1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 REPORTER'S TRANSCRIPT 8 FEBRUARY 22, 2011 9 10 ITEM H2 11 TAX PROGRAM NONAPPEARANCE MATTERS 12 ADJUDICATORY 13 FRANCHISE AND INCOME TAX MATTERS 14 15 16 17 18 19 20 21 22 Reported by: Juli Price Jackson 23 No. CSR 5214 24 25 26 27 28 1 1 P R E S E N T 2 3 For the Board Jerome E. Horton of Equalization: Chairman 4 5 Michelle Steel Vice-Chairwoman 6 7 Betty T. Yee Member 8 9 George Runner Member 10 11 Marcy Jo Mandel Appearing for John 12 Chiang, State Controller (per 13 Government Code Section 7.9) 14 15 Diane G. Olson Chief, Board 16 Proceedings Division 17 18 For the Board: Lou Ambrose Tax Counsel 19 20 Anthony S. Epolite Tax Counsel 21 22 ---oOo--- 23 24 25 26 27 28 2 1 INDEX OF SPEAKERS 2 ---o0o--- 3 NAME PAGE 4 H2.2a Felix Lin 4 5 H2.3 Marilyn Barrett 18 6 7 8 9 ---o0o--- 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 3 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 FEBRUARY 22, 2011 4 ---oOo--- 5 MR. HORTON: Ms. Olson, what is our next 6 scheduled matter? 7 MS. OLSON: Our next scheduled items are 8 nonappearance and with the coming hour of lunch, we 9 could take a break now, we do have two speakers that 10 have signed up for the -- to speak on your adjudicatory 11 matters. 12 MR. HORTON: Okay, what's the desire of the 13 Board? 14 MS. YEE: Let's do it. 15 MR. HORTON: Okay, let's do it. 16 MS. OLSON: You would like to hear the two 17 speakers? 18 MR. HORTON: Yes. 19 MS. OLSON: Okay. Our first on is on H2.2, 20 Felix Lin and Betty Lin. 21 ---o0o--- 22 H2.2 FELIX LIN AND BETTY LIN 23 NO. 477812 24 ---o0o--- 25 MS. MANDEL: Mr. Chair? 26 MR. HORTON: Yes? 27 MS. MANDEL: On this case the Controller has 28 asked me not to participate today. So, I'm just going 4 1 to step out. 2 Thanks. 3 MS. YEE: Mr. Chairman, I'm going to also 4 abstain from participating in this case. 5 MR. HORTON: Okay. Please note we've got two 6 Members that are not participating. 7 MS. STEEL: Mr. Chair, can we delay this after 8 lunch? 9 MR. HORTON: Okay. I think as a result of 10 recent information, Ms. Steel has asked that we delay 11 this until after lunch -- 12 MS. STEEL: If it's okay with taxpayer? 13 MR. HORTON: -- if -- 14 MR. LIN: It's okay. 15 MR. HORTON: -- it works with your schedule? 16 MR. LIN: Yes. 17 MR. HORTON: Rightfully -- rightfully so, so we 18 can -- so, Ms. Steel can take some other matters under 19 consideration as we proceed. 20 So, the Board is hereby out for lunch. 21 MS. OLSON: Recessed. 22 MR. HORTON: Recessed for lunch until 1:30. 23 Thank you. 24 (Whereupon the Board recessed.) 25 MR. HORTON: Members, let's reconvene the Board 26 of Equalization meeting for the day. We're going to 27 take up the speakers and then we will return back to the 28 G calendar. 5 1 MS. OLSON: Okay, our first speaker is Felix 2 Lin. 3 Please come forward. 4 ---o0o--- 5 FELIX LIN 6 ---o0o--- 7 MR. LIN: Mr. Chairman, Senator Runner, Members 8 of the Board, my name is Felix Lin. I was the founder 9 and CEO of AvantGo. 10 And there's a lot of material that's been 11 distributed in this case. The fundamental issue is 12 whether AvantGo was a California qualified small 13 business in 2001 and 2002, and, more specifically, 14 whether AvantGo met the payroll test requiring 15 substantially all of its payroll expenses attributable 16 to employment to be paid to people in California rather 17 than people outside of California. 18 If it's okay, what I'd like to do is just show 19 you an illustration -- 20 MR. HORTON: Yes, please. 21 MR. LIN: -- summarizing all the facts in the 22 case. 23 Fundamentally, this is a chart showing the 24 percentage of our work force that was in California from 25 inception, back in '97, to the time that we were sold to 26 Sybase in 2003. 27 As you can see, on Day 1, 100 percent of our 28 employees were in California. And as we grew very 6 1 quickly over the next four years, three and a half 2 years, we eventually came to employ over 300 employees 3 with 350 total, 300 of whom were in California. 4 MR. HORTON: I'm sorry, Mr. Lin, let's see if 5 we can -- oh, there we go, okay. 6 MR. LIN: Sorry about that. 7 MR. HORTON: Just for the record, could you 8 sort of -- I hate to ask you to do this, but start from 9 the beginning, before you had the mike? 10 MR. LIN: Sure. So, at the very -- this is a 11 graph of the percentage of AvantGo's work force in 12 California over time, from the day we started, back in 13 '97 until the day the company was sold to Sybase, back 14 in 2003. 