Vol. XIII, No. 34
September 18, 2000

CFO MAGAZINE ON TAX ADMINISTRATION:
CALIFORNIA IS A SORE THUMB

California’s tax agencies, mainly because of audit aggressiveness, received the highest (least friendly to business) rating among all states in the third biannual CFO magazine survey of business tax executives.

CFO’s September issue notes that the survey’s 71 responses rated states on issues such as nexus, audit aggressiveness, administrative fairness and overall environment. Two years ago, California and Massachusetts tied for the highest ranking when averaging the scores. Those two states, wrote CFO Senior Editor George Donnelly, “stick out like sore thumbs.”

The article notes that the state tax survey “reveals consistent patterns that would undermine claims that a state was unfairly singled out or having a bad year.”

California was followed in the overall ratings by Massachusetts, Illinois, New York, Pennsylvania and Connecticut.

California’s auditing policy was rated by far the most aggressive in the country in the poll, Mr. Donnelly reported.

The magazine quoted Rex Halverson of KPMG in Sacramento: “The aggressiveness of the tax auditors in California is legendary. They’re some of the better-trained auditors, and they’ll actually audit. They’re not just looking at things. They’re digging.”

According to the article, audits by the Franchise Tax Board on a business filing a unitary combined return trigger challenges from auditors looking for companies that may be trying to exploit a unitary position. Prentiss Wilson of Ernst & Young LLP in San Francisco was quoted as saying such unitary audits are “very intrusive and go on forever.”

Apple Computer’s Terry Ryan was critical of California’s water’s-edge rules for foreign-source income and dividends. “No state has anything that approximates California’s water’s edge. Those rules are really unfair to taxation, and they create an incredible burden that’s really unjustified. They could still raise the same amount of money and not make us jump through as many hoops.”

Mr. Halverson also said there are “too many layers of bureaucracy at the FTB.”

The article noted that the FTB has passed a resolution designed to limit the audit appeal process to two years. This action was urged by State Board of Equalization Chair Dean Andal, who also sits on the FTB. He said aggressive auditing is encouraged by the liberal California Legislature and the Department of Finance. “To reform the audit process, you have to balance the (state’s) need for revenue with the need for a pro-business culture. I do believe we could have more business and more jobs if we were not viewed so negatively.”
  

GOVERNOR SIGNS “SCHOLARSHIP” ENTITLEMENT PROGRAM

Governor Gray Davis signed a huge new entitlement program last week, providing college scholarships to low-income students with average-or-better high school grades.  The bills (SB 1688, Polanco and SB 1644, Ortiz), when fully operational, are estimated to cost taxpayers at least $1.2 billion a year.

For students with grades of “B” or better, scholarships up to $9,700 will be available to attend private universities (or somewhat less for enrollment at the University of California or at California state universities).  Those with a “C” average or better can get $1,551 to attend community college.

Governor Davis said, “These bills say to all California students, ‘If you do your part by studying hard, we will do our part to help you afford college.’”

The income ceilings on eligibility for the “B” average program are $64,100 (for a family of four), and $33,700 (for a family of four) for the “C” average program.

The program also includes a $1,000 merit scholarship for students in the top 10 percent of their class or the top 5 percent statewide.

The governor’s actions on legislation included:

• Estate Taxes. The governor signed AB 2818 (Corbett), clarifying the definition of property included in an estate and removing an unintended difference between federal and state estate tax laws, by providing that qualified terminable interest property (QTIP) trusts be treated the same under both laws. The net effect of this bill, sponsored by Controller Kathleen Connell, is that a portion of the estate tax currently going to the federal government will come to the state instead, with no change in overall estate tax liability.
  
  
• Interest on Erroneous Refunds. The governor signed AB 2897 (Assembly Revenue and Taxation Committee), providing that interest on erroneous bank and corporation tax and personal income tax refunds begins to accrue 30 days from the notice for repayment.
  
  
• Recision of Proposition 90 Base-Year Value Claims. The governor signed SB 1417 (Wright), allowing taxpayers, under specified conditions, to rescind their claim for transfer of their Proposition 13 base-year value to a comparable home in another county (pursuant to Proposition 90).  Since the inter-county base-year value transfer provision can only be used once, this allows taxpayers who move to a third home to transfer their base-year value by rescinding the base-year transfer to the second home.
  
