BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 450 N Street, Room 121 Sacramento, California REPORTER'S TRANSCRIPT AUGUST 25, 2010 SALES AND USE TAX APPEALS HEARINGS PETITION FOR REDETERMINATION filed by LYNNE MARIE GALLAGHER AND FRANCIS XAVIER GALLAGHER (Case No. 459368 BH) Reported by: Beverly D. Toms CSR No. 1662 1 1 2 P R E S E N T 3 4 For the Board Betty T. Yee of Equalization: Chair 5 Jerome E. Horton 6 Vice-Chair 7 Barbara Alby Acting Member 8 Michelle Steel 9 Member 10 Marcy Jo Mandel Appearing for John Chiang 11 State Controller (per Government Code 12 Section 7.9) 13 Diane Olson Chief, Board Proceedings 14 Division 15 For Board of David Levine 16 Equalization Staff: Tax Counsel IV 17 Stephen Smith Tax Counsel 18 Robert Tucker 19 Legal Department 20 Kevin Hanks Sales and Use Tax Department 21 22 For Petitioner: Jonathan Wexler Representative 23 Francis Gallagher 24 Taxpayer 25 ---OOO--- 26 27 28 2 1 Sacramento, California 2 August 25, 2010 3 ---oOo--- 4 MS. YEE: Let us reconvene the Board of 5 Equalization meeting. 6 Our next item? 7 MS. OLSON: Our next item is C5, Lynne Marie 8 Gallagher and Francis Xavier Gallagher. Please come 9 forward. 10 Board Proceedings has received contribution 11 disclosure forms for this afternoon's hearings from the 12 parties, agents and participants. All forms were 13 properly completed and signed. All parties, agents and 14 participants are on the Alpha listing provided to your 15 office. 16 Each person sitting at the table will introduce 17 themselves and if necessary their affiliation with the 18 taxpayer for the record. 19 Ten minutes is allocated for the taxpayer's 20 opening presentation -- I'm sorry, I'm out of breath -- 21 followed by ten minutes for the Department's 22 presentation and five minutes is allocated to the 23 taxpayer for rebuttal. 24 Ms. Yee. 25 MS. YEE: Okay, Members, we are on Item C5, 26 Lynne Marie Gallagher and Francis Xavier Gallagher. 27 Let's have Mr. Levine introduce the issues. 28 MR. LEVINE: Good afternoon, Madam Chair, 3 1 Members. David Levine for the Appeals Division. 2 The issue in this petition is whether 3 adjustments are warranted for claimed -- disallowed 4 non-taxable labor charges for claimed sales for resale. 5 MS. YEE: Thank you very much. Good 6 afternoon. 7 MR. WEXLER: Good afternoon. 8 MS. YEE: If you'll introduce yourselves for 9 the record you have ten minutes. 10 MR. GALLAGHER: Yeah, I'm Francis Xavier 11 Gallagher. 12 MS. YEE: Okay. 13 MR. WEXLER: Jonathan J. Wexler. 14 MS. YEE: Okay. Please proceed. 15 MR. GALLAGHER: I'm one of the owners of the -- 16 this business. My wife is the other owner. She's an 17 artist and a -- and a seamstress and we specialize in 18 the construction and alteration of predominantly used 19 wedding dresses. 20 When it was brought to our attention that -- 21 that we were not in compliance with -- with the law as 22 it was stated and our understanding of the law as it was 23 stated, we -- we were altering wedding dresses and not 24 charging tax on -- on the -- the used dresses and also 25 because we weren't aware that we had to. 26 When it was brought to our attention we -- we 27 remedied that -- that situation and kept dedicated 28 records, and our records now show that 82 percent of the 4 1 dresses that we -- that come through our salon are used. 2 We submitted a -- a DVD from a Good Morning 3 America who came to my wife and -- and did a piece on 4 this new emerging market for used wedding dresses. A, 5 because of the economy and, B, because of the vintage 6 nature of the dresses the brides were -- were looking 7 for. 8 So, when we -- when we -- when we were made 9 aware that we were not in compliance we made every 10 effort to get the information from the client when they 11 brought the dress. Because when -- when they come into 12 our place we didn't ask them is this new? Is it your 13 granny's? Whatever. It wasn't even on our radar to do 14 that. We're a -- we're a good honest family business. 15 And -- and in that -- in that regard 16 Mr. Wexler, our C.P.A., has been working very closely 17 with us to make sure we're in compliance. And we -- and 18 we are asking for mercy and for some relief in this 19 matter. We're a small family business and this would 20 impact six -- six employees, or six people involved in 21 the business. Single mothers. Yeah, minority -- 22 minority employees. And -- and we're asking for mercy 23 and some relief here because we -- we've been trying to 24 do our very best to remedy the situation. 25 MR. WEXLER: And Reg. 1524 states that 26 alterations on new clothes are subject to sales tax. 27 So, used clothes are not subject to sales tax. 28 So then we've done an analysis since this all 5 1 started and it keeps coming up as though somewhere 2 around 81 -- 82 percent of all dresses that come into 3 the store are in fact used. Because it's a -- it's a -- 4 it's a new market nowadays with Craig's list, with eBay, 5 with just the economy where people want to cut down on 6 things. All of a sudden if people don't want to spend a 7 couple thousand dollars on a wedding dress and they can 8 get one for a couple hundred dollars, they're -- 9 they're going that route more and more. 10 So I -- I printed out a listing this morning 11 from Craig's List showing -- I just typed in "wedding 12 dresses" and it's all individuals that own wedding 13 dresses. And I found 352 cases where people just in the 14 San Francisco area have used wedding dresses to sell to 15 people. 