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 OCTOBER 30, 2013 10 11 12 13 14 15 FINAL ACTION 16 (CASE HEARD OCTOBER 29, 2013) 17 18 19 20 21 22 23 24 25 REPORTED BY: Kathleen Skidgel 26 CSR NO. 9039 27 28 1 1 P R E S E N T 2 3 For the Board Jerome E. Horton of Equalization: Chairman 4 5 Michelle Steel Vice-Chairwoman 6 7 Betty T. Yee Member 8 9 George Runner Member 10 11 Marcy Jo Mandel Appearing for John 12 Chiang, State Controller (per Government Code 13 Section 7.9) 14 Joann Richmond 15 Chief, Board Proceedings Division 16 For Board of 17 Equalization Staff: Anthony Epolite Tax Counsel IV 18 Legal Department 19 Grant Thompson Tax Counsel IV 20 Legal Department 21 22 ---oOo--- 23 24 25 26 27 28 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 OCTOBER 30, 2013 4 ---oOo--- 5 MR. HORTON: Let us reconvene the meeting 6 of the Board of Equalization. 7 Ms. Richmond, the Board put over an item 8 yesterday and would like to take that matter up 9 today. Can you introduce the item again for the 10 record? 11 MS. RICHMOND: The item that was put over 12 from yesterday's meeting is B7a Pacific Coast 13 Building Products, Inc.; B7b Erin Sullivan; B7C 14 Patricia Anderson (deceased); B7d Carol Anderson 15 Ward; B7e John E. Anderson; B7f David Lucchetti and 16 Christine Lucchetti; B7g Keith Harris and Mary 17 Harris; and B7h James Anderson and Jacquelyn 18 Anderson. 19 MR. HORTON: Thank you. 20 Members, we will open this item up for 21 discussion. 22 Discussion, Members? 23 MS. YEE: I'll go. 24 MR. HORTON: Member Yee. 25 MS. YEE: Thank you, Mr. Chairman. 26 It's always good to sleep on a matter. 27 But, um, I wanted to see if I could try to provide a 28 framework for how we're going to decide this. After 3 1 reviewing the evidence and the testimony again last 2 evening into this morning, um, I'm actually feeling 3 quite unsatisfied with both sides. 4 I, uh, appreciated the passion with both 5 sides argued the case. Um, and, frankly, I thought 6 the most compelling part of the hearing yesterday 7 was the testimony by the plant managers who came 8 forward to, uh, really, uh, elaborate more on what 9 was happening at the various locations. So I 10 appreciated that aspect of the -- the hearing. 11 What I'm still troubled by is the, uh, 12 close to outright dismissal of the, uh, cost center 13 approach or the cost center, um, R&D credit study 14 that was provided to the Franchise Tax Board and not 15 really, uh, having the, uh, deep dive that could 16 have taken place with respect to, um, some of the 17 expenses. 18 And in fact, coming from a preliminary 19 audit determination for the 1999 year in which 20 qualified research was determined by the Franchise 21 Tax Board and recognizing that it was a preliminary 22 audit determination and, uh, the Franchise Tax Board 23 even articulating the disallowance of certain types 24 of expenses. Then fast forward to the subsequent 25 years where no qualified research was, um -- was 26 found and, uh, you know, really not giving us much 27 with respect to how we ought to evaluate the, uh -- 28 the, uh, expenses. 4 1 So, um, I want to see if I could just start 2 with, uh, how I view -- and -- and I really am 3 trying not to go back to looking at this 4 project-by-project. 5 I appreciate the testimony with respect to 6 what was happening at the different plants, was able 7 to review all of the documents again with respect 8 to, um, each of the projects and putting that up 9 against the various authorities that were discussed 10 during the hearing yesterday. 11 The -- the framework that I'd like to 12 follow is, first, uh, just backing out the projects 13 that we know were outside of the years at issue. So 14 I think there were four projects that were 15 identified. 16 MR. EPOLITE: Those were projects 18, 20, 17 21, and 27. 18 MS. YEE: Okay. I don't believe those are 19 properly before us, um, so I would start there. 20 Uh, with respect to the rest of the 21 projects, I still have some question with regard to 22 projects that had expenses attributed to it that 23 occurred either prior to the start date or after the 24 end date. Um, and I think there were numerous ones 25 of those. 26 I still don't feel satisfied about the 27 explanation for -- or how we ought to regard those 28 expenses. And maybe, Appeals, you can elaborate on 5 1 that. 2 It seems to me that the appellants define 3 the start and end date. And to the extent there are 4 expenses that are identified at each end of the -- 5 outside each end of those, I mean I can understand 6 that projects continue to incur expenses. But how 7 do we -- how do we -- how ought we treat those? 8 MR. EPOLITE: Appellants stated that the 9 dates that they gave related to the -- 10 MS. YEE: Documentation. 