  
• No- and Low-Property Tax Cities.  The governor signed legislation sponsored by the city of Saratoga that allows no- and low-property tax cities in Santa Clara County to avoid having their property tax allocation reduced when another city tax is reduced if the city has also increased another tax (SB 1883,Sher).  In 1996, Saratoga voters repealed the city’s utility user tax.  As a result, the city also lost $730,000 in property tax revenue.  However, in 2000 voters approved a $15 million bond for libraries, raising property tax rates.  No- and low- property tax cities are cities that did not levy a property tax prior to Proposition 13 and thus were not originally allocated a share of the remaining property tax because they did not lose any revenue.  In the 1980s, these cities jammed through legislation giving themselves a share of the property tax allocation, providing they did not reduce other taxes.
  
  
• Possessory Interests. The governor signed legislation suggested by the Los Angeles County assessor excluding new month-to-month possessory interests with a value of $50,000 or less from the supplemental assessment roll.
  
  
• Wertin Fix. The governor signed AB 2896 (Assembly Revenue and Taxation Committee), clarifying the Wertin decision.  The bill allows the Franchise Tax Board to use electronically stored information to prepare deficiency assessments.  It also requires the FTB tax booklet to include a statement informing taxpayers they may be requested to furnish a copy of their tax return to the FTB.  
  
  
• Museum of Flying Tax Exemption.  The governor vetoed legislation granting a sales tax exemption for the Museum of Flying (AB 2475, Kuehl).  The governor said, “Although I recognize the revenue losses from this bill are minor (estimated by the BOE to be $4,000), I am vetoing the bill based on my concern about the continued erosion of the sales and use tax base through the expansion of exemptions.”  The Museum of Flying, located at the historic Santa Monica Airport at the exact spot where the Douglas Aircraft Company was founded, has over 40 flight-ready World War II aircraft.
   

INDIANS SEEK SALES TAX EXEMPTION

The Agua Caliente Band of Cahuilla Indians and the Agua Caliente Tribal Corporation have launched a suit maintaining that they are not subject to state tax law requiring them to collect sales tax on purchases of food and beverages by non-tribal members at a tribal resort.

Initially, the U.S. District Court for central California denied the tribe’s claim.  Judge Manuel Real determined that the Eleventh Amendment of the U.S. Constitution, prohibiting suit against a state by a citizen of another state or foreign state, barred the tribe’s claim.  He dismissed the action for lack of jurisdiction.  However, this decision was reversed on appeal.  In a September 11 decision by the U.S. Court of Appeals for the 9th Circuit, the court said, “We conclude that the tribe’s claims fall within the Ex Parte Young exception to the Eleventh Amendment bar, that Coeur d’Alene does not alter the scope of the young exception in this case, and that the district court therefore erred in concluding that it lacked jurisdiction.  Accordingly, we reverse and remand.” (Agua Caliente Band of Cahuilla Indians v. Galen Hardin.)

The suit was filed naming Galen Hardin, a tax compliance specialist at the State Board of Equalization, as the defendant, along with members of the board.

The decision means the suit will go forward on the issue.  It is not known if the BOE will appeal the decision to the U.S. Supreme Court.

If the Indians ultimately prevail, it raises the specter of the creation of a number of tax havens throughout the state where shopping centers, etc., could be located.
 

BOE APPROVES DROP SHIPMENT REFORM REGULATION

The State Board of Equalization last Wednesday adopted a new sales tax regulation (1706) to give taxpayers a safe harbor for determining sales tax due on drop shipments. The regulation establishes a presumption that the retail selling price of the drop-shipped property to the drop shipper is cost, plus 10 percent.  This establishes a safe harbor for drop shippers for computation and remittance of sales tax to the state.  Prior to this change, drop shippers were required to remit tax on a price sold by the retailer, and they often did not know the tax rate.

Prior to adoption of the regulation, the board considered and rejected a request (by letter) from Morrison & Foerster attorney Chuck Moll to delete an example from the regulation.  BOE attorney David Levine told the board the example was correct.  BOE Chair Dean Andal said he was not thrilled by “day-before” requests for amendments.

Other BOE developments:

• Decision on Bad Debt Sales Tax Refund.  In an important sales tax decision, the board ruled on a 3-1 vote that an auto finance business that finances autos by purchasing the contract of sale from the auto retailer can obtain a sales tax refund as a result of bad debts, if the company is present at the auto dealership at the time of sale (either physically or electronically), if the successor transaction is contemporaneous, and full consideration was paid for the contract (Appeal of WFS Financial Inc.).
  
