BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 5901 Green Valley Circle, Room 207 Culver City, California REPORTER'S TRANSCRIPT MARCH 23, 2011 ITEM C8 SALES AND USE TAX APPEALS HEARINGS PETITION FOR REDETERMINATION filed by ERITECH INTERNATIONAL, INC. (Case No. 469541 AC) Reported by: Beverly D. Toms CSR No. 1662 1 1 2 P R E S E N T 3 4 For the Board Jerome E. Horton of Equalization: Chairman 5 Michelle Steel 6 Vice-Chairwoman 7 Betty T. Yee Member 8 George Runner 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 Division 14 15 For Board of David Levine Equalization Staff: Appeals Division 16 Scott Lambert 17 Sales and Use Tax Department 18 Robert Tucker Legal Department 19 Kevin Hanks 20 Sales and Use Tax Department 21 For Petitioner: Ali Khoshkhoo 22 Representative 23 ---OOO--- 24 25 26 27 28 2 1 Culver City, California 2 December 15, 2010 3 ---oOo--- 4 MS. OLSON: Our next item is C8, Eritech 5 International, Incorporated. Please come forward. 6 MR. HORTON: Thank you. Mr. Levine, as they 7 come please introduce the issues in this case. 8 MR. LEVINE: The issues in this petition are 9 whether audit adjustments are warranted and whether 10 petitioner was negligent. 11 MR. HORTON: Thank you very much. To the 12 Petitioner, you have ten minutes to make your 13 presentation, commencing with your introduction, and 14 then we will hear from the Board and return to you for 15 rebuttal. 16 Please commence. 17 MR. KHOSHKHOO: Good afternoon, Mr. 18 Chairman, -- 19 MR. HORTON: Good afternoon. 20 MR. KHOSHKHOO: -- other ladies and gentleman, 21 Members of the Board, my name is Ali Khoshkhoo, 22 representing Eritech International. 23 There is two issues on the -- on the case. 24 Issue One is just we are not accepting the test period 25 representing the entire audit period because of the fact 26 that disallowed claimed non-taxable reduced from 27 $490,000 to 249,4 -- 249,000, which was about 50 percent 28 during the audit period. 3 1 Also unreported sales tax reduced some amount 2 and excess district tax reduced, too. During the audit 3 with respect to our request to disallow claimed 4 nontaxable sales should be comprised -- comprised of 5 only drop shipment for the four companies, we audit 6 original test period for drop shipment ourselves and 7 discover that the total drop shipment to four companies 8 were $183,000. The corrected amount by auditor on her 9 March 3, '09 report was 249, as I stated before. 10 Comparing these two figures shows that another 26 11 percent correction on -- on the top of the originally 50 12 percent correction. 13 The Department contention was only limited to 14 code. Petitioner might have made drop shipment to more 15 than four companies during the audit period. 16 This is -- to me is like unfair and unjust 17 guessing to deny the changing the method of the audit or 18 recalculation or redetermination. 19 The test period selected by the Petitioner, 20 we -- we try to select our own test period after the 21 audit is done, one period before and one period after 22 the test period. 23 The test period proves that the error was 24 minimal. There was some error, it was minimal, and 25 additional testing or recalculation should be warranted. 26 They put the burden of the proof on us but 27 they're not giving the chance of doing so. 28 On the issue of where we were negligent or not, 4 1 I have to just give you some history of the issues. We 2 lost the electronic data due to the computer crash and 3 we hired Mr. Augusa (phonetic) to reconstruct our sales 4 record. Unfortunately -- after he done that 5 unfortunately he has passed away later. We had no 6 access to him to come forward and explain what he did. 7 In absence of his health and mental function due to 8 influence of heavy medication, which we find out later 9 all of his calculation on the adding machine tape was 10 incorrect. This of course was totally out of our 11 control and we discovered this so late. 12 The Department also admits or says that Mr. 13 Asigulian (phonetic), President of the company, forget 14 to get a new seller's permit in 1998 when he incorporate 15 his business. This of course wasn't the -- obviously 16 wasn't intentional and caused him a problem later on 17 during the audit. And Mr. Asigulian also forget to file 18 a petition for redetermination, again caused him 19 problem. So these are the facts that it was -- nothing 20 was like negligent. 