1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 DECEMBER 14, 2011 10 11 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 12 APPEAL OF 13 LEPRINO FOODS COMPANY, 481272 14 (ITEM B2) 15 AGAINST PROPOSED ASSESSMENT OF 16 ADDITIONAL INCOME TAX 17 18 19 20 21 22 23 24 25 26 27 Reported by: Kathleen Skidgel 28 CSR No. 9039 1 1 P R E S E N T 2 For the Board Jerome E. Horton of Equalization: Chairman 3 4 Michelle Steel Vice-Chair 5 6 Betty T. Yee Member 7 8 Marcy Jo Mandel Appearing for John 9 Chiang, State Controller (per Government Code 10 Section 7.9) 11 Diane G. Olson 12 Chief Board Proceedings Division 13 14 For Board of Anthony Epolite Equalization Staff: Staff Counsel 15 16 Supervising Tax Counsel For Franchise Tax Daniel Biedler 17 Board: Tax Counsel 18 Bill Hilson Tax Counsel 19 20 For Appellant: Amy L. Silverstein Attorney 21 Charles E. Olson 22 Attorney 23 William Roger Erickson Taxpayer 24 25 ---oOo--- 26 27 28 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 DECEMBER 14, 2011 4 ---oOo--- 5 MR. HORTON: Ms. Olson. 6 MS. OLSON: Our next item is B2, Leprino Foods 7 Company. 8 Please come forward. 9 MR. HORTON: As the taxpayer comes, 10 Mr. Epolite, would you please introduce the issues in 11 this case. 12 MR. EPOLITE: Sure. 13 Good afternoon, Chairman Horton, Members. 14 There are three asset categories, thus, three 15 issues before the Board in this matter. The assets at 16 issue are Appellant's electrical transformer assets, 17 electrical generator assets, and brick and tile assets. 18 In each instance, the question before the Board 19 is whether Appellant has shown that the particular asset 20 type is qualified property for purposes of Revenue and 21 Taxation Code Section 23649 and eligible for the 22 Manufacturer's Investment Credit. 23 MR. HORTON: Thank you. 24 Would the taxpayers please introduce themselves 25 for the record. 26 You'll have 10 minutes to make your 27 presentation. 28 MS. SILVERSTEIN: Good afternoon, Chairman 3 1 Horton and Board Members. 2 I'm Amy Silverstein with the firm of 3 Silverstein & Pomerantz. I'm representing Leprino 4 today. And with me is my colleague, uh, Charles Olson, 5 as well as Roger Erickson from Leprino. 6 May I begin? 7 MR. HORTON: Welcome. Yes. 8 MS. SILVERSTEIN: Okay. Um, do you all have a 9 handout that we prepared? 10 MR. HORTON: Yes. 11 MS. SILVERSTEIN: Okay. We had a -- more or 12 less, go through it page-by-page, although, um, making 13 some modifications. 14 Can you hear me okay, too? It's -- 15 MR. HORTON: Yes. 16 MS. SILVERSTEIN: -- awkward. 17 Okay. Um, so I just wanted to start out by 18 explaining a little bit about Leprino. 19 Leprino is a manufacturer of cheese products, 20 um, for wholesale. They make cheese for a whole variety 21 of uses, uh, such as pizza. Um, they have three major 22 plants in California, and they employ approximately 23 1600, uh, people in California. And they have a total 24 of 10 plants around the country. They're headquartered 25 in Colorado. 26 Um, as Mr. Epolite explained, the -- the three 27 issues relate to the MIC. And I wanted to just, um, set 28 the stage by reminding, um, the Board of the liberal 4 1 construction of the MIC in favor of taxpayers. The 2 Board has heeded this, um, in case after case. I'm 3 confident it will be heeded again today. 4 Um, and of course the reason for this is the 5 MIC is an incentive, and so it wouldn't make much sense 6 to construe it narrowly against the taxpayer. It 7 would -- it would defy -- defy the purpose of the 8 incentive. 9 Um, I'm going to actually go in the opposite -- 10 or a different order than Mr. Epolite, um, listed the 11 issues and start with, um, what we refer to as brick and 12 tile coverings. 13 Um, and here, while the issue is the, um -- the 14 eligibility for the MIC in each case, the issues are 15 slightly different. Um, the issue with respect to the 16 brick and tile coverings is whether they're tangible 17 personal property or structural components of the 18 building. 19 Um, basically the building, um, the 20 manufacturing facilities have a concrete floor, and 21 that's the structural, um -- the structure of the floor 22 is the concrete floor. And the brick and tile 23 coverings, are placed on top of the floor and on some of 24 the walls, um, purely for a sanitation function, not a 25 structural function. 26 You can imagine, um, that a -- a -- any food 27 manufacturer has to meet the highest of sanitary 28 conditions. And so basically they put these coverings 5 1 on the floor. Um, they're specialized -- they're made 2 of a specialized product and they can withstand 3 extremely harsh chemicals that will -- will completely 4 sanitize, um, the facility and make sure that there's -- 5 you know, it's not -- it's not, um, infested in any way 6 with something that could make the public sick. 7 Um, the question of, um -- the -- the -- I just 8 want to make clear that we call them bricks, but they're 9 really just thin tile coverings, as are the tiles. 10 They're not the bricks that you think of as -- as, you 11 know, structures that you might use to build a -- a -- a 12 building. They serve no structural function. 13 Um, the -- the -- there's been some confusion, 14 I think, about what the proper law is to apply in this 15 case. Um, and I want to make sure my main -- my main 16 function here today, my main purpose, is to make sure 17 that we're all clear on what law applies. 18 Actually, Mr. Epolite, in the hearing summary, 19 I think, um, got it exactly right. And I want to make 20 sure that that's the law that the Board applies. 21 And basically, um, the -- the question is 22 whether these -- these items are tangible personal 23 property, which is defined in California law, which 24 incorporates, um, a -- a series of federal statutes. 25 And this Board, in the Bronco Wine's case, recognized 26 that, um, those federal statutes and regs apply. 27 They're binding. And along with them, the federal cases 28 that interpret those federal statutes apply, um, to 6 1 interpret the California law. And this is, I think, the 2 key point that the Franchise Tax Board has disputed 3 and -- and actually gotten wrong. 4 Um, and the import of that is there's actually 5 a federal case that addresses essentially these exact 6 same items. It's the Hospital Corp. case, and it 7 involved, um, tiles that were placed on the floor, um, 8 for the very same purpose, to keep the hospital 9 sanitary. They were -- they were affixed in a similar 10 way. They were described in a very similar way. And 11 the federal case determined that these tiles were 12 tangible personal property. And it's our position that 13 that case alone, um, resolves this -- this question. 14 But we're not solely relying on that. Um, in 15 addition, this Board has, um -- has adopted, again from 16 a federal case, um, a test from Whiteco Industry, um, 17 case. And it has six -- uh, six factors that the -- the 18 courts and the boards look at to determine whether items 19 are tangible personal property or structural. 20 And, um, we reproduced the -- the -- the six 21 factors on page six and applied them. And I don't know 22 that I have time actually to go through all of them. 23 But they're all, um, in the case law given equal weight; 24 one is not considered more important than another. And 25 they all, um -- essentially they -- they're factors to 26 look at. So the -- the application in its totality, 27 does this -- does this support the determination that 28 the items are -- are tangible personal property or 7 1 structural? 2 And you'll see that in every case the answer to 3 the -- the question of each factor is that the factor 4 supports a finding that the items are tangible personal 5 property. There's not one, um, factor that cuts the 6 other way. 7 And so, in addition to the federal case, which 8 we, um, submit is -- is determinative of this issue, the 9 application of the Whiteco test also results in, um -- 10 necessarily in a conclusion that these items are 11 tangible personal property and not structural components 12 of the building. 13 Um, I'd be happy to answer questions about that 14 issue, or I can move on to the next issue. 