David R. Doerr, principal contributor
Ronald W. Roach, editor
Over the past two and one-half months, there have been substantive negotiations between FTB staff and the business community over the content of the regulation. While the changes were not sufficient to remove business opposition to the regulation, some improvements were made. Among changes to the August 2 draft were provisions that:
As amended, taxpayers not only have to keep, but may have to create and/or translate, a very broad category of documents. Included are all documents relating to determination of: (1) profit and loss; (2) capital structure factor; (3) apportionment factor; (4) unitary or non-unitary relationships with affiliates; (5) determination of business versus non-business income, and (6) transfer-pricing issues.
In testimony before the board, Fred Main, representing the California Chamber of Commerce, and Cal-Tax's David R. Doerr unsuccessfully urged the board to modify translation requirements. They said this imposed huge additional regulatory cost burdens on business and exceeded the statutory authority granted to the board by Revenue and Taxation Code Section 19141.6. Mr. Richard E.V. Harris, of the Orrick, Herrington and Sutcliffe law firm, also strongly objected to the regulation, saying the scope should be limited to that of federal law.
On a procedural level, the board agreed with a request from Mr. Doerr to format the regulation in a user-friendly basis by using indentations of subdivisions and blocking of the indented provisions with appropriate titles.
Other FTB developments:
State Board of Equalization Chair Johan Klehs said such a practice was "unsatisfactory" and noted the BOE intends to answer 100 percent of the calls received on its 800 number.
Mr. Goldberg said the FTB was budgeted for only a 60 percent response. The board adopted a motion requesting staff to initiate a budget change proposal to fund the service at 100 percent.
She questioned staff projections as possibly out of date. She said changes in the tax system, such as a flat tax, and the governor's plans for privatization could reduce need for added staff. She said, "I cannot imagine staff will grow at the same level as in the past."
Dr. Connell said the state should examine revenue bonds in light of the state's overall bond capacity and priorities.
Supporting the new building, Mr. Klehs said, "I do not see any legislative action on tax reform in the next two years."
The board also voted to oppose federal limits on California's method of "source" taxation of out-of-state residents. According to Mr. Goldberg, only 13 states impose a source tax and California is its principle practitioner.
If Congress links the two concepts and will only support the IRS offset if the source tax is limited, it was the sense of the board that the proposal still should be supported if the compromise is the only game in town.
San Francisco's mayoral contest produced a runoff between former Assembly Speaker Willie Brown and incumbent Frank Jordan in the biggest news from off-year balloting in California last Tuesday. There were no statewide ballot measures or political contests, just a smattering of local races and issues.
In the San Francisco race, Mr. Brown received 33.9 percent of the vote compared to Mr. Jordan's 31.4 percent. A third candidate, Roberta Achtenberg, had 27.4 percent of the vote. The runoff is scheduled December 12, although it was unclear whether snafus in absentee vote counting would result in court challenges. A victory by Mr. Brown would reduce the number of Democrats in the 80-seat Assembly to 38 if Republicans manage to hold an Orange County seat in the November 28 recall election of ex-Speaker Doris Allen.
Meanwhile, in a closely watched election in Los Angeles County, voters in the City of Covina, by a 54 percent majority, said they want to keep a controversial utility tax. Measure M, an advisory vote, asked voters this question: Do you want to maintain the tax until replacement funds can be found to prevent "drastic cuts in vital services?"
Earlier, voters recalled members of the council who had imposed a utility tax without submitting the question to voters, but the replacement council imposed an even higher utility tax. The current council had vowed to abide by the will of the electorate. The future of the tax is unclear, though, because of a state Supreme Court ruling last September 28 that such a tax cannot be imposed without voter approval.
School parcel taxes seemed to do fairly well in several small school districts. In Davis (a Yolo County community dominated by a University of California campus), 74.4 percent of the voters approved the renewal of a $120 per parcel tax. In San Mateo County's Las Lomitas School District, 80.9 percent of the voters approved a $98 per parcel tax, while a $76 per parcel tax was also approved in the Menlo Park School District by more than 83 percent of the vote.
On the losing side were parcel taxes in Santa Rosa for elementary and high schools and a $96 per parcel tax in the Brisbane School District, which received 57 percent of the vote but needed two-thirds approval.
Other election results included approval of a parcel tax for city services in Atherton (San Mateo County). A special tax was turned down by voters in Sausalito (Marin County).