21 Mr. Asigulian was also President of the company 22 and as an employee of the company should not be dual 23 determined as Petitioner predecessor for the liability 24 purposes. 25 These are the argument that I have, Mr. 26 Chairman. 27 MR. HORTON: Thank you very much for your 28 presentation. Will the Department introduce themselves. 5 1 You have ten minutes to make your presentation. Sir, 2 then we'll return to you for five minutes rebuttal. 3 MR. LAMBERT: Good afternoon, Mr. Chairman. My 4 name is Scott Lambert. I'll be representing the Sales 5 and Use Tax Department today. To my right is Kevin 6 Hanks, also with the Sales and Use Tax Department. And 7 to Mr. Hanks' right is Robert Tucker with the Legal 8 Department. 9 To start off, the -- the taxpayer's records 10 apparently had been destroyed, or computer crash, which 11 led to some of the audit techniques that we used here. 12 There was no Sales Journal and therefore we needed to 13 test on a block sample basis. There was no way to go 14 through and -- and -- and pull out a statistical sample. 15 So, we selected three particular months to -- 16 to do the test. And the errors in those months appear 17 to be consistent from month to month. And the 18 projection of the error, at least in the taxable sales, 19 was narrowly 100 percent. 20 So, that led to the issue of the Department 21 recommending a penalty, in this particular case the ten 22 percent penalty, and there were several reasons why that 23 was done. As I mentioned, the hundred percent error 24 rate on taxable sales, the -- the lack of records, but 25 that in and of itself would not cause the penalty. 26 It's also noticed that this was the first audit 27 but the corporate President is involved in -- or is a 28 corporate officer in three other corporations and was 6 1 involved with them before this -- this sales tax audit. 2 It also should be mentioned that there was an 3 invoice that showed no tax that was to one of the U.C.s, 4 that when the -- the U. C. provided the invoice to us it 5 did have sales tax on it, although the Petitioner's 6 records indicated that it was an exempt sale. 7 So, referring to the drop shipments, there -- 8 the Petitioner wants us -- or wants the Department to 9 look at those on an actual basis. And just from the 10 test, itself, there are other drop shippers in that 11 test. There's no way of knowing that there aren't even 12 additional drop shipments and whether any of those are 13 taxable. That's the reason why we do a test here. 14 The -- with -- with all that said, the 15 Department would like to hear from the Petitioner in 16 regards to exactly what the accountant prepared for this 17 audit and how that affected the outcome. And -- and at 18 that point we may have additional statements to make. 19 MR. HORTON: Let me just say that's entirely up 20 to the Petitioner. 21 MR. LAMBERT: Exactly. 22 MR. HORTON: Or -- unless the Members wish to 23 pose that question. 24 On rebuttal, please. 25 MR. KHOSHKHOO: Yes, on the issue that 26 Department brought up that they found one invoice that 27 there was like tax collected and they found another 28 invoice -- the same similar invoice that there -- there 7 1 wasn't tax on it, it's just one invoice among 2,000 2 invoices for the test period. And I don't think that is 3 strong evidence to prove that our records are not 4 reliable. 5 On the issue of reaudit, I mean the issue of 6 the accountant, how he maded this, we asked him to 7 reconstruct based on the month and the quarters for the 8 three years tax period. What he did is separate 9 everything in three -- four categories of taxable and 10 non-taxable and he added by the adding machine tape and 11 put the adding machine tape on the side of the folder 12 along with the actual invoices. 13 But how he did it we have no knowledge of doing 14 it because unfortunately he passed away, he wasn't able 15 to clear the whole issues for us. 16 MR. HORTON: Does that conclude your rebuttal? 17 MR. KHOSHKHOO: Yes. 18 MR. HORTON: Thank you very much. I'm going to 19 just pose a general question to the Department to see if 20 that changes any of your comments. 21 MR. LAMBERT: I believe it does. 22 MR. HORTON: All right, would you like to share 23 that with the Board? 