1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 AUGUST 25, 2010 10 11 SALES AND USE TAX APPEAL HEARING 12 APPEAL OF 13 C1 GRIMMWAY ENTERPRISES, INC. 14 NO. 379508, 379965 (AR) 15 AGAINST PROPOSED ASSESSMENT OF 16 SALES AND USE TAX 17 18 19 20 21 22 23 24 25 Reported by: Juli Price Jackson 26 CSR No. 5214 27 28 1 1 2 P R E S E N T 3 For the Board Betty Yee of Equalization: Chair 4 Jerome E. Horton 5 Vice-Chair 6 Barbara Alby Acting Member 7 Michelle Steel 8 Member 9 Marcy Jo Mandel Appearing for John 10 Chiang, State Controller (per Government Code 11 Section 7.9) 12 Diane G. Olson, 13 Chief Board Proceedings 14 Division 15 For Board of David Levine 16 Equalization Staff: Staff Counsel 17 18 For Department: Chris Schutz Tax Counsel 19 Robert Tucker 20 Tax Counsel 21 Kevin Hanks Chief, Headquarters 22 Operations Division 23 For Petitioner: Joseph A. Vinatieri 24 Attorney 25 Jason DeMille Attorney 26 Steve Barnes 27 Taxpayer 28 ---oOo--- 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 AUGUST 25, 2010 4 ---oOo--- 5 MS. OLSON: Our first item is C1, Grimmway 6 Enterprises. Please come forward. 7 Board Proceedings has received contribution 8 disclosure forms for this morning's hearings from the 9 parties, agents and participants. All forms were 10 properly completed and signed. No disqualifying 11 contributions were disclosed. All parties, agents and 12 participants are on the alpha listing provided to your 13 office. 14 Each person sitting at the table will be asked 15 to introduce themselves and, if necessary, their 16 affiliation with taxpayer for the record. 17 For this first case 15 minutes is allocated for 18 the Petitioner's opening presentation, followed by 15 19 minutes for the Department's presentation and five 20 minutes is allocated to the taxpayer for rebuttal. 21 Ms. Yee? 22 MS. YEE: Thank you very much. Let us all get 23 situated. Looks like we're going to be nourished this 24 morning. 25 MR. VINATIERI: Healthy carrots. 26 MS. YEE: Good morning. Let me have Mr. Levine 27 introduce the issues in this matter. 28 Good morning. 3 1 MR. LEVINE: Good morning, Madam Chair, 2 Members, David Levine for the Appeals Division. 3 The issue in this petition and claim of 4 Grimmway Enterprises, Inc. is whether the purchase and 5 use of the subject equipment qualifies for the partial 6 exemption provided by Revenue and Taxation Code 7 Section 6356.5. 8 MS. YEE: Thank you very much. 9 Good morning, gentlemen. 10 MR. VINATIERI: Good morning. 11 MS. YEE: If you'll introduce yourselves for 12 the record. You have 15 minutes for your presentation. 13 MR. VINATIERI: Good morning, Members of the 14 Board, I'm Joe Vinatieri on behalf of the Grimmway 15 Farms. 16 MR. DE MILLE: I'm Jason DeMille on behalf of 17 Grimmway Farms. 18 MR. BARNES: Steve Barnes, CFO of Grimmway 19 Farms. 20 MS. YEE: Please proceed. 21 MR. VINATIERI: Thank you. 22 Thank for the time this morning. And, as you 23 can see, we have -- my partner, Jason DeMille, and also 24 Steve is the CFO of Grimmway. 25 Grimmway's a carrot farmer. They're located in 26 the Bakersfield area and they pioneered baby carrots, as 27 you can see, we have some here. 28 Grimmway grows and harvests carrots, takes them 4 1 to a facility, which is located near the carrot fields 2 where it produces the carrots, including whole and baby 3 carrots. 4 Now, as you can see, we have a package of whole 5 carrots and we have a package of baby carrots right here 6 (indicating). 7 And if a picture's worth a thousand words, a 8 video clip is worth ten thousand words. So, what we'd 9 like to do right is show you a three minute clip of the 10 Food Network show called "Unwrapped." Some of you've 11 probably seen it. It was produced in 2006. And it 12 shows how Grimmway produces baby carrots. 13 (Whereupon there was a video presentation.) 14 MR. VINATIERI: There's the package we just 15 saw. Actually, this is the newer one, thank you, it's 16 fresher. 17 In 2001, as part of the budget deal, AB 426 18 from -- by Cardoza proposed partial sales tax exemptions 19 to provide modest tax relief to the agricultural sector 20 or our economy and to encourage farming and farmers. 21 And I am sure many of you remember this because 22 there wasn't a single dissenting vote. The bill created 23 a partial sales tax exemption for farm equipment and 24 machinery that was purchased for use by a qualified 25 person to be used in producing and harvesting 26 agricultural products. 27 Thereafter, this Board enacted Reg. 1533.1. 28 And the reg provides that a person is qualified for the 5 1 partial exemption if the person is engaged in a line of 2 business described in Standard Industrial Code, SIC 3 Codes 0111 to 0291, or -- or if the person's engaged in 4 01 and 02 and performs activities -- activities in 0711 5 to 0783. 6 The reg also provides that equipment is used in 7 producing and harvesting ag products when it's used in 8 performing activities again described in Major Groups 9 01, 02 and 07 of the SIC Code. 10 So, Grimmway is a farmer engaged in the 11 production of vegetables under 0161. It also performs 12 activities described in 0723, namely various activities 13 on its crops with the intent of preparing them for 14 market. 15 As a qualified person, Grimmway claimed the 16 partial exemption on the farm equipment and machinery 17 which it purchased for use in producing and harvesting 18 the baby carrots. 19 However, the Department says that Grimmway is a 20 manufacturer engaged in manufacturing baby carrots under 21 SIC Code Section 2099 and denied the partial exemption. 22 The issue for this Board to determine is 23 whether the Grimmway is a farmer, 0161, which performs 24 activities on its carrot crop with the intent of 25 preparing them for the market, 0723, or is it basically 26 a manufacturer of prepared products under 2099? 27 Grimmway is entitled to the partial exemption. 28 It is a qualified person who purchased equipment to be 6 1 used in producing and harvesting ag products. 2 Let's go through "qualified person." 3 Grimmway's a carrot farmer. Nobody disputes that. 4 Grimmway also performs activities described in 0723. 5 It starts with a raw, fresh carrot and ends 6 with a raw fresh carrot -- in this case, a baby carrot. 7 0723 involves various activities performed on 8 crops subsequent to their harvest with the intent of 9 preparing them for market. And there is some examples 10 of those activities that fall within 0723. 11 For example, one is what we call flax 12 decorticating and retting. After harvest, flax is 13 retted or, in other words, rotted, by soaking it in 14 water and chemicals to bacterially dissolve the pectins 15 and lignins inside the plant stems. You didn't know 16 we'd be going back to high school chemistry. After 17 retting, the plant systems are decorticated, which 18 involves removal of the stem husk to retrieve the flax 19 fiber. And, as you can see, this is a rather invasive 20 chemical process. 21 But that's in 0723, as is grain grinding. 22 Grain grinding is done for animal feed. Grain grinding 23 involves reducing the size of the grain so it can be 24 more easily digested by the animal. It's done by 25 impact, shearing, or attrition. It's basically cut. 26 It's then chopped up and ground into fine pieces. 27 Another in 0723 is nut hulling and shelling. 28 Almonds -- we're in the middle of the almond capital 7 1 here, for example, have an outer husk, which must be 2 removed and which then exposes the inside shell, which 3 then must also be removed before you can eat the nut. 4 Abrasive rolls remove the hulls and then friction is 5 used to grind off the shell. 6 Another one in 0723, corn shelling. The corn 7 is dried, either on the stalk or in dryers, and then the 8 cobs are put into a machine that removes the kernels 9 from the corn by pressure and friction. The kernels are 10 then used for animal feed or fuel. 11 Lastly in 0723, and there are several other 12 examples, but we also have the packaging of fresh 13 vegetables. It's covered as an activity in 0723, the 14 packaging. 15 We think we're most closely aligned with the 16 grain grinding, but even the Appeals attorney thought 17 were close to maybe nut or corn shelling. 18 For example, if you refer to page 8 of the 19 D & R, the D & R admits that, 20 "The activities listed under SIC Code 21 Section 0723 includes some activities that may 22 arguably be likened to Petitioner's activities 23 at issue," such as, "nut and corn shelling," 24 "which may be likened to carrot peeling" 25 because they involve "the removal of an outer 26 layer." Therefore, "the process of carrot 27 peeling could be classified under 0723." 28 But then the D & R asserts that grain grinding, 8 1 which involves "the process of changing a grain into a 2 desired size" is not similar to what Grimmway does with 3 its carrots because "grain grinding primarily involves a 4 pressure and friction process to reduce the size of the 5 grain." 6 Well, that's exactly what Grimmway is doing. 7 We just saw it on the video. That carrot's outer layer 8 is finely sandpapered and a large carrot is basically 9 made into a smaller carrot. It's a carrot. 10 What Grimmway does is similar to grain 11 grinding, we think, but it's much less invasive and 12 intrusive than some of the other examples. Grimmway 13 makes a larger carrot smaller. 