1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 MARCH 23, 2011 10 11 SALES AND USE TAX APPEAL HEARING 12 APPEAL OF 13 EARTH-N-WARE, INC. 14 459938 (EA) 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 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 Government Code 13 Section 7.9) 14 15 Diane G. Olson, Chief 16 Board Proceedings Division 17 18 For Board of David Levine Equalization Staff: Staff Counsel 19 Robert Tucker 20 Tax Counsel 21 Kevin Hanks Chief, Headquarters 22 Operations Division 23 For Department: Cary Huxsoll 24 Tax Counsel 25 For Petitioner: Scott Kauffman 26 Attorney 27 Gerald Newton Taxpayer 28 ---oOo--- 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 MARCH 23, 2011 4 ---oOo--- 5 MS. OLSON: Our next item is C5, Earth-N-Ware, 6 Incorporated. 7 Please come forward. 8 MR. HORTON: Mr. Levine, please introduce the 9 issues in the case. 10 MR. LEVINE: The issues in this petition of 11 Earth-N-Ware, Inc. are whether disallowed claimed exempt 12 sales in interstate commerce actually qualified for the 13 exemption, whether adjustments are warranted to 14 unreported taxable cigarette rebates and whether 15 Petitioner was negligent. 16 MR. HORTON: Thank you very much. 17 To the Petitioner, please introduce yourself 18 for the record. You have ten minutes to make your 19 presentation, at which time the Board will hear from the 20 Department. And then we'll return to you for 21 rebuttal. 22 Please commence. 23 MR. KAUFFMAN: My name is Scott Kauffman. I'm 24 the attorney for Earth-N-Ware. 25 MS. YEE: Could you speak into the microphone 26 for us? 27 MR. KAUFFMAN: I'm sorry. 28 MS. MANDEL: You can move it if you're more 3 1 comfortable sitting a little to the left or the right. 2 MR. KAUFFMAN: Is that okay? 3 MR. HORTON: You can move it whatever's 4 comfortable for you. 5 MR. KAUFFMAN: I'm okay? 6 MR. HORTON: Yeah. 7 MR. KAUFFMAN: With me is Mr. Newton. He and 8 his wife Suzanne are the owners of Earth-N-Ware. 9 The issue, as has been stated, is whether -- 10 MR. HORTON: One second, you might want to move 11 it the other way. There you go, you seem to -- okay, 12 there, you go. 13 MR. KAUFFMAN: Thank you. 14 The issue as stated is whether Mr. Newton has 15 shown by a preponderance of the evidence whether his 16 sales of the cigarettes were the in the state of Nevada. 17 The first time I met with Mr. Newton, I told 18 him, after listening what he had to tell me and after 19 listening to the auditor's report, I told him that I 20 thought his only real chains to prevail would be if he 21 hand an opportunity to sit before you ladies and 22 gentlemen. 23 And he said, "Why's that, Mr. Kauffman?" 24 And I said, "Gerry, you showed the auditors 25 your invoices. You showed the auditors your 26 bank statements. They tied the invoices out to 27 he bank statements. They tied the bank 28 statements out to the -- out to the -- not 4 1 only the sales and use tax returns, but out to 2 the income tax returns. Still you were not 3 able to prevail." 4 In fact, the auditor's report stated, 5 "Total sales reported in the sales logs, net of 6 lottery sales, were found to be in agreement 7 with total sales recorded in the sales and use 8 tax returns. Total sales reported were in 9 agreement with the total sales reported in the 10 federal income tax returns. No significant 11 differences were found between recorded and 12 reported taxable sales. Claimed nontaxable 13 sales from real sales were examined on an 14 actual basis and no errors were reported." 15 In addition, the auditors, after looking -- 16 spending four days in Mr. Newton's store stated in the 17 report, 18 "Mr. Newton provides a very plausible and 19 detailed description of what facts led to the 20 transactions. Mr. Newton provided a logical 21 and plausible description of the transactions." 22 So, I told Mr. Newton that I thought the only 23 opportunity for him to prevail was if he had opportunity 24 to sit down before you ladies and gentlemen, where you 25 could look him in the eye and see that he is a person of 26 honor, a person of character, a person of honesty. 27 AND because so much of our presentation depends 28 upon Mr. Newton's credibility, I am going to shut up 5 1 now, quit being this mouthpiece and give the rest of our 2 time to him. 3 MR. HORTON: Thank you very much. 4 MR. NEWTON: Well, I started the business -- I 5 started getting ready for the business in the '90s, 6 early '90s, by taking trips to Mexico or So Cal for 7 pottery. That was the -- what the business was going to 8 be about. In fact, that's how the name came about. 9 We actually opened in mid-'92, but within a 10 couple of months of opening, I realized that there was 11 no way that we were going to make it selling just 12 pottery. 13 I had met a supplier in Tecate, Mexico who was 14 very helpful and set me up with the pottery. But he 15 also realized that I wasn't going to make it just doing 16 that. He suggested that he had some cousins that might 17 be able to help me. I met them. They came up to my 18 store, showed me how I could start selling cigarettes to 19 supplement my pottery business. And that they would buy 20 from me once I got established because they had a 21 business of selling cigarettes, American-made 22 cigarettes, in Mexico -- which I will get to more in a 23 minute. 24 We eventually then added lottery also to our 25 sales. I believe that was in 1993. And that became 26 even a more important part of our business from a profit 27 standpoint than the cigarettes. 