16 So, it's -- it's a huge market. And my 17 client's wife specializes in this. This is what she 18 does. She's a seamstress but she specializes 19 specifically in the used market. 20 And earl -- earlier on Good Morning America was 21 talking about doing weddings inexpensively. So they 22 give examples. And I don't know if you guys got the DVD 23 of what we had sent. We sent a copy of -- of the Good 24 Morning America segment. 25 And within that it -- it shows -- it talks 26 about how to do weddings inexpensively. One of the 27 segments was how -- how to get a wedding dress done 28 inexpensively. 6 1 And so within that they talked about her and 2 they found her because that's what she specializes in, 3 used wedding dresses. 4 MS. OLSON: Board Proceeding put it on a link 5 yesterday to all the members. There -- it wasn't -- 6 MS. MANDEL: It was a U-Tube -- 7 MS. OLSON: Yeah. 8 MS. MANDEL: -- video link. 9 MS. OLSON: Right. Yeah. 10 MS. MANDEL: I -- I watched it this morning. I 11 got it this morning. 12 MS. YEE: Please proceed, Mr. Wexler. 13 MR. WEXLER: Yeah. So -- so that's how they 14 found her. They -- they found her because of the fact 15 that they were looking, they investigated. They'd asked 16 around like who does this, who specializes in this 17 unique market. And it's -- it's this business, Wee 18 Scotty. 19 So -- so when we did the analysis, talking 20 about if -- if you -- if you impacted the 82 percent 21 used clothing amount then we come up with a reduction of 22 the sales tax issue of total of $16,000, which is a huge 23 impact for my clients. You know, and again it just is. 24 I mean, that just -- we've -- they've -- they've been 25 tracking it for the last year or two in terms of like 26 new versus used, this whole issue came up, it's always 27 around 81, 82 percent. 28 MS. YEE: Okay. Anything further, gentlemen, 7 1 at this point? 2 MR. GALLAGHER: In regards to the -- the 3 seller's permit situation, you know, from our experience 4 when I -- when we were getting goods for resale a copy 5 of the seller's permit was -- was all that -- you know, 6 fabric stores or whatever would -- would require from 7 us. And we did some -- some sample making for -- for 8 other clients who then left and it was either a sample 9 for -- for show or they would -- it would be for resale. 10 And -- and we at -- and we didn't diligently 11 collect the resale numbers; we didn't charge them tax 12 and keep it and -- and since we were made aware of that 13 fact and the -- when we -- when we -- the thing started 14 when we set up business. My wife's an artist. She's 15 not a businesswoman. She's an artist. That's what she 16 does, she's a creative seamstress. And -- and she 17 probably didn't do enough to find out exactly what was 18 required to be in compliance with -- with resale 19 certificates. 20 And -- and when she was made aware of it she 21 took all steps, and we -- we set -- we got the numbers 22 for all the clients that we could find. Some of them 23 had lied to us. Some of them had vanished. You know. 24 But we spent a lot -- a lot of time and it's very well 25 documented, and -- and if -- and if we could get a 26 little relief on that -- on that front it would be very, 27 very helpful. 28 MS. YEE: Okay. 8 1 MR. WEXLER: Yes, those are the two main issues 2 and, you know, these taxpayers are always -- done 3 everything in good faith and they really do want to do 4 everything right, and they really are now. 5 But -- so there's the -- the two main issues 6 and I have a lot of clients and these guys really do 7 take it seriously. 8 MS. YEE: Okay. 9 MR. WEXLER: We do ask for some type of relief. 10 MS. YEE: All right. Thank you, Mr. Wexler. 11 Mr. Gallagher, we're going to give you time on rebuttal 12 after we hear from the Department. Okay. 13 Department, please. 14 MR. SMITH: Good afternoon, Madam Chairwoman 15 and Members of the Board. I'm Steve Smith from the 16 Board's Legal Department, along with Bob Tucker and 17 Kevin Hanks, representing staff. 18 The Department believes the recommendation of 19 the Appeals Division should be upheld because it has not 20 been established that further adjustments are supported. 21 During the three-year audit period Petitioner 22 reported $44 in tax and Petitioner reported non-taxable 23 sales of more than half a million dollars. 24 To verify the accuracy of Petitioner's 25 reporting the auditor performed a block sample of the 26 first year of the audit period. 27 During this year Petitioner reported about 28 $223,000 in non-taxable sales. The auditor accepted 9 1 that about 76,000 of this was non-taxable and the 2 auditor questioned $74,000 in sales that Petitioner 3 believed were to non -- for non-taxable alterations. 4 And the auditor also questioned about $74,000 in sales 5 that Petitioner regarded as non-taxable sales for 6 resale. 7 With regard to the questioned alterations, 8 Regulation 1524 provides that charges for alterations 9 performed to new clothing are subject to sales tax 10 because such alterations are considered fabrication 11 labor. And charges for alterations performed to used 12 clothing are not subject to sales tax because such 13 alterations are repair labor. 14 The Court of Appeals upheld the validity of 15 Regulation 1524 in the case of Duffy versus State Board 16 of Equalization. And in so doing the Court stated that 17 new clothing means clothing not previously worn except 18 for trying on or fitting. 