14 And what Grimmway does is less invasive and 15 intrusive, certainly than flax decorticating and rotting 16 or nut hulling and shelling or corn shelling. 17 Grimmway starts with a carrot, ends with a 18 carrot and then packages the carrots, which have also 19 been denied exemption. 20 So, now let's talk about the second aspect, 21 producing and harvesting ag products. Grimmway's 22 equipment is used in producing and harvesting ag 23 products because it's used in activities in Major 24 Groups 01 and 07 of the SIC. The meaning of "producing 25 and harvesting ag products" is illustrated in the regs 26 implementing the liquefied petroleum gas, or LPG, and 27 the farm and machinery equipment exemptions, which were 28 all enacted by AB 426. The definition of the phrase is 9 1 identical in each regulation. 2 Three examples for the LPG exemption are found 3 in 1533(b)(4). 4 First, example A, a farmer who uses LPG to 5 perform an activity on his crop and is entitled to the 6 partial exemption because he's performing activities in 7 Major Groups 01 and 07. Pretty simple. 8 Example 2, a farmer engages a third party to 9 perform services on the farmer's crop. The third party 10 uses the LPG and he's entitled to the partial exemption 11 because he's performing activities found in Major 12 Group 7 on the farmer's crops. 13 But example C, a farmer sells his crop to a 14 third party, a processor, which performs services on the 15 crop using the LPG. In this example, because the 16 processor is a purchaser of the crop and not a farmer, 17 he does not qualify for the partial exemption because 18 he's performing a nonqualified post harvest activity 19 found in Major Group 20. 20 Now, there are similar examples, not quite as 21 clear, but similar examples in the farm and machinery 22 equipment exemption at 1533.1(b)(5). 23 In the first example there is a farmer who 24 grows grapes and removes the moisture from the grapes. 25 That farmer is entitled to the partial exemption. This 26 is because he's a farmer who is performing activities in 27 Major Groups 01 and 07 -- taking out that moisture to 28 make sure those grapes don't rot. 10 1 In the second example, the farmer sells his 2 crop to a third party, who is a processor, who then 3 performs services to that crop. The third party 4 processor, who is not a farmer, does not qualify for the 5 partial exemption because he's performing activities 6 then in Major Group 20. 7 So, what do we learn from these examples? 8 First, a farmer who is performing these activities on 9 his own crop qualifies. 10 The second, if a farmer hires a third party to 11 perform these activities, the equipment qualifies. 12 However, third, if the farmer sells the crop to 13 a processor who performs the activities, he doesn't 14 qualify for the exemption. He's not a farmer. 15 So, in sum, Grimmway's a farmer and performs 16 activities found in Group 7. It's engaged in producing 17 and harvesting ag products and it's entitled to partial 18 exemption. 19 Oh, there's one last thing that needs to be 20 said and that is the purpose and the character of the 21 carrot is preserved. Grimmway starts with a raw, fresh 22 carrot and ends with a raw, fresh carrot. 23 Grimmway does not manufacture the carrot into a 24 new or a different product. It does not cook. It 25 doesn't mash or make the carrot into something else. 26 The purpose and character of the carrot is preserved. 27 It's still a carrot. 28 Grimmway's whole and baby carrots result in 11 1 raw, fresh carrots which are prepared for market under 2 0723. 3 Grimmway also shreds carrots and juices carrots 4 for further processing by others, but it hasn't claimed 5 the partial exemption on those manufacturing activities. 6 It only claimed the partial exemption with respect to 7 its activities in producing baby carrots. And the staff 8 agrees that the equipment used for the whole carrots is 9 exempt. 10 So, what's the conclusion here? It's pretty 11 simple, a carrot is a carrot is a carrot. Whether it's 12 a large carrot or a baby carrot, a carrot is a carrot. 13 Thank you. 14 MS. YEE: Thank you very much. 15 Gentlemen, do you have any further comments at 16 this point? 17 If not, we'll give you time on rebuttal. 18 Okay, very well. 19 Department, please? Good morning. 20 MR. SCHUTZ: Good morning. Madam Chair and 21 Members of the Board, I'm Chris Schutz from the Board's 22 Legal Department, along with Robert Tucker, from the 23 Board's Legal Department and Kevin Hanks from the Sales 24 and Use Tax Department. 25 Petitioner's liability and refund claims should 26 be redetermined in accordance with Appeals Division's 27 recommendation because the tangible personal property at 28 issue is not primarily used in a qualifying activity 12 1 under Regulation 1533.1. 2 Petitioner grows carrots. At issue is 3 machinery and equipment used in the activity of turning 4 undersized carrots into a product termed "baby carrots" 5 by cutting, grinding and polishing these carrots to 6 resemble baby carrots. 7 Also at issue is machinery and equipment used 8 to cool and store baby carrots and forklifts used to 9 unload incoming vegetables and load and move packaged 10 baby carrots. 11 Specifically, Revenue and Taxation Code 12 Section 6356.5, subdivision (a), provides for a partial 13 exemption from sales and use tax purchases of farm 14 equipment and machinery. 15 In order to qualify for this partial exemption, 16 three requirements must be met: The purchaser must be a 17 qualified person, the property must qualify as farm 18 equipment and machinery or parts thereof, and, three, 19 the farm equipment and machinery or parts thereof must 20 be used primarily, which means used 50 percent or more 21 of the time, in producing and harvesting agricultural 22 products or 100 percent of the time with regard to 23 vehicles. 24 As to what types of activities fall into 25 producing and harvesting agricultural products, 26 Regulation 1533.1, subdivision (b)(5), explains that 27 producing and harvesting agricultural products involves 28 the cultivation of land or the growing, raising or 13 1 gathering of commodities described in Major Groups 01 2 and 02 of the Standard Industrial Classification Manual 3 and integral civilities thereto described in Major Group 4 07 of the SIC Manual. 5 With regard to Major Group 01, this includes 6 establishments engaged in the production of crops, 7 plants, vines, trees, carrots, flowers, seeds and 8 vegetables. 9 Major Group 2 includes establishments in 10 keeping, grazing and feeding livestock. 11 Major Group 7 includes establishments engaged 12 in performing soil preparation services, crop services 13 and other veterinary animal services and horticultural 14 services and farm labor management services. 15 Regulation 1533.1, subdivision (b)(5), goes on 16 to explain that, except as otherwise provided under 17 Major Groups 01, 02 and 07, producing and harvesting 18 activities do not include post harvesting activities, 19 nor those activities described or otherwise designated 20 in Major Group 20, Food and Kindred Products of the SIC 21 Manual. 22 Thus, here, we must first determine whether the 23 activities of cutting, grinding and polishing carrots to 24 produce baby carrots is a post harvesting activity or an 25 activity that is described in Major Group 20 of the SIC 26 Manual. 27 If it is an activity that is described in Major 28 Group 20, then the equipment and machinery used for that 14 1 activity does not qualify for the partial exemption. 2 If the activity is just merely a post 3 harvesting activity, then the machinery and equipment 4 may only qualify for the partial exemption if the 5 activity is otherwise provided for in Major Groups 01, 6 02, and 07. 7 First off, there really can be little question 8 that cutting, grinding, and polishing carrots in order 9 to turn them into baby carrots is a post harvesting 10 activity. 11 So, the next question is whether this activity 12 is described in Major Group 20 of SIC Manual or, as 13 specific to this case, is an activity described in SIC 14 Code 2099. We believe it is. 15 The SIC Manual explains that Major Group 20 16 includes manufacturing or processing foods and beverages 17 for human consumption. With regard to SIC Code 2099, 18 food preparation, not elsewhere classified, activities 19 included in this SIC Code are manufacturing prepared 20 foods and miscellaneous foods, specialties, including 21 the manufacture of fresh or refrigerated salads and 22 vegetables peeled for the trade. 23 Thus, the cutting, grinding and polishing of 24 carrots to make baby carrots is a manufacturing activity 25 that is described within SIC Code 2099, as it is peeling 26 and cutting vegetables for the trade. This activity may 27 also be classified as preparation of fresh salads. 28 This conclusion is supported by the North 15 1 American Industrial Classification System, which has now 2 replaced the SIC Codes. This system classifies 3 carrots -- cut, peeled and sliced fresh -- within the 4 manufacturing code Section 311991, perishable prepared 5 food manufacturing. Also included within NAICS Code 6 Section 311991 are the activities of manufacturing 7 salads, fresh or refrigerated and vegetables and 8 potatoes, cut or peeled. These activities are 9 specifically described in SIC Code 2099. 