  Pillsbury, Madison and Sutro attorney Richard Nielsen, representing WFS Financial, pointed out that if there is a bad debt and the sales tax had been paid on the bad debt amount, a retailer gets the refund.  However, he said BOE staff takes the position that if the contract is sold to a finance company, neither the retailer nor the finance company can get a sales tax refund as a result of a bad debt.  In effect, the state keeps money to which it is not entitled.
  
  At issue in the case was the definition of “successor” in a board regulation that allows successors to get the bad debt refund.  BOE staff took the position that it meant successor to the business.  The taxpayer said successor meant successor to the contract.  Voting in favor of the taxpayer’s interpretation were Mr. Andal, Member Claude Parrish, and Marcy Jo Mandel for Controller Kathleen Connell.  Voting no was Member John Chiang. Member Johan Klehs was absent from last week’s meeting due to a death in the family.
  
  
• Political Attack Launched on the Board. Some county assessors and elements of the spending lobby launched an attack on the board last week through an article by Bernadine Tansey and Kenneth Howe in the San Francisco Chronicle.  Their gripes: objections to the direction given assessors not to assess non-assessable business intangibles, and unhappiness that, because of declines in value, assessments of state-assessed property are not producing enough revenue for increased spending.
  
  One target of attack is the board’s assessor handbook for its provisions that restate statutory and constitutional law that intangibles relating to a business are not to be included in the value of the property of the business.  The property tax is only to be a tax on the value of property.
  
  Although no one quoted in the article claims that any state assessee is incorrectly assessed, assessors and a county spokesperson are critical of the fact that revenues from the state assessment roll are declining.  Pat Leary, a lobbyist for counties, says it is time for the Legislature to look into the effect of board policies on state revenues. (Ms. Leary may be unaware that utility assessment is a constitutional function of the board.)
  
  Cal-Tax General Counsel Greg Turner said the article lends credence to the charge that local officials are not interested in fair assessments; they are just revenue agents interested in high values to generate more revenue to satisfy the spending lobby’s appetite.
  
  A target of the attack was Mr. Andal, who has a reputation of trying to protect taxpayers from unfair treatment by tax administrators.  Riverside County Assessor Gary Orso is quoted as saying, “I wouldn’t call it a love-hate relationship.  Unfortunately, it’s more of a hate relationship.”
  
  Mr. Andal says the board values property of each company correctly and said the decline in value is due to a host of factors, including aging equipment, the divestiture of power plants (which show up in the local assessment roll, rather than the BOE’s), a slowdown of new construction by utilities, the expiration of a “settlement agreement” that artificially propped up values, and deregulation that results in non-monopolies that are generally of less value than monopolies.
  
  
• Sales Tax: Nutritional Feeding Therapies.  The BOE Business Taxes Committee last Wednesday agreed to clarify how the sales tax applies to nutritional feeding therapies.  Board members accepted a staff recommendation to include enteral feeding as part of the definition of meals that are exempt from sales tax. The board also decided to include the bags, tubing and related items used to dispense the meal as prosthetic devices exempt from sales tax.
  
  Despite the urging of Charles Guenther, representing pharmacists, the board concluded that other related supplies would remain taxable.  Mr. Andal said there was no statutory authority to classify such products as tax exempt.  The changes adopted will be incorporated in board sales tax Regulations 1593 and 1591, and will be noticed for a formal regulatory hearing soon.
  
  
• Secrecy in Government. As the board began to consider staff’s budget change proposals for 2001-2002, it was informed that the Department of Finance said the board must keep the change proposals “secret.”  Mr. Andal said that documents before the board at a public hearing should be available to the public and called the position of the Department of Finance “offensive to me.”  The board asked BOE Chief Counsel Tim Boyer to research the issue.
  
  
• Assessment Appeals Manual. The BOE Property Tax Committee adopted a number of changes to its Assessment Appeals Manual to reflect current developments.  Among the noteworthy changes to the manual are provisions to reflect the requirement for appeals board members’ training (SB 1234) and the conflict-of-interest provisions for persons associated with appeals boards (SB 1231).  New language also reflects Sunrise Retirement Villa v. Dear, providing there is no statute of limitation for filing an appeal if the applicant claims that an erroneous change-of-ownership determination occurred.  In addition, changes to the manual reflect recent rules relating to assessment appeals adopted by the board.
  
