EXTAX^®
Controlling and Recapturing Sales and Use Tax Overpayments

PROTESTING A CALIFORNIA SALES & USE TAX AUDIT
By Daniel M. Davis, CPA

Imagine you are shepherding a sales and use tax audit through the State Board of Equalization’s administrative appeal process.  You already have argued before a Board staff counsel, but your client’s case is complex, and the Board attorney’s written conclusions are unfavorably muddled.  The case now is scheduled for a oral hearing before the elected Board Members, where you must overcome the staff counsel’s report, clarify the fact pattern, and summarize and support the appropriate application of the law and regulations.  Because most of the Board Members are not experts in either sales and use tax law, audit procedures, or accounting principles, you must present your position in layman’s terms, while at the same time being prepared to overcome sophisticated and possibly misleading rebuttals by senior board staff officials.

And you have ten minutes to do it.

Early in 1995, the Board of Equalization began limiting the time allowed for business tax hearings.  The theory behind the time limits sounded plausible: a presentation to the full Board should be limited to a summary of the arguments, because the details of the case would have been provided at the appeals review conference held earlier by a staff counsel or supervising auditor.  In practice, however, this theory has not always held up, and occasionally it has failed miserable.  To understand why, a brief description and history of the board’s appeal process is in order.

The Sales and Use Tax Department of the State Board of Equalization operates approximately sixteen administrative districts throughout California.  Although all of these districts report to the Chief of Field Operations in Sacramento, each has a good deal of latitude in administering its own audit program, and there are noticeable differences in policies and procedures from district to district.  These differences often cause the staff’s audit methods and interpretations of the issues to vary according to location.

However, inter-district differences are not officially recognized, and as an audit is completed, reviewed, and transmitted to the Sacramento headquarters for billing, an informal presumption builds up within the agency: if the audit got this far, it must be right.  This unstated presumption often makes overcoming inferior audit methods or correcting initial misinterpretations of the facts more difficult than resolving the underlying issues.

Once the local district has reviewed an audit and all discussions are completed, the audit report is transmitted to Sacramento for issuance of a Notice of Determination (official billing).  The taxpayer then has 30 days from the date on the Notice to either pay the assessment or file a petition for redetermination.  If a petition is not filed within the 30 days, the Notice of Determination becomes final¹.

A petition for redetermination need not be in any particular form, but it must be in writing, state the grounds for disagreement, and be signed by the taxpayer or an authorized representative².  When the petition is accepted, the audit begins its long journey through the administrative appeal process.

Once the Sacramento headquarters office accepts the petition, the audit is returned to the district of origin.  The reason, in theory, is to allow the district to contact the taxpayer and review any new evidence.  In practice, a satisfactory resolution is unlikely at this level, especially if the initial disagreement resulted from poor audit methods or district misinterpretation of the facts or law.  If an agreement cannot be reached, the audit staff should be asked to return the audit to Sacramento for rescheduling of a conference with the Appeals Review Section.

The Appeals Review Section is part of the Board’s legal division and is nominally independent of any review by the audit staff.  The agency characterizes appeals review conferences as “informal administrative reviews” of the positions advanced by the opposing parties.  The Board distinguishes these conferences from hearings, which is a term reserved for oral presentations to the Board Members themselves.

An appeals review conference may be conducted either by a staff counsel (attorney) or a supervising auditor, depending on whether the controversy involves legal or audit issues.  There are more staff counsels than supervising auditors in the appeals review section, and cases involving both legal and audit issues are generally heard by attorneys.

A typical conference might include three people: a presiding staff counsel, the taxpayer’s representative, and a member of the audit staff.  The proceedings are not intended to be adversarial, but the staff representatives often consider themselves protectors of the revenue and defenders of the audit program, which virtually forces taxpayers’ representatives into an active defensive posture.  Such a system might result in some degree of rough justice if the debates were held before an impartial arbiter.  However, protestations of impartiality notwithstanding, the person who will issue a written conclusion (called a “Decision and Recommendation”) is still employed by the agency that performed the audit.

There are wide variations in both bias and technical ability among individual staff attorneys and hearing auditors, and many are both competent and fair.  However, a small minority exhibit a strong bias in the state’s favor, and others with a limited comprehension of accounting, auditing and sampling techniques tend to defer to the judgement of the audit staff when in doubt.

Since the selection of presiding party is relatively random, taxpayers’ representatives must be ready to clarify technical concepts and complex transactions to an arbiter who may be unskilled in such matters, in the face of vigorous staff opposition which probably will be given a disproportionate weight in the decision process.

Such conditions can result in an unreasonably adverse Decision and Recommendation despite the representative’s best efforts, especially if the client’s case is at all weak to begin with.  If your client does not wish to accept the staff counsel’s recommendations, three alternatives are available:

Filing a settlement proposal;
Requesting reconsideration;
Requesting an oral hearing before the elected Board members.

Filing a proposal with the Board’s settlement section is a parallel procedure which may be initiated any time during the administrative appeal process.³  Generally the settlement section will not agree to a significant reduction unless the taxpayer’s case is strong and/or the assessment was based on some degree of estimation.  Poor financial condition rarely is taken into consideration, although the logic of such policy is unclear.

A request for reconsideration may be filed within 30 days of issuance of the Decision and Recommendation.  The request will be accepted only if new evidence has become available.  Otherwise, taxpayers must request an oral hearing before the full Board of Equalization within 30 days of the date on the letter informing them of this option.  The Board hearing is the only one actually mandated by a specific section of California’s Revenue and Taxation Code.⁴

The Board itself is made up of five Members.  Every ten years the state is redivided into four Equalization districts, each of which elects its own Member.  The fifth Member is the state Controller, who usually delegates attendance at hearings to a staff representative.  No particular legal or accounting background is required of board candidates.

