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 FEBRUARY 2, 2012 10 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 11 APPEAL OF 12 COMCAST CABLEVISION CORPORATION OF CALIFORNIA, TAXPAYER, 13 AND COMMON PRODUCTION SERVICES I, INC., ASSUMER 14 NO. 424198 15 AGAINST PROPOSED ASSESSMENT OF 16 ADDITIONAL INCOME TAX 17 18 19 20 21 22 23 24 Reported by: Juli Price Jackson 25 CSR No. 5214 26 Kathleen Skidgel 27 CSR No. 9039 28 1 1 2 P R E S E N T 3 For the Board Jerome E. Horton of Equalization: Chair 4 Michelle Steel 5 Vice-Chairwoman 6 Betty T. Yee Member 7 George Runner 8 Member 9 Marcy Jo Mandel Appearing for John 10 Chiang, State Controller (per Government Code 11 Section 7.9) 12 Diane G. Olson Chief 13 Board Proceedings Division 14 15 For Board of Grant Thompson Equalization Staff: Staff Counsel 16 17 For Franchise Tax Jeffrey Margolis Board: Tax Counsel 18 Carl Joseph 19 Assistant Chief Counsel 20 For Appellants: Jeffrey A. Friedman 21 Attorney 22 Jon Sperring Representative 23 John Alchin 24 Witness 25 Neal Grabell Witness 26 Larry Smith 27 Witness 28 Bill Costal Witness 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 FEBRUARY 2, 2012 4 ---oOo--- 5 MR. HORTON: Let us reconvene the meeting of 6 the Board of Equalization. 7 Ms. Olson? 8 MS. OLSON: All right. Our first item is B1, 9 Comcast Cablevision Corporation of California, Taxpayer, 10 and Comcon Production Services I, Inc., Assumer. 11 Board Proceedings has received contribution 12 disclosure form for this morning's hearings for the 13 parties, agents and participants. All forms were 14 properly completed and signed. All parties, agents and 15 participants are on the alpha listing of your office. 16 For today's first hearing, additional time has 17 been provided -- 30 minutes is allocated for the 18 taxpayer's opening presentation, followed by 30 minutes 19 for the Franchise Tax Board presentation and 15 minutes 20 is allocated for the taxpayer for rebuttal. 21 Mr. Horton? 22 MR. HORTON: Thank you very much. 23 Mr. Thompson, would you please introduce the 24 issues in this case? 25 MR. THOMPSON: Thank you and good morning, 26 Chairman Horton, Members of the Board. 27 MR. HORTON: Good morning. 28 MR. THOMPSON: There are four issues in this 3 1 case. 2 The first issue is whether a $1.5 billion 3 termination fee, received by Appellant in connection 4 with a merger with Media One should be treated as 5 non-business income. 6 The second issue is whether Appellant's 7 subsidiary, QVC, should be treated as unitary with 8 Appellant. 9 The third issue is whether Appellant has shown 10 that it is entitled to a dividends received deduction. 11 And the the third issue is whether the 12 Appellant has demonstrated that the accuracy-related 13 penalty should be removed. 14 MR. HORTON: Okay, thank you very much. 15 I would ask the Appellant and the Franchise Tax 16 Board to do what they can to delineate each issue very 17 discretely in your 30 minute presentation. Identify the 18 issue that's being addressed, cover the issue, go on to 19 the next issue and so forth. And, hopefully, we can 20 have your cooperation with that. 21 These are very complex issues and I think 22 separating them out will allow us to hear the details on 23 each of the issues and actually distinguish the issues 24 where they do have some commonality, okay? 25 As we indicated, you have 30 minutes to make 26 your presentation. We will return to you on rebuttal, 27 after the Department has had an opportunity to make 28 their presentation. They too will have 30 minutes as 4 1 well. 2 Please commence with your introductions. It's 3 also my understanding that you would like to swear in 4 some witnesses? I'd like to go ahead and accommodate 5 that from the onset, after your introductions. 6 MR. FRIEDMAN: Thank you. Good morning, 7 Mr. Chairman and honorable Board Members. 8 MR. HORTON: Good morning. 9 MR. FRIEDMAN: And happy groundhog's day. 10 On behalf of Comcast, I'm Jeffrey Friedman with 11 Sutherland. With me today is my co-presenter, Jon 12 Sperring of PricewaterhouseCoopers. Also with me today 13 and participating in the presentation are John Alchin, 14 the retired co-CFO of Comcast, Neal Grabell, the retired 15 General Counsel of QVC. 16 In addition, we have other retired executives 17 with us today and available to you. 18 MR. HORTON: Anything to do with groundhog's 19 day? 20 MR. FRIEDMAN: We're getting to that, 21 Mr. Chairman. Okay, I promise I'll be back to that. 22 Larry Smith, co-CFO of Comcast is also with us 23 today and Bill Costal, the retired CFO and COO of QVC 24 are also here, Mr. Chairman. 25 MR. HORTON: Okay. 26 MR. FRIEDMAN: Is now a good time to swear the 27 witnesses? 28 MR. HORTON: Yes, please. 5 1 Miss Olson? 2 Would you -- would the individuals you'd like 3 to have sworn in please stand? 4 MS. OLSON: Please raise your right hand and 5 please state your name for the record. 6 MR. HORTON: Excuse me, I'm going to ask that 7 they come forward and so it's on the record and so they 8 speak into the mike and they state their names. 9 MR. ALCHIN: John Alchin. 10 MR. HORTON: Okay. 11 MR. SMITH: Larry Smith. 12 MR. HORTON: Okay. 13 MR. GRABELL: Neal Grabell. 14 MR. Costal: And Bill Costal. 15 MR. HORTON: Okay. 16 MS. OLSON: Do you swear or affirm to tell the 17 truth in these proceedings? 18 MR. ALCHIN: I do. 19 MR. SMITH: I do. 20 MR. GRABELL: I do. 21 MR. Costal: I do. 22 MS. OLSON: Thank you. 23 MR. HORTON: Please commence. 24 MR. FRIEDMAN: Thank you very much. 25 Out of the four issues that Mr. Thompson noted, 26 we're going to focus on two in our opening. 27 MR. HORTON: Okay. 28 MR. FRIEDMAN: The first issue we'd like to 6 1 talk about is the allegation, the FTB allegation, that 2 Comcast and QVC comprised a single unitary business. 3 The second issue we'll focus on later is the 4 FTB's allegation that Comcast's receipt of a $1.5 5 billion termination fee should be characterized as 6 apportionable business income. 7 The FTB misstates the facts of this case and 8 the relevant law in this case. And we look forward to 9 discussing both with you today. 10 I'd like to first address the allegation that 11 Comcast's 57 percent ownership of QVC resulted in a 12 unitary business. The allegation's plainly false. 13 First, the FTB bases its position on the notion 14 that the potential to control a subsidiary -- the 15 potential to control a subsidiary is enough. I want to 16 emphasize that Comcast's 57 percent interest QVC is not 17 by itself enough. 18 There must be proof of actual control. There 19 must be proof of actual integration. There must be 20 proof of actual flows of value, not the potential. 21 Second, turning to the facts, it's interesting 22 to note that the FTB conducted two separate audits, one 23 of Comcast and one of QVC. Yes, you heard me right. 24 The FTB separately audited these two companies, treated 25 them independently. FTB's own auditors didn't view 26 these companies as integrated. 27 As a result of these separate audits, the FTB 28 had unrestricted access to Comcast's books and records. 7 1 The FTB had had unrestricted access to QVC's books and 2 records. The FTB characterizes its own audit as, quote, 3 unquote, thorough. But yet it has not provided one 4 shred of evidence that the companies are actually 5 integrated in any way -- not one cancelled check, not 6 one accounting entry, not one loan document, 7 intercompany agreement or shared function. 8 The FTB has not produced any evidence of a 9 unitary relationship. And there's a reason why. There 10 was no unitary relationship. Rather -- and as we'll 11 discuss more later -- the FTB is relying on forward 12 looking statements and news reports taken out of context 13 from such authoritative sources as The Hollywood 14 Reporter, the LA Variety and Wikipedia. Now my 15 12-year-old daughter can amend Wikipedia. My 16 14-year-old daughter can tweet about it. It doesn't 17 necessarily make it true, though. 18 And this is lot of the context of this case. 19 Statements taken out of context on unreliable 20 information in the first place. 21 Third, I'd like to note that there have been no 22 less than 15 declarations -- 15 declarations -- filed in 23 this case by Comcast and QVC executives. These 24 affidavits are from senior executives of both companies. 25 The affidavits have been filed by the CEOs of Comcast 26 and QVC, the CFOs of Comcast and QVC, the General 27 Counsels of Comcast and QVC and numerous other 28 individuals who have firsthand knowledge regarding the 8 1 relationship or, frankly, the nonrelationship between 2 these two companies. 3 It is unprecedented -- unprecedented -- to 4 substantiate a unitary finding when the CEOs of both 5 accused companies state unequivocally -- 6 unequivocally -- that there were no sharing of business 7 plans. There were no sharing of policies and 8 procedures. There were no sharing of employees. There 9 were no sharing of facilities. There were no sharing of 10 intangibles. There were no sharing of treasury 11 functions. There were no sharing of vendors. There 12 were no sharing of marketing. 13 There's no sharing of tax functions. There's 14 no sharing of legal functions. There is no sharing, no 15 sharing, no sharing between these two companies -- not 16 one shred of evidence. 17 Yet the FTB stands stands by its conclusion 18 that there was a unitary relationship, when this no 19 sharing shows that there was no flow of value between 20 two companies. Comcast and QVC were not integrated in 21 any way -- not vertically, not horizontally and not 22 functionally. 23 The fact that there was a separate independent 24 business relationship that was negotiated in arm's 25 length terms and made available to Comcast on the exact 26 same terms available to all large cable and satellite 27 providers, doesn't change anything in this case. But 28 yet the FTB will attempt to convince you it does so. 9 1 And we'll come back to that as well. 2 The FTB's unitary -- unitary position is based 3 on the existence of common ownership and a wish for 4 something more. At one time Comcast may have wished to 5 integrate QVC into its cable business. And there is 6 some statements taken out of context that indicate that 7 wish. And the FTB certainly wished there was a unitary 8 relationship, but there was none. The wish, which is 9 really like an FTB fantasy, just never came true. Don't 10 get me wrong, Comcast had the potential to control QVC. 11 In fact, Comcast joined forces with Liberty 12 Media, a third party, to take QVC private in 1995 as a 13 result of a transaction proposed by the former CEO of 14 QVC. 15 However, and I'm going to repeat again, the 16 potential to control is not enough. Actual control, 17 actual integration, actual flows of value must be shown. 18 The FTB has not shown it. 19 As this chart demonstrates over here 20 (indicating), the Supreme Court, the US Supreme Court, 21 and the California courts have required a showing of 22 actual control -- ownership is not enough. There are a 23 number of important cases where there was, in fact, the 24 requisite ownership percentages, there was, in fact, 25 requisite intercompany transactions and still no 26 intercompany -- still no unitary finding, still no flows 27 of value, still no integration. 28 I'd now like to turn to Neal Grabell, the 10 1 retired General Counsel of QVC to hear from his 2 perspective on QVC's business and operations. 3 Neal, before I let you start here, are you 4 employed QVC today? 5 MR. GRABELL: No, I'm not. 6 MR. FRIEDMAN: Are you employed by Comcast 7 today? 8 MR. GRABELL: No, I'm not. 9 MR. FRIEDMAN: Are you receiving any 10 compensation for being here today? 11 MR. GRABELL: No, sir, I'm not. 12 MR. FRIEDMAN: Okay, thank you. 13 Please begin. 14 MR. GRABELL: I was the General Counsel and 15 Corporate Secretary of QVC from 1987 to 2008, when I 16 retired. In fact, I was the lawyer who incorporated QVC 17 in 1986. 18 And during my tenure there I participated in 19 every significant business decision that QVC made, 20 including business expansion and strategic decisions. 21 I negotiated and drafted the carriage 22 agreements or affiliation agreements between QVC, on the 23 one hand, and the cable companies, such as Comcast, and 24 the satellite companies, such as DirecTV, on the other 25 hand. 26 Comcast never participated in QVC's business 27 operations. There was no Comcast involvement in any 28 significant business decision before, during or after 11 1 Comcast's 57 percent ownership interest in QVC. 2 Quite, frankly, Comcast had no experience in 3 QVC's type of business. They were a cable company and a 4 cellular telephone company at the time. And we were an 5 electronic retailer, which is an unusual niche in the 6 retailing market. 7 MR. FRIEDMAN: John, you were the co-CFO of 8 Comcast during these years. And before I ask you to 9 describe your view of the relationship or the investment 10 purpose that Comcast had in QVC, are you an employee of 11 Comcast? 12 MR. ALCIHIN: No, I'm not. 13 MR. FRIEDMAN: Are you an employee of QVC? 14 MR. ALCHIN: No, I'm not. 15 MR. FRIEDMAN: Are you being paid to be here 16 today? 17 MR. ALCHIN: No, I am not. 18 MR. FRIEDMAN: Okay. Thank you, John. 19 Much has been made regarding the veracity of 20 our affidavits in this case. And we wanted to just take 21 it head-on the fact that we have a number of executives, 22 both sitting on either side of me and behind me, that 23 have no financial interest in this case at all. 24 Okay, thanks, John. 25 MR. ALCHIN: Thank you, Jeff. 26 I joined Comcast in 1990 as Senior Vice 27 President and was Executive Vice President from 1995 and 28 co-CFO with Larry Smith from 2002 to 2007. 12 1 We always treated our investment in QVC as a 2 passive investment. Ralph and Brian Roberts were 3 attracted to QVC because of Joe Segel's outstanding 4 business track record. Joe founded the Franklin Mint 5 and then, subsequently, QVC. 6 QVC turned out to be a fantastic investment and 7 quickly became a retailing powerhouse. QVC set an 8 American record for retail sales in its first full year 9 of operations. 10 While we valued our investment in QVC, we very 11 quickly realized that we did not have the expertise to 12 get involved in its business. And, frankly, we didn't 13 have any incentive to interfere with their business 14 because we had no experience as running a retailer. 15 Most importantly, QVC's executive team performed 16 exceptionally well. 17 Then in 1993 Barry Diller joined QVC as CEO 18 with the ambition to expand QVC beyond electronic 19 retailing. Neal was there and I'll ask him to talk 20 about QVC under Barry Diller. 21 MR. GRABELL: Thank you. 22 Before Barry Diller came to QVC he had been the 23 CEO of Fox and, before that, the CEO of Paramount. And, 24 so, he didn't come to QVC just to run a televised 25 shopping channel. He wanted to use the large cash flow 26 from QVC's business, which was several hundred million 27 dollars a year, and use that to acquire businesses in 28 the entertainment industry. 13 1 For example, he wanted QVC to acquire 2 Paramount. And we engaged in a hostile tender offer for 3 Paramount. But when the price became too high in the 4 bidding war, he shifted his attention to CBS. There was 5 an opportunity to merge QVC and CBS and, for Mr. Diller, 6 the opportunity to run the merged entity would have 7 enabled him to realize his ambitions. 8 QVC was performing well. And the company 9 thrived under Mr. Diller while he was the CEO. He was 10 clearly good for the company, but he was a hands off 11 CEO. In many respects Mr. Diller was the public face of 12 the company but he was focused on the day-to-day 13 operational issues. 14 In fact, Doug Briggs, one of the executives, 15 really ran the company. He was the only one who really 16 knew the recipe to the secret sauce of QVC success. QVC 17 was performing very well and the company grew. We were 18 a publicly traded company and our soared. 19 MR. ALCHIN: We were thrilled with our 20 investment in QVC. And, as you can see by the chart 21 over there on the right, the company continued to grow. 22 This is a chart showing revenues from the outset through 23 until today. 24 The proposed merger, though, with CBS was 25 really problematic for Comcast. The merger would have 26 forced us to sell a large part of our investment in QVC 27 due to prevailing FCC rules. Comcast would have had to 28 reduce its ownership interest from approximately 15 14 1 percent to no more than 5 percent of the new merged 2 entity. 3 Comcast proposed and entered into a deal with a 4 third party, another one of the QVC shareholders, namely 5 Liberty Media, that was a better deal for us than was 6 the proposed CBS deal. 7 Comcast proposed a tender offer that resulted 8 in our owning 57 percent and Liberty Media owning 43 9 percent of QVC. And we were really thrilled with that 10 outcome. 11 MR. FRIEDMAN: Neal, it had to have been an 12 exciting time for you to be General Counsel of a company 13 that you incorporated and everybody seemed to want to 14 get a piece of. 15 Can you tell us a little bit about this -- this 16 this time period and the ultimate acquisition of 57 17 percent by Comcast? 18 MR. GRABELL: It was a very exciting time. We 19 were involved in potential mergers and acquisitions, but 20 with the departure of Mr. Diller, the QVC executives 21 were able to put the distractions of mergers and 22 acquisitions behind us and focus on the day-to-day 23 business of retailing. 24 Mr. Diller contributed a lot to the company. 25 But, as I said, his attention was focused primarily on 26 external -- external matters and not the day-to-day 27 operations of the company. 28 Comcast was a very longstanding shareholder of 15 1 QVC. And we, the QVC executives, had a very good 2 relationship with them. It really couldn't have worked 3 out better for us. Comcast respected our operational 4 abilities and the performance that QVC had under our 5 work -- under our tenure. And Comcast was willing to 6 let Doug Briggs, our President, and the other QVC 7 executives run the business as we saw fit. 8 For instance, I continued to do my job as 9 General Counsel. I was involved in various transactions 10 and in litigation and not once did I feel I had to 11 consult with or listen to the General Counsel of 12 Comcast. I was able to operate my department as I saw 13 fit. 14 MR. FRIEDMAN: John, you went from a very short 15 period of time of CFO of a publicly-traded company, 16 Comcast, 15 percent interest shareholder in QVC for a 57 17 percent shareholder in QVC. 18 Can you tell us a little bit about what was 19 going on in Comcast at that time? 20 MR. ALCHIN: Certainly. I mean, it was a very 21 exciting development for us to take on a majority 22 interest in QVC. However, our immediate and highest 23 concern was insuring that the QVC executive team 24 remained in a place. 25 We viewed the QVC executives as critical to 26 maintaining the growth and ensuring that the value 27 of our investment continued to grow. 28 Brian Roberts met with Doug Briggs to entice 16 1 him to run QVC, to continue running QVC. Doug had been 2 with QVC for many years and we viewed him as the key 3 operating executive. We needed to ensure that he stayed 4 with the company so -- and, for that reason, we were 5 willing to agree to conditions that you might otherwise 6 think to be somewhat extreme. 7 The most significant demand that Doug made was 8 that if he was going to run QVC, he was going to run it 9 only on the condition that there was no interference 10 from Comcast. Doug had quite some difficulty working 11 for Barry Diller. And he insisted that the only way he 12 would accept the CEO role with Comcast owning 57 percent 13 of the company would be if Brian and Comcast agreed to 14 autonomous management for QVC. 15 This may sound like a significant, maybe even 16 extreme, concession, but it really wasn't. We had 17 confidence in Doug. He had a terrific track record. 18 And I think one way of describing it, he seemed to be 19 the only person who knew the secret sauce to making the 20 the success that QVC really was. 21 Most importantly, though, Comcast didn't have 22 any experience whatsoever at running a retailer, let 23 alone an electronic retailer. It wasn't like Comcast 24 had any executives at all that we could parachute into 25 the QVC operation. 26 In fact, we didn't transfer any of our 27 employees to QVC, even though the two companies are 28 headquartered only some 25 or 30 miles apart. And we 17 1 enjoyed a great relationship with QVC. 2 Larry and I, along with Brian Roberts and Ralph 3 and Julian Brodsky, had quarterly financial review 4 meetings with Bill Costal and Doug Briggs. To the best 5 of my recollection, every one of those meetings involved 6 a review of simply outstanding results. The results 7 illustrated on that chart over there (indicating) attest 8 to the consistent and fantastic growth before, during 9 and after Comcast's ownership. And this is all under 10 the QVC management team. That's why we were so focused 11 on keeping them there and so willing to give them the 12 autonomy they demanded. 13 As Comcast spokesman for the investor 14 community, one of the spokespersons for the investor 15 community, the review meetings gave me insights into 16 QVC's financial results. I, in turn, shared those 17 results and insights with Comcast's investors for very 18 obvious reasons. 19 The investors in Comcast were very focused on 20 this very significant, but passive investment that we 21 had in QVC. 22 MR. FRIEDMAN: Neal, you mentioned before that 23 you, as General Counsel of QVC, was left alone. Your 24 lawyers were left alone. John Alchin just testified to 25 the fact that Comcast made a business decision to stay 26 out of Com -- of QVC's way. 27 Can you give us any examples or describe or 28 elaborate a little bit more on Comcast's living up to 18 1 that commitment? 2 MR. GRABELL: Yeah. They kept their word. For 3 the eight years that they were the majority owner, they 4 did they not interfere with our operations. 5 At times they night make suggestions, but it 6 was clear that they weren't demanding that those 7 suggestions be adopted. And, many times, in fact, most 8 times they were rejected. We made very significant 9 expenditures, entered into numerous transactions. And 10 we built large facilities, for example, we started 11 German and a Japanese television shopping businesses, 12 each with an investment of over $60 million. We built 13 and equipped out a distribution center in Rocky Mount, 14 North Carolina for over $100 million. And we did this 15 all without needing to seek or obtain Comcast's consent. 16 We did these things because we thought they were great 17 for QVC. 18 Most important, QVC and Comcast operated at 19 arm's length. I was responsible for negotiating the 20 carriage agreements, or the affiliation agreements, 21 between Comcast and QVC. And, believe me, those 22 negotiations were very hard fought, tooth and nail. 23 This occurred both before, during and after Comcast's 24 majority ownership. 25 As a result of our independence and autonomy, 26 QVC was able to continue to outperform our competitors 27 and produce great results. 28 MR. FRIEDMAN: Well, there you have it from two 19 1 senior executives at each of the companies that are with 2 you here today. 3 Comcast did not integrate QVC. QVC did not 4 integrate with Comcast. There are allegations made. 5 There are quotes taken out of context that QVC somehow 6 benefited by being owned by Comcast. There are items 7 discussed in the briefing that Comcast somehow benefited 8 by being an owner of QVC. And in some ways they did, as 9 a passive investor. But there were no flows of value. 10 I welcome the questions at any point you're 11 ready about transfers of technology, of business 12 knowhow, of relationships, of any of those sorts of 13 things that you would expect to see between an 14 integrated set of businesses. None of them existed 15 here. 16 In all of the years in which I've been 17 practicing State and local tax, in all the years in 18 which I've worked on unitary tax issues, I've never seen 19 a wholly, or a 57 percent owned subsidiary or a 20 wholly-owned subsidiary so distant from its parents, 21 irrespective of the fact that the executives had good 22 rapport with each other. 23 Nevertheless, the FTB, over and over and over 24 again makes allegations of integration, flows of value. 25 They've engendered a debate has to what unitary test to 26 apply here, contribution dependency, three unities test. 27 Frankly, none of that makes any difference to 28 us at all. All of those tests are designed to show one 20 1 thing -- was there a flow of value between the companies 2 to justify a unitary finding? 3 We've looked. We've questioned witnesses. 4 We've performed our own examination of the books and 5 records. We've requested copies of the FTB audit files 6 and have gone through those. 7 We've gone through the news reports, which we 8 find, oftentimes, wrong or taken out of context. We've 9 looked at the 10K information cited by the FTB in its 10 briefing, often either wrong, taken out of context, 11 projecting into the future or coming from outside of our 12 audit period. None of it demonstrates a flow of value 13 under any unitary test that you can choose from. 14 The FTB has repeatedly asked for more briefing, 15 more oral argument time -- which I'm taking advantage of 16 right now, quite frankly. And they even asked for extra 17 rebuttal time, which they were not granted. 18 Over and over and over again they tried to make 19 a case of a unitary finding where there is none -- 20 groundhog's day, indeed. It's not happening. There's 21 no evidence here. They can do this over and over again. 22 It's time to stop this. I hope that we're able to save 23 the judicial system more appeals, more briefing, more 24 unfounded allegations today. 25 I'd like to take another moment to address the 26 carriage arrangement that Neal Grabell negotiated on 27 behalf of QVC with Comcast. 28 Neal, as General Counsel and as he described 21 1 before, oversaw all the contract negotiations that QVC 2 had with Comcast, with TCI, with Time Warner Cable, with 3 Cox Cable, with DirecTV and the other satellite 4 providers. 5 This agreement was the same with Comcast as it 6 was with every other large cable and satellite provider. 7 The fact that it existed during our period of ownership 8 doesn't prove anything. It certainly doesn't 9 demonstrate a flow of value. 10 In fact, it demonstrates quite the contrary, 11 that the parties treated each other at arm's length, 12 negotiated with each other at arm's length and did not 13 favor each other over other competitors. 14 QVC was never integrated with Comcast, as 15 demonstrated by our witnesses, the 15 affidavits I 16 mentioned earlier, and, most importantly, the lack of 17 any documentary evidence produced by the FTB. 18 This, in fact, relates back to the point I made 19 earlier. FTB conducted a quote, unquote, thorough audit 20 of these companies and hasn't produced any evidence from 21 those audits that demonstrates a flow of value. 22 One additional rationale offered up by the 23 FTB -- by the way, in their very last brief, at a point 24 in time when we were prevented from responding, bears 25 worth mentioning here today. 26 And that is the fact that QVC, at a point in 27 time when it was owned by two companies, two unrelated 28 companies -- Comcast and Liberty Media -- produced 22 1 options to its two shareholders. So, Comcast received 2 options; Liberty Media received options pro rata to 3 their ownership percentage. 4 Now, some of those options that were paid to 5 Comcast ended up in the hands of Comcast executives. 6 FTB would like you to believe that that shows a flow of 7 value between QVC and Comcast. 8 What the FTB does not tell you is that it's 9 clear that those options were paid to Comcast executives 10 for Comcast services, that the options were approved by 11 the Comcast Compensation Committee and that that 12 Compensation Committee looked at all of the Comcast 13 compensation paid to that executive and made clear that 14 it was for compensation for Comcast services. 15 John Alchin, how much performance of services 16 did you provide to QVC? 17 MR. ALCHIN: Absolutely nothing. 18 MR. FRIEDMAN: Did you receive any of these 19 options? 20 MR. ALCHIN: Yes, I did. 21 MR. FRIEDMAN: Okay. Please listen very 22 carefully to the FTB's evidence -- not what they say 23 about their evidence, but what exactly is their 24 evidence. Please listen very carefully and what you'll 25 see is there are statements taken out of context or from 26 unreliable sources or based on forward looking 27 observations and statements -- none of which show actual 28 integration. They all show a potential to integrate and 23 1 show a wish to integrate. 2 Frankly, the FTB's case is built on a wish. 3 With us again is John Alchin, Neal Grabell, Larry Smith, 4 Bill Costal. They're all available for your questions 5 whenever you're ready. 6 With that, I'll turn to our second issue, the 7 termination fee. The termination fee's been 8 interesting. Rather than a factual debate, which is 9 what we have before us here on the QVC-Comcast 10 relationship, we have more of a legal dispute. 11 Comcast received a $1.5 billion payment from 12 Median as a result of a failed merger agreement. 13 Comcast and Median signed a contract for Comcast to 14 acquire Median. It's important to put this transaction 15 or proposed transaction into context. Comcast 16 was acquiring a company that was larger than it. Median 17 was a larger -- larger company than Comcast. This 18 transaction would have more than doubled the size of 19 Comcast. It was an extraordinary transaction, unusual 20 and, in fact, hard to believe in today's day and age. 21 22 As part of that contract, that acquisition 23 contract, there was a termination clause that if either 24 party walked away, either Median or Comcast, if either 25 party walked away from the deal, they had to pay $1.5 26 billion to the other party, a termination fee. The 27 purpose of the termination fee was simple. It was to 28 provide a disincentive from walking away from the deal, 24 1 a negotiated deal. 2 Another important point about the $1.5 billion, 3 it wasn't calculated based upon lost profits. It wasn't 4 calculated based upon relative size. It was an 5 arbitrary number intended to keep the parties into the 6 contract, preventing either one from walking away. 7 Of course, what ended up happening is AT & T 8 came in and offered a sweeter deal to Median. Median 9 ultimately walks away from Comcast. Median pays us $1.5 10 billion. 11 Those are the facts of this issue. One last 12 fact -- between the point in time in which we signed the 13 contract to the point in time in which it was terminated 14 was 46 days -- very quick point in time. 15 Our dispute relates to California's definition 16 of apportionable business income. As the California 17 court, Supreme Court has already made clear, there are 18 two tests. I'm going to take them one at a time. 19 The first test is the transactional test. The 20 transactional test was analyzed by the California 21 Supreme Court in the Hoescht Celanese case as requiring 22 a showing as to whether the transactions or activities 23 occur in the taxpayer's regular trade or business, in 24 the course of their regular trade or business. 