10 This also leads credence to the conclusion that 11 cutting and grinding and polishing carrots to make baby 12 carrots is an activity that is within SIC Code 2099. 13 Now, Petitioner contends that the activity of 14 cutting, grinding and polishing carrots to make baby 15 carrots is not properly classified under 2099 of the SIC 16 manual because the FDA still considers baby carrots to 17 be fresh produce and, therefore, these carrots are not 18 processed or manufactured in the sense they still remain 19 a fresh carrot. 20 Petitioner contends that creating fresh produce 21 must be classified under SIC Code 0723 and not SIC 22 Code 2099. As support for this contention, Petitioner, 23 in part relies on the statement from Thomas Stenzil, who 24 in turn cites to an FDA fact sheet dated March 12th, 25 2007, which describes the FDA's intention to issue final 26 guidance for safe production of fresh cut fruits and 27 vegetables, as evidence that fresh fruit -- fresh-cut 28 fruits and vegetables are still considered fresh and, 16 1 thus, their preparation falls within SIC Code 0723 and 2 not SIC Code 2099. 3 First off, Petitioner's attempt to place fresh 4 produce in SIC Code 0723 is really a distinction without 5 relevance since of vegetables peeled and cut for the 6 trade and salads would still be considered fresh 7 produce, even under Mr. Stenzil's explanation of 8 fresh-cut produce and the FDA's fact sheet statement 9 referring -- referred to by Petitioner. 10 And the activities to create these products is 11 found under SIC Code 200 -- 2099. More importantly is 12 that FDA Guidance for Industry Guide to Minimize 13 Microbial Food Safety Hazards of Fresh-cut Fruit and 14 Vegetables, which was published in February 2008, and 15 this is -- this is the guideline that was referred to in 16 the FDA fact sheet which was presented by Petitioner. 17 And in looking at this fact sheet, I was able 18 to click through to the actual -- the actual guidelines 19 that were referenced in the FDA fact sheet and these 20 guidelines explain their scope and they state that 21 fresh-cut fruits and vegetables are not raw agricultural 22 commodities because they are no longer in their raw or 23 natural state and, instead, have become processed foods 24 as the term is defined in the federal Food and Drug 25 Administration and Cosmetic Act. The Act defines 26 processed food as any food other than raw agricultural 27 commodity and includes any raw agricultural commodity 28 that has been subject to processing, such as canning, 17 1 cooking, freezing, dehydrating or milling. 2 Thus, fresh-cut fruits and vegetables are 3 properly considered processed foods and are subject to 4 the current good manufacturing practices requirements 5 for foods that the FDA promulgates. 6 Thus, these guidelines make it clear that the 7 FDA considers fresh-cut fruits and vegetables, such as 8 baby carrots at issue here, to be considered processed 9 or manufactured foods that is -- that are no longer in 10 their natural state. 11 As such, this supports our conclusion that the 12 activity of processing and manufacturing these baby 13 carrots falls within SIC Code 2099. 14 Additionally, since the cutting, grinding and 15 polishing is not a qualifying activity, the machinery 16 and equipment used to store or cool the carrots after 17 this activity occurs also fails to qualify. And since 18 forklifts are used, in part, to move the processed 19 product once it's been processed, they are not being 20 used exclusively in agricultural operation as required 21 for vehicles and they do not qualify. 22 Next I will address why the activity of 23 cutting, grinding, polishing carrots to make baby 24 carrots is not within SIC Code 0723. 25 The SIC manual explains that Major Group 07 26 describes activities such as crop services for others on 27 a contract or fee basis within this Major Group SIC Code 28 0723 describes the activities of establishments 18 1 primarily engaged in performing services on crops 2 subsequent to their harvest with the intent of preparing 3 them for market or further processing. Thus, this SIC 4 Code describes activities by persons that support crop 5 and animal farm operations. 6 SIC Code 0723 describes crop services that 7 represent the most basic amount of post harvesting 8 activity necessary to prepare the crops for market or 9 further processing. Thus, these activities appear to be 10 post harvesting activities that are not -- that are 11 normally incident to growing, raising or harvesting of 12 agricultural commodities such as cleaning nuts, hauling, 13 shelling, custom grain grinding, drying of fruits and 14 vegetables, and sorting, grading and packing of fruits 15 and vegetable. At most, these activities either prepare 16 and preserve the raw agricultural commodity for 17 transportation to market, for example, curing potatoes, 18 drying, sorting and packing fruits and vegetables or 19 separate the edible portion of the commodity from the 20 nonedible portion of the commodity, nut or corn 21 shelling. 22 Cutting, grinding and polishing carrots in 23 order to turn the carrots into baby carrots or other 24 carrot shapes that Grimmway now sells, such as carrot 25 sticks, crinkle-cut coins, carrot chips, carrot dippers 26 and shredded carrots, all of which are fun shapes 27 Petitioner processes, is beyond the scope of Section 28 0723, since this activity is more than the basic amount 19 1 necessary to prepare these carrots for market or further 2 processing. 3 Instead, this is manufacturing carrots into a 4 processed food product that is ready to eat in a new and 5 easy to eat form that, as the video Petitioner 6 presented, illustrates has created increased consumption 7 and is beyond the processing activity normally incident 8 to growing, raising or harvesting of the agricultural 9 commodity. 10 Accordingly, the cutting, grinding and 11 polishing of carrots is a post harvest activity that 12 does not fall within SIC Cod 0723. And as such, the 13 purchase of tangible personal property for these 14 activities does not meet the requirement of the partial 15 exemption for farm machinery and equipment. 16 Now, a few additional points, if I have time? 17 For the reasons I have just stated why the activity of 18 cutting, grinding and polishing carrots to make 19 ready-to-eat baby carrots is not an activity described 20 under SIC Code 0723, however, even if that type of 21 activity were in 0723, 0723 is limited to activities 22 performed for others on a contract or for fee basis. 23 Here Petitioner is performing activities for 24 itself and not on a contract or fee basis. Thus, since 25 it is not performing the activities for others, its 26 activities do not come within SIC Code 0723. 27 Now, Petitioner argues that it is performing 28 the activities for others because carrots are sold to 20 1 consumers. However, I note that Petitioner also argues 2 that it does not fit within SIC Code 2099 because it 3 believes the activities of vegetables cut and peeled for 4 the trade refers to services that are performed for 5 others on a contract or fee basis. Thus, Petitioner 6 argues that it is not performing the activities on a 7 contract or fee basis. 8 Thus, Petitioner's argument is contradictory 9 between these two -- either it is performing on a 10 contract or fee basis or it's not. 11 If it's -- if it's performing on a contract or 12 fee basis, it seems like then certainly it's -- it meets 13 the definition of cut or peeled for the trade, if that 14 definition does include on a contract or fee basis. 15 Finally, Petitioner contends that like the 16 Manufacturers' Investment Credit under Section 23649, 17 which provides a credit for certain qualified property, 18 Section 6356.5, partial exemption, should be interpreted 19 liberally in favor for taxpayers. 20 Petitioner also contends that the Department is 21 not following these guidelines and is narrowly 22 interpreting the statute. In other words, that the 23 Department is grinding away at the carrot given to the 24 farm industry by this exemption. 25 Two things with this point, generally, tax 26 exemption statutes are to be strictly construed against 27 the taxpayer claiming them, and No. 2, under Section 28 6356.5 subdivision (b), it states that qualified persons 21 1 means any persons engaged in a line of business 2 described in Codes 0001 to 0291 inclusive and any other 3 person that uses farm equipment or machine to assist in 4 these lines of business described in this paragraph. 5 Thus, the only reference or guidance given in 6 the statute is to activities described in Major Group 01 7 and 02. There is no reference or direction given in 8 6356.5 to Major Group 07 of the SIC Manual. Thus, it 9 may be fairly said that the inclusion of Major Group 07 10 and the Regulation 1533.1 already represents a liberal 11 interpretation in favor of the taxpayer of the exemption 12 found in 6356.5. 13 And even under this liberal interpretation, the 14 activities of cutting, grinding and polishing carrots to 15 make ready to eat baby carrots still does not qualify. 