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 JULY 24, 2012 10 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 11 APPEAL OF 12 DAVID DU TRAN AND THUYEN THI TRAN 13 No. 547815 14 AGAINST PROPOSED ASSESSMENT OF 15 ADDITIONAL INCOME TAX 16 17 18 19 20 21 22 23 24 Reported by: Juli Price Jackson 25 CSR No. 5214 26 27 28 1 1 P R E S E N T 2 For the Board Jerome E. Horton of Equalization: Chair 3 Michelle Steel 4 Vice-Chairwoman 5 Betty T. Yee Member 6 George Runner 7 Member 8 Marcy Jo Mandel Appearing for John 9 Chiang, State Controller (per Government Code 10 Section 7.9) 11 Joann Richmond Chief 12 Board Proceedings Division 13 14 For Board of Anthony Epolite Equalization Staff: Staff Counsel 15 Lou Ambrose 16 Staff Counsel 17 18 For Franchise Tax Sonia Deshmukh 19 Board: Tax Counsel 20 Michael Cornez Tax Counsel 21 22 For Appellant: Kim Le 23 Representative 24 David Du Tran Taxpayer 25 26 ---oOo--- 27 28 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 JULY 24, 2012 4 ---oOo--- 5 MR. HORTON: Let us convene the meeting of the 6 Board of Equalization. 7 Miss Richmond, what is our first item? 8 MS. RICHMOND: Good morning, Chairman and 9 Members. Our first item on this morning's agenda is 10 the Corporate Franchise and Personal Income Tax Appeals 11 hearings. There are eight oral hearings on today's 12 agenda. Our first oral hearing is B1, David Du Tran and 13 Thuyen Thi Tran. Please come forward. 14 Board Proceedings has received contribution 15 disclosure forms for this morning's hearings from 16 parties, agents and participants. All forms are 17 probably -- excuse me, all forms were properly completed 18 and signed. All parties, agents and participants are on 19 the alpha listings provided to your office. 20 Each person sitting at the table will be asked 21 to introduce themselves and, if necessary, their 22 affiliation with the taxpayer for the record. Ten 23 minutes is allocated for the taxpayer's opening 24 presentation, followed by 10 minutes for the Franchise 25 Tax Board's presentation and five minutes is allocated 26 to the taxpayer for rebuttal. 27 Mr. Horton. 28 MR. HORTON: Thank you very much. 3 1 Mr. Epolite, would you please introduce the 2 issues in this case? 3 MR. EPOLITE: Good morning, Chairman Horton, 4 Members. Anthony Epolite and Lou Ambrose of the Appeals 5 Division. 6 The issue before the Board in this matter is 7 whether the monetary transfers from Vanco, Inc. to Vanco 8 Trading, Inc. may be considered shareholder loans from 9 Appellants to their S corporation for purposes of 10 increasing their basis in corporate indebtedness. 11 And I would note for the Board that the 12 Franchise Tax Board has agreed to abate the late filing 13 penalty for 2003 and the late payment penalty for 14 2003. 15 MR. HORTON: Thank you very much for the 16 abatement. 17 The taxpayer will have ten minutes to make 18 their introduction. We would ask that you commence with 19 your intro -- make your presentation, my apologies. We 20 ask that you commence with your introductions for the 21 record. 22 MR. LE: My name is Kim Le, CPA. And this is 23 my client, Mr. David Tran. 24 MR. HORTON: Welcome, sir. 25 MR. LE: And we here to present our case here 26 that Mr. Tran is owner of both company, Vanco Trading, 27 Inc. and Vanco, Inc. And Vanco, Trading, Inc. we 28 call -- so, what happened is during the time that the 4 1 company Vanco Trading, Inc. is about closing, it's -- he 2 run a supermarket, Vanco Trading, Inc. is about to close 3 the business and cash flow is very tight. He is the 4 owner of both company, 100 percent owned. And he 5 basically very unsophisticated. He write checks to 6 advance to both company. And then when -- sometime like 7 Vanco Trading, Inc. need the money instead of have 8 Vanco, Inc. pay him back and then he supposed to write a 9 check to Vanco Trading, Inc., he run the company like a 10 mom and pop shop and he very unsophisticated. He 11 doesn't have even a high school degree. And he came 12 here as a Vietnamese refugee and he run his shop, 13 basically, cash flow and day-to-day business. 14 So, he have -- instead of having Vanco, Inc. 15 pay back him the loan and then he pay -- he write a 16 check to Vanco Trading, Inc., he can't afford it because 17 the cash flow and very tight. And, therefore, he 18 ordered Vanco, Inc. to write a check to Vanco Trading on 19 his behalf. And he did numerous check like that during 20 the year and knowing that that will not meet the 21 criteria as far as the shareholder have to put direct 22 money into the Vanco Trading, Inc. 23 At the end of the year we summarize all the 24 checks that Vanco, Inc. wrote to Vanco Trading, Inc. 25 And then we basically have the Board of Director minutes 26 and saying that while we approved that those 27 transactions is basically represent the money sending 28 back to the shareholder and the shareholder give to -- 5 1 contributed to -- excuse me, loan to Vanco Trading, Inc. 2 and, therefore, the shareholder has the increased basis 3 in Vanco Trading, Inc. 4 The Board's basically take the position on the 5 book saying that, well, unless the shareholder loaned 6 directly to the company and he have to be poorer in a 7 way, but our position is he's run the store as a mom and 8 pop shop. And he loaned the money to both company and 9 he's poorer in a way, in a material sense, anyway. And 10 the Board keep saying that he's not poorer, but, 11 actually, he's poorer. 12 And then Vanco Trading, Inc. basically 13 closing -- at that stage, they closed the supermarket in 14 2003 and he honestly pay back all the vendor the money 15 that the company owe. And that's why he need to get 16 more money to pay back to the vendor. 17 And, therefore, we ask the Board to take 18 substance over form in this time because my client 19 doesn't even speak good English. He understand very 20 limited English. And he run the business on a 21 day-to-day basis and try to cash with the cash flow. 22 And had he have the -- the checks written to him from 23 Vanco, Inc. and then he deposit to his bank account and 24 then he will write a check to Vanco Trading, Inc., Vanco 25 Trading Inc. will have not have enough -- will not have 26 cash fast enough to pay the vendor. 