School bonds were getting the necessary two-thirds vote in the Moraga and Lafayette school districts in Contra Costa County and the Emery School District in Alameda County. A bond issue also was approved in the Oak Grove School District in Santa Clara County.
In Woodland (Yolo County), a school bond issue was narrowly defeated, and a school bond measure in Pittsburg (Contra Costa County) appeared too close to call.
Assembly Speaker Brian Setencich says he will push a pro-business agenda in 1996, including tax relief that he said would improve California's economic environment.
The Fresno Republican told the Sacramento Press Club luncheon last Tuesday that he has been working to produce for all members in the closely divided Assembly the equity and stability needed for them to at least have opportunities to advance their agendas.
He said his agenda includes support for a tax cut and tax incentive legislation to improve the business climate, as well as freedom from unnecessary regulations. He said he supports Governor Pete Wilson's 15 percent personal and business income tax cut proposal that cleared the Assembly this year but has been rejected by the Senate Revenue and Taxation Committee. He told a reporter after the luncheon that the governor's proposal, with modifications, could be considered in the year ahead.
He also said he was hopeful that a Senate-Assembly conference committee will produce consensus tax relief. This panel, led by Senate President Pro Tem Bill Lockyer, failed to produce a compromise in September when Assembly Republicans refused to support tax increases included in the proposed package by majority Senate Democrats and minority Assembly Democrats.
The new Assembly leader said he was sure of one thing: the Assembly he leads in January will be prepared to consider tax relief relatively early in the session. Last year's leadership battles paralyzed the legislative process in the Assembly until June.
Specifically, Mr. Setencich said he will pursue his own tax-credit bills that failed to clear the Assembly in 1995 and have become "two-year bills." He has the month of January to win house-of-origin approval or they are dead, but he may also seek to have the provisions ride along in a conference committee vehicle.
His bills are AB 643, a tax credit for small business costs of health care, and AB 703, a tax credit for one-third of the costs of enhanced oil recovery.
The 33-year-old former professional basketball player (in Europe after playing collegiately at Cal State-Bakersfield) was elected speaker of the Assembly in September with only two Republican votes, his and that of embattled ex-Speaker Doris Allen, who is the subject of a recall campaign in Orange County.
Although Republicans outnumber Democrats 41-39, they have not been able to elect their caucus leader (formerly Jim Brulte and now Curt Pringle) to the speakership post. A successful recall of Ms. Allen (with a Republican elected to succeed her on November 28) and the possible election of ex-Speaker Willie Brown as mayor of San Francisco in a December runoff), further reducing Democratic ranks, might give Mr. Pringle the edge he needs to oust Mr. Setencich when the Legislature reconvenes January 3.
Mr. Setencich, meanwhile, has been working individual members of the House and says he has a "half-dozen" Republicans prepared to support him, a number which he said he hopes will grow to at least a dozen by January.
Much of the Q&A session at the Sacramento Press Club was devoted to recently published comments critical of Republican right wingers and their threats to cut off political campaign funding. A Los Angeles Times story described how he refused to kowtow to the Assembly GOP leadership and their scare tactics, firing campaign staff that the Assembly GOP leadership had dispatched to Fresno in 1994 to help him get elected. He said they were incompetent and almost cost him the election. In return for the campaign help, he was to pledge loyalty to caucus leaders and caucus positions. He did not.
In The Times, Mr. Setencich said he is a "very independent Republican" who mostly sides with the Republican Party on fiscal and economic issues.
Contrary to popular perception and propaganda from counties, official state records now show that county revenues actually increased in 1993-94, the year of the big property tax shift. The annual report on county financial transactions from Controller Kathleen Connell states county revenues increased 3.81 percent in 1993-94, from 1992-93 (from $24,653,910,925 to $25,592,978,925).
The counties compensated for a 26.61 percent drop in property tax revenue by increasing special benefit assessments (by 59.72 percent), by increasing fines and penalties (by 59.87 percent), by increasing miscellaneous revenue (by 13.05 percent) and by new state subventions.
In fact, the increase in state subventions, primarily from the 0.5 percent sales tax for law enforcement approved by voters in November of 1993, amounted to $1.346 billion (from $9.417 billion to $10.763 billion). This nearly offset the $1.429 billion property tax loss without the need for any increases in benefit assessments and fines.
A state senator is hounding the state's tax collectors because he believes they are going too far by imposing sales and use taxes on cartoons and comic strips.
