1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 NOVEMBER 17, 2010 10 11 SALES AND USE TAX APPEAL HEARING 12 APPEAL OF 13 FIVE FRIENDS 14 (Item C3) 15 AGAINST PROPOSED ASSESSMENT OF 16 SALES AND USE TAX 17 18 19 20 21 22 23 24 25 26 27 Reported by: Kathleen Skidgel 28 CSR No. 9039 1 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 P R E S E N T 2 For the Board of Equalization: Jerome E. Horton 3 Vice Chair 4 Barbara Alby Acting Member 5 Michelle Steel 6 Member 7 Marcy Jo Mandel Appearing for John 8 Chiang, State Controller (per Government Code 9 Section 7.9) 10 Diane G. Olson, Chief 11 Board Proceedings Division 12 13 For Board of Equalization Staff: David Levine 14 Staff Counsel 15 Robert Tucker Tax Counsel 16 Kevin Hanks 17 Chief, Headquarters Operations Division 18 19 For Department: Chris Schutz Tax Counsel 20 21 For Petitioner: Ned Roscoe, Representative John Roscoe, Representative 22 23 ---oOo--- 24 25 26 27 28 2 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 NOVEMBER 17, 2010 4 ---oOo--- 5 MR. HORTON: Ms. Olson, what's the next item? 6 MS. OLSON: Our next item is C5, Five Friends. 7 Please come forward. 8 Excuse me, C3. 9 MR. HORTON: C3. Thank you Ms. Olson. 10 Mr. Levine, please introduce the matter. 11 MR. LEVINE: It looks like we have two of the Five 12 Friends in this petition where the issue is whether the 13 subject cigarette rebates are taxable. 14 MR. HORTON: Thank you. 15 Gentlemen, you'll have ten minutes to make your 16 presentation. We will give you an additional five minutes 17 on rebuttal. Please introduce yourself for the record. 18 MR. NED ROSCOE: Good afternoon. My name is Ned 19 Roscoe. I'm a supervisor with Five Friends. 20 MR. JOHN ROSCOE: My name is John Roscoe. I'm an 21 agent for Five Friends. 22 MR. HORTON: Thank you. Please commence with your 23 presentation. 24 MR. NED ROSCOE: We have appeared in front of the 25 Board on this similar topic several times. In this case 26 the confusion relies on -- there's a statement in the audit 27 that says, "All of the retailers' gross receipts are 28 presumed subject to tax unless proven otherwise. The 3 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 burden's on the retailer." We accept that. It says, "The 2 gross receipts, including all amounts received with respect 3 to the sale, are taxable unless there's a specific 4 statutory exclusion." 5 And we'd say that in regulation 1671.1 that was 6 adopted by the Board, the purchase discount paragraph 7 addresses exactly what happens in our industry and should 8 provide an exclusion. 9 In the appeals decision, it says that "for each 10 such taxable retail sale, petitioner received a portion of 11 the selling price from the purchaser and the remainder from 12 Phillip Morris", as if the ghost of Phillip Morris was by 13 every register making a contribution to that register as 14 each sale occurred. That's not the way that it works. 15 In the documents that I've given you, there are 16 some promotional notices from Phillip Morris, the largest 17 cigarette manufacturer, that refer to the Stars 18 pay-on-purchase methodology. I've highlighted them. What 19 the Stars pay-on-purchase methodology refers to is the Star 20 System. And I've given you the technical manual this time 21 for the Stars System. 22 The Stars System is a method by which wholesalers 23 report to Phillip Morris on the purchases by retailers. 24 The Stars pay-on-purchase methodology is the method that 25 Phillip Morris uses to reimburse retailers. It's done on 26 purchases by the retailers. It is not based upon sales. 27 If a retailer made purchases and then made no sales, just 28 held the inventory, they would still get the rebate. 4 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 That's contrary to the language written in the appeal. 2 I think the language in the appeal comes from 1671, 3 section (c)(3)(A) that requires on a transaction by -- by a 4 transaction basis a specific reduction in the selling 5 price. What it ignores is the language that the purchase 6 discounts are based upon the amount of prior or future 7 purchases. But these are trade discounts and excluded from 8 gross receipts. That's what it says in the section (b)(2) 9 of 1671.1. 10 In the -- to go on to the discussion of what is the 11 consideration, in the Dell case against the State Board, 12 the percentage price is to be measured against the 13 consideration for the sale. The consideration is actually 14 what the customer buys to get the merchandise out of the 15 store. Nothing is reported from that sale to Phillip 16 Morris. 