11 MR. EPOLITE: -- documentation presented, 12 which would have been the earliest document and the 13 last document provided and the dates of those 14 documents. But what still doesn't make sense, even 15 if they were doing that, they were still, 16 nonetheless, claiming expenses in other fiscal 17 years. 18 MS. YEE: Mm-hmm. 19 MR. EPOLITE: So, there seems to be a 20 discrepancy. 21 MS. YEE: Okay. All right. 22 Um, so there's that set of cases then, 23 where we've got expenses outside of the start and 24 end date period. 25 With respect to the remainder of the 26 projects, um, my view this morning is, uh, I think 27 there's some merit to look at, um, allowing the 28 credit consistent with what the Franchise Tax Board 6 1 had done in 1999. 2 And the reason I say this is because I 3 don't, uh -- we didn't have a lot of examination of 4 the, um, additional materials that were provided, 5 um, for the subsequent years. And I think coupled 6 with the testimony yesterday, certainly the 7 declarations, everything that we have before us, um, 8 I feel like I can get there without having to go 9 project-by-project. But that's -- I'd be open to 10 hearing other input about that. 11 MR. HORTON: Further discussion, Members? 12 Um -- 13 MS. YEE: I mean the one thought, 14 Mr. Chairman, that maybe, um, what I can't reconcile 15 is really then if -- if -- if we were to rely on 16 where the Franchise Tax Board was going in 1999, how 17 we then, um, look at this "substantially all" 18 requirement -- and especially if we're not looking 19 project-by-project. That's -- that's where I'm hung 20 up. 21 MS. MANDEL: Um -- 22 MR. HORTON: Member Mandel. 23 MS. MANDEL: If -- maybe I can restate, 24 uh -- restate it, um, sort of taking into account 25 the things that I heard you say. So I'll just be 26 like a translator, and you can beat me up if I 27 mistranslate. 28 Um, what I hear you say is, uh, considering 7 1 all of the -- once you take out the projects that 2 are clearly outside the years, and I hear you saying 3 take out with respect to where there was 4 discrepancies so that you're only looking at within 5 the -- the years for which the start and end dates 6 were identified because those were based on 7 documents. 8 That considering, um, all of the documents 9 presented and the testimony -- and particularly you 10 found the testimony compelling and we had both 11 written and obviously the oral testimony here and at 12 the prior hearing. That you're, um -- that it -- 13 that in terms of, um, "substantially all" that, 14 uh -- um, that as a factual matter, considering all 15 of that evidence, that there was qualified research 16 that met the standard. Um, but that, um -- 17 What was the preliminary audit, was 99 -- 18 the preliminary audit was 80 percent allowance on 19 cost. 20 MR. EPOLITE: That's correct. 21 MS. MANDEL: But that um -- but that, uh, 22 your comfort level was at that 80 percent cost in 23 that you saw some, um -- took some comfort in that 24 from -- from what the first auditor was doing. And 25 considering the entire case as a whole. 26 MS. YEE: Great translation. Thanks. No, 27 that's exactly right. 28 Um, I think the, uh -- I mean, I think the 8 1 preliminary audit did provide some, um -- for me at 2 least, some direction of how this matter should have 3 been reviewed in the subsequent years, and albeit 4 that it didn't get the more robust review for the 5 subsequent years. But, at the very least, um, 6 I think, uh, I do want to rely on that for what we 7 do for the subsequent years. 8 MR. RUNNER: Let me just, a quick 9 question. 10 MR. HORTON: Mr. Runner. 11 MR. RUNNER: Um, the -- the -- the 80 12 percent in the -- in the 1999 year -- 13 MS. YEE: Mm-hmm. 14 MR. RUNNER: And I -- and I think the 15 reason why, if -- actually, I believe, was initially 16 rejected by the taxpayer was because they did not 17 include, um, utilities in -- in that 80 percent. Am 18 I understanding that correctly? 19 MR. EPOLITE: I believe that's correct. 20 MR. RUNNER: Okay. Um, and at least my 21 understanding in some -- and actually in some issues 22 that have come before us where we've had to deal 23 with this issue, and we did this on a -- on the, um, 24 you know, on a -- under the same kind of cost 25 centered analysis on projects that have been before 26 us that we found in favor of the taxpayer, we 27 have -- we have included utilities; is that correct? 28 MR. EPOLITE: Yes, that's correct. 9 1 MR. RUNNER: So the 80 percent is really 2 in -- in the sense deficient for what we've even 3 found in the past when it comes to this issue. Is 4 that -- would that be fair? 5 MS. MANDEL: Um, well just -- 6 MR. RUNNER: Just a minute. Let me just -- 7 I'm asking the -- 8 MS. MANDEL: Okay. 9 MR. RUNNER: -- Appeals. 