27 And also probably at the time he deposit to his 28 account and when Vanco Trading clear the check, maybe 6 1 the money not even there. So, that's why they need to 2 do a shortcut by take from Vanco, Inc. and pay to Vanco 3 Trading, Inc. 4 So, we ask the Board, consider like a mom and 5 pop shop situation and sympathize for his situation and 6 then allow the increase in basis. And then we have -- 7 the thing is at the end of the year, we summarize all 8 the transactions. We record the book in both company 9 and in both corporate tax return and on his personal 10 return consistently the way that -- based upon his 11 intention. I mean, that's that all it is. 12 And then four years after the Board came and 13 audit and they -- they say that then -- so, I mean, we 14 already present our intention at the time by booking in 15 both company consistently with the way that we -- we 16 reflect his intention. So, ask for your consideration 17 for that. 18 And then also want to say that the Board 19 contends that Vanco, Inc., is not even a business 20 entity. They keep saying that Vanco, Inc. does not 21 exist, just probably a checking account. And just for 22 your information, the -- I mean I have a -- this much 23 correspondence (indicating) back and forth, material we 24 supply to the Board. But the auditor came to my office. 25 She spend one hour at the beginning of the audit. And 26 around -- nearly about four month before the audit she 27 spent half hour. And then she sent me a notice of all 28 the number, all the detail -- never have an exit meeting 7 1 with me. Never go over with me why this number, this 2 number. 3 I feel like very unprofessional. And since the 4 technical default in the way handling the audit, I mean, 5 you cannot audit the client and then lock it out and 6 give them a bunch of detail numbers and never go over 7 with me why we have this number, why the basis is this, 8 this -- explain to me the number. I don't even have the 9 exit meeting. I didn't have the exit meeting with the 10 Board auditor. 11 So, I feel it's very -- like the Board used a 12 hammer and hammer us and say, "Hey, here's the way, you 13 got to accept it." And they just quote the law, the 14 books and everything else and I say, "This is a mom and 15 pop shop. And we tried to present the intention. And 16 it's supported by the Board of Director minutes and also 17 by the promissory note that the company signed that he 18 owe the shareholder at the end of the year for that 19 amount mentioned with the book and everything." And 20 they still disagree. 21 So, to me, like even after two years, two 22 months doing the audit, they don't even know that Vanco, 23 Inc. a real business. And I attached in the exhibit 24 there -- we, you know, the company just basically the 25 same company, just changed name from Vanco, Inc. 26 If you look at Exhibit 3B, it say, "Certificate 27 of Amendment of Articles of Incorporation." The company 28 changed the name from Vanco, Inc. to Vanco-Delta Foods, 8 1 Inc. If you look at the tax return 2002, the name is 2 Vanco, Inc. In 2003 the name is Vanco-Delta Food, Inc., 3 dba Vanco Foods Company. So, just a simple thing to 4 present to the Board. Just a simple matter like that 5 the Board -- the Franchise Tax Board could not even 6 detect the -- the simple thing like that is existing 7 company. They filed tax returns, the same ID number and 8 they couldn't even notice that. 9 And they keep saying that it is not a business 10 entity. So, I feel like they don't do their job that 11 they supposed to do on a simple matter here and they're 12 using a hammer to hammer us. 13 And then also another thing I'd like to point 14 out is if Vanco, Inc. -- if we didn't treat it that way, 15 Vanco Trading, Inc. is a closing business. Nobody 16 loaned the money to Vanco Trading, Inc. unless it is 17 from the stockholder. Because knowing that intention of 18 the shareholder when he wrote the check from Vanco, Inc. 19 to Vanco Trading, otherwise, if we leave it the way it 20 is mean Vanco, Inc. loaned to Vanco Trading, Inc. -- the 21 way that the Franchise Tax Board force us to treat -- 22 meaning that Vanco Trading, Inc. would owe Vanco, Inc. 23 that money, but Vanco Trading Inc. is a closing 24 business. So, therefore, Vanco, Inc. would write a bad 25 debt -- a bad loan -- would write a bad debt and they 26 would have a deduction anyway. So, to us, like either 27 way we should have a deduction -- either increase basis 28 from shareholder or Vanco, Inc. would write a bad debt 9 1 from Vanco Trading, Inc. and they would have a deduction 2 for the loss flowing to his K1 anyway. 3 And, beside, I just ask the Board for 4 sympathize of my client lost almost every business that 5 he owned so far. And he lost his house. He on a short 6 sale in June 2012. So, right now, I mean, he's broke 7 and I'm -- I talk to one of the -- I talked to -- I 8 think I talked to Mrs. Mandel, right? Or I talked to 9 some of the Franchise Tax Board Members, I said that 10 even me showing today is -- I don't even have -- I 11 couldn't even get paid because he doesn't have any money 12 to pay. He's -- his house -- he lost the house. He 13 lost businesses, everything. 14 So, I -- I -- I hope that the Board considered 15 that and doesn't -- doesn't have to go through this and 16 then I just want to have the -- the reconsideration of 17 the Board treating him like an unsophisticated person 18 trying to make a living here, trying to do a business 19 here -- and just like a mom and pop shop. That if you 20 see that point and then you will see that our -- our 21 reasoning would make sense. Thank you. 22 MR. HORTON: Thank you very much. You'll be 23 given an additional five minutes on rebuttal after we 24 hear from the Franchise Tax Board. 25 Franchise Tax Board has ten minutes to make 26 their presentation. We would ask that you commence with 27 your introductions -- 28 MS. DESHMUKH: Thank you. 10 1 MR. HORTON: -- for the record. 