And the news media has been lighting up the switchboard at the State Board of Equalization in Sacramento. Headlines ranged from the San Francisco Chronicle's, "Cartoonists' Response to State Sales Tax -- *?!#@!!" to The Sacramento Bee's, "Tax on cartoons no joke."
Senator K. Maurice Johannessen late last month raised the issue in a letter to BOE Chair Johan Klehs. He also issued a news release condemning the practice and demanding an explanation.
"All I can figure is that the Board of Equalization thinks Californians laugh too much. California must be in far worse shape than we'd even imagined, if this is what the tax collector has to do to fill the coffers," the senator said.
Creators Syndicate of Los Angeles was notified earlier this year that it owed taxes, with interest and penalties, on cartoons dating back to 1987. Richard Newcombe, the syndicate's president, said, "Cartoons are really words with drawings. If the state has the power to censor or tax words with drawings, it's a very small step to start taxing words without drawings."
An appeal by a freelance political cartoonist from San Francisco, Paul Mavrides, is scheduled to be heard by the BOE on January 10, said BOE spokesman Steve Martarano. He said Mr. Mavrides (a creator of the Fabulous Furry Freak Brothers) took his case to the news media 18 months ago. Asked whether Mr. Klehs had responded to the senator, or to media inquiries, Mr. Martarano said BOE officials were reluctant to comment because of the pending appeal.
Dennis Fox, supervisor of the Audit Evaluation and Planning Section in the Sales and Use Tax Department at the BOE, explained the staff's position in an interview with Caltaxletter.
Mr. Fox said taxing finished artwork has been a "long-standing policy" -- a 1939 sales and use tax law. However, it was not enforced for newspaper cartoons over the years because newspapers were exempt from the state sales tax. The Legislature and Governor Pete Wilson approved legislation in 1991 that extended the state sales and use tax to newspapers.
As BOE auditors examined the newspaper industry, they noticed expenses for cartoons and comic strips. Thus, he said, the cartoon tax is being enforced as fallout from audits.
"A few prominent cartoonists (he didn't say who) have registered with the state and have been collecting the tax (when they sell their work to publishers)," Mr. Fox said, explaining that cartoons are taxable as tangible property purchased for physical use. He said it is no different than the work of a graphic artist for an advertising agency. Most graphic artists, he added, are complying with the law.
Cartoonists' pasteups are pieces of property, finished art, that the publisher uses, Mr. Fox said, adding that the state does not tax original manuscripts, because the value is in the words, not the paper.
Furthermore, he said newspapers are liable for use taxes on cartoons purchased from out-of-state artists.
Mr. Newcombe believes the BOE is discriminating against a form of expression, and that the true value of cartoons are intangible ideas -- not subject to a tax. He said the cartoon, as an element of a newspaper or magazine, already is subject to sales tax for the overall publication.
"This fight is so important that we would take it to the Supreme Court. We would talk with every newspaper and syndicate in the nation about a boycott. We would even move out of California," Mr. Newcombe told the Chronicle.
Meanwhile, in unrelated business, the BOE on October 26 took these actions:
The board had postponed action on the regulation (see Caltaxletter of August 15) at the request of Senator Alfred Alquist.
At issue is the length of time the exemption will qualify for lease payments.
BOE Member Brad Sherman said the length of the exemption should extend for six years because that is what Mr. Alquist, sponsor of the original legislation, proposed during the 1995 legislative session.
Staff said the length of time should only be three years, because the governor vetoed the omnibus bill in which the six-year provision was contained (AB 397, Hannigan). Mr. Sherman said the veto was not because of the six-year provision, so the six-year period reflected legislative intent. The board voted 3-2 for the staff position, with Mr. Sherman and BOE Member Dean Andal dissenting.
State Controller Kathleen Connell told the 11th annual Franchise Tax Board Tax Policy Conference that government needs to be innovative about raising revenue without raising taxes.
Noting interest about a "flat tax" at the federal and state levels, she also announced that she plans to sponsor a flat-tax conference early next year.
Dr. Connell was the luncheon speaker at the November 1-3 conference in San Diego, which was attended by 350 to 400 persons. She said the state should focus on "tax cheats" to optimize revenue collections without increasing tax rates.
She also called for performance audits in government, and indicated that the California Medi-Cal program, which had never had a financial audit, was going to be fully audited by her office. In a subsequent announcement, she also said her office will conduct full-scale fiscal audits of the Department of Corrections and the Department of Education.