15 MR. HORTON: Please move on. We will return 16 and allow you on rebuttal -- 17 MS. SILVERSTEIN: Okay. 18 MR. HORTON: -- to respond what the Department 19 has said. And then possibly the Members may very well 20 have questions. 21 MS. SILVERSTEIN: Okay. So my main objective 22 there is to make sure that the right case law is applied 23 because I think the Franchise Tax Board has, um, 24 confused the issue and somewhat potentially misled this 25 Board. 26 Um, the next, um, issue I want to turn to is 27 the transformer assets. And basically -- and the issue 28 here is not whether they're tangible personal property 8 1 or not, but it's whether they're used in the 2 manufacturing process. So it's a slightly different 3 issue. 4 Um, I want to make very clear that this Board 5 has already decided this issue in, um, two other cases 6 that have -- have come before it. Um, and then the main 7 argument that the Board's making against us right now 8 has also been resolved by this Board -- um, rejected by 9 this Board. 10 The transformer assets are, um -- it's a -- 11 it's basically a set of assets that, um, the -- the 12 Leprino purchases, um, electricity at a very high 13 voltage and very high volume. And the transformer 14 assets step that down to a voltage that can be actually 15 used in the, um -- in the manufacturing plant. And 16 it's -- it's necessary to the manufacturing process 17 because they to have buy, um, elec -- they need so much 18 electricity in this plant that in order to buy it in the 19 quantity and for it to be economical, they actually have 20 to buy it in this manner and then step it down in order 21 to be able to use it. 22 Um, the reason the asset is -- it's used 23 throughout the manufacturing process because electricity 24 is necessary at every step of the manufacturing process. 25 Without the electricity, the, um -- there would be no 26 manufacturing. 27 Um, the -- um -- the manufacturing process is 28 defined in the case law as the period beginning from 9 1 when the raw materials go into the process until the -- 2 the -- basically the end of the fabrication. 3 At every point in time, the electricity from 4 this transformer is being used. And we think it's very 5 clear that the electricity is being used throughout the 6 manufacturing process. 7 Um, the two cases this Board has decided that, 8 um, held just that, with identical assets, um, were 9 Foster Poultry Farms and Sierra Pacific. And we would 10 submit that in light of those -- the fact that the Board 11 found that these exact same assets, um, were eligible 12 for the MIC in those earlier cases, for the very same 13 reasons, um, these assets are eligible for the MIC. 14 Um, really the only counter-argument that's in 15 play here is, um, that the Franchise Tax Board has said 16 that somehow these assets are not, um, eligible because 17 they don't touch the product or they're not -- they 18 don't actually -- you know, work -- they don't -- they 19 don't touch the product. They don't change the product. 20 Um, this Board rejected that very same argument 21 in the Granite Rock case last year. And I don't see why 22 that should be -- it shouldn't be in dispute at all 23 today. It's not supported by the statutes, the regs, 24 um, and this Board wisely rejected it in that earlier 25 case. 26 MS. OLSON: Time has expired. 27 MR. HORTON: Thank you. We will return to 28 you -- 10 1 MS. SILVERSTEIN: Okay. 2 MR. HORTON: -- on rebuttal. 3 The Department has 10 minutes to make its 4 presentation. 5 Please commence with your introduction for the 6 record. 7 MR. BIEDLER: Thank you, Mr. Chairman, Members 8 of the Board. 9 My name is Daniel Biedler, Tax Counsel with 10 Respondent Franchise Tax Board. To my right is Bill 11 Hilson, also Tax Counsel with the Franchise Tax Board. 12 The Manufacturer's Investment Credit or MIC is 13 a limited credit. The law does not allow the credit for 14 everything a manufacturer owns. This case involves only 15 the three types of property that have been presented out 16 of all the other items that the taxpayer claimed MIC for 17 and mostly received. 18 The first type of property I will also discuss 19 is the brick and tile coverings cemented to walls and 20 floors. The MIC is allowed for qualified property which 21 must be tangible personal property. Tangible personal 22 property does not include inherently permanent property 23 or structures. Cementing the bricks and tiles in place 24 makes them a structural component of the building which 25 is inherently permanent and, thus, do not qualify. 26 In the appeal of Bronco Wine, your Board held 27 that the definition of "tangible personal property" in 28 Respondent's Regulation 23649-5 is controlling. 11 1 Subdivision (b)(1) of that regulation provides, in part, 2 that all property, other than structural components of a 3 building or other inherently permanent structures, shall 4 be considered tangible personal property. 5 "The determination of whether property will 6 be treated as inherently permanent ... shall be 7 made under the Internal Revenue Code section 8 1245(a), so that generally property will be 9 treated as inherently permanent (and thus not 10 tangible personal property) if the property is 11 either intended to be or is in fact affixed 12 permanently, and is either incapable of being 13 moved or, if movable, would suffer a 14 significant degree of damage upon its removal." 15 In Bronco Wine, your Board held that for 16 purposes of the MIC it was appropriate to incorporate 17 federal law when defining the term "tangible personal 18 property." Consistent with the definition of tangible 19 personal property in Respondent's Regulation, Federal 20 Regulation Section 1.48-1(c) provides that tangible 21 personal property does not include "land and 22 improvements ... such as buildings and inherently 23 permanent structures, (including items which are 24 structural components ..." 25 Subdivision (e)(2) of that regulation addresses 26 types of property that are not considered tangible 27 personal property under federal law. That provision 28 defines the term "structural components" to include 12 1 "such parts of a building as walls, partitions, floors 2 and ceilings, as well as any permanent coverings 3 therefor such as paneling or tiling; windows and doors." 4 Here, the bricks and tiles are cemented to the 5 surfaces they cover and are irreparably damaged in the 6 process of removal. In other words, they become 7 permanently affixed structural components. 8 Applying the Whiteco Industry factors to this 9 case, the bricks and tiles are clearly inherently 10 permanent when affixed to the structure. For example, 11 if they're moveable at all, the bricks and tiles are 12 incapable of being moved without extreme care, effort 13 and cost. Appellant does not appear to actually remove 14 and reuse bricks or tiles. 15 The bricks and tiles are cemented in place and 16 remain there until they're no longer suitable. This 17 seems a reasonable and appropriate understanding of the 18 meaning -- of the term "permanent." Actual use by the 19 taxpayer, as I said, seems to be to leave them in place 20 until they are damaged and then are required to be 21 replaced. But they are not reused. 22 The adhesive used is essentially concrete in 23 durability and permanence. If they're ever removed 24 before damage, the strength of the adhesive is so great 25 as to make removal without damage unlikely. The force 26 required to break and remove the mortar is more than 27 enough to break the brick or tile. 28 The totality of -- pardon me. I skipped ahead 13 1 of myself. 2 Your Board in Bronco Wine ultimately declared 3 that the application of the Whiteco analysis requires a 4 determination of whether the property at issue can 5 reasonably be moved and placed back into productive use 6 without damaging the property. Your Board concluded 7 that this approach avoided the need for Respondent to 8 examine the taxpayer's subjective intent with regard to 9 the future use of the property at the time when the 10 property was placed into service. 11 Looking at the totality of the circumstances of 12 the use of these tiles and bricks, Appellant does not 13 remove or reuse them. They are destroyed in the process 14 of removal. When affixed, the bricks and tiles become 15 inherently permanent parts of the wall and floor 16 structures. They are not -- they are thus not qualified 17 property. 