25 So, the first step is to identify the relevant 26 transaction or activity. Now the Franchise Tax Board 27 would have you believe that the relevant transaction or 28 activity is the entering into a merger or an 25 1 acquisition. This was not Comcast's only acquisition, 2 of course. They have acquired other cable companies 3 both before and after this event. However, this 4 transaction was a bit unusual, having more than doubled 5 the size of the company if it ever went through. But, 6 nevertheless, that's not the relevant transaction or 7 activity under the Hoescht Celanese case. 8 Let me talk for a moment about what Hoescht 9 Celanese said regarding the transactional test. The 10 Franchise Tax Board argued that the funding of a 11 pension, the contributions to a pension plan, are the 12 relevant transactions or activities to be analyzed under 13 the transactional test. 14 The California Supreme Court rejected the FTB's 15 suggestion and, instead, looked to the actual income 16 event, which was a pension reversion. Again, the FTB 17 argued the funding of the pension plan is the relevant 18 transaction of activity. The California Supreme Court 19 rejected them and decided we had to look at the income 20 event, which was a pension reversion. 21 The pension reversion, of course, was not in 22 Hoescht Celanese's regular trade or business and it 23 didn't satisfy the transactional test in that case. 24 What about our facts? We entered into a 25 contract. The FTB once again argues that we should be 26 examining the entering into a merger agreement as the 27 relevant transaction or activity in determining whether 28 that's in the regular course of Comcast trade or 26 1 business. 2 However, entering into a merger contract and, 3 in fact, even acquiring a company doesn't produce any 4 income. It doesn't produce any gain. It produces 5 nothing. It's a acquisition, it's not a taxable event. 6 The termination fee was triggered and $1.5 billion was 7 paid to Comcast. That was a taxable event and that's 8 the relevant transaction or activity under the Hoescht 9 Celanese analysis. 10 So, Step 1 of the Hoescht Celanese 11 transactional test is identification of the relevant 12 transaction or activity. It's the trigger of a 13 termination fee, $1.5 billion. 14 It is clear that Comcast's receipt of the 15 termination fee was a once in a corporate lifetime 16 event. Were there other contracts that Comcast entered 17 into that had small termination fees, relatively small 18 termination fees? Yes, there were some. Was the 19 receipt of a termination fee in Comcast regular trade or 20 business? Absolutely not. And the executives here can 21 help testify to that point as well. 22 Nevertheless, FTB over and over again repeats 23 its prior litigation position in the Hoescht Celanese 24 case and should once again fail. Groundhog's day 25 indeed. 26 I'm going to move to the functional test, the 27 second test for business income under Hoescht Celanese, 28 this one's quite simple and straightforward, 27 1 MS. OLSON: Time has expired. 2 MR. HORTON: Okay. Can you wrap it up in about 3 a minute? 4 MR. FRIEDMAN: Yes, I can. 5 Thank you, Mr. Chairman. 6 The functional test requires the identification 7 of a property right and requires it to be integrated or 8 interwoven into the taxpayer's trade or business to 9 justify it under the functional test and for it to be 10 business income. 11 Regardless of whatever FTB's arguments are, 12 which are hard to, frankly, understand as to the 13 identification of a property right -- the contract, 14 MediaOne's cable businesses, the termination clause -- 15 none of those property rights, such as they are, were 16 integrated or interwoven into Comcast's trade or 17 business. This contract failed in 46 days. Nothing got 18 integrated in Comcast's trade or business. 19 Thank you very much. 20 MR. HORTON: Thank you. We'll now move to the 21 Department. The Department will have 30 minutes as well 22 to make their presentation. 23 We would ask that you commence with your 24 introductions for the record. 25 MR. MARGOLIS: Yes. Mr. Chair and Members of 26 the Board, my name is Jeff Margolis and with me today is 27 Carl Joseph, the Assistant Chief Counsel for the 28 Multistate Tax Division of the FTB's Legal Department. 28 1 May I have a few extra minutes at the end to 2 cross-examine the witnesses as well? 3 MR. HORTON: Uh -- 4 MR. MARGOLIS: It won't take very long. 5 MR. HORTON: Sure. I mean we're going to have 6 to allow them additional time on rebuttal as well -- 7 MR. MARGOLIS: Right, I understand that. 8 MR. HORTON: -- to balance it out. 9 MR. MARGOLIS: Okay, thank you. 10 MR. HORTON: Sure. 11 MR. MARGOLIS: The first issue I will address 12 is the taxation of the termination fee and that should 13 be a very simple issue for you to decide. I say it's 14 simple because there has already been a federal 15 determination. The IRS has determined that the fee 16 constituted income, that the income was ordinary and 17 that it was from lost profits from the taxpayer's 18 business. 19 Comcast had every incentive to fight that 20 determination and for a time, it did. But Comcast 21 ultimately agreed to the IRS determination. And that 22 the determination is now presumptively correct. 23 So, the issue of whether or not the termination 24 fee constituted income or represented the payment for 25 lost profits is or should be behind us. And I haven't 26 heard any argument any more that it was no longer -- 27 that it was not income. 28 Now the further issue of whether that ordinary 29 1 income constituted business or non-business income 2 requires application of the two tests for business 3 income. And if either test is satisfied, the income 4 constitutes business income. 5 Here again your job is made simple by three 6 things. First, in this case we have Comcast's own 7 admissions. Second, we have cases that are directly on 8 point. And, third, if, after considering the facts in 9 the cases you're unsure on how to rule, you have a 10 presumption. It says income shall be classified as 11 business income unless it's clearly classifiable as 12 non-business income. 13 Under the transactional test income is business 14 income if it results from transactions and activity in 15 the regular course of the taxpayer's trade or business. 16 So, first you have to decide what types of 17 transactions did Comcast engage in as part of its 18 regular course of business? And, second, whether the 19 termination fee arose from such transactions and 20 activity. 21 Now here the fee arose from an activity that 22 Comcast has been regularly engaged in from the time it 23 first bought a cable company in Tupelo, Mississippi. 24 Comcast continued to expand, primarily through 25 acquisitions. This is not something that Comcast 26 denies. Acquisitions were its primary engine of growth. 27 The frequency of the Comcast acquisition 28 activity was analyzed by the FTB's auditors. They 30 1 determined that during the 15 years prior to and 2 including the years at issue, Comcast engaged in over 30 3 such acquisitions. 4 In fact, if you look at Hoescht Celanese charts 5 behind me -- and these are -- I believe it's Exhibit -- 6 the first few pages of the exhibit I gave you -- during 7 the 1999 year alone, they had six acquisitions pending 8 as of December 1999. 9 So, clearly they were very -- very actively 10 engaged in acquiring other cable companies. In fact, 11 the Andersen memo confirms this. The opinion memo says 12 that Comcast has been making acquisitions and, piece by 13 piece, putting together a nationwide cable network. 14 It also said that when the Comcast group 15 acquired stock of other cable companies and related 16 businesses to grow its cable enterprises, these 17 acquisitions were more than passive investments. These 18 stock acquisitions became part and parcel of the Comcast 19 group and were and are now woven into the group's 20 business strategy. 21 This is not something I heard Mr. Friedman 22 deny. These were the very facts upon which Comcast 23 based its return position. 24 So, all the evidence supports -- points in the 25 same direction. It supports the conclusion that Comcast 26 was regularly engaged in acquisition activities. And 27 the Median contract was just another acquisition, 28 another building block, to use the terminology that the 31 1 Andersen memo uses, that Comcast entered into as part of 2 putting together its integrally woven business. 3 So, that's all you need for the business income 4 test -- a regularly conducted activity of the taxpayer 5 and income arising from that regularly conducted 6 acquisition activity. It's a simple issue. That's it. 7 The arguments Comcast makes in response aren't 8 something that should give you any pause whatsoever. 9 These same arguments were made and rejected 13 years ago 10 by the Oregon Supreme Court in Pennzoil. And it was 11 rejected just six months ago by you in the Appeal of 12 Sonic Automotive. 13 Pennzoil is an Oregon case -- actually, two 14 decisions in the same case -- one by the Oregon Tax 15 Court and another by the Oregon Supreme Court -- both 16 upholding business income treatment. 17 Now, you may wonder why you should pay any 18 attention -- any attention to these out-of-state 19 opinions? Well, you should pay attention to them 20 because the California Supreme Court has said that you 21 should. UDITPA is a uniform set of laws that's been 22 adopted by 20 states, including California and Oregon. 23 And UDITPA specifically says that it should be 24 interpreted uniformly. And the California Supreme Court 25 has said that because it should be interpreted 26 uniformly, opinions from other states are relevant. It 27 said this in the Hoescht Celanese case. It said it in 28 the General Motors case and in the Microsoft case. 32 1 In fact, if you read the Oregon Supreme Court 2 decision in Pennzoil, it's pretty obvious that the 3 judges there thought they were applying Hoescht Celanese 4 when they reached their decision that the income 5 constituted business income. They cited Hoescht 6 Celanese four times in support of their reasoning. 7 Now, the facts of Pennzoil are very similar to 8 the facts here. Like Comcast, the Pennzoil case 9 involved a failed stock acquisition. Pennzoil entered 10 into an agreement to purchase stock in Getty Oil. Just 11 three days later Getty decided to sell itself to Texaco 12 instead. Pennzoil sued Texaco, claiming that Texaco had 13 damaged Pennzoil by interfering with its contract to 14 acquire the Getty stock. It obtained a judgement for 15 $11 billion, which it ultimately settled for 3 billion. 16 Now, Pennzoil, unlike Comcast, reported the 17 recovery as income on its return. But it reported the 18 income as non-business income. And Pennzoil made 19 exactly the same arguments that Comcast is making here. 20 Just as Comcast argues that the termination fee 21 did not arise from the Median contract, but from the 22 termination of that contract, Pennzoil argued that the 23 settlement award did not result from the Getty contract, 24 but from Texaco's interference with that contract. 25 And just as Comcast argues that it was not in 26 the business of failed mergers, Pennzoil argued that it 27 was not in the business of suing companies for 28 interfering with its contracts. 33 1 The Tax Court rejected all of these arguments 2 and found that because the business -- because the 3 income arose from the Getty contract, it was irrelevant 4 what particular action it took to actually collect the 5 income arising from that contract. 6 The court stated, and I quote, 7 "It does not matter whether the contract 8 was sold, stolen, condemned, interfered with or 9 cancelled, the income realized by Pennzoil was 10 income arising from that contract." 11 Pennzoil also argued that the damage award was 12 not business income because the Getty contract was to 13 acquire stock, whereas Pennzoil was an operating oil and 14 gas company. 15 Comcast makes the same argument. But the court 16 rejected this argument because Pennzoil, like Comcast, 17 frequently engaged in acquisition activities in -- in 18 order to expand its existing operating business. 19 Pennzoil made another argument that Comcast has 20 made here today, claiming that because the Getty 21 acquisition was larger than any it had ever attempted 22 before, it wasn't part of its regular trade or business. 23 The court rejected this argument citing, in fact, the 24 California Supreme Court's decision in Hoescht Celanese, 25 which says you look at the nature of the transaction to 26 see if it's -- if it has the same nature as the type of 27 transactions you regularly engage in. It said that the 28 statute doesn't refer to size, it refers to the nature. 34 1 The court said that although the Getty contract 2 may have been the largest ever negotiated by Pennzoil, 3 it could, quote, 4 "Find no basis for separating transactions 5 based on size alone. Because the very act of 6 negotiating the Getty contract was an activity 7 undertaken in the regular course of Pennzoil's 8 unitary business, all of the income arising 9 from that contract, including the interference 10 with it, constituted business income under the 11 transactional test." 12 So, Pennzoil is directly on point and you 13 should adopt its persuasive precedent because it's from 14 another UDITPA jurisdiction which has the same laws as 15 California and because the court in Pennzoil was really 16 trying to apply California precedent. It was applying 17 the Hoescht Celanese decision. 18 In fact, your Board, just six months ago, quite 19 appropriately, relied upon Pennzoil in Sonic Automotive 20 in your decision there. Now, that's an unpublished 21 decision. And an unpublished decision is not itself 22 precedential but it's based upon an interpretation of 23 authorities that are precedential. It's based on 24 Hoescht Celanese, Pennzoil and the case called Atlantic 25 Richfield, which we've also briefed. And those 26 authorities do apply to this case as well. 27 And it's important for your Board to apply the 28 law consistently, even consistent with your unpublished 35 1 decisions. Consistency in the law is something that 2 benefits both taxpayers and tax authorities. 3 Now Sonic, Like Pennzoil and Comcast, involved 4 a busted contract. Sonic is an auto dealer with 5 dealerships throughout the country. Sonic entered into 6 a contract to purchase the BMW dealership in Texas. But 7 BMW refused to let Sonic go through with the purchase. 8 So Sonic sued BMW and a settlement was reached under 9 which Sonic was paid $2 million in exchange for 10 assigning its rights under the contract. 11 Sonic figured the gain as non-business income 12 and Sonic argued to your Board -- made the same 13 arguments that Comcast makes, that the income arose from 14 a unique transaction, a, quote, "once in a corporate 15 lifetime event." 16 Your Board, citing as authority Hoescht 17 Celanese and Pennzoil, rejected Sonic's arguments as 18 follows, you said, and, I quote, 19 "Appellant argues it is not in the business 20 of earning assignment fees and that this was an 21 unprecedented, once in a corporate lifetime 22 occurrence. It is, however, the nature of the 23 transaction and activity that gives rise to the 24 income, not the form in which it is received 25 that controls whether the income is business 26 income." 27 Your Board, therefore, concluded in Sonic that 28 the income was obtained through the taxpayer's regular 36 1 acquisition activities and constituted business income. 2 And you said that this -- this -- this held true, quote, 3 "Regardless of whether it was received in 4 the form of an assignment fee, as is the case 5 here, a settlement, as was the case in 6 Pennzoil, or a court-ordered sale, as was the 7 case in Atlantic Richfield." End quote. 8 Since the transaction test clearly applies, you 9 don't even need to consider the functional test. And I 10 don't want to spend too much time on it. But, briefly, 11 the functional test looks to see whether the income 12 arises from property, including intangible property, 13 such as contract rights, was an integral part of the 14 taxpayer's trade or business. 15 Now Comcast argues that since it held the 16 Median contract rights for just six weeks before the 17 contract was terminated, or 43 days, there was not 18 enough time for the property, that is, the contract, to 19 become integrally related to its business. 20 Now, the Oregon court, the Tax Court, that is, 21 rejected this precise argument in Pennzoil, where the 22 taxpayer only held the contract rights for three days 23 before the contract was repudiated. It said that while 24 because the statute defining business income contains no 25 time limit, it's just irrelevant the shortness of time. 26 According to the Tax Court the contract's, 27 quote, 28 "Very creation was a result of Pennzoil's 37 1 unitary business activities. Consequently, it 2 was inherently an integral part of Pennzoil's 3 regular trade and business." 4 So, under both tests, the transactional and the 5 functional test, the termination fee constituted 6 business income. 7 Now I'm going to move on to the QVC unity 8 issue. As you know, there are several tests for unity 9 and if any of those tests are met, the business -- the 10 income must be -- the businesses must be treated as 11 unity -- unitary. 12 We're relying on the contribution and/or 13 dependency test, which is also known as the flow of 14 value test. Contrary to what Mr. Friedman says, the 15 contribution or dependency test or the flow of value 16 test does not require integration. It does not require 17 control. It simply requires that there be contribution 18 or dependency between the entities or flow of value. It 19 has nothing to do with integration or control. 20 Here again analyzing the unity issue is 21 relatively simple because of Comcast's own admission -- 22 admissions and actions. The Andersen memo said that all 23 of Comcast's cable and cable-related businesses were 24 integrally related and that when there was a benefit or 25 an injury to one part of the business, when they claimed 26 there was an injury from the failure to merge with 27 Median, that there was a benefit or injury to all of the 28 cable and cable-related businesses. 38 1 And Comcast, when it filed its 1999 tax return, 2 it took the position that this integral relationship 3 extended to QVC. And it did this because it used its 4 basis in the QVC stock to offset $168 million of the 5 termination fee gain. 6 And under the Andersen opinion memo, it could 7 not have done this unless the gain was integrally 8 related -- unless the cable gain was -- unless these 9 businesses were integrally related to each other. 10 Comcast can not lightly escape the consequences 11 of this return position which constitutes and admission 12 against them. As the US Tax Court stated in the Pinson 13 case, taxpayers cannot, quote, 14 "disavow their own tax return treatment of 15 the transaction." 16 Comcast's use of QVC basis to offset its cable 17 company gain strongly supports the FTB's position on 18 unity. 19 Nevertheless, in addition to this fundamental 20 flaw in Comcast's argument, the FTB has plenty of other 21 evidence to support its unitary determination. 22 Comcast was a founding shareholder of QVC. And 23 there was an operational relationship from the very, 24 very beginning. When QVC was first formed, Comcast 25 entered into a programming agreement with QVC, agreeing 26 to distribute -- or also it's known as carrying or 27 carriage agreement -- with QVC's programming to its 28 cable subscribers for two years. 39 1 In exchange for promising to carry the QVC 2 programming, Comcast was able to purchase QVC stock on a 3 heavily, heavily discounted basis. When QVC went public 4 at $10 a share in 1987, Comcast was allowed to buy 5 900,000 shares at just 20 cents a share. That's a 98 6 percent discount from the price these shares were 7 offered to the public. In this manner, it became QVC's 8 second largest shareholder. 9 Now Comcast not only received discounted stock 10 from QVC, it also received substantial amounts of 11 commission payments each year based upon the amount of 12 merchandise that QVC sold to Comcast subscribers. The 13 amounts of these intercompany payments were very 14 significant. During the two years in this appeal alone, 15 in commission fees Comcast received a total of over $17 16 million. 17 And if you look at the value to QVC, this means 18 that QVC sold merchandise to Comcast customers of about 19 $340 million during these two years. 20 Comcast also received extra consideration each 21 time the carriage agreement was renewed. When the 22 original two-year carriage agreement was renewed and 23 replaced with a seven-year carriage agreement, Comcast 24 was allowed to make more bargain purchases of Comcast -- 25 of QVC stock. 26 And when this agreement was renewed later, QVC 27 again paid additional consideration just for signing and 28 renewal agreement. 40 1 QVC also made payments to Comcast for favorable 2 channel placement. It's better to have your channel at 3 a lower channel number where more people are likely to 4 see it. So, QVC paid Comcast extra for this. 5 QVC was willing to make these payments to 6 Comcast because Comcast was providing something valuable 7 in return. QVC was just a TV program, what's known as 8 content. And Comcast was a cable television provider 9 and it needed content. That is, it needed programs to 10 distribute to its cable subscribers. Each business, 11 without the other, is worthless. Thus, the relationship 12 between the Comcast and QVC has been referred to as a 13 vertically integrated one. 14 Now vertical integration is a term of art, it's 15 not the same is integration for business income 16 purposes. It's an economics term. The Federal 17 Communications Commission, that's the FCC, which governs 18 the television industry, says that, quote, 19 "Vertical integration occurs where a video 20 programming distributor has an ownership 21 interest in a video programming supplier or 22 vice versa." End quote. 23 Under the FCC's definition, Comcast and QVC 24 were vertically integrated. Industry analysts also have 25 characterized the relationship between Comcast and QVC 26 as vertically integrated. 27 One stated that, quote, 28 "The signs of marrying content providers 41 1 with distribution providers to achieve vertical 2 integration abound. For example, Comcast's 3 toehold in electronic commerce, QVC." 4 And your Board has held that a vertically 5 integrated business enterprise has consistently been 6 regarded as a classic example of a unitary business. 7 You said that in Dr. Pepper and again in Appeal of Saga 8 Corp. There's also a regulation that applies, 9 Regulation 25120 (b)(2). It says that, 10 "Vertically integrated businesses are 11 almost always unitary." 12 So, that really should be enough -- more than 13 enough for unity. But, as they say in the home shopping 14 business, but wait, there is more. There were 15 intercompany flows of value from shared officers and 16 directors, from joint investments and from joint 17 promotional activities. 18 Almost immediately after QVC was formed, QVC 19 appointed Comcast's President, Brian Roberts, to QVC's 20 Board of Directors. He was also appointed to the Board 21 of Directors Executive Committee and he remained on both 22 the Board of Directors and QVC's Executive Committee for 23 the next 15 years. 24 Ralph Roberts, the Chairman of the Board of 25 Comcast, also served with QVC's Board of Directors for 26 12 years. 27 And Comcast helped launch a new channel for QVC 28 in 1994 called Q2. And QVC paid more money to Comcast 42 1 to do this. It paid them $10 million in launch fees. 2 It also paid them commissions on the sales of products 3 by Q2 to Comcast subscribers. Comcast subscribers 4 comprised about 20 percent of the audience for this 5 channel until Q2 stopped broadcasting in 1998. 6 And in 1993, after Barry Diller was brought in 7 as QVC's President, QVC attempted to take over Paramount 8 Communications, another content company. And Comcast 9 was a very strong backer of this deal and pledged to 10 commit funds to the deal. 11 According to one contemporaneous press report, 12 Comcast's Brian Roberts was heavily enmeshed in QVC's 13 battle to acquire Paramount Communications and was on 14 the phone with Mr. Diller several times a day plotting 15 strategy. Although this takeover attempt was rebuffed, 16 it shows how Comcast and its CEO, Brian Roberts, were 17 heavily involved in QVC's major business decisions and 18 moves. 19 But in 1994 Barry Diller tried to take QVC in a 20 direction that Comcast opposed. And Comcast intervened 21 forcefully. Comcast, combining with Liberty Media, 22 bought out all of the other shareholders and stopped the 23 merger. 24 Now the minutes of Comcast's Board of Directors 25 reveal why they intervened to stop the merger. The 26 Chairman of Comcast's Board of Directors, Ralph Roberts, 27 urged Comcast's Board to stop the merger because under 28 the proposed merger, Comcast's role would be limited to 43 1 that of a passive investor. 2 Now this shows that, unlike what Mr. Friedman 3 was saying today, how they were just a passive investor, 4 that they didn't want to be a passive investor and that 5 they never were a passive investor. And that's why they 6 opposed the buyout of -- the merger with CBS, because 7 they did not want to be passive. 8 So, Comcast became a majority owner of QVC. 9 Mr. Diller left and an agreement was reached between 10 Comcast and Liberty Media providing that Comcast would 11 manage QVC and appoint all of its directors. 12 And after Comcast became the majority owner, 13 the operational ties between Comcast and QVC further 14 increased. After the takeover Comcast began using QVC 15 to issue valuable stock options to the Comcast 16 executives it had appointed as officers and directors. 17 Comcast also began referring to QVC as one of its, 18 quote, "core businesses" in its SEC reports. And 19 Comcast loaned money to QVC to help it expand overseas. 20 After the takeover QVC launched its internet 21 business called IQVC and Comcast and QVC began investing 22 in cable and internet companies, sometimes jointly 23 investing in these companies that would strategically 24 benefit QVC's business. 25 Comcast invested in companies developing 26 interactive set top boxes and became an early investor 27 in a company called At Home, which was involved in 28 providing high speed access using cable -- high speed 44 1 internet access using cable television infrastructure. 2 Comcast believed that that high speed internet service 3 would enhance the value of QVC as cable subscribers 4 would see products on the QVC channel and cable 5 television and then turn to Comcast high speed internet 6 modems and purchase products directly from QVC. 7 Comcast and QVC also made investments jointly. 8 They formed a company called Interactive Technology 9 Holdings, ITH, that made joint investments -- some 10 during our years -- to companies that were providing 11 services and products to QVC or buying products from 12 QVC. So, they helped promote these companies and, at 13 the same time, these companies would then enter into 14 contracts with QVC. These companies were companies such 15 as Global Sports, The Knot, a wedding website, and 16 CommerceHub, which provided back office support for QVC. 17 Now what is Comcast's response to this long 18 list of document of flows of value? Well, they say that 19 QVC was self sufficient, that it was autonomous. Well, 20 they weren't autonomous. The QVC was content. And, as 21 it's annual report stated, its business, quote, 22 "depended," end quote, on cable distributors like 23 Comcast. 24 The companies were vertically integrated and 25 vertically integrated companies are almost always 26 unitary. Again the test for unity is contribution or 27 dependency, not whether a company could get by on its 28 own if it had to. 45 1 Comcast also claims that there was no strong 2 central management. This is an argument -- this is a 3 response to an argument that the FTB has never made. 4 We're not claiming that there was strong 5 central management. So, Comcast's response to our 6 argument is simply irrelevant. A lack of strong central 7 management does not negate unity. Your Board has 8 rejected this argument in the Appeal for Trails End. 9 All strong central management does is create a 10 presumption, a strong presumption of unity, just 11 like the existence of a vertically integrated enterprise 12 does. 13 But in this case, the FTB doesn't need the 14 benefit of a presumption because -- of the presumption 15 from strong central management because here we have 16 introduced contemporaneous documents, most of them from 17 Comcast itself, that shows there were actual as opposed 18 to presumed flows of value. 19 Comcast also claims that the transactions 20 between Comcast and QVC were at arm's length and that 21 QVC entered into similar transactions with other 22 companies. 23 Even if this was true, it's simply not 24 relevant. Your Board has rejected this argument in the 25 Appeal of Nippondenso as well as the Appeal in 26 Dr. Pepper. 27 The intercompany payments and operational 28 relationships, like the one we have -- the ones we have 46 1 here do not lose their unitary significance just because 2 companies entered into similar arrangements with the 3 other companies. What matters for unitary purposes is 4 what happens between the parties, not what happens with 5 anybody else. And intercompany transactions, even arm's 6 length transactions, still constitute a significant 7 indicator of a unitary flow of value. Having customers, 8 even arm's length customers, are good things for 9 businesses to have. You don't have to take advantage of 10 them to get a flow of value from them. 11 Comcast also claims that there were 12 intercompany -- that the intercompany payments were 13 inconsequential. But based upon the chart that we have 14 given you in your handout, it turns out that actually 15 Comcast Exhibit -- Exhibit 15 attached to their 16 sur-reply brief -- they state that there were only -- 17 MR. HORTON: Excuse me, sir, you might want to 18 take the mike with you or use the mike closest to you. 19 MS. MANDEL: -- they state that there were only 20 $35 million of payments from QVC to Comcast during 2001 21 and 2002. But that includes only the commission 22 payments. They received 37 million more dollars in 23 character channel placement fees. 24 So, the exhibit is clearly understating the 25 amount of the -- of the payments from QVC to Comcast. 26 And those were by over 100 percent. 