17 In the Southern California Edison v. State Board of 18 Equalization it says that the sales price from gross 19 receipts, as used in this section and in section 6012, 20 refers to the price agreed on at the initial sales 21 transaction. Initial sales transaction is when the 22 customer buys the purchase. It's not when the retailer 23 buys it from the wholesaler. We don't pay sales tax based 24 upon our purchases from our wholesaler. We pay sales tax 25 based upon the amount that we sold. 26 MR. HORTON: Thank you, sir. 27 Members of the Department, please introduce 28 yourself for the record, then commence with your 5 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 presentation. 2 MR. SCHUTZ: Chair Members, I'm Chris Schutz from 3 the Legal Department. To my right is Robert Tucker, also 4 from the Legal Department, and Kevin Hanks from the Sales 5 and Use Tax Department. 6 Here, petitioner's liability should be redetermined 7 in accordance with the Appeals Division's recommendation 8 because the amounts received as promotional payments from 9 Phillip Morris for which petitioner was required to reduce 10 the retail sales price of its cigarettes by the amount of 11 the promotional payment are considered taxable as part of 12 petitioner's gross receipts. 13 Petitioner operated a number of cigarette and 14 tobacco shops, and petitioner purchased cigarettes and 15 other tobacco products from local distributors. But 16 petitioner did not purchase cigarettes directly from 17 manufacturers such as Phillip Morris. 18 During the audit Phillip Morris provided 19 information regarding rebates it made to petitioner during 20 the audit period. Specifically, Phillip Morris provided 21 its Retail Leader Agreements with petitioner for 2006 and 22 2007 and a summary of documents showing payments to 23 petitioner under promo code C and P. The measure of tax at 24 issue is based on the schedule of payments under promo code 25 P that we received from Phillip Morris. 26 Amounts received under promo code C did not require 27 petitioner to make the reductions in its retail selling 28 price. So it was considered nontaxable as allowance for 6 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 shelf space and merchandise. However, under -- for amounts 2 received under promo code P, petitioner was required to 3 reduce the retail selling price of its products by amounts 4 it received. 5 Sales tax is imposed on a retailer's retail sales 6 of tangible personal property and is measured by a 7 retailer's gross receipts. Gross receipts is the total 8 amount of the sales price, and includes all receipts, cash, 9 credit and property of any kind received for the sale. 10 This includes amount received from any source, provided 11 they relate to the retail sale. Amounts received by the 12 retailer from a third party relate to the retailer's retail 13 sale when the third party requires the retailer to 14 specifically lower its retail selling price by the amount 15 received in order to receive those amounts. 16 Accordingly, as in this case, when a third party 17 such as Phillip Morris provides rebates or promotional 18 payments, and as a condition of receiving the payments or 19 promotional -- the rebate or promotional payments, requires 20 the petitioner to lower retail selling price directly by 21 the amounts received, the amount received is part of the 22 retailer's gross receipts. 23 Here the available contracts require that 24 petitioner reduce its retail selling price of cigarettes by 25 the amount received under plan P as promotional payments. 26 Accordingly, these amounts are properly includable in 27 petitioner's gross receipts. 28 Now I note in petitioner's opening presentation it 7 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 said that it was based on -- the purchase is based on the 2 Stars payment. However, if you look at the contract that 3 we were provided, specifically -- it specifically states 4 that, one, retailer agrees to not artificially inflate its 5 retail selling price so that it would offset the amounts 6 received. Two, under -- in Exhibit F, it also requires 7 that promotional allowances are not payable on any sale 8 that is not conducted on a face-to-face basis, thus, mail 9 orders, Internet sales, would not be included in the amount 10 that would qualify for the promotional payments. 11 Now, with -- also there are other types of -- if 12 they also made wholesales, they wouldn't be required -- 13 these wholesales that petitioner would have made would not 14 have been part of the promotional payout. 15 Now, even though Phillip Morris tracks payments 16 using the Star Systems which is based on the petitioner's 17 purchases, it has a right to audit petitioner's books to 18 look at what retail sales it made. And in regard to 19 remedies that -- there's a section on remedies in this 20 agreement that says P -- Phillip Morris will exclude from 21 the store's qualifying sales any cigarettes that are sold 22 to other retailers or other wholesale trade discounts or 23 otherwise do not qualify as -- are nonqualifying sales. 