10 MR. EPOLITE: I think each appeal stands on 11 its own in determining -- 12 MR. RUNNER: Okay. So let me say this, 13 this would be different than what we've found in the 14 past then by not including utilities? It either is 15 or it isn't. 16 MR. EPOLITE: Well -- 17 MR. THOMPSON: Well, I wouldn't think it's 18 inconsistent. I think it's just, uh -- uh, it's 19 a -- it's a -- it sounds like an approximation and 20 adjustment based on the sense of the record. 21 MR. RUNNER: I guess my question, though, 22 is, in the past when we have found for these, we 23 have included utilities? And I think the answer to 24 this was yes. 25 MR. EPOLITE: Yes. 26 MR. RUNNER: This one does not include 27 utilities at the 80 percent? 28 MR. EPOLITE: Correct. 10 1 MR. RUNNER: So this would be different. 2 MR. EPOLITE: If you excluded the 3 utilities, yes. 4 MR. RUNNER: Thank you. Okay. That's -- 5 that's all my point, that's all. 6 MS. MANDEL: And -- and in my -- the way I 7 understood the comment about the record, um -- and 8 there was discussion yesterday about the -- I don't 9 really want to speak for you. But there was 10 discussion yesterday about the Cohan rule. 11 MS. YEE: Right. 12 MS. MANDEL: And that the expenses -- 13 that -- that -- and FTB talked about expenses 14 needing the sort of the nexus and reasonable. 15 So I -- what I was just hearing wasn't 16 necessarily that it was 80 percent for the exact 17 same reason that was given in the -- I mean that -- 18 I'm just -- that's what I heard, that was sort of 19 based on. 20 MS. YEE: That's right. 21 MR. RUNNER: No. I -- I -- I -- I hear 22 that. But I just want to make -- we -- I can -- we 23 can get to 80 percent for different reasons. I just 24 wanted to point out -- 25 MS. MANDEL: Yeah, yeah. There was -- 26 MR. RUNNER: -- that the 80 percent that we 27 had done before -- excuse me -- the finding we had 28 done before included utilities. This one doesn't, 11 1 so that's all. 2 MS. MANDEL: Well, the -- the '99 original 3 preliminary audit she was -- I don't know if it was 4 a she or he -- was excluding utilities when their 5 number happened to be an 80 percent number. And 6 utilities under appropriate circumstances of being 7 extraordinary utilities are -- 8 MR. RUNNER: Included. 9 MS. MANDEL: -- are includable. 10 MR. RUNNER: Right. 11 MS. MANDEL: I didn't necessarily 12 understand the 80 percent being proposed here as 13 being on exactly the same basis of all utilities or 14 whatever being necessarily being excluded. But 15 that's really for Ms. Yee to say. 16 MR. HORTON: Um, further discussion, 17 Members? 18 MR. RUNNER: I -- I -- I just got some of 19 my notes back, so I -- can you go through, again, 20 those -- I think there were four projects, um, that 21 in the discussion to be excluded because they were 22 outside the date. Just -- 23 MS. YEE: Yeah, 18, 20. 24 MR. RUNNER: What numbers were those? 25 MS. YEE: 18, 20, 21 and 27. 26 MR. RUNNER: Okay, thanks. 27 MS. YEE: And then there were numerous ones 28 where the, uh, expenses claimed preceded the project 12 1 start date. 2 MR. RUNNER: Okay. That's all -- I just 3 needed to clarify. 4 MS. YEE: Okay. 5 MR. RUNNER: I just didn't have it in front 6 of me. 7 MS. YEE: All right. 8 MS. MANDEL: And then the expenses and 9 start date differentials are in the chart in the 10 hearing summary, right? 11 MR. EPOLITE: That's correct. 12 MS. YEE: Right. 13 MS. MANDEL: That's the chart on, uh -- 14 MR. THOMPSON: Page 248. 15 MS. MANDEL: 248 to 249. 16 MR. EPOLITE: Yes. 17 MR. HORTON: Further discussion, Members? 18 Um, you know, I, too, was concerned about 19 the, uh -- the testimony and the positions of -- 20 of -- of the Department. 21 The Department seemed to argue that the, 22 uh, their analysis was based on whether or not 23 research activity existed at all. And, um, their 24 establishment of a standard of evidence that would 25 allow them to summarily dismiss all the other 26 evidence was somewhat concerning, and particularly 27 given the case law that -- that supports that and 28 the Treasury Code that supports that. 13 1 The evidence itself, uh, should be based on 2 what's available and what is customary in the 3 industry. And so, to summarily dismiss all of the 4 evidence is inherently wrong. Um, and we have to 5 compel ourselves to examine the facts as they exist 6 before us, which I believe Congress has eloquently 7 articulated that in the absence of scientific 8 evidence, uh, that there is no standard of evidence 9 that is a cookie cutter for every industry. That 10 there is no specific scientific evidence. 