2 MS. DESHMUKH: Good morning, Chairman Horton 3 and Members of the Board. My name is Sonia Deshmukh and 4 sitting next to me is Michael Cornez. And we represent 5 the Franchise Tax Board on this matter. 6 MS. YEE: Could you pull the microphone -- 7 MS. DESHMUKH: Sure. 8 MS. YEE: -- straight out in front of you? 9 Thanks. 10 MS. DESHMUKH: Is that better? 11 MS. YEE: Yeah. 12 MS. DESHMUKH: Appellants are the shareholders 13 of multiple S corporations. One of those corporations 14 in 2003 and 2004 made transfers to another one of 15 Appellants' wholly-owned corporations. 16 Even though those transfers were between the 17 wholly-owned corporations, the Appellants are attempting 18 to treat those transfers as if they were personal loans 19 from the shareholder directly to the recipient 20 corporation. They want to treat those transfers as 21 direct shareholder loans so that they can increase their 22 basis in the recipient corporation and take large losses 23 that were passed through in 2003 and 2004. 24 But because the funds did not come directly 25 from Appellant and because Appellants did not have an 26 incorporated pocketbook under the law, they may not 27 take -- they may not increase their debt basis by these 28 amounts. Appellants will not lose the ability to take 11 1 these losses, but they will to suspend them until a year 2 in which have sufficient basis to take the losses. 3 Appellants owned Vanco Trading, Incorporated, 4 which I will call "Trading" here today to avoid 5 confusion. Trading claims large losses on its 2003 and 6 2004 California income tax returns. Appellants also own 7 several other corporations, including Vanco, 8 Incorporated, also known as Vanco-Delta Foods, as we've 9 learned here today, which I will call "Inc." 10 The FTB disallowed the losses because the 11 losses exceeded Appellants' basis in stock and basis in 12 debts loaned to the corporation. Subchapter S allows S 13 corporation losses to pass through to the shareholder to 14 the extent of the shareholder's basis in debts -- in 15 stock and debts loaned to the corporation. 16 Appellants reported shareholder loans to 17 Trading in 2003 and 2004. During audit and protest, 18 however, they were unable to document all of these 19 claimed loans. Appellants submitted cancelled checks 20 reflecting personal transfers from the shareholders to 21 Trading in the amounts of 655,000 and $35,000 in 2003 22 and 2004, respectively. 23 The FTB accepted those amounts as personal 24 loans from the shareholder and permitted Appellants to 25 take losses against those amounts. However, Appellants 26 also argue that their other closely held business made 27 advances to Trading that should be treated as personal 28 shareholder loans. 12 1 During audit, Appellants provided canceled 2 checks reflecting transfers from Inc. to Trading in 2003 3 and 2004. The FTB did not treat these amounts as 4 shareholder loans because they did not come from the 5 shareholder personally. The law limits S corporation 6 losses to the amount of the shareholders' actual 7 economic outlay. 8 With regard to these direct loans between 9 wholly-owned businesses, the law places a high burden on 10 taxpayers seeking to treat the transfers as shareholder 11 loans in order to increase debt basis. The taxpayers 12 must prove that the indebtedness actually runs to the 13 shareholder rather than solely between the wholly-owned 14 businesses. And in this case Appellants have not 15 established these facts. 16 Appellants' attempt to argue that Inc. acted as 17 an incorporated pocketbook for Trading. "Incorporated 18 pocketbook" is a term that has been applied in a few Tax 19 Court memorandum decisions where the taxpayers were 20 allowed to treat transfers between wholly-owned 21 businesses as shareholder loans. But in those cases the 22 taxpayers provided substantial evidence of an obvious 23 intent to treat the transfers as shareholder loans at 24 the -- contemporaneous with the time -- with the 25 transfers. And the funds transferred were from 26 undistributed retained earnings that already been taxed 27 to the shareholder. 28 In this case the promissory notes reflecting the 13 1 2003 transfers is dated after the transfers took place. 2 The minutes of the Board of Directors, provided by 3 Appellant, is also dated after the 2003 transfers took 4 place. Both of the promissory notes and the minutes of 5 the Board of Directors -- sorry -- are dated after the 6 2003 transfers took place. Both of the promissory notes 7 provided by Appellants lack the formal indicia of a 8 valid note that you would expect to see, such as a 9 maturity date or interest payments, details regarding 10 those payments. The promissory notes and the minutes of 11 the Board of Directors prove that Appellants didn't have 12 the requisite intent to treat the transfers as 13 shareholder loans at the time of the transfers. 14 In addition, there is no evidence that the 15 funds transferred were from undistributed retained 16 earnings that had already been taxed to the 17 shareholders. Inc. didn't have sufficient undistributed 18 earnings in 2003 or 2004 to distribute to the 19 shareholders. 20 In addition, there's no evidence of a loan from 21 Appellants to Inc. So, Appellants claim that the 22 payments to Trading were repayments of a loan, of a 23 shareholder loan to Inc., cannot be substantiated. 24 Finally, Appellants submitted an additional 25 schedule reflecting a loan from Trading to the 26 shareholders. That schedule details loan amounts that 27 were repaid by Appellants to Trading in 2003. Many of 28 those loan repayments reflected in the schedule 14 1 correspond with the amounts that Appellants claim were 2 actually shareholder loans to Trading. So, it's unclear 3 whether the payments from Appellants to Trading were new 4 loans or whether they were actually repayments of a loan 5 from Trading to the shareholders. If that's the case, 6 then Appellants have already increased their basis 7 excessively and have taken more losses than they -- they 8 should have. 9 As I previously noted, the FTB has already 10 given Appellants credit for these transfers. And we do 11 not now seek to adjust the basis that has been 12 determined at audit. However, I make this point only to 13 note that Appellants may have already taken larger 14 losses than they're entitled to. 15 The multiple loans and transfers between 16 Appellants and their affiliated corporations in this 17 case are quite difficult to track because of the lack of 18 documentation and the inconsistencies that we see in the 19 documentation that has been provided. 