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State Board of Equalization:
 Water Therapy Medical Devices Subject to Sales Tax

In two similar cases heard this week, a split Board of Equalizaton held that specified water therapy medical devices are subject to sales tax.

In use, the devices are partly on a patient and partly on the floor. They provide temperature therapy to a patient's injured bodily part by circulating temperature-controlled water through tubes into a wrap that is placed around the injured body part.

Team Post-Op Inc. argued that the devices are exempt as orthotic devices, but board staff believes otherwise.

The Team Post-Op case centered on two issues: are the apparatuses "orthotic devices," and are they worn on the body?

BOE Appeals Department attorney David Levine argued that they are not orthotic devices, asserting they don't meet the statutory definition, as they don't brace or support a body part. Revenue and Taxation Code Section 6369(c)(3)(A) exempts only devices that are used as a "brace, support, or correction for the body structure."

Patrick Leone, representing Team Post-Op, said the device "corrects the body structure," and thus qualifies. It aids in the relief of swelling so patients can move more muscles, he said.

Section 6369 also requires that orthotic devices be "worn" on the body. The board, by regulation, has expanded this to require that they be "fully worn." Mr. Runner asked staff if there is a difference between "worn" and "fully worn." He said "fully worn" was narrow, and outside the scope of the statute.

The taxpayer insisted that the entire device in question is an integrated unit, and the portion on the body would not work without the part on the floor.

The board denied Team Post-Op's appeal by a 3-2 vote (BOE Chair Jerome Horton, BOE Member Betty Yee and Deputy State Controller Marcy Jo Mandel voting to deny, and BOE Member George Runner and BOE Vice Chair Michelle Steel voting in favor of the taxpayer).

In a similar case, Brandi R. Paris contended that aqua therapy pumps sold by her company, Vital Medical, were not subject to sales tax. These machines consist of a pump and reservoir that circulate hot or cold liquid through a wrap on a part of the body. She said the devices were fully wearable by patients.

Ms. Paris also contended that she had trouble with BOE staff, asserting they would not listen, and that they made four errors that had to be corrected, requiring reopening of the audit and causing time delays. She added that it took the BOE staff 13 months to find one error.

As in the Appeal of Team Post-Op, board staff said the product was not exempt from sales tax, as it was not a medicine or orthotic device.

The board denied Ms. Paris' appeal by a 4-1 vote (Ms. Steel provided the lone vote in favor of the taxpayer's position).

In other action from the BOE's meetings:

Bureaucratic Snafu: Taxpayer Not Personally Liable for Company's Sales Tax. Initially, board staff said that business owner Vladimir Rodzai was personally liable for $922,737 of sales tax liability, as his corporation was suspended by the secretary of state. His representative, former state Senator and Los Angeles City Councilman Nate Holden (in the Senate from 1974 to 1978, and on the City Council from 1987 to 2003) said the secretary of state made a mistake, and produced a letter attesting to the error. Board staff said that ended their case, and the board held in favor of Mr. Rodzai.

Constitutional Challenge Launched on BOE Applying Sales Tax on Property Leased to Insurance Companies. Fidelity Asset Management Inc. has launched a constitutional challenge to BOE Regulation 1660, which requires a sales tax to be imposed on property leased to insurance companies.

Attorney Joe Vinatieri, representing the company, said there is an "equal protection" violation, because a use tax – not a sales tax – is imposed on property leased to other businesses. Insurance companies would be exempt from a use tax, due to the constitutional provisions imposing an insurance gross receipts tax in lieu of such a tax.

BOE attorney Cary Huxsoll said the lease was a "continuing sale," and could be subject to sales tax, because the courts have said that states have wide discretion in taxation.

Mr. Vinatieri said there is no rational basis for treating these lease payments – but not all other lease payments – as continuing sales.

The board voted 3-2 to deny the appeal, with Mr. Horton, Ms. Yee and Ms. Mandel in the majority.

DMV Snafu Hurts Taxpayer. Fighting back tears, Kimberly Shena Grigsby told the board that she was a victim of incompetence at the Department of Motor Vehicles, which did not collect use tax at the time she registered a vehicle in 2005. She assumed the DMV had collected the tax, and did not know that the tax had not been collected until she got a notice from the BOE in 2008.

The taxpayer said her husband died, and she does not have the funds to pay the assessment plus interest. She said she should be relieved of the tax, as it was a DMV mistake, and should be relieved of the interest due to the BOE's delay of several years in advising her of the unpaid tax.

Ms. Steel moved to grant the taxpayer's petition, and was joined by Mr. Runner, who said, "For us to chase this poor lady for clearly a DMV mistake is ridiculous." The motion was defeated on a 2-3 vote.

The board then unanimously voted to delete the interest charge that had been added to the tax, and urged her to seek an offer in compromise.

Qualified Purchaser Program Update. Jeff McGuire, deputy of the BOE's Sales and Use Tax Department, provided an update of three changes to the Qualified Purchaser Program adopted by the board in July 2011:

An unresolved issue, from taxpayers' standpoint, is a change to align the due dates of use tax returns filed by qualified purchasers with due dates for Franchise Tax Board returns. Since the inception of the qualified purchaser program in 2009, interested parties, including CalTax, CalChamber, Spidell Publishing Inc. and the California Society of Enrolled Agents, have repeatedly supported and urged the board to support this change. Proponents of this change even secured SB 884 (Ashburn) in 2010 that passed the Senate but did not clear the Assembly. BOE staff has resisted this change, and the board has not adopted it.

According to Mr. McGuire, the BOE has deregistered 296,000 of the 500,000 qualified purchasers currently registered because they have filed three consecutive returns with a zero balance. The BOE will deregister 10,000 more qualified taxpayers this month, he said. Mr. McGuire also noted that staff will be attempting to identify closed accounts that have "a high probably of a use tax liability."

Discussing delinquent accounts for the 2011 filing season, Mr. McGuire noted that the BOE mailed delinquency notices to 300,000 taxpayers in May. This resulted in 195,000 taxpayers filing returns, leaving 105,000 taxpayers who have not yet filed for 2011. The BOE plans to send a second round of delinquency notices this month, and hopes that half of the delinquent taxpayers will respond. If they respond with a zero-balance return, the BOE will deregister them.

For the 2012 filing season, Mr. McGuire stated that the BOE does not plan to identify any additional qualified purchasers, and will send a reminder to 200,000 existing qualified purchasers on April 1.

Ms. Steel asked staff to report on the compliance costs related to the board's qualified purchaser program, and Mr. McGuire said he would provide the information to her.

February 3, 2012
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