Dr. Connell urged adoption of important budget reforms including a two-year budget, a two-to-three percent budget reserve and a requirement for a real balanced budget. "Internal borrowing must stop," she said.
Other conference highlights:
He said, "The test of unity of a holding company with operating companies is fundamentally one of facts and circumstances." He indicated that staff will publish regulations later this year allowing combination of holding companies to a greater degree.
A key issue revolves around what property qualifies under Internal Revenue Code Section 1245 (a). According to Hal Kessler, senior tax consultant at Arthur Andersen, the FTB is reading into the statute that the property qualified for the credit is only property defined in IRC Section 1245 (a)(3)(a). He said he thinks FTB is wrong on this issue.
Steven M. Danowitz, partner in Ernst and Young, said that the law's provision that property must be "chargeable" to a capital account to qualify was being unjustifiably narrowed by the FTB. He said the FTB is reading "chargeable" as "charged" and if property is "expensed" (although it could be chargeable to a capital account) it will not qualify.
Another issue is the assignment of the credit to the manufacturing entity only, rather than to the unitary group. The FTB is proposing to limit the credit to the single entity. Mr. Danowitz said pending cases on the solar energy tax credit should provide guidance.
Other points in contention include a requirement that for leased property the sales tax must be paid up front, and the interpretation of "directly allocable" in the capitalized labor part of the tax credit.
Scott Ewing, staff counsel for the FTB, reminded taxpayers that the claim for the 1994 and 1995 credit must be on Form 3535 for 1995.
It was also disclosed that the BOE has received 367 claims for the manufacturing property sales tax exemption as of October 1, totaling $3 million in exempt revenue.
Economists Arthur Laffer and Victor Canto and Assemblyman Howard Kaloogian have submitted their flat tax constitutional amendment initiative to the attorney general for title and summary. Once cleared for circulation, they intend to gather about one million signatures needed to qualify for the November 1996 general election ballot.
In a November 6 press release, Dr. Laffer said, "Our proposal eliminates a multitude of taxes including the sales and gas tax, the personal income tax and the bank and corporation tax and replaces them with a flat tax on businesses and individuals." A flat tax rate would be determined by a formula set forth in the initiative.
COURT UPHOLDS MILL VALLEY PARCEL TAX
The First District Court of Appeal has upheld a flat-rate parcel tax imposed by the City of Mill Valley for municipal services (Joel Neecke v. City of Mill Valley). The tax was approved in a 1987 election by only a majority of the city's voters. Opponents argued it required two-thirds voter approval under Proposition 13, because it was a special tax.
The court said that since the funds from the tax were available for the city's general use and the proceeds were deposited in the general fund, the tax was not a "special tax." The court also said a city was different than a special district that could only use a tax for a special purpose.
The California Supreme Court has turned down a Franchise Tax Board request that the court grant review of an appellate court decision in Richmond Wholesale Meat Company vs. Franchise Tax Board. The First District Court of Appeal found that the company's food and oil businesses were unitary under the "diverse business" principle (see Caltaxletter of July 24). In the order denying review, the court decertified the decision. At the FTB tax conference, it was reported that neither party sought decertification.
The long-awaited Franchise Tax Board regulations relating to apportionment of income of banks and financial corporations (Regulation 25137-4.2 and Regulation 25137-4) have been scheduled for hearing before the board at 1 p.m. on December 11 (at BOE headquarters).
It has been almost one year since a public hearing was held last November 30 on the regulations by an FTB staff hearing officer. Because of the delay, the effective date of both regulations has been changed to January 1, 1996.
The objective of the regulation is to move toward multi-state uniformity in the taxation of financial institutions. A uniform rule, developed by the Multi-state Tax Commission, is the framework for California's proposed rules. Industry supported the proposed regulations at the November 30 hearing, and little, if any, opposition is expected when the proposals reach the board.
Four tax agency regulations have been approved by the Office of Administrative Law, filed with the Secretary of State and have become effective since November 1. They are:
The Campbell Union High School District in Santa Clara County (where Cal-Tax's David R. Doerr went to school) joined the ranks of school districts that have imposed a special assessment under the Lighting and Landscaping Assessment Act. The district board on November 1 unanimously approved a $12 assessment for each dwelling unit in the district. The district expects to reap $881,000 for maintenance. A large turnout of voters at the board meeting reacted negatively to the action.