20 Appellants appear to have disregarded the 21 separate form of their businesses, transferring money 22 between the corporations whenever needed and without 23 accurate documentation. But this treatment does not 24 amount to an incorporated pocketbook under the law and 25 cannot increase Appellants' basis in Trading. 26 Appellants have not proven that they made 27 shareholder loans to Trading and, accordingly, the 28 claimed losses should be denied. Thank you. 15 1 MR. HORTON: Thank you. 2 On rebuttal, please? 3 MR. LE: Well, the incorporate -- incorporate 4 pocketbooks, I would -- I know the law defining 5 incorporated book like when you make the -- the 6 undistributed earnings, however, here I want to make -- 7 I want to hope that the Board considered that like when 8 a person run the small business, like mom and pop shop, 9 and he think that's all money belong to him. So, 10 therefore, in his mind, the money in this company or 11 this company is the same. 12 Knowing that and knowing that's not in 13 accordance with the law that the company -- based upon 14 what we know, the company at the end of the year 15 summarized all of the transactions and reflect that as 16 the long term shareholder and treated -- in both book we 17 reduce the loan on this book (indicating) and we 18 increase the loan on this book (indicating). And, 19 therefore, reflected so in the promissory note and the 20 minutes of the corporation at the end of the year. 21 And you said that the notes and the minutes 22 book is after the end of the year, but we had -- we have 23 the book, have the notes at the end of the year. So, 24 the intention of the taxpayer is clearly made by booking 25 and recording and reporting on the tax return 26 consistently in both company and his personal tax 27 returns. 28 I don't see what else -- what more intention 16 1 the Board -- the Franchise Tax Board is looking for. 2 Also that on the various transaction that Vanco Trading 3 pay back, whatever you mentioned, is already netted 4 against and the net amount is 999,000 -- $999,815. I 5 note at the end of the year it's a net amount of -- 6 after Vanco Trading paying back. So, it's already 7 netted, only considered in that amount. 8 Basically I just ask the Board to reconsider 9 the position of reality of unsophisticated businessman 10 running the business. At the end of the year as the 11 outside consultant we know that's -- that's their 12 intention and, therefore, we treat the book in the way 13 that the -- the taxpayer intend to reflect it. 14 And -- and the Board can now -- can suspect, 15 you know, whatever they want, but the reality is as 16 simple as that. 17 MR. HORTON: Thank you very much. Discussion 18 Members? 19 Member Steel. 20 MS. STEEL: Franchise Tax Board that -- you 21 know, you said it's very hard to track the documents 22 that, you know, how they transferred the money from one 23 corporation to, you know, I can't follow your -- Trading 24 to Inc. or, you know, but according to the taxpayer 25 right now that they said that all the personal and those 26 two corporations' tax returns are matching with all the 27 numbers. So, there is a taxpayer's intention that, you 28 know, a lot of small mom and pop stores, that they just 17 1 don't understand that, you know, they are the full, you 2 know, shareholder for one of the small corporations. 3 So, even without other documents, can't you 4 trace from the tax returns? 5 MS. DESHMUKH: Actually, no. I don't believe 6 that the loans were reflected in both books. We haven't 7 received -- 8 MS. STEEL: Not on the books, but tax returns 9 itself? 10 MS. DESHMUKH: On the tax returns? Well, they 11 did report the shareholder loans on Trading's tax 12 return. However, we don't see any evidence of these 13 transactions on Inc.'s tax returns, so -- 14 MS. STEEL: Did not match those numbers? 15 MS. DESHMUKH: -- well, they just didn't treat 16 it consistently. 17 MR. LE: They do match, she doesn't know. They 18 do match. 19 MS. STEEL: Okay. 20 MR. LE: Because if you look at Exhibit -- if 21 you look at Exhibit 1B and 1C, you can see that the 22 amount $732,000, the last number, 732,000, Inc. reads in 23 Exhibit B as a credit, increased the loan from 24 stockholder and in the Exhibit C to Vanco-Delta Food, 25 Inc. we decreased the loan basis. So, therefore, it 26 consistently treated for both book and tax. 27 And I'm a CPA. I do both book and tax for the 28 company. And I know it's matching. I can prove that. 18 1 MS. STEEL: So, Franchise Tax Board, did you 2 looking at that exhibit that they called here, 3 $732,648 -- 4 MS. DESHMUKH: And, so, it looks like that's -- 5 MS. STEEL: -- it's loans to stockholders right 6 there (indicating). 7 MS. DESHMUKH: Right, okay. Yeah, it looks 8 like that's classified as a loan to the stockholders 9 from Vanco-Delta Foods. 10 But it's my understanding that that's what the 11 argument was. I thought it was a loan from the 12 shareholders to Vanco-Delta -- to Inc. or Vanco-Delta 13 Foods that was then repaid in the form of these 14 transfers to VTI. 15 So, this seems to contradict what they 16 originally argued. 17 MR. LE: No, no, it's not -- not contradict at 18 all. 19 MR. HORTON: Pardon me, sir. 20 MS. STEEL: I can -- I can just get it straight 21 from the taxpayer's side, yes. 22 MR. LE: Excuse me, it's not contradict at all 23 because, as I explained, the shareholder gave money to 24 Vanco, Inc. and supposed -- Vanco, Inc. supposed to give 25 it back to him. And he give to Vanco Trading, Inc. and 26 I already explained why he couldn't do it -- because of 27 the cash flow in that situation. 