Courts:
Limit on Qualified Small Business Tax Incentive Hits Legal Snag

California tax law again has been found to be discriminating against interstate commerce. In an August 28 decision in Frank Cutler v. Franchise Tax Board, the Second District Court of Appeal held: "We are bound to and do conclude that, because the statute affords taxpayers a deferral for income received from the sale of stock in corporations maintaining assets and payroll in California, while no deferral is afforded for income from the sale of stock in corporations that maintain assets and payroll elsewhere, the deferral provision discriminates on its face on the basis of an interstate element in violation of the commerce clause."

The case also illustrates the glacial slowness in California in getting tax appeals resolved. The tax in dispute for this case was for the 1998 tax year. It wasn't until May of 2004 that the FTB disallowed gain deferral, and then almost three years later (February 2007), the FTB denied an administrative protest. In July 2009, the BOE voted 5-0 to reject the taxpayer's appeal, and finally in August 2012, the case was decided by the appellate court.

In the case, Frank Cutler sold stock in U.S. Web Corporation and purchased stock in several other small businesses. U.S. Web Corporation did not meet statutory requirements that 80 percent of its assets and payroll must be in California.

The court cited language in a U.S. Supreme Court holding in Fulton Corp. v. Faulkner (1996), which said, "A regime that taxes stock only to the degree that its issuing corporation participates in interstate commerce favors domestic corporations over their foreign competitors in raising capital among North Carolina residents and tends, at least, to discourage domestic corporations from plying their trades in interstate commerce."

The court said the FTB insists the California property and payroll requirement does not discriminate against interstate commerce, but "it offers no cogent analysis to support its assertion."

The Court of Appeal decided the remedy to the discrimination against interstate commerce should be determined by the trial court. At issue is whether the stock purchased did or did not meet other requirements for qualified small business stock separate from the property and payroll factors.

Justice Elizabeth Grimes wrote the decision, and it was concurred in by Presiding Justice Tricia Bigelow and Justice Madeleine Flier.

The case is Frank Cutler v. Franchise Tax Board, Second District Court of Appeal, 2012, No. B233773.

Representing Mr. Cutler were attorneys Marty Dakessian, Margaret Grignon, Zareh A. Jaltorossian and Mike Shaikh with the Reed Smith law firm.

August 31, 2012
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