16 Thank you. 17 MS. YEE: Thank you, Mr. Schutz. 18 You have five minutes on rebuttal. 19 MR. VINATIERI: Hard to rebut in five minutes, 20 but let me give my best. 21 I heard several different -- 22 MS. YEE: Actually, before you do that -- I am 23 sorry, let me just pose a question. 24 I heard something, but I don't know that I had 25 the loop closed, but I want you to comment on it. 26 You were speaking to the Petitioner's, I guess, 27 conflicting assertions with respect to whether they are 28 producing for or providing services for others on a 22 1 contract or fee basis and then this concept of peeled 2 for the trade. 3 I'm not so sure I heard the definition of what 4 you think peeled -- I heard your definition of what 5 peeled for the trade means. 6 I mean, you were kind of talking about it 7 within the context of the conflicting assertions, but I 8 wanted to kind of get your sense from -- get the 9 Department's sense of what you believe peeled for the 10 trade -- 11 MR. SCHUTZ: Right. 12 MS. YEE: -- means. 13 MR. SCHUTZ: The terminology "peeled for the 14 trade" that was terminology that -- that wasn't carried 15 over -- carried over to the NAICS Code. 16 Petitioner has presented, you know, a statement 17 from the Census Bureau that peeled for the trade means 18 for -- done for other businesses. 19 Now, Petitioner certainly does do this for 20 other businesses in that he -- it's selling the carrots 21 on the wholesale market to Raley's, to Bel Air. Also 22 it's selling these carrots to -- for further processing 23 to food service industry. So, it does seem like it's -- 24 it's processing for the -- for other businesses. 25 And if peeled for the trade means that it's 26 supposed to be for other businesses. 27 MS. YEE: Okay. But I guess within the context 28 of SIC Code 2099, is that kind of a logical definition 23 1 of what peeled for the trade could be? 2 MR. SCHUTZ: It's not a definition that was -- 3 MS. YEE: I know it's not specifically. 4 MR. SCHUTZ: -- that has been -- that is 5 specifically defined. 6 MS. YEE: Right. 7 MR. SCHUTZ: It's not a definition that has 8 been carried over into the NAICS Codes, it just says, 9 "vegetables cut and peeled now for manufacturing." It 10 doesn't say "peeled for the trade." 11 The Petitioner has presented a statement 12 from -- 13 MS. YEE: Yes, we saw that. 14 Okay, okay, I just wanted to kind of get a 15 sense of where the Department was on that definition. 16 Thank you. 17 Gentlemen, you have five minutes on rebuttal. 18 MR. VINATIERI: Thank you. 19 Several different issues were raised here and 20 I'm going to try to go through them as quickly as I can. 21 First of all, the first issue is you just 22 indicated is peeled for the trade. First of all, we 23 don't peel, right, as for the trade, so to speak. We 24 are -- we lightly sand and grind. I think you saw it on 25 the video. 26 But, secondly, is the U. S. Census Bureau's 27 question and answer center and we gave you a copy of 28 exhibits. This exhibit was entered at the Appeals 24 1 conference and it's actually Exhibit 4. 2 And this came back to us from the Census Bureau 3 because we asked what does it mean "peeled for the 4 trade"? 5 Here's what it says, quote, 6 "The phrase 'peeled for the trade' indicates 7 that this business activity is being done for 8 another business. Thus, the word trade. 9 Normally anything done for the trade is paid 10 for by a contract or fee basis." 11 So, the problem -- the distinction that the 12 Department, I think, is missing is two-fold. No. 1, we 13 are doing this for our own business. We are doing this 14 for our own business for the market. That's No. 1. 15 We're not doing it for another business, therefore, it 16 can't be for the trade. The trade indicates it is for 17 somebody else. 18 And here's the other problem that results, I 19 think there's been a mixup on the part of staff and that 20 is there is a difference between the chain of 21 distribution after a product is made and it goes to the 22 consumer, the ultimate consumer, versus the chain of 23 manufacturing where a manufacturer takes other materials 24 and puts them together into a final product, which then 25 goes to the chain of distribution to the ultimate 26 consumer, such as salads in 2099. 27 We don't do that. We don't do that with baby 28 carrots. So, there is a fundamental distinction and an 25 1 erroneous assumption on the part of the staff with 2 respect to this peeled for the trade. We can't fall in 3 it because of what we do. 4 No. 2, the NAICS situation, the indicated 5 NAICS 31191, which is the new thing, the new NAICS way 6 of looking at this, remember, NAICS here is irrelevant 7 and that is that the legislature and the Board 8 specifically used the SIC Code, not NAICS, okay? So, 9 NAICS doesn't really apply. 10 Secondly, however, even with NAICS, when NAICS 11 came in, it came in in 1998 -- excuse me, 1997, when 12 this exemption was put in, it was 2001. So, at the time 13 the legislature did this, NAICS was already in existence 14 and yet the legislature used SIC Code. 15 And in doing that, thirdly, the SIC Codes 16 themselves do not cleanly translate into NAICS Codes. 17 Let me give you an example. 2099, maple syrup, 18 under SIC Code 2099, maple syrup is a manufacturing 19 activity, but now, under NAICS, it's 1198, it's now a 20 farming activity. They swapped it. 21 0723, the grain grinding we're talking about, 22 was crop activity we talked about, it's now in 31119, 23 which is a manufacturing activity, however, other grain 24 grinding from 0723, is still in post harvest activities 25 under the successor to 0723. 26 And vegetables peeled for the trade, that's no 27 longer around in the NAICS Code. So, the utilization of 28 NAICS, you can't really do that here. 26 1 Let me give you the third point. We talked 2 about fresh food and it being in 2099. The only fresh 3 food you see in 2099 is -- relates to the salads and the 4 potatoes peeled for the trade. You had vegetables, you 5 had -- you have -- and then you have the salads. 6 As I said, salads are an end product that had 7 been manufactured by putting lettuce together, shredded 8 carrots and other types of things that's then going to 9 the consumer. That's not what we're talking about here. 10 We're talking about just the baby carrots. 11 Let me get you another issue here, Mr. Schutz 12 had talked about Group 7 and what I wanted to talk to 13 you about is that, remember, the Cardoza bill was to 14 benefit California farmers. And part of the problem 15 with the staff's position here is that what they're 16 saying -- it would allow the exemption for machinery and 17 equipment for someone who performs services for a 18 farmer, but would deny the exemption if the farmer uses 19 the equipment to perform the activities on his own farm 20 crops. It doesn't make any sense, it doesn't carry out 21 the intent to help the farmer. 22 Additionally, we -- it doesn't -- 15333.1 23 clearly distinguishes between engaging in a line of 24 business versus performing activities. The focus is on 25 the activity, not on some kind of contractual 26 relationship. And that's important. You don't -- there 27 is no discussion of that whatsoever. 28 And there's a good example of that in 1533.1 27 1 (b)(5), which we talked about, that's on the farmer with 2 the grapes. He -- the farmer there uses crop drying 3 machinery to remove the wet from the grapes so they 4 don't mold and -- 5 MS. OLSON: Time has expired. 6 MS. YEE: Finish your thought, Mr. Vinatieri, 7 I'm sure we'll have questions. 8 MR. VINATIERI: Okay. And, specifically with 9 respect to that, taking that -- taking the -- drying it, 10 0723 specifically says that's an activity, that's okay. 11 And, so, it says drying of fruits and 12 vegetables, but in that there is no discussion 13 whatsoever of doing it for somebody else or doing it on 14 a contract basis. 15 The example itself, the Board's own example, 16 says that the farmer can do it on his own crops. He's 17 not doing to somebody else, he's doing it for his own 18 business. 19 MS. YEE: Thank you very much. 20 Discussion, Members? Questions? 21 Ms. Steel, please? 22 MS. STEEL: I think all these numbers coming 23 out and bottom line is I was looking at that 0723 and 24 2099 and packaging is nontaxable, but salad, fresh, 25 refrigerator -- refrigerated is taxable. So, there is 26 really -- this is really thin line here. 27 But when I read these regulations that process 28 the 0723 is mostly under -- under that is vegetables and 28 1 fruits processed. And under 2099 is mostly 2 manufactured. 3 So, I want to ask Department that SIC Code 2099 4 includes products that are transformed actually into new 5 products, such as baking powder, box lunches and pizza. 6 How can you classify that fresh carrot is under 7 2099? I mean, I know there is very thin line, it 8 depends on how you translate these code, but, you know, 9 I still see that overall you can look at the big 10 pictures of two regulations, but how can small carrot 11 can be transformed or manufactured to other products? 12 I am looking at that a carrot is a carrot. 13 MR. SCHUTZ: 20 -- in 2099 also includes 14 vegetables that are cut and -- cut or peeled. It also 15 includes salad -- salads. 