11 If the books and records are available, the 12 evidence is there to support the case, we cannot 13 summarily dismiss it. In fact, we have to figure 14 out a basis for doing so. 15 What also concerned me was that there 16 are -- there were three different entities that 17 seemed to have examined books and records and the 18 activities involved. Those entities included the 19 FTB, the Internal Revenue, and the taxpayer 20 themselves performed a separate study. In each case 21 there was a conclusion that research and development 22 exists. 23 And so when we go to the tax code, there 24 are four tests that we have to determine if those 25 tests are met. The first one is whether or not 26 there is qualified research. And these three 27 examinations by the FTB and the Internal Revenue 28 seemed to have concluded that there's qualified 14 1 research. 2 I've actually toured the facility and 3 concluded, based on my analysis and observation, 4 that there was qualified research. 5 And so we're in a position where the 6 Department has not examined the documents and the 7 evidence that was provided and left it up to the 8 Board to either rely on the Internal Revenue's 9 conclusion, which was they concluded a hundred 10 percent, or rely on the FTB's previous conclusion 11 where they concluded 80 percent, including and 12 excluding certain items. 13 We can go in and take a look at -- which I 14 did -- take a look at the FTB's previous original 15 analysis and conclusion. And they included and 16 excluded certain items, of which, quite frankly, 17 utilities can be included. 18 I -- I -- I fundamentally believe that even 19 the executive salary can be included if in fact 20 there's evidence that that was part of the research 21 and development activity. 22 We cannot summarily dismiss factual 23 evidence. The law does not do that. The law is 24 simply a policy established over a period of time. 25 The Department also eloquently articulated 26 the acquisition of equipment and the use of that 27 equipment for environmental purposes, complying with 28 the building code, and did a excellent job, I 15 1 believe, of doing so. And used that as a basis of 2 argument that because these activities exist, then 3 there could not be or should not be any research and 4 development. 5 The court cases in the Trinity, McFerrin, 6 Union Carbide and Fudim all indicate that you cannot 7 do that. So -- as well as the -- there's no basis 8 in law of dismissing factual evidence. 9 So that in itself was somewhat concerning 10 and now put the responsibility on the Board to make 11 these determinations. 12 As it relates to item four of the four-part 13 test it asks us to take a look at whether or not 14 substantially all the activity, the research and 15 development activity can be concluded as research 16 and development. 17 Here's where I have somewhat of a 18 challenge, Members, in just trying to determine the 19 start and end point of the research activity. The 20 appellant has testified that their start point as it 21 relates to the research activity excluded the 22 acquisition of the equipment, excluded the 23 installation of the equipment that would not meet -- 24 would not be considered qualified activity. It 25 excluded that. So the starting point in the amount 26 that the taxpayer reported only included the 27 activity relative to research and development. 28 And so, based on my understanding of the 16 1 law as it informs me, that's the point in which we 2 begin to analyze the 80 percent. And in doing so, 3 it is -- it appears that the taxpayer has met that 4 requirement, uh, has met the burden of proof of 5 providing documentary evidence to support the 6 research and development did exist, that it 7 substantially existed and, um, therefore, is 8 entitled to the credit. 9 Now, how do we go about measuring that 10 credit in the absence of a -- of an analysis by FTB? 11 Is where the challenge comes in. 12 So, a question of the Appeals. The items 13 that we're excluding from the test period, was 14 that -- were those amounts included in the amount 15 that was claimed? 16 And the reason I ask, because in September 17 we started out with 34 projects. And then it 18 expanded to 64 projects. And, if I remember the 19 testimony correctly, the -- the expansion of the 64 20 projects was to reflect the continuity of -- of the 21 claim, basically. 22 MR. EPOLITE: Mr. Horton, are you referring 23 to projects 18, 20, 21, and 27? 24 MR. HORTON: Yes. 25 MR. EPOLITE: Projects 18 and 27, there 26 were zero claimed expenses. 27 For project 20, appellants claimed expenses 28 of $34,266. And for project 21, they claimed 17 1 expenses of $102,605. 2 MS. MANDEL: And the -- and-- 3 MR. HORTON: And 27? 4 MR. EPOLITE: Zero. 5 MS. YEE: Zero. 6 MR. HORTON: Zero. So we're taking out of 7 the -- the amount claimed, because it's outside the 8 audit period, approximately 134,000. 