Annual Update on MIC Appeals in
By
Chris Micheli
This article provides a semi-annual update on pending and decided cases before the California State Board of Equalization (SBE) concerning the Manufacturers’ Investment Credit (MIC). The pending cases have made their way through the administrative process at the tax agency, the Franchise Tax Board (FTB). Generally, after audit and protest, cases can go before the 5-member SBE that sits as a tax court for purposes of reviewing appeals from an FTB determination.
If the taxpayer is unsatisfied with
the outcome at the SBE, it can take its case to a Superior Court. However, if the FTB is unsatisfied with the
outcome at the SBE, it cannot appeal a case to a
I. OVERVIEW OF THE MIC STATUTE
In 1993,
Qualified Taxpayer -- For purposes of the MIC, the law provides that a “qualified taxpayer” is any taxpayer described in Standard Industrial Classification (SIC) Codes 2011 to 3999 (which is Division D, “Manufacturing”), or 7371 to 7373 (software developers) of the SIC Manual, 1987 edition. Generally, a qualified taxpayer may be an individual, partnership, C or S corporation, limited liability company, trust, or estate.
Qualified Property -- There are four major requirements for property to qualify for the MIC: It must be (1) tangible personal property, (2) which is depreciable or amortizable under Internal Revenue Code Section 1245(a)(3)(A), (3) which is “primarily used” in the manufacturing or a related process, (4) which is placed in service in California on or after January 1, 1994.
Qualified Cost – To qualify for the MIC, sales tax must be paid on the qualified property, and the costs must be properly chargeable to the taxpayer’s capital account.
Save Mart Supermarkets
Major issue: Qualified taxpayer
Representing
the taxpayer: Jeffrey M. Vesely of
Pillsbury Winthrop in San Francisco and Michael D. Herbert of
PricewaterhouseCoopers (then with Andersen) in
Briefs Filed: Briefing Completed – Taxpayer filed opening and reply briefs; FTB filed reply brief. FTB filed petition for re-hearing; taxpayer filed reply brief to re-hearing petition.
Status: Decided – 4-0 decision in favor of the
taxpayer on
Summary: This case involved the threshold question of who qualifies for the MIC. At issue was the FTB regulation’s reliance upon the SIC Manual and its “establishment rules.” The taxpayer argued these provisions restricted the scope of who qualifies for the MIC. The FTB argued the regulation was a reasonable interpretation of the statute.
Decision: SBE issued a written decision in favor of the taxpayer that invalidated the FTB’s MIC Regulation (Title 18, Section 23649-3, concerning qualified taxpayer requirements).
Major issue: Qualified property
Representing
the taxpayer: Robert Reynolds and
Derrick Brannan of PricewaterhouseCoopers in
Briefs Filed: Briefing Completed – Taxpayer filed opening and reply briefs; FTB filed opening and reply briefs.
Status: Decided – 5-0 decision in favor of the
taxpayer on
Summary: This case involved whether a concrete-mix truck is qualified property and at what point does the manufacturing process end. As a result of similar cases, the FTB issued Legal Ruling 2001-4, which sets forth two holdings. First, the manufacturing process ends at the point that the ready-mix concrete reaches the job site. Second, only the mixing drum, and not the chassis, of the truck qualifies for the MIC. The taxpayer argued that the statute does not support bifurcation of qualified property. The FTB argued a dual-purpose analysis is appropriate and is supported by the old federal ITC law.
Decision: SBE issued a written decision in favor of the taxpayer that bifurcation of an asset is not permitted.
Bronco Wine Company
Major issue: Qualified property
Representing
the taxpayer: John Youngquist, a
sole practitioner in
Briefs Filed: Briefing Completed – Taxpayer filed opening and reply briefs; FTB filed opening and two reply briefs; Wine Institute filed an amicus curiae brief.
Status: Decided – 5-0 decision in favor of the
taxpayer on
Summary: This case involved whether large steel tanks and their foundations used in the winemaking process qualify for the MIC or whether they are inherently permanent structures. At issue was whether the FTB Regulation’s requirement that only tangible personal property under IRC Section 1245(a)(3)(A) qualifies, or whether that provision restricts the statute, which only references IRC Section 1245(a) property. The taxpayer argued that the regulation impermissibly narrows the scope of the statute. The FTB argued that it was proper to follow federal law in determining what constitutes tangible personal property.
Decision: SBE issued a written decision in favor of the taxpayer that large wine tanks are tangible personal property and qualify for the MIC, but underlying concrete foundations do not qualify for the MIC. Also, it was proper for FTB to adopt federal statutes, regulations and case law to determine what constitutes tangible personal property.