Before 1995, taxpayers were allowed a good deal of latitude in presenting their cases to the Board.  As of January 1, 1995, specific time limits were imposed, and as of January 1, 1996, the board’s new Rules of Practice became effective.  Codified under the California Code of Regulations, Title 18, Division 2, Chapter 10, Regulations 5010 through 5087, the rules contain many potential pitfalls for practitioners, particularly those accustomed to operating under the less formal policies of the past.

Specific time limitations for presenting cases (arguably the most onerous of the restrictions) are not spelled out in the Rules.  However, Regulation 5077 does require the staff to inform taxpayers in writing of how much time they will be allowed.  The customary allocation is thirty minutes, but that period includes a presentation by the Board staff and a period for the Members to ask questions, leaving the petitioner no more than ten minutes to present its case and five minutes to respond to the staff.  Additional time may be requested, but extensions beyond an extra five minutes for each side are seldom granted.

Before January 1, 1996, petitioners were allowed to submit written presentations and exhibits in virtually any reasonable format, at any time up to and including the hearing itself.  In an apparent overreaction to this rampant liberalism, Regulation 5075 now restricts the form, content, and submission time of “briefs,” which so far are being interpreted to include virtually every type of written analysis.

Briefs are optional in sales and use tax cases, but the limits on hearing times make written presentations a practical requirement for all but the simplest of issues.  A petitioner’s brief (defined as an “opening brief”) must contain, at a minimum, a statement of the facts, a discussion of the issues, and supporting legal citations.  The brief must be filed with the Chief of the of the Proceedings Division at the Board’s headquarters in Sacramento, no later than 30 days before the hearing.   Copies must be provided to the other parties.⁵

A reply brief may be filed by any party in response to the opening brief.  It must be filed no later than 15 days before the hearing and contain a statement of the facts and issues (as understood by the responding party), legal citations, and any affirmative defenses.  Reply briefs also are filed with the Chief of the Proceedings Division, with copies to be provided to the other parties.⁶

Briefs may not exceed 30 handwritten or typed 8 1/2 “ by 11” pages, excluding exhibits.  Each page must be double-spaced, in characters not to exceed 12 per inch.  If a brief does not conform to these limitations, the Chief of the Proceedings Division may return it and give the party 10 days to resubmit in compliance.  Failure to do so will be considered a waiver of the opportunity to submit the brief.⁷

Reasonable extensions of time to file briefs may be granted, but only upon a showing of extreme hardship.  Requests for such extensions must be submitted in writing before the brief normally would be due.⁸

Each hearing begins with a report by the Board staff on whether all parties have filed the necessary campaign contribution disclosure statements.  Following this introduction, a Board attorney states the facts, issues, applicable law, and the tentative view of the Sales and Use Tax Department (Department).  The petitioner and/or their representative then state their position and provide evidence, followed by a similar presentation by the Department.  Finally, the petitioners are allowed to offer a brief rebuttal.⁹

Either side may offer witnesses to testify under oath, and the Board Chair may direct witness to testify independently.  Each party may cross examine opposing witnesses.¹⁰

According to Regulation 5079[c], any relevant evidence, including affidavits, declarations under penalty of perjury, and hearsay, may be presented if deemed “the sort of evidence on which responsible persons are accustomed to rely in the conduct of serious affairs.”  This regulation appears to conflict with the Board’s interpretation of Regulation 5075[c] (“Opening Briefs”), under which written evidence might well be disregarded if submitted less than 30 days before the hearing.  To be safe, the prudent representative will submit any written evidence within an opening brief (or an exhibit to such a brief) before the 30 day deadline, at least until clarification is provided.  Regardless of how evidence is presented, the Board may refuse to consider anything it decides is irrelevant, untrustworthy, or unduly repetitious.¹¹

As in all tax cases, the burden of proof falls on the taxpayer in all factual matters except where otherwise provided in statutes or regulations.  However, where the Department asserts an issue of fraud with intent to evade tax, the burden shifts to the state as to that particular matter.¹²

Once all parties have made their presentations, the Board may decide the case, take it under consideration for a later decision, or continue the hearing to a later date.  A majority vote of the quorum (at least three members are needed for a quorum) is required for all decisions or actions.¹³

After the Board makes its final decision, a Notice of Redetermination (final billing) is issued.  The taxpayer then has 30 days to pay or negotiate a payment schedule.¹⁴   Once the assessment has been paid, the only remaining avenue of protest is to file a claim for refund, and then take the case to court when the claim is denied.

The practical effect of the new Rules of Practice is to enhance the importance of resolving most issues before they are heard by the board.  When a case must proceed to the Board level, the best general approach is to submit a strong written presentation in the required format; render the relevant facts and issues down to a concise, bare bones framework; and prepare to rebut vociferous opposition from the other side.

About the Author:

Daniel M. Davis graduated with honors from San Jose State University in 1968 and earned his MBA in taxation from Golden Gate University in 1979.  A former sales and use tax manager for Fujitsu America, Inc., Dan also spent 11 years as managing partner of a Salinas CPA firm.  Before entering public accounting, Dan worked for the State Board of Equalization as a branch office supervisor, district audit reviewer and senior tax auditor.  He has taught a variety of tax subjects, and his articles have appeared in The Practical Accountant, California Lawyer, RIA’s State and Local Taxes Weekly, The California Accountant, and various other publications.  Dan is a senior sales and use tax consultant with Arthur Consulting Group, Inc.

 

The Successful California Accountant, Vol. XLVII No. 6, Spring 1996