27 Comcast also claimed that the relationship with 28 QVC remained the same after taking -- after QVC took 47 1 over majority ownership in 1995. This argument's 2 factually incorrect, illegally irrelevant. 3 As I've noted, lots of things changed in 1995. 4 And basically they were unitary but for the requirement 5 of ownership from the outset. And, as you found in 6 Dr. Pepper, if you have a unitary owners -- unitary 7 pre-existing relationship, you don't expect anything to 8 change. All you need to have unitary -- all you need to 9 have unitary is common ownership. So, there is no need 10 for anything to change in order to find a unitary 11 relationship because the unitary relationship was 12 pre-existing. 13 Comcast also claims it had a fiduciary duty to 14 its minority shareholders, but that's simply irrelevant 15 under any of tests of unity. The presence or absence of 16 other shareholders doesn't make a difference. 17 Comcast claims that the businesses were so 18 different that there could not have been a meaningful 19 flow between the two of them. This is wrong on both the 20 facts and the law. And here you just have to look at 21 the statements they were making at the time, rather than 22 their after the fact declarations. At the time, they 23 were saying that the businesses were complementary. 24 As stated in Comcast's 1996 annual report by -- 25 and this is a quote, 26 "By developing strong positions in both 27 content and distribution, we have increased our 28 revenue generating potential and spread our 48 1 risk more effectively. The complementary 2 nature of our business has also created 3 opportunities for cross promotion, operation 4 synergy we've only begun to exploit." 5 And in 1988's annual report, Comcast said, 6 "The QVC home shopping channel helps in 7 giving increased value to the Comcast service." 8 I also want to comment on some evidence they 9 put in but they've never really talked about. They have 10 an exhibit here talking about an FTB audit of Liberty 11 Media in later years. We think it's very improper for 12 them to bring this up because the FTB can't disclose 13 what happened with respect to this Liberty Media audit. 14 Their evidence is hearsay. We don't know -- I can't 15 disclose to you whether or not it happened. I can't 16 respond to you. I mean, maybe it didn't make any tax 17 difference. 18 Liberty Media is a very different company than 19 Comcast. And if you can give any consideration 20 whatsoever to that argument, we really want to have 21 further briefing on it because what we do with Liberty 22 Media is completely irrelevant and should not be given 23 any consideration. Certainly what a low level FTB 24 auditor -- a position their -- they may or may not have 25 taken is not binding with anything you do here. 26 Let me move on to the penalty. I noticed that, 27 you know, there is four ways to get out of the penalty. 28 The first, the easiest way is simply not to underpay 49 1 your tax. And that's the -- that's what they did for 2 federal tax return purposes, they reported the income on 3 the original return and then they amended. They could 4 have taken the same safe route for State tax purposes 5 but they didn't. They chose to take a risk and they got 6 caught in California. 7 And none of the other excuses apply. 8 Substantial authority doesn't apply, because they 9 need -- because to have substantial authority you have 10 to have substantial authority for the facts as well the 11 law. The IRS technical advice memorandum says that they 12 had no factual basis for the essential factual basis for 13 their position, which was that Median intended to pay 14 Comcast for damages to goodwill. 15 In fact, today Mr. Friedman said something 16 completely different. He said that the termination fee 17 was to bind the parties to the contract. So, he's 18 admitting that the entire basis for the return position 19 was not correct. 20 Now they've had eight years to come up with 21 some factual evidence to support their position, but 22 they haven't come up with any. And now their attorney 23 admits that that factual position was wrong. So, 24 there's -- there can't be any substantial authority for 25 their position. 26 There also wasn't any substantial disclosure. 27 I have these charts up here and there's nothing on their 28 Schedule R or their Schedule M that say anything about a 50 1 termination fee or say anything about a $1.5 million 2 receipt. We have cases -- we have cited cases here 3 where taxpayers have made far more substantial 4 disclosures than the one Comcast made where they've 5 actually filled out the Form 8275, which is the form you 6 are supposed to file when you're making that -- when you 7 try to make an adequate disclosure, and the courts have 8 said it's still not adequate because you didn't have the 9 facts to support the position reflected in the 8275. 10 So, even if they had disclosed it, they have no basis 11 for the facts that support their -- that they are using 12 as the basis for their legal position. 13 And finally, there's a statutory catchall 14 exception for taxpayers with a deficiency, despite the 15 exercise of reasonable cause and good faith. They don't 16 qualify for this exception either because to do the -- 17 to qualify under that exception they have to really show 18 you what advice they sought, what they received and show 19 the content of the advice and show that they followed 20 that advice. Here they haven't done that. We have 21 asked for this information repeatedly. We have a very 22 sophisticated taxpayer. We have a tax issue involving 23 hundreds of millions of dollars and we -- they claim 24 there's all these discussions. They haven't given us 25 any evidence of them. All they've given us is the 26 Andersen opinion memo, which they didn't even discuss 27 today. 28 And when they did give us one memo the -- it 51 1 says that the day before the California return was due, 2 their head tax guy, Mr. Donnelly, he said that, 3 "You should file this -- you should file 4 your California return consistent with your 5 federal return. And by -- and, in fact, you 6 should report the income as a capital gain and 7 take it out." 8 Now if Comcast had actually followed his 9 advice, which is the only written advice they've given 10 us about this, it would have disclosed the existence of 11 the return. But Comcast, for some reason that's never 12 been explained in documentation, decided not to follow 13 that course of action. And, so, the income was not 14 reported at all. 15 We also -- 16 MS. OLSON: Time has expired. 17 MR. MARGOLIS: If I may have just one more 18 second to talk about the regulation penalty exception? 19 There's a penalty exception by regulation under 20 Regulation 1916 -- 21 MR. HORTON: Just out of curiosity, if we were 22 to say no? 23 MR. MARGOLIS: I will stop, I promise. 24 MR. HORTON: Okay, we're going to allow you one 25 more minute to wrap up and then we'll give you your 26 requested time to question the witnesses. 27 MR. MARGOLIS: Okay, thank you. 28 MR. HORTON: We'll balance it off on the 52 1 Petitioner's side as well. 2 MR. FRIEDMAN: Okay. 3 MR. MARGOLIS: Okay. There is an IRS 4 regulation that basically says that if a taxpayer makes 5 the determination as to business or non-business income 6 and they make the wrong choice, we -- the FTB -- and 7 they do this in good faith, the FTB will not impose a 8 substantial understatement penalty. 9 But under the reg itself you have to have a 10 determination by the taxpayer. Here the taxpayer's 11 return, there was no determination that it was either 12 business or non-business income. The determination 13 referred to the regulation is not a determination in 14 your head, it's not a determination in a memo to the 15 file, it's a determination on the file -- on the return, 16 sorry. 17 And also we think that the evidence here 18 certainly shows a lack of good faith because they didn't 19 report this fee as business income to to any other 20 state. 21 Thank you very much. 22 ---o0o--- 23 24 25 26 27 28 53 1 MR. HORTON: You're welcome. Does that 2 conclude your presentation? 3 MR. MARGOLIS: I do -- I do have a few 4 questions for the witnesses, yes. Um -- 5 MR. HORTON: Uh, could you identify which 6 witness you want to pose the question to? 7 MR. MARGOLIS: I have a few questions for 8 Mr. Grabell. 9 MR. GRABELL: Yes. 10 MR. MARGOLIS: Mr. Grabell, uh, do you agree 11 that the FCC does view the QVC -- the QVC channels' 12 programming, don't they? 13 MR. GARDNER: For an entirely different 14 purpose, but yes. 15 MR. MARGOLIS: Okay. And, um, isn't it true 16 that Comcast -- 17 MR. HORTON: Uh, one second. 18 Can you give us clarity on the purpose? The 19 different purpose, the distinction between the two? 20 MR. GRABELL: They -- they do it for their 21 regulatory purposes which is completely different from 22 the way that Comcast is looking at its business. 23 MR. HORTON: Okay. 24 Please continue. 25 MR. MARGOLIS: And, uh, isn't it true that, uh, 26 Comcast and QVC, during the time that they were majority 27 owned, that they did make joint investments in companies 28 such as Global Sports, CommerceHub and The Knot? 54 1 MR. GRABELL: Yeah, I'm glad you asked. I 2 negotiated those. And, again, we fought tooth and nail 3 with Comcast on the specific terms. Those were very 4 much arm's length where we invested with them. 5 MR. MARGOLIS: And you invested in companies 6 that were related to QVC's business, did you not? 7 MR. GARDNER: CommerceHub was related. The 8 Knot was not at the time until subsequently. And, um, 9 GSI later became related to QVC's business, yes. 10 MR. MARGOLIS: Okay. And, um -- 11 That's all I have for you. Thank you. 12 MR. GRABELL: Thank you. 13 MR. MARGOLIS: And, Mr. Alchin, um, first I 14 wanted to apologize to you if I did misinterpret some of 15 your statements in, uh -- in one of the, uh, the 16 exhibits. 17 But I'd like you to take a look at Exhibit QQQ. 18 And there is some -- something underlined there. 19 There's two sections underlined. And I want you to read 20 the second underlined portion that starts with the 21 words: "The iQVC Web site ..." 22 MR. ALCHIN: "'The iQVC Web site is a good 23 example of how to transform business from one 24 media platform cable to another Internet. A 25 lot of people watch the cable program and then 26 order online,' he says." 27 MR. MARGOLIS: Okay. So, um, is that probably 28 something you were talking about at -- at this, uh, 55 1 event? 2 MR. ALCHIN: Yeah. I believe this was, uh, as 3 quoted by the press after a presentation that I made at 4 the Paine Webber conference. Um, I forget the year in 5 which this -- this happened. 6 MR. MARGOLIS: So you agree that, um, Comcast, 7 by developing its high speed Internet business, uh, that 8 benefited the QVC business, do you not? 9 MR. ALCHIN: The reason for Comcast getting 10 into the high speed Internet access business had 11 everything to do with expanding our, uh, core business. 12 Had nothing to do with, uh, necessarily assisting QVC. 13 If you look at the growth of Comcast today, a 14 significant majority of the growth of the company comes 15 from our Internet access business. And at the same time 16 the video business, provision of video signals and 17 entertainment, is a almost flat business. 18 MR. MARGOLIS: But, I mean, the iQVC Web site, 19 I mean, you could have -- it's -- you can use the same 20 content from the QVC cable channel and just put it on 21 the Web and -- and deliver that to customers; isn't that 22 correct? 23 MR. ALCHIN: Certainly QVC -- and I'll leave it 24 to Neal to give you an example, perhaps, of how much of 25 their business comes from the Web today and how much 26 comes from television viewing. But it's just another 27 way. So you can get QVC's signals from satellite 28 companies, from telephone companies, from cable 56 1 companies, or from access through the Internet. 2 MR. MARGOLIS: And didn't -- 3 MR. ALCHIN: So there's basically four 4 venues. 5 MR. MARGOLIS: And didn't Comcast have -- at a 6 time they had an interest in -- in satellite companies, 7 cable companies, telephone companies and Internet 8 companies, correct? 9 MR. ALCHIN: Well, we had no interest in a 10 satellite company. 11 MR. MARGOLIS: Oh, didn't you have a -- didn't 12 you have an interest in DBS for a while, in direct 13 broadcasting? 14 MR. ALCHIN: Uh, prior -- in a -- in a company 15 called Primestar. But I'm thinking of the -- of the two 16 existing, uh, surviving satellite companies, uh, DIRECTV 17 and, um, DISH. Thank you. Yeah. 18 MR. MARGOLIS: And wasn't Comcast doing, uh -- 19 paying comp -- uh, investing in companies that were 20 developing set-top boxes? 21 MR. ALCHIN: Yes, we were. 22 MR. MARGOLIS: And wasn't one of the hopes that 23 you could simply purchase automatically online, through 24 your set-top box, you could purchase products you saw on 25 QVC channel? 26 MR. ALCHIN: Um -- 27 MR. HORTON: That's somewhat speculative. 28 MR. ALCHIN: Yeah, I -- 57 1 MR. HORTON: Um, I'll leave it up to the 2 witness to respond. 3 MR. MARGOLIS: Okay. I think we already have 4 documents in the record on that. 5 That -- that's enough. Thank you very much. 6 That's all I have. 7 MR. HORTON: Okay. The Petitioner will have 15 8 minutes on rebuttal. We'll allow a similar time to, uh, 9 address the witnesses if that be the desire of the 10 Petitioner, to respond to the specific questions that 11 were asked. 12 MR. FRIEDMAN: Thank you, Mr. Chairman. 13 Uh, we'll begin with addressing, um, the FTB's 14 claims regarding the imposition of a penalty. And then 15 we'll address some of their other claims as well. 16 MR. HORTON: Sure. 17 MR. FRIEDMAN: Okay. 18 MR. SPERRING: Why are we discussing 19 accuracy-related penalty today? The FTB imposed -- 20 MR. HORTON: Excuse me. Could you pull the mic 21 just a little bit closer? 22 MR. SPERRING: Sure. 23 The FTB imposed a $1.5 million penalty on 24 Comcast because it filed consistent with its amended 25 federal return for 1999, and it did not itemize its 26 MediaOne termination fee on its M-1. 27 Let's be, uh, clear. Had Comcast filed 28 inconsistent with it's federal return and treated the 58 1 termination fee as nontaxable, nonbusiness income, there 2 would be no penalty. 3 So, the reason why we're talking about the 4 penalty is because FTB doesn't like which nontaxable 5 bucket Comcast put the termination fee in. 6 And we would agree with Mr. Margolis that there 7 are four safe harbors that are out there, um, that would 8 prevent the imposition of this penalty. The first is 9 substantial authority. The second is adequate 10 disclosure. The third is reasonable basis and good 11 faith. And the fourth is Regulation 19164. 12 And as far as substantial authority, um -- and 13 the first thing before I talk a little bit about, um, 14 the Andersen Memo, the first thing you got to keep in 15 mind is, as you can see in this chart to my left, that 16 substantial authority is below 50 percent. Okay. So it 17 is not the relatively high standard that FTB would have 18 you believe. 19 And there can be -- obviously, since it's below 20 50 percent, you can have substantial authority for more 21 than one position. Okay. But Comcast felt that they 22 needed to be consistent with how they filed their most 23 recent federal return, and so they filed consistent with 24 the federal return, which was, uh, the termination fee 25 was a return of capital. 26 So if you look at, um, what the IRS did, okay, 27 and how they responded to, uh -- uh, Comcast's amended 28 return, well, what they did was they, uh, requested, uh, 59 1 a Technical Advice Memorandum from headquarters. Okay. 2 As you can see, there's standards for requesting a TAM. 3 Okay. And right here are the standards laid out for 4 you: That the law and regulations are not clear on the 5 issue and there's no published precedent; that there's a 6 lack of uniformity; that, uh, you have a doubtful or 7 contentious issue involved in a number of cases; the 8 issue is unusual or complex; or, finally, that the 9 Director believes it's in the best interests of the 10 service to issue a TAM. Okay. 11 So, um, again, if you go back to our standard 12 here, substantial authority, okay, taxpayer believes 13 that they have substantial authority, less than 50 14 percent. The IRS believes that the issue is at least, 15 um -- uh, not -- new enough, novel enough issue, they 16 feel they need to issue a TAM. Okay. 17 And so, then let's go -- let's read the TAM, 18 because it's a short little five-page TAM. And what you 19 see in the TAM is, um -- uh, on page three here, uh, 20 what does it say? It says: 21 "The termination fee provision in agreement 22 one, beyond providing the trigger for the 23 payment of the termination fee, is silent as to 24 the allocation of the recovery of either lost 25 profits or damage to capital and does not lend 26 any guidance in resolving this issue." 27 So when Mr. Margolis says that the factual 28 basis -- that the TAM said they had no factual basis for 60 1 their position, well, guess what, okay, the TAM's also 2 saying that there's no factual basis for the IRS. Okay. 3 So what does -- what does the IRS do in the 4 TAM? Well, what they say is, let's look at what 5 commentators have said about termination fees. And so 6 on page four they quote a bunch of commentators that 7 talked about termination fees. And, uh, they go to the 8 Columbia Business Law Review. They go to Cardoza Law 9 Review. They go to the restatement of contracts. And 10 after, uh, walking us through what the commentators 11 said, here's what they say: 12 "Based on the underlying purpose of the 13 termination fee provision, as discussed above, 14 principles of contract law and the 15 above-mentioned authorities, it is 16 reasonable" -- "it is reasonable to conclude 17 that the taxpayers bargain for a termination 18 fee provided for the benefit of the bargain or 19 expectancies damage, as such, they are equated 20 to lost profits." 21 So what -- what they are saying is that they 22 have, the IRS has reasonable, okay, uh -- uh -- um, 23 basis to conclude. And later on they go: 24 "Additionally, the termination fee 25 provision in agreement one is silent as the 26 allocation of the recovery to either lost 27 profits or damage to capital, and the service 28 has substantial support." 61 1 Again, sort of like substantial authority. 2 So, the service is coming in and saying, well, 3 okay, there is an absence of -- of documentation in the 4 contract as to what MediaOne's intent was when they 5 paid. Okay. And as a result, we're going to look at 6 outside commentators, and we believe that it is 7 reasonable and they have substantial support for their 8 position that it is a return in capital as opposed to 9 taxpayer's position. Okay. 10 So the TAM is pretty clear, okay, that, um -- 11 uh, this is a novel issue, okay. We don't have any 12 contemporaneous documentation, so they're going to look 13 at to what commentators said. 14 So to argue that the taxpayer did not have 15 substantial authority, I think flies in the face of, 16 one, the IRS manuals for when they issue a TAM, and two, 17 what the TAM actually says. 18 But -- but let's move on. Let's talk about do 19 we have substantial -- uh, adequate disclosure, because 20 FTB talks about cases, although they don't cite them 21 verbally here. But if you look at McCoy, okay, what 22 does it say? It says: 23 "Where, as here, no attachments were made 24 to the returns in question, taxpayer can still 25 satisfy the requirements of adequate disclosure 26 by providing, on the return, sufficient 27 information to enable respondent to identify 28 the potential controversy involved." 62 1 Well, wait. We had $2.5 billion sitting on our 2 M-1, of which one -- of which 1.5 was the termination 3 fee. So how can you say that that is not adequate 4 disclosure on the face of the return? 5 And when you look at Jacques, okay, when you 6 look at Jacques, um -- uh, in that case, there was no -- 7 um, the Court found there was adequate disclosure. 8 There was no Schedule. There was simply a W-2, line on 9 the W-2 that said "other income." Okay. And that other 10 income, uh -- uh, was a loan that, uh -- uh, they 11 characterized -- taxpayer characterized a nontaxable 12 loan. And the service said, nope, it is taxable. But 13 because you have it on the line in your W-2, you have 14 the amount, you have adequate disclosure, no penalty. 15 MR. FRIEDMAN: Jon, if I could interject. 16 MR. SPERRING: Sure. 17 MR. FRIEDMAN: I'd like to jump in on the 18 penalty, too, but I'm hoping to get into it in the 19 question-and-answer later because I have some strongly 20 held views on it, too. 21 Um, I also want to address some of 22 Mr. Margolis's contentions on the termination fee and 23 the alleged relationship between QVC and Comcast. And 24 I'll try to do it as quickly as I can. 25 On the termination fee, what you just have 26 heard is an ignoring of California Supreme Court case 27 law. If you listen very carefully to what Mr. Margolis 28 says, he doesn't describe Hoeschst Celanese, he 63 1 describes what other courts have said about Hoeschst 2 Celanese. But let's assume that that's relevant and 3 let's walk through it together very quickly. 4 First, he talks about the Pennzoil case. The 5 Pennzoil case is from the Oregon Supreme Court. The 6 Oregon Supreme Court looks at liquidated damages -- I'm 7 sorry, regular damages as a result of litigation between 8 companies regarding contractual interference, $3 billion 9 of damages. 10 What the Oregon court did is they used an "in 11 lieu of" analysis associated with the damages to look 12 through what the damages are replacing. There's no "in 13 lieu of" analysis in California courts. You won't find 14 a California decision that uses an "in lieu of" 15 analysis. But yet, Mr. Margolis fails to recognize 16 that, and he'd rather have you focus on an Oregon court 17 regarding -- rather than the California Supreme Court's 18 decision in Hoeschst Celanese. 19 Let's talk about the Sonic case. The Sonic 20 case, in a published decision, I believe a consent 21 decision, not necessarily subject to the most robust 22 debate and briefing. I'm quite stunned by their 23 continued reference to the Sonic decision. First of 24 all, it's unpublished. And in another case I've had 25 recently the Franchise Tax Board when out of their way 26 to take me to task for referencing, in a footnote, an 27 unpublished decision. But yet they're here to do 28 arguing that you should pay attention to it. 64 1 But let's assume it's relevant. In Sonic the 2 taxpayer sold BMW dealerships. The transaction or 3 event, the transaction or activity produced a gain. 4 It's distinguishable from a termination fee. The 5 termination fee produced the gain, not the entering into 6 a contract to acquire a cable company that never 7 happened. Sonic's distinguishable from the FTB position 8 to focus on the entering into a contract that never was 9 consummated. 10 Finally, FTB takes great glee in looking at the 11 Atlantic Richfield case from Colorado. I won't bore you 12 with all the facts of that case, except to note that in 13 the Atlantic Richfield case -- again, not a California 14 case, a Colorado case -- the taxpayer sold oil reserves 15 as part of a settlement with the federal government. 16 The event, the activity, the transaction produced a gain 17 and the analysis focused on that activity. 18 It's entirely consistent with the taxpayer's 19 position here. You focus on the activity that produces 20 the gain, that's the triggering of a termination fee. 21 That termination fee was a once in a corporate lifetime 22 event for Comcast. It does not produce business income. 23 Okay, on the contribution and dependency test, 24 the no integration argument I find quite confusing. 25 What Mr. Margolis would have you believe is that we 26 should ignore all other areas of unitary law and focus 27 solely on his favorite contribution or dependency test. 28 And in defending that position, he argues that 65 1 integration's irrelevant, but then will come back later 2 and rely on FCC reports in other nontax classifications 3 for an integration conclusion. I find that confusing, 4 conflicting and inconsistent. 5 He then looks to the Andersen memo. He beats 6 us -- he beats on this Andersen memo in his briefing, 7 over and over again. Ask him what the Andersen memo 8 relates to. The Andersen memo relates to a federal tax 9 position, not a state position, a federal tax position; 10 a federal tax position that was abandoned by the 11 taxpayer, but nevertheless, a federal tax position. 12 Is there a unitary business principle concept 13 for federal tax purposes? Is there a contribution 14 dependency test for federal tax purposes? Is there a 15 three unities test for federal tax purposes? No. 16 That Andersen memo had nothing to do with 17 California state taxation or any other state taxation. 18 Again, he's taking language out of context for a 19 different purpose. 20 Finally on the Andersen memo, he takes quite, 21 uh, liberty in describing the reduction of basis in the 22 QVC stock. Yes, consistent with that position, Comcast 23 reduced the basis in its QVC stock. Again, what 24 Mr. Margolis does not tell you is that they reduced the 25 basis of all their consolidated assets. They didn't 26 single this one out. They didn't distinguish between 27 unitary assets and nonunitary assets. This was a 28 federal tax position. There's no concept of the unitary 66 1 business principle. 2 And finally, I have to -- I can't resist the 3 temptation to take on his point regarding the carriage 4 agreements and commissions paid. Neal Grabell, sitting 5 next to me, negotiated all of those between QVC and 6 Comcast and with all the other cable companies. He's 7 better equipped to talk about what actually was 8 negotiated. But I'll say this: You can take the 9 numbers that Mr. Margolis has and compare them to the 10 numbers that we have, multiply them by five, and it's 11 still a rounding number for Comcast, less than one 12 percent. 13 The numbers that we say they are are .24 14 percent of Comcast revenues. Mr. Margolis would like to 15 double them. That's fine. It's .5 percent of Comcast 16 revenues. I hardly see a contribution or dependency on 17 .5 percent of arm's length transactions between two 18 parties. Mr. Margolis fails to mention that. 19 The Paramount deal. Yes, the Roberts were 20 interested in the Paramount deal. QVC was negotiating 21 with Paramount to acquire it. Of course a cable company 22 would be interested if a company that owned a 15 percent 23 stake in at that time was negotiating with a content 24 provider. 25 That deal never happened, but yet Mr. Margolis 26 finds that as -- as clues or evidence of a unitary 27 relationship. 28 And then finally, I'll end with this thought. 67 1 Mr. Margolis, over and over again, will tell you that, 2 yes, there's more; QVC is just another content company, 3 just like ESPN, just like the Disney channel, just 4 like -- just like HBO. What he fails to tell you is 5 it's anything like a content company. 6 Comcast reported it as not a content company. 7 They reported it as an electronic retailer in its 8 audited financial statements. Content companies get 9 paid by Comcast. Comcast pays ESPN a certain amount of 10 money per subscriber. Comcast pays HBO for the right to 11 carry HBO. 12 Did Comcast pay QVC to carry QVC? No. QVC 13 paid Comcast. QVC's an advertiser; it's not a content 14 company. But nevertheless, Mr. Margolis takes quite 15 glee in pointing to FCC reports that for other purposes 16 will characterize it as a content company. 17 Thank you, Mr. Chairman. 18 MR. HORTON: Thank you very much for your 19 presentation today. 20 Uh, Members, we're going to open it up for 21 discussion. I'm going to, uh, separate the discussion, 22 however, in order to assure continuity. 23 Uh, I'd like to start out, with the permission 24 of the Members, with the termination fee. Uh, second, 25 we'll go to the unitary discussion. Then the dividend 26 deduction. And then the penalty. 27 So, uh, on the termination fee, uh, discussion, 28 Members? 68 1 MS. YEE: Yes. 2 MR. HORTON: Member Yee. 3 MS. YEE: Thank you, Mr. Chairman. 4 Um, my questions for each of these issues will 5 probably begin in the same manner, and I really want to 6 get clear about the authorities. 7 And, um, I think what I'd like to do is maybe 8 pose this question to the Appeals, um, Division if I 9 could. Uh, I've had a lot of different court decisions 10 cited, um, different reliance on them. Um, I personally 11 am not partial to prior Board decisions that have not 12 been published, but I think they're instructive. But 13 certainly not, um, something that I am going to be 14 looking at with, um, as -- as kind of a priority point. 15 But my, uh, first question really relates to, 16 uh, how, uh, we ought to look at court decisions that 17 are rendered by Supreme Courts in other states. Now, I 18 know that, uh, the Pennzoil case has been cited by both 19 sides, um, although I don't believe it's, um, in 20 conflict with the Hoeschst Celanese case. And, in fact, 21 I think the Pennzoil decision really relied on the 22 Hoeschst Celanese framework. Um, but how do we look 23 at -- how -- how -- how should the Board consider those 24 types of decisions? 25 MR. THOMPSON: Uh, well, the Board is certainly 26 free to consider, uh, decisions in other states, uh, to 27 the extent the Board finds the decisions persuasive and 28 helpful and, uh, with similar facts. 69 1 Uh, the Board is not bound by those decisions, 2 but, uh, there -- the Board, uh, ought to consider them. 3 And whether the Board finds them persuasive and 4 relevant, would be in the judgment of the Board. 5 MS. YEE: Okay. Um, are you familiar with that 6 decision, Mr. Thompson? 7 MR. THOMPSON: The Pennzoil? 8 MS. YEE: Yes. 9 MR. THOMPSON: Yes. 10 MS. YEE: Okay. And did you -- if you can 11 respond, um, did you find any inconsistency with that 12 particular decision with Hoeschst Celanese? 13 MR. THOMPSON: With regard to Hoeschst 14 Celanese? 15 MS. YEE: Uh-huh. 16 MR. THOMPSON: Um -- 17 MS. YEE: Understanding the facts are 18 different, um -- 19 MR. THOMPSON: Yeah. You know, it's a tricky 20 question because -- and it's a good question, but I -- 21 because it's ultimately going to be a judgment for the 22 Board, and I don't want to certainly interfere with how 23 the Board might approach things. 24 Um, but I think, uh, those, uh, two cases are 25 similar, at least arguably, uh, in the sense that in 26 Pennzoil you had, uh, this oil company trying to 27 acquire, uh, oil reserves. And I believe it's in 28 Pennzoil, uh, where they acquired the oil reserves, 70 1 sometimes through exploration and sometimes through 2 acquisitions. And I think the Court looked at that and 3 said, uh, that looks to us, uh, like it arose from the 4 regular activity of acquiring oil reserves. 5 And so, uh, you know, I think the Board could 6 find analogy to that case, uh, with the facts here, but 7 it's certainly not bound to. And I think Appellant had 8 a good point about the, uh, "in lieu of" language in the 9 decision, which is a little different than what we've 10 seen in Hoeschst Celanese. 