19 It could not be reliably determined from 20 looking at Petitioner's invoices whether the alterations 21 had been performed to new or used clothing. Therefore, 22 an attempt was made to contact customers to verify 23 whether the altered clothing was new or used. 24 In most instances the address of the customer 25 was not available. Consequently, only 17 customers were 26 contacted. Of these customers three indicated that the 27 alterations were performed on new clothing. And 14 28 indicated that the clothing was used. 10 1 The auditor made adjustments for the 14 2 customers who indicated their clothing was used and this 3 reduced the questioned transactions for alterations from 4 about $74,000 to about $70,000. Dividing this by the 5 reported non-taxable sales for the sample period yielded 6 an error rate of about 31 percent, and this was applied 7 to the entire audit period. 8 With regard to the questioned sales for resale, 9 these transactions generally involve sewing, cutting or 10 the production of articles of clothing. Petitioner did 11 not obtain any resale certificates, but Petitioner did 12 often obtain the customer's seller's permit number. 13 Based upon responses to XYZ letters and also 14 the auditor's review of computer records regarding the 15 purchaser's businesses, the $74,000 in questioned sales 16 for resale was reduced to about $45,000 in disallowed 17 claimed sales for resale. 18 This was just less than 20 percent of the 19 reported non-taxable sales for the sample period and 20 this error rate was also applied to the entire audit 21 period. 22 A few customers indicated in their XYZ 23 responses that they had purchased the clothing for their 24 own personal use. But most of the remaining questioned 25 sales for resale could not be contacted because the 26 address of the customer is unknown. 27 The Department did not accept that a 28 transaction was a -- a non-taxable sale for resale based 11 1 only on a seller's permit number in lieu of a resale 2 certificate because the other elements required to 3 report a sale for resale were missing, including a 4 statement by the purchaser of the property described and 5 that it was for resale. 6 Without having obtained a resale certificate or 7 an XYZ letter saying the purchase was for resale the 8 Department does not recommend further adjustments to the 9 sales for resale. 10 The Department notes that a majority of the 11 remaining disallowed sales for resale involve sales of 12 patterns and samples, and the Department believes that 13 clothing manufacturers and retailers are generally 14 consumers of these items. 15 For these reasons the Department believes the 16 recommendation of the Appeals Division should be upheld, 17 and I'd be happy to answer any questions the Board 18 Members may have. 19 MS. YEE: Thank you very much, Mr. Smith. 20 You have five minutes on rebuttal, Mr. 21 Gallagher and Mr. Wexler. 22 MR. WEXLER: Calling by the same percentage on 23 the ones that they were able to con -- on the customers 24 they were able to contact, there were -- I believe you 25 said that there were three customers that said it was 26 new and 14 that said it was used. That's still about 81 27 percent or so. So they're talking about 80 percent of 28 the ones that are used versus new. 12 1 So -- so the biggest issue on this one is that 2 you have these taxpayers that -- they're trying to do 3 everything right. I mean, it's a small business. They 4 employ local people. They're really trying to do 5 everything right. 6 So then when they first started the business 7 they just -- at that -- at that point they weren't 8 tracking new versus used. So when a customer comes in 9 they're probably never going to see them again, 10 hopefully because it's a wedding. You know, you don't 11 want repeat customers on a wedding. 12 So -- so you have that situation going for you. 13 And so you don't always necessarily -- you're probably 14 not going to see the person again, especially because 15 they're probably going to be moving after they get 16 married, anyways, because they're going to be moving in, 17 you know, with their -- with their spouse. 18 So -- so it would be difficult to -- to contact 19 them. So, since then we've consistently -- for the last 20 year and a half we've been tracking it and it's always 21 come up somewhere in the neighborhood of about 80 22 percent used. And -- and, again, this -- this is an 23 area where the Bay Area, San Francisco, Sacramento, its 24 people are pretty astute to find the best possible deal. 25 And nowadays with Craig's List, with eBay, you 26 can find -- you know, if a wedding dress is worn once 27 and somebody paid 5,000 bucks for it, if they can pay 28 500 bucks for it and then have somebody alter it, 13 1 it's -- it's a win-win for everybody. 2 MR. GALLAGHER: And that's what we do. 3 MS. YEE: Okay. Thank you very much. 4 MR. WEXLER: So -- so I can -- I just really 5 want to stress that, to consider how Good Morning 6 America found -- find them, if not for the fact that 7 these are a specialty, and they wouldn't have found them 8 if they were only doing a small percentage of it, as 9 (inaudible). 10 MS. YEE: Okay. Anything further? 11 MR. GALLAGHER: No. 12 MS. YEE: Okay. Thank you very much. 13 Members, discussion? Questions? 14 MS. STEEL: Question. 15 MS. YEE: Yes, Ms. Steel. 16 MS. STEEL: Usually when we audit these stores 17 we use the latest information or latest year. For this 18 audit seems like we did the first part of it, it was 19 really hard to get all the informations. Why we did 20 that? 21 MR. HANKS: Right. Ms. Steel, we looked at 22 that, as well, and -- and actually I contacted the 23 auditor to -- to ask them why that was done. And 24 actually in -- in consultation with the taxpayer it was 25 learned that the records from that first year of the 26 audit period were actually the most complete, and so 27 that's why that year was selected to sample. 