28 We were only making 50 cents a carton on the 6 1 cigarettes that we sold to B and T. We were making 25 2 cents on a carton of cigarettes that we sold to a 3 customer, a walk-in customer. We made six cents on a 4 dollar sale of lottery. We made two cents on a dollar 5 sale of cigarettes. So, lottery was more important to 6 us in the long run. Pottery sales basically became 7 insignificant. Our No. 1 seller was lottery, our No. 2 8 seller was cigarettes. 9 We made to deliveries to B and T primarily on 10 Saturdays, not always on Saturdays. The invoices -- the 11 exhibits that we sent in, we had a copy of every invoice 12 for the three year period of the audit. And the dates 13 of the 31st or 30th, the end of the month delivery could 14 have fallen on any day. So, it wasn't always just a 15 Saturday. But they were made usually on Saturday, after 16 normal business hours, which we would close at 7. And 17 by 7:30 I would be on the road. It's about a seven hour 18 to seven and a half hour round trip, which got me back 19 in time for opening on Sunday. 20 The -- and that process went on for 15 years -- 21 not quite 15, but almost 15 years. And it was an 22 important part of the business because of volume. We 23 got a very good price on our cigarettes from the 24 distributors, not the manufacturers. And I will get 25 back to that more too. 26 Let me jump back just a second to the market 27 that B and T had. There's two markets for American-made 28 cigarettes in Mexico. The first one is directed at 7 1 tourists. That's not what they had. Their market was 2 the one that is directed to expatriate Americans that 3 live in Mexico and, apparently, Mexicans that are better 4 -- well off. I have gotten this information, basically 5 in the last three years, since the audit, and it's all 6 secondhand, speaking to people that I know who live in 7 Mexico most of the time and Mexican nationals that go 8 back and forth. 9 And one of the questions I asked is, 10 "Well, how do these people know where to get 11 the cigarettes?" 12 He says, 13 "They don't have to know, they just have to 14 ask -- the retailer, the store whatever they 15 buy from -- if they can get these cigarettes?" 16 And they said, it's all I got to do is ask. If 17 you look this up on the internet, all the information 18 that I found on the internet pertains to the other 19 market, where you can buy American cigarettes and 20 Canadian cigarettes at the duty free stores and the 21 airports. And, again, that is not the market B and T 22 was supposedly selling to. 23 I was criticized in the audit, or subsequent to 24 the audit -- let me rephrase that -- subsequent to the 25 audit that it was unlikely, based on the hours that I 26 worked, that I would make this trip every week. I 27 do that -- that's just the way I lived. I've been 28 working long hours as long as I can remember. 8 1 And I did not keep track of things like gas, 2 mileage. I didn't use it. I didn't need it as a 3 deduction. When I made those trips, I was carrying a 4 large amount of cigarettes that were anywhere from 10 to 5 $30,000 in value. And coming back I was carrying a 6 large amount of money. I didn't want to make any stops. 7 So, I planned it out so that I didn't have to make any 8 stops. I didn't have to stop to get gas. I had a large 9 tank, extended tank, on the vans. Like I say, I can't 10 provide you with receipts for things that I never -- I 11 just didn't keep anything like that. 12 And now I would like to jump now to what is 13 second -- what I consider the second issue, the 14 buydowns. 15 MS. OLSON: Time has expired. 16 MR. HORTON: We will allow to time on rebuttal 17 and then I'm sure, if necessary, we will present 18 questions to allow your client to continue. 19 To the Department, please introduce yourself 20 for the record. You have ten minutes and then we will 21 return for five minutes on rebuttal. 22 MR. HUXSOLL: Good morning, Mr. Chairman, 23 Members of the Board. 24 I'm Cary Huxsoll, from the Board's legal 25 Department, along with Robert Tucker and Kevin Hanks, 26 representing staff. 27 The Department properly disallowed Petitioner's 28 claimed interstate commerce sales. No adjustments are 9 1 warranted to unreported cigarette rebates. 2 Petitioner claimed over $4 million in exempt 3 sales in interstate commerce. All sales were made to 4 B and T Services, Incorporated. Petitioner has not 5 provided any documentation supporting its claim that 6 cigarettes were delivered outside of California. 7 The invoices provided by Petitioner are 8 unsigned. They're not supported by any documentary 9 evidence of actual delivery in Nevada. Petitioner's 10 bank deposits cannot demonstrate where deliveries were 11 made and, thus, do not demonstrate that the sales in 12 question were exempt sales in interstate commerce. 13 We note further that in Petitioner's exhibits 14 that provided 20 invoices with different dates contained 15 matching sales figures. These numbers conflict with the 16 amounts the auditor determined from Petitioner's sales 17 journal during the audit. 18 No adjustments are warranted for unreported 19 cigarette rebates. Petitioner does not dispute that it 20 was paid rebates by cigarette manufacturers or that 21 these rebates constitute taxable gross receipts. 22 Petitioner contends, though, that it collected 23 and remitted sales tax on the rebates. Petitioner did 24 not provide any document demonstrating the rebates it 25 received were included in the tax it reported. Thus, we 26 concur with the recommendation of the Appeals Division. 27 Thank you. 28 MR. HORTON: Thank you very much. 10 1 Rebuttal, please? 2 MR. KAUFFMAN: Yes, thank you. 3 Ladies and gentlemen, the Department's 4 proposing to assess Mr. Newton -- 5 MR. HORTON: Sir, I'd like to encourage you to 6 speak into the microphone. 7 MR. KAUFFMAN: I am so sorry. 8 MR. HORTON: No problem. 