15 You can see from the very beginning, from the 16 time we started in my living room, all of our work force 17 was here in California. In '98 we had ten employees, 18 only one of whom was an outside salesperson working out 19 of their home office outside of California. 20 We eventually grew to 350 employees in 2000. 21 And even then, with 50 of our employees outside of 22 California, 85 percent of our work force was still 23 located here, okay. 24 And what's interesting here, of course, is that 25 the Franchise Tax Board agreed that even up until 2000 26 we met the payroll test. There's no question, okay. 27 So, at the peak of our employment, when we had 28 the maximum number of employees working outside of 7 1 California, we met the payroll test. After the period 2 in dispute, the Franchise Tax Board agrees also that we 3 met the payroll test. 4 What had happened in 2001 and 2002, however, 5 after the dot-com bubble burst, after 9/11, after a lot 6 of people lost their jobs, after the start of the 7 recession, we were forced to retrench. We laid off a 8 lot of people, unfortunately. 9 But as you can see from this graph, we actually 10 laid off a relatively smaller percentage of workers here 11 in California than we did outside of California. All 12 right, we were saving jobs for Californians. 13 And in the course of doing that, we paid a lot 14 of severance to the people in the UK. In California, 15 many of these people that we had hired very quickly in 16 1999, 2000 and had worked for us for a year, maybe less, 17 we gave them three weeks severance. It was a minimum of 18 two weeks, plus a week for every year they worked, okay, 19 which we thought was fair. 20 For the people in the UK, however, the law 21 required us to pay 22 weeks of severance, minimum. So, 22 even if somebody only worked for six months, they would 23 get five and a half months severance. But we chose to 24 do that so we could save those jobs in California, okay. 25 So, if you look what's happening, right, just 26 from the number of people working during this period of 27 2000, 2001, 2002, we're employing relatively larger 28 numbers of Californians. True, we're laying people off 8 1 but we're saving more jobs for Californians. 2 And, so, what happens here is during this 3 period in dispute -- it's ironic that the Franchise Tax 4 Board would question whether we're a qualified 5 California small business. Because, in fact, before 6 this period we had a smaller percentage of people 7 working in California. And that percentage is growing 8 over time, okay. 9 The only way it's possible to create a 10 situation where it appears that we're not a qualified 11 California small business is to misinterpret the 12 statute -- both the spirit of the law and the letter of 13 the law. 14 The payroll test requires that 80 percent of 15 our payroll expense attributable to employment be in 16 California. What the Franchise Tax Board is doing is 17 it's ignoring "attributable to employment." It's saying 18 severance is a payroll expense, which I agree it's a 19 payroll expense, but it's not a payroll expense 20 attributable to employment. 21 MS. OLSON: Time has expired. 22 MR. LIN: If I can -- 23 MR. HORTON: Do we have any other witnesses on 24 this matter? 25 MS. OLSON: No. 26 MR. HORTON: This is it? 27 Please continue. 28 MR. LIN: Okay. 9 1 MR. HORTON: Let's -- let's grant him another 2 five minutes and then -- 3 MR. LIN: Okay. The point I want to make here 4 is both the spirit of the law and the letter of the law 5 intend for us to create jobs for Californians or, in the 6 case of bad times, to save jobs for Californians -- 7 which is exactly what we were doing. 8 Okay. The letter of the law says, "Payroll 9 expense attributable to employment in California," okay. 10 If you ignore "attributable to employment in 11 California," and just say it's just payroll expenses, 12 then, yeah, you could make the argument we paid more to 13 people outside California. 14 But what's perverse about this is that if we 15 had saved 20 jobs in the UK and fired 20 people in 16 California, we'd have met the qualified small business 17 test. 18 MR. LIN: That clearly couldn't have been what 19 the -- could not have been what the legislator 20 (verbatim) wanted us to do, right? 21 Secondly, the spirit of the law is clear as 22 well. We want to save jobs for people in California. 23 I respectfully ask that the Board recognize 24 that the interpretation of the statute is to both create 25 jobs or save jobs for people in California. 26 But the language is explicit and requires that 27 we look at every word of the statute that says we have 28 to recognize that we're talking about payroll 10 1 attributable to employment. 