18 The second and third types I'll deal with 19 together, to an extent; they're both electrical in 20 nature. In order to qualify for the MIC, the electrical 21 assets must satisfy the law's requirement that tangible 22 personal property be used for manufacturing or 23 processing of property, which of course begins at the 24 top point in time in which any raw materials are 25 received and introduced to the process of transforming 26 those raw materials. 27 The statute defines "manufacturing" as the 28 activity of converting or conditioning property by 14 1 changing the form, composition, quality or character. 2 The definition of "processing" is the physical 3 application of the materials and labor necessary to 4 modify or change the characteristics of property. In 5 this case the property, the raw material is milk. 6 Therefore, as you can see from these 7 definitions, the statute requires that the property 8 being claimed for the MIC have both a timing connection 9 in the process and a physical connection, acting upon 10 the raw materials. 11 Appellant's electrical assets do not have both 12 of these connections. Electricity is not itself applied 13 to the raw materials in the processing of milk but is an 14 intermediary between the electrical assets and the 15 property actually acting on the raw materials. 16 Therefore, the act of generating electricity or 17 conditioning the electricity from transmission lines 18 occurs apart from or outside of the physical act of 19 processing milk. 20 The electrical generator assets are not 21 qualified property because the conversion of fuel to 22 electricity is not a qualified activity. To the best of 23 Respondent's knowledge, the electrical generator assets 24 were not activated and thus not actually used. Even if 25 they had been, the electricity would not have been used 26 in the process of milk into other products because, one, 27 generators convert the fuel to electricity; two, that 28 machinery to which the electricity flows would only be 15 1 operated to remove, not process, materials into cheese; 2 and three, the electricity generated is not applied 3 directly to the raw materials. 4 With regard to the generators qualifying for 5 the MIC as being used in a maintenance function, the law 6 requires claimed property to be primarily used for 7 manufacturing or processing or maintenance and defines 8 "primarily" as used 50 percent or more of the time. 9 The generators would not qualify on the basis 10 of maintenance because the generators have not been used 11 to power, clean out of equipment, and even if they had 12 been activated, the amount of time they would be active 13 would be for far less than 50 percent of total time. 14 Similarly, the electrical transformer assets 15 are not qualified property because the act of converting 16 the electricity, the step up from the transmission 17 lines, is not a qualified activity. The qualified 18 activity, processing milk into other products, does not 19 begin until after the electricity has been converted and 20 that that electricity has been transported to, uh -- to 21 another physical location. The transformer assets are 22 located adjacent to, but not inside, the building. 23 As with the generators, the electrical 24 transformers do not come into physical contact with the 25 raw materials or the intermediate or finished products. 26 They are physically separated from the raw materials 27 during every stage of processing because they do not 28 physically act on the raw materials. And because the 16 1 electricity from them does not act upon the raw 2 materials either, the transformers are not used 3 primarily in the process of transforming milk. 4 To allow the milk for items as removed from the 5 physical changes required to meet the definitions of 6 "processing" and "manufacturing" would seem to expand 7 the MIC to any property owned and used by a taxpayer 8 that uses electricity or indirectly influences, however 9 remotely, a taxpayer's qualified activity. 10 Appellant's reliance on the federal cases is 11 insufficient and inappropriate as those cases have an 12 analysis of requirements in federal investment tax 13 credit that are different from the MIC. To qualify for 14 the federal credit, federal law provides that tangible 15 personal property must be used as an integral part of 16 certain qualifying activities. 17 Appellant has taken this federal integral part 18 requirement and argued that as long as property is 19 indispensable and used simultaneously with the 20 processing of raw materials, that property is qualified 21 for purposes of the MIC. 22 However, whether property qualifies for the 23 federal investment tax credit by virtue of being an 24 integral part of a qualifying activity is not sufficient 25 for Appellant to prevail as the property must meet the 26 requirements of California law. 27 As described previously, the electrical 28 transformer and generator assets do not satisfy the 17 1 requirements of the MIC. For these reasons, Respondent 2 respectfully requests your Board uphold its action in 3 this matter. 4 MR. HORTON: Thank you. 5 On rebuttal. 6 MS. SILVERSTEIN: Again, Chairman Horton and 7 Board Members, the Franchise Tax Board has made so many 8 misstatements of our position, the facts, and the law 9 that it's -- it's nearly incredible. 10 Um, I think I may have to go backwards, but I 11 want to make it clear that we, um -- with regard to the 12 federal law, we are only using it in the way that this 13 Board has said it must be used, which is to define 14 "tangible personal property." It's not for eligibility 15 for the MIC. We're not saying that if something's 16 eligible for the ITC, then it's eligible for the MIC. 17 And the Board has completely -- the Franchise Tax Board 18 has completely, um, turned that issue up on its head. 19 Um, I also, um -- I want to, um, address the 20 brick and tiles, mainly because, again, there were so 21 many misstatements in there. 22 Um, first, um, the Franchise Tax Board's 23 factual statement completely, um, deviated from and 24 misstated the record in this case. The facts as to, um, 25 the use and purpose of the bricks and tiles were stated 26 in an affidavit that was, um, signed under penalty of 27 perjury by the Vice President of Technical Services 28 Engineering and Construction for Leprino Foods. And he 18 1 makes it very clear that the, um -- that the tiles are 2 purely for sanitary purposes. They serve no structural 3 function at all. 4 But most importantly, they're -- they're put 5 into place, they're designed to be removable. And the 6 reason they use tiles, um, rather than a single floor 7 covering is if -- if there is damage or such, for some 8 reason they need to replace part of the floor, they can 9 remove one tile or several tiles and not have to replace 10 the whole floor. So their design, their -- their whole, 11 um -- the -- the -- the way -- their use is -- is 12 intended to be that they're removable. 13 Um, they also, um, can be removed with no 14 damage. Now, as a practical matter, if they're not 15 going to remove them, they're not going to be as careful 16 as they could be, but it -- but the -- the, affidavit 17 under penalty of perjury makes clear that they can be 18 removed easily without damage. 19 Um, they're also affixed in such a way to 20 preserve the, um -- the sanitation. So the materials 21 they use to attach them and the grout all serves a 22 sanitation function. 23 Um, the -- the Franchise Tax Board claims that 24 the fact that they use cement -- I'm not even sure if 25 that's the right name for the material. But the fact 26 that they use this -- this certain material, um, means 27 that they're part of the building. There's no such law 28 that -- that says that, and the Franchise Tax Board 19 1 didn't cite any. 2 If you look at the Whiteco test, one factor is, 3 What is the manner of affixation of the property to the 4 land? It's not the sole factor. It's not 5 determinative. It's one of six factors. 