9 MR. KAUFFMAN: The Department is proposing to 10 assess Mr. Newton for almost a half million dollars of 11 tax liability on the basis that he failed to maintain 12 his records. 13 But he kept his records. He kept his invoices. 14 He kept his bank statements. The auditors, when they 15 were there, they tied out the invoices to the bank 16 statements. They tied out the bank statements not only 17 to the sales and use tax returns, they tied them out to 18 the federal income tax returns. 19 The Department says this is just plain 20 unbelievable that someone would be making the -- you 21 know, these types of trips every week to Nevada. But to 22 me what's even more unbelievable is that someone would 23 be selling 700 cartons a week to either a wholesaler or 24 retailer in California and then be stupid enough not to 25 put that cash in his mattress, but to actually go ahead 26 and put it into his bank account and then to report and 27 pay federal income taxes upon that money and report it 28 to the Board. 11 1 Every sale was reported to the Board on the 2 sales and use tax returns, not just for the audit 3 period, but for a period of 15 years. I think when you 4 look at all of the evidence together, I think by a 5 preponderance of the evidence, by a more likely than not 6 standard, we have shown that these sales could not have 7 taken place anywhere except outside the State of 8 California. 9 You want to go ahead? 10 MR. NEWTON: Yes. I'd like to first start by 11 answering -- jumping to the buydowns. I made a mistake 12 in 2006, the middle year of the audit, by -- when we 13 incorporated, it changed everything. We didn't get 14 1099s any more from the cigarette manufacturers. So, I 15 had to separate the information that I had relative to 16 income that we got from them, which was contracts. 17 MR. KAUFFMAN: There's one important point we 18 need to make and we have it here. 19 MR. NEWTON: I need to get back to that. 20 If you look at Exhibit C, that is the fourth 21 quarter of the audit period, our purchasing data. And 22 the first page is a recap of it. It gives the dates, 23 the vendor, the quantity of cigarettes we purchased and 24 the cost. And the total of 10,736 is not all 25 cigarettes, but 99 percent cigarettes, 10,736 cartons of 26 cigarettes at 330,000. 27 On Exhibit D, it is the same format and the -- 28 for the fourth quarter of 2010, last year. Again date, 12 1 vendor, the quantities and the cost. The total 2 quantity, 4,128 versus what we sold of 10,736 -- 4,128 3 is what we're selling roughly now on a quarterly basis 4 versus 10,000, almost 11,000, back when I had business 5 with B and T. 6 MR. KAUFFMAN: And the reason this is important 7 is that during the audit period, B and T terminated the 8 contract. And the purpose of this is to show the sharp 9 drop in cigarette sales or cigarette purchases by 10 Mr. Newton after the contract was terminated. 11 MR. HORTON: Does that conclude your -- 12 MR. NEWTON: I have one more. On the -- on 13 the -- 14 MR. KAUFFMAN: We're done. 15 MR. HORTON: All right. Member Yee and then -- 16 MS. YEE: Let me have Ms. Mandel. 17 MR. HORTON: Ms. Mandel? 18 MS. MANDEL: I just wanted to hear the end of 19 the rebates that is in issue and I know -- 20 MR. KAUFFMAN: Yes. 21 MS. MANDEL: -- you moved your exhibits. 22 MR. KAUFFMAN: Thank you. 23 MR. NEWTON: The rebates were claimed in 2006 24 by me, in a mistake, as income on my federal tax return. 25 Based on that and in the writeup by the -- when we went 26 through the review with the DO -- the Department of -- 27 the BOE, the lawyer, they said that -- I have it written 28 here, let me find it. 13 1 It says, "Income tax returns," on page -- it 2 was under the Appeals Division summary, page 3, the 3 second sentence states, 4 "On the income tax returns, however, the 5 Department noted that Petitioner had separately 6 reported rebate income as other income." 7 That implies to me that I did that for three 8 years, which is not true. I made a mistake one year. I 9 did not do it in 2005 and I discovered the problem in 10 2007 when I did my taxes in '7. 11 Those -- there is no way I could have not 12 passed on rebates to the customers. The cigarette 13 companies verify that every two weeks. If you're in 14 violation of that, you lose not only any monies they owe 15 you -- you get paid, normally, four to six weeks after a 16 sale for a buydown, a rebate. 17 If you get caught not passing that on, any 18 monies they owe you, you don't get. And the contract 19 ends. 20 And the only reason that they assumed this was 21 income was because of my mistake. But even if I had 22 done that every year, a rebate is not income, in my 23 mind. 24 MS. MANDEL: Okay. I think that the issue on 25 the rebates, as I understood it, was whether when you 26 sold the cigarettes, whether you collected and remitted 27 sales tax in an amount that included, you know, whatever 28 the rebate amount was? So, if you sold the cigarettes 14 1 for five bucks to someone and you got -- and there was a 2 $2 rebate associated with that sale, was the tax that 3 you collected based on $7 and remitted based on $7? 4 That's how I understood. The issue was that 5 you were saying that you did. 6 MR. NEWTON: Well, that's how I did it. 7 MS. MANDEL: Okay. 8 MR. NEWTON: I treated buydowns exactly like a 9 coupon. You applied the tax, then you applied the 10 coupon for buydown I don't think that was what is in 11 dispute here. 12 MS. MANDEL: Okay. That's -- is that 13 different, Mr. Hanks, than the way you guys understood 14 how he was doing it? Or did you -- can you help out? 15 Because I thought he -- that the argument was 16 whether or not he had already paid the tax on it. 17 MR. HANKS: Correct, that's how I understood 18 the discussion was that I believe the Petitioner was 19 mentioning that he taxed the discounted price, in your 20 example, and he reported tax on that $5 sale to the 21 Board. 