -- basically the same thing as what 24 the payroll factor is for apportionment purposes and 25 not -- not -- not exclude something like severance pay? 26 MS. HODGES: Our basis is based on the idea 27 that the plain language of the statute should control 28 and it says we've established that it's a payroll 22 1 expense, severance pay. And it wouldn't -- it wouldn't 2 exist but for a preexisting contractual employment 3 relationship. So, you have an expense that is 4 attributable to employment. 5 MS. MANDEL: And -- and I guess the taxpayers' 6 response to that is probably that what she was saying 7 before, which is how does that fit with what the 8 Legislature was trying to do in adopting the exclusion 9 to encourage development of small business. 10 MS. KELLERMAN: May I respond to that? 11 MS. MANDEL: Is that -- 12 MS. KELLERMAN: That's correct. That's 13 correct. And in fact employment -- as she says, it's 14 attributable to employment, but employment is defined as 15 covered employment is limited to those providing 16 services. 17 MS. MANDEL: And that's in the qualified -- 18 MS. KELLERMAN: That's in -- that's in the Hire 19 Act. It's in the Hire Act. It's in the Court case, 20 Exhibit A, B and C. It's -- it's throughout each of 21 those we provided today. 22 MS. HODGES: It's not in the statute. It's in 23 new legislation draft -- enacted in 2010 applying to 24 payroll, Social Security taxes, et cetera. 25 MS. KELLERMAN: But it's a credit you would get 26 on your -- if you apply. 27 MS. HODGES: The Legislature didn't -- 28 MS. KELLERMAN: So in this -- if it was total 23 1 payroll expense such that you -- you hired someone and 2 then fired them under the FTB's definition you would be 3 entitled to a tax credit for that -- that person you 4 fired. 5 MS. MANDEL: Does -- is there anything in the 6 legislative history of the qualified small business 7 stock provisions that talk about whether California or 8 was it just a -- 9 MS. HODGES: The legislative history more talks 10 about these requirements generally saying that they were 11 modeled after the Federal incentives but designed to 12 ensure investment in California businesses. They don't 13 specifically talk about -- 14 MS. MANDEL: How that's going to be -- 15 MS. HODGES: Correct. 16 MS. MANDEL: -- determined. 17 MS. YEE: Okay. Anything further, Ms. Mandel? 18 MS. MANDEL: Well, the only thing -- other 19 thing I didn't hear FTB talk about is the substantially 20 all. Because I guess they didn't get past the severance 21 pay 80 percent. 22 MS. HODGES: We're arguing that we're still at 23 64 percent which not even Appellants have argued a 24 substantially all. I'd be happy to address that if you 25 would like me to, what our argument regarding how you 26 should define that. 27 MS. KELLERMAN: May I -- 28 MS. MANDEL: Yeah, and I think you're at 64 24 1 percent because -- for those two years where they did 2 have some employment, you're saying if you don't get 3 over whatever threshold you might choose, whether it's 4 80 or 85 -- 5 MS. HODGES: No. 6 MS. MANDEL: -- you get nothing. 7 MS. HODGES: No. 8 MS. MANDEL: That's -- that's what I'm hearing. 9 That's how they -- 10 MS. HODGES: Okay. 11 MS. MANDEL: -- view what you're saying. 12 MS. HODGES: Let me clarify that for you. The 13 statutory requirement is that 80 percent of a 14 corporation's payroll expense, and that's 15 specifically -- well, it's stated as 20 but let's just 16 say 80 -- specifically required for substantially all of 17 a taxpayer's holding period. 18 What we did is look at the Schedule R 19 information. And in the years when the payroll factor 20 was less than 80 percent we did not allow any months 21 because they did not meet the statutorily defined 22 requirement that the payroll expenses were 80 percent. 23 As a result, when you added up the number of 24 months -- but for years when they did, they got 12 25 months. So when you add up those months that equals 64 26 percent to test the substantially all portion of the 27 statute. 28 MS. MANDEL: Well -- 25 1 MS. HODGES: Did I clarify -- 2 MS. MANDEL: What do you -- what do you do if 3 the taxpayer has -- you know, not everybody forms their 4 company on January 1st and sells it on December 31st. 5 So, how does -- are you treating -- how do you treat 6 like a short period or -- I mean you got a few months on 7 one end and a few months on the other end. You know, 8 they -- they form their company in October and sell -- 9 sell it, you know, sometimes in March or April. 