28 And knowing the purpose, intention of the 19 1 taxpayer, at the end of the year, we reclassified 2 732,000 in both companies, both books, and support by 3 Board of Director minutes approval and also by the 4 promissory note for the amount of -- that the company 5 owed the shareholder at the end of the year. 6 And we reflected both in financial statement, 7 books, tax returns in both company and also on his 8 personal tax return. Everything's match. 9 MS. STEEL: Okay, I got that. 10 So, Franchise Tax Board, how about intentions 11 here from corporations, you know, directly from Inc. to 12 Trading, so that intention, can we buy that -- 13 MS. DESHMUKH: Uhh -- 14 MS. STEEL: -- by the law? 15 MS. DESHMUKH: -- right. Under the law the 16 intention is -- must be contemporaneous with the 17 transfers. 18 So, that means that at the time -- the 19 taxpayers -- at the time that Inc. made the transfers to 20 Trading, the taxpayers would have show that they 21 intended to treat those as shareholder loans from the 22 shareholders to Trading. 23 But, in fact, the promissory notes and the 24 minutes of the Board of Directors are dated at the end 25 of 2003, December 31st, 2003, after the transfers had 26 already taken place in 2003. 27 MS. STEEL: But we just heard that they were 28 very tight with the cash flow. So, sometimes -- 20 1 it's his own company, he can transfer the money and then 2 he can prepare the paperwork. 3 So, you know, that I -- I don't think that's 4 really big deal here because as long as you have 5 paperworks there that documents and promissory note that 6 he's going to pay back. 7 So, as long as it matches on the -- you know, 8 for exhibit shows that that amount up to penny that it 9 matches and there is intentions that money's so tight he 10 couldn't transfer his personal, but, you know, from one 11 to another. And a lot of mom and pop stores, especially 12 what I heard from taxpayer then who has less than high 13 school education, that didn't know that, you know, how 14 this process works. 15 So, how can we help this taxpayer then? Can 16 you looking at the tax return more carefully and with 17 this exhibit, because we just got this exhibit this 18 morning, so, if you can study it, if you have little 19 more time, do you think you can study and go through it 20 with the CPA that -- who is -- he's a expert that, you 21 know, he's here, that -- you know, well, we are looking 22 through with the paperworks is different than what he's 23 explaining. 24 So, if we give you right after this and can you 25 come back this afternoon? I mean, if it's okay with the 26 Chair? 27 MR. CORNEZ: May I add something? 28 MS. STEEL: Yes. 21 1 MR. CORNEZ: If in -- if -- because these -- 2 because both Inc. and Trading are S corporations, loans 3 and loan repayments and income and losses and 4 distributions of cash all affect basis. 5 MS. STEEL: By the laws, yes. 6 MR. CORNEZ: So, to the extent Inc. repays a 7 loan that is reclassified on Trading's books, then the 8 shareholders' basis in the debt and the stock in Inc. 9 would have to go down as a distribution, which would be 10 a taxable event if they didn't have sufficient basis or 11 loan amounts. 12 So, the reclassification does not undermine the 13 issue with respect to the tax consequences from the 14 transactions. You know -- 15 MS. STEEL: So, you don't -- 16 MR. CORNEZ: -- there's a taxable -- 17 MS. STEEL: -- Inc. is itself? 18 MR. CORNEZ: -- pardon? 19 MS. STEEL: Inc. itself -- 20 MR. CORNEZ: Inc. is an S corporation, so, 21 there's taxable events with respect to distributions and 22 income and loan payments and stuff between Inc. and the 23 shareholders. 24 If they -- if they don't report those 25 correctly, then the fact that they want to deem the loan 26 between Trading -- between Inc. and Trading as their own 27 loan would be fine if they reported that money 28 personally. But there is no evidence that they reported 22 1 the reclassification as a distribution or as income. 2 MS. STEEL: But how about the tax return 3 itself, the -- 4 MR. CORNEZ: It doesn't show that. 5 MS. STEEL: -- okay. I am done, thank you. 6 MS. YEE: Mr. Horton? 7 MS. STEEL: Yes just -- 8 MR. LE: Well, it does not affect the tax 9 return or the business at all from the Vanco, Inc. 10 standpoint because we never increased the business of 11 Vanco, Inc. by that amount. 12 We never treated like the -- you know, after we 13 know the intention of the taxpayer, we only -- we do the 14 reclassification in both company and, therefore, only 15 affected Vanco, Inc. Trading -- it would be Vanco 16 Trading, Inc. basis. 17 The Vanco, Inc. here, we never treat that 18 amount as shareholder loan to Vanco, Inc. return 19 whatsoever. It doesn't affect at all. 20 And we can prove to him whatever. It does not 21 have any conflict here both tax and return. I mean, he 22 can sit there with me, I can prove that. 23 MS. STEEL: Thank you. 24 MR. HORTON: Member Yee. 25 MS. YEE: Thank you, Mr. Chairman. 26 I wanted to just see if we were all clear about 27 the entities that we're speaking about here and probably 28 a question of the Franchise Tax Board with respect to 23 1 whether Vanco, Inc. is the same entity as Vanco-Delta 2 Foods. 3 How -- how do you look at Exhibit 3B that the 4 Appellant has provided? 5 MS. DESHMUKH: Is that the Articles of 6 Incorporation? 7 MS. YEE: Right, uh-huh. 8 MS. DESHMUKH: Yes, the point I was making in 9 the brief is basically that -- just that there was 10 confusion regarding the name, whether it was Vanco, 11 Incorporated or Vanco-Delta Foods. So, I couldn't tell 12 from the documents that I was looking at whether they 13 were the same corporation or whether they were different 14 corporations. But it doesn't not really affect the 15 outcome -- 16 MS. YEE: Okay. 17 MS. DESHMUKH: -- here today. 18 MS. YEE: All right. And then I just wanted to 19 note -- and I -- you mentioned it in the presentation 20 you just made to us that there was an increase in 21 Appellants' debt basis allowed -- 22 MS. DESHMUKH: Yes. 23 MS. YEE: -- for the repayment of debt to 24 Trading? 25 MS. DESHMUKH: Right. 26 MS. YEE: So, you, essentially, looked at those 27 as if they were loans -- 28 MS. DESHMUKH: Correct. 24 1 MS. YEE: -- from the Appellants to Trading? 2 MS. DESHMUKH: That's right. 