22 And he's saying, 23 "I already reported that tax and, therefore, I 24 need to see that you give me credit for it." 25 Now in our audit we -- we have not -- we have 26 not treated it the way that the Petitioner is 27 interpreting it because we haven't been able to verify 28 that those amounts were reported to us. 15 1 So, we've looked at the value of these rebates. 2 We've separated the rebates in connection with the 3 buydown programs from the display programs because we 4 have -- 5 MS. MANDEL: Right. 6 MR. HANKS: -- dollars for both. 7 MS. MANDEL: Right. 8 MR. HANKS: And we're asserting tax -- 9 MS. MANDEL: You're asserting -- 10 MR. HANKS: -- just on the buydown portion. 11 MS. MANDEL: -- you're asserting tax on the 12 buydowns. 13 Now, if he -- if he -- it's been so long since 14 I've looked at, you know, the particulars of how they do 15 it. 16 The way he just explained it, he put tax -- tax 17 on. 18 So, in my example, sir, if the customer walked 19 in and had to pay 5 -- had to hand you $5, you charged 20 tax on the $5 and then applied the rebate amount? 21 Or you charged tax on $7 if it was a $2 rebate 22 and charged -- 23 MR. NEWTON: The way ours was calculated was we 24 had an -- our prices, a customer came in, he saw $5. 25 MS. MANDEL: Okay. 26 MR. NEWTON: That included the tax, okay. And 27 it also included any rebates. The tax was calculated 28 first, before we posted the price. 16 1 And the auditors verified that. 2 MS. MANDEL: Okay. 3 MR. NEWTON: Go ahead. 4 MS. MANDEL: Let me stop you right there to 5 make sure I got the math understanding. 6 So, if before there was a rebate it would have 7 been a $7 price -- 8 MR. NEWTON: Right. 9 MS. MANDEL: The -- what I am hearing you say 10 is you calculated what tax would be on a $7 price, 11 recognizing it was a rebate. 12 You then sold the product for a tax included 13 price of $5 and I just had to hand you $5 and I got it? 14 MR. NEWTON: Correct. If that was what it 15 worked out to be. 16 MS. MANDEL: Okay. So, the way he's explaining 17 it, it sounds like he has the tax on the rebate amount 18 up front. 19 And part of what I heard the Department say was 20 you couldn't figure that out from the documents? 21 MR. HANKS: Correct. 22 MS. MANDEL: Okay. 23 MR. HANKS: There were register tapes for us to 24 see. 25 MS. MANDEL: Okay, from the register tapes. 26 But you can't figure out from the register 27 tapes because what he's saying today is that the price 28 he posted, which is what's going to show on the register 17 1 tape, was a tax included price after he made the 2 adjustments. 3 And he's saying that somehow that was verified 4 at audit -- at least that it was -- I mean, can you tell 5 from the register tapes that it's tax included or was 6 it -- 7 MR. NEWTON: Well -- 8 MS. YEE: Posted price? 9 MR. NEWTON: In our case, all's you can tell on 10 the register tapes is what was entered, $5 rung up or 11 $10 rung up -- 12 MS. MANDEL: Okay. 13 MR. NEWTON: -- for cigarettes. 14 But what the auditors had, what I had given 15 them was a spreadsheet that shows where -- what our cost 16 is, what our price is, what the markup is, what the tax 17 is. 18 It used to contain the buydowns. And it would 19 subtract -- but it would show that our price was our 20 price plus our markup was what tax was calculated to be, 21 after the tax calculations our sales, our price, it was 22 subtracted from the price. And that was what was 23 posted. 24 So, for example, if the carton cost $30, we had 25 a five dollar buydown on it, the tax -- we made a 26 quarter -- the tax was charged on $30.25, then we 27 subtracted $5 from that and posted that price. 28 MS. MANDEL: Okay. 18 1 MR. NEWTON: That was verified. 2 MS. MANDEL: Okay, Mr. Tucker, you're making a 3 face. 4 So, did -- are you following what he's saying? 5 MR. TUCKER: Yes, I'm following what he is 6 saying. Unfortunately, it wasn't -- there weren't 7 sufficient documents to be able to determine that that 8 was what occurred. 9 MS. MANDEL: Okay. 10 MR. TUCKER: That's ultimately -- 11 MS. MANDEL: Well, that's what it says in your 12 stuff, weren't sufficient documents. 13 MR. TUCKER: Right. There were no register 14 tapes, there were no comments that reflect -- 15 MS. MANDEL: Okay. So, there's nothing -- 16 there's no -- you can't find any -- he's saying that the 17 auditor verified that that's what they were doing. 18 So, I'm just -- and you're just saying that 19 there's nothing written in the -- 20 MR. TUCKER: The -- 21 MS. MANDEL: -- work papers that suggests it. 22 And then where -- 23 MR. TUCKER: -- there -- 24 MS. YEE: -- he's focused -- hang on a second, 25 before -- I'll run out of steam eventually, not to 26 worry -- where he's focused is that because of the way 27 he reported on his federal income tax return, where he 28 reported that one year and it was listed as other -- 19 1 other income. 2 So, for that -- for that -- I guess one 3 question might be for that year where it was -- where he 4 -- I don't have to talk so loud now -- for that year 5 where it came as other income, does -- does that then -- 6 does that number and gross receipts on his -- whatever 7 it's called on his total sales on his income tax return, 8 does that tie back to -- because if it tied back to his 9 sales tax return, because presumably if he had -- if he, 10 in fact, had tax on the rebate figure the way that he's 11 describing it, then it ought to tie in with his income 12 tax return. 