10 MS. HODGES: Got it. 11 MS. MANDEL: I mean how. 12 MS. HODGES: In this case if for the whole year 13 they met it we gave -- we would give them the short -- 14 the short months, like five months. If we had 15 information available we recognize that the statute says 16 any period and we recognize that that could be 17 reasonably interpreted to mean quarterly, monthly -- if 18 the information was available to test on that we would 19 do that. We just don't have the information -- 20 MS. MANDEL: Because you -- 21 MS. HODGES: -- available. 22 MS. MANDEL: Because you're using -- you're 23 using the annual Schedule R. 24 MS. HODGES: Correct. 25 MS. MANDEL: So you're like so therefore I got 26 to look at that whole year. 27 MS. HODGES: Yes. 28 MS. MANDEL: But if you had their -- 26 1 MR. LIN: Quarterly. 2 MS. MANDEL: -- payroll books that went into 3 the Schedule R for every month -- 4 MS. HODGES: We'd look at that -- 5 MS. MANDEL: -- you'd look at every month then? 6 MS. HODGES: Yes. 7 MS. MANDEL: Okay. 8 MS. KELLERMAN: May I reply to that? 9 MS. YEE: Ms. Kellerman, please. 10 MS. KELLERMAN: Thank you. 11 The -- actually, the -- the table she's 12 referring to on page 11 shows that they used the 13 California payroll factor as it applies for that whole 14 year, and then they equated into months. 15 So our argument is that you should -- the month 16 is the only -- only measure that's equivalent in all 17 seven periods. So you have to look at the months 18 individually. 19 So, to take these under 80 percent for a year 20 and apply it to 24 months just is not -- it's not -- 21 it's a punitive result for these taxpayers. 22 Or if I may continue ar -- argument, is that it 23 would make more sense if you're going to do that, you're 24 going to look at the averaging that Schedule R provides 25 for you, is to use that average times 12 months. And -- 26 MS. HODGES: Can I respond to that? 27 MS. MANDEL: Can -- let me, before I forget 28 this -- I'm sorry. I'm sorry, Ms. Steel. 27 1 MS. YEE: Ms. Mandel, continue then. 2 MS. MANDEL: The way I understand the facts in 3 this case, unlike you know things that might happen in 4 some other case, the -- the big key is the severance pay 5 which is in a limited period of time, which happened to 6 happen during these two years. And I don't know if it 7 was -- I don't remember if there was information that, 8 you know, all of a sudden people were laid off mid-year 9 and so the 22 weeks carried forward. MR. LIN: 10 Right. 11 MS. MANDEL: So my question is whether you 12 would have records aside from the Schedule R, but the 13 underlying records that would show when these -- when 14 this severance pay was really hitting on a monthly 15 basis. Because 22 weeks, if that's what they were 16 getting, is not a full year. And if you could show -- I 17 mean, we might still have the -- we might -- 18 MR. LIN: We -- we do have it. 19 MS. MANDEL: I mean I'm just -- I'm just 20 wondering whether that's where -- would it make a 21 difference -- I haven't done the, you know, math, that 22 if somebody -- if you weren't -- if you didn't -- if the 23 severance pay wasn't hitting until halfway through 2001 24 and halfway through -- so that you would get some of the 25 months in those years counted on a monthly basis because 26 the other years I don't think there's any dispute about 27 the 80 percent. And -- and FTB is nodding yes. 28 Are you nodding yes? 28 1 MS. HODGES: I am nodding yes. 2 MS. MANDEL: So do you -- do you have that kind 3 of -- do you have that kind of information available? 4 MR. LIN: So we -- we don't have the 5 month-to-month payroll. Unfortunately, we just haven't 6 been able to get those records. The company has been 7 acquired twice since -- since we started. 8 What we do know historically is that the layoff 9 occurred in April of 2001 and in August of 2002. So, in 10 both years, the 22 weeks of severance would be fully 11 captured in each of those years. 12 MS. MANDEL: But there's more than 22 weeks in 13 a year. 14 MR. LIN: Right, that's what I'm saying. 15 MS. MANDEL: So the -- 16 MS. KELLERMAN: Go ahead. 17 MS. MANDEL: I can do that math. I'm just 18 wondering if you -- if you have or if there's publicly 19 available, whether it was through SEC filings or 20 whether -- whoever, did Ernst and Young do the 21 returns -- whether they still have information that 22 might be available to you somehow, or some other type of 23 information to show when people, you know, were letting 24 go -- being let go. I mean, maybe you don't have the 25 exact payroll records but maybe you have something that 26 would help go to trying to determine it on a 27 month-to-month basis because there also may not be a 28 dispute about what the dollar figure is of the severance 29 1 pay, itself. 