2 And, as all of us know, the big difference 3 between a severance check and a payroll check is 4 employment. 5 You can't include severance when you're talking 6 about payroll expenses attributable to employment. 7 So, I respectfully ask that the Board find that 8 the interpretation of the statute is as we described, 9 such that you find in favor of the Appellants. 10 MR. HORTON: Thank you very much, Mr. Lin. 11 Discussion, Members? 12 MS. STEEL: Mr. Chairman? 13 MR. HORTON: Yes. 14 MS. STEEL: I want to ask Mr. Lin to explain 15 about the payroll factor. 16 MR. LIN: So, I think what's -- what's clear 17 from all of the work that was done is that at the point 18 in time when we had a maximum of people working outside 19 of California, more than 85 percent of our payroll was 20 still here in California. 21 Now the payroll test, I don't know whether it's 22 80 percent or 85 percent, there's a lot of discussion 23 about whether the legislature meant for it to be 80 to 24 85, but more than 85 percent of our work force was 25 located in California. And I believe, looking at the 26 numbers as well, well over 80 percent of all of our 27 payroll expenses attributable to employment were in 28 California as well throughout the entire time. 11 1 MS. STEEL: Thank you. 2 MR. HORTON: Thank you very much. 3 Any other discussion, Members? 4 Let me ask Mr. Epolite, can you give us some -- 5 just for a point of clarification on the law and what it 6 says in regards to the percentages and how we measure 7 that? 8 MR. EPOLITE: Well, the Franchise Tax Board 9 utilizes payroll information off the 4100 R, which is a 10 form for businesses -- unitary businesses. And they use 11 the payroll information reported on those forms for 12 purposes of calculating to determine whether a company 13 has met the 80 percent payroll test. 14 And it was on that basis that the Franchise Tax 15 Board determined that for the 2001 and 2002 years that 16 less than 80 percent of AvantGo's payroll was 17 attributable to California. 18 MR. HORTON: And how the severance pay treated 19 in that computation? 20 MR. EPOLITE: It was Franchise Tax Board's tax 21 board other severance pay was included in those 22 totals. 23 MR. HORTON: And your argument is, Mr. Lin, 24 that it should not have been? 25 MR. LIN: That's correct. 26 MR. HORTON: And what does the law say as it 27 relates to severance pay? 28 I mean, is there any case law? Is there any 12 1 interpretation -- 2 MR. EPOLITE: Not -- 3 MR. HORTON: -- as to whether or not that's 4 included as part of the payroll or -- 5 MR. EPOLITE: -- no, not relating to any income 6 tax statutes. 7 And it's our interpretation that the severance 8 pay would be included as part of payroll expense in the 9 statute in that the statute provides that a corporation 10 does not meet the 80 percent test if more than 20 11 percent of the corporation's total payroll expense is 12 attributable to employment located outside of 13 California. 14 And, in staff's opinion, that is not a what 15 test, that is -- as in what is payroll -- but a where 16 test, where is payroll attributable to employment 17 located outside of California? 18 So, it was our conclusion that the statute is 19 talking about where payroll was located as opposed to 20 describing what -- a type of payroll. 21 MR. HORTON: Well, the debate here seems to be 22 centered around severance pay and whether or not the 23 severance pay is attributable to employment. 24 And, so, if an individual's employed and they 25 receive severance pay, would that be attributed to 26 employment or is that attributed to something else? 27 I -- Mr. Lin? 28 MR. LIN: Severance pay is attributable to 13 1 unemployment, right? It's what you pay somebody because 2 They're not going to be able to come to work any more. 3 And it's clear to anybody that the difference 4 between a paycheck and a severance check is that you 5 either get to go to work or you get to go look for work, 6 right? 7 And the statute was designed to incent 8 (verbatim) job creation in California. If you have to 9 include severance pay, there is two questions I ask: In 10 the statute, if it was all payroll expenses, including 11 severance pay, it would not need to have written a 12 statute to include the words "attributable to 13 employment." They would have simply said, "All payroll 14 expenses in or outside of California." 15 MR. HORTON: Now, is the severance pay based on 16 the number of years? Based on the position? Based on 17 the work performance? Or is it -- 18 MR. LIN: None. In the -- 19 MR. HORTON: -- a person will receive -- if a 20 person worked for the company, let's say for a year 21 versus an individual that had worked there for 25 years, 22 would there be a differential in the severance pay? 23 MR. LIN: Not in the UK. In the UK it was a 24 flat 22 weeks of severance if you were employed. 