9 Is that where we are? 10 MS. MANDEL: That's the first group. 11 MS. YEE: That's the first group. 12 MR. EPOLITE: Out of that group, yes. 13 MR. HORTON: Out of that group. There are 14 other groups? 15 THE WITNESS: Well, the -- 16 MS. MANDEL: The discrepancy group. 17 MR. EPOLITE: The table that has the -- the 18 discrepancies for the expenses claimed outside of 19 the project years. On pages 248 and 249. 20 MR. HORTON: Okay. 21 MR. RUNNER: What was the total on that? 22 MR. EPOLITE: On that table? 23 MS. MANDEL: The table itself doesn't have 24 a total, I don't think. 25 MR. HORTON: Maybe Appeals can give us a 26 number. 27 MR. EPOLITE: Approximately $4 million. 28 MR. HORTON: Is the -- would the taxpayer 18 1 be time-barred on the items outside of the period in 2 question? 3 MR. EPOLITE: Well, the expenses that 4 they're claiming are inside the appeal years. But 5 the problem with those four projects, all either 6 completely began and ended before the appeal years 7 or began and ended completely after the appeal 8 years. So they identified four projects that aren't 9 even within the six appeal years. 10 MR. RUNNER: Was that -- was that their 11 testimony? 12 MR. HORTON: And so, um -- 13 MR. EPOLITE: It's -- 14 MR. THOMPSON: It's -- 15 MR. HORTON: Uh -- 16 MR. RUNNER: Go ahead. I'm sorry. I'll 17 follow up. 18 MR. HORTON: The, uh -- so that, um -- 19 what's the basis in law that we would be excluding 20 the project outside of the period when the expenses 21 are within the period? 22 MR. THOMPSON: Each year stands on its own. 23 It's a bedrock principle of law. 24 MR. HORTON: Okay. 25 MR. THOMPSON: So we can't be granting for 26 expenses outside the appeals years. 27 MR. RUNNER: Could you speak a little 28 louder there? I missed that. 19 1 MR. THOMPSON: Each year stands on its own. 2 That's a bedrock principle of law. So we can't be 3 granting expenses for outside the appeal years. 4 MR. HORTON: Okay. Pull the mic a little 5 closer just in case we return to you for some 6 reason. 7 Okay. 8 MS. STEEL: Mr. Chairman. 9 MR. HORTON: Member Steel. 10 MS. STEEL: You know, it's really 11 interesting that, you know, we had a full Board 12 hearing last year, September, and then we had the 13 year and -- one year and one month and came back, 14 and five hours yesterday, and we still questioning, 15 and for project-by-project. 16 And then, you know, we -- if we had -- 17 I think we had enough time to -- if we change it 18 from cost center basis to project basis, I think we 19 had enough time to really prove it. 20 As of now, that last year -- yesterday's 21 five hours gone, I think we should just make a 22 motion that -- just make it really simple. Forget 23 about excluding those four or others. I'll just 24 make a motion, very simple, that 80 percent of the 25 all claims -- 26 Mr. Chairman, I want you to hear when I 27 make a motion. 28 MR. HORTON: I'm listening. The good Lord 20 1 gave me two ears. Go ahead. 2 MS. YEE: Sorry. 3 MR. HORTON: Go ahead. 4 MS. STEEL: I already did. 5 MR. HORTON: Okay. 6 MR. RUNNER: I'll second it. 7 MR. HORTON: Member Steel has moved -- 8 Member Steel has moved to -- to allow 80 percent of 9 the amount claimed. Second by Member Runner. 10 Uh, discussion, Members? 11 MR. RUNNER: Let me speak to it real quick. 12 To me, it's a reasonable spot to be for a 13 couple reasons. Number one, the FTB did do the 14 analysis and did do the audit and came up with the 15 80 percent; and that 80 percent, we know, um, in 16 their analysis at that point, did not include some 17 of the traditional issues that this Board has 18 actually approved in the past and is the issue of 19 utilities. 20 So it seems to me the 80 percent is kind of 21 like a bottom line. And so it's reasonable, as we 22 talk about projects that are in or out, that maybe 23 that 80 percent is -- is probably wanting in terms 24 of even what our own policies have been as we've 25 approved these in the past. 26 On top of that, we still have at the other 27 end of this issue an IRS audit that gave them a 28 hundred percent based upon the same accounting 21 1 methods of the -- of the -- of the year that was 2 right outside of this period, but at least it was 3 the same accounting method. 4 So, I think the 80 percent is a very 5 reasonable for us and -- and for the taxpayer. 6 I think it's justifiable on our part. 7 I don't think getting in and out of whether 8 or not something happened in the period, out of the 9 period, I do not -- I do not believe the testimony 10 was quite the same as what was related in terms -- I 11 don't believe -- I shouldn't say that. 12 I don't believe that the taxpayer would 13 believe that these issues that are being -- that 14 we're -- the $4 million that was being dismissed was 15 indeed not righteous and was not done inside the 16 period. I believe that they believe the work was 17 done. I think that was the testimony. 