2 MR. LIN: So -- so a lot -- 3 MS. MANDEL: Did -- did you have a -- you seem 4 to be -- 5 MS. HODGES: I don't think we know for sure 6 what the dollar payment is. The 2.4 figure is -- was 7 reported in the financial statements. 8 MS. MANDEL: Right. 9 MS. HODGES: And it could be -- there could be 10 a book tax difference for -- they're an accrual corp -- 11 accrual method corporation, but for payroll factor 12 purposes you report on a cash basis. 13 So I don't know if 2.4 is the right number. 14 That also seemed to include lease termination costs. 15 So -- 16 MS. MANDEL: Costs of closing office kind of 17 thing? 18 MS. HODGES: Yes. I'm not sure what the right 19 number is so we do have that hurdle to overcome, also. 20 MS. MANDEL: Okay. What -- but I think they 21 understand that. 22 MR. LIN: So -- 23 MS. YEE: Mr. Lin. 24 MR. LIN: -- a logical -- a logical way to 25 think about this is that at the end of 2000 we met the 26 payroll test. Okay. So therefore the very first four 27 months of 2001 we should get credit, right? Because we 28 didn't have the layoff yet. So there should be at 30 1 least four months that we count in 2001. 2 Then you move to the layoff and you pay people 3 severance for up to 22 weeks. Now we know we -- we laid 4 off more people outside of California than in 5 California. So at the conclusion of those 22 weeks we 6 are then in compliance again for the rest of that year. 7 Right? 8 So, for all of 2001 we should only lose credit 9 for 22 weeks. Okay. 10 For 2002 we meet the payroll test for the first 11 eight months of the year until we had the layoff in 12 2002, at which point we again lay off more people 13 outside of California than we lay off in California. 14 After 22 weeks of severance we're then again in 15 compliance which we see again in 2003 we met the payroll 16 test. 17 So really out of the entire seven tax periods 18 there's actually only 44 weeks that we're not in 19 compliance. That's even if you include the severance. 20 MS. KELLERMAN: May I -- 21 MS. HODGES: We just don't know what the 22 numbers are. 23 MS. MANDEL: Well, okay, we don't know what the 24 numbers are -- 25 MS. YEE: Right. 26 MS. MANDEL: -- in terms of the -- I mean they 27 say they know what the number is but you say we don't 28 know what the number is in terms of how much the 31 1 severance pay is. 2 MS. HODGES: Also we -- were they giving 3 California employees severance? I know there were 4 documents attached to SEC filings -- 5 MR. LIN: We -- we did. 6 MS. MANDEL: Okay. 7 MS. YEE: Okay, but -- 8 MS. MANDEL: But however much -- however big 9 the severance -- you know, it's like a big balloon, the 10 severance pay -- however big it is, what they're saying 11 is we -- you know, we did our layoffs starting from this 12 point. We know that overseas there's a bigger 13 requirement -- this is what they're saying. And I know 14 you're saying, well, I don't know that for a fact and so 15 perhaps they would have to show you something or show 16 the Board something that would substantiate that. 17 I mean, I have some familiarity that 18 overseas -- I don't know what the rules are in the UK, 19 but I just remember tales of don't fire the -- don't 20 fire the maid because we'll have to pay her for a year 21 even though she's not working so great. 22 But you -- you know, so -- what they're saying 23 is whatever the number is leave the number in. We don't 24 care if you leave the number in -- I mean they do care 25 but, you know, for purposes of this leave the severance 26 pay number in, whatever it is. 27 MS. HODGES: Uh-huh. 28 MS. MANDEL: But we didn't have severance pay 32 1 'til we laid people off. If we didn't lay them off 2 until April of one year and the maximum that people got 3 paid -- severance pay for is 22 weeks, and if we had a 4 similar situation the next year where we didn't lay 5 people off until August and then we had 22 weeks, 6 they're saying that only those 22-week -- during those 7 22-week periods is there even a possibility on it? 8 Whether you're doing it week by week or month by month 9 only in those 22 weeks each of those years is there a 10 possibility that we're blowing the payroll test because 11 that's when we had the -- that's when we had the 12 severance pay issue? 