24 MR. LAMBERT: Well, how -- how we conducted the 25 audit was off those adding machine tapes in tracing the 26 taxable sales to that. 27 Given the fact that we only had one month, 28 there was no way to determine exactly when -- what went 8 1 into their quarterly worksheets. So, if -- if there 2 were sale -- taxable sales that were not included on 3 that adding machine tape that we considered taxable 4 because it wasn't on there, if in fact they reported 5 that it shouldn't be an error. 6 So, the only way -- I'll just step back one 7 second. The Department doesn't have any problem with 8 the test that was done. But the results might be 9 affected by that adding machine tape. So, if the 10 Petitioner was able to go back for each one of the 11 quarters and reconstruct their sales into their sales 12 tax worksheets in order for the Department to see 13 exactly what sales were included in there, both taxable 14 and non-taxable, and verify that in fact they've 15 reconstructed those sales, we would be able to go back 16 and take a look at the test periods that we did and see 17 if in fact those -- those sales that they had tax were 18 reported. And if they were we would remove them from 19 the audit. 20 MR. HORTON: Sir, do you understand what they 21 shared? 22 MR. KHOSHKHOO: Yes. Yes. 23 MR. HORTON: Any comments on that? 24 MR. KHOSHKHOO: The only comment that I have 25 is, for example, when we did this reconstruction and on 26 the disallowed claimed non-taxable, for example, as I 27 mentioned before, from $490,000 it's dropped to 249. 28 And again, once again, from that $249,000 dropped to 9 1 183,000, which is like about 70 percent reduction, 2 reduced amount on the -- on the errors. 3 And this is like one sample. It -- it can be 4 on the taxable not reported as well, too. 5 And again, putting this -- putting this -- 6 sorry about that, putting this burden on -- on the 7 person that he did all these calculation and preparation 8 and categorization and how he did it, how he come up, we 9 don't know. 10 MR. HORTON: What -- what I would encourage you 11 to do, the Department is attempting to share with you a 12 way in which they might be prepared to adjust their 13 findings. And if you have some knowledge or that you 14 can share that may justify the direction that they have 15 said they may potentially go I would suggest that you 16 share that with us. 17 If not, we will continue with the process. 18 MR. KHOSHKHOO: Maybe we continue. 19 MR. HORTON: Okay. Further discussion, 20 Members? Mr. Runner. 21 MR. RUNNER: Quick question in regards to 22 just -- and this is actually a little for my 23 edification, this process, too -- in regards to the 24 test -- the items that then were not -- that the tax was 25 not collected on, or not paid on -- in regards to the 26 drop shipping, California -- that basically he's 27 operating out of California. He's doing things through 28 the internet and through -- through ebay, and so the 10 1 idea that he would have used a drop shipper at that 2 point to then go ahead and send that product, whatever 3 that is, then to the customer, it's the assumption then 4 that the drop shipper then is indeed responsible then 5 for that -- for that sales tax at that point? 6 MR. LAMBERT: It -- it depends. If the 7 out-of-state -- if it's an out-of-state company then 8 they would be -- 9 MR. RUNNER: Out-of-state drop shipper? 10 MR. LAMBERT: An out-of-state drop -- well, 11 he's the drop ship -- but an out-of-state company that 12 made the third sale. Because what you have here in a 13 drop shipment is they're making a sale to someone, let's 14 say, in New York. 15 MR. RUNNER: Right. 16 MR. LAMBERT: And then the person in New York 17 is selling to somebody in California and they're just -- 18 the New York company is just directing the taxpayer to 19 deliver it to the customer in California. 20 If that customer in New York or -- well, the -- 21 the second party in New York, does not have a permit 22 with us, then they may be responsible for the tax if the 23 person it's being delivered to in California is the 24 consumer. And if they -- 25 MR. RUNNER: Even if it's a -- even if -- so at 26 that point under -- under drop ship -- 27 MR. LAMBERT: Six -- 28 MR. RUNNER: -- regulation -- 11 1 MR. LAMBERT: 6007. 