18 And so I think the 80 percent is a 19 reasonable issue given the fact that, again, it's 20 the FTB's own number in the beginning, minus the 21 utilities, and then it's certainly far short of what 22 the IRS found in the -- in the -- in the year 23 following the audit. 24 MR. HORTON: Um, there are a couple things 25 that sort of concerns me about not adhering to the 26 body of law that -- relative to excluding, uh, the 27 items that are not within the audit period or the 28 period in question. 22 1 Um, and so let's see if we can get 2 somewhere in the ballpark and still establish, uh, 3 the essence of the conclusion by the FTB in the 4 original audit, that of all the activity that, uh, 5 their analysis concluded that there was 80 percent. 6 And, um, certainly my analysis as a former 7 auditor and specialist for some 22 years was that 8 there -- the activity, at least two of the plants, 9 was very closely to the 80 percent. Um, in fact, 10 one was more than 80 percent and the other was less 11 than 80 percent. And I would have to sort of 12 average the two. But there, again, I'm 13 micro-managing the audit process which is not, uh, 14 what, uh, this body is called upon to do. 15 So -- 16 MS. MANDEL: No, but you -- you know, based 17 on all of the evidence in front of you -- 18 MR. HORTON: Well, let -- let -- let me 19 conclude. 20 Um, so I think we're -- we're probably 21 around 85 percent, actually, um -- uh, in excluding 22 the items that were not within the audit period. 23 And, quite frankly, I think that number, or 24 somewhere around that number, percentage, would 25 yield the same results as the, uh, motion by Member 26 Steel and second by Member Runner. 27 But I just want to stay as factual as I 28 can. And, uh -- and particularly in light of 23 1 AB 2323, we want to provide subsequent fact patterns 2 of legal analysis that is consistent with court 3 cases and the law itself. 4 So even if it's 85 percent, 95 percent, I 5 don't know how to get to that calculation. Um, and 6 as well, I think it's -- we need to be clear because 7 at the end of the day this will be interpreted by 8 FTB. And I want to be clear to them because there 9 is no adjudication after that. 10 MS. MANDEL: Can I -- can I translate? 11 Because I just got to make sure I'm keeping it all 12 straight in my little head here. 13 MR. HORTON: Sure. 14 MS. MANDEL: So what I'm hearing you say is 15 it's the back-out projects that are the four 16 projects that were identified as outside the years. 17 And I think I heard you say take out the projects 18 that had the discrepancy where there were costs that 19 were allocated at the Board's request, but that were 20 outside the years where the documents identified. 21 That's the chart. 22 I thought I heard you say that. Those were 23 the first two pieces of Ms. Yee's, but, um, you can 24 correct me on that. 25 And then what I heard you say was, if you 26 took out -- if you took out that, that you really 27 thought, overall, the evidence was that the nexus 28 and reasonableness of the costs for what was left 24 1 was at 85 percent. 2 Now, am I right about the middle piece? 3 MR. HORTON: Your interpretation is correct 4 relative to the, uh -- the items. It's the 5 percentages. Um -- 6 MS. MANDEL: The 85 percent at the end? 7 MR. HORTON: Give me a minute or so. Let's 8 see if we can -- 9 MS. MANDEL: Okay. 10 MR. HORTON: I hate to do this in my head. 11 MS. MANDEL: I know. I -- 12 MR. RUNNER: Yeah. Can we get the math on 13 that? Maybe, that would be -- I mean, to see the 14 difference. Because again, if the end result, to 15 me, is 80 percent of the total, I'm good with it. I 16 just need to know what the math is. 17 MR. EPOLITE: I'll do Ms. Steel's math 18 first; how's that? 19 MR. RUNNER: Okay. 20 MR. EPOLITE: Well, that's easy. 21 MR. RUNNER: Mm-hmm. 22 MR. EPOLITE: 80 percent of $40 million of 23 expenses would be $32 million. 24 MS. YEE: Right. 25 MR. RUNNER: Okay. 26 MR. EPOLITE: So 399. 27 MS. MANDEL: I knew I should have brought 28 that little machine with me. 25 1 MR. RUNNER: There's an app for that. 2 MS. MANDEL: Yeah. 3 MR. EPOLITE: So, Mr. Horton, it would be 4 40 million, less the 30 -- less the 4 million in the 5 table, and then 85 percent of the balance. 6 MS. MANDEL: Well, unless -- unless the 7 four projects that were outside -- 8 MR. RUNNER: 130 -- 9 MS. MANDEL: They have no QREs. 10 MR. EPOLITE: Which is 130,000. 11 MS. YEE: Yeah. 12 MR. EPOLITE: That's -- for purposes of 13 this calculation, I'd say is de minimus. 