11 MS. YEE: Okay. Okay. Uh, and the reason I'm 12 kind of focused on this is, um, seems to me the, um, 13 disagreement to the termination fee issue, uh, relates 14 to, uh, I guess the, uh -- what generated the taxable 15 income, whether it was the actual transaction or whether 16 it was a conversion or whether whatever it is. 17 Um, but -- and part of why I don't see the two 18 cases being, uh, inconsistent is that it really does 19 kind of back you up to look at the origin of the claim. 20 And so if you -- and this is where I'd kind of like the 21 Appellants to comment, um -- but, um, it was the merger 22 agreement that generated the taxable income, not the 23 fee. So, but for the cancellation of the agreement, 24 would not have generated the income. So -- and that's 25 the point of Pennzoil that I'm kind of trying to just 26 compare. 27 MR. THOMPSON: Okay. 28 MS. YEE: Okay. 71 1 MR. FRIEDMAN: I'd like to address that if I 2 could. 3 MS. YEE: Okay. 4 MR. FRIEDMAN: I'd love to address that if I 5 could. 6 MS. YEE: Please. 7 MR. FRIEDMAN: Okay. Um, just a word on, um, 8 Pennzoil. And Pennzoil is kind of a contractual 9 interference case, unlike Atlantic Richfield which was 10 an attempt to acquire, sell off oil reserves. And 11 Pennzoil, uh, a company was accused of interfering with 12 an agreement and was sued by another company, and 13 ultimately there was a judgment of $11 billion entered 14 into on behalf of the company and resolved for a 15 $3 billion settlement. And that was the factual 16 pattern. 17 And what the Oregon court did in that case was, 18 in looking at how to treat that $3 billion of settlement 19 proceeds that resulted from litigation, and an award 20 actually, a judgment, the Court used this "in lieu of" 21 test that the attorney referenced. The "in lieu of" 22 test said what was the $3 billion in lieu of? And what 23 they had decided was the $3 billion was in lieu of 24 acquiring another company and, as a result, they thought 25 that that company would be part of the taxpayer's 26 business. And that's how the analysis worked in the 27 Pennzoil case out of Oregon. 28 Now, yes, they cited Hoeschst Celanese. They 72 1 cited Hoeschst Celanese also for the proposition that 2 the Hoeschst Celanese's Court's holding delineated a 3 transactional and functional test. But not necessarily, 4 and in fact didn't define the transactional test in the 5 same way as Hoeschst Celanese. So Pennzoil did not 6 adopt the transactional test definition that the 7 California Supreme Court devised in Hoeschst Celanese. 8 Taking that analysis through our fact pattern, 9 absolutely Comcast engaged in acquisitions of other 10 cable companies. If you viewed this transaction as just 11 yet another one of those, then one could argue that it 12 occurred in Comcast's regular trade or business. And 13 that -- that is the FTB's argument as I understand it. 14 However, that acquisition never occurred. 15 There was a termination of a contract. It was the 16 termination fee that produced the gain. It's the 17 termination that's the regular -- that is the activity 18 or transaction that should be analyzed under the 19 Hoeschst Celanese analysis. The termination was not an 20 event that occurs in Comcast's regular trade or 21 business; quite the opposite in fact. It was a once in 22 a corporate lifetime event. 23 This, by the way, Board Member Yee, is the same 24 kind of analysis that we saw in Hoeschst Celanese where 25 FTB argues it's the funding of the pension that should 26 matter, because that created a buildup of assets that 27 ultimately led to the gain. Just like this signing of a 28 contract creates the buildup leading to the termination 73 1 fee. But the Hoeschst Celanese Court rejected, rejected 2 the funding of the pension. And rather, they looked at 3 the reversion itself. And the Court was very clear 4 about this; it's the reversion itself that produces the 5 gain to be analyzed. That's the activity. It's the 6 termination itself that produces the gain to be analyzed 7 as the activity, not their entering into the pension, 8 not the entering into a merger agreement. 9 MS. YEE: Okay. 10 Franchise Tax Board, can you -- 11 MR. MARGOLIS: Well, I'll mention the, uh -- 12 the "in lieu of" language. Then maybe Mr. Joseph can 13 talk about Hoeschst Celanese somewhat. 14 But as far as the "in lieu of" language in 15 the -- 16 MS. YEE: Could you pull the microphone in 17 front of you -- 18 MR. MARGOLIS: I'm sorry. 19 MS. YEE: -- Mr. Margolis. 20 MR. MARGOLIS: As far as the "in lieu of" 21 language in Pennzoil, um, first of all the whole "in 22 lieu of" concept arises when you receive a payment in 23 litigation. And what you do is you look to characterize 24 the nature of the payment, uh, through litigation by 25 saying, In lieu of what was it received? And that's -- 26 that's a very basic principle of tax that applies pretty 27 much everywhere. And, in fact, the Andersen memo kept 28 saying that that's the principle that should be applied. 74 1 So it's -- I'm sup -- I don't know why 2 Mr. Friedman is -- is having -- is making an issue with 3 that. And if you read the Pennzoil court, um, I think 4 they were talking about in lieu of what was -- looking 5 at what the payment from Texaco was received because, 6 um, Pennzoil wasn't in a contract with Pennzoil. And so 7 they said, well where -- I mean Pennzoil was not in a 8 contract with Texaco. It was in a contract with Getty 9 and it got the payment from -- from, uh, Texaco. 10 And so the Court said, well, wait a second, how 11 do we get -- What does this payment from Texaco relate 12 to? And they say, What was it paid for? And they used 13 the "in lieu of" test because on -- whenever you get a 14 damages payment you say, In lieu of what was it 15 received? And they said, well, this was received from 16 our contract with Getty. 17 But here, the termination fee and the contract 18 was all one in the same. I mean, the termination fee 19 was in a contract that this taxpayer, Comcast, you know, 20 had with MediaOne. And the fee arose from that 21 agreement. You don't even have to worry about the "in 22 lieu of" test. It's not even relevant to this case. 23 MR. JOSEPH: Yeah, I think -- I'm sorry. I 24 think one of the problems that -- that we're having is 25 that, uh, the representers for Comcast are trying to 26 make the, uh, transactional test sort of a very narrow, 27 what was the very last thing that happened that actually 28 popped the income. And that's the only thing that 75 1 really is relevant. 2 And I think that's really, uh, pretty harmful 3 narrowing of really what the test says. It says the 4 transaction or activity that gave rise to the income. 5 The transaction or activity here was, of course, 6 entering into a merger agreement, the creation of the 7 contract itself. Uh, I think what they're -- what the 8 proposition they're bringing up is -- is, uh, well, it's 9 kind of worrisome because it -- it -- it really takes 10 out the whole question of what is the transaction or 11 activity that you are engaged in and replaces it with 12 was the very thing that gave rise to this particular 13 item of income, at that moment, was that a transaction 14 that you normally do? And -- and I think that's an 15 awfully narrow way of looking at the case. 16 Uh, certainly, you know, something to keep in 17 mind here is, you know, these considerations cut both 18 ways. I mean, if we're dealing with an in-state 19 taxpayer who was to do this type of transaction, being 20 that narrow would result in all the income being 21 assigned to California. And that seems impermissibly 22 broad too, from a Constitutional perspective and from 23 the perspective of -- of policy and applying the rule. 24 So, I think they're narrowing it a bit too far 25 when they -- when they want to get it down to the very 26 last item, when the test only says transaction or 27 activity. 28 I don't know if that helps or not. 76 1 MS. YEE: It's helpful. Okay. 2 Um, was the, uh, termination fee income 3 reported anywhere? I mean, did you -- did Comcast 4 report it? 5 MR. FRIEDMAN: Well, it was ultimately taxed 6 for federal tax purposes. And I believe it was taxed by 7 some other states. 8 MS. YEE: What about the -- your domicile 9 state? 10 MR. FRIEDMAN: Uh, I don't recall. But I know 11 that's an issue that the FTB has -- I haven't reviewed 12 that return, but I know that's an issue that FTB has 13 taken, um, notice of in its briefing. 14 MS. YEE: Okay. 15 MR. FRIEDMAN: I haven't confirmed it. 16 I will say this though, is that Mr. Joseph 17 shouldn't worry. Uh, we didn't narrow -- we're not 18 creating a worrisome situation. The California Supreme 19 Court did, if he's worried at all. And the language is 20 right there. That's not my language. That's not Jon 21 Sperring's language. That's not Comcast's language. 22 That's the California Supreme Court, in rejecting the 23 FTB argument in that case, that's the same argument that 24 they're presenting you with today. 25 Remember, the FTB argued it was the funding of 26 the pension. And it's a classic argument to say that if 27 you come up with a more narrow definition of a business 28 income item, then it will hurt the in-state companies. 77 1 I don't know how that's relevant at all to this 2 litigation. 3 MR. JOSEPH: Can I respond at all? 4 MS. YEE: I'm fine for now. 5 Thank you, Mr. Chairman. 6 MR. JOSEPH: May I respond just briefly? 7 MR. HORTON: Member Yee. 8 MS. YEE: Yes. 9 MR. JOSEPH: I think what the difference is, 10 is that a pension reversion itself is an activity, you 11 know. And it's -- it's -- it's a little different than, 12 you know, basically somebody deciding that a term in a 13 contract that you've agreed to is going to be exercised. 14 The actual pension reversion itself was a whole 15 series of things that they actually had to engage in to 16 get the job done. They had to form a new pension plan. 17 They had to fund it with adequate assets. They had to 18 get the assets that were left over back to them. 19 It wasn't a simple -- you know, it's not -- 20 here we're just saying a termination fee in a -- in a 21 contract that they negotiated isn't the activity. The 22 activity is the triggering of an element in the 23 contract. That -- that's, to me, a lot narrower. 24 MR. MARGOLIS: Certainly if in Hoeschst 25 Celanese there had been 30 reversions of pension plans, 26 they would have found it was business income under the 27 transaction test. But the fact found by the Hoeschst 28 Celanese Court was that there had only been one pension 78 1 reversion ever. And, you know, if there had been 30 it 2 would be a lot different. 3 MS. YEE: Mm-hmm. I understand. Thank you. 4 Thank you, Mr. Chairman. Let me stop there. 5 MR. HORTON: Member Steel. 6 MS. STEEL: Is this negotiation was done in 7 California? 8 MR. FRIEDMAN: No, it was not. 9 MS. STEEL: Okay. How many mergers, um, did 10 Comcast tried last -- during this tax period or before 11 or after? 12 MR. FRIEDMAN: How many mergers? 13 MS. STEEL: Right. 14 MR. FRIEDMAN: There were a number of mergers. 15 I don't have the exact figure -- 16 MS. STEEL: Okay. 17 MR. FRIEDMAN: -- Mrs. Steel, but there was, 18 uh -- there was quite a few. 19 MS. STEEL: So how many failed? 20 MR. FRIEDMAN: Uh, none to my knowledge. 21 MS. STEEL: Except this? 22 MR. FRIEDMAN: Mm-hmm. 23 MS. STEEL: So this one is the first time ever 24 got termination fee? 25 MR. FRIEDMAN: That's correct. 26 MS. STEEL: Is this a usual practice on a 27 contract, when this kind of merger going on? 28 MR. FRIEDMAN: There are termination fees 79 1 included in certain merger agreements; certainly not 2 all, but some. It's unusual to collect a termination 3 fee, and it's incredibly unusual to collect a 4 termination fee of this size, especially in this era, 5 1998 to -- 6 MS. STEEL: So even it's on the contract, it 7 fails, then a lot of times you don't collect. 8 MR. FRIEDMAN: Most mergers do go forward. Um, 9 it's rare to have a termination fee paid. 10 MS. STEEL: Okay. Thank you. 11 MR. FRIEDMAN: Thank you. 12 MR. HORTON: Member Runner. 13 MR. RUNNER: Just a follow-up on a -- on some 14 of that same line there. Um, so in the history -- 15 during this period of time that we're dealing with, um, 16 there were no other termination fees collected then by 17 Comcast? 18 MR. FRIEDMAN: There were no termination fees 19 collected, to my knowledge, during this time period. 20 And certainly none negotiated at all of this size. 21 MR. RUNNER: Um, to the, um, FTB. Um, one of 22 the arguments that you made is -- is a -- a -- a long 23 list of acquisitions that were made -- 24 MR. MARGOLIS: Yes. 25 MR. RUNNER: -- during that period of time, 26 indicating, um, that that was, um, I guess the operating 27 procedure or business plan, um, for, uh -- for Comcast, 28 right? 80 1 MR. MARGOLIS: Correct. 2 MR. RUNNER: And there seems to be in the -- in 3 the argument an equivalency between the acquisitions 4 that were made and the fulfilled acquisitions and, 5 therefore, resulting in a merger, um, resulting in what 6 would be clearly additional new business income as a 7 result of a merger, and a termination fee. Can you help 8 me understand how you get there? 9 Um, it seems to me acquisitions are a total -- 10 totally different issue than the idea of revenue or 11 money coming in from a termination fee. 12 MR. JOSEPH: Sure. Uh, I guess I would -- I 13 would ask you to -- to sort of recognize that in the 14 world of cable television the thing that you need is you 15 need access to subscribers. Subscribers are the raw 16 material of the cable business. The more subscribers 17 you get, the more money you make. 18 So, these acquisitions are essentially an 19 effort to acquire what is essentially the raw material 20 of their business, the subscribers. 21 MR. RUNNER: Mm-hmm. 22 MR. JOSEPH: So, I think the best way to answer 23 your question is kind of by analogy. If you had someone 24 who, like the other cases, say, was in the oil or gas 25 business, and they were out buying the raw material for 26 their business, and in a contract to acquire an oil 27 reserve or something, uh, the contract headed south and 28 they ended up having to collect a liquidated damages 81 1 provision or a termination fee. The activity, just as 2 the activity here, is an activity that is related to 3 something very core to the business and, therefore, the 4 income that arises from that activity is apportionable 5 income. Just like the failed purchase of an oil well 6 would be, uh -- give rise to income for -- for the oil 7 company, the failed subscriber acquisition by Comcast 8 should also give rise to apportionable income. 9 MR. RUNNER: Well, I guess I'm a bit confused 10 by that because the core business is the actual new 11 subscribers; that's -- that's the goal. The goal is the 12 new subscribers. And that's -- 13 MR. JOSEPH: That's right. 14 MR. RUNNER: So that's the completed 15 consummated acquisition. 16 MR. JOSEPH: True. 17 MR. RUNNER: That didn't take place here? 18 MR. JOSEPH: No, it did not. 19 MR. RUNNER: So I'm -- I'm having -- I'm having 20 trouble following your -- your thought -- 21 MR. JOSEPH: Right. 22 MR. RUNNER: -- if that is the goal and that 23 never took place. 24 MR. JOSEPH: Right. I think -- I think what 25 I -- the best I can say to you is when taxpayers enter 26 into transactions in their normal course of business, 27 not all transactions turn out the way that they envision 28 them turning out. 82 1 Nevertheless, when they enter into those 2 transactions as a normal part of their business, the 3 income or loss that results from it is going to be 4 apportionable business. 5 It doesn't -- you don't have to know going in 6 that this particular thing is going to have a certain 7 outcome to have the activity create business income. 8 It's the activity that matters, not the source -- not 9 the item of income that's produced at the end of the 10 day. 11 MR. RUNNER: Well, that would be true if their 12 business was collecting termination fees. 13 MR. JOSEPH: Well, no. I -- I -- I think -- 14 again, I'd like to relate it back to my -- my analogy 15 about the oil and gas business. They're trying to pick 16 up something that's core to their business. 17 MR. RUNNER: Right. 18 MR. JOSEPH: More subscribers. 19 MR. RUNNER: I get -- yeah, I agree with that. 20 I get that part. 21 MR. JOSEPH: And so, when they enter into an 22 activity in an effort to do that and that activity gives 23 rise to an item of income, albeit not the item of income 24 they wanted which is subscriber revenue down the road, 25 it's still an item of income from a transaction or 26 activity in their normal course of their business. This 27 is how they get new subscribers. 28 MR. RUNNER: Again, I agree it's certainly 83 1 additional income. The question is, is it to their core 2 business? 3 MR. JOSEPH: Right. 4 MR. RUNNER: Right? 5 MR. JOSEPH: And I guess I'm saying that -- 6 that -- that for purposes of the test, the question is, 7 is the transaction or activity part of the core 8 business, not the particular item of income that is 9 created. And that's, I think, where -- where we're 10 having the confusion. 11 MR. RUNNER: Okay. 12 Okay, thank you. 13 MR. HORTON: Further discussion, Members? 14 Question of the Department. In Hoeschst 15 Celanese, the Court seemed to -- to separate the 16 reversion from the pension, even though they are one 17 integral transaction, um, and then they isolated that. 18 Um, in doing so, uh, they attribute the income to the 19 reversion. 20 In the case before us, what's the difference as 21 far as fact patterns and how we should treat that? 22 MR. JOSEPH: I didn't hear the question. I'm 23 sorry. 24 MR. MARGOLIS: I'm sorry. Um, could you 25 restate the question again? I didn't follow exactly. 26 MR. HORTON: Sure. Sure. 27 In the Hoeschst Celanese case, um, the Court 28 saw that, uh -- well, in a normal course of activity 84 1 when you have a -- a pension plan, typically the 2 reversion is anticipated. It may not always happen, but 3 it is one of the variables that could exist. Yet the 4 courts -- and the Court saw that they were integrated, 5 but yet still the Court separated them. 6 Um, how was that distinguishable from this 7 case? 8 MR. MARGOLIS: Go ahead. 9 MR. JOSEPH: You want me to do it? 10 MR. MARGOLIS: Yeah, go ahead. 11 MR. JOSEPH: Just trying to be nice. 12 MR. HORTON: I've got a coin, but -- 13 MR. JOSEPH: I think -- I think what you're 14 asking is -- it sounds like you're asking, they 15 separated the pension reversion activity from the 16 activity of funding the pension plan. And here can we 17 separate the termination fee income from the activity of 18 entering into the merger? 19 And I think what I'd say is, the termination 20 fee was part of the very same activity; it's not a 21 separate activity. In -- in the Celanese case, they 22 funded a pension for many, many, many years. And 23 through the way the market operated, you know, they 24 ended up with it being over-funded. 25 I think it's important to see that really it's 26 the actual activity of getting into the merger agreement 27 that gives rise to this income. It's not two things; 28 it's one. I mean, realize the point of why you have the 85 1 termination fee in this agreement. It's supposed to 2 be -- it's there to keep the parties from going out and 3 shopping around. It's supposed to be big enough to keep 4 MediaOne from go out -- going out and getting somebody 5 else to come in and buy them. It's a term in the 6 contract that's there for a very specific purpose 7 related to the very activity of trying to make the 8 merger happen. It was anticipated to be there. 9 Now, in this case, I mean AT&T came along and I 10 guess they thought it was worth a lot more money so they 11 were willing to go ahead and -- and pay the termination 12 fee. But the termination fee activity was the contract 13 negotiation to enter into the contract of merger. 14 That's where it comes from. It's not really two things. 15 It's part of that activity. 16 MR. MARGOLIS: You to have realize -- excuse 17 me -- that the pension plan is not -- in Hoeschst 18 Celanese, is not part of the taxpayer. The taxpayer 19 does not pay income on the earnings of the pension plan. 20 It's a tax exempt organization that's totally separate 21 from the taxpayer. 22 So the whole time that the tax -- that the 23 pension plan's operating, it doesn't contribute to 24 the -- the income of the taxpayer at all. It's a 25 separate -- it's a separate entity. And it's only -- 26 it's only after many years of operations that the 27 taxpayer said, well, looks like there's a lot of extra 28 money built up in this pension plan; we're going to 86 1 cause a reversion and we'll get the money back. 2 MR. JOSEPH: Mr. Friedman's ready to go. 3 MR. FRIEDMAN: I'm ready to go. Ready to go. 4 May I? 5 MR. HORTON: Okay. Sure. 6 MR. FRIEDMAN: You just heard a terrific 7 description by Mr. Joseph and Mr. Margolis of a losing 8 argument in Hoeschst Celanese. That was the losing 9 argument. 10 If you could put, Ellen the same chart back up 11 that we had a moment ago. I would ask to reconcile the 12 California Supreme Court's language in Hoeschst Celanese 13 with the position that they're taking in our case. 14 Because, Mr. Chairman, you're exactly right. There was 15 a pension plan, there was a provision within the pension 16 plan. We pulled it. We went into the California 17 briefing in the Hoeschst Celanese litigation, pulled the 18 actual -- actual pension plan, which was a contract. 19 Within that contract there was a pension reversion 20 clause. 21 We have a contract. There's a termination 22 clause. The California Supreme Court didn't look at the 23 entering into the pension and the funding of the pension 24 as the relevant transaction and activity. You should 25 look at the going into a merger agreement with MediaOne 26 as the relevant activity. 27 The California Supreme Court looked at the 28 reversion clause, and we suggest you should look at the 87 1 termination clause. 2 MR. HORTON: What's your, um, view on the 3 Department's position that the activity that gave rise 4 to the transaction, that they're interconnected, and in 5 Hoeschst Celanese they specifically spoke to, uh, the 6 transaction as well as the activity that gave rise to 7 the income? 8 MR. FRIEDMAN: Yes. 9 MR. HORTON: Presumably, a -- a -- a 10 continuation existed. 11 MR. FRIEDMAN: Yes. This truly is Groundhog 12 Day because this was the litigation position in Hoeschst 13 Celanese of the FTB, that it was one integrated plan and 14 you should look at that one integrated asset and the 15 fact that that asset was used -- which is more of a 16 functional test analysis, I would argue -- it was used 17 in the taxpayer's trade of business. 18 If Mr. Joseph is right, by the way, if his 19 formulation of the transactional test is correct, then 20 every transaction a business engages in would produce 21 business income. 22 Now I would argue that if Comcast regularly 23 received termination fees -- and this could happen. You 24 could have a series of events happen where you enter 25 into agreements and termination fees are triggered 26 because the agreements fail. And if Comcast had four, 27 five, six, seven termination fees, all of a sudden 28 that's an activity engaged in by Comcast's regular trade 88 1 or business. This was once in a corporate lifetime. 2 MR. HORTON: Mr. Thomas. 3 MR. THOMPSON: Let me take a moment, if I can, 4 to offer a thought about Hoeschst Celanese. I think all 5 the parties are rightly focused on what's the underlying 6 transaction or activity. Uh, the Board might consider 7 why the Court in Hoeschst Celanese, uh, decided, uh, 8 that you could not look to the underlying pension 9 transactions. It said that, uh, those transactions 10 normally never generated taxable income. 11 MR. FRIEDMAN: Right. 12 MR. THOMPSON: Now, here, I'm sure Appellant 13 has argued that, uh, their merger agreements never 14 generated taxable income. And I think one way the Board 15 could look at this is, are the transactions or 16 activities of managing the securities of the pension 17 fund, are those similar to the activities at issue here? 18 Or are activities at issue here more similar to, uh, the 19 acquisition activity in Pennzoil? 20 MR. HORTON: Okay. Um, the Department made 21 reference to the subsequent use of the income as it 22 related to the filing of the federal income tax return. 23 Um, and the Petitioner -- I don't want to go to the 24 penalty. But in Hoeschst Celanese they -- they speak to 25 the relevance of the subsequence use of the income. 26 Possibly the Petitioner can share with us how the income 27 was used and why that is or is not significant to this 28 case. 89 1 MR. FRIEDMAN: Um, I believe Mr. Alchin can 2 address how the income was used. For the $1.5 billion 3 termination fee? 4 MR. HORTON: Yes. 5 MR. ALCHIN: Uh, I mean the -- that was just, 6 uh, credited to corporate funds. Um, you know, not 7 dedicated to any specific use. We had never received a, 8 uh -- 9 MR. HORTON: Let me expound on the question. 10 MR. ALCHIN: Sure. 11 MR. HORTON: Because there was some specific 12 testimony that I think, uh -- I don't want to say it's 13 helpful. But certainly helpful to us understanding, in 14 that the income was not allocated to all of the 15 businesses within the corporate, uh, structure, for lack 16 of a better term. I'm trying to stay away from using 17 the term unity, unitary. 18 MR. FRIEDMAN: If I could address that, Mr. 19 Chairman. 20 MR. HORTON: Sure. 21 MR. FRIEDMAN: Um, first of all, the use of the 22 proceeds, as a general matter, there's some debate 23 regarding the relevance and the weight to be placed on 24 the use of the proceeds as it relates to a unitary 25 finding generally. So I will say it, unitary. 26 However, um, it's clear under California law, 27 and under Hoeschst Celanese I think it's crystal clear, 28 that the use of the proceeds is not helpful, not even 90 1 relevant, for the transactional test. There may be some 2 relevance for the functional test, but clearly not 3 relevant for the transactional test. 4 And I think that even FTB is now acknowledging 5 that that's where the real fight is as relates to this 6 issue, is on the application of the transactional 7 test. 8 MR. HORTON: Okay. I'll go to FTB. 9 MR. JOSEPH: Uh, I -- I -- I don't agree with 10 that at all. The Court in Celanese, citing to another 11 case in the transactional test part of the brief -- of 12 the -- of the opinion said relevant considerations 13 include the frequency and regularity of similar 14 transactions, the former practice of the business, and 15 the taxpayer's subsequent use of the income. 16 I -- I do think it's relevant. And they did 17 use it. They just put the money back in to just their 18 normal corporate accounts and used it in their normal 19 flow of their operational business. 20 MR. FRIEDMAN: If I could, if the use of the 21 proceeds is relevant for the transactional test, every 22 transaction produces business income. 23 MR. JOSEPH: Well, every transaction in the 24 normal course of a trade or business. 25 MR. HORTON: Excuse me. Um, just for future 26 reference, we're going to do our best to stay away from 27 a colloquy. Okay. 28 All right. 91 1 MR. SPERRING: Sure. Mr. Horton, to answer -- 2 Chairman Horton, to answer your question, um, I think 3 the Board of Equalization in Occidental Petroleum, 4 footnote three, addressed your question head-on and said 5 that how the taxpayer spends the money is of no, uh, 6 consequence to the determination of whether it's 7 business income or nonbusiness income. And that was a 8 published Board of Equalization case. 9 MR. HORTON: Okay. 10 Further discussion, Members? 11 Okay. Members, that concludes the termination 12 discussion. We'll now move to discussions on the -- 13 pardon? 14 MS. MANDEL: Can I have half a minute? 15 MR. HORTON: Okay. Members, we're going to 16 take a half a minute break. No. Let's take a five 17 minute break. 18 ---oOo--- 19 20 21 22 23 24 25 26 27 28 92 1 MR. HORTON: Members, we're reconvening the meeting of 2 the Board of Equalization. We're opening discussions on 3 unitary. 4 Member Steel? 5 MS. STEEL: To the taxpayer side, that 6 Franchise Tax Board was talking about this was the 7 vertical integration and I didn't hear why not. 8 MR. FRIEDMAN: Okay. Thank you. 9 It seems to me they said said two things. One 10 is integration doesn't matter and then later -- 11 MS. STEEL: Right. 12 MR. FRIEDMAN: -- they said vertical 13 integration matters. 14 It's -- we're not vertically integrated. And, 15 in fact, we're not vertical and we're not integrated. 16 MS. STEEL: That's why you are here to try to 17 tell us. 18 MR. FRIEDMAN: I'll just take two minutes or so 19 to elaborate -- 20 MS. STEEL: Okay. 21 MR. FRIEDMAN: -- as to why. 22 We're not vertical, because to be vertical you 23 have to be steps in a process. The FTB loves talking 24 about the oil cases, Mobil Oil and Exxon and all the 25 other oil cases where you have a refining operation and 26 a retail sale of gasoline and steps in between. 27 This is not that case. We're a cable company. 28 We acquire content to put on our cable systems like 93 1 ESPN, Disney channel, et cetera, et cetera to make for 2 an attractive package of cable programming to sell to 3 you and me. 4 Nobody buys -- and no offense -- nobody buys 5 Comcast cable service to get access to QVC. They may do 6 so to get access to ESPN. They may do so to get access 7 to Showtime, but not to QVC. And the business 8 relationship reflects that. 9 The business relationship isn't Comcast paying 10 QVC like Comcast pays ESPN. QVC has to buy its way into 11 the channel and pay Comcast for the right to carry. So, 12 it's not steps in the process, that's the vertical part. 13 Integration -- FTB says on one hand it doesn't 14 matter. On the other hand it says we're integrated. 15 We're not integrated for all the reasons that I said in 16 my opening, which is that there were no common shared 17 functions. There was no common business plans. There 18 was no common corporate culture. There was no 19 integrated strategy or integrated operations -- 20 integrated anything. 21 MS. STEEL: Okay. To the Franchise Tax Board, 22 you were talking about there is like 30 acquisitions 23 that Comcast went through and tried to expand. 24 What that has anything to do -- you didn't 25 really quite explain what that has anything to do with 26 this -- the transaction. 27 MR. MARGOLIS: Well, it doesn't have anything 28 to do with the unity issue, per se. It has to do with 94 1 the termination fee issue as to whether or not the 2 termination fee arises from something that they -- the 3 type of transaction. 4 MS. STEEL: You were talking about the unity at 5 that point. 