6 The other factors are whether the property is 7 capable of being moved, whether it's designed or 8 constructed to remain permanently in place. Are there 9 circumstances that tend to show, um, that the property 10 may be moved? Um, how substantial is the job of 11 removing it? Are they readily removable? And how much 12 damage would the property sustain upon its removal? 13 If you look at every single one of those 14 factors, they're consistent with the fact that these 15 tiles are designed to be removable and that they can be 16 removed without any damage, certainly to the cement 17 floor, but also to the bricks and tiles themselves. 18 They simply aren't structural components of the 19 building, um, because they don't serve a structural 20 function. Their sole function is sanitation and to be 21 removed. 22 And I want to point out that the definition, 23 um, that the Franchise Tax Board uses, um, to say that 24 they're structural functions, because there's a list, 25 and one of the things in that reg that's listed is, 26 um -- is, uh, bricks, I think they use. 27 The reg makes very clear that sometimes bricks 28 serve a structural function and sometimes they serve 20 1 another function, as does any property. And the reg 2 also talks about, for example, a, um -- a -- a -- 3 machinery, um, to meet temperature or humidity 4 requirements. If the purpose of the machinery is to 5 protect the building, then it's structural. If it has 6 some other purpose, like to make -- to make the 7 machinery work, to make the employees comfortable, then 8 it's not structural. 9 And that's -- that's exactly the case here. 10 There may be instances when bricks and tiles are 11 structural, but in this case they're not. In this case 12 they purely serve a sanitation function. 13 Um, I think the only other point that I want 14 to, um -- if I have time, I want to respond to is, um, 15 the generator. Which, um, it's our position that it 16 qualifies for the MIC under the provision that, um -- 17 that, um, requires -- that allows the MIC for property 18 that maintains the property that's used in 19 manufacturing. 20 Um, the generator is there in case there's an 21 electrical outage. If there is and there's cheese in 22 the -- in the -- in the manufacturing -- the vat, um, 23 electricity goes out, it solidifies, the -- the -- the 24 manufacturing, the vat is -- is irreparably damaged. It 25 can't be used. 26 The generator is necessary to prevent that 27 damage to the manufacturing, um -- to the vat. If it 28 weren't there -- it's there to maintain the property, 21 1 which is the requirement of the statute. That's its 2 sole use. It's always used for that purpose. It's at 3 the ready. And, um, it's part -- it's necessary to the 4 manufacturing process, um, to maintain the -- the 5 property. If it weren't there, um, it's -- it's as 6 fundamental as -- as all of the rest of the property. 7 Um, so I would take issue with the Franchise 8 Tax Board's claim that it doesn't act -- that it's -- 9 that it's not being used. It's always being used. 10 MS. OLSON: Time has expired. 11 MR. HORTON: Thank you. 12 Um, discussion, Members? 13 Member Steal. 14 MS. STEEL: Um, brick and tile, well, you know, 15 I think I've been hearing enough, but just one question. 16 You say you can remove just one piece at a time or just 17 few pieces. 18 According to Department that when you try to 19 remove those bricks or tiles, that it's going to break 20 the -- uh, break or take them apart. 21 So which part -- which side is telling us the 22 truth here? Without looking at it, I just, you know -- 23 so -- 24 MS. SILVERSTEIN: I actually don't -- I -- I 25 don't know, um, where those facts came from. I don't 26 think there's any -- 27 MS. STEEL: That's why I'm asking you a 28 question. 22 1 MS. SILVERSTEIN: Yeah. So -- I mean, the fact 2 that it's going to break. 3 What I'm referring to, um, is the affidavit 4 that I mentioned, um, by Scott Savage, the Vice 5 President of Technical Engineering Services, in 6 paragraph 10, um, he says, um -- 7 Wait, where is this? Is that the right one? 8 MR. OLSON: Yeah. It says: 9 "Both acid resistant brick floor tiles and 10 glazed or ceramic wall tiles, in principle, can 11 be removed and reused in another location if 12 necessary." 13 MS. STEEL: So you can just pull it out and you 14 can reuse it for another place? 15 MS. SILVERSTEIN: Yeah. There's no -- there's 16 no -- there's no question they can be removed without 17 damage. As a practical matter, because of sanitation, 18 they may not be used again in this type of manufacturing 19 facility. But they're intact, and they could be used 20 for another purpose. 21 MS. STEEL: You can just remove it? 22 MS. SILVERSTEIN: Yes. 23 MS. STEEL: Okay. Um, let's go back to the 24 transformer. And I didn't hear much about that. It's 25 in separate location; it's not inside of the same room. 26 So how it's been wired? Can you explain little more 27 about that? 28 MS. SILVERSTEIN: Yeah, there -- there are, 23 1 um -- um, cables -- 2 MS. STEEL: Mm-hmm. 3 MS. SILVERSTEIN: -- that attach the, um -- the 4 transformer to the property -- you know, to the main 5 part of the manufacturing facility, and that's how the 6 electricity travels. They're -- they're large cables 7 that are not -- you know, they're not removed. They're 8 just in place. 9 MS. STEEL: Okay. 10 MR. OLSON: It's literally right outside the 11 door of the factory. It just can't be in the factory 12 because it would be a fire hazard. 13 MS. STEEL: Okay. 14 Um, for generator that -- has this company ever 15 used it, or -- I know in case when electricity goes out 16 and then you have to use it because everything's going 17 to be spoiled. So have -- 18 MS. SILVERSTEIN: You know, it's not in the 19 record whether they do or not. The Franchise Tax Board 20 claims they don't. We have no reason to believe that's 21 correct. 22 MS. STEEL: Well, no, I totally understand 23 because for emergency use, that you really need 24 something, that's why you have it. But I'm just asking 25 you, have you ever -- you know, that company used this? 26 MS. SILVERSTEIN: We actually don't have the 27 answer to that. If -- if they, um -- it's our position 28 that it's always being used because it's -- it's right 24 1 there ready to flip a switch, you know, when the 2 electricity goes out. And that's -- 3 MS. STEEL: So -- so -- 4 MS. SILVERSTEIN: -- that in effect is 5 maintaining -- 6 MS. STEEL: So when electricity goes out, what 7 happen to those cheese? You have to throw everything 8 out -- 9 MS. SILVERSTEIN: Yeah. Well -- 10 MS. STEEL: -- if you don't have generator? 11 MS. SILVERSTEIN: Well, it would -- it would 12 ruin the machine because it would -- 13 MS. STEEL: The machine itself. 14 MS. SILVERSTEIN: -- solidify and then you 15 couldn't -- it would be very difficult to get it out. 16 MS. STEEL: Okay. 17 MS. SILVERSTEIN: So it's not even a question 18 of -- of saving the cheese. It's a question of 19 saving -- 20 MS. STEEL: Saving the machine itself. 21 MS. SILVERSTEIN: -- the machines, exactly. 22 MS. STEEL: Thank you. 23 MR. ERICKSON: If I might add, we have those 24 generators at all of our plants, all 10 of them. Three, 25 of course, are in California. Whether or not the 26 generators on the California plants were ever used or 27 not, I couldn't speak to that; nor can I that they were 28 ever used at any of the other plants. But I would 25 1 speculate that we have had power outages. So at the 2 other plants, I would speculate that they probably were 3 used. 4 MS. STEEL: I totally understand. I -- I heard 5 enough. Because when you said that when electricity 6 goes out, then it's going to ruin the machine itself, 7 that's why you really have to have that. 8 MS. SILVERSTEIN: Mm-hmm. 9 MS. STEEL: That was the answer, right? 10 MR. ERICKSON: Yes. 11 MS. STEEL: Okay. Thank you. 12 MR. HORTON: Member Yee. 13 MS. YEE: Thank you very much, Mr. Chairman. 14 Um, I'm going to pose this question to Appeals. 15 Um, I guess I had a slightly different recollection. 16 But, um, comparing and contrasting, um, what's at issue 17 here with the, uh, Foster Farm Poultry, um, case and the 18 Sierra Pacific case. Um, I remember the Sierra Pacific 19 case a little bit clearer. Uh, but could you just help 20 us connect the dots perhaps? 