14 MS. MANDEL: I couldn't remember the 15 number. 16 MS. YEE: Yeah. 17 MR. EPOLITE: That would be 30 million 600, 18 versus 36. 19 MR. HORTON: So 90 percent will get us 20 there. 21 MR. RUNNER: New calculation. 22 MR. EPOLITE: 32.4 million. 23 MR. HORTON: Yeah, that got us there. 24 Okay. 25 MR. RUNNER: I would -- let's see. 26 You want to do a subsequent motion? 27 MR. HORTON: I would, um -- there's a -- 28 there's a motion and a second on the floor. We 26 1 would -- we can either have a subsequent motion or 2 return to the maker of the motion and ask them to -- 3 for a friendly amendment to their motion. 4 Member Steel. 5 MS. STEEL: I'm going to stay with my 6 motion. 7 MR. HORTON: There's a motion on the 8 floor. 9 MS. STEEL: What's the subsequent motion? 10 MR. HORTON: Member Steel moves. Mr. 11 Runner seconds. 12 MS. MANDEL: She's asking a question. 13 MR. RUNNER: Hold on. Let's talk through 14 that. Hold on, let's make sure. 15 If my understanding is correct, see if I 16 get this -- what I've heard is correct. The 17 intention would be to go to 90 percent, minus those 18 projects, which would get the taxpayer 19 $32,400,000. 20 MR. HORTON: Well -- 21 MR. RUNNER: Approximately. 22 MR. HORTON: Members, um -- 23 MR. RUNNER: Is it -- 24 MR. HORTON: The -- the amount of the claim 25 is insignificant from my perspective. 26 MS. YEE: Right. 27 MR. RUNNER: I -- I agree, but I'm just 28 trying to compare. 27 1 MR. HORTON: My concern is with the law. 2 MR. RUNNER: Mm-hmm. 3 MR. HORTON: And with the case law relative 4 to the matter, and that we stay consistent with 5 that. 6 MR. RUNNER: And I agree. I'm just trying 7 to get the numbers straight in my head. 8 So, following your understanding of the 9 case law, the -- it would result in approximately 10 $32,400,000 for the taxpayer. 11 MS. YEE: I -- I -- 12 MR. RUNNER: Um, and just -- just to 13 clarify, going with -- going with the motion that is 14 on the floor, it would be approximately $32 million. 15 Do I -- is that -- 16 MS. STEEL: 36 million. 17 You know what, let -- give me another 18 figure there. Just after five hours, my brain is 19 not -- 20 MR. EPOLITE: That's okay. 21 MS. STEEL: -- really working well. 22 MR. EPOLITE: The claimed expenses were 23 approximately 40 million. 24 MS. YEE: Right. 25 MR. EPOLITE: So 80 percent of that amount 26 would be 32 million. 27 MS. STEEL: It's 32 million. 28 MR. EPOLITE: 32 million. 28 1 MS. STEEL: And then if we do 90 percent 2 plus project is 32.4 million. 3 MR. RUNNER: That's correct. 4 MR. EPOLITE: Yes, that's correct. 5 MS. STEEL: Okay. 6 MR. EPOLITE: Mr. Horton's proposal. 7 MS. YEE: Mr. Chairman, let me offer a 8 substitute motion if I might. Uh, let me -- my 9 motion is to, uh, essentially, uh, disallow the 10 projects that fell outside of the years at issue. 11 MR. RUNNER: Mm-hmm. 12 MS. YEE: Um, also to, um, remove the 13 expenses that were incurred before the years at 14 issue and before -- actually, before the project 15 start date and after the project end date. And to 16 allow 80 -- 90 percent of the -- is it -- were we at 17 90 percent? Ninety percent of the, uh -- 18 MR. HORTON: Balance. 19 MS. MANDEL: Other claims. 20 MS. YEE: -- of the balance, right of the 21 other claimed expenses. And this is in 22 consideration of all of the evidence and testimony, 23 and certainly consideration of the authorities 24 discussed. 25 MS. STEEL: So what's that number comes out 26 to? 27 MR. HORTON: Um, so moved. Is there a 28 second? 29 1 MS. STEEL: I just want to look at the 2 number first. 3 MR. EPOLITE: That's the 32,400,000. 4 MS. STEEL: The 32.4 -- I second that. 5 MR. HORTON: Second by Member Steel. 6 Objection, Members? 7 Hearing none, such will be the -- 8 MS. YEE: May I make a statement -- 9 MR. HORTON: -- motion -- 10 MS. YEE: -- about this case, Mr. Chairman? 11 MR. HORTON: -- case. 12 Yes, Member Yee. 13 MS. YEE: I just really have to say on 14 these research and development cases, both sides 15 have to do better. 16 It really is, uh -- I mean, each of us take 17 our responsibility very seriously. But when we 18 really are lacking the analysis that should really 19 guide us in terms of how we make this determination, 20 it's very, very difficult. 21 And, again, I appreciated the passion with 22 which both sides argued the case, but it really -- 23 I'll speak personally -- did not serve me well. 24 MS. STEEL: Can I have a statement, too? 25 MS. YEE: And -- and at the end of the day, 26 I agree with you, Mr. Chairman, it is about the law 27 and the authority. It should never be about the 28 bottom line number. 30 1 MR. HORTON: Member Steel. 