6 MR. MARGOLIS: Well -- 7 MS. STEEL: So many -- 8 MR. MARGOLIS: -- well, there is an 9 interrelationship, yes, in that when they did take over 10 the -- when they received the income from the 11 termination fee, they took the income and they applied 12 it against basis in assets that were cable and 13 cable-related on the ground. And all those assets were 14 part of one integrally related enterprise. 15 So, what the FTB is saying is because the 16 theory on which they offset all this income -- remember, 17 they sheltered this income in all these different 18 businesses and they said -- and the theory under which 19 they were able to do this is that they said these 20 businesses are interrelated and that they were all 21 damaged by the failure to merge with Median. 22 And, of course, the contract was only with 23 Comcast. And the only way that they could offset it -- 24 offset the income with damages -- with basis on anybody 25 besides Comcast is to say that Comcast and these other 26 entities were integrally related. So, they -- on that 27 theory, what they were saying is QVC was integrally 28 related with Comcast and that's why you can offset the 95 1 income with QVC basis. 2 So, there is -- there is that relationship, 3 yes. 4 MS. STEEL: Okay. But that -- that part is the 5 separate part. I'm talking about unitary business here 6 that -- between QVC and Comcast that -- that doesn't 7 have any relationship with those other 30 acquisitions 8 that Comcast went through. 9 MR. JOSEPH: You're correct, this isn't about 10 those other acquisitions. 11 I think what we're -- the reason we brought up 12 how they treated the -- the $1.5 million is -- 13 MS. STEEL: So, you were talking about that 14 termination itself? 15 MR. JOSEPH: -- that's right. 16 MS. STEEL: But if that's the only one time 17 happen. 18 MR. JOSEPH: That's right. 19 MS. STEEL: So, that has nothing do with the 20 other transactions that whatever happened. 21 MR. JOSEPH: That's true. What it -- 22 MS. STEEL: That's not really related to 23 anything here. 24 MR. JOSEPH: -- well, it's only related in one 25 sense and that is when it came time for Comcast to 26 determine how they were going to file their federal 27 return, they determined that the loss of the merger with 28 Median, which was a big merger for them, when that 96 1 failed, they determined that it damaged the goodwill of 2 their cable businesses. And when they applied that -- 3 that damage -- 4 MS. STEEL: How can you know it's been damaged 5 when the transaction didn't even go through -- 6 MR. JOSEPH: Well, that's a -- 7 MS. STEEL: -- at all? 8 MR. JOSEPH: -- that's a good question for 9 them. That's what they put on their federal return. 10 I mean, that's what's in that Arthur Andersen 11 opinion memo is that their business was damaged to the 12 extent of $1.5 million -- billion dollars in goodwill. 13 And when they did that on their federal return, 14 part of the business they said was damaged was QVC. 15 And, so, that begs the question for us of how could QVC 16 have been damaged in that transaction if it wasn't part 17 of the cable-related business? 18 MS. STEEL: Can you explain that? 19 MR. FRIEDMAN: Sure, I'd love to. 20 The return, the return, the return that FTB's 21 referring to, federal tax return. 22 MR. JOSEPH: Yeah. 23 MR. FRIEDMAN: The Andersen memo, federal tax 24 advice. That position, abandoned. 25 The fact that we mechanically reduced the basis 26 in all of our consolidated assets, the FTB is using -- 27 using that as some evidence of a unitary relationship 28 that has no relevance at all for federal tax purposes. 97 1 The relevance of this Andersen memo here is -- 2 escapes me. 3 MR. SPERRING: And keep in -- keep in mind, 4 right, the purpose of the the -- federal of that federal 5 position was to determine the intent of the payor. 6 So, Andersen was speculating as to the intent 7 of Median. So, Median -- all we know is Median paid 8 $1.5 billion. 9 Did they pay it for lost profits or did they 10 pay it for damage to the network? Andersen took the 11 position that if you look at what evidence was 12 available, there was substantial authority, okay, less 13 than 50 percent, for the proposition that MediaOne's 14 intent -- 15 MS. STEEL: Uh-huh. 16 MR. SPERRING: -- was to compensate Comcast for 17 the damage, okay, to their infrastructure. In no way, 18 okay, was the law concerned about Comcast's, okay, 19 intent, okay, or how they operated. 20 The law only focused on the intent of Median. 21 MS. STEEL: Right. Sorry, I didn't mean to go 22 back to that termination fee, but -- 23 MR. HORTON: It's okay. 24 MS. SPERRING: Thank you. 25 MS. STEEL: Thank you. 26 MR. HORTON: Mr. Runner. 27 MR. RUNNER: Yeah, to FTB, one of the issues 28 that the Appellants brought up is the issue of 98 1 independent audits between QVC and -- and Comcast. 2 What's -- help me understand -- 3 MR. MARGOLIS: Sure. 4 MR. RUNNER: -- the relevancy. 5 MR. MARGOLIS: Sure. At the time the audit was 6 undertaken, these companies -- Comcast had sold QVC. At 7 that time it had no ownership interest in QVC at all. 8 So, when the FTB did an audit of Comcast, 9 Comcast chose its representative and QVC chose its 10 representative. We have no ability to share 11 confidential information back and forth because that was 12 after our period, when they were no longer commonly 13 owned and they were no longer unitary. 14 MR. RUNNER: So, you think -- you think that 15 that is irrelevant to this discussion -- 16 MR. MARGOLIS: Sure. 17 MR. RUNNER: -- because it's post sale at that 18 point? 19 MR. MARGOLIS: Sure, yeah. 20 MR. RUNNER: Comment? 21 MR. FRIEDMAN: It's interesting, Senator 22 Runner, because the FTB looks at a lot of post period 23 events as relevant to their allegation of a unitary 24 finding, but conveniently ignores this one. 25 If we were unitary, we would have all of the 26 books and records. We would have incorporated them into 27 our tax returns and they could audit our relationship 28 with QVC -- us being Comcast -- and not have to 99 1 independently go after QVC, at least initially. 2 I mean, if we're -- 3 MR. RUNNER: Why would they do that if the 4 audits are go during the post? 5 MR. FRIEDMAN: Because if we were integrated -- 6 that's a great question, Senator Runner. 7 If we were integrated, we would have access to 8 all their books and records for that period in time. In 9 fact, we would be responsible -- 10 MR. RUNNER: If it was outside the audit, what 11 would that -- what would the reason be? 12 MR. FRIEDMAN: We would retain those records 13 from a period of time when we were unitary, even though 14 we don't own them any more. 15 MR. RUNNER: But what would -- what would FTB's 16 interest be at that point to go back to those books if 17 it was outside the audit? 18 MR. FRIEDMAN: Well, I think what -- if I 19 understand -- 20 MR. RUNNER: Okay. 21 MR. FRIEDMAN: -- correctly -- maybe I don't, 22 but what -- if I understand correctly is 1998 and 1999 23 closed. FTB subsequently comes in and audits that 24 period at a point in time where -- after we've disposed 25 of QVC. I think that's what they're saying. 26 And I think what Jeff is saying is that as a 27 result, it made sense to them to go after both companies 28 independently. 100 1 Typically what happens, what I've seen in 2 practice is if you allege that two businesses are really 3 one, you go after the parent. 4 MR. RUNNER: Uh-huh. 5 MR. FRIEDMAN: And if there is some problem 6 there, then you come up with a Plan B. They never did 7 that here. 8 MR. RUNNER: Okay. Let me follow up with some 9 of the discussion too that came from FTB in regards to 10 the preferential treatment in regards to the carriage 11 agreements. 12 MR. GRABELL: Thank you, Senator. 13 Yes, QVC did allow Comcast to purchase stock 14 for 20 cents a share when the public bought it for 10 15 cents (verbatim) a share, but it offered the same deal 16 to every other cable system that was willing to carry 17 its show. 18 QVC pays a 5 percent commission to Comcast. 19 QVC pays a 5 percent commission to every other cable 20 carrier, every other cable company and satellite company 21 that carries the QVC programming. 22 MR. RUNNER: So, that issue then, there was no 23 different treatment of Comcast than any of the others 24 who carried -- who -- who carried QVC? 25 MR. GRABELL: That's right. 26 Same thing with the Q2 offering that 27 Mr. Margolis referred to, the renewal of the channel 28 position payments that he referred to, those were all 101 1 offered to cable companies on the same terms. 2 MR. RUNNER: Okay. Let me go back to FTB then. 3 How does that -- how does that square up then with the 4 integration and special treatment, if it was offered to 5 everybody? 6 MR. MARGOLIS: Well, under your own decisions 7 there doesn't have to be special treatment. You don't 8 have to prefer one party over another to have a flow of 9 value. Having any customer, even an arm's length 10 customer, is still a unitary flow of value. 11 And here there were some special benefits. I 12 mean, for example, the Comcast carriage agreement had a 13 most favored nations clause, which meant that Comcast 14 automatically got the benefit of any proved contract 15 provision that any other carrier might have gotten. 16 MR. RUNNER: Was that not in any other 17 contracts? 18 MR. MARGOLIS: It may well have been in some of 19 the other contracts, because some of the other -- you 20 know, with some of other major shareholders we've asked 21 for that information and it hasn't been provided. But, 22 you know, not everybody can be most favored. 23 MR. RUNNER: So, you don't know if it was just 24 unique to Comcast? 25 MR. MARGOLIS: No, I -- I -- I believe it was 26 with one or two other of the -- 27 MR. RUNNER: Okay. 28 MR. MARGOLIS: -- major shareholders, yes. 102 1 MR. RUNNER: Okay. 2 MR. MARGOLIS: But we think they got the most 3 favored nation -- 4 MR. RUNNER: But a major shareholder does not 5 constitute on its -- on its own unity. 6 MR. MARGOLIS: Right. 7 MR. RUNNER: Right? 8 MR. MARGOLIS: Right, right. 9 MR. RUNNER: Okay. 10 MR. MARGOLIS: I mean, you can -- 11 MR. RUNNER: Okay. 12 MR. MARGOLIS: -- you don't need a preference 13 for unity. 14 MR. RUNNER: Right. 15 MR. MARGOLIS: You simply need a -- an 16 operational relationship, which this carriage agreement 17 showed. 18 MR. RUNNER: But it showed for everybody who 19 was in that business -- or anybody who had -- who -- 20 they did it equally amongst all. 21 Now I understand what your argument is, it 22 doesn't make any difference, but I am just trying -- in 23 my own head I'm trying to get through that. 24 If they were treated -- I'm having -- I'm -- 25 you know, I'm having difficulty seeing how you become 26 unitary if that is, indeed, what it is you did for 27 everybody else out there. 28 MR. MARGOLIS: Well, you -- I mean there's 103 1 still an operational relationship between Comcast and 2 QVC, even if they had an operational relationship with 3 other companies. 4 I mean, your Board held this in the Appeal of 5 Dr. Pepper, where Dr. Pepper, you know, had lots of 6 similar arrangements with other bottlers. And they -- 7 you still found it was unitary. 8 MR. JOSEPH: Can I? 9 MR. MARGOLIS: Yeah, go ahead. 10 MR. RUNNER: Uh-huh. 11 MR. JOSEPH: Yeah, I think the simple analysis 12 here is -- this is the major issue that gave rise to a 13 line of -- well, one, that gave rise to a line cases 14 called the instant unity issue, which is on Monday I 15 don't own 50 percent of you and on Tuesday I do. 16 Am I -- how can I be unitary on Tuesday if I 17 wasn't on Monday? That's -- Dr. Pepper that's cited as 18 one of those cases. In Dr. Pepper, the bottler had 19 over 500 different agreements, licensing agreements, 20 with parties other than who ended up owning over 50 21 percent of it. 22 And your Board said, that doesn't matter. What 23 matters is they had the arrangement with their owner and 24 that's the arrangement that matters for unity. 25 And the day that they got 50 percent or more 26 ownership, they're unitary -- even though they still 27 maintained 500 other licenses with 500 other entities, 28 that doesn't matter. Once they get over the 50 percent 104 1 threshold, that intercompany relationship -- in that 2 case it was a bottler and, you know, the special syrup 3 kind of thing -- that relationship becomes a unitary 4 business once you get the requisite ownership. 5 And that's -- that's really similar to what we 6 have here. 7 MR. FRIEDMAN: Can I address that? 8 MR. RUNNER: Real quick. 9 MR. FRIEDMAN: Okay. In Dr. Pepper, the 10 subsidiary acquired 80 percent of its transactions with 11 the parent -- Dr. Pepper and Dr. Pepper Bottling. 12 Here Comcast, of course, less than 1 percent. 13 But even from QVC's perspective, 10 percent of its 14 transactions were with Comcast, at worst, 10 percent -- 15 not 80 percent, 10 percent and that is a material 16 difference. 17 If Comcast and QVC were unitary, then QVC 18 should be unitary with Liberty Media, with TCI and all 19 the other seed investors that took stock in the origin 20 of QVC. 21 MR. RUNNER: Let me go back to another issue or 22 another question. 23 I think there was -- FTB, you all read -- I 24 think it was a quote out of a -- out of a -- some 25 article somewhere along the line that talked about 26 Comcast's goal to be become a more active investor. 27 MR. MARGOLIS: That was from the Board of 28 Directors' minutes. 105 1 MR. RUNNER: Okay. And what -- and what -- and 2 just to clarify, becoming a more active investor is not 3 on its own creating unity, right? 4 MR. MARGOLIS: Correct. 5 MR. RUNNER: Okay. 6 MR. MARGOLIS: But the point that Mr. Friedman 7 kept saying was that they were a passive investor. And 8 the Board of Directors' minutes of -- of Comcast said 9 that, 10 "We did not want QVC to merge with CBS 11 because if that happened, we would have been 12 limited to having a 5 percent voting role. And 13 if we have a 5 percent voting roll, we will be 14 relegated to becoming a passive investor." 15 So, the inference from reading that is that 16 they were not a passive investor at the time and they 17 didn't want to become one in the future. 18 MR. RUNNER: Okay. Well, let me just again say 19 that my observation would be or my understanding is -- 20 but even if they misdefined themselves as being active 21 versus passive, being active does not, in itself, create 22 that relationship, right? 23 MR. MARGOLIS: It may because if you're 24 actively involved in someone else's company, you might 25 be sharing your expertise. 26 MR. RUNNER: Right, right, right, absolutely. 27 That's -- that's a different issue, though. But just by 28 the definition of active and passive, though? 106 1 MR. MARGOLIS: Correct. 2 MR. RUNNER: I mean, you know, active could be 3 the fact that you've got an investment and you're 4 concerned about what direction the company your 5 investment's going in, and, so, you're are going to 6 protect your investment. 7 MR. MARGOLIS: Correct, mere management is 8 not -- 9 MR. RUNNER: Right. 10 MR. MARGOLIS: -- is not in and of itself -- 11 MR. RUNNER: So, you'd make some decisions 12 based upon correcting your investment? 13 MR. MARGOLIS: Correct. 14 MR. RUNNER: Okay, thank you. 15 I'm done. 16 MR. FRIEDMAN: Mr. Runner -- 17 MR. RUNNER: Well, again, they -- let's talk 18 about active versus passive -- 19 MR. FRIEDMAN: Sure. 20 MR. RUNNER: -- because I think they defined 21 your role at that point -- how did you all see 22 yourselves, active or passive? 23 MR. FRIEDMAN: We have a slide that I'm sure my 24 friends can get up. 25 I think we've established -- and I think FTB 26 has, frankly, stipulated to, we weren't an active 27 participant in QVC's business. I think that Jeff noted 28 that at the very beginning that they're not alleging 107 1 that any more. 2 I think protecting our investment, because of 3 that CBS deal, we either had to go small or go big. We 4 protected our investment, we went big. That doesn't 5 change the nature of the investment. Whether it's small 6 or big, it could still be passive. 7 MR. GRABELL: And if I may point out that -- 8 MR. RUNNER: Okay. 9 MR. GRABELL: -- the statement in the Board of 10 Directors meeting occurred before Mr. Briggs made his 11 demand that he be the sole Controller of QVC. 12 And, so while Comcast may have wanted to be 13 more active, Mr. Briggs said, 14 "Well, if you want me to be your CEO, here 15 are my conditions and that is that I run it 16 without interference." 17 MR. RUNNER: Okay. 18 MR. HORTON: Member Yee. 19 MS. YEE: Thank you, Mr. Chairman. 20 I'm going to try to back us up a little bit, if 21 I could. And I appreciate the questions that have been 22 posed on -- related to the unitary issue thus far, but I 23 think it really might make sense to just get some 24 context here. 25 I want a pose a question to the Appeals 26 Division again and that is, I know there are generally 27 two approaches for determining whether unity exists and 28 I wanted to just see if we can at least get clear about 108 1 how those ought to be applied. 2 MR. THOMPSON: Sure. 3 MS. YEE: So, there's the three unities test, 4 so, obviously looking at whether there is unity of 5 ownership, unity of operation, unity of use and then 6 also the dependency or contribution test. 7 And my first question related to the two 8 approaches is, does one carry more weight than the 9 other? 10 MR. THOMPSON: Absolutely not. There's no 11 authority that any -- either test carries more weight 12 than the other. 13 The courts look to both tests. And this 14 issue's been squarely addressed in the Dental Insurance 15 case and the A. M. Castle case. And they are 16 alternative tests. And they look at many of the same 17 facts and factors. 18 This is what the Court of Appeals had to say 19 about that issue in A. M. Castle, they said California's 20 tax regulation setting forth -- I'm not quoting, but 21 they said, in essence, California's tax regulations 22 setting forth the dependency or contribution test must 23 be given deference. And there is no constitutional 24 constraint which compels us to apply the three unities 25 test in all cases. 26 And it went on to note -- and I'm quoting here, 27 "As a practical matter, the dependency or 28 contribution test overlaps with the three 109 1 unities test in many areas and many of the same 2 facts and factors are used in either test." 3 MS. YEE: Okay. And it's dependency or 4 contribution, right, not "and"? 5 MR. THOMPSON: That's correct. 6 MS. YEE: Okay. And I know we've been focused 7 really on kind of the minority-majority ownership 8 question. 9 I wanted to pose -- I guess I wanted to make a 10 statement and then just have both sides kind of comment. 11 It seems to me, just looking at the business of 12 both Comcast and QVC that an argument could be made that 13 there was a form of contribution and that the 14 contribution was essentially QVC providing -- and I do 15 want to question Mr. Grabell again about the meaning of 16 programming content that -- so, QVC providing 17 programming content to Comcast and Comcast then 18 providing a distribution of that programming content to 19 its subscribers. 20 Why would that not be sufficient in terms of 21 determining that there was a form of contribution here? 22 MR. FRIEDMAN: It could be determinative, it's 23 just not here. And let me explain why. 24 MS. YEE: Okay. 25 MR. FRIEDMAN: In a case like Dr. Pepper, when 26 you have one party so dependent upon the other party, 27 like 80 percent dependent on the other party, and then 28 you inject an ownership interest between the two of 110 1 them, those two things by themselves could create a 2 unitary relationship because of that substantial 3 dependency, 80 percent dependency. 4 In our case Comcast had a 10 percent 5 distribution of QVC's services. Moreover, looking at it 6 from the lens, which I believe is the more accurate one, 7 from Comcast's perspective, Comcast is the taxpayer, 8 should be Comcast's perspective, QVC was generating less 9 than 1 percent of its revenues -- hardly significant. 10 So, looking at the intercompany transactions 11 that I think everyone understands is arm's length now, 12 despite what has been said in the past, looking at the 13 relatively low amount from either Comcast's perspective, 14 1 percent, or QVC's perspective of 10 percent, those 15 things -- ownership and low level intercompany 16 transactions by themselves, arm's length basis, not 17 enough to determine a unitary relationship. There's no 18 no California precedent that would substantiate that. 19 In fact, there are a number of California cases 20 where you've have had greater percentages of ownership 21 and intercompany transaction and still not unitary 22 findings, like Tenneco West, et cetera. 23 So, if it was 50 percent, 60 percent, 70 24 percent of dependence, possibly -- but 10 percent? 25 There's no -- it would be unfounded here. 26 MS. YEE: And I guess I'm still stuck as to why 27 the percentages matter, but let me hear from the 28 Franchise Tax Board and I'll just kind of follow up. 111 1 MR. JOSEPH: I want to say one thing. 2 MR. MARGOLIS: You can start. 3 MR. JOSEPH: I'm not sure that we are going to 4 be able to agree with -- let me just read from 5 Dr. Pepper. In Dr. Pepper, the case says that, 6 "Appellants contend that because the 7 intercompany sales between Dr. Pepper and DPSC 8 and its subsidiaries amounted to only 1 percent 9 of Dr. Pepper's total annual sales, and 9 to 10 13 percent of DPSC's total sales, the flows of 11 value were de minimis." 12 They made that exact argument and they didn't 13 win. 1 percent and 9 to 13, I'm sorry but I don't see 14 the 80 percent in -- in the opinion. 15 MS. YEE: And this may be a simplistic way of 16 looking at, but as I'm looking at the means for how we 17 determine unity, it's dependency or contribution. I 18 don't know that -- and I want to -- and I have another 19 series of questions about flow of value, but with 20 respect to, you know, do we have to quantify that value? 21 Does it have to be, you know, a flow two ways, but 22 before you even -- before I pose that question, it 23 really is -- as we're talking about dependency or 24 contribution. 25 It just seems to me, just on the pure 26 contribution test that there is kind of evidence that 27 there is something going on on both ends. 28 MR. FRIEDMAN: Yeah, we have a definite 112 1 misunderstanding on the Dr. Pepper case, by the way. 2 I have some quotes here in front of me. DPC 3 was the sole source of the trade name, concentrate and 4 syrup. DPC provided an essential -- an essential 5 component that made up a substantial part of DPSC's 6 sales. Over 50 percent of DPSC's concentrate and syrup 7 purchased were from DPC. I don't see the low numbers 8 that I'm hearing hearing from FTB in the case. 9 Putting that aside, though, contribution or 10 dependency -- contribution or dependency -- 11 MS. YEE: Uh-huh. 12 MR. FRIEDMAN: -- certainly is a legitimate 13 test, as we've heard from Appeals staff here. 14 But contribution and dependency is one of the 15 oldest tests of a unitary relationship. We've never 16 had a case in California where we've had 10 percent from 17 one party perspective, 1 percent from another party 18 perspective by itself create a unitary relationship -- 19 never happened. 20 MS. YEE: Uh-huh. 21 MR. FRIEDMAN: I'm a little confused as to 22 whether FTB is now moving backward on its operational 23 interdependence. 24 I thought we had established early on that the 25 companies were autonomous with separate management and 26 executives and business practices and policies. 27 And I'm wonder if they're moving away from that 28 now? 113 1 MS. YEE: Clarify your position on that. 2 MR. MARGOLIS: We've -- we've said that we're 3 not claiming that there was strong -- strong central 4 management. And we're not claiming the benefit of the 5 presumption from strong central management. 6 We are claiming that there's an operational 7 relationship between the two companies from the carriage 8 of the signal. 9 MS. YEE: Uh-huh. 10 MR. MARGOLIS: You have to realize that that 11 operational relationship generated, or, you know, an 12 economy of scale here because Comcast -- it had a broad 13 cable infrastructure and as digital compression came 14 along, it had more and more channel capacity. 15 And, so, it tried to develop and/or purchase 16 content to fill up that extra capacity. It could 17 deliver 50, 100, 200 channels as time went by and it 18 didn't have programming to show on it. 19 So, it was trying, you know, so, QVC basically 20 said, "You know, we have a program that we can fill your 21 extra capacity with." So, that's why companies like 22 Comcast have gone into programming. That's why they 23 merged with NBC. I mean that's -- that's what cable 24 companies do, they try to get into relationships with 25 content providers because it provides economies of 26 scale. 27 MS. YEE: Okay, let me go to Appellants. 28 MR. FRIEDMAN: Yeah, I was hoping that maybe 114 1 rather than the lawyer talking, maybe the two business 2 people can talk regarding whether either party viewed 3 QVC as content. 4 MS. YEE: Actually, that would be great because 5 I do want to follow up on Mr. Grabell's characterization 6 of programming content for a SEC reporting purposes. 7 MR. ALCHIN: Thank you. 8 There's no doubt as our channel capacity 9 expanded, we were looking for content to fill that 10 increased capacity. 11 But there were content providers lined up at 12 the door wanting us to pay them money to carry their 13 differentiated content. Obviously, the HBOs and 14 Showtimes of the world were at the front of the line, 15 the ESPNs of the world. 16 And you only have to look at the rate schedule 17 that we paid these various content providers to see what 18 we considered to be important for the viewers and what 19 viewers consider to be important. 20 And, on the flip side of that same coin, the 21 QVCs and HSNs, with absolutely no disparity to my good 22 colleagues from QVC, the QVCs and HSNs of the world, 23 they were willing to pay us. 24 In the case of QVC, a standard fee, I believe 25 identical to every single cable distributor, every 26 satellite distributor, every telephone distributor of 27 video signals today, is 5 percent. I don't know off the 28 top of my head what HSN pays, but I know it's 115 1 significantly more than that. 2 So, we have no trouble filling up the 3 additional capacity that we have because there's any 4 number of content providers who are determined to try 5 and get money from our pocket into their pocket to 6 provide that. 7 But QVC and HSN are decidedly different. 8 They're electronic retailers and they pay us. We don't 9 pay them. 10 MS. YEE: Okay. Thank you, that's helpful. 11 Mr. Grabell, can you clarify your earlier 12 statement about -- in the 10Ks, what was meant by 13 "programming content"? 14 You stated there was a distinction to be made 15 about the use of that term for regulatory as compared to 16 business purposes. 17 MR. GRABELL: Well, I'm not -- I'm certainly 18 not an expert on FCC regulatory matters, but my 19 understanding is that the -- 20 MS. YEE: SEC. 21 MR. GRABELL: FCC, Federal Communication 22 Commission -- 23 MS. YEE: Oh. 24 MR. GRABELL: -- and their -- their 25 classification of programmers. But I think you may be 26 referring to the FCC competition report, in which QVC 27 was classified as a programmer. 28 If you look at that report, it is focusing on 116 1 programmers which pay the cable operators. And QVC is 2 listed and, I think, incorrectly, because we don't -- I 3 am sorry -- it's the other way around -- in which the 4 cable operators pay the programmers. 5 And, so, for example, where Comcast pays ESPN. 6 We are listed on that and I think erroneously, because 7 we don't get paid by Comcast or any of the other 8 distributors of the programming. We pay for 9 distribution. So, I think even the FCC had it wrong 10 there. 11 As to what appears in Comcast's 10K, as an 12 employee of QVC and as its former General Counsel, I 13 can't really comment on that. 14 MR. FRIEDMAN: A couple of other additional 15 reactions. I'm not a big fan at -- of relying on 16 federal tax principles in a State unitary case 'cause 17 there is no unitary business principle for federal tax 18 purposes. 19 But if you look at the federal tax returns of 20 QVC, which we have done, and of programming assets, like 21 E channel or Golf channel, which Comcast also has 22 interests in, if you look at the industry codes, the 23 industry codes on the federal tax returns -- QVC is 24 listed as a retailer. E channel and Golf channel are 25 listed as programmers. 26 Now, the fact that the FCC competition report 27 lumped them together is something that doesn't seem to 28 have any relevance for purposes what of the parties' 117 1 intentions were clearly. 2 The Comcast 10K -- and I'm not sure if you're 3 referring to the Comcast financial statements, 4 consistently in 1998 and 1999 and the data included in 5 those financial statements included QVC as an electronic 6 retailer. 7 FTB has made much in their briefing of the fact 8 that in the narrative description, not in the numbers, 9 but in the narratibe description, there's an "other 10 programming category" where they describe the various 11 investments that Comcast had and included QVC within 12 that category, but then goes on to describe QVC as an 13 electronic retailer. 14 Consistently QVC was listed as an electronic 15 retailer and disclosed as an electronic retailer. 16 MS. YEE: Okay. They were an electronic 17 retailer for the purpose of categorizing packages of 18 programming services. 19 So, I guess what I'm trying to establish here 20 is really kind of on this concept of a flow of value. 21 And it seems to me that the difficulty is here is that 22 we can't quantify what that is and -- but it seems to me 23 that QVC really had a need to be able to reach viewers 24 and, i.e., Comcast subscribers, right? And Comcast did 25 receive compensation from QVC, okay. 26 So, why does that not constitute a flow of 27 value? 28 MR. FRIEDMAN: QVC had a lot of needs. It had 118 1 a need to reach subscribers through its relationships 2 with Comcast and every other large cable and satellite 3 provider. It had a need to deliver its products via 4 UPS. It had a need to do a lot of things -- to acquire 5 specialized products, which I won't begin to describe. 6 They had a lot of needs. 7 The fact that they entered into intercompany 8 transactions on arm's length terms, in my opinion, 9 should not create a flow of value without a lot more of 10 a showing than that. 11 MS. YEE: Okay. Mr. Thompson, on the issue of 12 flow of value, what have the courts instructed us with 13 respect to how we determine -- yeah, I guess, how we 14 determine value of the flow of value -- how we -- how we 15 look at this? 16 I mean, is it an exchange? Is it -- I mean, 17 how do we look at this? 18 MR. THOMPSON: Let me make a few points. 19 MS. YEE: Because you can't assign kind of a 20 hard number to it. 21 MR. THOMPSON: Right. 22 MS. YEE: It's not specific tangible products, 23 so -- 24 MR. THOMPSON: Right. I guess I would make a 25 couple of points. 