16 These are -- these are things that transformed, 17 somewhat minimally, but there's distinction between 0723 18 and 2099, we believe, is that in 0723 you're looking at 19 post harvesting activities that are really the minimal 20 post harvesting activities necessary to get the ag -- 21 well, the agricultural product to market or for further 22 processing, while 2099 represents manufacturing and that 23 includes cutting of the vegetables or making them into 24 salads, which is really just, you know, a mix of 25 vegetables or maybe all of the same vegetables, you can 26 have -- certainly a salad with all of the same types of 27 lettuce or all the same type of vegetables. 28 MS. STEEL: I think that's the reason that they 29 1 put a salad specifically that, you know, mixing with the 2 other vegetables, but this one is packaging just carrot 3 itself. 4 So, I -- you know, when I was looking at this 5 case, it was very, very thin line, I mean, you know, 6 here taxable or nontaxable. There is like really gray 7 area right there that I'm reading. 8 And I'm more into that looking at that with the 9 salad and packaging vegetables, this is one of packaging 10 vegetables, because if they mix this carrots with other 11 stuffs that in it, then I can more into that it's 12 manufactured. 13 But right now that I am looking at it that no 14 matter what you look at, it's just a small carrot there. 15 I am not just looking at with other stuffs that looking 16 at. 17 And another thing is that that was the thin 18 line that we cannot really translate these laws right. 19 Then they have the -- Mr. Thomas Stenzil, the expert, 20 said that baby carrots are fresh-cut produce and fall 21 under SIC 0723. 22 Why we ignoring this? 23 MR. SCHUTZ: I don't think we're ignoring this. 24 In fact, I looked at what Mr. Stenzil said and I looked 25 at the FDA fact sheet that Mr. Stenzil pointed to to 26 support his proposition that these fresh-cut produce are 27 fresh. 28 But looking at the guidelines that are 30 1 mentioned in the FDA fact sheet, it does say that -- it 2 does make a distinction that fresh-cut produce is a -- 3 is a manufactured product, that they process 4 manufactured food, and, therefore, it falls within -- 5 within the guidelines for current good manufacturing 6 practice requirements under the FDA. 7 So, the FDA certainly considers these carrots 8 processed carrots to be manufactured goods. And it -- 9 it has them under their guidelines for -- for good -- 10 good practices with manufactured goods. 11 MS. STEEL: I can go back to 2099 that I'm 12 reading it here, like almond paste, box lunches, chili 13 pepper or powder, pizza -- these are not fresh carrots 14 that we are looking at in the bag. 15 So, we can -- we can look just like every line 16 by line, but we can look overall the law here that 17 2099 -- I am looking at this as a manufacturing means 18 that the salad package itself with other stuffs versus 19 the carrot itself is there. It's more of a vegetable 20 process, it's different than manufacturing. 21 So, that's -- I meant, it's been really 22 bothering me that, you know, I'm looking at the case 23 that it's very thin line, but looking at the package, 24 it's -- no matter what you look at it, it's not the 25 salad, but it's fresh vegetables. And it's just carrots 26 only. That's what I'm looking at. 27 So, I am not really buying that you tried to 28 explain to me that it's still manufacturing. I don't 31 1 see any manufacturing here, just cut. That's all I'm 2 looking at. 3 So, cut is not really manufacturing. You know, 4 I am still confused, but that's the way I am looking at 5 it. The package itself, carrot is a carrot, right 6 there. 7 So, thank you. 8 MS. YEE: Thank you, Ms. Steel. 9 Other questions, Members? Discussion? 10 MR. HORTON: Madam Chair? 11 MS. YEE: Mr. Horton, please. 12 MR. HORTON: To the Department, for the purpose 13 of being consistent in the interpretation, I want to get 14 your views on -- under the U. S. Department of Labor, 15 Occupation and Safety Health Administration, Group 7 16 there includes grain grinding as part of the process. 17 And it appears that we're dealing with 18 semantics in some form or fashion here in trying to 19 distinguish at what point does the manufacturing process 20 begin and at what point is there further processing of a 21 product that has been harvested, okay? 22 If you take the bag of carrots before us and if 23 they were to grind that down, smooth that particular 24 carrot, without cutting it in half or cutting it in 25 three different pieces, that process would be exempt; is 26 that right? 27 MR. SCHUTZ: No. I think -- if they were to, 28 for example, they had a machine that was able to grind 32 1 the carrot to look like Dora the Explorer so kids would 2 eat it, we would -- 3 MR. HORTON: No, no, no, I'm not saying into a 4 different shape. 5 But the large carrot, if they clean it after 6 they pulled it out of the ground and they take that 7 existing carrot and chopped the head off, which is part 8 of the carrot when it was harvested and then they take 9 it and send it through a grinding machine, maybe for the 10 purpose of further cleaning it so as it's not dirty or 11 making it look more appealing to the customer, any of 12 that considered manufacturing? 13 MR. SCHUTZ: No, it -- certainly there's an 14 incidental amount of cutting, you have to cut the carrot 15 from the stem, you have to -- or you may wish to, if 16 there is some ugly looking bit sticking out, you may 17 wish to peel those off or grind those off, but -- but 18 the difference between that activity and turning them 19 into cute baby carrots is that that activity is really 20 incidental to the growing, raising and harvesting of an 21 agricultural product. 22 It's really just getting it ready for market so 23 it fits in the 0723 as a raw product versus -- versus 24 manufacturing it, where you're cutting it, you're 25 grinding it and you are making -- you are preparing it 26 for ready to eat use. 27 MR. HORTON: That carrot's to ready eat, the 28 large one. 33 1 I mean, I pull it, I rinse it off and I eat it. 2 I mean, I don't know if that's the -- I don't know if 3 we're properly characterizing it from that perspective. 4 So -- like I'm having -- what I want assistance 5 with is trying to distinguish, if you will, when does 6 the manufacturing process begin? 7 I can tell you, I mean during the legislative 8 process when the bill came up and the debate on the 9 floor was basically, you know, if it happens on the 10 farm, it's okay, even though subsequent to that 11 interpretation of the legislature from the debates, the 12 Board of Equalization sort of narrowed that down -- as 13 they generally do. 14 But the intent was -- is to once you harvest 15 the product, you can clean it. You prepare it. Get it 16 ready for market. Until you place it in the bag, the 17 product in which you harvest -- we look more at the 18 character of the product. 19 Is it a tomato? At the end of the process is 20 it still a tomato? The answer is yes, then whatever you 21 did between pulling it out of the ground and getting it 22 ready for the market was part of the exempt process. 23 If, in fact, you began to alter it so that it 24 now becomes part of -- an integral part of another 25 product, in the case of a salad, in the case of juice, 26 in the case of almonds, it becomes paste -- I mean, the 27 intent is that you've now placed it in the process of 28 becoming part of another product. 34 1 The carrot can actually be peeled and shredded 2 into little fine pieces that you see in these mixed 3 salads that they're now bagging. The intent of that is 4 for that smaller piece of carrot, if you will, to become 5 part of a -- an integral part of another product, thus 6 it enters into the manufacturing process. So, at the 7 end of the day you end up with a different product. 8 You can chop the carrot into coin-like size and 9 you can chop it to -- not a tomato, usually you don't 10 put tomatoes in there, but other lettuce, celery, that 11 kind of stuff, but the intent is that it enters into a 12 manufacturing product because the intent is to create 13 another product. 14 And, so, that's where the legislature was at 15 some challenge with this on the farm concept, because as 16 farms began to evolve, they actually got into the 17 manufacturing process. They were no longer harvesting, 18 processing, cleaning, refining, packaging and sending it 19 to the market. They actually began part of the 20 manufacturing process -- they shredded, they cut and 21 they sent it to another manufacturer. 22 And that subsequent manufacturer actually 23 incorporated that product into an end product which was 24 now a salad. 25 So, in the Group 7 there is grain grinding, 26 which appears to be -- by the taxpayer's description, it 27 appears to be changing the size of the product, altering 28 the size of the product, but at the end of the day 35 1 ending up with the same character of a product, which is 2 a grind. 3 How do we distinguish that activity from the 4 cutting of a carrot, which at the end of the day you 5 still end up with some form of a carrot that is not -- 6 it's not a salad, it's not juice, it's not -- and it's 7 not intended or can it be -- or, I guess, at one point 8 it could become a salad, but it's certainly not -- it 9 would be a pretty lumpy salad with the carrots in it, 10 but I guess you could do that, but that's not the 11 intended purpose of the process. 