21 MR. EPOLITE: Um, the Sierra Pacific case was 22 about boilers and turbines, steam generation assets for 23 I believe, um -- 24 MS. YEE: Was that the wood-drying? 25 MS. MANDEL: Lumber mill. 26 MS. YEE: Was that the wood-drying? 27 MR. EPOLITE: Correct, it was the lumber mill. 28 MS. YEE: Okay. 26 1 MR. EPOLITE: Um, and then Foster Farms was an 2 electrical substation and power distribution property. 3 MS. YEE: Okay. 4 MS. MANDEL: That was on a -- on a 5 nonappearance calendar. 6 MS. YEE: Okay. And -- and -- and, um -- okay. 7 That's why, because we didn't have an oral -- 8 MS. MANDEL: That's why you don't remember it. 9 MS. YEE: All right. All right. 10 MS. MANDEL: The Foster Farms was on a 11 nonappearance calendar. 12 MS. YEE: Nonappearance calendar. Okay. Got 13 it. 14 Um, are there, um -- I mean, is it appropriate 15 for us to kind of look at -- 16 MR. EPOLITE: Well, the decision was not a 17 formal decision -- 18 MS. YEE: Right. 19 MR. EPOLITE: -- so it's not binding upon the 20 Board. 21 MS. YEE: Okay. 22 MR. EPOLITE: So it's up to the Board to 23 determine what weight it wants to give to those cases 24 based on comparing the facts, the circumstances of the 25 assets in those cases versus what we have before the 26 Board today. 27 MS. YEE: Okay. Um, the reason I'm asking is 28 that I, uh -- I understand the statements that are being 27 1 made about the, um -- the electrical transformer assets 2 with regard to, um, the manufacturing process not being 3 possible without them. Um, although, uh, you look at 4 the manufacturing process of cheese itself, um, I 5 certainly can understand where the Franchise Tax Board 6 is coming from in terms of the assets not really having, 7 you know, much contact with, um, the product and -- and 8 directly with the process. 9 I mean, it seems like it's -- it's there to 10 maintain the equipment. Um, so I'm -- I'm trying to see 11 how to kind of make that stretch. 12 MS. SILVERSTEIN: I mean the requirement is 13 that the asset be used in the manufacturing process. It 14 doesn't say that the asset actually has to do the 15 manufacturing. I mean, one step removed -- there's 16 nothing in the -- the statute that -- that says anything 17 about how close it has to be related. 18 The irony is that the Franchise Tax Board is 19 not disputing the used in the manufacturing process with 20 respect to the bricks and tiles. Of course, they don't 21 touch the cheese either. You know, they don't 22 manipulate the cheese. They don't -- you know, they 23 don't do the things that the Franchise Tax Board is 24 claiming the electricity -- the transformer doesn't do. 25 Um, you know, furthermore, the -- the -- in the 26 Granite Rock case, this Board, I believe, resolved that 27 issue. So it -- it seems unusual to me that we need to 28 debate it again. 28 1 MR. OLSON: If -- if I may. Yeah, in the 2 Granite Rock case, um, you may remember from about a 3 year-and-a-half ago, um, one of the issues in that case 4 was that there was a two-and-a-half-mile conveyor belt, 5 the purpose of which was to transport waste product away 6 from the factory after the manufacturing of the -- the 7 product had happened. 8 The -- the -- the waste was brought out on a 9 truck and then dumped onto that conveyor belt. And the 10 conveyor belt whisked it away to a place where it could 11 be dumped. So, there's no question that that asset in 12 no point came in contact with what was being 13 manufactured. 14 But, as -- as I understood your Board's 15 decision, it was that if it weren't for that conveyor 16 belt which -- which removed the waste product, the 17 manufacturing process would eventually have broken down 18 because there would have been too much waste and it 19 would have interrupted the manufacturing process. 20 So it's -- it's things that are necessary for 21 the -- for that process to happen. And we would submit 22 that the transformer assets are in the same category. 23 MS. YEE: Okay. 24 MS. MANDEL: That was about the process not 25 having -- wasn't ended, I thought was part of it. 26 MS. SILVERSTEIN: There's a great deal of 27 discussion at the hearing about touching, this exact 28 issue. And many of the Board Members commented that, 29 1 um, that there was no -- there didn't seem to be any 2 requirement in the statute about proximity and touching, 3 and outright rejected that -- the imposition of that 4 requirement by the Franchise Tax Board. 5 MS. YEE: Okay. The source of the electricity 6 that you purchase on this kind of economic -- 7 MS. SILVERSTEIN: It's -- it's purchased from a 8 utility -- 9 MS. YEE: Okay. 10 MS. SILVERSTEIN: -- in such bulk and at such 11 voltage that it needs to be stepped down in order to run 12 the manufacturing facility. 13 MS. YEE: And -- and that's your only option 14 for -- 15 MS. SILVERSTEIN: It is, because of the, um, 16 the quantity that's required and just economically it's 17 really -- it's the only sensible way to run this -- 18 these plants. 19 MS. YEE: Okay. 20 Franchise Tax Board, do you have -- I'm focused 21 on the -- the, um, electrical transformer assets. 22 Because it seems to me -- I mean, I -- I -- there would 23 be no manufacturing without them. But it's, uh -- and 24 that is the source of electricity. Um, so help us kind 25 of -- 26 MR. BIEDLER: Well, I would like to remind the 27 Board that there is no "but for" exception, element, 28 qualification in the statute or the regulations. In 30 1 fact, that seems to be more like the "integral part" 2 requirement of the investment tax credit, which is 3 worlds apart from the MIC in that respect. 4 Integral part, the electricity's an integral 5 part of operating the machinery. Absolutely. However, 6 the MIC doesn't allow the credit just because, but for 7 this we wouldn't be able to do that. Because then the 8 MIC presumably could be applied for on anything that the 9 taxpayer's owns. 10 MS. YEE: Even if this is the only source of 11 electrical supply? 12 MR. BIEDLER: Well, how do you make a 13 distinction? 14 MS. YEE: Uh-huh. 15 MS. SILVERSTEIN: And it's not so much the 16 electricity though. It's what these assets are doing to 17 the electricity. 18 MS. YEE: No, I understand. I understand. 19 MS. SILVERSTEIN: So -- and then further, the 20 statute requires that it's used in the manufacturing 21 process. The Franchise Tax Board's main argument is 22 that it actually occurs before the manufacturing 23 process. But that's inaccurate because you need 24 electricity all throughout the manufacturing process. 25 So the transformer is -- is -- is doing what it 26 does throughout the entire process at every 27 point during -- it doesn't strictly start at the 28 beginning, before, and then stop. It's going throughout 31 1 and being supplied throughout that period. 2 MS. YEE: Okay. 3 Um, let me come back in a moment, Mr. Chairman. 4 Thank you. 5 MR. HORTON: Further discussion, Members? 6 MS. MANDEL: Could -- could I get an 7 explanation on the generator assets? Um, because, you 8 know, there's -- I'm trying to understanding how the 9 generator assets are connected -- where they are and how 10 they're connected to the machines that they are supposed 11 to be, um, protecting. Because it's, uh -- if you have 12 a power outage, it's not that -- my assumption, because 13 I couldn't -- I couldn't -- you know, we don't really 14 have pictures of any of this stuff which makes it 15 actually a little hard to conceptualize. Um -- is that 16 it's not that the power goes out and some guy runs and 17 flips a switch on a generator that's somewhere or they 18 haul it out and connect it. 19 I mean, I'm trying to understand what -- what 20 the structure is in relation -- 21 MS. SILVERSTEIN: Right. 22 MS. MANDEL: -- to this equipment that it's 23 trying to protect or where -- I saw one picture where it 24 looked like an aerial picture of an entire plant that 25 has a arrow with "emergency generator". But, um, I 26 don't really understand where everything is and how it 27 is, um, attached and interacting with the equipment it's 28 trying to protect. 32 1 MS. SILVERSTEIN: So it's -- it's, um -- maybe 2 Roger can explain further, but it's -- it's right 3 adjacent to the -- the, uh -- the equipment it's 4 intending to protect. I mean, it's -- it's very large. 