24 So Phillip Morris, one, is stating that it's not -- 25 that the promotional plan is -- there are certain types of 26 sales that the promotional plan will not qualify for. Two, 27 that it has a right to look at the books and records. And 28 three, that it has a right to reduce the amount of 8 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 promotion by nonqualifying sales. Therefore, it is based 2 on sales, even though petitioner might argue that well, 3 Phillip Morris has never done this. Under the contract, 4 Phillip Morris certainly had the right to look at their 5 sales and reduce the amount received by its retail sales. 6 Additionally, petitioner, when he talks about the 7 target price in 1671(b)(2), that is different than what 8 happens here. A target price is maybe you set a specific, 9 like 9.99 price, in general. But here you have a direct 10 reduction where the agreement here is requiring that on a 11 dollar-for-dollar, penny-for-penny basis, the cigarette 12 retailer, petitioner, must reduce its retail selling price. 13 And so that does tie it on a transaction-by-transaction 14 basis and puts it really under 1671, the provision with 15 regard to taxable rebates and not these purchase or trade 16 discounts. 17 If you have any questions, I'd be happy to answer 18 them. Thank you. 19 MR. HORTON: Thank you very much. 20 Mr. Roscoe, on rebuttal. 21 MR. NED ROSCOE: The sentence that the Department 22 is referring to reads that, "Agreements wherein the 23 retailer agrees to sell the products at a target price for 24 a period of time are also purchase discounts and excluded 25 from gross receipts when the discount is based on the 26 number of products purchased by the vendor." The vendor is 27 above the retailer. It's nobody else. 28 In the Department's presentation they talked about 9 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 what might happen at Phillip Morris, because they contract, 2 therefore this sentence in the State Board's regulation can 3 be ignored. Actually what happens is it's calculated based 4 on purchases, just as it says in this sentence. 5 He talked about it having to be reduced 6 dollar-for-dollar. If the retailer did not sell the 7 product, they would still get the rebate. They do get the 8 rebate. If there's theft, if it's all stolen, they still 9 get the rebate even if it's not sold. If it's returned to 10 the manufacturer, the rebate is reduced. It's all based 11 upon what happens at wholesale. 12 Now, in the regulation 1671.1 it talks about a 13 rebuttable presumption. I've had conversations with Linda 14 Cardwell of the State Board of Equalization. I've had 15 conversations with Jeff McGuire of the State Board of 16 Equalization. Written both letters after I asked them what 17 is a rebuttable presumption? And in practice I can tell 18 you, there is no rebuttable presumption despite the 19 language of the regulation. In practice, the Department's 20 policy is to take everything, to take as taxable regardless 21 of what the law says. 22 We feel special about this. Twice we've done 23 surveys of chains that have more than 8,000 stores. We've 24 looked at -- we've gotten receipts from them, and they're 25 names like Walgreens, 7-Eleven, Safeway, Long's Drugs. 26 They do not charge sales tax in a way consistent with the 27 Department's position. We've made this available to the 28 Department, and it has been ignored. That not only is the 10 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 Department pursuing a course that is contrary to the 2 regulation, the treatment, which Department employees will 3 agree is disparate, is unfair, it's unequal. It violates 4 the equal protection clause of the Constitutions. But we 5 continue. 6 MR. HORTON: Thank you very much. 7 Discussion, Members? Seeing none, is there a 8 motion? 9 MS. MANDEL: Take the matter under submission. 10 MR. HORTON: It's been moved by Ms. Mandel, second 11 by myself. Without objection, Members, such will be the 12 order. 13 (The matter concluded at 2:36 p.m.) 14 ---oOo--- 15 16 17 18 19 20 21 22 23 24 25 26 27 28 11 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, KATHLEEN SKIDGEL, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 November 17, 2010 I recorded verbatim, in shorthand, to the 10 best of my ability, the proceedings in the above-entitled 11 hearing; that I transcribed the shorthand writing into 12 typewriting; and that the preceding pages 1 through 11 13 constitute a complete and accurate transcription of the 14 shorthand writing. 15 16 Dated: December 17, 2010 17 18 19 ____________________________ 20 KATHLEEN SKIDGEL, CSR #9039 21 Hearing Reporter 22 23 24 25 26 27 28 12 TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333