13 MR. TUCKER: The sales and use tax returns and 14 the federal income tax returns do tie out together. 15 MS. MANDEL: They tie out together based on 16 sales on the income tax? 17 MR. TUCKER: The sales equal -- the amount 18 reported for sales on the income tax return, within a 19 dollar or two, equal the amounts reported. 20 MS. MANDEL: Okay. And, so -- 21 MR. HANKS: So, that doesn't calculate the 22 other income. 23 MS. MANDEL: Well, doesn't it include -- 24 MR. TUCKER: Right. 25 MS. MANDEL: -- the other income figure that he 26 entered, which he's saying that year it was a -- he did 27 his -- he's saying he did his federal income tax return 28 wrong that year. 20 1 MR. TUCKER: Correct. 2 MS. MANDEL: Okay. 3 MR. TUCKER: The question -- the problem that 4 staff was confronted with is that there was no proof 5 that the rebates were included in the gross receipts. 6 MS. MANDEL: So, what about his spreadsheet and 7 of how he -- when was this spreadsheet produced? 8 I mean, when did you do that? 9 MR. NEWTON: The spreadsheet? 10 MS. MANDEL: Yeah, were you -- 11 MR. NEWTON: It was during the audit. 12 MS. MANDEL: During the audit? 13 MR. NEWTON: Right. 14 MS. MANDEL: But where did the information on 15 it come from? 16 I mean -- 17 MR. NEWTON: Oh, I keep -- well, this balances 18 to -- it starts off with a price, which comes from the 19 invoices. 20 MS. MANDEL: Okay. 21 MR. NEWTON: And then the -- our price and it 22 shows our markup and then it shows what the sales tax is 23 on it. 24 MS. MANDEL: Right. 25 MR. NEWTON: Okay. And then if there is a 26 buydown, it's deducted from the price after tax is 27 calculated. 28 So, it's like you would do a coupon. 21 1 MS. MANDEL: Okay. And I understand that. I 2 guess some -- and did you put that spreadsheet together 3 for purposes of the audit? 4 MR. NEWTON: No, no. I used to do -- I use 5 this audit -- this continually. 6 MS. MANDEL: Okay. 7 MR. NEWTON: Because this is -- this is what 8 sets our price. 9 MS. MANDEL: So -- so, when you gave them -- 10 showed them that at the audit, was that something you 11 printed off your computer that had been produced or that 12 you had done the calculations and made the spreadsheet 13 during the audit -- 14 MR. NEWTON: Yes. 15 MS. MANDEL: -- during the time frame that 16 we're talking about and then the auditor comes in later 17 and you say, "Here is my stuff from those years."? 18 MR. NEWTON: No, they were using in the current 19 one. 20 MS. MANDEL: They were using current? 21 MR. NEWTON: And comparing that to our posted 22 price. 23 MS. MANDEL: Oh, to make sure that what you -- 24 okay. 25 MR. NEWTON: That our buydown, the tax was 26 applied prior to the buydown. 27 MS. MANDEL: Right. So, when they were in your 28 store, they could see by looking at what you had that, 22 1 in fact, your posted price was done that way? 2 MR. NEWTON: Yes. 3 MS. MANDEL: You are still making a face, 4 Mr. Tucker. 5 MR. TUCKER: I guess that's just the way that 6 -- unfortunately -- 7 MS. MANDEL: It's just your face, I'm sorry. 8 MR. TUCKER: Yeah, I apologize. 9 MS. MANDEL: I just want to make sure you 10 understand -- yeah, what he's saying. 11 MR. TUCKER: I understand. I think the -- once 12 again, it just comes back to a problem of documentation 13 and that we couldn't go back to the actual daily 14 register tapes to confirm that those were the prices. 15 MS. MANDEL: But I understand -- okay, so, I 16 understand why -- I guess I understand why it wouldn't 17 show on his register tape because he's doing it before 18 he actually posts a price. 19 So, his -- if his -- if his price is all 20 inclusive, then that's -- that's the number that's going 21 to be on his register tape, there's not going to be a 22 breakout on the register tape. 23 So, is what you're saying more that, well, 24 yeah, okay, fine, on the date when we were in the store, 25 that's how it was done, but I don't know that's how it 26 was done two years ago during the audit period? 27 I just -- I mean, he's -- 28 MR. HANKS: Right. 23 1 MS. MANDEL: -- we haven't heard somebody sort 2 of say, "This is how I did it," which I guess you're -- 3 if that's how he did it, was that the right way -- was 4 that a right way to do it and then it would have been 5 taxed? 6 It would have been in there, the tax on the 7 rebate. 8 MR. HANKS: Yes, the way he's describing it is 9 correct. 10 MS. MANDEL: So -- so, what -- what then does 11 he have -- do you have -- do you have that information 12 back from this time period of the audit, your sort of 13 schedule showing how you calculated price? 14 Or do you -- 15 MR. NEWTON: Well, I probably have dozens of 16 them going back, but I don't keep them all because every 17 time the price changes, I have to redo it. 18 MS. MANDEL: Yeah. 19 MR. NEWTON: And that happened a lot. 20 But what we -- what the auditor did, what they 21 worked from, was my daily receipt log. And it showed 22 everything -- every ring up for pottery, lottery and 23 cigarettes and then every invoice to B and T. 24 And then -- then I did an invoice recap report, 25 which was by day and showed invoice amounts, weekly 26 sales, weekly taxable sales. 27 And then there is copies -- behind all of that 28 were copies of each of the tax returns for that month or 24 1 quarter because that changed over time too. 2 MS. MANDEL: Okay. 3 MR. NEWTON: And then all of this balanced to 4 my federal forms. 5 And during the audit period, those -- like I 6 say, these prices all included. The only reason I 7 believe the issue came up was my mistake of saying it 8 was income, because -- 9 MS. MANDEL: Let me -- 10 MR. NEWTON: -- it shouldn't be income. 11 MS. MANDEL: -- okay, let me -- so, other than 12 in 2006, I think you mentioned something about a 1099. 