12 The intended purpose of the process is just to 13 cut it in and half and have basically a half of a 14 carrot. What's the difference between grain grinding 15 and altering this product? 16 MR. SCHUTZ: I think the difference is that -- 17 that with the grain grinding, that's an activity that is 18 normally incident to the growing, raising and harvesting 19 of that particular agricultural commodity. 20 MR. HORTON: Help me understand that process. 21 What happens in grain grinding? 22 MR. SCHUTZ: Well, it says grain grinding and 23 it's custom. So, my understanding that -- that that is 24 cutting down that particular grain. 25 MR. HORTON: Cutting it down? 26 MR. SCHUTZ: Right. And I think -- I think 27 that there is a -- certainly a cutting process can be 28 involved again with carrots where you're cutting off the 36 1 top off and you're preparing it for -- for market. 2 MR. HORTON: My understanding of grain grinding 3 is that you have this grain. 4 MR. SCHUTZ: Right. 5 MR. HORTON: And you end up with something that 6 is like really tiny. I mean, they end up chopping it up 7 and so forth. 8 Is my understanding correct? 9 MR. SCHUTZ: Right. I think it's -- it's 10 basically turning it into some sort of grain that is -- 11 that then can be not quite milled to flour, but it's 12 ready for that next step. 13 MR. HORTON: When you take it to the next -- 14 well, at that point, is that considered exempt? 15 MR. SCHUTZ: No, milling is certainly -- 16 MR. HORTON: Not milling, grain grinding? 17 MR. SCHUTZ: Right, that's under 0723. And 18 that is because it -- I think it falls under 0723 19 because that is an activity that was normally incident 20 to the harvesting -- the harvesting activity of the 21 grain. 22 Just like nuts, you -- you are shucking and 23 hauling them or corn you're shucking the corn to get to 24 the actual edible portion versus the nonedible portion 25 of the commodity and that's what's -- 26 MR. HORTON: I don't think whether it's edible 27 or not is not the issue because you can eat the grain 28 before you chop it down. 37 1 MR. SCHUTZ: Well, yeah, certainly not with 2 grain, but in the other activities described in 0723. 3 MR. HORTON: Let's say with grains if we could. 4 That's the example that the taxpayers put forth and, so, 5 I just want to stay with that as a point of consistency 6 with the way we viewed another product and how it was 7 treated -- being mindful -- I'm looking at the process, 8 not necessarily whether it's edible -- the process 9 determined if it becomes an integral part of another 10 product. 11 Even almond -- the mashing of an almond to have 12 almond paste, well, clearly that's no longer an almond, 13 the almond now is a paste. So -- but grain grinding, 14 so -- 15 MR. SCHUTZ: I would only say that for -- with 16 regard to almond paste versus -- 17 MR. HORTON: No, no, no, let's stay with grain 18 grinding. 19 MR. SCHUTZ: Right, I mean, when it's ground -- 20 when the grain is ground, it's still a grain, just like 21 when an almond is ground, it's still an almond. 22 But then you can see that there is a fine 23 distinction between almond paste where it's just been -- 24 it's basically ground almonds is in Code 2099. 25 So, I don't think it's necessarily the process, 26 it's that that process that is incident to the 27 agricultural activity versus not being incident to the 28 agricultural activity. And that's clearly a distinction 38 1 that you can make between saying a grain -- basically 2 a ground almond mound versus a ground piece of grain. 3 That -- why the difference? Why is one in 2099 4 and the other one is 0723? 5 And it's because 0723 represents post 6 harvesting activities that are incident to -- generally 7 incident to the agricultural activity of harvesting. 8 And that's a distinction, it's just the minimal 9 amount necessary -- 10 MR. HORTON: I got to tell you, I'm having a 11 problem distinguishing the two. 12 I mean because if you take a grain, in this 13 case -- I mean, I get the distinction, they certainly 14 don't seem to be drawing the line at the same place. 15 You take the grain and you shuck it, you clean 16 it, you get it ready and then you chop it into a couple 17 of -- two or three different pieces and then you run it 18 through a machine and you grind it down to even a finer 19 piece. 20 I mean, you are doing a lot of activity, a lot 21 of cutting, a lot of grinding, sanding and you end up 22 with a with grain that is yay big (indicating), I guess, 23 and then comes out to be real tiny. 24 And the reason they do it is because -- they do 25 it for the cows to consume. I mean, that's why they go 26 through that process because they don't want the cows 27 consuming -- it's easier for them to digest it. 28 And, so -- but at the end of the day to the 39 1 farmer, that grain that has been chopped into fine, 2 little pieces for consumption by the cows is considered 3 exempt. 4 And, so, why? Because at the end of the day it 5 is still a grain. 6 I mean, I learned something else, I learned 7 that grits is made out of corn, I didn't know that. 8 It's a new thing, I had to go to the website to learn 9 that. Isn't it interesting? 10 But you take corn and you chop it down and it 11 becomes something different. In that case you are 12 manufacturing, in my mind, because I can't distinguish 13 the corn. I don't know that the character -- I believe 14 the character has changed. 15 You take an almond and you chop it into -- in 16 half or you split it, you really have two pieces of an 17 almond. And they sell that, I understand. 18 I asked my wife about it and she said, "Yeah, 19 we use the half almonds for baking purposes and stuff 20 like that." So, there's a way to split it in half, but 21 it's still an almond. 22 But then when you start mashing it into a 23 paste, well, that activity is a little bit different and 24 you got a different product that is used typically 25 differently than an almond -- the whole use of it is 26 different. 27 So, it seems to me that the debate is centered 28 around whether or not the character of the product is 40 1 changed, the intended use of the product is changed from 2 that in which it was -- from the point that it was 3 harvested to the time that is now available for 4 consumption. 5 So -- well, unless you can share me -- 6 throughout this process -- I'm sure my colleagues have 7 some other questions, but just wanted to kind of share 8 with you where I am and maybe you can kind of enlighten 9 me as to what the distinction is we go through the 10 process. 11 You want to try now or -- 12 MR. SCHUTZ: Well, certainly, I think -- I 13 think it is what I said, it's that that grain -- the 14 grain grinding is a process that was normally incident, 15 probably historically, was probably incident to the 16 growing and raising of the grain and harvesting of the 17 grain as an agricultural commodity. And, therefore, it 18 fit into 0723. 19 Where -- where this now cutting -- cutting 20 vegetables so that they're -- that they are -- that 21 they're -- cutting vegetables is something that is 22 changing -- it's manufacturing and processing and is 23 under 2099. And 2099 certainly refers to cutting and 24 peeling of vegetables or salads. 25 And salads, you know, the definition of a salad 26 is just generally, you know, a dish of raw vegetables. 27 So, certainly a bag of raw vegetables could be -- 28 arguably could be considered a salad. 41 1 MR. HORTON: Can you hold that bag up? 2 Is that a salad or a carrot? 3 MR. SCHUTZ: It certainly could be a carrot 4 salad put together. 5 I mean -- I mean, at least under like just the 6 general -- and I'm just reading from the World 7 dictionary of what a salad is. But, I mean, regardless 8 of whether or not it's a salad, it's still a cut 9 vegetable. And that is something that is under 2099. 10 MR. HORTON: Here they have -- I was just 11 looking and they have tobacco grading. Are you familiar 12 with that process? 13 MR. SCHUTZ: No. 14 MR. HORTON: Yeah, I'm only familiar because I 15 was on the GO Committee, but -- it's not something I 16 actually bothered to look up, but that there -- the 17 process is they're separating the tobacco, they're 18 trying to get the best tobacco. 19 You know, when you end up with -- you end up 20 with, I guess, a cigar that costs more money -- I don't 21 smoke so I don't know anything about the stuff -- but I 22 do know that, you know, certain leaves and a certain 23 section of the leaf is better than the other section of 24 the leaf and, so, they actually split it and they say, 25 "Oh, this piece is better," for whatever reason. And, 26 so, they cut it up and so forth. 27 And they seem to include tobacco grading in 28 this process. 42 1 MR. SCHUTZ: And that certainly sounds like 2 something that's normally incidental to the growing and 3 raising of tobacco and preparing that tobacco for 4 market. 5 MR. HORTON. So, is your argument that cutting 6 a grain several times into a smaller grain is 7 incidental? 