28 MS. STEEL: You mean out -- out of those 14 1 years -- 2 MR. HANKS: Correct. 3 MS. STEEL: -- that first part they had 4 received but they didn't have the last part of it? 5 Taxpayer, was that right? 6 MR. GALLAGHER: I don't recollect. I don't 7 have that information in front of me. The -- the -- 8 audit. And why was it incomplete, I wonder. Because we 9 keep computer records. 10 MS. STEEL: All of them? 11 MR. GALLAGHER: Yeah. Unless the computer ate 12 the data. 13 MR. HANKS: We're also told that there were 14 consultations done with the taxpayer's representative at 15 that time, Mr. Todd Farrell, and so this audit 16 methodology was discussed with him and he agreed that 17 that was the most representative period for us to 18 review. 19 MS. STEEL: That's really odd. And then let's 20 go back to the percentage of, you know, 17 XYZ letters 21 and -- actually more went out and only 17 came back. 22 And three are the new ones and 14 are the used ones. 23 Why we didn't figure -- use that percentage? Seems like 24 we just try -- you know, number is really fascinating 25 because you can just plug into any calculations and come 26 out totally different numbers here. 27 Why we didn't calculate as what taxpayer said 28 that three out 14 are the, you know, new ones that we 15 1 can say those are the new ones that they have to pay 2 sales tax on it. 3 So, why we didn't figure that, instead of that 4 that you put that one out and then total amount minus 5 and try to figure it out so number came out to 30 some 6 percent instead of 8 percent -- is that 8 percent or 7 80 -- yeah, about 20 percent. 8 MR. HANKS: Right. Ms. Steel -- and Mr. Smith 9 probably has a -- a response to this question, too, but 10 I just wanted to add that -- that if you look at the two 11 categories that the Department is disallowing, what that 12 equates to is -- is our treating half of the taxpayer's 13 sales as -- as taxable; the other half exempt from tax. 14 So I just wanted to clarify that. Especially 15 with respect to Petitioner's argument today that -- that 16 80 percent represents used clothes. 17 So I just wanted to -- to let you know that. 18 With respect to the test, however, the auditor had 19 telephone numbers where they could contact the 20 purchasers of -- of the property. Unfortunately, they 21 weren't able to contact all of these purchasers through 22 that source. There are many instances where we did not 23 have address information so we couldn't write these 24 purchasers and ask them what type of property they 25 were -- they were having altered. And the Department 26 typically doesn't look at -- at the responses that -- 27 that we're getting and -- and base our test on -- on 28 just those responses. 16 1 So the 17 responses in this case, we generally 2 wouldn't do that. We generally select a test period, 3 which we've done in -- in this case for the first year, 4 examine all those transactions from -- from that 5 year where the records were the most complete, and then 6 make a determination what percentage of -- of those 7 sales represented taxable charges. 8 But there is one last component, too. In 9 consultation with the taxpayer, with -- with Mrs. 10 Gallagher, as I understand it, she indicated to our 11 staff that the majority of the -- the sample 12 transactions that we're looking at were sales of -- of 13 what's known as sample dresses, sample wedding dresses. 14 And the Petitioners had originally argued 15 that -- that these sample wedding dresses were used 16 garments. That's -- 17 MS. STEEL: The sample means somebody wore it? 18 It's like they leased out. Is that the one? 19 MR. HANKS: Actually, as -- as I understand it 20 the -- the sample dresses is -- is a representative 21 dress that you might see in a bridal salon; they only 22 have one dress of -- of that type. And if -- if you're 23 in a hurry and -- and want to have your wedding within 24 the next couple of months -- 25 MS. STEEL: Right. 26 MR. HANKS: -- your only option at that point 27 really is to buy this sample dress, the only one that 28 they have at -- 17 1 MS. STEEL: Buy or rent. 2 MR. HANKS: -- at the store, versus ordering 3 your size in -- in that type of a dress. And that 4 construction might take six months or longer to -- to 5 manufacture, as I understand it. 6 MS. STEEL: Do you have an answer to that? 7 MR. GALLAGHER: My wife was -- was -- her 8 contention was that -- that a sample dress has -- is a 9 used dress because it has been used for its intended 10 purpose. Its intended purpose is to represent a 11 designer in a show room. And it's the -- they usually 12 come to us grubby, broken and used, in a used condition. 13 In a used -- so the sample dress -- as defined by law 14 the sample dress says was it used -- was the dress used 15 for its intended purpose? Yes, it was. Its intended 16 purpose was to represent a sample, to be a sample in a 17 showroom. 18 The law's a wee bit gray in that area for me. 19 And also for my wife, who's -- you know, she's not a 20 liar and she's not -- she's certainly not skilled enough 21 to read between the lines in that law. 22 MR. WEXLER: But even -- even within that, only 23 a small percentage of those are in that category. 