3 MS. YEE: Okay. And what you would need with 4 respect to the transfers from Inc. to Trading -- 5 MS. DESHMUKH: Uh-huh. 6 MS. YEE: -- is not only contemporaneous 7 documentation that that, indeed, it was what those 8 payments represented, but that the payments are 9 characterized as such as well? 10 MS. DESHMUKH: That's right. 11 MS. YEE: Okay. So, what typically does that 12 look like? 13 MS. DESHMUKH: Well, typically it is promissory 14 notes. The books and records of the taxpayer will 15 generally reflect a contemporaneous intent. 16 Also they would have treated -- as we discussed 17 just a minute ago, they would have treated the 18 distributions as distributions from Inc. on their 19 personal tax returns. We just -- we haven't seen any of 20 that. 21 MS. YEE: And the two promissory notes that did 22 -- that were presented are problematic because -- I want 23 to just be clear -- 24 MS. DESHMUKH: Sure. 25 MS. YEE: -- with the Appellants on that. 26 MS. DESHMUKH: Well, the first one was dated 27 after transactions took place. Both the promissory 28 notes lack many of the indicia that you would expect to 25 1 see in a valid promissory note -- so, maturity date or 2 details regarding the interest payments. 3 And, similarly, the minutes of the Board of 4 Directors is also dated after the 2003 transfers took 5 place. 6 MS. YEE: Okay. Then to Mr. Le, given that, do 7 you have anything preceding the end of 2003 that would 8 document -- 9 MR. LE: Well, the -- 10 MS. YEE: -- the nature of those? 11 MR. LE: -- it is a mom and pop shop. And, you 12 know, the various transactions during the year, you 13 cannot have a promissory note for each transaction. 14 So, therefore, at the end of the year we 15 summarized the total and then we reflected such and then 16 there was a promissory note. I don't know whether you 17 mean after the December 31st, 2003, but both the minutes 18 and the promissory note was December 31st, 2003 date as 19 I recall. 20 And, you know, in reality you don't have like 21 20 promissory notes every time you write a check from 22 Vanco, Inc. to Vanco Trading, Inc., you execute a 23 promissory note because it's impractical for a mom and 24 pop shop. 25 So, at the end of the year, we -- we know 26 exactly how much is total and we summarize the total and 27 we reflect that in both company. And, therefore, we -- 28 we have a promissory note showing the total amount at 26 1 the end of December 31st, 2003. 2 We don't have the -- the 20,000 here, 30,000 3 here, 40,000 here. 4 MS. YEE: Okay. But you understand why that's 5 problematic for the Franchise Tax Board? 6 MR. LE: Well, I mean, the -- as far as the 7 promissory note, I think only terms there, the amounts 8 there and the -- the lender's name there, the borrower 9 there and, you know, everything's there. 10 I don't know what she means not appropriate. 11 MS. YEE: Okay. I guess to the Franchise Tax 12 Board, even -- even if the Appellants had decided that 13 that particular transaction would take place at the end 14 of the year, would you have wanted to see something 15 booked or some -- some substantiation that that was 16 their intent sooner that, I guess? 17 MS. DESHMUKH: Yes. At the time of the 18 transfers or, at the very least, if they treated the 19 transactions consistently as shareholder loans. 20 Like -- as we were talking about before, if 21 this was intended to be a distribution from Inc. to the 22 shareholders and then from the shareholders to Trading, 23 we would have liked to see some consistency there. So, 24 either, you know, the shareholders reporting income from 25 that distribution or adjusting their basis in Inc. 26 MS. YEE: Mr. Le, you have -- 27 MR. LE: Again I -- she -- she keep -- she keep 28 raising the distribution, distributed earnings. We have 27 1 nothing do with that in this case. 2 The company just simply loaned and repay the 3 loan from and to shareholder. We are that way. 4 Okay, we are not talking about distribution 5 here, you confuse the stuff with the law and you keep 6 using that language. We don't have any distributions to 7 talk about here. 8 MS. YEE: Let me stop there, Mr. Chairman. 9 MR. HORTON: Sure. 10 MS. MANDEL: Mr. Horton? 11 MR. HORTON: Member Mandel. 12 MS. MANDEL: Sure. I just want to clarify that 13 because my understanding from the papers was -- of what 14 was coming from, I called these companies differently 15 than you did. 16 Let's see, the money that was coming from -- 17 let me use this little chart -- from Vanco, Inc., that 18 went straight to Trading instead of routing through the 19 taxpayer, my understanding of the way that was explained 20 was that the funds from Vanco, Inc. were repaying former 21 loans that the taxpayer had made to Vanco, Inc. 22 That's the -- and you're -- and the FTB is 23 nodding yes. So, that's your understanding of it as 24 well? 25 MS. DESHMUKH: That's -- 26 MS. MANDEL: That's the explanation? 27 MS. DESHMUKH: -- right. 28 MS. MANDEL: And that's why they're saying that 28 1 you would not see an income treatment on the taxpayer's 2 return. 3 And now you're shaking your head no. So, can 4 you explain why you think that even if it's a repayment 5 of a loan to taxpayer, you know, in a short way, by 6 going straight into Vanco Trading, that you think 7 they'd still be in a position to recognize income, 8 assuming there was earnings or doing something. 9 'Cause you're saying no and that's where there 10 seems to be a dispute right now. 11 MS. DESHMUKH: Well, if it was repayment of 12 debt from Inc. to the shareholders, then we would have 13 seen the shareholders report interest income from the 14 repayment of that debt. 15 In addition, if it was repayment to debt, then 16 that have would have adjusted the shareholders' debt 17 basis in Inc. And that adjustment may have affected the 18 pass through of losses from Inc. to the shareholders. 19 And we haven't seen that on the tax returns. 20 MS. MANDEL: Mr. Le. 21 MR. LE: Yes, I think it's only applicable 22 when -- when the company has -- if the company used 23 the -- the loan balance at the beginning of the year 24 from the shareholder to the company and used that as a 25 business for the tax return purposes. 