8 MR. SCHUTZ: I think that that activity is 9 incident to the growing, raising and harvesting of 10 grain. It's probably historically when people thought 11 of people who grow grain, they also did some grinding of 12 that grain. So, it's something that's incident to. 13 MR. HORTON: No, they don't grind -- they don't 14 grind it, not only -- they cut it. 15 MR. SCHUTZ: Right, grinding and cutting. 16 MR. HORTON: They cut into -- they cut it like 17 three or four times. 18 MR. SCHUTZ: Right, I had my steel-cut oatmeal 19 this morning. 20 MR. HORTON: Yeah, they cut it all up into 21 little, small pieces. 22 So, the cutting activity in itself is 23 incidental -- 24 MR. SCHUTZ: Yeah, and I don't think -- 25 MR. HORTON: -- in this case? 26 MR. SCHUTZ: -- the distinction between cutting 27 versus grinding that was stated in the D & R, I don't 28 think that that's really the point. 43 1 I think the point is that the activities in 2 0723 just represent, you know, the minimal amount of 3 post harvesting activities -- post harvesting activities 4 that were necessary to get the product to market and are 5 just the -- are incidental to -- 6 MR. HORTON: You need to cut it to go to 7 market. 8 Anyway, I'm going to leave it alone. I'm just 9 going to share with you what my thoughts is and then I'm 10 going to leave it alone. 11 The -- Madam Chair, if I may? 12 MS. YEE: Yes. 13 MR. HORTON: The cutting of a produce, in and 14 of itself, has been determined to be incidental. 15 In fact, the grinding has been determined to be 16 incidental. 17 It appears to me that the intent of the 18 legislature is to say if you're entering into the 19 manufacturing process, where you're actually creating 20 something different, you're altering the character of 21 the product, wherein you're taking an almond, you're -- 22 you plan to add oil and all these other ingredients to 23 make an almond paste, well, that's manufacturing. 24 If you are taking salad and you are cutting it 25 up, a head of salad and you're cutting it up into small 26 pieces and your intent is to make a salad, a bunch of 27 smaller pieces where you're going to add fine-cut 28 carrots and maybe beets and so forth, and other types of 44 1 salads you're going to put together, you're producing a 2 new product. 3 In this case they cut the carrot maybe three 4 times. They polish it. They get it to the market 5 because, you know, what has happened here appears to be 6 is this funny thing called evolution in the 7 manufacturing process. 8 We have sort of evolved to a state where now we 9 have these baby carrots. And, I mean, you couldn't tell 10 my grandbaby that that's not a carrot. You -- she would 11 think -- she asked for them, she says, "Carrot," it's 12 one of her words she can say. And if I gave her that 13 big thing, she would push it away, you know. 14 So, it's hard for me to conceive that the 15 character of the product has actually changed just by 16 mere cutting. And it seems that the cutting, in and of 17 itself, does not constitute a manufacturing process. 18 What determines that is when it enters into the 19 stream of being -- becoming another product other than 20 that in which it was originally produced for. 21 Anyway, thank you. 22 MS. YEE: Thank you, Mr. Horton. 23 Ms. Mandel? 24 MS. MANDEL: No, not at this time. 25 Mr. Horton mentioned that almond paste is 26 something more than just smushed almonds. 27 MS. YEE: Okay. 28 Ms. Alby? 45 1 MS. ALBY: Thank you. 2 I have a question for staff. When the carrots 3 are prepared for market, they have to have the tops 4 cut off, removed, yet their character and their purpose 5 remain the same, they're still carrots. That's exempt. 6 Then they are sorted by size. The large 7 carrots are sent off for packaging. The smaller ones 8 are sent to be cut a second time and polished. Their 9 character and purpose is still preserved. They remain 10 carrots. They're not juice. 11 And if you think what's the little things in 12 that bag is a salad, don't invite me to dinner. They're 13 still carrots. 14 Why does the first cut not make them ineligible 15 for the exemption? 16 MR. SCHUTZ: Two things, first, the first cut 17 is something that is normally incident to the growing, 18 harvesting and is preparing just a raw product. 19 And the FDA does -- the FDA has distinguished 20 between raw agricultural products and fresh-cut produce, 21 which is considered a manufacture -- by the FDA -- a 22 manufactured product. 23 I'd also like to mention that the NAICS Code, 24 which does deal with -- is sort of the newer code that 25 does deal with sort of different and new inventions -- 26 under 31191, which is a manu -- considers cut and peeled 27 baby carrots, specifically, as a manufactured product. 28 So, the NAICS Code considers them now a 46 1 manufactured product, cut and peeled baby carrots, as 2 well as the FDA and requires them to be, you know, fall 3 under their guidelines for the current good 4 manufacturing practices. So, the FDA also considers 5 these baby carrots as a manufactured product. 6 MS. ALBY: Could I -- Mr. Vinatieri, could you 7 respond to that? 8 MR. VINATIERI: Yes. First of all, what 9 counsel is referring to relative to FDA, this 10 distinction between a raw -- a raw item versus 11 fresh-cut, I'm not the familiar with that. 12 All I can tell you is that if you look at 0723, 13 many of the items in 0723 are raw and they're fresh. 14 And several of them are raw and they've been cut. That 15 was the process of the corn husk, the shelling and the 16 like. 17 So, I'm not familiar with what Mr. Schutz is 18 talking about relative to this raw versus fresh-cut out 19 of the FDA. 20 Secondly, with regard to NAICS, as I indicated 21 earlier in our rebuttal, NAICS isn't really relevant 22 here. What's relevant is SIC. 23 And somehow even if NAICS was relevant, the 24 problem is NAICS has recategorized various items. So, 25 that as I said on the maple syrup, which was in 2099 in 26 SIC is now in the equivalent of 0723 in the new NAICS. 27 So, it's not is if there's this bright line 28 that says, okay, if NAICS says this, this must be the 47 1 way it is. Because it's all over everywhere. 2 And, in fact, as we indicated, there is no such 3 thing any more as "peeled for the trade." I mean, I 4 will be candid with you, my view on this whole case is 5 that the staff has drawn a distinction, has drawn a line 6 much too prematurely. And the fact is that when they 7 were confronted with the baby carrots, they looked 8 everywhere to find, well, what does this say about baby 9 carrots? I suspect this is what happened. 10 And they couldn't find anything about carrots, 11 per se, but what they did see was in 2099, they saw 12 vegetables. Okay, carrots are veggies. And it said, 13 "peeled." Oh, well, on carrots, you peel, which is 14 what -- you know, we think -- if we're unsophisticated 15 and we're hanging out in the kitchen, instead of this 16 kind of sophistication, peeled -- and then they said, 17 well, so, there's the carrots, they're peeled. So, it 18 must fall into 2099. 19 The problem with that is they didn't look to 20 see what "for the trade" means. And for the trade means 21 for another business, as we see in the Exhibit 4 that 22 came to us from the Census Bureau, who are the people 23 who did SIC and who did NAICS. 24 So, there is a fundamental disagreement or 25 misunderstanding here that if the NAICS says -- 26 supposedly, I guess what Mr. Schutz is saying is that, 27 therefore, baby carrots have to fall into it. I don't 28 think that's the case at all. 48 1 MS. ALBY: Thank you. 2 MS. YEE: Mr. Horton? 3 MR. HORTON: Thank you, Madam Chair. 4 Mr. Schutz, do you have a copy of that? 5 MR. SCHUTZ: Certainly. I have several copies, 6 I can -- I presented -- and really all that I'm -- all 7 that I'm referring to is -- 8 MR. HORTON: No, no, no, I just want to know if 9 you have a copy? 10 MR. SCHUTZ: Yes. 11 MR. HORTON: Can you -- is it in our -- okay. 12 Which -- which was referred to in the 13 legislation? Was it -- was NAICS referred to in the 14 legislation? 15 MS. YEE: SIC, S-I-C. 16 MR. HORTON: Or did they refer to -- 17 MR. SCHUTZ: They referred to the SIC 0011 and 18 00291. 19 MR. VINATIERI: And 07 -- 20 MR. SCHUTZ: No, the legislation didn't refer 21 to 07. 22 MS. YEE: No. 23 MR. VINATIERI: That's correct, the Board did 24 that. 25 MR. HORTON: So, I mean, at the time that the 26 legislation was written, they didn't seem to intend to 27 rely on NAICS at the time? 28 MS. YEE: I think their -- the conversion may 49 1 not have been completed at that point in time. 2 MR. HORTON: Yeah. So, you know, but you 3 brought up something that's kind of interesting, I 4 wanted to explore a little bit. 5 And that is the fork in the road for these 6 carrots, where the large carrots go one way and the 7 smaller carrots go another way. Can you tell us what 8 happens there? 9 And I mean, prior to baby carrots, what 10 happened to the smaller carrots -- I mean, not the 11 baby -- the smaller carrots, but it was a complete 12 carrot, you know, it was a fork in the road that someone 13 mentioned that at some point the larger carrots go this 14 way (indicating) and the smaller carrots go this way 15 (indicating). 16 Is there some sort of division that occurs 17 there? 