24 MR. GALLAGHER: Yeah. 25 MR. WEXLER: Most -- most of them are in the 26 category where they're just purchased from a finish 27 store, from eBay, inherited, whatever. 28 So, I wasn't privy to that conversation because 18 1 I wasn't part of the audit at that time but I do know 2 that initially she was just trying to handle the audit 3 at the -- on her own at the time, probably didn't 4 understand the questions what were being asked of her 5 because she's not an accountant, not -- you know, she's 6 not a financial person. Like my client said, she's more 7 of an artist. And that's what she does. 8 So I'm not sure what she said in terms -- in 9 terms of like the sample, whatever, but I believe that 10 she probably looked at it as like when she used the word 11 "sample" she also was -- was putting into that just used 12 generally. 13 So I think the -- the most fair way is to go -- 14 is to go nowadays, in other words, what it's been in 15 terms of like new versus used. 16 One of the things that I see on this report 17 from the auditor, which also is a little bit troubling, 18 is it's dated August 18, 2009 where the auditor 19 comments, "The Good Morning America segment of expensive 20 weddings was aired on May of 2009," which is well 21 outside the audit period. 22 So, she's not -- it's -- that's when it aired. 23 But the percentages have always been the same. But what 24 I'm trying to get at is that if it weren't for the fact 25 that this is their specialty there never would have been 26 the segment in the first place. 27 So -- so Good Morning America never would 28 have -- never would have found my clients if -- if they 19 1 weren't specializing in the used wedding market. 2 So -- so it's -- it's -- again, I wasn't -- I 3 think where the whole audit got off track when the whole 4 issue of samples versus used came up. Because, yeah, a 5 very small percentage of the dresses are in fact 6 samples. And I -- I do understand that. In fact -- 7 MS. STEEL: What's the percentage of the 8 samples were? 9 MR. WEXLER: My definition of a sample is 10 simply if it's from a store and it was basically there 11 for people to try on at the store, and those people 12 ended up bringing it to -- to their shop and then 13 altered that, I believe that in fact would be a taxable 14 event. 15 But, that -- again, that's a small percentage 16 of the whole thing. I'm talking about the 82 percent 17 that were -- are clearly used from -- from a used store 18 or inherited. 19 MS. STEEL: Right. I saw that there's others. 20 So, there's a -- a mark on others are the used ones or 21 new ones? 22 MR. WEXLER: Well, it would be -- it would be 23 82 percent used. 24 MS. STEEL: And then -- 25 MR. WEXLER: It would be a small percentage 26 that are -- that are new, and others would be in the 27 category of the -- of the samples. 28 MS. STEEL: Samples. 20 1 MR. WEXLER: Yeah. 2 MS. STEEL: So, those samples that we count as 3 a new cannot be new because it's samples, but by the law 4 how we categorize that? 5 MR. SMITH: The Department's position is that 6 any clothing sold for the first time at retail and not 7 functionally worn by the purchaser is regarded as new 8 clothing. And that's -- 9 MS. STEEL: But people don't buy as a new 10 because it's a sample. And then it's a leased out ones, 11 too, right? 12 MR. SMITH: If it had been leased we wouldn't 13 regard it as new, but I don't believe that's what a 14 sample dress is. 15 MS. STEEL: So just the sample, itself? 16 MR. SMITH: I think it's just been tried on in 17 the bridal -- 18 MS. STEEL: So includes that -- 19 MR. SMITH: -- in the store. 20 MS. STEEL: -- that what's the percentage of 21 these invoices provided because seems like we have 22 almost all the invoices that we have, that's what Mr. 23 Hanks just said. 24 MR. SMITH: Yeah, we -- 25 MR. HANKS: Right. 26 MR. SMITH: -- we don't know the percentage, 27 Ms. Steel. Petitioner's representative said it's small. 28 The -- the invoices themselves just -- 21 1 MS. STEEL: No, not just samples, but the 2 taxable and non-taxable. Because without counting that 3 XYZ letter went out and 17 came back, only three was new 4 and 14 was used ones. 5 MR. SMITH: Uh-huh. 6 MS. STEEL: If we prorata the numbers it's only 7 like 20 percent new. But when you looking at all those 8 invoices that we came out almost 30 some percent but we 9 did -- did different calculation from that -- those XYZ 10 letters, so one -- my question is from those invoices 11 that almost all of them that we had the figures, that 12 out of that that how many were new and how many were 13 not? So what's the percentage coming out from those 14 accurate numbers, that's what I'm asking. 15 MR. SMITH: Of the 17 transactions where we -- 16 MS. STEEL: No. 17 MR. SMITH: -- got a response? 18 MS. STEEL: From the -- the first year audit 19 that we got all the receipts. Well, Mr. Hanks just said 20 that -- that you had -- the auditor said that we have 21 more informations in the first year of audit than later 22 of the years. That's why we audited them -- 23 MR. HANKS: Right. 24 MS. STEEL: -- for first year. So out of those 25 informations what was the percentage of new and used? 26 MR. SMITH: Well, the -- all the invoices -- 27 the printed invoices say "alteration." 28 MS. STEEL: Uh-huh. 22 1 MR. SMITH: But we don't know from looking at 2 the invoice, itself, whether it's new or used. 3 Now, Petitioner made a handwritten notation on 4 many of the invoices at the bottom. And the handwritten 5 notation generally said "alteration" or "alteration 6 other." And Petitioner has told us that "alteration" 7 meant it was new and "alteration other" meant it was 8 used. 9 MS. STEEL: So if -- 10 MR. SMITH: But with -- when we got three 11 response -- yes responses from the tax -- from 12 customers, two of those people who said it was a new 13 dress, the invoice said "alteration other." 