2 MS. STEEL: When this case, that when 3 taxpayer gave to the Franchise Tax Board 1999 on 4 cost center basis, so if they do that, they have to 5 follow up with it. But if it's against the law and 6 everything has to be followed up by project basis, 7 then I think we had enough time because this audit 8 is 1999 to 2004. We could have gone to change it 9 and we didn't have to suffer actually. 10 This is a part of our work, but after five 11 years we still get confused, after two full Board 12 hearings plus five hours. 13 So, I think making very clear that what we 14 are asking from the taxpayers then I think it's much 15 easier for both of us, as Board Members and as 16 Franchise Tax Board, and much easier for taxpayers. 17 So we should give them right directions and, you 18 know, prepare the right, uh -- the method or right 19 way to, you know, come out to the Board hearings. 20 MR. HORTON: Member Runner. 21 MR. RUNNER: Yeah, I think my observation 22 of this whole process would be this is, uh -- that 23 the FTB has now, a couple of times, and I know that 24 this is true within a number of audits that they're 25 doing right now, is centered on this 26 project-oriented analysis and -- and audits. 27 It's pretty clear now that the ones that 28 have come before this Board, even though we might 31 1 have -- you know, we found our way through a couple 2 of concerns and the issues in this particular case, 3 but we've consistently, I think, identified the fact 4 that that's not how this Board looks at those. Or 5 at least that's not the only way the Board looks at 6 those; that we do look at these in a -- in a broader 7 context, um, in regards to the activity that's 8 taking place. 9 And so I would hope that, yes, everybody 10 could document better, but I also hope the FTB gets 11 the message in regards that we're willing to take a 12 look at the broader understanding in regards to how 13 these qualified projects are evaluated. 14 MR. HORTON: So, Members, possibly we can 15 charge Appeals -- now that we've voted on the 16 matter, the matter is now behind us. But possibly 17 we can charge Appeals with bringing some 18 clarification as it relates to the Internal Revenue 19 Code 40, 41 and the other bodies in the 20 interpretation of the standard of evidence, whether 21 or not the standard of evidence should -- should 22 comply with some, uh, pre-established standard as it 23 relates to science and so forth. Or, whether or not 24 the -- the -- the subsequent conclusion or the 25 position of Congress in that no taxpayer should be 26 held to a standard so high that to cause them to 27 have to compile documents that are not consistent 28 with their line of practice in an industry. 32 1 The other thing that might be helpful is to 2 take a look at the various case laws -- Trinity, 3 United States versus McFerrin, Union Carbide and so 4 forth -- to codify, if you will, the views as I 5 would interpret it that the blending of 6 off-the-shelf product with research and development 7 in and of itself is not sufficient to summarily 8 dismiss the evidence provided by the -- the 9 taxpayer. 10 And then relative to the four-part -- for 11 the purpose of compelling the Department to impeach, 12 if you will, the evidence provided as not being 13 sufficient as opposed to summarily dismissing or not 14 even examining the evidence provided by the taxpayer 15 as it relates to the 80 percent rule, possibly some 16 clarification might be helpful there as well. 17 MR. THOMPSON: Is it possible we could 18 address some of those issues in the decision which 19 we would bring back to the Board for review? 20 MR. HORTON: That's -- 21 MR. THOMPSON: Make sure the Board's in 22 agreement with it. 23 MR. HORTON: -- the exact direction -- 24 I think that would be helpful. But there are a 25 number of cases -- as Mr. Runner has indicated, 26 there are a number of cases that are lined up to 27 come before us, and it's important that we 28 communicate our understanding of the law. If, for 33 1 no other reason, just to give some guidance to both 2 the taxpayer and the Department. 3 Further discussion, Members? 4 Hearing none, Ms. Richmond, what's our next 5 matter? 6 ---oOo--- 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 34 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, KATHLEEN SKIDGEL, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on October 30, 2013 I recorded verbatim, in 10 shorthand, to the best of my ability, the 11 proceedings in the above-entitled hearing; that I 12 transcribed the shorthand writing into typewriting; 13 and that the preceding pages 1 through 34 constitute 14 a complete and accurate transcription of the 15 shorthand writing. 16 17 Dated: December 11, 2013 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL, CSR #9039 22 Hearing Reporter 23 24 25 26 27 28 35