5 It's not something you'd pull out -- 6 MS. MANDEL: Yeah. 7 MS. SILVERSTEIN: -- and then plug in. It's -- 8 it's there at the ready, um, like any other piece of 9 manufacturing -- of equipment in the facility. 10 MS. MANDEL: Okay. So it -- is it -- 11 MS. SILVERSTEIN: And it's -- 12 MS. MANDEL: Is it attached, you know, so that 13 when it -- when the generator -- I'm just trying to 14 figure out how does it -- how does it, uh -- how does it 15 start -- you know, if there's a power failure, what 16 happens? Does it just, you know, go uh-oh, and click 17 itself on or -- 18 MS. SILVERSTEIN: I mean -- and it's always 19 attached through wires and cables. 20 But do you know the answer to that? 21 MR. ERICKSON: I would liken it to a backup on 22 your computer. 23 MS. MANDEL: Mm-hmm. 24 MR. ERICKSON: If the power goes out, it kicks 25 on immediately and saves your computer. I would liken 26 it to that. 27 MS. SILVERSTEIN: But it's -- 28 MR. ERICKSON: It's automatic. 33 1 MS. MANDEL: Right. But it's a big piece of 2 equipment. 3 MS. SILVERSTEIN: Yeah, but it's always 4 connected. Yeah, it's -- 5 MR. ERICKSON: Cable coming in from the 6 transformers, and then attached into that cable is the 7 generator, sitting there ready to kick on if it needs 8 to. 9 MS. MANDEL: Right. Okay. So it's sort of 10 like having a battery attached at all times, in a 11 sense. 12 MR. ERICKSON: Good analogy. 13 MS. MANDEL: For my little brain. 14 MR. ERICKSON: Yeah, although it's 15 diesel-powered. 16 MS. MANDEL: Except that it's making power not 17 through a battery somehow. 18 MR. ERICKSON: Correct. 19 MS. MANDEL: However those machines do it. 20 It's doing it without the benefit of electricity from 21 the outside world. 22 MR. ERICKSON: Right. 23 MS. SILVERSTEIN: And if it weren't 24 instantaneous, it wouldn't serve its function. 25 MS. MANDEL: Okay. That -- that -- that helps 26 understand what it's doing. 27 MR. OLSON: For the emergency generators in 28 particular, I would bear in mind that -- that we argue 34 1 that it qualifies for the MIC because it's used to 2 maintain the other, the -- the -- the machines where the 3 cheese actually goes through. 4 So -- so the question of how attached it is, I 5 think, is less important for the generator in particular 6 because it's sort of like -- 7 MS. MANDEL: Well, I can tell you why the 8 question came to my mind, and maybe you won't speak any 9 further down the line you're going. 10 It came to my mind because the Franchise Tax 11 Board says, or somewhere I had, it's just like spare 12 parts in the closet. And, um, a spare part in the 13 closet is not really being placed into service until you 14 take it and put it in the machine so it can do what it 15 can do. Which was why I was thinking, well, is this 16 something that's, um, you know, like some people have 17 them at some kind of thing that you might have at home 18 that -- that you don't -- you -- you -- it's not 19 instantaneous. 20 MS. SILVERSTEIN: Right. 21 MS. MANDEL: It's not hooked up to anything. 22 But when I need it, I'm going to drag it out of the 23 closet -- 24 MS. SILVERSTEIN: Right. 25 MS. MANDEL: -- and make it start happening. 26 MS. SILVERSTEIN: Yeah, I don't think that's 27 how -- 28 MS. MANDEL: That's why I was asking the 35 1 question. 2 MS. SILVERSTEIN: I don't think that analogy 3 was apt at all because it's at the ready. It's always, 4 you know, going to be used. Whereas, a spare part you 5 would to have take it, replace, you know, do 6 something -- there would be some condition precedent to 7 using it. 8 MS. MANDEL: Yeah. So, um, I guess then the 9 question is why is that -- why is that not there with 10 the purpose of maintaining the equipment? 11 MR. BIEDLER: The backup generator is not -- 12 not only is it not acting on the raw materials, which is 13 required for -- 14 MS. MANDEL: Well, but they're talking -- 15 they're trying to do -- 16 MR. BIEDLER: Right. 17 MS. MANDEL: Their alternative is that it's 18 there to maintain the equipment. 19 MR. BIEDLER: I apologize. It is also not 20 acting on the machinery that works -- that it would work 21 in case of a power outage, which we haven't been able to 22 demonstrate actually happened, uh, so it's not on. It's 23 not being used, just like a spare part in a closet would 24 not be being used. 25 MS. MANDEL: So you're sticking with the spare 26 part analogy. 27 MR. BIEDLER: Only to the extent that it's not 28 actively engaged, and thus it can't satisfy the primary 36 1 test. 2 MS. MANDEL: It's not actively engaged because 3 it's not, uh -- I mean, I guess their argument is that 4 it's constantly monitoring the presence of power from 5 the outside; that that's how it functions. 6 MR. BIEDLER: I'm sure there is equipment that 7 does that. I'm not sure that the generator that was 8 claimed for the MIC, that generates the power itself -- 9 if we're going to call it all one piece, then maybe, 10 but -- 11 MS. MANDEL: Well, yeah, when people say 12 generator assets, then -- you know, whenever someone 13 says assets, then, to me, maybe is a bunch of things 14 that together do the whatever. 15 So your question now would be whether they've 16 shown that the assets that they're claiming the MIC for 17 actually do what they've just described. That's what I 18 just heard you say. Are my little ears wrong? 19 MR. BIEDLER: I'm not certain I followed your 20 restatement of the question. But if I may -- 21 MS. MANDEL: Okay. 22 MR. BIEDLER: -- attempt a response, uh, to 23 your earlier question, yes, it is like a piece of 24 inventory in that it is not actively engaged. 25 Now, to ascribe a role for the whole generator 26 of monitoring whether the power is still on so that the 27 automatic kick-on activation of the generator can occur, 28 then there might be some way to look at that as being 37 1 used actively. But how much of that -- those assets -- 2 because, remember, the MIC is asset by asset -- which 3 part of that is actually being used in that way all the 4 time? And the part that generates the electricity -- 5 MS. MANDEL: Okay. So if I buy one giant -- 6 you know, I don't know what these things are and how 7 they put it on their books, and whether they buy six 8 pieces and put them together and make a big piece. And 9 is it -- is it one truck or is it two pieces? You know, 10 that whole thing we used to have. 11 But, so if they bought one giant box, came from 12 the master generator manufacturer, one giant box, and 13 it's a box that makes sure that there's electricity 14 coming from the outside and going through the machines; 15 and when it senses there is none, it kicks on its own 16 internal making of power to keep the machine going so it 17 doesn't get jammed up and busted; if that's one asset, 18 then -- you know, then it doesn't sound like a spare 19 part in the closet. 20 But it sounds like what you're saying is, if 21 that one box is really two boxes from a manufacturer, 22 that -- that you might think that the one that's doing 23 the monitoring, the box that's doing the monitoring is 24 constantly in use, but not the box that's waiting to be 25 kicked on by the monitoring box to do the power because 26 it's asset by asset for the MIC. 27 MR. BIEDLER: Well said. 28 MS. SILVERSTEIN: The only problem is they 38 1 use -- the word "use" comes in the used in the 2 manufacturing part of the statute and this is the 3 "maintain" part. So the idea that it has to be used all 4 the time is misleading. 5 I mean, I think, um -- and, furthermore -- 6 you -- maybe you can speak to this better -- but, I 7 mean, it's always been described to me as the generator, 8 you know, not like, you know, all these pieces assembled 9 together. 10 MS. MANDEL: And you -- and you -- and you 11 would probably say that, even if you had the two boxes 12 under their thing, that the box that's waiting to be 13 kicked into place is being used to maintain because 14 it's -- it's not in the closet, waiting to be brought 15 out. 16 MS. SILVERSTEIN: They're all attached. They 17 all work in tandem. Um, and they're all there to 18 instantaneously prevent this irreparable damage. 