26 But in the case that if the shareholder loan 27 the company the money during the year and they pay right 28 back and go through the other companies, no -- 29 1 MS. MANDEL: So, you're saying because it -- 2 because the -- I got to go back to my chart. 3 You're saying because the loan from taxpayer to 4 Vanco, Inc. and then the money from Vanco, Inc. to Vanco 5 Trading was all within the single tax year -- 6 MR. LE: Most of that -- most of that happen 7 during the year, okay. 8 Some of that may be related to the beginning 9 like they mentioned, but I think the -- and if you look 10 at the Exhibit -- you look at Exhibit 1B -- 11 MS. MANDEL: -- yeah. 12 MR. LE: -- you can see that the second and 13 third line from the -- second and third line from the 14 Exhibit 1B, you can see that there was an amount, 15 $3,629.12. 16 We -- because the Vanco Trading is on accrual 17 basis, therefore, we even accrued the interest there. 18 We accrued the interest on a loan. We calculate the 19 interest on a loan in the -- and then we have accrued 20 interest there, okay. 21 So, what they saying is on theory if you repay 22 the loan, you have to recognize is the income. If you 23 deduct it, the loss based upon the business you used 24 before, but it's not the case here. 25 MS. MANDEL: Have you -- have you reviewed 26 these? 27 I guess it's the same question Ms. Steel asked 28 you -- have you arrived the transactions, general ledger 30 1 transactions -- 2 MS. DESHMUKH: I -- 3 MS. MANDEL: -- to see how they fit in with 4 what you've been arguing? 5 MS. DESHMUKH: -- yeah. I have taken a look at 6 them. I haven't been able to examine them closely, but 7 I don't see anything that would really change our 8 position. 9 You know, another thing I'd like to point out 10 is that although the taxpayers argue that there was a 11 loan from the shareholders to Inc. and then these 12 transfers were actually repayment of those loans, we've 13 never seen any -- we haven't seen a promissory note or 14 anything else that evidences a shareholder loan to Inc. 15 So, we really don't know when that loan was 16 made, if it was made, when the transfers were made, you 17 know, the terms of that note. So, it's very difficult 18 to look at these transactions and say that they actually 19 match up with a valid loan. 20 MR. LE: If you look at the -- can I say? 21 If you look at Exhibit 1C, at the end of the 22 year, Vanco Trading, Inc., the loan to shareholder, we 23 already reclassified to Vanco Trading, Inc., so -- 24 MS. DESHMUKH: But, see, again on Exhibit 1C, 25 these -- the reclassification is as a loan to 26 stockholder, which is confusing because, you know, it 27 was my understanding that we were talking about a loan 28 from the shareholders to Vanco, Inc., not a loan from 31 1 Vanco, Inc. to the shareholders. 2 MS. MANDEL: The last -- maybe you're looking 3 at a different line than he's looking at. 4 MS. DESHMUKH: Oh, are we talking -- 5 MS. MANDEL: 'Cause on 1C, the last line is, 6 "Offset loan from David to loan to VTI, advances to 7 VTI." 8 MS. DESHMUKH: Okay. 9 MS. MANDEL: Loans to stockholder is above that 10 with a credit. So, I think he's referring to the line 11 below that says "offset loan." 12 MS. DESHMUKH: Okay. 13 MS. MANDEL: That has the 732. 14 But -- you -- you just got this this morning, 15 so -- and the print is small. 16 Okay, thank you. 17 MR. HORTON: It might be helpful for the FTB to 18 restate how the repayment from Inc. should have been 19 reported. 20 MS. DESHMUKH: Okay. 21 MR. HORTON: Being mindful that my concern is 22 more of a form over substance and intent, even though it 23 may not have been established timely, whether or not the 24 subsequent actions and the contemporaris (verbatim) 25 evidence reflected in the records support their 26 intent. 27 MR. CORNEZ: Even if we accept all their facts 28 as true, that there was, in fact, a loan from Inc. to 32 1 Trading -- 2 MR. LE: There was. 3 MR. CORNEZ: -- because both of these entities 4 are S corporations, there has to be -- you can't get 5 more money out than you put in, whether it's via loans 6 or capital contributions by the shareholders. And if 7 the taxpayers get credit for loan basis for money loaned 8 from Inc. to Trading, they'll get more than they put in 9 unless they report it on to their individual tax 10 returns, the transactions between Inc. and themselves. 11 So, they -- so, that's why we have this sort of 12 confusing thing about it's a deemed distribution from 13 Inc. to the taxpayers and a deemed contribution from 14 taxpayers to Trading because that's the way they would 15 get basis. It would be okay for Inc. to loan the money 16 directly to Trading or give the money directly to 17 Trading and the taxpayers to get credit for it if they 18 properly reflected on their personal tax return the S 19 corporation's ups and downs, if you will, between Inc. 20 and themselves. 21 Without that evidence, claiming credit -- the 22 individual taxpayers claiming credit for the loan from 23 Inc. to Trading has the potential to give them a double 24 deduction, if you will. That's -- and, so, that's the 25 missing evidence here is that Inc. and the taxpayers 26 have properly reported the loans back and forth, 27 distributions back and forth or as he -- or as has been 28 characterized, reclassifications. 33 1 Without looking at all these tax returns, we 2 don't know that that was properly done between all three 3 entities. 4 MR. HORTON: Okay. At the risk of being 5 redundant, I'll go to Mr. Le. 6 MR. LE: Yes. I think his concern is 7 unjustified because based upon the double entry system 8 in accounting system, you increase this, you decrease 9 that, you can never have a duplicate entry because the 10 double accounting system. 11 Therefore, whatever he -- his concern is no -- 12 no -- no basis at all. And we can challenge the 13 Franchise Tax Board. We can match it. We can show you 14 the tax business, the shareholder business from the S1 15 and every number you ask for. 16 MS. MANDEL: Mr. Horton? 17 MR. HORTON: Ms. Mandel. 