25 MR. HORTON: Irrespective of -- 26 MR. LIN: That's right. 27 MR. HORTON: -- the number of years of your 28 employment, your employment status? 14 1 MR. LIN: Regardless of job, regardless -- 2 MR. HORTON: How about in California? 3 MR. LIN: In California there's no requirement 4 either. 5 MR. HORTON: How did the company treat it? 6 MR. LIN: We chose to give people a year -- I 7 mean a week of severance for every year they worked for 8 the company, with a minimum of two weeks. 9 MR. HORTON: So, in California it was tied into 10 the number of years worked? 11 MR. LIN: That's right. 12 MR. HORTON: Tied into employment? 13 MR. LIN: That's right. 14 MR. HORTON: And the argument is is that the 15 California severance pay should not have been included 16 in the computation? 17 MR. LIN: I wouldn't have included severance 18 anywhere in the world in that computation. 19 MR. HORTON: Wow. 20 MS. STEEL: Because you tried to match with UK 21 that you have to work for that company for 20 years. 22 MR. LIN: See, if you don't include severance 23 anywhere in the US, right, then it's clear what's 24 happening here. 25 There's only two ways that you can get wages -- 26 either we're paying big bonuses, right, to people 27 outside on the US or we're paying severance, right? 28 And at the starting point in 2000, the tax 15 1 board auditor recognizes that we are already meeting the 2 payroll test, right. 3 So, we're already meeting the payroll test. 4 And then the percentage of our work force in California 5 is increasing, right? 6 So, logically, we can't be paying more wages 7 outside of California, right? Our work force in 8 California is growing. So, the only thing that's 9 affecting this calculation is the severance pay, which I 10 agree, we paid a big severance to people in the UK so we 11 could keep people in California working. 12 MR. HORTON: Mr. Runner? 13 MR. RUNNER: Yeah, it seems to me that the 14 intent -- I have got to believe that the intent of the 15 program is to try to create California jobs, and that 16 means working. 17 And I have great difficulty then understanding 18 how severance then would go to the intent of that, which 19 is not a job, it's a -- it's a paid benefit of such. 20 It would be -- it would be almost like if you 21 included retirement in your in -- you know, it's a -- 22 it's something other than a job-related work issue. 23 So, yeah, I'm -- at least, you know, I -- I 24 understand, at least, I think, the intent of the 25 interpretation is to be very specific in regards to all 26 work. 27 But again, I -- I'm just having difficulty 28 understanding how a severance package, particularly when 16 1 it's driven by a policy, you know, outside of the United 2 States in regards to what it's requiring the taxpayer to 3 do, then should undermine the ability to lose the tax 4 benefit. 5 MR. HORTON: Okay. Any other discussions? 6 Well, thank you, Mr. Lin, and -- 7 MR. LIN: Thank you. 8 MR. HORTON: -- we commend you for your efforts 9 to be conscious of creating jobs in the State of 10 California. 11 You know, the challenge that I see is is that 12 the interpretation of the law, you know, the Supreme 13 Court has often ruled that companies have the ability to 14 structure their finance in such a way to actually pay 15 the minimum amount of taxes under the law. 16 But subsequent to that performance and that act 17 of taking some conscious act of -- of arranging your 18 finances, the consequences are uncontrollable. I mean, 19 the consequences sort of fall back to the letter of the 20 law. 21 And therein is where I'm having somewhat of a 22 challenge in that by policy, by rule, by your testimony, 23 the severance pay in California seems to be attributed 24 to employment. Had the company taken a policy that 25 existed in the UK, which may have been a little more 26 expensive by -- as well, because one day in the UK, you 27 get severance pay, you've got to spend a little more 28 time, you've got to earn your severance pay in the State 17 1 of California, which ties it right back into the 2 employment. 3 It makes it more beneficial to the companies 4 that exist in California that they, in turn, don't have 5 to pay severance pay to everyone, irrespective of their 6 position in the company. 7 But let me think about it. 8 Thank you very much for your presentation. 9 We have one additional witness, I believe? 10 MS. OLSON: We have one more speaker for H2.3, 11 Marilyn Barrett. 