19 MS. MANDEL: So, as you can see, I have a 20 little trouble because I didn't have pictures of 21 everything, trying to understand what's going on. 22 MR. ERICKSON: The generator itself is one big 23 piece of equipment, manufactured by Caterpillar. So it 24 has a diesel engine on it that kicks on. 25 Now, what triggers that kicking on, I think 26 it's built into the unit, but I -- I couldn't guarantee 27 that. I'm not an engineer. 28 MR. HORTON: Further discussion, Members? 39 1 MS. MANDEL: It, um -- and you have the 2 brick -- the brick and tile as being used because it's 3 in the -- in the, uh -- used in the manufacturing 4 process because it's -- it's, uh -- I'm going to 5 describe your process all wrong -- because it's, uh, 6 present in the environment of the assembly line where 7 the cheese is being made and you're not allowed to make 8 the cheese in that assembly line without the proper 9 sanitary -- that it's in there as opposed to transformer 10 assets. Did you make a distinction that the transformer 11 assets are outside the building? Did that make a 12 difference to you? 13 MR. BIEDLER: It's -- the fact that they're 14 outside the building is less weighty in my mind. 15 Just -- it's an easy way to conceive -- 16 MS. MANDEL: Okay. 17 MR. BIEDLER: -- of the separation from the 18 materials. 19 MS. MANDEL: Because she's -- she's -- I'm 20 sorry. The taxpayer's making the point that they're 21 like, you guys wanted all this -- we got to find a 22 better word than "touching" these days. Um, you wanted 23 the, uh, electrical transformer assets to -- to have 24 some closer connection with the cheese-making than you 25 perceived, which has been described as touching, I 26 guess, in all the materials. And, um -- and yet the 27 brick and tile assets which, you know, in the best 28 world, I guess, doesn't touch the actual cheese. Um, so 40 1 they saw that that was somehow inconsistent. 2 So can you explain that, why you think that's 3 consistent? 4 MR. BIEDLER: I would be happy to, yes. Thank 5 you. "Touching" is too limiting a concept. 6 MS. MANDEL: Oh, well, I didn't mean it that 7 way. 8 MR. BIEDLER: Oh. Oh. 9 MS. MANDEL: I just meant in the current news 10 environment I didn't like the word. 11 MR. BIEDLER: I hadn't even thought of that. 12 MS. MANDEL: Oh, sorry. 13 MR. BIEDLER: But I agree. I agree. 14 Physically acting upon, the physically acting 15 upon the raw materials is the -- is the component that 16 could be shorthanded one way or another. 17 MS. MANDEL: Mm-hmm. 18 MR. BIEDLER: But the -- the coverings, the 19 brick and tiles, they do provide the sanitary 20 environment. So they have indirect actions upon the raw 21 materials. They hold the machinery. 22 In the rooms where the cheese is ready for 23 packaging and it had to maintain a temperature, it's 24 sitting on, perhaps -- and I may be imprecise in my 25 description -- on pallets that have to be main -- 26 sitting on these tiles. 27 So there is a physical indirect connection for 28 those that is less attenuated than the electrical, uh, 41 1 properties. It's part of their function, as opposed to 2 the electricity equipment being generating or 3 transforming electricity, which even that isn't directly 4 acting upon the raw materials. 5 MS. MANDEL: Right. But then for the generator 6 they have the alternative argument which seems to be the 7 one they're more relying on. 8 Okay. 9 MR. BIEDLER: Though I would also hesitate to 10 create a situation where a taxpayer could slap on a 11 monitoring component to a piece of equipment and thus be 12 able to claim the whole equipment. Which was what came 13 to mind when we spoke of the generator may have a module 14 that monitors whether the power is on from the main 15 lines. 16 MS. MANDEL: Well, then you're going to argue 17 about whether that's one or two assets. 18 MR. BIEDLER: Right. 19 MS. SILVERSTEIN: I think Mr. Erickson 20 clarified that. 21 MR. HORTON: Member Yee. 22 MS. YEE: Uh, I wanted to go back. I'm sorry. 23 I think, uh, is maybe some of the confusion related to 24 whether we're talking about manufacturing cheese as 25 opposed to processing cheese? 26 I mean, the -- the -- I'm looking at this issue 27 of the electrical transformer assets again and the 28 statement that Appellants made is an assertion that 42 1 these assets are used throughout the entire process. 2 And I think you meant throughout the entire 3 manufacturing process. 4 MS. SILVERSTEIN: Yes, exactly. 5 MS. YEE: And Franchise Tax Board is, um, I 6 think, asserting that the conversion of electricity 7 doesn't begin until, uh -- well, actually that the 8 cheese-processing doesn't begin until after the 9 conversion of electricity. 10 So I'm trying to see -- I'm trying to see if 11 those are the same things or kind of different? 12 MS. SILVERSTEIN: There are different two 13 different prongs in the statute and one refers to 14 "manufacturing" and the other to "processing." And 15 we're not relying on "processing." Processing, um, 16 either explicitly, or at least a lot more closely, does 17 involve manipulating the material, the raw material. 18 MS. YEE: Okay. 19 MS. SILVERSTEIN: But "manufacturing" doesn't 20 have that same requirement. And it's important to 21 distinguish between the two of them. I do think the FTB 22 may be conflating them. 23 MS. YEE: Well, let me go to the Franchise Tax 24 Board and see. Because I'm just trying to see if 25 they're -- if you're making a distinction about that. 26 MR. BIEDLER: With regard to the concurrency of 27 time, no dispute. 28 MS. YEE: Okay. 43 1 MR. BIEDLER: It's the requirement for 2 "manufacturing" as well as "processing," in their 3 definitions, and just this plain language of the statute 4 that there be a physical interaction with the raw 5 materials. 6 So, to have used the words begin -- this occurs 7 before the processing begins, it's more -- that was more 8 intended to be a spacial illustration. Kind of been 9 difficult to -- to communicate the concepts. 10 MS. YEE: Yeah. Yeah, it is challenging. 11 Okay. 12 MR. OLSON: If I can just say one thing on that 13 issue. "Process" and "processing" are two different 14 defined terms in the statute. 15 The manufacturing process is defined as the 16 period beginning at the point when raw materials are 17 introduced into the manufacturing, processing, refining, 18 fabricating or recycling activity and ending at the 19 point when the product reaches its completed form. 20 "Processing" is -- is a defined term, and I 21 don't have it in front of me. But it is defined in a 22 way that makes it sound like -- sorry, but touching is 23 required. But if you go back to the "manufacturing 24 process" definition, you'll see that -- that it 25 encompasses manufacturing, processing, refining, 26 fabricating or recycling activity. 27 So processing is just one of five different 28 things that you -- that you can do to qualify as -- as 44 1 having a manufacturing process. 2 MS. YEE: It's always never helpful when you 3 have a term in a definition that's a term you're trying 4 to define. 5 MR. OLSON: Indeed. 6 MS. YEE: Okay. 7 All right. Thank you, Mr. Chairman. 8 MR. HORTON: Sure. 9 Further discussion, Members? 10 Question of the taxpayer. Um, the electrical 11 transformer asset, was that -- the decision to acquire 12 that, the bulk electricity, was that an economic 13 decision or is that a manufacturing decision? I mean, 14 the initial decision to acquire the electricity that 15 way. 16 MS. SILVERSTEIN: My understanding is it's both 17 because there's such volume of electricity that's 18 required, that there would be no other way to supply 19 this volume to this manufacturing facility. 20 Do you want to elaborate on that? 21 MR. ERICKSON: Well -- excuse me. Each of our 22 plants has a transformer, uh, substation, we call it. 23 MR. HORTON: So how do you distinguish the 24 economic value of buying in bulk versus the presumed 25 necessity relative to the manufacturing process? 26 MS. SILVERSTEIN: Well, I mean, I think it's -- 27 I think the answer is it's a necessity. I mean, there's 28 no other way to buy this, um -- this -- to get this 45 1 quantity of electricity that's required to run this 2 massive plant. 3 Um, to -- to the extent that there are economic 4 savings and consequences, that's great. I mean, I 5 don't -- that's not to drive -- that's not what's 6 driving it. It would -- there would be no way to -- to 7 buy it the way we all buy electricity for our home and 8 run this, you know, massive plant. 