14 MS. STEEL: Out of XYZ or that's a separate 15 answers? 16 MR. SMITH: It -- well, it's analogous to an 17 XYZ letter but it was something that we created 18 particularly for this situation that says did you buy 19 this dress new or did you buy it at a vinta -- you know, 20 at a consignment store. It -- it served the function of 21 an XYZ letter but it was created just for this audit. 22 MR. HANKS: So, unfortunately, we can't -- 23 MS. STEEL: I just want to see the numbers, 24 something really close because it seems like we have all 25 the record there for first year. And if taxpayer said 26 that there's "alteration" and "alteration others," and 27 when the taxpayer said one is new and one is used -- 28 used the garment, then we fixed that we have to have 23 1 percentage there, then must be much more accurate than 2 we send all these XYZ letters went out and we don't have 3 a lot of customers' addresses. So only 17 came back and 4 according to taxpayer it's 14 -- I mean, according to 5 us, too, 14 used one and three new ones, still that 6 percentage is less than 20 percent. That's what we have 7 number here if we prorata the percentage out of it. 8 But when we had all the documents here and 9 auditor already looked through all the documents, and 10 according to taxpayer there said used and others, new 11 one, then we should have those numbers out of hundred 12 garments, and then we had 80 percent or 70 percent were 13 used and something percent new, that must be more 14 accurate than only 17 XYZ letter came back. 15 So that's why I'm asking you that if you have 16 almost all the documents here for the first year, we 17 should have a number and that number is not really 18 exceeding 30 some percent that we really have other ways 19 to calculate. You know, went around that take minus and 20 try to, you know, put those with the percentage on it. 21 So I just want to look at the accurate number 22 here. But, you know, seems like we don't even have that 23 number. And then we have -- only numbers we have is 17 24 out of that 14 were used, three are new ones. Even we 25 calculate that as a percentage it's less than 20 26 percent. 27 So, what Department came out with just minus 28 and try to figure it out whole numbers, this is totally 24 1 wrong figure because you used other to do it. 2 You know, I already said that. I love math and 3 math is just really fascinating. You can put any 4 figures out and you come out a hundred different numbers 5 here. 6 So more of the simple way to put it, it's about 7 20 percent. So if you have those numbers the first year 8 we audited and then those figures coming out with others 9 and used ones, then I want to look at those numbers 10 that, you know, what was the percentage of others and 11 what was the percentage of new ones or used ones. 12 MR. SMITH: I can say that during the appeals 13 process Petitioner's representative -- I think it might 14 have been a different representative at the time, but -- 15 but they stated that under their analysis $22,715 in 16 sales were of alterations related to new clothing. 17 And that -- and that's -- actually, that works 18 out -- 19 MS. STEEL: It's about three percent -- 3.98 20 percent. 21 MR. SMITH: That's $22,700 within the test 22 year. So -- I think. 23 MR. HANKS: If I could add, though, too, 24 Ms. Steel, I think the difficulty here, and I think the 25 fundamental difference that -- that staff had with -- 26 with how the -- the taxpayer was reporting, is the 27 taxpayer understood that none of their sales basically 28 were -- were subject to tax. They believe that -- that 25 1 all of their sales with the exception of $500 of -- of 2 these sales were exempt from -- from tax. 3 They understood that their sales of the sample 4 dresses were exempt from tax because in -- in their mind 5 they were looking at a -- a dress that had been worn 6 before and in their mind that -- that qualified as a 7 used dress. 8 Unfortunately, you know, for us the -- the 9 regulation indicates otherwise and our case law 10 indicates otherwise. The dress is -- 11 MS. YEE: But -- but the sample -- 12 MS. STEEL: I -- I -- yeah, I get that, because 13 taxpayer said, yes, they were. Even that included it's 14 very small number. So I just want to have the over 15 numbers of those receipts that we have as what were used 16 and what were new ones. That's the only thing. 17 If you have those and love to look at it and if 18 we cannot really come out with the numbers and I can't 19 even figure it out here. 20 MR. HANKS: Ms. Steel, I could -- 21 MS. MANDEL: Are -- are you -- are you 22 following what she's asking you, because you had said 23 there was everything for the first year. She's 24 focused on that you had everything for the first year so 25 she's looking at -- 26 MS. STEEL: Relative -- 27 MS. MANDEL: -- then give me the split that was 28 there for the first year. 26 1 MR. HANKS: Right. 2 MR. SMITH: I think -- 3 MS. MANDEL: That's what it sounds like. 4 MR. HANKS: Right. 5 MS. MANDEL: But you're not answering that so 6 I'm just wondering if you're following what she's 7 asking. 8 MR. HANKS: Right. 