12 ---o0o--- 13 H2.3 RONALD N. FRAZAR AND JANE A. FRAZAR 14 NO. 494349 15 ---o0o--- 16 MS. OLSON: Please come forward. 17 ---o0o--- 18 MARILYN BARRETT 19 ---o0o--- 20 MS. BARRETT: I'm here on a petition for a 21 rehearing in the matter of Ronald N. and Jane A. Frazar. 22 And this case deals with the issue of the 23 validity of a regulation that instituted domicile 24 sourcing rule for the sale of, in this case, a sale of 25 stock. 26 My client was a resident of the State of 27 California when they sold the stock and then moved to 28 Montana shortly thereafter. 18 1 However, at the time that they moved, there was 2 no rule or law in effect that would source the 3 installment income in the State of California. And we 4 spent some time talking about this last June. And I am 5 filing the petition for a rehearing under the -- on the 6 basis that I think the law was not applied correctly. 7 I -- the Board's opinion or determination 8 letter stated no basis for its position. They just said 9 that -- just ruled against my client. 10 I listened to the webcast and the only comment 11 I heard then was that there was no change in the law, 12 even though I pointed out -- and that the Franchise Tax 13 Board was correct to follow the mobilia doctrine and 14 insert that in a regulation as the rule for the source 15 of the income. 16 I pointed out that at the time -- that under 17 the rules of statutory construction the mobilia doctrine 18 had been repudiated by the State legislature when it 19 enacted the statute that imposed an accrual method of 20 accounting for determining sourcing. 21 That statute was in effect for over 46 years 22 before it was repealed. When it was repealed, there was 23 a gap in the law. 24 However, I think under the separation of powers 25 the Franchise Tax Board does not have the power to enact 26 law and did so. 27 I was -- I found it interesting this morning a 28 couple of times you raised questions, Members raised 19 1 questions about what the IRS would have done. And as I 2 had mentioned last June, in a comparable matter before 3 the Congress, the US Congress in 1986, they specifically 4 enacted a sourcing rule that dealt with income that was 5 earned -- effectively connected to the US trade or 6 business by a foreign person so that they could capture 7 installment income received when that foreign person 8 left the US and was no longer a taxpayer in the US. And 9 they did so because they felt that the IRS by itself did 10 not have the power to tax that income without specific 11 legislation. 12 And I think this is a comparable case. There 13 is a gap in the law on how to source these rules because 14 of the repeal. It was repeal of Section 17554 that had 15 the accrual method. But I don't think that Franchise 16 Tax Board has the power to make law. 17 I also think under Section 19047 it does state 18 that the Board, when rendering a determination, should 19 set forth the basis for its determination. And that 20 that was not done in this case. 21 I think when a taxpayer does have a dispute, 22 spends a lot of time, energy and money in fighting that 23 dispute, they do deserve an explanation for your -- for 24 your decision. 25 MS. OLSON: Time has expired. 26 MR. HORTON: Take a few more minutes, ma'am. 27 Sounds like you want to share some additional 28 information with us. 20 1 MS. BARRETT: Yes. One thing I pointed out in 2 the petition for rehearing is that I did find a -- with 3 respect to the comment that there was no change in the 4 law when the mobilia case was in effect for sourcing the 5 income from intangibles and then the State legislature 6 enacted the accrual method, I did find a ruling by the 7 Franchise Tax Board that points out that there is a 8 change. 9 The accrual method does not match the mobilia 10 doctrine in all cases. So, it was a change in the law. 11 And the accrual method, when it was repealed, left the 12 gap. There was no source rule to take that place in the 13 legislature -- the legislation. 14 But I do think it is the job of the State 15 legislature, not the Franchise Tax Board, to enact tax 16 laws. 17 MR. HORTON: Okay, thank you very much for your 18 presentation. 19 Any discussion, Members? 20 Hearing none, thank you so very much. We 21 appreciate your testimony here today. 22 ---o0o--- 23 24 25 26 27 28 21 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 FEBRUARY 22, 2011 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 21 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: March 19, 2011 17 18 19 ____________________________ 20 JULI PRICE JACKSON 21 Hearing Reporter 22 23 24 25 26 27 28 22