13 Did you get or -- 14 MR. NEWTON: Well, when I was a sole 15 proprietorship -- 16 MS. MANDEL: Correct. 17 MR. NEWTON: -- they used to send us 1099s with 18 a nice breakdown. And it had on it contractual 19 payments, the buydowns were separate, coupons were 20 separate. 21 Well, I didn't know it at the time, but when we 22 changed to a corporation, they don't send us 1099s any 23 more, even the lottery stopped sending us 1099s. 24 And I asked my accountant, the guy that does my 25 taxes. I said, what's -- he says you don't have to send 26 1099s to a corporation, which was news to me because I 27 used to rely on those. 28 Without them, I had to do that all manually and 25 1 go back and separate out contractual payments from 2 cigarette companies, which is income, from buydowns, 3 which isn't. 4 Well, in '06 I was rushing to get the tax data 5 to -- for the federal to my accountant because another 6 thing that changed was my taxes were no longer due in 7 April, they're due in March. 8 MS. MANDEL: Right. 9 MR. NEWTON: Well, like I said, I wish I had 10 never done this. 11 But, so, when I was in the process of rushing 12 to get the information, I transmitted all of the data to 13 him. I put that in there on my -- listed it as rebates 14 under my other income category. 15 After the fact, when I found out about it and I 16 made a comment to him, "It's rebates, you shouldn't have 17 included that." 18 He said, "You know, you shouldn't have sent 19 it." 20 Well, he's probably right. I shouldn't have. 21 And I didn't do it other than that one year. 22 But I -- I believe that subsequent to the 23 audit, when apparently they go through a review, they 24 said, well, if he's claiming that as income, he wasn't 25 passing it on to the customer, which is impossible to 26 do, first off, because you would lose your contract. 27 And the only reason you do buydowns is to be 28 competitive. If you're not going to put it into the 26 1 price, there's no reason to do it. You can't put it in 2 your pocket. 3 MS. MANDEL: Okay. I hear what he's saying and 4 I'm -- and you hear what he's saying? 5 And I'm wondering what it is you need to see 6 for this time period? 7 MR. HANKS: Ms. Ms. Mandel this is what I'd 8 suggest, if we could, I would really like to look at the 9 journal that you've got. 10 Because if we can examine that journal and see 11 how you have accounted for even the quarterly sales 12 because we've got the recap of all the quarterly 13 reported amounts, we've got the amounts for the 14 deductions taken for sales tax. 15 You indicate that you sold the cigarettes on 16 a tax included basis. If we could back into those 17 numbers based on the journal information you have there, 18 perhaps we could satisfy ourselves that the amounts were 19 reported were included in one of our returns. 20 MR. HORTON: Members, let's hear from 21 Mr. Levine. 22 And then, if it be the desire of the Members to 23 grant a 30-30-30 to allow that to happen, we can 24 entertain a motion. 25 MR. LEVINE: What I was going to suggest is if 26 we're going 30-30-30, there is a line of discussion that 27 we didn't include in the D & R that occurred to me as 28 I'm listening to this, perhaps Petitioner can clarify 27 1 now. 2 But only a -- my recollection is only a person 3 licensed as a cigarette distributor can hold taxfree 4 cigarettes. So, Petitioner's presumably is buying tax 5 stamped cigarettes and it's hard to accept -- anything 6 is possible, but it's hard to accept that someone in 7 Nevada is going to pay for California taxes and I assume 8 they have to pay Nevada too because tobacco taxes are 9 really strict. 10 I doubt they get credit. But it's just hard to 11 believe that someone would buy tax paid stamped -- tax 12 paid cigarettes. 13 So, perhaps they can clarify now or in a later 14 submission. 15 MR. KAUFFMAN: We can clarify now. 16 MR. HORTON: Tax paid California? 17 MR. NEWTON: Pardon? 18 MR. HORTON: California, tax paid cigarettes. 19 MR. KAUFFMAN: Yes. 20 MR. NEWTON: That's the only kind I can buy. 21 And they were buying them in Nevada. They don't -- as 22 far as I know, they don't have to pay Nevada anything 23 because they're not selling them in Nevada. 24 They're just taking possession of them in 25 Nevada and then they ship them to Mexico. It's illegal 26 to sell them in Nevada because of the California tax 27 stamp. 28 Oh, yeah, apparently the State taxes -- the 28 1 State tax stamp is a -- was one of the things that 2 distinguishes the true American-made cigarettes from the 3 other ones. And in Mexico you can get both -- the ones 4 that -- they look the same, but they're not. And they 5 flip it over and if it's got a tax stamp on it, they 6 know that's the one they want. 7 MR. HORTON: Yeah, I only chuckle because 8 Congress made a similar statement when they acknowledged 9 the methodology in which we use here in the State of 10 California is recognized throughout the United States as 11 giving credibility. So, it's good to hear that again. 12 Let's discuss this a little bit more, seems 13 like -- because there still is -- I don't know if you 14 responded, maybe Member Yee can frame -- 15 MS. YEE: Actually, I wanted to talk about a 16 different issue. 17 MR. HORTON: Well -- 18 MS. YEE: I guess this relates to the rebate 19 issue. My concern is really that income not having been 20 reported on the sales and use tax return and, so, we've 21 -- which kind of brings us nowhere with respect to that 22 issue. 23 I'm open to the Department trying to back into 24 an amount, but I would be willing to give more time for 25 that to happen. 