  
• Houseboats. The board approved amendments to Regulation 1661 to provide that houseboats over 30 feet long are deemed to be mobile transportation equipment.  There was no opposition to the change.
  
  
• Access to Records. The board adopted Regulations 8000-8016, clarifying the types of records available at the board and how they may be accessed.  There was no opposition.
  
  
• Bradley-Burns Allocation of Sales Tax from Motor Vehicles. The board adopted Regulation 1803.5, clarifying the allocation of local sales tax revenue from long-term leases of motor vehicles.  There was no opposition.
   

VLF EARMARKING STAYS ON EL DORADO COUNTY’S BALLOT

A citizens’ initiative requiring El Dorado County to spend one-half of the revenue generated from the vehicle license fee (“car tax”) on roads will stay on this fall’s ballot, visiting Superior Court Judge Richard Haugner has ruled.

However, El Dorado County Supervisors have voted to appeal Judge Haugner’s decision.  County Counsel Lou Green said, “I do not think we got a favorable decision on the law.”  He argued that the Board of Supervisors has exclusive authority in budget matters.  Keith Brooks, attorney for the initiative’s supporters, said there are no limits in the county’s charter on the initiative power of the people.

 
ALPINE COUNTY FAILS TO MEET ASSESSMENT LEVEL REQUIREMENTS

Alpine County has failed to meet statutory assessment level standards, according to State Board of Equalization sources. The county was found to have an average assessment ratio of 89.69 percent, substantially less than the 95 percent required by law.  Thus, Alpine becomes the first county to fail to meet this standard since it was placed in law in 1986.

The BOE also found the county failed to meet the equity test enacted in 1995 as part of Cal-Tax’s assessment reform bill, that requires each assessment to be reasonably close to the county’s average.  The county’s assessments were determined to be outside the statutory requirement of 7.5 percent of the sum of absolute differences.  For the county, the sum of absolute differences was found to be 11.24 percent.

As a result of these findings, the Assessor’s Office will lose the allocation of 5 percent of property tax revenues collected from “supplemental roll” assessments.  Dave Peets is Alpine County’s assessor.
 

SALES TAX TO REACH RECORD HIGH IN AVALON

POTPOURRI: SYMPOSIA, SIGHTINGS, SALUTES & SNAFUS

THE GIFT THAT KEEPS ON GIVING.  San Diego City Council members voted last week to increase their retirement benefits.  The biggest change will allow members to begin collecting pensions at age 55, rather than 60.  Under the new plan, the mayor and council members would be eligible for 3.5 percent of their salary times the number of years in office.  Beside their pensions, retired council members also get free health insurance for themselves.  Mayor Susan Golding and four or five council members are leaving office this year.

TAX $$$ @ WORK: THE BIG BONANZA. John Bogie, superintendent of Lost Hills Union School District, collected approximately $155,000 in compensation last year.  (The average for a superintendent was $106,000 in 1999.)  The district, one of the poorest in central California, has two small schools and about 80 employees.  District residents have asked the Kern County Grand Jury to look into district-paid trips for Mr. Bogie and his wife, Judith, to Hawaii, New Orleans, Colorado, and Washington, D.C.  Mr. Bogie also gets use of a district-supplied Crown Victoria with paid gasoline, and a $100,000 life insurance policy.  Mr. Bogie defended his contract, which he said was approved by the school board.  He said his nine-day trip to Hawaii in 1998 was to attend a five-day conference organized by the California Association of Middle Schools.  He said he needed the extra days on each side of the conference because, “you don’t want to be suffering from jet lag when you get back.”

SANTA CLARA COUNTY ASSESSMENT REPORT ISSUED.  Santa Clara County Assessor Larry Stone has published the first “Assessor’s Annual Report” for 2000-2001.  For tax junkies it is a goldmine of information.  Among items: the net local assessment value grew by $15.35 billion (9.74 percent) from 1999 to 2000.  The assessor was successful in assessment appeals by maintaining the enrolled value of 93 percent of all appeals filed.  Nearly one million in unspent funds were returned to the county by the assessor.  In Santa Clara County during the last 15 years, the average assessed value of single-family homes has ranged from 42 percent to 56 percent of market value (due to Proposition 13).  Stanford University receives the largest exemption in the state at $3.3 billion.  Single-family homes are a majority of all values of locally assessed property (at 55 percent of the roll) and grew in assessed value at 9.6 percent his year.  Research and development industrial real property grew in assessed value by 21.1 percent and the assessed value of electronic and machinery manufacturing real property grew at 12.5 percent.  With the economy strong, the number of assessment appeals dropped from 6,627 in 1996 to 1,753 in 1999.  The highest assessed value of an owner-occupied home in the county is $25.25 million.

