This article is from Cal-Tax Digest, published
by the California Taxpayers' Association.
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Taxpayers in California rightfully celebrated a portion of the recent California Supreme Court decision in Yamaha Corporation of America v. State Board of Equalization (98 Daily Journal D.A.R. 9211, Aug. 28, 1998), but our work is not yet complete, and neither is that of the BOE.

The Supreme Court resolved the question of what standard of judicial review should be provided an annotation interpreting the statutory or regulatory law. What remains to be resolved, however, is the proper role of these annotations at the administrative level and whether the BOE will establish some structural guidelines giving them substance and credibility.

At issue in Yamaha was whether Yamaha was liable for use tax when it shipped resale inventory property by common carrier as a gift to an out-of-state recipient. The resolution to the dispute centered on the interpretation of Section 6009.1 of the Revenue and Taxation Code. It excludes from the definition of "use" subject to tax the "retaining or exercising of any right or power over tangible personal property for the purpose of subsequently transporting it outside the state for use thereafter solely outside the state ... "

Overruling the trial court, the Second District Court of Appeal concluded that the transaction was a taxable use in California, siding with the BOE. The court reached this conclusion in large part by relying on language from prior decisions suggesting that the BOE's interpretation of the law be given a limited standard of review. The BOE's conclusion that there was a taxable use would be "deferred to" unless it was "arbitrary, capricious or without a rational basis." (2nd Dist. Court of Appeal, Opinion on Rehearing, fn. 2, citing American Hospital Supply Corp. v. State Bd. of Equalization, (1985) 169 Cal.App.3d 1088.)

To make matters worse, the BOE's interpretation of Section 6009.1 was not the product of a public and deliberative regulatory process, but by way of an annotation published in its Business Taxes Law Guide (annotations are also published in the Property Tax Law Guide). Annotations are mere summaries of so-called "back-ups" that are intended to be the substantive legal analyses supporting the conclusions of the annotations. Unfortunately, the back-ups can be as conclusory as the annotation, providing little in the way of substantive analysis. Because these back-ups are considered "legal rulings of counsel," they are not subject to the regulatory process pursuant to the Administrative Procedures Act ("APA"). (See Gov. Code Sec.11342(g)). In application, therefore, the Court of Appeals decision would have allowed BOE counsel to "make law" entirely outside the scope of public participation, outside even the Board's participation, and enforce it in court.

In overturning the Court of Appeals decision, Supreme Court Justice Janice Brown notes:

"An agency interpretation of the meaning and legal effect of a statute is entitled to consideration and respect by the courts; however, unlike quasi-legislative regulations adopted by an agency to which the Legislature has confided the power to "make law," and which, if authorized by the enabling legislation, bind this and other courts as firmly as statutes themselves, the binding power of an agency's interpretation of a statute or regulation is contextual: Its power to persuade is both circumstantial and dependent on the presence or absence of factors that support the merit of the interpretation." (Yamaha, at 9212)

Greg Turner is general counsel for the California Taxpayers' Association.

Of most significance is the court's recognition of the distinction between annotations, their back-ups, and regulations that merely interpret the law, and regulations that are the "product of a delegated legislative power conferred on the agency." (Yamaha at 9213). It is only the latter which is afforded a limited standard of review. With respect to any other pronouncement by an administrative agency, the Supreme Court said:

"Courts must, in short, independently judge the text of the statute, taking into account and respecting the agency's interpretation of its meaning, of course, whether embodied in a formal rule or less formal representation. Where the meaning and legal effect of a statute is the issue, an agency's interpretation is one among several tools available to the court. Depending on the context, it may be helpful, enlightening, even convincing. It may sometimes be of little worth." (Yamaha at 9212).

From the court's perspective, the usefulness of annotations and their backups lies in the substance and thoroughness of their arguments, which is as it should be. Such opinions should carry the authority of persuasion, not the crutch of absolutism.

Of course, even in their current state, the entire question about the form and use of annotations would never have arisen if the BOE weren't using the "legal opinions of counsel" exception from the Administrative Procedures Act to attempt to "make law." The objection to the BOE's annotations and their back-ups isn't that they exist. Both the Franchise Tax Board and the Internal Revenue Service have similar opinions that can be of great assistance to taxpayers. The objection is that many of the annotations lack credible legal underpinnings and the BOE continues to use annotations both in audits and in appeals as evidence of what "the law" is.

In many respects, the abuse of the exception for legal rulings of counsel from the APA by the BOE was predicted by the Office of Administrative Law (OAL) at the time the legislation exempting these opinions was adopted. OAL had this to say in its letter to then-Assemblyman Bruce Young, who carried the legislation excepting legal rulings of counsel from the APA: "Because legal rulings can have broad regulatory effect, we are concerned that this exemption could be construed to completely exempt regulatory actions of both boards from the requirements of the [APA]."

It is time for the Office of Administrative Law, or the BOE on its own accord, to adopt basic guidelines for the development and use of annotations and their back-ups. Such guidelines should at a minimum:

• Prohibit the use or reliance on annotations in audits or appeals as evidence to establish what the law is;
• Require that every annotation have a back-up which conforms to a consistent and basic structure of a legal analysis. A backup should have: (a) a clear and concise rendition of the relevant facts; (b) a statement of all relevant statutory and regulatory law as well as any judicial or administrative precedent; (c) an analysis which thoroughly applies the law to the facts, and (d) a conclusion supported by the analysis.
• Ensure that annotations and their back-ups are published within a reasonable amount of time from the date of their drafting or be discarded and include the date the annotation was first published.
• Create some process which permits taxpayers to comment on and/or challenge an existing or proposed annotation.

Finally, the annotations and the back-ups should be readily available to the public for review. The annotations alone are relatively useless. The backups, which provide the substantive analysis, is what is important to the taxpayer and must be available either for purchase or free over the Internet.