2 MR. RUNNER: -- they are the responsible -- he 3 is the responsible party on that condition? 4 MR. LAMBERT: That -- that's right. But only 5 up to ten percent unless they can show that the sale 6 was -- 7 MR. RUNNER: Ten percent of the wholesale -- 8 or -- 9 MR. LAMBERT: Ten percent of their cost. 10 MR. RUNNER: Yeah. 11 MR. LAMBERT: Yeah. Unless they can show it 12 was less than that. So -- 13 MR. RUNNER: I wonder if -- okay, just again, 14 he -- California company, he's -- how about the one that 15 would be -- he's -- he has a drop shipper that he's 16 contracted with that's going ahead and providing that 17 product to the consumer and all that takes place in 18 California? 19 MR. LAMBERT: Yeah, then the -- the second 20 person is the one that's responsible for the tax 21 because -- 22 MR. RUNNER: The second person being -- 23 MR. LAMBERT: -- because they would -- well, 24 they would be required to have a permit. The -- 25 MR. RUNNER: The drop shipper would be 26 responsible for the permit at that point -- 27 MR. LEVINE: I think -- 28 MR. RUNNER: -- okay. 12 1 MR. LEVINE: I think he's got it backwards. 2 MR. RUNNER: Oh. 3 MR. LEVINE: Unless I misunderstood I heard you 4 say drop shipper with the product -- my understanding is 5 he's the drop shipper. 6 If he's not the drop shipper we have a 7 completely different situation. 8 MR. RUNNER: Well, let me find out because I 9 guess I -- 10 MR. LEVINE: He's the drop ship -- 11 MR. RUNNER: I was thinking that there was some 12 things that were -- actually that they were ordering 13 that he's not the drop shipper on. But is that -- 14 MR. KHOSHKHOO: We are drop shipping at some 15 places. 16 MR. RUNNER: Okay. And do you use -- do you at 17 times use a drop shipper, yourself? 18 MR. KHOSHKHOO: Meaning that they are dropping 19 as us, we are shipping it out? 20 MR. RUNNER: You're using them to deliver the 21 product. 22 MR. KHOSHKHOO: Yes. 23 MR. RUNNER: So you can do -- 24 MR. KHOSHKHOO: Yes. 25 MR. RUNNER: You do both sides of the deal? 26 MR. KHOSHKHOO: Interval -- interval, yes. 27 MR. LEVINE: When -- if this taxpayer is making 28 a retail sale and it's delivered into California this 13 1 taxpayer is responsible -- 2 MR. RUNNER: Right. 3 MR. LEVINE: -- for the tax without regard to 4 the drop shipper. 5 MR. RUNNER: He'd be the -- right. 6 MR. LEVINE: It's only when his company acts as 7 the drop shipper where we have -- for someone else's 8 retail sale where we have this problem of he's not 9 really making a retail sale but he might be treated as 10 if he is. 11 MR. RUNNER: Okay. 12 MR. HORTON: Okay. 13 MR. KHOSHKHOO: May I add something, please? 14 MR. HORTON: Mr. Runner. 15 MR. RUNNER: I'm done. 16 MR. HORTON: Okay. Any further discussion, 17 Members? 18 Sir, would you like to elaborate? 19 MR. KHOSHKHOO: In regards to drop shipment, as 20 I mentioned before we audit the entire test period 21 ourselves. The entire drop shipment amount was 22 182,000 -- $183,000, the actual amount, while the audit 23 came with 249,000 after the reduction from 490,000. So 24 it is just like it -- it wasn't accurately audited. So 25 this is -- this is our point in argument. 26 MR. HORTON: Okay. Thank you very much. 27 Members, is there a motion? 28 MS. YEE: Move to take the matter under 14 1 submission. 2 MR. HORTON: It's been moved by Ms. Yee to take 3 the matter -- 4 MR. KHOSHKHOO: I'm sorry, Mr. Chairman, I 5 apologize -- 6 MR. HORTON: -- under -- 7 MR. KHOSHKHOO: -- under the -- 8 MR. HORTON: Sir, it's been moved to take the 9 matter under submission. 10 Is there a second? 11 MS. STEEL: Second. 12 MR. HORTON: It's been second by Ms. Steel. 13 Without objection, Members? Such will be the 14 order. 15 Sir, if you could share your concerns with Mr. 16 Levine that might be helpful to give him some guidance. 17 My apologies, we were just in the middle of executing. 18 MR. KHOSHKHOO: I understand. 19 MR. HORTON: Thank you. 20 MR. KHOSHKHOO: Thank you. 21 ---oOo--- 22 23 24 25 26 27 28 15 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 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 15 13 pages constitute a complete and accurate transcription 14 of the shorthand writing. 15 16 Dated: April 6, 2011. 17 18 19 ____________________________ 20 BEVERLY D. TOMS 21 Hearing Reporter 22 23 24 25 26 27 28 16