18 MS. MANDEL: One of the things that was in 19 Mr. Le's thing this morning -- and I don't know what 20 happened at -- at protest, whether there was a protest 21 hearing or not in the case -- but he talks about not 22 having actually had a sit down with the auditor, that 23 the auditor -- that the audit took a long time, but he 24 had a short meeting and a short call or something and 25 that he was never able to sit down and -- and show her 26 anything or discuss it with her. 27 And he's got all of the tax returns. And he's 28 a CPA. He's pretty adamant. I mean, it might -- it 34 1 might not work out, but FTB's saying they haven't seen 2 it on the tax returns and I don't know if they've seen 3 all of the tax returns that he keeps putting his hand 4 on. I don't know if it makes a difference or not, but 5 do you have any information about whether there was a 6 protest hearing and -- because I didn't like seeing that 7 he felt that he didn't have appropriate handling at 8 audit. 9 MS. DESHMUKH: Right. At audits we don't 10 usually have an exit meeting. So, we did issue a audit 11 presentation sheet that explained the issues and then at 12 protest there was also a protest hearing -- and, you 13 know, the full administrative process the taxpayers 14 underwent in -- at protest. 15 So, I haven't seen any indication that the 16 taxpayers were given short shrift in this case. 17 MR. HORTON: Further discussion, Members? 18 Member Steel. 19 MS. STEEL: I think for this exhibit today 20 that, you know, we received, I think, you know, you said 21 it might not be necessary or it's not really relevant, 22 but I think -- it's just assumption that, you know, 23 taxpayer is guilty no matter what. 24 So, I want Franchise Tax Board to review it, at 25 least, and look at it. And then, you know, I want to 26 hear from Franchise Tax Board. 27 MR. HORTON: We would ask that you channel that 28 through the Department. Let's see -- review the 35 1 documents. 2 MS. DESHMUKH: Okay. 3 MR. HORTON: Share if that has changed your 4 position. To the extent possible, have a discussion 5 with the taxpayer. And all future communication shall 6 come before the Appeals. 7 MR. EPOLITE: Mr. Chairman, I would recommend a 8 30-30-30 process in which -- in this instance I would 9 recommend that we have the Franchise Tax Board go first 10 to enable them to review the documents. And then after 11 they've had the opportunity to do that, to then give the 12 taxpayers the chance to respond. 13 MR. HORTON: I would -- 14 MS. STEEL: Just -- 15 MR. HORTON: -- I would be supportive of that, 16 but more for the purpose of assuring that the taxpayer 17 has an understanding of the law, depending on the will 18 of the Board to that degree. 19 Member Mandel. 20 MS. MANDEL: It -- it appears to me, just from 21 looking at what's sitting in front of them, that they 22 have -- they may have more that would be relevant than 23 the general ledger schedule that they showed, that the 24 lawyers on the FTB side, talking to the CPA so that they 25 can at least understand what he did -- they might not 26 ultimately agree with it, they might I think it wasn't 27 the right thing to do -- but it's -- it seems like there 28 has to be some kind of conversation just -- which 36 1 Mr. Cornez seems to be agreeing with -- rather than just 2 the FTB look at the few pieces of paper that he put in 3 hair. 4 MR. HORTON: Okay. Further discussion, 5 Members? 6 Is there a motion? 7 MR. CORNEZ: Can I enter -- can we have more 8 than 30 days? 9 MR. HORTON: One second, sir. 10 Further discussion, Members? 11 Is there a motion? 12 MS. STEEL: 30-30-30. 13 MR. HORTON: Member Steel moves -- 14 MS. STEEL: We just heard from Franchise Tax 15 Board, do you need more than 30 days? 16 No? Yeah? 17 MR. CORNEZ: I think that it would be quite 18 useful to be able to go through all the tax returns and 19 then sit down and talk to the taxpayer and -- 20 MS. STEEL: So, how long? 21 MR. CORNEZ: -- make sure we understand it. 22 And I don't think 30 days is sufficient time. So, I 23 would think 60 days for the FTB. 24 MR. HORTON: Let's see if we can shape a 25 30-30-30 to allow that? 26 Mr. Epolite? 27 MR. EPOLITE: We can allow that, the additional 28 time necessary. 37 1 MR. HORTON: Okay. So, the motion is a 2 30-30-30, giving consideration for the additional time 3 to the Franchise Tax Board, to be monitored by the 4 Department, and particularly Mr. Epolite. 5 Second by -- 6 MS. MANDEL: Second. 7 MR. HORTON: -- Member Mandel. Without 8 objection, Members, such will be the order. 9 Thank you very much for appearing before us. 10 Mr. Epolite will share with you what the 30-30-30 means. 11 Basically, the Department will take under 12 consideration your additional evidence, it may take them 13 a little longer than 30 days. And then they will confer 14 with you. You have additional time to respond to that. 15 And, hopefully, some resolution will com. 16 MR. LE: Can I -- 17 MR. HORTON: Member Mandel. 18 MR. LE: -- can I ask one thing? 19 MR. HORTON: Normally not, but under the 20 circumstances -- 21 MR. LE: Oh, assuming that we provide 22 everything they need to actually turn every number tied, 23 that's mean that would the Board concur with our 24 intention and purpose of the things here, assuming -- 25 MR. HORTON: We're a ways away from the Board 26 concurring. 27 So, Mr. Epolite will share with you what will 28 transpire from the henceforth. 38 1 Thank you very much for appearing before us 2 today. We appreciate your testimony and the evidence 3 that you have provided as well. Thank you. 4 MR. LE: Thank you. 5 ---o0o--- 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 39 1 REPORTER'S CERTIFICATE. 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, JULI PRICE JACKSON, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 JULY 24, 2012 I recorded verbatim, in shorthand, to the 10 best of my ability, the proceedings in the 11 above-entitled hearing; that I transcribed the shorthand 12 writing into typewriting; and that the preceding pages 1 13 through 39 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: SEPTEMBER 4, 2012 17 18 19 ____________________________ 20 JULI PRICE JACKSON 21 Hearing Reporter 22 23 24 25 26 27 28 40