Major issue: Qualified property; qualified costs
Representing
the taxpayer: Douglas Bramhall of
KPMG in
Briefs Filed: Briefing Completed – Taxpayer filed opening and reply briefs; FTB filed opening and reply briefs.
Status: Decided – 3-1 decision in favor of the
taxpayer on
Summary: This case involved the question whether only “direct” costs of capitalized labor under IRC Section 263A qualify for the MIC. At issue was the FTB Regulation’s provision that direct, but not “indirect,” costs of labor qualify under the capitalized labor exception to the requirement that sales or use tax be paid. The taxpayer argued that there is no basis to bifurcate direct and indirect labor when the costs are paid to a third-party contractor. The FTB argued that the federal UNICAP regulations distinguish between direct and indirect costs of labor, and that a similar requirement is appropriate for the MIC.
Decision: SBE expected to adopt a written decision on
Teichert Construction
Major issue: Qualified property
Representing the taxpayer: Teichert’s Treasurer.
Briefs Filed: Briefing Incomplete – Taxpayer filed opening brief; FTB did not file any brief.
Status: Resolved – same outcome as Milpitas Materials/Minnis case.
Summary: This case involved whether a concrete-mix truck is qualified property and at what point does the manufacturing process end. The taxpayer argued that the statute does not support bifurcation of qualified property. This case was filed in order to protect the taxpayer’s refund claim.
Decision: The FTB and taxpayer settled the appeal upon issuance of SBE’s written decision in Milpitas Materials/Minnis case.
Baxter Healthcare
Major issue: Qualified costs; qualified property; documentation
Representing
the taxpayer: Steven Danowitz,
Prentiss Wilson, Glynn Bystrom, and Michele Chang of Ernst & Young in
Briefs Filed: Briefing Completed – Taxpayer filed opening, supplemental opening, and reply briefs; FTB filed opening and reply briefs.
Status: Oral argument likely in March 2003.
Summary: This case involves several major issues. First, do only “direct” costs of labor under IRC Section 263A qualify for the MIC? At issue is the FTB Regulation’s requirement that direct, but not “indirect,” costs of labor qualify under the capitalized labor exception to the requirement that sales or use tax be paid. The taxpayer argues that there is no basis to bifurcate between direct and indirect labor when the costs are paid to a third-party contractor. The FTB argues that the federal UNICAP regulations distinguish between direct and indirect costs of labor. Second, what are the parameters of the definition of “special purpose buildings and foundations,” and the equipment used therein? The taxpayer argues that the entire building qualifies when the economic test and the 2/3 usable volume test are met. The FTB argues that only the “clean room” portion of the building qualifies for the MIC, and the entire building does not satisfy the 2/3 requirement. Third, what level of documentation is required by the taxpayer to prove its MIC claim? The taxpayer argues that it has provided sufficient substantiation to support its claim. The FTB argues that the information provided by the taxpayer does not provide enough detail to make the required determinations.
Decision: Pending.
Foster Dairy Farms
Major issue: Qualified costs; qualified property
Representing
the taxpayer: Yvette Stowers of
Deloitte & Touche in
Briefs Filed: Briefing Incomplete – Taxpayer filed opening brief; FTB filed opening brief.
Status: Settlement process pending.
Summary: This case involves whether there must be an allocation between direct and indirect labor paid to third-party contractors. The case concerns Legal Ruling 2000-1 and whether it is an accurate interpretation of the statute, as well as whether it requires excessive documentation of third-party contract costs. The taxpayer argues that third-party capitalized labor does not need to be allocated. The FTB argues that the federal UNICAP regulations distinguish between direct and indirect costs of labor, and form an appropriate requirement for the MIC.
Decision: Pending, but the FTB and taxpayer should settle the appeal based upon the SBE’s written decision in the California Steel Industries case.
Trend Offset Printing
Major issue: Qualified costs
Representing
the taxpayer: Jess Pennilla of
Deloitte & Touche in
Briefs Filed: Briefing Completed – Taxpayer filed opening and reply briefs; FTB filed opening and reply briefs.
Status: Oral argument likely in February 2003.
Summary: This case involves whether the entire replacement cost in an IRC Section 1033 exchange qualifies for the MIC. The taxpayer argues that the MIC statute is silent as to any Section 1033 adjustment. Rather, only IRC Section 179-type deductions were considered. FTB argues that gain deferred under Section 1033 is not included in the measure of the replacement property’s basis for depreciation purposes.
Decision: Pending.
Chris
Micheli is an attorney and registered lobbyist for the