26 My other question, actually, relates to the 27 voluminous exhibits that we received relative to 28 invoices. And my question is, are these contemporaneous 29 1 invoices? 2 They weren't signed and I'm curious as to 3 why. 4 MR. NEWTON: When I made a delivery, I gave 5 them two copies. And the copy that they gave me back 6 was what they used when they were going through the 7 delivery and checking things off. They were -- they 8 were unlegible (verbatim). 99 percent of the time the 9 guys that I actually delivered to didn't speak English. 10 So, they --what I would point to the signature line, 11 even on the wet or -- and/or crumpled up invoice that I 12 got back, they just put a line through it, like it was 13 okay. 14 Well, when I got back to my shop, because I 15 knew I had to keep these, I would print off another copy 16 for these -- this journal, I guess it's called. This is 17 what the auditors used to do the audit. This was the 18 primary -- this plus all of our purchasing data, but -- 19 those were the audits that I sent you as Exhibit A and 20 B. Those invoices were copies of what I did from, you 21 know, during that period. 22 MS. YEE: Okay. And the subsequently submitted 23 ones were also from the period? Or were they reprinted 24 later on? 25 MR. NEWTON: The ones that I sent you were the 26 reprinted ones. That's all I had. 27 MS. YEE: All right. 28 And then with respect to the bank statements, I 30 1 think what makes this difficult is we're having a hard 2 time really nailing where the deliveries were being 3 made. And certainly from the bank statements we're not 4 able to determine that. 5 Any other documentation that might help? 6 MR. NEWTON: The bank statements are basically 7 almost impossible because of the commingling of the 8 funds because of lottery money and the cigarette money 9 is -- the only thing that's consistent is whenever I 10 made a trip to Nevada, the next banking day there was 11 always a large deposit. It may have been even larger 12 than just the money generated from Nevada because of 13 lottery. 14 MS. YEE: Okay. Was this your first audit? 15 MR. NEWTON: Pardon? 16 MS. YEE: Was this your first audit? 17 MR. NEWTON: Yes. 18 MS. YEE: And you're still in business? 19 MR. NEWTON: Barely. 20 MS. YEE: All right, thank you. 21 MR. HORTON: All right. 22 Mr. Runner? 23 MR. RUNNER: A couple of questions just to 24 clarify. 25 This -- this particular piece here, is this -- 26 is this what -- your signature's on here, right? 27 MR. NEWTON: Yes. 28 MR. RUNNER: And whose -- and the driver's 31 1 signature is who? 2 MR. NEWTON: This -- these are part of the 3 cigarettes that I buy. 4 MR. RUNNER: Okay, okay. So, these have 5 nothing to do with the delivery over in -- 6 MR. NEWTON: No, no. 7 MR. RUNNER: -- Nevada? 8 MR. NEWTON: No. 9 MR. RUNNER: Okay. 10 MR. NEWTON: This is just a comparison of -- 11 MR. RUNNER: I just wanted to clarify that. 12 So, these have nothing to do with that. So, 13 what is -- when you would make that delivery to 14 Nevada -- 15 MR. NEWTON: Yes, sir. 16 MR. RUNNER: -- you would get nothing back 17 other than cash from -- once you gave them -- once you 18 sold them the -- those cigarettes? 19 MR. NEWTON: Yes. 20 MR. RUNNER: What would they -- would they sign 21 anything? Would they give you anything? 22 Would they -- 23 MR. NEWTON: They just initial, yes, they'd 24 give me the money. 25 MR. RUNNER: Right, right, I got that part. 26 MR. NEWTON: Yes. 27 MR. RUNNER: And give you then what -- I mean, 28 any receipt of -- that they had received anything or -- 32 1 MR. NEWTON: Well, they kept a copy of that. 2 MR. RUNNER: They'd keep a copy of this 3 (indicating)? 4 MR. NEWTON: No, no. They'd keep a copy of 5 this invoice (indicating). 6 MR. RUNNER: They'd keep a copy of that 7 invoice? 8 MR. NEWTON: Right. Those are invoices from my 9 supply. 10 MR. RUNNER: They'd keep -- but they wouldn't 11 sign that and give a copy of that back to you? 12 MR. NEWTON: They'd scribble on it, but it 13 really wasn't a legitimate -- a good signature. 14 MR. RUNNER: Okay, so -- 15 MR. NEWTON: But I brought two copies with 16 me. 17 MR. RUNNER: Okay. 18 MR. NEWTON: And gave them both, one that I 19 wanted them to sign. 20 MR. RUNNER: Give a copy of a scribbled one? 21 MR. NEWTON: Well, they used it as a work sheet 22 when they were counting the cigarettes. 23 MR. RUNNER: And -- but then they gave it back 24 to you? 25 MR. NEWTON: They gave it back. 26 MR. RUNNER: And do you have one of those that 27 they used as a work sheet with the scribble on it? 28 MR. KAUFFMAN: He's hard of hearing, so -- 33 1 MR. RUNNER: Okay. 2 MR. NEWTON: I might not now. 3 MR. RUNNER: Okay. 4 MR. NEWTON: I didn't keep them very long. 5 MR. RUNNER: Okay. Again part of this 6 discussion it seems to me, for me, is what -- how these 7 transactions took place and where they took place is 8 obviously a key part of this discussion. 9 So, you know, trying to find something that 10 would help you to determine that there was something 11 actually took place over there is all I'm trying to 12 find. 13 Let me ask you about this, in your own 14 recordkeeping you used, you did these deliveries? 15 MR. NEWTON: Oh, yeah. 16 MR. RUNNER: And then you would drive this van 17 back and forth every week? 18 MR. NEWTON: Well -- 19 MR. RUNNER: Almost -- 20 MR. NEWTON: -- there were -- 21 MR. RUNNER: Almost every week, almost every 22 week? 23 MR. NEWTON: Almost. 24 MR. RUNNER: Do you -- does your filing -- does 25 your income tax filing reflect that kind of vehicle use 26 for business purposes? 