9 MR. SMITH: I -- I believe that my 10 understanding is that the invoices were the most 11 complete for the first year and we have all the 12 invoices, but the problem is you can't tell from looking 13 at the invoice whether the garment was new or used. 14 MS. STEEL: But it's not taxpayer said their 15 put used one and others, or other and new ones, you 16 know, whether -- 17 MR. SMITH: Right, but we found -- 18 MS. STEEL: -- whatever the -- the way they put 19 it. 20 MR. SMITH: I'm sorry to interrupt you. 21 MS. STEEL: Sorry. Sorry. 22 MR. HANKS: Still perhaps -- perhaps -- 23 MS. STEEL: I just -- I just want to have 24 comfort number here, not like going around just -- 25 MS. YEE: Why -- why don't you speak to what 26 was troublesome about the documents for the first year. 27 It sounds like it didn't square up with what was entered 28 in the General Ledger potentially. 27 1 MR. SMITH: Well, the -- the invoice would just 2 say "alteration" -- 3 MS. YEE: Uh-huh. 4 MR. SMITH: And then there would be handwritten 5 notations on many invoices that would say "alteration" 6 or "alteration other." In the three -- and Petitioners 7 represented that "alteration other" meant it was new. 8 In the three cases where the customer said -- 9 wait -- 10 MR. TUCKER: The other way around. 11 MR. SMITH: -- the other way around, they 12 said -- 13 MS. YEE: "Other" is used. 14 MR. SMITH: -- "alteration other" meant it was 15 used. 16 MS. YEE: Uh-huh. 17 MR. SMITH: In the three cases where the 18 customer said this was a new dress, in two of the three 19 times the -- the invoice said "alteration other." So, 20 this kind of impeached the reliability of the 21 notation -- 22 MS. STEEL: How many cases -- 23 MR. SMITH: -- that was made at the bottom. 24 MS. STEEL: -- are we talking -- sorry, Mr. 25 Smith. But how many -- how many alterations we talking 26 about per year and then you had the sample of two? 27 MR. SMITH: There were 230 alterations I 28 believe -- 28 1 MS. STEEL: So out of 230 -- 2 MR. SMITH: -- in the first year -- 3 MS. STEEL: -- out of 230 we called three and 4 they said two were new, instead of -- 5 MR. SMITH: 17 -- we contacted -- we got 6 responses from 17 -- 7 MS. STEEL: Let's not go back. 8 MR. SMITH: Three said it's new and of those 9 three -- 10 MS. STEEL: That's the XYZ letters. 11 MR. SMITH: Yes. 12 MS. STEEL: What is that -- the other three 13 you're talking about? Those are the new ones, that XYZ 14 letters. So what you are saying is those XYZ letters 15 came back, those three are new ones, right? 16 MR. SMITH: Right. 17 MS. STEEL: So what that has anything to do 18 with the others that we contacted the customers and you 19 said it used to be used -- used one but they said it's 20 new. So they -- they lied about XYZ letters or we did 21 another call? 22 MR. SMITH: The customer said that the dress is 23 new but the handwritten notation on the invoice that 24 related to that sale said "alteration other." So that 25 led the auditor to believe that the handwritten notation 26 was not a reliable indicator of whether the garment was 27 new or used. 28 MS. STEEL: This meant -- you just said 29 1 "others" are the new ones. 2 MR. TUCKER: He correct -- 3 MS. STEEL: No, let's -- let's -- okay, 4 let's -- I just want to have some calculation here 5 that -- you know, some concrete percentage because, you 6 know, we are just so much off. 7 So we are not -- are you talking about 17 XYZ 8 letter went out, that -- is that the one you're talking 9 about or are we talking about others that from those 10 other documents that we called, even they said it's not 11 others but they still said it's new ones? 12 MR. SMITH: We received 17 responses. 13 MS. YEE: Pursuant to? 14 MR. SMITH: To the letters that went out for 15 the people -- 16 MS. STEEL: XYZ letter. 17 MR. SMITH: -- we were able to -- 18 MS. STEEL: And then three came with the new. 19 14 -- 20 MR. SMITH: Used. 21 MS. STEEL: Yeah. But what is -- what you are 22 talk -- you were talking about the other two. 23 MR. TUCKER: Pardon me, Ms. Steel, the two that 24 he's referring to are of the three that were returned. 25 MS. STEEL: Right. 26 MR. TUCKER: We -- there were only -- 27 MS. STEEL: So we know -- so we already know 28 those are new ones. 30 1 MR. SMITH: Right. 2 MR. TUCKER: Right. 3 MS. STEEL: But what you are saying is those 4 new ones that according to the taxpayer's record said 5 "others" but others are already new ones, that's what 6 they are saying. 7 MR. SMITH: You listened to what I said the 8 first time, which was wrong. "Alteration others" meant 9 that it was used. I misspoke and -- 10 MS. STEEL: So "alteration others" are used? 11 MR. SMITH: Used. 12 MS. STEEL: So, according to those records with 13 used, but when we send XYZ letters -- the taxpayer want 14 to send the XYZ letters out, those came back was marked 15 as a new. 16 MR. SMITH: Correct. 17 MS. STEEL: Okay. So, let's go back now. 18 The first year, so if we put those others then, 19 you know, we can come out that how much error rate here. 20 So, if we went out the first year of record out of 230 21 how many are new others on it and how many are not 22 others on it? 23 MR. SMITH: I don't know the answer exactly, 24 but I believe that in terms of dollars it would be 25 22,700 would say it's a new garment. And roughly 26 200,000 would say it was -- wait, that's out of 200,000. 