9 MR. HORTON: So is the transformer associated 10 with transforming this massive amount of electricity 11 into usable electricity? 12 MS. SILVERSTEIN: It's -- yeah, it steps down 13 the voltage. 14 MR. HORTON: Okay. And -- and so the intended 15 purpose of -- of the equipment is to step down the 16 voltage, and then at that point that that electricity, 17 like many other intrinsic components of the process, is 18 used in the manufacturing process. 19 MS. SILVERSTEIN: Used throughout the process, 20 because you need electricity at every step, from 21 beginning to end. 22 MR. HORTON: And how would that differ from a 23 manufacturing plant that didn't need a transformer, that 24 just plug into the normal flow of electricity? 25 MS. SILVERSTEIN: I mean, I guess, um, the 26 question would be whether the -- the plug is part of the 27 machine and gets -- you know, is -- is eligible for the 28 MIC. 46 1 MR. HORTON: A touchy thing, huh? 2 MS. SILVERSTEIN: Well, I mean, it's -- it 3 would -- it would be, you know, what part -- you know, 4 what's necessary to get the electricity to run the -- 5 the manufacturing equipment? You might need a plug, 6 right? 7 I mean, it's not -- it's not the electricity 8 per se, um, that, you know, we're saying has anything to 9 do with the eligibility for the MIC. It's the equipment 10 that, you know -- that helps run the -- the 11 manufacturing equipment. 12 And so, you know, a simple machine might need a 13 plug. 14 MR. HORTON: Okay. The brick and tile 15 covering, the -- the Department seems to be using the 16 argument of affixation and, therefore, it becoming real 17 property as opposed to tangible personal property that 18 could qualify. 19 The affixation of -- of the brick and tile 20 covering, uh, they refer to a chemical or the -- refer 21 to it as cement. Whatever it's called, is it necessary 22 in order to withstain (verbatim) the, um -- the cleaning 23 process? 24 MS. SILVERSTEIN: As I understand, there's two 25 functions. I mean, the first is to hold it in place. 26 Because if the tile could move, it wouldn't serve the 27 sanitary function. So it has to be, you know, 28 reasonably secure to the ground. 47 1 MR. HORTON: Mm-hmm. 2 MS. SILVERSTEIN: Moreover, the materials they 3 use to -- 4 MR. HORTON: And why does it have to be? 5 MS. SILVERSTEIN: Well, because if it -- I 6 mean, obviously sanitation -- 7 MR. HORTON: Relative to the manufacturing 8 process. 9 MS. SILVERSTEIN: Sanitation is of utmost 10 importance to any food manufacturing. And so, if, um -- 11 you know, these -- I understand it's listeria is the 12 main concern. If that got, you know, from the floor to 13 someone's hand or, you know, somehow got to the food, I 14 mean, the consequences are obvious. 15 So, um, the whole -- the entire facility is 16 just, you know, so pure. I mean, everywhere you go 17 people have masks and gloves, and they have to wipe 18 their feet at every, um, doorway. Um, so this is one 19 element of that sanitation process. 20 Um, the tiles, as I said, they need to be 21 secure; because if they could move, that could 22 compromise the sanitation, um, you know, if something 23 got underneath and they weren't able to clean entirely. 24 They have to be secure. 25 And then they're -- they're, um -- the 26 materials that they use are, the grout and the cement, 27 so to speak, underneath -- 28 MR. OLSON: Mortar. 48 1 MS. SILVERSTEIN: Mortar, they call it 2 actually, um, that has to be super strong to withstand 3 harsh, harsh chemicals that kill the listeria. 4 Um, so all of those components, the way it's 5 attached and then the, um -- the grout and such, are 6 designed for a sanitation function. Um, they're not -- 7 they're not structural at all to the building. 8 MR. ERICKSON: I might add, the grout that is 9 used is -- is, um, specially designed to prevent these 10 little listeria bacteria from entering into it. If 11 there are -- if it's somewhat porous, the listeria can 12 get in there and grow and cause a sanitation issue. 13 MR. HORTON: Is that the only area in the 14 building that this, uh, preventive measure is taken, in 15 and around the manufacturing process? 16 MS. SILVERSTEIN: It's not in the offices, if 17 that's what you're asking. 18 MR. ERICKSON: No. It's not in the offices. 19 MR. HORTON: Okay. Um, the electric generator 20 asset, um, question of the Department. You use the 21 analogy of a spare part, uh, in trying to help us 22 conceptualize how this generator is used. In this case 23 the generator sounds as if though it's an integral part 24 of the -- it's attached to, uh, the manufacturing, the 25 equipment itself. And it serves a function of not just 26 sitting in the room, but a function of, uh, 27 participating in the process when necessary; sort of 28 like insurance, not for repair, just to ensure that the 49 1 process continues to operate. 2 Help me, uh, understand your analogy in how the 3 part in the closet serves in that same function? 4 MR. BIEDLER: The part being in the closet 5 does -- analogy does break down at the separation. 6 The generator is indeed connected to the 7 machinery, which it would power if the main building 8 power were to fall off. So the question becomes, even 9 if it -- is distinguishable from a part in the closet 10 and it is sitting there and there's a component 11 monitoring the power level, is it being -- is that asset 12 being primarily used, which is 50 percent or more of the 13 time, in the process? 14 And it doesn't actually power the machines to 15 make cheese. It would only operate to clear the 16 machine. So that would reduce the amount of time it 17 actually is being active and used, other than standing 18 by. And so my position essentially, that standing by is 19 not sufficient to be used. 20 MR. HORTON: Uh, the Department indicated that 21 the -- this is -- this is new to me. I didn't quite get 22 this out of the briefings, that the generator is only 23 used to flush out the machine. It really doesn't 24 manufacture anything. Let's say hypothetically, there's 25 a power outage and the generator kicks in. What's the 26 purpose at that point? I mean, what happens? 27 MS. SILVERSTEIN: Just a reminder that there's 28 a -- there are two prongs of the -- or more, but two 50 1 relevant prongs to the MIC. One is, used in the 2 manufacturing process. The other is, used to maintain 3 the equipment. And we're saying that it's used to 4 maintain the equipment. 5 So, it wouldn't really -- I mean, it's not 6 necessary that it actually be used to manufacture. It's 7 just that if it's not there and the electricity goes off 8 and the cheese gets stuck, it will ruin the equipment. 9 It's used to maintain the equipment because it can clear 10 out the cheese, flesh it out, and then the equipment, 11 you know, will be able to be used again when the 12 electricity comes back on. 13 MR. HORTON: And that's the sole purpose? 14 MS. SILVERSTEIN: Yes. 15 MR. OLSON: That's the sole use, yes. 16 MS. SILVERSTEIN: So we're not -- we're not -- 17 it's not our position that it's used in manufacturing. 18 It's used to maintain the equipment. 19 MR. HORTON: Manufacturing -- 20 MS. SILVERSTEIN: To maintain the equipment. 21 MR. HORTON: The equipment. 22 MS. SILVERSTEIN: Yeah. 23 MR. HORTON: Thank you. 24 Further discussion, Members? 25 Hearing none, is there a motion? 26 MS. YEE: Move to take the matter under 27 submission. 28 MR. HORTON: Moved by Member Yee to take the 51 1 matter under submission. Second by Member Mandel. 2 Without objection -- 3 MS. SILVERSTEIN: Thank you. 4 MR. HORTON: -- such will be the order. 5 Thank you so very much for appearing before us 6 today. The Board will take your matter under 7 consideration and send you a written report of our 8 decision. 9 ---oOo--- 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 52 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 December 14, 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 52 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: December 28, 2011 17 18 19 ____________________________ 20 KATHLEEN SKIDGEL, CSR #9039 21 Hearing Reporter 22 23 24 25 26 27 28 53