13 And that the other months would be clean of 14 severance pay. And that there's not really a dispute 15 based on how many -- you know, what -- I mean, that -- 16 that's what he's saying and you're saying well, I 17 don't -- I don't really know when they laid off and how 18 long it really went for. And those are things that they 19 might be able to come up with something on. 20 But -- 21 MS. HODGES: Great. 22 MS. MANDEL: But just on the general construct 23 of it's only a 44-week period if we were to look 24 month -- month to month is there -- is there an issue -- 25 because you said earlier, yeah -- 26 MS. HODGES: I would -- 27 MS. MANDEL: -- if you had information you 28 would look month to month. 33 1 MS. HODGES: If I had month-to-month 2 information I would be happy to look at it, but we don't 3 know the cause of the shortfall and I know from 1990 -- 4 MS. MANDEL: What -- what do you mean 5 shortfall? 6 MS. HODGES: Excuse me, that it doesn't meet 80 7 percent. 8 MS. MANDEL: Okay. 9 MS. HODGES: I -- the payroll was decreasing in 10 California from 199 -- 1999 to 2000 it went down four 11 percent, so I just don't know. 12 But if they have information we'd -- 13 MS. MANDEL: Yeah. Because when I read through 14 this my reaction -- one of my reactions was how come 15 we're not looking -- how come we're not looking month to 16 month. How come we're getting zero for some of these 17 years where we know they had all these employees in 18 California and most of their employees have always been 19 in California according to the numbers? And how come 20 they're getting zero for the whole year? 21 So I was happy to hear you say, well, if I knew 22 what to do month to month I would -- I would -- I would 23 count the months. And I -- maybe they can, you know, 24 produce some information that would -- 25 MS. KELLERMAN: May I -- 26 MS. MANDEL: -- take their words and make them 27 into doc -- you know, documents that are out there in 28 the world that -- 34 1 MS. YEE: Yeah, Ms. Kellerman, can you help? 2 MS. KELLERMAN: May I respond? 3 MS. YEE: Yeah. 4 MS. KELLERMAN: They're -- you know, the -- the 5 reports filed with the SEC indicate the exact months of 6 the layoff and the exact dollar amounts. There are no 7 payroll records -- monthly payroll records available. 8 We were able to obtain annual payroll records for 2002 9 but it's just California and the United States and 10 Illinois and that there's an 80 percent within -- within 11 the domestic just based on those alone. 12 But I wanted to -- to reply to something else 13 you said. You asked whether Ernst and Young perhaps had 14 records. Ernst and Young put these tax returns together 15 and felt it necessary to attach a disclosure statement 16 saying that they had to use estimates because they 17 didn't have individual information from the subsidiary 18 and they felt -- so the number -- every number on that 19 tax return is somewhat suspect because they -- and they 20 felt it large enough to protect themself from penalty 21 with a huge net operating loss on a tax return -- they 22 felt it necessary to say, "We can't really, you know, 23 tell you that these numbers are accurate," but that is 24 entirely -- the Schedule R on those two tax returns is 25 entirely what the Respondent is relying on. 26 MR. LIN: I think -- so a couple things. One, 27 as Sheila mentioned, the dates of the layoffs, April and 28 August, are public information. They've been reported 35 1 in the 10Qs as well as in news articles and other things 2 that we can find on line. 3 The -- we don't have per employee information 4 about exactly how much any individual employee's 5 severance was. It's possible that a managing director 6 would have a longer severance than 22 weeks. 7 However, what I can tell you is that when you 8 look at the rate of growth for AvantGo we were hiring 9 employees at an incredibly fast rate. The people that 10 we were letting go were the newest employees. And so 11 really the severance that we are paying, since we were 12 laying off the newest employees first, we were paying 13 really the minimum severance. Right. 14 And when you look at it in California the 15 minimum severance was -- I mean we were generous, the 16 minimum severance was about two weeks. We ended up 17 paying most people four to five weeks. 18 What I remember, in Eng -- in the UK, however, 19 was that the minimum severance was guided not by 20 anything that we can control, but by statutory 21 regulation. That was 22 weeks. And I don't have it in 22 these notes here, but in fact there is public 23 information that shows that the minimum required 24 severance for these employees would be 22 weeks. And we 25 can provide that, as well. 26 MS. KELLERMAN: We've actually already provided 27 that information. 