26 No. 1, the whole purpose of unitary accounting 27 is to deal with situations where separate accounting, 28 just looking at the dollars and cents transaction, does 119 1 not account for all of the benefits that a corporation 2 gets from being part of a multistate business. 3 In Rose, with railroads and the like, where 4 they said, look, one track of railroad going through 5 Idaho may not be valuable in and of itself, but when you 6 have tracks in every state, you've got a pretty good 7 business going on. 8 All right. Now as far as whether the 9 intercompany transactions were significant enough, the 10 courts certainly evaluate the level of transactions. 11 But there's no cut-off point. And I -- I think it's a 12 risk to focus on percentages too much. 13 You know, I would look at -- consider that in 14 Container Corp. the intercompany transactions were 15 minimal. And they found unity on pension contribution. 16 All these cases, you've got to look at all the 17 facts. And, so, it's easy to point -- pick out one 18 factor or another from any of the cases that support 19 your side -- for the parties to do that, rather, and 20 trot out that case or language about that particular 21 factor. But in all these cases the courts look at the 22 whole ball of wax. 23 On the idea of quantitative substantiality, I 24 would like, if I could, to read from a Board decision in 25 the Saga Corp. decision, which is cited in the briefing. 26 There the Appellant had argued that the FTB had 27 not been able to prove a measurable earnings increase. 28 And this is what the Board said, 120 1 "Appellant rather than Repsondent bears the 2 burden of proof. Appellant must establish by a 3 preponderance of the evidence that the unitary 4 connections present in this case are, in the 5 aggregate, so trivial and insubstantial as to 6 require a holding that a single unitary 7 business did not exist. 8 "Second, a discrete and measurable earnings 9 increase from each corporation in the group is 10 not necessary. 11 "This interpretation -- Appellants' 12 interpretation was rejected in Butler Brothers 13 versus McColgan. There the taxpayer argued 14 that the economies of quantity purchasing would 15 not be effective if the California sales were 16 eliminated." 17 I'm starting to paraphrase here in the interest 18 of time -- and the Appellant urged the court that the 19 California store made no contribution to those bulk 20 purchasing savings. 21 But the Supreme Court -- and this was probably 22 50 years ago -- refuted this sophistic argument by 23 pointing out that taking each store in turn could make 24 the same contention and show that none of the sales in 25 any of the states contributed to the savings resulting 26 from quantity purchasing. 27 So, I think one question here is, do you look 28 at this relationship with QVC and see it as a distinct, 121 1 unrelated business based on the affidavits and the 2 testimony you've heard on the one hand? Or do you look 3 at it and do you see it as analogous to a railroad case 4 or this Butler case, where sure, no one signs up for 5 cable service to get QVC, I would assume. But you could 6 probably make that argument about some other channels as 7 well. 8 And once you have -- I don't know how many 9 channels they have, but a hundred channels or a number 10 of channels, then perhaps the whole is greater than the 11 sum of the parts. And that's the issue here, is the 12 whole greater than the sum of the parts? 13 MS. YEE: Okay. Franchise Tax Board, please? 14 MR. MARGOLIS: Thank you. I want to respond to 15 the content arguments that Mr. Friedman made. 16 Look at what -- 17 MS. YEE: Can you respond to try to get more 18 clarity on this issue -- 19 MR. MARGOLIS: Yes. 20 MS. YEE: -- about whether there was kind of a 21 a flow of value? 22 MR. MARGOLIS: Sure, sure. I mean, Comcast -- 23 Comcast needed programming to fill its cable wires and 24 QVC needed distribution. 25 And at the time that Comcast took over QVC in 26 1995, brian Roberts said -- and this is a quote, 27 "Our proposal to acquire QVC demonstrates 28 our committment to grow in a number of areas 122 1 within the telecommunications industry, 2 especially in programming." 3 That's Exhibit KKK. 4 And when -- when they took it over, Mr. Roberts 5 wrote a letter to Barry Diller, and this is Exhibit MMM, 6 it says that acquiring Comcast -- acquiring QVC, quote, 7 "Helps fulfill our longstanding vision to 8 build a strong programming capability." 9 So, Comcast, it had programming assets already, 10 they've admitted that. This was another programming 11 asset that they could share value with and they could 12 put in their wires to give a more complete -- let's say 13 a more complete meal or, you know, more complete benefit 14 to their customers. 15 So, it added value. The individual part -- the 16 sum was greater than the individual parts. 17 MS. YEE: Mr. Friedman? 18 MR. FRIEDMAN: Yeah, I'd like to address some 19 legal points and then I know John Alchin would like in 20 on this as well. 21 And I do feel like I'm fighting a two front 22 battle here. The Appeals section provided a 23 disappointing analysis here, quite frankly. Looking at 24 Container's and intercompany transactions and the 25 isolation of all of the other factors that took place in 26 the Container case -- by the way, none of which are 27 present here, including the transfer of executives from 28 the parent to the subsidiary in the Container case -- 123 1 but focusing exclusively on the low level of 2 intercompany transactions does not give Container its 3 due. It's very disappointing. 4 The other case aside by the Legal Appeals 5 Division really stands for the proposition of separate 6 legal entity accounting and then separate geographic 7 accounting. 8 No one's arguing for separate geographic 9 accounting in this case. No one's trying to undermine 10 formulary apportionment. That's not what this case is 11 about. 12 Regarding what just heard from Mr. Margolis, 13 the forward looking statements that John Alchin's going 14 to address here in a moment, has to do what the Comcast 15 family was hoping QVC may become one day as a result of 16 hiring Barry Diller. But I'll have Mr. Alchin describe 17 that some more. 18 MR. ALCHIN: Thank you. I mean, Mr. Margolis's 19 quote from Brian Roberts, absolutely, that's probably 20 verbatim from what Brian said. 21 But consider the context and go back to my 22 opening remarks. When Barry Diller agreed to come as 23 CEO of QVC, there was an aspiration, there was a goal 24 for Comcast and QVC to grow into a much larger content 25 company. That doesn't mean for one moment that we 26 viewed QVC's business as traditional content, but it was 27 an attempt to use the ever increasing cash flow that was 28 being generated by QVC to grow into something much 124 1 larger. 2 You just have to look at the history of what 3 happened after Barry Diller came on to the company. 4 First of all, Paramount, subsequently CBS, neither of 5 them electronic retailing. It was all an attempt, a 6 goal, an aspiration, a wish that was never executed to 7 become something very much bigger within the broadly 8 defined content entertainment category. 9 MR. FRIEDMAN: One thing I wanted to ask you 10 about, John, as well, regarding the relationship that 11 you had with QVC -- you being Comcast with QVC -- and 12 Liberty Media had with QVC. 13 And maybe Neal can address this as well. 14 Wasn't there some protections put in place to make sure 15 that there were no flows of value to insure that Liberty 16 Media's interests were protected? 17 MR. ALCHIN: Absolutely. And Neal can speak 18 directly to the -- the charge that he saw as his 19 responsibility as General Counsel to protect that. 20 But the way -- the structure that we had with 21 Comcast, 57 percent ownership with QVC, was somewhat 22 unique because our 47 partner, namely Liberty Media, was 23 the owner of the only major competitor to QVC. So, 24 that's why they didn't have any Board representation. 25 They had certain veto rights to protect their 26 investment, but, at the same time, it was really run by 27 an entrenched management team with oversight from 28 representatives from Comcast representing the Board -- 125 1 being the Board members. 2 MR. GRABELL: As General Counsel of the 3 company, I saw it as my duty to represent the company 4 not its individual stockholders. 5 And, so, whenever we were in transactions with 6 either of our stockholders, I acted in what I thought 7 was the best interests of the company, and not in the 8 best interests of the stockholder. 9 And sometimes that created great conflict, but 10 that's where my duty stood, is to represent the company 11 as a whole and not benefit one stockholder or the 12 other. 13 MR. FRIEDMAN: And weren't you told by Comcast 14 to ensure that you did not favor Comcast in any way? 15 MR. GRABELL: Yes. At the time I had a 16 discussion with some -- with one of the directors and 17 said, "Now, remember this your duty." 18 And I felt I carried out that duty by making 19 sure that neither stockholder got a benefit, that we 20 acted in what was the best interests of QVC. 21 MS. YEE: Okay. Mr. Chairman, my last 22 question, if I could pose it to Appeals -- 23 MR. HORTON: Sure. 24 MS. YEE: -- Division? 25 Just to avoid any inflation of terms that have 26 been kind of bounced around, if we were to look at 27 applying the contribution or dependency test to 28 establish unity, or to look at solely the flow of value 126 1 test, is there a requirement that the -- that the 2 businesses have to be independent and operating 3 autonomously? 4 The reason I ask is because I'm am not as 5 dismissive of Container Corp. and I think there is some 6 merit to that decision. But I think that was one of 7 the -- 8 MR. THOMPSON: Yeah, I think -- you know, 9 both -- both parties have, you know, naturally, I 10 suppose, presented somewhat truncated views of law. 11 I mean, Appellant is correct to point out that 12 there's a language in a lot of decisions that says, 13 "Look, just because you have the mere potential to 14 control, that's not enough." 15 But if you read those decisions, for example, 16 in Woolworth, it doesn't stop there. It says, 17 "Mere control is not enough if the 18 businesses are discrete, mere potential control 19 is not enough if the businesses are discrete 20 business operations." 21 On FTB's side, I think some of their arguments 22 almost made it sound like control was irrelevant. And I 23 want to be clear here, I appreciate and they're right to 24 point out they're not relying on the strong, the 25 presumption -- the special presumption that can arise 26 from strong centralized management. 27 But certainly the level of control is an 28 important consideration for the Board. It's something 127 1 that all of the cases look at. 2 Just one moment, please. I thought this might 3 come up, I did make some notes. 4 In Container Corp., and -- excuse me, Container 5 Corporation and in other cases as well, the courts have 6 found that there need not be day-to-day control. That's 7 very clear. 8 The courts frequently look to whether there is 9 control over major policy issues or there's a sharing of 10 expertise and knowledge. In that regard, the courts 11 often look at interlocking executives and officers. 12 By itself, the point is well taken, that's not 13 enough. However, the courts do see that as -- and the 14 Board is seeing that -- as a strong indicator, another 15 factor to look at, together with the other factors. 16 I have nothing to add in these cases, but at 17 this point I think it might add more confusion than help 18 to fill in more case names. 19 MS. YEE: I appreciate that, Mr. Thompson. 20 Thank you very much. 21 Thank you, Mr. Chairman, I'll stop. 22 MR. HORTON: I want to see if -- if FTB and the 23 Appellant can bring some clarity to the control issue, 24 being mindful of the necessity to look at the 25 preponderance of the evidence. 26 Relative to the control issue, is it -- is it 27 FTB's position that the opportunity to control is 28 sufficient? 128 1 Or does there -- is there -- is it necessary to 2 prove that they actually exercised the control? 3 MR. MARGOLIS: Well, we're not claiming that 4 the opportunity to control is sufficient. Obviously, 5 the opportunity to control was necessary because you 6 need majority ownership. If you have majority 7 ownership, you, obviously, have the opportunity to 8 control. You need something more than majority 9 ownership. 10 So, you need majority ownership combined with 11 contribution or dependency and that's really all you 12 need, a flow of value. And here you have that. 13 MR. JOSEPH: Certainly when you -- I'm sorry. 14 MR. HORTON: But without control -- I mean, 15 let's -- by your own testimony, this notion of 16 automatically becoming unitary by virtue of ownership -- 17 I can't recall the case that was cited -- but control 18 seems to be a prevailing factor. 19 And, so, again I -- we have witnesses that have 20 testified that they have no control. And if we look at 21 the Tenneco case, it makes reference to the fact that if 22 the control did not exist, that the company actually did 23 everything it could to distinguish the two entities and 24 to create autonomy between the two, then there is no 25 unity. 26 Can you -- 27 MR. MARGOLIS: Well, I think that -- I think 28 that the -- actually, the reasoning in Tenneco, I think, 129 1 is somewhat relevant to this case because in Tenneco 2 what the -- what the court did is it looked at the 3 contemporaneous documents and the contemporaneous 4 statements. And it said that what was contemporaneously 5 stated about their -- the relationships between the 6 companies was a lot more weighty than what they were 7 saying after the fact at the trial where there is a tax 8 dispute. So, that's really the rule I tag out of 9 Tenneco. 10 And here Comcast and QVC were saying that there 11 were flows of value between the two at the time. For 12 example, I have here when Comcast went to merge with 13 AT&T in 2001 or 2002, they filed a public interest 14 statement with the Federal Communications system -- 15 Commission showing why the public would benefit from 16 allowing this merger. 17 And one of the things they said is that -- and 18 this a quote, they said, 19 "The combined firm will be able to benefit 20 from the particular expertise each has 21 developed in areas of electronic commerce and 22 customer care. Comcast has gained valuable 23 experience in customer care -- care systems 24 through its QVC operations." 25 So, this is just another shared expertise that 26 flows back and forth because these companies have been 27 in business together for years. 28 I mean, Mr. Roberts was one of the Executive 130 1 Committee of QVC's Board of Directors from when -- from 2 the first year it was in operation, for the next 15 3 years. So, there is -- there are -- there is an 4 operational relationship and it is a a flow of value. 5 You don't need strong central management in 6 order to have the unitary relationship. 7 MR. HORTON: I agree that you don't need strong 8 central management, but you need to have some 9 decisionmaking occurring relative to the major 10 decisions, at a minimum, between the two. 11 Is there any evidence that that occurred? 12 MR. JOSEPH: Well, I -- first of all, I would 13 say that we do have interlocking boards here. We have 14 shared officers and directors. We have an agreement 15 with Liberty Media that they -- I'm sorry, the Appellant 16 would have control over Comcast -- over QVC. 17 What you've heard in the testimony today was 18 that there was an agreement with Mr. Briggs -- is that 19 the name -- that they would leave him alone and let him 20 run it. 21 We've never seen such an agreement in writing, 22 have we? I've never seen such an agreement, you know. 23 Clearly if such an agreement existed, it would 24 be very, you know, germane to the discussion that we're 25 having right now. But we've never seen such an 26 agreement. 27 Now if you're talking about businesses that are 28 not sharing flows of value, like in Tenneco you're 131 1 talking about a conglomerate. You know, they really 2 were in different lines of business. Those elements of 3 control get more and more important because, really, 4 that's where the flows of value exist. They don't have 5 any other, really, you know, thing that sharing amongst 6 themselves. 7 Here you have interlocking boards. You have 8 shared officers -- you have directors and officers that 9 are shared. You have an agreement that they would have 10 control. And you have companies that share a lot of 11 flows. 12 I think that's more than enough. 13 MR. HORTON: On the flow of value, I believe it 14 was A. M. Castle that spoke to the necessity to have a 15 considerable economic interdependency. 16 And, so, I'm curious if your views on the fact 17 that prior to the acquistion that flow of value existed 18 between QVC, as well as a number of other cable 19 companies? 20 And, so, the same flow of value that existed 21 prior to the acquisition of a majority of the stock 22 continued to exist afterwards. Is it necessary to 23 distinguish that flow of value from -- I understand it's 24 not necessary to -- that the -- the fact that it is or 25 is not an arm's length transaction is not something that 26 we consider -- but is it necessary to distinguish the 27 flow of value from Comcast versus any other cable 28 company? 132 1 MR. JOSEPH: Well, only in the sense that 2 Comcast is the only one who has the requisite amount of 3 ownership for the -- for the analysis to matter. 4 You have to have -- 5 MR. HORTON: That takes us back to control -- 6 MR. JOSEPH: -- well -- 7 MR. HORTON: -- being able to control the flow 8 of value. 9 MR. JOSEPH: -- yeah, Joseph but this is -- 10 this is basically, you know, it's statutorily required 11 that you have to have over 50 percent ownership. 12 MR. HORTON: Right. 13 MR. JOSEPH: That -- that's mechanical. It's 14 not -- your question about control is a little different 15 than that. But it -- I think what you're getting at is 16 did something have to change? Did something have to be 17 different? 18 And I think the answer in the case law is 19 pretty clear no. There doesn't have to be anything that 20 changed, anything that's different. It's enough that 21 that -- that you had the flow of value and now you need 22 the statutory requisite percentage of ownership. 23 MR. HORTON: Speak to me about the carriage 24 agreements and how that establishes a flow of value 25 different than what exists between any other entity. 26 MR. MARGOLIS: Well, we think there's a flow of 27 value between every significant carrier and QVC. 28 I mean, there's -- you know, but you can't have 133 1 majority ownership with more than one distributor. So, 2 basically, I mean there was a flow of value with all -- 3 between every distributor and every content provider. 4 And here there's a -- there's a very 5 significant flow because QVC was the major provider, 6 probably provided more than 50 percent of Comcast's home 7 shopping entertaimment. And Comcast provided 10 percent 8 of QVC's sales. 9 So, you know, you don't -- it doesn't have to 10 be more than -- than the flows to the other 11 distributors, it simply has to be a significant flow 12 combined with majority ownership. 13 MR. JOSEPH: Yeah, they say in their annual 14 reports quite often that QVC is dependent upon their -- 15 their arrangements with all of the cable companies. 16 You know, without the cable companies they 17 can't get to my house, essentially. And if I can't see 18 the signal, I can't buy the product. 19 So, without the cable company, no sale. So, 20 they are dependent upon them for that purpose. And here 21 we have that dependency and we have the company that 22 actually owns more than 50 percent of them. 23 MR. FRIEDMAN: Can I address that, Chair? 24 MR. HORTON: Sure. 25 MR. FRIEDMAN: Couple observations or reactions 26 to what we just heard. 27 One is I think the FTB just acknowledged that 28 they think that there was a flow of value between QVC 134 1 and all of the cable and satellite companies and it 2 wasn't for -- if it wasn't for the ownership 3 requirement, they'd be unitary with all of them? 4 That's somewhat rhetorical, but there's no case 5 that substantiates such a position where you could have 6 a unitary relationship with everybody you're doing 7 business with or, at least, all your sales channel 8 partners 9 Secondly, there's never been a case -- there's 10 never been a case where the ownership requirement has 11 been met, there's been a modest number of intercompany 12 sales and nothing more. 13 We're pressing to find that flow -- the accused 14 flow of value and we can't seem to find it. Container, 15 which is a case I love, doesn't necessarily support 16 contribution or dependency, but it's clearly a unitary 17 case, had a whole slough of them -- debt that was held 18 in guarantee by parents, advice and consultation 19 provided by the parent, manufacturing techniques, 20 engineering, design and architecture provided by the 21 parent, insurance provided by the parent -- it's those 22 whole host of aggregated activities that led to that 23 unitary finding. 24 We had none of that. The FTB will look to some 25 forward looking statements made by some executives. 26 Again, they conducted a thorough audit of both companies 27 and haven't produced a shred of evidence. 28 Regarding the agreement between Mr. Roberts and 135 1 Mr. Briggs, the one that Carl Joseph just suggested that 2 we should turn over, there was no written agreement. 3 It was an agreement that was -- that was 4 constructed over a lunch when Mr. Roberts was hoping to 5 convice Mr. Briggs to stay with the company and run it 6 autonomously. 7 There is no parole evidence rule in State 8 taxation. There's no requirement that somebody had to 9 write down that agreement on a cocktail napkin. There's 10 no written agreement to turn over. Believe me, I wish 11 there was, I'd love to show it to you. But we've had 12 testimony from a number of witnesses that supported the 13 same view. 14 MR. HORTON: Speak to the loan between QVC and 15 Comcast that was made. Was that -- is there any 16 distinguishing factors around it? 17 MR. FRIEDMAN: Yeah, there's a -- I'm glad you 18 raised that, Mr. Chairman. 19 There's an allegation of a loan made between 20 Comcast and QVC, I believe it was a $20 million loan, if 21 I recall correctly. If you look at the FTB briefing on 22 that point, they -- they cite to a Hollywood Reporter 23 article that substaniates the loan. 24 We went back and looked for that loan. And as 25 it turns out, there was no loan -- at least we can't 26 find any evidence of it. 27 And I'll turn to Neal Grabell. He was General 28 Counsel during that time. 136 1 MR. GRABELL: There was no loan that they're 2 referring to. The $20 million that was to be invested 3 in international operations, which is what I think 4 they're referring to, was -- did not occur. 5 We were generating, as I said, hundreds of 6 millions of dollars of cash. We didn't need to borrow 7 $20 million to -- to invest in our -- in this case, 8 British operations. 9 MR. HORTON: Were there any joint investments 10 as referred to by the Department? 11 MR. GRABELL: Yes, we -- we -- we and Comcast 12 both invested in the three entities that Mr. Margolis 13 described. 14 And our relationship with Comcast, as I said, 15 was at arm's length in those investments. 16 MR. HORTON: Question of the Department, 17 given -- presuming that it was at arm's length, 18 what's -- what's the significance of those investments? 19 MR. MARGOLIS: Well, those investments are 20 significant because, basically, these -- these are -- 21 the companies that they invested in tended to promote 22 QVC's business. 23 For example, Global Sports, this was a company 24 that Comcast invested money in, in Global Sports, and 25 then Global Sports entered into an agreement to, I think 26 it was run a sports website for QVC. I'd have to look 27 at my notes to see that. 28 MR. HORTON: Okay. 137 1 MR. MARGOLIS: They also invested in 2 CommerceHub jointly. 3 Commerce -- 4 MR. HORTON: So, you see that as a flow of 5 value? 6 MR. MARGOLIS: Sure. If you want to get -- if 7 you have a -- you need someone to do your back office 8 work and you, basically, fund the company that is going 9 to do your back office work, that's a flow of value. 10 And CommerceHub was providing order fulfillment 11 services for QVC. So, that is a flow of value. 12 And as far as the loans, there's actually two 13 loans, you know. If the $20 million loan in 19 -- in 14 these years didn't happen, uhm, you know, I wasn't aware 15 of it, uhm, but there was a $30 million loan in 19 -- 16 when was it -- in 1989, when they bought out the big 17 competitor, CVN. 18 And that loan was on terms that were not 19 available to the general public. Basically, they 20 invested $30 million in QVC. QVC used the money to buy 21 CVN. And this was convertible stock that they -- it was 22 a convertible loan. So, they converted it into shares 23 of QVC stock in a very favorable manner -- which was not 24 available to the general members of the public. 25 MR. FRIEDMAN: 1989 -- 1989, there was a loan 26 in 1989 when QVC was teetering. Two shareholders lent 27 QVC money to insure that that QVC didn't go out of 28 business. 138 1 Why did they lend money? To protect their 2 investment, their passive investment. 3 Neal, I don't know if you recall any details 4 associated with that, but if you can maybe elaborate as 5 to the condition of QVC at that time? 6 MR. HORTON: What I'd like to do is go to -- 7 unless you prefer to -- Neal? 8 MR. GRABELL: Well, the -- the loan -- first, 9 it was a $50 million loan with Liberty Media. There was 10 also a $30 million loan with Comcast but it was, again, 11 on arm's length term, it was a 10 percent interest rate. 12 It had the normal types of protections that lenders 13 get. 14 MR. HORTON: Vertical integration -- one would 15 argue that vertical integration exists between every 16 business that is within your thought process and that 17 we're all integrated in some form or fashion -- be it 18 wheat, the seed or whatever, it's all integrated in the 19 production of food and so forth and so on. 20 So, how does vertical integration without 21 control -- why does it even matter? 22 It's a question of the Department. 23 MR. JOSEPH: Well, I think that the court cases 24 have made it pretty clear that when you have businesses 25 that economically -- I understand your point, but I 26 think we need something a little tighter than that -- 27 that economically when you have businesses that are 28 vertically integrated, the case law -- and I think 139 1 economists too -- would say that there's a very high 2 likelihood when that occurs that there are going to be 3 flows of value. 4 And that's why the presumption exists and 5 that's why the cases find it important. 6 Now, your point about control -- 7 MR. HORTON: Can you -- can you speak to the 8 case? It may help. 9 MR. JOSEPH: Yeah. 10 MR. HORTON: Just so I can look it up and -- 11 MR. JOSEPH: Okay, hang on. 12 MR. HORTON: -- read it, if I haven't already, 13 which is probably the case. 14 MR. JOSEPH: Let's see, I'm trying to use the 15 long hearing summary. 16 Let's see -- yeah, I'm trying to find it. 17 MR. HORTON: Question of the Appellant while 18 he's looking -- the statements that were made in the -- 19 in the minutes and the -- so forth, those various 20 different documents, who made those statements? And 21 what authority did they have to make them? 22 MR. FRIEDMAN: In the -- I am sorry, in the 23 Comcast minutes? 24 MR. HORTON: Yes. 25 MR. FRIEDMAN: They were made by -- there is a 26 couple of them I recall. I think one was maybe made by 27 Ralph Roberts, if I'm -- if I'm tracking with you. 28 MR. HORTON: Were the statements made in the 140 1 way of -- that the entire Board sort of concurred with 2 the statement? 3 Or is this a statement that one individual made 4 or -- 5 MR. FRIEDMAN: It was one individual made as 6 far as I'm concerned. I think it was in minutes to 7 meetings. It was attributed to one individual. 8 Does that sound right? 9 MR. ALCHIN: I'm sorry, I missed that. 10 MR. FRIEDMAN: A question regarding statements 11 made in Board of Directors minutes and were they 12 reflective of the entire Board of Directors or were they 13 reflective of an individual's perspective? 14 And my -- my understanding is they were 15 reflective of an invidual's perspective, not the Board. 16 MR. THOMPSON: Ralph Roberts, the Chairman of 17 the Board. 18 MR. FRIEDMAN: Right, yeah. 19 MR. ALCHIN: And I think what Ralph is 20 describing there is just an aspiration. 21 Once again, when Barry Diller came on board 22 there was a goal to build a larger content company. But 23 it was a -- you know, something that was never achieved 24 in this time frame. 25 MR. MARGOLIS: Actually, the minutes 26 that were -- recorded Ralph Roberts was at the time 27 Mr. Diller was leaving and Comcast was acquiring 28 majority ownership. This was two years later. 141 1 But it was a statement by Ralph Roberts as to 2 saying why they required majority ownership was because 3 they did not want to become a passive investor. 4 MR. FRIEDMAN: No, it was also before the -- 5 the agreement with Doug Briggs to stay on with company 6 and run the company on an autonomous way. 7 So, again, there was -- there was -- there were 8 a few instances over the life cycle of QVC and its 9 ownership by Comcast where there was a notion that maybe 10 QVC would become something else, not a mundane 11 electronic retailer -- no offense -- but a more 12 traditional content company like Paramount. That deal 13 fell appart, like CBS, that deal fell apart. It never 14 happened. 15 And there was an expectation that something 16 else might be around the corner one day. It never 17 happened. 18 Again I noted in the opening, there was some 19 forward looking statements, some kind of wishing going 20 on. It never materialized. 21 MR. HORTON: Department? 22 MR. MARGOLIS: What's that? 23 MR. HORTON: I'm coming back. 24 MR. MARGOLIS: Are you ready? 25 MR. JOSEPH: I think I found it. I might -- 26 MR. HORTON: Okay. 27 MR. JOSEPH: -- okay, there's two places in my 28 little notes here. 142 1 The first one is from Appeal of Dr. Pepper, 2 which we've talked about a lot, which says, 3 "Your Board has held that a vertically 4 integrated enterprise has consistently been 5 regarded as a classic example of a unitary 6 business." 7 And then in the regulations, in 25120 (b)(2) it 8 says, 9 "The taxpayer is almost always engaged in a 10 single trade or business when its various 11 divisions or segments are engaged in different 12 steps in a vertically structured enterprise." 13 That's what I was thinking of. 14 I mean, it makes sense, you know, if you're 15 talking about the classic, dig it out of the ground, 16 turn it into a -- or sell it, you know, to the jewelry 17 store, that makes perfect sense. 