18 MR. BARNES: The distinction is that the larger 19 carrots -- 20 MR. HORTON: And prior to baby carrots, what 21 happened? 22 MR. BARNES: They all went into a bag like this 23 (indicating), the cello bag there with the whole carrot. 24 The distinction was when the baby carrots 25 became a product, people liked a thinner baby carrot, a 26 smaller one. So, the larger carrots, they're real wide 27 at the -- in diameter, they're more popular to be 28 consumed in that form versus a thin carrot that is more 50 1 popular to be consumed in this form. 2 So, really, the distinction only came about 3 once the baby carrots were developed. 4 MR. VINATIERI: Mr. Horton, are you referring 5 to -- when you say, "the fork in the road," we saw in 6 video that they're pulled out and they're cut and 7 they're peeled and they go into the trucks to the 8 facility. 9 And, by the way, this facility, baby carrots, 10 is in the field. I think you indicated that the idea of 11 the legislature was if it's on the farm, then that's 12 what it takes. It's the farmer. 13 MR. HORTON: They were wrong, though. 14 MR. VINATIERI: Well, this -- this all happens 15 on the farm, so to speak. 16 MR. HORTON: Right, I think the Board of 17 Equalization was right in their interpretation -- 18 MR. VINATIERI: So -- 19 MR. HORTON: -- ultimate interpretation. 20 MR. VINATIERI: -- what happens, as I 21 understand it, is -- 22 MR. HORTON: Only because I'm here now. 23 Go ahead. 24 MR. VINATIERI: No comment. 25 What happens is, as we discussed, Steve 26 indicated that -- that once you hit the fork in the 27 road, after you go through all of the process that you 28 see up there, the whole carrots are cleaned and washed 51 1 and they're taken to another facility nearby and then 2 they're essentially kept -- kept wet. And then they're 3 bagged. 4 Whereas, the other carrots that we saw just 5 continued through the process. And they're cut and 6 they're lightly sandpapered and then they end up in a 7 package like this (indicating). 8 MR. HORTON: All right. Thank you, thank you 9 very much. 10 MS. YEE: What carrots -- 11 MR. HORTON: That does give me some pause. 12 MS. YEE: -- what carrots get shredded? 13 MR. VINATIERI: There's another group of 14 carrots that don't make the -- don't make it to -- they 15 don't look good from a baby carrot standpoint or any 16 other use. Those get shredded. 17 And there's ones, I guess, also, Steve, that 18 end up going and getting juiced? 19 And, of course, on the shred and on the juice 20 and all that, we never took the exemption on that 21 because we see that as manufacturing because it's 22 becoming a new product. It's no longer a fresh carrot, 23 so to speak. 24 MS. YEE: So, Grimmway does also produce those 25 products? 26 MR. VINATIERI: Yes. 27 MS. YEE: Okay. 28 MR. VINATIERI: Oh, yes. In fact, they -- and 52 1 they take -- on the juice, for example, they take it and 2 then they sell it to make V8 juice. So, a component is, 3 you know, of V8 is carrot juice. 4 So, we've never taken exemption on any of that 5 because we do see that as manufacturing. 6 It's just this line we're referring to relative 7 to these baby carrots. 8 MS. YEE: Okay. I've got a couple of questions 9 and maybe just a comment. 10 First of which, I think when we look at these 11 Major group categories, I can't imagine that baby 12 carrots was in anybody's head when these lists were 13 developed, but -- so, that's kind of one comment. 14 The second comment is, I think, to the 15 Department, I think what would have been helpful to me 16 was just to understand in what instances we've actually 17 allowed the exemptions, just by way of comparison. 18 And do you have any sense of -- 19 MR. SCHUTZ: As far as historically for other 20 taxpayers, no. 21 MS. YEE: And the reason I asked -- 22 MR. SCHUTZ: I reviewed -- 23 MS. YEE: -- let me tell you why I'm asking. 24 This is a tough one in terms of kind of knowing 25 where to draw the distinction. 26 Having been on the other end of this when the 27 law was actually enacted, I can tell you that there was 28 not any deeper thought about to what this would apply 53 1 except for, as Mr. Horton described, yeah, these are 2 activities on the farm. 3 And in trying to now make that distinction, I 4 certainly -- I agree with Ms. Steel, I think that this 5 is kind of a 'tweener for me as well. 6 But not knowing -- I think I was looking for a 7 little bit broader context in terms of the instances 8 where the exemptions have been allowed and then contrast 9 it to what's being produced here. 10 And if you don't have that information -- 11 MR. SCHUTZ: Right, no. All I've looked at was 12 the legal opinions, but they didn't address the distinct 13 -- these distinctions with regard to baby carrots or 14 anything really like this. 15 They were more like fungicides and different -- 16 different things that were used on particular crops and 17 not, you know, the production of crops or what crops are 18 produced into. 19 MS. YEE: Right, okay. Thank you. 20 Other questions, Members? 21 Mr. Horton? 22 MR. HORTON: Madam Chair, please? 23 MS. YEE: Yes? 24 MR. HORTON: Question of the taxpayer. 25 What happens when -- I know you may not do this 26 necessarily, but you chop up a carrot and you do have 27 the larger pieces and it goes on a party tray? 28 You know, if go in the store and you can buy 54 1 this party tray of vegetables and have carrots in it, 2 tomatoes and other stuff inside of that, in your mind, 3 that process would be considered what -- manufacturing 4 or part of the harvesting? 5 MR. VINATIERI: It's similar to taking the 6 shred and giving it to Dole, for example, because Dole 7 makes a lot of different types of salad mixes with coin 8 carrots and that. And that's -- a party platter kind of 9 thing is the same kind of deal, it's a -- it's kind of a 10 different product. 11 MR. HORTON: So, in that case you are preparing 12 the baby carrots for further processing in the 13 manufacturing process? 14 MR. VINATIERI: Steve, let me ask, how much -- 15 do we do a lot of that? Or is that -- 16 MR. BARNES: No, of the -- of the other, the 17 shred type, extreme cuts? 18 MR. HORTON: No, this is actually a small 19 carrot? 20 MR. BARNES: Right, on the baby carrots, we 21 sell more than 80 percent for direct consumption in that 22 form, maybe, like I said, a very small minority is going 23 out to wholesales to be put on party trays and things 24 like that. 25 On the other -- on the extreme cuts, you can 26 flip that percentage, like 80 percent of the shred goes 27 to like salad guys. 28 MR. HORTON: And what was the ratio -- you said 55 1 100 percent for something and 50 percent usage for 2 something? 3 MR. SCHUTZ: For forklifts, which are vehicles, 4 it needs to be 100 percent. 5 I also note that they do have like -- they do 6 produce things called "Little Dippers," which are 7 essentially baby carrots with some sort of salad 8 dressing, probably ranch salad dressing. 9 I don't know if that's what you -- if that's 10 what Mr. Horton was thinking. 11 MR. HORTON: I am. 12 What percentage of your -- of the process is 13 used for that? 14 MR. BARNES: Much less than 1 percent, we 15 hardly sell any of those. 16 MR. HORTON: So, 80 percent of your activities 17 is cut, polish, put in a bag, sell as a carrot? Is that 18 what your testimony is? 19 MR. BARNES: Of the baby carrots, yeah, more 20 than 80 percent goes for direct -- in consumption in the 21 consumer-type bag like that (indicating). 22 MR. HORTON: When you say, "of the baby 23 carrots," are there other carrots that can be processed? 24 MR. BARNES: I'm not counting like the whole 25 carrot and the shredded -- I'm just saying of this 26 particular product. 27 MR. HORTON: Well, you take the whole carrot 28 and cut up and put it in a tray in another process? 56 1 MR. BARNES: No, we don't produce any trays. 2 MR. HORTON: Or prepare it for someone else to 3 place it in a tray or place it in a salad, or whatever? 4 MR. BARNES: Right. All that type of product, 5 including the shreds and all that, they go through -- 6 they're in a different building, the one where we're not 7 claiming the exemption. 8 MR. HORTON: Okay. So, when that happens, the 9 whole carrot goes to another building somewhere and 10 whatever is prepared to go to another -- 11 MR. BARNES: To another manufacturer. 12 MR. HORTON: -- another manufacturer? 13 MR. BARNES: Right. 14 MR. HORTON: Okay, thanks. 15 MS. YEE: Thank you, Mr. Horton. 16 Other questions, Members? 17 Hearing none, may I have a motion, please? 18 MS. MANDEL: Take it under submission. 19 MS. YEE: Motion by Ms. Mandel to take this 20 matter under submission. 21 Is there a second? 22 Second by Mr. Horton. Without objection, that 23 motion carries. 24 Thank you very much everyone. We will discuss 25 your matter later today -- 26 MR. VINATIERI: Thank you. 27 MS. YEE: -- and send you a written notice of 28 our decision. 57 1 Thank you. 2 ---o0o--- 3 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 58 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 AUGUST 25, 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 pages 1 13 through 58 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: January 10, 2011 17 18 19 ____________________________ 20 JULI PRICE JACKSON 21 Hearing Reporter 22 23 24 25 26 27 28 59