28 MS. YEE: Yeah, I was going to say I think you 36 1 have -- 2 MS. KELLERMAN: It's in the -- 3 MS. YEE: -- the -- let me -- I just want to 4 get clear, for the Franchise Tax Board what -- what 5 specifically would you need to look at? Because you've 6 seen the SEC filings obviously. 7 MS. HODGES: Right. I notice ADP was their -- 8 their payroll tax preparer. Any records that ADP might 9 have. 10 MS. KELLERMAN: I -- the only ones I was able 11 to obtain from somebody at E & Y -- or, actually, I'm 12 sorry, from the -- the acquiring company, were records 13 for 2002. And those -- those -- those have been 14 provided. It indicates the number of employees in each 15 state that's being paid. We had evidence that there was 16 only one employee left in Illinois yet there were five 17 people on the payroll. So that indicates that four were 18 receiving severance. 19 We have no records whatsoever for the UK. 20 They're just not available to us. 21 MS. YEE: Okay. 22 MS. KELLERMAN: All we have is -- is 23 corroborating evidence that we were required to pay for 24 the -- and the number of employees. We have the number 25 of employees before and after. And the -- 26 MR. LIN: Total several months severance that 27 was paid to the UK. 28 MS. KELLERMAN: And the total severance that 37 1 was paid by -- by area. 2 MS. YEE: Uh-huh. Okay. Any other suggestions 3 for what they could produce? 4 MS. HODGES: I -- those -- those are the things 5 we look at. 6 MS. YEE: Okay. Very well. 7 MR. HORTON: Anthony wants to say something. 8 MR. EPOLITE: Madam Chairwoman. 9 MS. YEE: Yes, Mr. Epolite. 10 MR. EPOLITE: If I might. 11 MS. YEE: Yes. 12 MR. EPOLITE: The severance pay issue here is 13 really the threshold issue to get past because as Ms. 14 Mandel was trying to get to here, by trying to narrow 15 the months in which there's severance pay what you're 16 doing is picking up months in the numerator for purposes 17 of calculating the holding period, which then gets you 18 to the second issue which is defined substantially 19 all -- 20 MS. YEE: Yup. 21 MR. EPOLITE: -- of the taxpayer's holding 22 period. And that's an issue in this case as to whether 23 substantially all test is met and whether that is an 80 24 percent test for the holding period or 85 percent as 25 argued by Respondent. 26 So, severance pay is one thing. You want to 27 pick up months for Appellant so that there's additional 28 months for purposes of the -- meeting the 80 percent 38 1 payroll test. But then it's a matter of -- there's the 2 denominator for each Appellant's holding period and how 3 many months you're picking up in the numerator for 4 substantially all of their holding period and whether 5 that's meeting an 80 percent substantially all test or 6 an 85 percent substantially all test. And that needs to 7 be determined still. 8 MS. YEE: Yes, okay. Thank you. 9 Ms. Kellerman. 10 MS. KELLERMAN: My -- the Board in Cantor went 11 through this process just as Respondent and I did. I've 12 got this many 80 percents; she's got this many 85 13 percents. They went through that entire discussion and 14 came up with the conclusion that the common and legal 15 use of the word would be 80 percent. And they were 16 defining the word substantially, not substantially 17 equivalent or substantially all. 18 MS. YEE: It didn't quite happen that way 19 but -- okay. 20 MS. KELLERMAN: Oh, I can read it to you. 21 MS. YEE: No, that's all right. We remember 22 that. 23 Okay, Mr. Horton. 24 MR. HORTON: No, no questions. 25 MS. YEE: Okay. Other questions, Members? 26 Okay, hearing none is there a motion? 27 MS. MANDEL: Take it under submission. 28 MS. YEE: Okay, motion by Ms. Mandel to take 39 1 the matter under submission. Is there a second? 2 MR. HORTON: Second. 3 MS. YEE: Second by Mr. Horton. 4 Without objection. Okay, we will take this 5 matter under submission. 6 Thank you all very much for coming forward. 7 We're going to discuss your matter later today -- 8 MS. KELLERMAN: Great. 9 MS. YEE: -- and send you written notice of our 10 decision. Thank you. 11 Thank you, Franchise Tax Board. 12 ---oOo--- 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 40 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 July 13, 2010 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 40 13 pages constitute a complete and accurate transcription 14 of the shorthand writing. 15 16 Dated: August 23, 2010. 17 18 19 ____________________________ 20 BEVERLY D. TOMS 21 Hearing Reporter 22 23 24 25 26 27 28 41