27 MR. NEWTON: No, because I -- I used it for 28 personal use too. And I was under the impression that I 34 1 had to keep a log if I wanted to write it off, which I 2 really didn't need a writeoff, so, I didn't do that. 3 MR. RUNNER: Because you never paid tax? 4 You don't have any income tax liability for the 5 State of California or you don't have an income tax 6 liability, you have not had to pay? 7 MR. NEWTON: Oh, no, no. We've had to pay, but 8 we're not making that much money. So, you know, it was 9 a small amount that we were making. 10 MR. RUNNER: Okay. I guess I am struggling 11 over a business transaction and a business operation 12 that would have a legitimate business deduction that 13 would then lower your tax exposure and you're choosing 14 not to do it. 15 MR. NEWTON: Well, for example, the '86, where 16 I made the mistake claiming buydowns as income, had I 17 done it right, we wouldn't have had -- we would not -- 18 we would have had a net loss. And I ended up paying 19 taxes on about $3,000, if I remember right. 20 But, again it was my -- I didn't even find out 21 about it until a year later. 22 MR. RUNNER: And then you have no other -- you 23 have no other receipt of gas that you would have bought 24 when you got back? 25 Because, I mean, obviously, you can get -- you 26 can get from your place to Nevada and back again in a 27 tank. 28 MR. NEWTON: Yes, that's right. 35 1 MR. RUNNER: But you're going to have to need 2 gas right away. 3 MR. NEWTON: Right. 4 MR. RUNNER: You don't have any receipt of 5 transactions of gas either before or right after these 6 trips? 7 MR. NEWTON: I don't use a credit card. 8 MR. RUNNER: Okay. 9 MR. NEWTON: I always paid cash. 10 MR. RUNNER: Okay. Let me ask you this, one of 11 the issues that you said that there would be an influx 12 of cash into your bank account on the day after these 13 trips. 14 MR. NEWTON: The next banking day. 15 MR. RUNNER: Let me ask our folks, did you -- 16 did we reflect that? 17 Did we see -- did we -- did we do any kind of a 18 correlation between these dates of these trips and the 19 bank balances on those dates and deposits? 20 MR. HUXSOLL: There is generally a deposit from 21 the dates that I've seen of the Saturday deliveries, 22 that Monday there was a deposit around $11,000. 23 But it's unclear. So, there was -- there were 24 deposits, but there was a whole series of deposits and 25 attempting to connect them back to the deliveries. 26 MR. RUNNER: Okay, thank you. 27 MS. MANDEL: Mr. Horton -- 28 MR. HORTON: Ms. Mandel? 36 1 MS. MANDEL: -- one more question? 2 When -- when -- if we go on a 30-30-30 -- and I 3 don't know, maybe you have looked at this before -- but 4 with -- again with respect to determining the rebate 5 question, you said that gross sales on income tax 6 returns tied out to sales tax returns. 7 My question is whether the -- I don't know if 8 we ever really look at it this way -- but whether the 9 sales tax reported makes sense in light of the gross 10 sales, the taxable sales reported? 11 I mean, if -- because it sounds like if the 12 rebates -- and one thing would be if the rebates were 13 included in -- already included in the reportable 14 measure, then your -- your -- your sales tax actually 15 reported would be higher than you would have expected if 16 it was just, you know, the cash that someone handed, 17 which was the more what we used to see when people 18 weren't. 19 And if this time period was after -- when is 20 this time period? Well, some people may have been 21 reporting, I don't -- you know, there was much older 22 time periods where there was more stuff about rebates. 23 So, if this time period was after when people 24 were getting more information about how to report, it 25 might be relevant. 26 MR. HANKS: We can certainly look at that. 27 I was thinking the same thing. Though when we 28 did reconciliation of the federal income tax return to 37 1 gross receipts to the reported receipts, they tied 2 exactly. So, that gave us an indication that the rebate 3 income wasn't reported because the rebate income was 4 separately stated in the federal income tax returns. 5 That's why he believe they weren't reported to 6 us. 7 MS. MANDEL: Right. But I don't know if we 8 ever compared to the sales tax. You know, we look at 9 the gross number of receipts, but I don't know if we 10 ever look at the sales tax dollars and on those receipts 11 whether they make sense in a general realm. 12 MR. HANKS: Well, as I say, we'd be happy to 13 look at -- at the information that the Petitioner is 14 supplying -- 15 MS. MANDEL: Okay, thanks. 16 MR. HANKS: -- in case we can back into the 17 fact that those amounts were reported on one of our 18 sales and use tax returns, if that's the Members' 19 desire. 20 MR. HORTON: Okay, Members. 21 Further discussion, Members? 22 Is there a motion? 23 MS. MANDEL: Take it under submission. 24 MR. HORTON: It's been moved to take it under 25 submission. 26 MS. YEE: Second. 27 MR. HORTON: Second by Ms. Steel. 28 MS. YEE: Ms. Yee. 38 1 MR. HORTON: Ms. Yee, my apologies. 2 Without objection, Members, such will be the 3 order. 4 MR. KAUFFMAN: Good day. 5 MR. HORTON: Thank you so very much for coming. 6 The Board will take your matter up under 7 consideration later on this evening and send you a he 8 written report of our decision. 9 ---o0o--- 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 39 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 MARCH 23, 2011 I recorded verbatim, in shorthand, to the 10 best of my ability, the proceedings in the 11 above-entitled hearing; that I transcribed the shorthand 12 writing into typewriting; and that the preceding pages 1 13 through 39 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: April 7, 2011 17 18 19 ____________________________ 20 JULI PRICE JACKSON 21 Hearing Reporter 22 23 24 25 26 27 28 40