18 And in this case it is a little different in 19 that we're talking about access to the raw material 20 being subscribers. And what are you going to show those 21 subscribers? What is it that you're going to put down 22 that down line that's going to make you money? 23 You're going to put programming on there. This 24 programming makes you money from commissions. Other 25 programming makes you money from fees. But you have to 26 do something that's interrelated with programming to 27 actually take greater advantage of having that access 28 into people's houses. 143 1 And I think also -- and maybe one of the folks 2 from Comcast can talk about this -- during the time 3 we're talking about here, you know, Comcast -- these 4 were pretty exclusive agreements in most jurisdictions. 5 I mean, if you were -- you were the cable company in a 6 particular area, there might be some satellite folks 7 maybe around, but is that pretty true? 8 I mean, we're back in the '90s here. 9 MR. HORTON: I'm not going to allow that. I 10 mean -- 11 MR. JOSEPH: I'm sorry. 12 MR. HORTON: -- I don't really see the 13 significance of that. 14 MR. MARGOLIS: Mr. Horton, I think what 15 Mr. Joseph was getting to is that Comcast subscribers a 16 only have one way of getting the TV signal. 17 I mean they're -- they sign up with Comcast. 18 They're not also going to sign up with the satellite 19 service as well. They're not also going to sign up -- 20 and since most jurisdictions only have one cable 21 provider, if QVC wants to make it to this customer, the 22 only way he can get there is completely dependent on the 23 cable company that has access to that subscriber. 24 So, the only way he could have made these -- 25 the 10 percent of its -- of its profits was by agreeing 26 with Comcast to -- for Comcast to carry its signal. 27 MR. ALCHIN: Mr. Chairman, may I respond? 28 MR. HORTON: Sure. 144 1 MR. ALCHIN: Thank you. 2 I think -- I think that really mischaracterizes 3 what was going on in the market at that point in time. 4 At this time you had mushrooming numbers of 5 subscribers growing in the satellite business. We were 6 in fierce competition. We had to rebuild our cable 7 systems. In the time that we owned QVC, we spent over 8 $7 billion rebuilding our networks. 9 At the same time the satellite companies 10 launched their service. There were a huge number of QVC 11 customers buying product and they're getting 12 distribution through satellite distribution of the 13 signal. And we were competing fiercely to keep our 14 customers. 15 At the same time, we're just in that period 16 where telephone companies are coming in as competitors 17 as well. 18 So, I think it's just not right to characterize 19 this cable platform as being the only way that QVC could 20 get access to the end customer. 21 MR. HORTON: Okay. The Department referenced 22 an intercompany commission fee as part of the carriage 23 agreement. And that -- I'm presuming that commission 24 fee sort of signifies a flow of value as well as a 25 dependency. 26 Does the Appellant have any response to that? 27 MR. FRIEDMAN: Neal, do you want to just 28 describe the carriage arrangements? 145 1 MR. GRABELL: Yeah, the commission -- we paid 5 2 percent of sales to all distributors for the zip codes 3 in which customers purchased. So, this was uniform 4 throughout the company. 5 The 10 percent of revenue that we derived from 6 Comcast customers, had we lost it, it would have hurt. 7 Would it have been fatal? No. So, I don't think I 8 would say we were dependent on the Comcast revenues. 9 It was very significant. It was important. 10 But we were not dependent on it. 11 MR. FRIEDMAN: I mean, again it seems to me 12 that QVC was no more dependent upon Comcast than they 13 were on UPS or FedEx. 14 They had ways to reach their customers. If 15 those ways were cut off, then they would have to do 16 something -- a different business practice, whether it's 17 engage in more sales through the satellite companies or 18 through the telephone companies or something else -- 19 just like they would ship differently -- no different. 20 MR. HORTON: The courts have -- have found that 21 the level of dependency is not necessarily the issue. 22 Do you differ with that? 23 MR. FRIEDMAN: Well, of course, we argue that 24 there is no dependency here. 25 But, clearly -- and I think as we have heard 26 from the attorney from the State -- you look at all of 27 the factors in aggregate to determine whether there is 28 enough of a connection, enough of an integration, enough 146 1 of a control or enough of a flow of value to demonstrate 2 or to justify a unitary relationship. 3 So, yeah, there is a measuring that must go on. 4 And certainly there's a number of cases that support the 5 notion that intercompany sales are okay. Certain 6 transfers of executives are okay. Certain guarantees of 7 debt are okay. Certain transfers of IP are okay. 8 Certain shared functions, especially stewardship-type 9 functions are okay. 10 But I do think that you don't look at any of 11 those things in isolation. You look at the aggregate of 12 activities and connections. 13 MR. HORTON: The Department spoke of a change 14 in the term of the agreement, I believe, from a two-year 15 agreement to a seven-year agreement and that somehow 16 that the ultimate agreement provided a flow of value 17 different than what would have existed in the open 18 market. 19 Am I characterizing that -- 20 MR. MARGOLIS: Well -- 21 MR. HORTON: -- just -- I really just want you 22 to -- if you could -- just refresh our -- my memory of 23 why you thought that was significant. 24 MR. MARGOLIS: -- well, I was just showing all 25 of the different forms of the consideration received 26 under the agreement. 27 It received commission fees of 5 percent, which 28 during our -- the eight years that they were a majority 147 1 owner amounts to about $99.8 million, according to their 2 own exhibit. 3 But also each time they renewed their 4 agreement, they -- QVC paid them more, sometimes it paid 5 them in cash, sometimes it paid them in stock. But that 6 was in addition to the $99 milllion that it got just in 7 commission fees alone. 8 And it also gave them -- from time to time they 9 got special addendums to pay for channel placements. 10 So, there's really three -- at least three 11 different types of commissions and sometimes they even 12 got launch fees. 13 So, that's all we're trying to do. There's 14 various fees they recevied under these agreements. 15 ---o0o--- 16 MR. HORTON: Okay. Further discussion, 17 Members? 18 Okay. In such case, we will move on to the 19 third issue which is the dividend deduction. 20 MR. FRIEDMAN: Maybe, um -- and this may be a 21 relief. We're going to stand on our briefing. Unless 22 you'd like to engage in questions, we're comfortable 23 standing on our briefing, understanding that there's 24 other law in the state. 25 MR. HORTON: I think you have that option. 26 MR. FRIEDMAN: Okay. 27 MR. HORTON: Um, discussion, Members? 28 Okay. Members just gave it to you. Uh, okay. 148 1 Far be it from me to question my colleagues. 2 Uh, the last and final issue is the penalty, 3 um, issue. 4 Discussion, Members? 5 MR. FRIEDMAN: Mr. Chairman, if I may interrupt 6 for a moment. 7 MR. HORTON: No, you may not. 8 Discussion, Members? 9 It wouldn't appear that there's any discussions 10 on the penalty item. Okay. 11 MS. YEE: Actually -- 12 MR. HORTON: Member Yee. 13 MS. YEE: We've, uh, talked a little bit about, 14 uh, the substantial authority exception. Uh, I guess I 15 want to delve into a little bit about, uh, what would 16 be, um -- Mr. Thompson, I'm sorry. I kind of keep 17 putting you in the hot seat. 18 Um, I'm trying to get a grasp of what would 19 constitute substantial authority for tax treatment. Um, 20 and this speaks to, um, I guess the validity of TAMs, 21 other types of notices, other types of -- 22 MR. THOMPSON: Right. 23 MS. YEE: Yeah. 24 MR. THOMPSON: Well, uh, Appellant is correct 25 that substantial authority does not have to be greater 26 than 50 percent. You will often see practitioners say, 27 yeah, maybe 40 percent. The reg, of course, doesn't 28 give a percentage. 149 1 MS. YEE: Mm-hmm, right. 2 MR. THOMPSON: So that's a little imprecise, 3 but maybe it's helpful. 4 Um, the regulation indicates that the question 5 is simply whether the authorities for the position are 6 substantial in relation to the other authorities. And 7 in making that determination, you look at the facts and 8 consider whether the cases are, uh, materially 9 distinguishable. And if they're materially 10 distinguishable, they are not substantial authority. 11 Or, um -- when the decisions were issued, who 12 they were issued by, and you consider all the facts and 13 weigh them and say, is the authority for the position 14 substantial, not necessarily winning, but substantial in 15 relation to contrary, uh, the contrary position. 16 In the hearing summary in the staff comments, 17 uh, we set forth what we understood to be representative 18 of the authorities relied on by the parties. Uh, and I 19 can discuss those if you'd like. But I -- I -- I think 20 the question for the Board is, uh, again, whether the -- 21 whether the authorities are substantial -- whether 22 Appellants' authorities are substantial in relation to 23 the contrary authorities set forth in the TAM. 24 Let me add, also, with respect to the TAM, the 25 TAM -- this may risk stating the obvious, but it doesn't 26 support Appellants' affirmative position. It finds 27 against Appellant on the return of capital position. So 28 it wouldn't constitute substantial authority in favor of 150 1 Appellant. 2 Does that make sense, because that's an 3 important point? 4 MS. YEE: That -- that's my question -- 5 MR. THOMPSON: Yeah. 6 MS. YEE: -- that I want to pose to the 7 Appellants. 8 MR. THOMPSON: Okay. Well, I mean -- 9 MS. YEE: It's kind of -- 10 MR. THOMPSON: It rules against the Appellants, 11 so it's not substantial authority for their position. 12 Now, that said, and I'm not looking, but I 13 imagine they're about to leap out of their seats. I -- 14 I hear their point that with regard to the reasonable 15 cause and good faith exception, that, uh, the Board 16 might look at that and say, this looks to us like this 17 was a tough issue. It's tough for me. And a TAM was 18 issued and we're drawing an inference from that that 19 there was some lack of clarity there, and that the Board 20 might consider that in the context of its reasonable 21 cause and good faith argument. 22 Um, I don't know if that's helpful. I'm happy 23 to address any followups. 24 MS. YEE: No, it is. Because what I'm trying 25 to do is to really get clear about, um -- um, on what 26 authority you're -- well, on what you're relying on to 27 make your argument with respect to substantial 28 authority. 151 1 I understand the purpose of the TAM. And, 2 yeah, TAMs are, by and large, for the purpose of trying 3 to provide some clarification in a particular area. Um, 4 I don't know if there -- I mean, it seemed to me there 5 was a little bit of reliance on the, um, Arthur Andersen 6 report. And, uh, I don't know that I would consider 7 that to be, um, along the lines of other types of 8 publications, guidance, you know, official guidance 9 that's been issued, uh, relative to how we ought to 10 apply, um, conclusion by tax professionals to determine 11 substantial authority. 12 So, can you, Mr. Sperring, maybe just kind 13 of -- just kind of for the Board, kind of just define 14 the pieces that you're relying on to help us look at the 15 exception here. 16 MR. SPERRING: Sure. And -- and -- yeah, 17 there's two points here; one substantial authority and 18 the other reasonable cause -- 19 MS. YEE: Okay. 20 MR. SPERRING: -- as Mr. Thompson mentioned. 21 MS. YEE: And speak about the TAM. 22 MR. SPERRING: Sure. 23 MS. YEE: Because I -- I'm not sure that 24 it's -- I'm missing something there. 25 MR. SPERRING: Sure. Sure. 26 Yeah, on substantial authority, what the TAM 27 said was -- the TAM acknowledged the basic law that 28 Arthur Andersen opined on. And that is that you go to 152 1 the origin of the claim. Okay. And so it goes to 2 payor's intent. 3 And what the TAM said -- so there's -- so from 4 our perspective, right, you have an agreement in the 5 law. Okay. So right there we have something positive. 6 In the Arthur Andersen memo and the IRS, they agree on 7 the law. And then the issue is, well, do the facts 8 support, um, the conclusions that the Arthur Andersen 9 opinion, uh -- uh, reached? 10 And what the IRS said, is, well, you know, the 11 key, um, factual evidence would be documentary evidence 12 of, uh -- uh MediaOne's intent when they paid the claim. 13 And if you look at the determination agreement, it's not 14 there. Okay. So at that point the IRS and the TAM 15 said, well, let's look at, uh -- um, what other 16 commentators have said about the termination fee. Okay. 17 So, the thing that Arthur Andersen struggled 18 with is the same the IRS -- the same thing the IRS 19 struggled with; and that is, you don't have, uh, 20 contemporaneous documentation of MediaOne's intent. And 21 so, that's why there's a struggle. Okay. 22 And I think that's why both sides, if you will, 23 come down on, you know, it's less than 50 percent, 24 because it's not this the contemporaneous, uh, 25 documentation. 26 With that said, as Mr. Thompson pointed out, 27 um, and as FTB confirmed, the good news for the 28 taxpayer, right, is that they have four safe harbors 153 1 that they can rely on. And reasonable cause and good 2 faith is a safe harbor, just like substantial authority. 3 And so if your Board finds that we don't have 4 substantial authority, then the issue of do we have 5 reasonable cause and good faith. 6 And the thing that, uh, is, we think, very 7 helpful in there is, uh, the case laws, right, that have 8 been cited by, um, the taxpayers as well as the FTB. 9 And in a case that taxpayer cited, in Recovery Group, 10 okay, uh, what you had -- Recovery Group v. 11 Commissioner. It's a United States Tax Court Case, 12 2010. And in that case the taxpayer, an S Corporation, 13 entered into a covenant not to compete agreement in 14 connection with a buy-out plan for the founder 15 shareholder. The taxpayer, uh, erred in amortizing the 16 covenant not to compete over 12 months instead of 15 17 years, right. So they took it all in one tax year. 18 Okay. Clearly an error. Okay. 19 And, uh, so the IRS imposed an accuracy-related 20 penalty, and the tax court said, uh -- uh, that there 21 was reasonable cause and good faith. And why did they 22 say that? Well, the Court determined that the 23 representatives were competent professionals with 24 sufficient expertise. The CPA has been involved with 25 the buy-out agreement from the beginning. The CPA in 26 turn relied on another qualified professional, a tax 27 specialist who was also a CPA and held a Master's 28 Degree. 154 1 So here you have, in my opinion, right, an 2 obvious error, okay, in that you're amortizing something 3 over one year instead of 15 years. But because the 4 taxpayer had relied on a CPA, okay, a competent 5 professional, reasonable cause and good faith was found. 6 And if you look at the case cited by FTB, okay, 7 Boyle, okay, Supreme Court 1984, in Boyle reasonable 8 cause was not found to be there because, um -- uh -- uh, 9 there was a specific duty. Okay. The Court 10 distinguished the taxpayer situation where Congress has 11 specifically charged a specific duty to file in a state 12 tax return within a specific time frame. 13 So there, okay, the, uh, accountant did not 14 file the return on time. And the Court distinguished 15 and said, on the other -- on the other hand, on a matter 16 of tax law, the Court stated when an accountant or an 17 attorney advises a taxpayer on a matter of tax law such 18 as whether a liability exists, it is reasonable for the 19 taxpayer to rely on that advice. 20 So here, Andersen is advising Comcast, tax 21 liability doesn't exist. Thus, it would be reasonable 22 to rely on it as opposed to whether you need to file a 23 return or not, a statutory duty. 24 And, um -- uh, the other case that the FTB 25 relies on, Candyce Martin 1999 Irrevocable Trust v. 26 United States, in that situation you had a taxpayer who 27 was, uh, involved in a -- uh -- uh, an abusive tax 28 avoidance transaction, okay, the Son of Boss, which -- 155 1 which the IRS had already put taxpayers on notice 2 that -- uh, that this was, um -- uh -- a, uh -- an 3 abusive transaction. And after that notice, um -- uh, 4 the adviser sold it to the -- to the taxpayer. And at 5 that point the Court determined the advice was 6 unreasonable, okay, because it was not based on all the 7 facts and circumstances and included unreasonable 8 factual and legal assumptions. 9 And then, um -- uh, finally I go to, um -- uh, 10 Neonatology Associates, and in that case, um -- uh, you 11 had a situation where the taxpayer was relying on an 12 insurance agent and not a tax expert. Okay. 13 MS. YEE: Okay. 14 MR. SPERRING: But, you know, we think the law 15 is pretty clear. When you rely on your tax preparer and 16 you're not, um -- uh, missing a duty, like filing a 17 return or making a payment, but it -- it goes to an 18 issue of tax law, that, uh, good faith and reasonable 19 cause, uh, you know, is warranted. And that's where we 20 think we're in that situation. 21 MS. YEE: Okay. Thank you, Mr. Sperring. 22 Franchise Tax Board. 23 MR. MARGOLIS: Yes. First of all, we didn't 24 cite the Boyle case I think that's a case that the 25 taxpayer relied on. It's a failure to file case which 26 really isn't relevant. 27 But when it comes to deciding whether or not 28 there's substantial authority for the taxpayer's 156 1 position, it's -- it's sort of a link in the chain 2 concept applies where a chain is only as strong as its 3 weakest link. And to have substantial authority, you 4 need to look at what all the elements are that are 5 critical to the taxpayer's ultimate filing position. 6 So if a taxpayer has to prove facts A, B and C 7 as well as legal positions D and E, unless it has 8 substantial authority for all three facts and all two 9 legal positions, it doesn't have substantial authority 10 for the position taking on the return. 11 And that's something that comes out of the 12 Recovery Group where there were several different 13 aspects of the Court's decision. And it looked at each 14 different element and decided did it have substantial 15 authority for this fact, for this legal position, and 16 went one by one through the entire process of 17 determining whether or not there was substantial 18 authority. 19 And although you can have substantial authority 20 with less than 50 percent of certainty, um, you can have 21 more than one, uh, position on substantial authority for 22 a legal position, but not for a fact. A fact is a fact. 23 There's either substantial authority for it or it's not. 24 And here, what the Andersen memo, uh, purported 25 to be based on were facts that were disclosed to them by 26 Comcast, and it relied upon those facts. And the IRS 27 TAM said we don't find any factual basis for those 28 facts. And Comcast hasn't proven any factual basis for 157 1 those facts. That's exactly what the IRS TAM said. 2 I mean there's normally a presumption that when 3 you receive income, when you receive a payment, it's 4 income. And here, they have -- they gave no facts to 5 prove that really MediaOne intended to pay for damaging 6 you. What they were paying for was lost profits. 7 Um, and yes, in the Recovery Group the taxpayer 8 was able to escape the penalties by the catch-all 9 provision for reasonable cause and good faith. But in 10 that case the taxpayer made a strong showing of exactly 11 what it told its legal advisers and exactly what the 12 legal advisers told it back. And they actually followed 13 that advice. 14 Here, all we have is an opinion letter, and 15 it -- it knew that there was something fishy about this 16 opinion letter because it didn't follow it for federal 17 purposes. This opinion letter was only written for 18 federal purposes. It wasn't written for state tax 19 purposes. So they obviously knew that this thing wasn't 20 all that reliable. 21 And so, um, they can't really claim good faith 22 here because they really didn't have exhibited good 23 faith. 24 Um, and also, when they were -- the opinion 25 letter doesn't tell them how to report it. Now, for 26 federal tax purposes they reported this as a capital 27 gain, and then they backed it out on Schedule D. And 28 that's how their state tax person told Comcast -- you 158 1 know, told his -- his subordinate to file the return for 2 California purposes. But for some reason, it wasn't 3 reported the way the in-house adviser told it to be -- 4 it to be reported. 5 Now if they had reported this as nonbusiness 6 income on the California return, we wouldn't be here. 7 That's not a problem. If this had reported this to 8 Pennsylvania and paid tax on a hundred percent of this 9 income, we wouldn't be here. But we are here because 10 they didn't, in good faith, take a position reporting 11 this income at all. 12 MS. YEE: Okay. Let me, uh, come back to 13 Mr. Sperring. I am curious as to why, uh, the opinion 14 letter wasn't followed when -- 15 MR. SPERRING: Great question. It was 16 followed. That was a misstatement by Mr. Margolis. 17 It was followed. It was followed on the 18 amended return. And -- and, again, the reason why it 19 was filed on the amended return was because they 20 understood they had substantial authority. They 21 understood that it was less than 50 percent. And so 22 that's why it was, uh, filed on an amended return at the 23 federal level. 24 The problem that Mr. Donnelly had as the State 25 Tax Director at the time was he felt duty-bound to file 26 consistent with the latest filed federal return, because 27 the state return was due after the federal return. So, 28 uh -- uh, once the federal tax group amended the federal 159 1 return, he felt duty-bound to follow that and that's 2 what he did. And he felt fine because the federal, 3 uh -- uh -- uh, folks provided the Andersen memo. They 4 clearly had substantial authority for that. So he, from 5 his mindset, he was duty-bound to do that. 6 And again, as the chart shows, even if, uh, the 7 taxing agency had thought there wasn't, um, substantial 8 authority, he had disclosure, it was on the M 1, okay. 9 It was, uh, you know, 1.5 billion out of 2.6 billion. 10 So it was, uh -- uh, there. That's what the auditor's, 11 first thing when they come in, they ask look at the M-1 12 and -- and all the supporting documentation. 13 And then lastly, keep in mind, from the good 14 faith perspective, which I know this Board's very 15 concerned about, from the good faith originally -- had 16 he not filed consistent, he would have filed the 17 termination fee as nonbusiness income, which, you know, 18 was my opening on this. We're really fighting over 19 which bucket. FTB doesn't like the fact that it -- it, 20 um -- he filed it as return in capital on the M-1, made 21 the adjustment there as opposed to putting it as 22 nonbusiness income. Because, either way, from 23 Mr. Donnelly's perspective, the amount he owed to 24 California was the same. And clearly, uh, he had -- uh, 25 we think more than substantial authority for his 26 position that it was nonbusiness income. 27 So, either way, he, uh -- uh, the amount of tax 28 that he was going to report to the state was the same, 160 1 and he felt duty-bound to follow the federal return. 2 MS. YEE: Okay. Uh, I may have missed this. 3 Was there a timing issue with respect to why the 4 position of the opinion letter wasn't reflected in the 5 original return? 6 MS. MANDEL: The original -- 7 MR. SPERRING: The original return to the IRS? 8 MS. YEE: Yes. 9 MR. SPERRING: Um -- uh, the timing issue was 10 Andersen memo made it clear that it was not a more 11 likely than not. 12 MS. YEE: Uh-huh. 13 MR. SPERRING: Okay. So as a result, okay, the 14 federal folks thought the safest approach is to file it 15 as an amended return, okay. So if the IRS disallows it, 16 you're not in a deficiency situation, okay. But that 17 was clearly different than California because 18 California, it -- they would have filed it as 19 nonbusiness, you see. 20 And so really, Mr. Donnelly was just choosing 21 between two buckets of nontaxable income to place it in. 22 And he -- he struggled with it, as we saw in the 23 e-mails. Ultimately, he came down, after talking to 24 competent advisers, you ought to follow the, um -- you 25 ought to be consistent with your, uh -- uh -- uh, most 26 recently filed federal return. 27 MS. YEE: Okay. 28 MR. SPERRING: And that's what he did. 161 1 MS. YEE: Okay. Now I appreciate the 2 clarification. 3 Thank you, Mr. Chairman. 4 MR. HORTON: Thank you. 5 Further discussion, Members? 6 Question of the Department. Um, the mere 7 seeking of a Technical Advice Memo, uh, seems to imply 8 some confusion. 9 Um, can you speak to -- I guess you can't. I 10 was going to ask can you speak to why the Technical 11 Advice Memo was requested? Can you speak to that? 12 MR. MARGOLIS: Um, I can speak to its 13 significance. I don't know exactly why it was 14 requested. 15 MR. HORTON: Okay. 16 MR. MARGOLIS: I used to work for the IRS 17 actually, then I worked in private practice for a while. 18 When -- during the course of an audit, uh, 19 taxpayers can actually request a Technical Advice 20 Memorandum. They can request it directly. Or if 21 they're about to get an adverse ruling from an auditor, 22 they might say could the auditor -- could you request a 23 Technical Advice Memorandum, because we don't like your 24 tentative decision. 25 So, you can't really be sure who generated the 26 Technical Advice Request. Whoever generates it, once -- 27 once a request is made, it's automatically -- they're 28 automatically going to write it up unless it's what's 162 1 called a frivolous request. 2 And so, the fact that a request was made where 3 a decision -- or a TAM was issued is really irrelevant. 4 And in any event, the standard here is not whether 5 there's confusion but whether or not there's substantial 6 authority. And when the Technical Advice Memorandum was 7 ultimately issued, it found that there's no factual 8 support for the taxpayer's position. So, just the 9 issuance of the Technical Advice Memorandum doesn't 10 really prove anything at all. 11 MR. HORTON: You know, this penalty has always 12 been a little troublesome for me. The issue of 13 substantial authority, uh, is somewhat subjective. And 14 when the taxpayer files a return, they file -- they rely 15 on the advice of the expertise within their grasp to 16 make a decision. To make a decision, the mere fact that 17 the Board of Equalization or the taxing authority 18 disagrees with that decision, um, is not an indication 19 of malice on their part or intentional disregard. 20 Uh, but, um, the question of the Appellant, you 21 make reference to the fact that it was listed on the 22 M-1. I believe it was the McCoy Enterprise case which 23 said it doesn't really matter. Uh, and so help me 24 understand why that is so significant from your 25 perspective. 26 MR. SPERRING: Good question, Mr. Chairman. 27 Um, in McCoy Enterprises, what you had there 28 was a, uh, a blown disc. And so, as a result, income 163 1 generated from the disc was going to be taxable. And so 2 what was, um, disclosed on the M-1 was the distribution 3 from the disc but not the income. Okay. 4 So here, we think we're readily distinguishable 5 because of the $2.5 billion number that was placed on 6 the M-1, or 2.6, excuse me; 1.5 was, uh, the termination 7 fee. 8 So as a result, um -- uh, you know, all of 9 that -- all the dollars were incorporated in the M-1, 10 unlike the situation, um, in McCoy. And again, you 11 know, we go back to, um -- 12 MR. HORTON: So, I mean it's your -- is your 13 position that the M-1 actually disclosed the termination 14 agreement as well as the significance of it? 15 MR. SPERRING: Um -- uh -- uh, well, our 16 position is that, um, the M-1 disclosed that we took a 17 $1.5 billion, okay, book to tax adjustment. And, in 18 other words, we received this payment and we were not 19 treating it as taxable income. Okay. 20 Now, they would have to go and ask why, right? 21 But they had, uh, on the return, the four corners of the 22 return, the numbers, uh, you know, that were excluded 23 out. They had the full 2.6 billion that Comcast 24 excluded from taxable income. 25 MR. HORTON: Is there any other authority, uh, 26 that you relied on other than the Arthur Andersen memo? 27 MR. SPERRING: Uh, yes, Mr. Chairman. We also 28 relied on a CPA Leonard Podolin. So we had, uh, two, 164 1 uh -- uh -- 2 MR. HORTON: Has the Department looked at that 3 document? 4 MR. MARGOLIS: Yes. It's just a cover letter 5 to show legal authority cited. It's a two-page cover 6 letter to the Andersen memorandum. 7 MR. HORTON: Department believes it's just a 8 cover letter. What legal authority did they cite? 9 MR. SPERRING: Um, well, Mr. Podolin does refer 10 to the Andersen memo, um, but he's, uh -- himself, was a 11 former Arthur Andersen partner, long-time CPA who the 12 company had used and relied on. 13 MR. HORTON: Any subsequent discussions? Any 14 discussions subsequent to the issuance of that letter? 15 I mean, once you receive the letter -- 16 MR. SPERRING: Yeah. 17 MR. HORTON: -- arguably there would be 18 conversation. 19 MR. SPERRING: Oh, yeah. 20 MR. FRIEDMAN: There were. 21 MR. HORTON: That occurred? 22 MR. SPERRING: Yeah. Yeah. Yeah. Again, um, 23 I guess keeping in mind, uh, Mr. Chairman, there would 24 be two -- two sets of discussion. There was amongst the 25 federal tax department at Comcast as to how they're 26 going to file. But then what was -- is really relevant 27 here is, among, uh, the state tax department how are 28 they going to file? And that was something that 165 1 Mr. Donnelly, um -- uh, reached out because he had to 2 file returns in multiple states. 3 And so some states -- for example, in Florida, 4 Florida took the position that you file consistent with 5 your, uh, original return. So Mr. Donnelly did that in 6 Florida. And classified it as nonbusiness income. 7 Okay. 8 So, um -- uh, he -- he -- he went through all 9 the states to try to find, uh, you know, how he should 10 file. And in California he was not able to find any 11 written advice from FTB, and we still haven't seen that 12 to this day. But he did talk to, um -- uh, Arthur 13 Andersen partners, uh, that -- uh -- that, um, do state 14 tax work, Salt Partners, who advised him that you file 15 in California, uh -- uh, consistent with your most 16 recent federal return. So your latest amended return, 17 which is what he did. 18 MR. HORTON: The Internal Revenue, uh, 19 ultimately made a decision. Uh, was that decision based 20 on any additional information other than your return? 21 MR. SPERRING: Well, um -- uh -- uh, the IRS 22 received the Andersen, uh, memorandum. So they had 23 that. That was, uh, turned over. They looked at that. 24 They acknowledged that. 25 MR. HORTON: Okay. 26 Further discussion, Members? 