HAYDEN TO RUN FOR COUNCIL. State Senator Tom Hayden, who cannot seek reelection this year due to term limits, announced his candidacy for an open seat on the Los Angeles City Council.  The liberal Brentwood Democrat is projected by Los Angeles county political observers as a leading contender for the seat being vacated by Council Member Mike Feuer.  The district stretches from Westwood to Van Nuys, and Mr. Hayden must move to become a resident of the district.

TAX $$$ @ WORK: Chargers Tickets. Taxpayers have already bought $3.35 million worth of tickets to San Diego Charger games as a result of meager turnouts at the football team’s first three home games of the season, two of them exhibition matches, reports the San Diego Union-Tribune. Under a 1996 agreement between the National Football League team and the city of San Diego, the city guaranteed to pay the team the equivalent of 60,000 attendance for each game in the 71,000-seat Qualcomm Stadium. There were only 51,300 fans at the September 10 game against New Orleans. The money comes from hotel tax revenues, but the city has put only $5 million in its reserve fund to pay for the whole season of seven home games. After that, the city will take money from the stadium operations fund, the newspaper reported. The Chargers will offset the ticket guarantee with rent that amounts to $6 million this year.  Meanwhile, the Oakland Raiders and officials of the city of Oakland and Alameda County are at odds over an alleged sell-out agreement. The Raiders claim they were misled with promises of sellouts, enticing them to move back from Los Angeles in 1995. The Raiders seek more than $1 billion in damages in a suit pending in Sacramento County Superior Court, where Judge Joe Gray has ruled that the team must honor the rest of a 16-year lease. According to coverage in the San Francisco Chronicle and Sacramento Bee, Oakland offered to settle the lawsuit if the team would agree to play in Oakland through 2025. The team rejected the offer as a publicity stunt.  The three-year court battle has already cost taxpayers $6 million in legal fees, the Chronicle reported last May.

TAX $$$ @ WORK: Judges’ Perks. According to a Los Angeles Times report August 20, Los Angeles County judges are receiving duplicate benefits and perks from state and local taxes, getting nearly $30,000 a year above their $118,000 base salaries. Some call it “double dipping.” For example, judges on the superior court get $22,400 in cash from the county for health and insurance benefits that are already fully provided by the state. They also get $5,520 a year in “professional development” funds for legal journals, educational books and conferences. The Times also reports that judges also get two retirement programs, one from the state and one from the county. The compensation of an L.A. judge is so high that they would be taking a pay cut if they accept promotions to the next level. Chief Justice Ronald George said the disparity between the more than 400 judges in Los Angeles County and those in the rest of the state doesn’t make sense. He called it “double dipping for benefits,” but stopped short of urging the state Legislature to intervene.  Presiding Judge Victor Chavez defended the current level of pay and benefits, and said it ought to be even more to attract the best lawyers to become judges. “Even with the benefits, we’re not at the level needed,” Judge Chavez said.

OAL APPROVES BOE’S ARCHITECT REGULATION.  The Office of Administrative Law (OAL) has approved the State Board of Equalization’s amendments to Sales Tax Regulation 1506, relating to architects.  The regulation provides that, in general, plans, renderings and models provided by an architect to a client are part of the architect’s services and not subject to sales tax.  However, if architects furnish plans, etc., after the completion of the contract, they would be subject to sales tax.  The regulatory changes are effective September 15.

OPEN-SPACE INTEREST COMPONENT.  The State Board of Equalization is advising assessors that the interest rate component to be used in the capitalization rate for valuing Williamson Act and open-space lands is 6 percent for 2001.

CORRECTION: MAJOR MENTAL GAFFE.  In our September 4 story on the evaluation of the assessors’ loan program, we attributed the 2 percent inflation factor to Proposition 218, when everyone knows it was established by Proposition 13.
  

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