27 MS. STEEL: It's about -- 28 MR. SMITH: So, 22,700 would be -- 31 1 MS. STEEL: New? 2 MR. SMITH: -- new, according to what 3 Petitioner says. 4 MS. STEEL: Out of 200 -- 5 MR. SMITH: And that's -- 6 MS. STEEL: No, Mr. Smith, I'm not asking what 7 Petitioner said. I'm asking you from the record that 8 how many -- 9 MS. YEE: Here, let me try this. 10 Ms. Steel is looking for an extrapolation based 11 on the response that you had received back after the 12 customer contact which showed that 14 were -- were used 13 and three were new. 14 Now, let's say even the two -- or the one that 15 was within the three didn't square up, we can kind of 16 keep it -- 17 MS. STEEL: So we can set aside those. 18 MS. YEE: -- set that aside. 19 MS. STEEL: And the first year of the record -- 20 MS. YEE: Right. So based on that, and using 21 that ratio of what would be taxable versus not, what can 22 we extrapolate over the course of the audit period? 23 MR. HANKS: Ms. -- Ms. Yee and Ms. Steel, we 24 haven't -- we haven't tracked that -- that difference 25 between the -- the amounts that were categorized as 26 "alterations" and "alterations other" because we 27 perceived that there was a difference of opinion 28 regarding what was new in -- in the taxpayer's mind. 32 1 What I could suggest alternatively is 2 perhaps -- perhaps if this were returned to the 3 Department we could conduct a -- a newer test. We'd 4 have more up-to-date information where we could do a 5 more -- an additional analysis to determine what 6 percentage fell in this category versus that. And that 7 would give us a truer reflection of -- of what this 8 percentage is. 9 MS. YEE: Okay. 10 MS. STEEL: That's what I want to suggest 11 because, you know, they had the most current numbers and 12 they have everything computerized. So if they can go 13 out, reaudit. 14 MS. YEE: Yeah, and I don't object to that but 15 I want Mr. Gallagher and Mr. Wexler to be aware of why 16 it's been so difficult because there have been 17 discrepancies and what we have found pursuant to the 18 customer contact isn't consistent with how, you know, 19 things have been reported internally. 20 So that's where we're really having some 21 trouble. But I think -- I mean, I certainly would 22 support another look. 23 MS. STEEL: So what can be the motion here? 24 MR. HORTON: 30 days. 25 MS. STEEL: 30-30-30? 26 MS. YEE: Yeah. 27 MS. STEEL: That's my motion. More, you said? 28 MS. YEE: You want some direction? 33 1 MR. TUCKER: I was just going to add, if they 2 have been keeping diligent records that might be helpful 3 to incorporate. 4 MR. GALLAGHER: We -- we have. 5 MS. YEE: Okay. Okay. 6 MR. HORTON: I'm -- 7 MS. YEE: Mr. Horton, yes. 8 MR. HORTON: You know, as I -- as I listen to 9 the debate I would be supportive of a 30-30-30. I would 10 suggest to the taxpayer that before that is -- before 11 the Department initiates that process that you take a 12 real good look at the numbers that you have here. It 13 appears that the numbers that the Department has 14 generated may actually be lower -- low -- lower at the 15 end of the day. 16 And so I'm certainly supportive of a 30-30-30 17 but your testimony here today seems to imply that the 18 number is a lower amount than what your most recent data 19 reveals. Thanks. 20 MS. YEE: Thank you, Mr. Horton. Okay. 21 Department, are we clear about what -- 22 MR. HANKS: I think we are, yes. 23 MS. YEE: Very good. Okay, Ms. Steel, do you 24 want to make a motion? 25 MS. STEEL: The motion is 30-30-30 and then get 26 reaudit -- 27 MR. HANKS: Yes. 28 MS. STEEL: -- for the most correct. 34 1 MR. HANKS: Yes. 2 MS. STEEL: Yeah. 3 MS. YEE: Okay. Okay. 4 MS. STEEL: Thank you. 5 MS. YEE: All right, we have a motion by Ms. 6 Steel for a 30-30-30 to allow a reaudit on hopefully 7 more up-to-date information -- with hopefully more 8 up-to-date information. 9 Is there a second? 10 MR. HORTON: Second. 11 MS. YEE: Second by Mr. Horton. 12 Without objection, that motion carries. 13 We are going to take another look at your 14 records but we're going to have the Department confer 15 with you and maybe, Mr. Levine, you can kind of just 16 describe the 30-30-30 process for -- 17 MR. WEXLER: As -- as part of that can we 18 submit what we've -- 19 MS. YEE: The -- the Appeals Division will -- 20 let him spell that out -- 21 MR. WEXLER: Okay. 22 MS. YEE: -- and then we'll have you ask 23 questions. 24 MR. LEVINE: The basic process is you have 30 25 days to submit any additional documentation or argument 26 you want, which would include your current list. I'd 27 suggest also if you're relying on the current percentage 28 of Craig's List, an explanation of why the percentage of 35 1 used wedding dresses sold on Craig's List isn't higher 2 now because that's how things go, worse economy, people 3 more proficient at internet, more sales. 4 And then after that 30 days the Department will 5 have 30 days to analyze, perhaps consult with you 6 further if they have more questions, and provide a 7 recommendation to Appeals. I'd suggest if you have any 8 questions rather than just compiling everything in your 9 30 days contact the Department if you want some advice 10 on what they need so we can make this as efficient as 11 possible. 12 MR. WEXLER: Okay. Perfect. 13 MS. YEE: Okay. Very well. Thank you very 14 much. 15 MR. GALLAGHER: Thank you. 16 MR. WEXLER: Thank you so much. 17 ---oOo--- 18 19 20 21 22 23 24 25 26 27 28 36 1 REPORTER'SCERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, BEVERLY D. TOMS, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 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 36 13 pages constitute a complete and accurate transcription 14 of the shorthand writing. 15 16 Dated: January 7, 2011. 17 18 19 ____________________________ 20 BEVERLY D. TOMS 21 Hearing Reporter 22 23 24 25 26 27 28 37