Board of Equalization Excoriated for Ignoring the Law and Binding Precedents

My thanks to Dan Walters of the Sacramento Bee for pointing out a California case where the California Board of Equalization (yet another California tax agency; this agency administers sales and use tax) was rightly excoriated. Dan Walters begins:

However, [the state] cannot tax services and other “intangibles.” And while there is a strong case for including services in the sales tax – particularly were it to mean an offsetting decrease in tax rates – until that moment comes, they are exempt.

One might assume that the folks at the state Board of Equalization who collect sales taxes would know that.

One also assumes they know that, under long-standing court decisions, when tangibles and intangibles are included in one transaction but easily separated, only the tangibles may be taxed.

However, the board’s tax collectors repeatedly have attempted to impose sales taxes on intangible portions of transactions and repeatedly failed when taxpayers have taken them to court.

This is the case of Lucent Technologies and AT&T. Last October, a California appellate court unanimously ruled against the BOE, and finding its position was not justified awarded $2.6 million to Lucent to cover its legal fees. (Lucent and AT&T will actually get more money, as I’ll discuss below.) The California Supreme Court refused to hear the case, so the judgment is now final. Here are two excerpts from the appellate court decision:

The trial court did not abuse its discretion in finding that the Board’s position was not “substantially justified.” A litigant’s position is “substantially justified” if it is “‘“justified to a degree that would satisfy a reasonable person, or ‘“‘has a “‘“reasonable basis both in law and fact.”’”’”’”’”…

In this case, each of the Board’s primary arguments was foreclosed by existing precedent, much of which comes from our Supreme Court. The Board’s arguments that placing computer software onto physical media turns the software itself into tangible personal property and that the taxable basis includes the software are irreconcilable with the rationales of Preston, supra, 25 Cal.4th at pages 211-212 and Navistar, supra, 8 Cal.4th at page 878, and with the specific holdings of Microsoft, supra, 212 Cal.App.4th at page 82 and Nortel, supra, 191 Cal.App.4th at pages 1275-1276. And the Board’s argument that the technology transfer agreement statutes do not apply is inconsistent with federal copyright law, with Preston, at page 214, and with our factually and legally indistinguishable decision in Nortel.

I include the actual citations just to show how poor the BOE’s arguments were. But the court’s summation needs to be put on a bulletin board at the BOE’s headquarters:

The Board’s conduct in this litigation falls squarely within the heartland of section 7156, and the core purposes of the Taxpayer’s Bill of Rights of which it is the key part—namely, to “deter[] state[] agents from asserting unreasonable and unfair claims and defenses against private citizens” and thus to “preserve[] the balance between legitimate revenue collection and ‘government oppression.’” The position the Board took in this case had been rejected by the Legislature that enacted the technology transfer agreement statutes, rejected by several courts interpreting those statutes, and specifically rejected by Nortel. Yet the Board continued to oppose AT&T/Lucent’s refund action, countersued for more than $18 million (and ultimately agreed to accept less than $2 million), propounded thousands of discovery requests, and generated a 20,000 page record on appeal. The net result is that AT&T/Lucent incurred more than $2.5 million in litigation costs to receive a tax refund to which it was indisputably entitled under controlling law. It is certainly up to the Board to decide whether to take positions at odds with binding, on-point authority, but section 7156 makes clear that the Board is not free to require taxpayers to bear the cost of a litigation strategy aimed at taking a third, fourth, or fifth bite at the apple. [citation omitted]

Oh yes, Lucent and AT&T were awarded costs for litigating the appeal. Dan Walters asks in his article how a small business would handle “the same imperious demands” of the BOE. They can’t; they almost always have to give in because to win is almost always a Pyrrhic victory. This is just another reason why the business climate in California is so dreadful.

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