27 Member Mandel. 28 MS. MANDEL: Um, only -- only if you give me 166 1 permission to go back an issue. So when you're ready to 2 do that -- if you're ready to do that. 3 MR. HORTON: Okay. 4 Member Yee. 5 MS. YEE: I just wanted to kind of get clear in 6 my mind just to pick up where you started to go. And 7 that is, um, it seems to me the tax treatment of -- I'm 8 looking for consistent tax treatment. And I now 9 understand kind of the amended return that was filed. 10 But, I guess, can you just kind of go through 11 jurisdiction by jurisdiction kind of how -- I heard 12 Florida. Didn't hear a whole lot about Pennsylvania. 13 But kind of what all happened, just so I can kind of get 14 in my head what -- how -- 15 MR. SPERRING: Right. Well, and I'm -- I'm 16 somewhat at a disadvantage. I only know -- I only know 17 what's in the record. 18 But, um -- uh -- uh, the only state where -- 19 um, besides Florida, where written advice was able to 20 find was I believe Illinois. And Illinois, uh, was, um, 21 ultimately, uh, what, um, the advisers told 22 Mr. Donnelly, uh, you know, for California. And 23 Illinois said, you file consistent with the, uh, amended 24 return, the most recent amended return. 25 So, given Illinois' sophisticated state, okay, 26 um, that also gave Mr. Donnelly some, uh, assurance, uh, 27 that, um, what he was doing in California was right. 28 MS. YEE: I guess authorities aside, what 167 1 actions actually took place? I mean, in terms of how it 2 was reported in the different jurisdictions? 3 MR. SPERRING: Well, um -- uh -- um, in most of 4 the -- in most of the, uh -- uh, the states, it was 5 going to be filed as nonbusiness income. 6 That's -- if that was your question. Is your 7 question -- 8 MS. YEE: And was it? I guess that's the 9 question. 10 MR. SPERRING: So -- yeah. 11 MS. YEE: Okay. 12 MR. SPERRING: To my knowledge, it was filed as 13 nonbusiness income in Illinois. 14 MS. YEE: Okay. And how about any other 15 jurisdictions? 16 MR. SPERRING: Well, I mean, what I've seen in 17 the record is Florida, Illinois and California. 18 MS. MANDEL: I think you're getting the 19 querulous looks from FTB. 20 MS. YEE: Do we know? 21 MR. SPERRING: I mean, if they know, please 22 say. 23 MR. MARGOLIS: I think that in the briefing 24 they took the position they said that they did not 25 report it in Illinois. And we've repeatedly asked them 26 for information about this Florida advice they got, and 27 they haven't disclosed it and they haven't, you know, 28 provided their Florida returns. So there's no 168 1 documentation to support what they're saying about how 2 they filed other -- in other jurisdictions. 3 And, in fact, you know, we've -- we've asked 4 them for the advice they got, um, about how to implement 5 the Andersen decision memo and what they were doing for 6 state tax purposes. And we heard back from Comcast's 7 attorney, um, and we were told, quote: 8 "We are not aware of Comcast requesting or 9 obtaining advice from outside tax professionals 10 regarding the state tax treatment of the 11 termination fee, nor do we believe Comcast 12 employees prepared any such analyses." 13 So, I mean, I'm sure there were -- I'm sure 14 there were discussions that happened, but I'm sure with 15 a big sophisticated taxpayer like Comcast they would 16 have been written down. But they're not being provided, 17 and I think that you should draw adverse inferences from 18 their failure to be provided. 19 MS. YEE: Well, and I don't want to draw any 20 inferences. I just want to know what happened. 21 MR. MARGOLIS: We don't know. 22 MS. YEE: Well, then I'm curious in terms of 23 what happened in the domicile state of Pennsylvania. 24 MR. SPERRING: Right. Well, I mean, I just -- 25 again, I go to the fact that they say, um, did not 26 report. I just want to clarify that, right. Did not 27 report. 28 Um -- uh -- uh, that would be consistent with, 169 1 uh, the federal return, that it's on the M-1 as opposed 2 to nonbusiness income. I mean, for all the states, 3 okay, they were going to report it as, um -- uh -- uh -- 4 um, you know, all the states, with the exception of 5 Pennsylvania. They were going to report it as 6 nonbusiness income or they're going to be consistent 7 with the federal return, depending upon whether the 8 state wants them to file on the original return or the 9 amended return. Okay. 10 So, that is what the issue that, you know, we 11 looked at for the penalty. 12 MS. YEE: Okay. 13 Thank you, Mr. Chairman. Let me stop there. 14 MR. HORTON: Okay. 15 Um, Member Mandel. 16 MS. MANDEL: Um -- 17 MR. HORTON: Acknowledging that you may be 18 dealing with either of the four issues. 19 MS. MANDEL: Okay. Well, on -- on the, um -- 20 on the penalty, it's my understanding from the 21 regulations, that if one were measuring substantial 22 authority -- and you can tell me if I got this wrong -- 23 that you measure substantial authority either at the end 24 of the tax year that you're talking about or at the time 25 you file your return. 26 Um, so I kind of understood references to the 27 TAM which presumably came up, the TAM itself, later -- 28 MR. SPERRING: Right. 170 1 MS. MANDEL: -- as, um, saying look at how they 2 analyzed all the authorities that were presumably in 3 existence at the time that you would measure substantial 4 authority, and look at their conclusion as being sort of 5 reasonable and those other things you said before, 6 Mr. Sperring. And so that that was -- that was why 7 Comcast was looking to the TAM. 8 I didn't take it that the TAM itself was being 9 used as substantial authority because it did not exist 10 at either of the measuring points for substantial 11 authority. 12 MR. SPERRING: Yeah. You're absolutely correct 13 on that. 14 MS. MANDEL: Okay. And then, um, you know, 15 whatever struggles there are with substantial authority 16 or even to disclosure, um, ultimately, what I understood 17 was that, that there was still, um, the reasonable basis 18 standard which did not require substantial authority or 19 did not require disclosure. But that all of the facts 20 and circumstances that might come into play, including 21 sort of how you might feel about the authority or how 22 you might feel about what was on the return or what 23 Mr. Donnelly had in his files preparatory, where he had 24 paperwork showing the alternative of nonbusiness income, 25 that all the facts and circumstances of the whole case, 26 including probably, um, the California regulation, um, 27 where the Franchise Tax Board made a policy decision 28 with respect to the penalty for where you report on a 171 1 return, um, on business, nonbusiness or unitary, that 2 all the facts and circumstances then fall in that bucket 3 of reasonable cause. 4 Is that what I. -- 5 MR. THOMPSON: I think you might have said 6 reasonable basis at one point. 7 MS. MANDEL: Reasonable basis, I'm sorry. 8 MR. THOMPSON: But you're thinking of 9 reasonable cause and good faith. 10 MS. MANDEL: Right. Okay. But all that does 11 come into play. 12 MR. SPERRING: Exactly. I mean, yeah, from 13 Mr. Donnelly's perspective, he had two choices. He was 14 going to either file consistent with the federal return 15 or file it as nonbusiness. Either way, California 16 couldn't tax it. And had he filed it nonbusiness, he 17 would have been protected by the regulation. 18 So he -- he -- the only reason why he didn't 19 was because his advisors were telling him, okay, you 20 ought to file consistent with your most recently amended 21 federal return. Okay. 22 So, in a sense, okay, he -- he took a risk, 23 okay. Because if he would have just filed it as 24 nonbusiness income, he would have been protected. Okay. 25 He took a risk. 26 But he took that risk because he was trying to 27 follow the law. He was trying to do what was right. 28 And what his advisors were telling him was in 172 1 California -- although we still, to this day, FTB hasn't 2 answered. We don't see anything published. But in 3 California, you're best off filing, uh, consistent with 4 your most recently filed amended return. That's what he 5 did. 6 MS. MANDEL: And I'm not sure about the, um, 7 you know, how things were reported in other states and 8 its exact relevance. Um, although maybe FTB has a point 9 of view on that. 10 But what -- and a focus on -- I guess the home 11 state is Pennsylvania, right. A focus on Pennsylvania. 12 Um, because I guess my focus is on what -- what happened 13 in California. 14 So, is there, um, some point to be made 15 about -- I mean, we do want to make sure that people 16 report everything consistent and report it everywhere. 17 But, um, usually I hear that in terms of a no income 18 argument. But how -- how would that come into play 19 on -- 20 MR. MARGOLIS: On good faith? 21 MS. MANDEL: -- on the penalty. 22 MR. MARGOLIS: Well, if you look at the Penson 23 case, they did take into account, uh, the position that 24 was taken in another state tax return. And they said if 25 you're going to take a position that's inconsistent on 26 another state tax return, that undermines your claim of 27 good faith. 28 Um, and, uh, here, I mean, taxpayer keeps 173 1 talking about, oh, we had a choice -- we had to follow 2 our most recently filed federal return. We really don't 3 care whether they filed consistent with their original 4 return or their amended return. What we care about is 5 whether or not they filed accurately. 6 It's the position that's taken on the 7 California return that you're looking at and you're 8 evaluating to see whether or not there's a reasonable 9 basis for that position. 10 MS. MANDEL: Well, and I understand that. 11 MR. MARGOLIS: People don't get out of the 12 penalty just because they filed consistent with a 13 federal return that would have been penalized. 14 And another thing, I mean, uh, Mr. Sperring 15 keeps talking about, oh, we had a choice of buckets to 16 put this into. Well, I mean, they could have put it in 17 a nonbusiness income bucket. But if they had put it in 18 a nonbusiness income bucket, it would have appeared on 19 the Schedule R. And if it would have appeared on the 20 Schedule R, a $1.5 billion amount of nonbusiness income 21 was almost guaranteed to -- to generate an audit. 22 And the way they did report it as an unitemized 23 Schedule M adjustment, it's not so likely to cause an 24 audit. So their choice of how they reported it, I 25 think, you know, may go to their good faith. 26 MS. MANDEL: But a $2.5 billion M-1 adjustment 27 is -- an auditor's not going to look at that right away? 28 MR. MARGOLIS: Not necessarily. You can have 174 1 very large depreciation adjustments and timing 2 adjustments. We have evidence here about the prior 3 year's return. They had a $1.8 billion adjustment. 4 Plus, in that year -- 5 MR. SPERRING: And they were audited. 6 MR. MARGOLIS: -- they itemized it. 7 MR. SPERRING: And they were still audited. 8 MR. JOSEPH: Only one thing. They talk about 9 filing consistent with their second federal return. The 10 problem is, that is precisely what Mr. Donnelly was 11 going to do. He was going to put it on the Schedule D 12 and then take it out. Uh, they didn't do that on the 13 California return. 14 MS. MANDEL: On the second -- on the second 15 federal return. 16 MR. JOSEPH: Yeah, the second federal return 17 backed the money out. And so, the second federal return 18 showed the amount in and then the amending of that 19 amount by taking it out. 20 That's what he wanted to do, and they didn't do 21 it. They put it on the M-1 instead. 22 MS. MANDEL: Well, wait a minute. An amended 23 federal return, you have to put in -- I mean, an amended 24 return you have what I did before, what I'm doing now. 25 MR. JOSEPH: Yes. 26 MS. MANDEL: So they can follow what Schedule 27 or place on your original return you -- you changed. 28 MR. JOSEPH: That's right. 175 1 MS. MANDEL: And they're not filing an amended 2 return in California. So you're not going to have that 3 page of something. But -- 4 MR. JOSEPH: Right. But if he would have put 5 it on the Schedule D, we would have seen it and it would 6 have been disclosed. 7 MS. MANDEL: Well, that goes to disclosure. 8 But I guess I'm talking about the ultimate of, you know, 9 everything -- everything that, um, comes into play. And 10 I think the testimony in the affidavits was that 11 ultimately, through discussions with the outside 12 advisors and the federal tax group, that the way they 13 filed with the M-1 adjustment was decided to be 14 consistent with the way it was reported for the amended 15 federal return. 16 I understand that amended returns have to have 17 a Schedule to show where the change in the underlying 18 return is made. And if it was reported originally, you 19 know, as -- on -- on a Schedule D, you're going to have 20 to tell them I took something off the Schedule D. 21 MR. JOSEPH: Yeah. We also would have seen it 22 if they would have attached the amended federal return 23 as well. But they didn't do that, so we didn't see 24 that. 25 And we would have probably at least had a 26 better chance of seeing it if they'd have itemized the 27 M-1 as they'd done in prior years and they didn't do 28 that either. 176 1 So it was -- it was very difficult, from what 2 was filed, to know that this issue was there. 3 MS. MANDEL: Well, let me go back since I 4 forgot it before. And you probably want to answer this 5 thing, and I hope I don't confuse the Board. 6 But if FTB could address the Tenneco case, 7 which, um, you know, there's a lot of -- this goes back 8 to unitary. There's a lot of discussion about how 9 independent, um, an operation QVC was. And we did have 10 that, you know, period of time where there were so many 11 cases involving, uh -- um, independent operations or 12 assertions of independent operations. 13 And, um -- and so when I -- when I hear the 14 taxpayer's discussion of its relationship with, um, QVC 15 and how QVC, you know, ran itself, um, I just would like 16 to hear, uh, since ultimately, um, you know, the 17 California courts say a variety of things. And I 18 think -- I always think of Tenneco West was, aha, it was 19 really a totally separate operation. So maybe you can 20 address Tenneco West. 21 MR. JOSEPH: Sure. Yeah, I think one of the 22 big issues of Tenneco West was it was a diverse 23 enterprise. And -- and in trying to find that or argue 24 that they were unitary, they were trying to make a 25 showing that they had strongly centralized management 26 with all of their subsidiaries. And the court -- 27 MS. MANDEL: So it was -- just to clarify, it 28 was the taxpayer taking the position that they were 177 1 unitary. 2 MR. JOSEPH: Yeah. 3 MS. MANDEL: Okay. 4 MR. JOSEPH: Um, so, yeah, it was an issue 5 there. And the Court did spend some time, obviously, 6 looking at the facts in the case and seeing what sort of 7 oversight it was. 8 Uh, but I think, again, I think the Appellants 9 are correct, we -- you have to look at everything that 10 happened together to get a sense of the weighing and the 11 balancing of things. 12 When you're talking about diverse lines of 13 business like Tenneco and the Court finds they don't 14 really have operational control and they -- they were 15 pretty autonomous, you start to be heavily on the side 16 that they weren't unitary with those subsidiaries. 17 The problem -- 18 MS. MANDEL: Because it's a diverse business. 19 MR. JOSEPH: I think -- diverse business and no 20 strong central management. Yeah, I think those two 21 things, uh, are -- you know, if you're diverse, you 22 better have something else going on. But if you aren't 23 diverse, it's not necessary -- you could, but it's not 24 necessary that you have strongly centralized 25 management. 26 MS. MANDEL: And you're not -- you're not 27 arguing strong centralized management here. 28 MR. JOSEPH: No, no, no, no. But -- but -- so, 178 1 again, I -- I think these are just all, you know, uh, 2 things to be weighed on the scales. And when you're 3 talking about vertically integrated enterprises, which 4 is our argument, um, the amount of management oversight 5 and interaction, we think is enough here when you're 6 talking about shared and common officers, directors and 7 full control of the board. 8 MS. MANDEL: Well, um, interlocking officers 9 and directors, you're going to have that with almost 10 every subsidiary, aren't you? I mean, is that -- just 11 the fact of interlocking officers and directors -- 12 MR. JOSEPH: Certainly has been shown in some 13 of these cases that they did not have interlocking 14 officers and directors, and that was held as something 15 against unity, that's true. Uh, but certainly in cases 16 where there were interlocking boards, that was noted by 17 the Court as well, uh, you know, under the idea that 18 when you do have interlocking officers and directors, 19 you probably have a concerted effort going on. 20 The taxpayer here is, uh, testifying that that 21 effort did not occur, so you have to weigh that, too. 22 MS. MANDEL: Mr. Friedman. 23 MR. FRIEDMAN: Okay. Thank you. 24 Um, A couple points in reaction, and then I'll 25 turn it to John Alchin to address his role as a -- as a 26 accused interlocking officer. 27 Strong centralized management wasn't the only 28 feature of Tenneco West. There was a lot more going on 179 1 in that case than strong centralized management. There 2 was, uh, investment activities going on, funding, and 3 there was approval of transactions greater than $100,000 4 that was required of the parent. 5 So it wasn't only -- certainly centralized 6 management was part of the case, but it wasn't the only 7 feature of the case, which I find interesting in looking 8 at the aggregate of the activities in a whole. 9 Um, one of the things that's come up in the 10 briefing quite significantly was the notion of 11 interlocking officers. And there's no doubt that 12 Comcast had designated certain, uh, Comcast executives 13 as assistant officers of QVC. In fact, John Alchin 14 sitting next to me is one of those accused. 15 So, John, maybe you can describe your role as 16 an assistant officer of QVC and what that meant to 17 QVC. 18 MR. ALCHIN: Yeah. I was treasurer of Comcast 19 and assistant treasurer of QVC. And I do not recollect 20 at any point ever doing anything in that function as 21 assistant treasurer of QVC, even signing a piece of 22 paper. I have no recall of that at, uh, at all. 23 As I described in my opening statement, my only 24 meetings at QVC took place on a quarterly basis with 25 Mr. Briggs and Mr. Costello, and it was financial 26 review. And beyond that, I have no recall of ever being 27 asked to do anything -- any other function for QVC. 28 MR. FRIEDMAN: Neal, do you have anything to 180 1 add as general counsel? 2 MR. GRABELL: I can tell you that we did not 3 consider them officers. We did not list them as 4 officers in our, uh, reports that we gave out the 5 public, to our vendors, to customers. Um, they did not 6 sit in on our officer meetings. Um, and they really did 7 not act as officers. 8 MS. MANDEL: That was the question I had, 9 Mr. Chairman. Thank you. 10 MR. HORTON: Uh, thank you very much. 11 Further discussion, Members? 12 Hearing none, um, to the Appellant and the 13 Department, we're going to allow a five-minute closing 14 statement from each of you. Uh, this has been an 15 extremely complex issue, uh, involving numerous court 16 cases and legal references and affidavits and so forth. 17 And see if you can wrap it up in a five-minute closing 18 statement. 19 Um, and we're going to take a five-minute 20 break. And we'll see you in five minutes. 21 (Whereupon a short break was taken.) 22 MR. HORTON: Members, let us reconvene by 23 welcoming Ms. Richardson, um, to the dais. Ms. Olson 24 had to leave, but we're certainly pleased with a 25 competent replacement. Welcome. 26 MS. RICHMOND: Thank you. 27 MR. HORTON: Um, to both parties, traditionally 28 the Board does not allow for closing statements, uh, in 181 1 a normal, formal sort of fashion. 2 What we traditionally do is we will ask 3 opening -- opening questions that will allow the 4 taxpayer to summarize their position. Uh, and it's just 5 part of the normal process. 6 Uh, this being a far more complex, uh, case, I 7 could certainly ask an opening question of both of you 8 and then listen to you articulate your position and 9 accept that as your closing statement. 10 We opted not to do that this time in order to 11 allow, uh, the articulation of the issues from your best 12 perspective so that we can ensure, uh, that everyone has 13 had a just and equitable opportunity to make their -- 14 make their case after the full deliberation by the 15 Board. 16 So, uh, with that, I'm going to start with the 17 Appellant, and then go to the Department as we 18 traditionally do. 19 MR. FRIEDMAN: Thank you, Mr. Chairman. Thank 20 you, Board Members, for your patience today. I very 21 much appreciate it. And I probably won't even use up my 22 full five minutes. 23 Um, we've heard an elaborate discussion and 24 sometimes a debate regarding the unitary business 25 principle as it relates to Comcast's ownership of QVC, 26 57 percent stake in QVC. 27 The points I want to emphasize in my close is 28 that nothing changed before, during, or after our 182 1 majority ownership. We've had numerous, uh, 2 nice-looking demonstratives placed up during today that 3 have reminded the Board Members that during the time in 4 which we were majority owner of QVC, during the time 5 before we were majority owner of QVC, and today, our 6 relationship has stayed the same. 7 QVC still has a strong executive force, still 8 does not share any Comcast functions, still engages in 9 its own activities with its own business plan, still 10 engages in a business on -- with a carriage agreement in 11 place with all the large cable companies and satellite 12 providers. Comcast is one of those. It was before, it 13 was during our majority ownership, and it is to this 14 day. 15 If the FTB's right and there's a flow of value 16 during our 57 percent stake ownership of QVC, then that 17 same flow of value would have to exist today at a point 18 in time in which it's a hundred percent owned by a third 19 party, Liberty Media. That flow of value would 20 essentially have to be a donation by Comcast to QVC. 21 They wouldn't have any benefit coming back to Comcast. 22 We own nothing of it today. 23 And, in fact, and I understand how FTB is 24 uncomfortable talking about it, but Liberty Media, which 25 owns QVC today, and owns other similar assets like HSN, 26 has not been unitized by the FTB. And I understand 27 FTB's characterization of that as a low level decision. 28 I find that hard to believe of companies of this size. 183 1 Um, a point or two on the termination fee. The 2 termination fee really comes down to the application of 3 the transactional test. I know that the FTB is enamored 4 with the -- with the, uh, Pennzoil decision out of 5 Oregon, and there is some cross-referencing between 6 those cases or between the states. But a recent Oregon 7 decision makes clear that Oregon will not look to 8 California, even when the underlying statutes are 9 similar, if the law is developing differently. 10 Here is that case. Oregon developed an "in 11 lieu of" test in the Pennzoil case. There's no "in lieu 12 of" test in California. Nobody's been able to cite one 13 for me. I've been looking, I can't find one. 14 Moreover, and probably most importantly, the 15 only transaction and activity to be analyzed regarding 16 the termination fee is the actual termination itself. 17 An acquisition does not produce any taxable income. I 18 think we can all agree on that as well. 19 And finally, I want to address the Andersen 20 memorandum. The Andersen memorandum has been hotly 21 debated by the parties. It's been held up by FTB with 22 the right hand saying that it doesn't provide strong 23 evidence of anything, and you heard Jon Sperring defend 24 the company's penalty position and the FTB's attacking 25 of the Andersen memo. But on the left hand the FTB is 26 then arguing that the Andersen memo provides some type 27 of evidence of a unitary relationship between Comcast 28 and QVC. 184 1 So either the Andersen -- you have to accept 2 one version of the FTB's treatment of the Andersen memo. 3 I don't see how you could accept both versions of the 4 FTB's treatment of the Andersen memo. 5 Nevertheless, you know what our view is 6 regarding the Andersen memo. It has no relevance to 7 state taxation, at least as it relates to a unitary 8 relationship. There's no unitary principle. There's no 9 unitary business principle. There's no unitary economic 10 theory for federal tax purpose. 11 The purposes of that memorandum was for federal 12 tax purposes. It had nothing to do with unitary theory. 13 And the fact that Comcast reduced its basis in QVC stock 14 should not be used against Comcast out of context. That 15 was a mechanical exercise that had nothing to do with 16 unitary theory. 17 Thank you very much. 18 MR. HORTON: We now go to the Department. 19 MR. MARGOLIS: I'd also like to thank you for 20 your careful consideration of this matter. I realize 21 it's very difficult, and we've barraged you with lots of 22 papers and lots of arguments. Um, but I don't think the 23 issues are -- at -- at their essence, are all that 24 complex. 25 On the unity issue, this is content and 26 distribution. They're a vertically integrated 27 enterprise and content and distribution fit together 28 hand and glove. There's inherently flows of value. And 185 1 we've even provided you with a color-coded chart. I 2 think it's the last, uh, exhibit that we provided you 3 with, which sort of summarizes all the various flows of 4 value. 5 Um, a hundred million dollars in commission 6 payments alone during the time that they were majority 7 ownership. That's -- that's a significant benefit and 8 that's a significant operational tie. 9 As for the claim that the -- that we are 10 accepting the Andersen memo for some purposes and 11 rejecting it for others, well, yes, it's true that the 12 Andersen memo, the conclusions of law were rejected by 13 the IRS. And we reject those conclusions of law as 14 well. But the Andersen memo was based upon facts, and 15 those facts were represented to them by Comcast. And 16 some of those facts we agree with. I mean -- and -- and 17 the IRS didn't disagree with them either. It accepted 18 the fact that the businesses are all integrally related. 19 That wasn't critical to the IRS denying the fact that 20 they couldn't claim damages for infrastructure. 21 So the essential facts about the relationship 22 between QVC and -- and Comcast and about how many 23 different acquisitions Comcast had made, that's a fact 24 that we agree with. And that's not something that the 25 IRS took issue with. 26 Um, now, moving on to the termination fee. 27 Well, you see right here from -- the earlier reports 28 that I've given you that, during our year alone, Comcast 186 1 entered into -- or had pending six different 2 acquisitions. It was something it was doing all the 3 time, and Comcast's counsel hasn't denied it. 4 And because this contract that generated all 5 this income was something that they had entered into as 6 part of their regular course of business, it's business 7 income under the transactional test. 8 We have a case that's directly on point. 9 It's -- it's Pennzoil. The facts are virtually 10 identical. And, um, we think that -- you know, and it 11 even is based upon Hoeschst Celanese. We think the 12 Comcast reading of Hoeschst Celanese is very unnatural 13 because what they're doing, um -- a case what it really 14 stands for, it stands for what it says. It doesn't 15 stand for what a party argued in the case. It stands 16 for what it says. 17 And in Hoeschst Celanese the Court says you 18 look at the transaction or activity that generated the 19 income. And here, this income arose out of the 20 acquisition transaction. 21 And finally, um -- oh, one more thing about the 22 acquisitions. I mean, when Comcast acquires different 23 companies, those companies become part of the unitary 24 group and they start generating income. 25 The -- the pension plan didn't start generating 26 income. It was not part of its regular business. It 27 only generated income once in its entire corporate 28 lifetime. Whereas these acquisitions, every time 187 1 another acquisition came on board, it started generating 2 income. 3 And with the penalty issue, I just want to say 4 you have to look at all the facts and circumstances. 5 MR. HORTON: I'm going to interrupt you just 6 for a second. 7 MR. MARGOLIS: Sure. 8 MR. HORTON: Just to ask that you pull the mic 9 a little closer. 10 MR. MARGOLIS: Sure. 11 MR. HORTON: I didn't want to disrupt your 12 rhythm there. 13 MR. MARGOLIS: I'm not sure if it was rhythm. 14 But, um, at any rate, on the penalty issue, we 15 urge you to look at all the facts and circumstances. 16 And we think that supports the FTB's position as to the 17 penalty. And you should also look at the fact that the 18 taxpayer bears the burden of satisfying each and every 19 one of the exceptions that it's claiming here. And they 20 provided virtually no evidence of any contemporaneous 21 discussions or advice. 22 Um, and you've also held many times that 23 contemporaneous evidence is the most credible. And 24 we've provided lots of credible contemporaneous evidence 25 on all our points here. 26 So thank you very much. 27 MR. HORTON: Okay. 28 Well, uh, thank you all for appearing before us 188 1 today. The Board will take this matter under 2 consideration later on this evening and send you a 3 written report of our decision. 4 MS. MANDEL: And so moved under submission. 5 MS. YEE: Second. 6 MR. HORTON: After a motion. 7 Thank you, colleagues. 8 Moved by Member Yee, second by Member Mandel, 9 uh, take the matter under submission, presumed by the 10 Chair. 11 And, uh, as previously stated, we'll take the 12 matter under consideration and send you a written report 13 of our decision. 14 Thank you so very much for appearing before the 15 Board. 16 MR. SPERRING: Thank you. 17 MR. JOSEPH: Thank you. 18 ---oOo--- 19 20 21 22 23 24 25 26 27 28 189 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, JULI PRICE JACKSON, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 February 2, 2012 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 53 and pages 93 through 148 constitute a 14 complete and accurate transcription of the shorthand 15 writing. 16 17 Dated: February 17, 2012 18 19 20 ____________________________ 21 JULI PRICE JACKSON 22 Hearing Reporter 23 24 25 26 27 28 190 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 February 2, 2012 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 13 54 through 92 and pages 149 through 189 constitute a 14 complete and accurate transcription of the shorthand 15 writing. 16 17 Dated: February 17, 2012 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL 22 Hearing Reporter 23 24 25 26 27 28 191