Overview of Current MIC Appeals in California

By Chris Micheli

This article provides an overview of appeals filed with the California State Board of Equalization (BOE) concerning the Manufacturers’ Investment Credit (MIC). These cases have made their way through the administrative process at the agency administering the corporate franchise and income taxes, the Franchise Tax Board (FTB). Generally, after audit and protest at the FTB, cases can go before the five-member BOE that sits as a pseudo-tax court for purposes of reviewing appeals from FTB determinations.

If the taxpayer is unsatisfied with the outcome at the BOE, the taxpayer can pay the tax and take its case to a Superior Court.  However, if the FTB is unsatisfied with the outcome at the BOE, it cannot appeal a case to a California trial court. The major issues emerging in these MIC cases should be reviewed and monitored by taxpayers and practitioners, and be taken into consideration in future planning activities.

In this article, five cases are briefly discussed, all of which should be concluded in 2002.  Once each case has been concluded at the BOE, each will be separately reviewed in a detailed article. This article will be updated on a regular basis to apprise readers of new MIC cases and the disposition of pending cases at the BOE.

I. OVERVIEW OF THE MIC STATUTES

In 1993, California enacted a 6 percent investment tax credit and a partial (equal to 5 percent) sales/use tax exemption for the purchase of certain property (generally machinery and equipment) purchased for use by manufacturers (See California Revenue & Taxation Code [CRTC] §§ 17053.49 (personal income tax law) and 23649 (corporation tax law) [for the MIC] and 6377 [for the partial exemption]).  The MIC statute has three major requirements.

Qualified Taxpayer Definition – For purposes of the MIC, the law provides that a “qualified taxpayer” is any taxpayer who falls within Standard Industrial Classification (SIC) Codes 2011 to 3999 (which is Division D, “Manufacturing”), or 7371 to 7373 (which is 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 Definition – 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) which is “primarily used” in a manufacturing or related process, (4) which is placed in service in California on or after January 1, 1994.

Qualified Cost Definition – 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.

II. SUMMARY OF PENDING CASES

The following is a summary of the five cases filed with the BOE and their current status. The cases are reviewed in order of when the taxpayer’s appeal was filed.

Save Mart Supermarkets

Major issue: Qualified taxpayer

Representing the taxpayer: Jeffrey M. Vesely of Pillsbury Winthrop in San Francisco and Michael D. Herbert of Andersen in San Francisco.

Briefs Filed: Briefing has been completed. Taxpayer filed opening and reply briefs; FTB filed reply brief. FTB filed petition for re-hearing; taxpayer filed reply brief.

Status: 4-0 decision in favor of the taxpayer on August 14, 2001. A written decision was not issued. A ruling on the petition for re-hearing has been set for February 6, 2002.

Summary: This case involves 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 restrict the scope of who qualifies for the MIC.  The FTB argued the regulation is a reasonable interpretation of the statute.

Milpitas Materials

Major issue: Qualified property

Representing the taxpayer: Robert Reynolds of PricewaterhouseCoopers in Sacramento.

Briefs Filed: Briefing has been completed. Taxpayer filed opening and reply briefs; FTB filed two reply briefs.

Status: Oral argument is set for February 5, 2002.

Summary: This case involves 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 argues that bifurcation of qualified property is not supported by the statute. The FTB argues a dual-purpose analysis is appropriate and is supported by the old federal ITC law.

Bronco Winery

Major issue: Qualified property

Representing the taxpayer: John Youngquist, a sole practitioner in San Francisco.

Briefs Filed: Briefing has not been completed. Taxpayer has filed opening and supplemental briefs; FTB must file reply brief by late March 2002.

Status: Briefs are still being filed; oral argument likely in early spring.

Summary: This case involves whether certain, large steel tanks qualify for the MIC or whether they are inherently permanent structures. At issue is whether the 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 argues that the regulation impermissibly narrows the scope of the statute.

Baxter Healthcare

Major issue: Qualified costs; third-party capitalized labor

Representing the taxpayer: Steven Danowitz, Prentiss Wilson and Glynn Bystrom of Ernst & Young in Los Angeles.

Briefs Filed: Briefing has not been completed. Taxpayer has filed opening brief; FTB must file reply brief by late January 2002.

Status: Briefs are still being filed; oral argument likely in early summer.

Summary: This case involves the question whether only “direct” costs of labor under IRC Section 263A qualify for the MIC. At issue is the FTB’s regulation 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 conflict between Legal Rulings 98-1 and 2000-1 is a key aspect of this case. The taxpayer argues that the regulation impermissibly narrows the scope of the statute.

Foster Dairy Farms

Major issue: Qualified costs; third-party capitalized labor

Representing the taxpayer: Yvette Stowers of Deloitte & Touche in San Francisco.

Briefs Filed:  Briefing has not been completed. Taxpayer has filed opening brief; FTB must file reply brief by late January 2002.

Status: Briefs are still being filed; oral argument likely in early summer.

Summary: This case involves the question of whether there must be an allocation between direct and indirect labor paid to third-party contractors. In addition, 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.

Chris Micheli is an attorney and registered lobbyist for the Sacramento governmental relations firm of Carpenter Snodgrass & Associates, where he specializes in tax legislative matters, as well as MIC-related issues. He can be contacted at (916) 447-2251 or cmicheli@carpentersnodgrass.com.