1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 MARCH 26, 2015 10 11 12 13 14 CHIEF COUNSEL MATTERS 15 J RULEMAKING 16 J1 PETITION TO REPEAL SALES AND USE TAX 17 REGULATION 1585, CELLULAR TELEPHONES, PAGERS, AND 18 OTHER WIRELESS TELECOMMUNICATION DEVICES 19 20 21 22 23 24 25 26 27 REPORTED BY: Kathleen Skidgel 28 CSR NO. 9039 1 1 P R E S E N T 2 3 For the Board Jerome E. Horton of Equalization: Chairman 4 5 Sen. George Runner (Ret.) Vice Chairman 6 7 Fiona Ma, CPA Member 8 9 Diane L. Harkey Member 10 11 Yvette Stowers Appearing for Betty T. 12 Yee, State Controller (per Government Code 13 Section 7.9) 14 Joann Richmond 15 Chief Board Proceedings 16 Division 17 For Staff: Bradley Heller Tax Counsel IV 18 Legal Department 19 20 ---oOo--- 21 22 23 24 25 26 27 28 2 1 INDEX OF SPEAKERS 2 SPEAKER PAGE 3 Ed Howard 5 California Tax Reform Association 4 5 Daniel Hattis 5 Attorney 6 Hattis Law 7 ---oOo--- 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 3 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 MARCH 26, 2015 4 ---oOo--- 5 MR. HORTON: Ms. Richmond, our next case, 6 please -- item. 7 MS. RICHMOND: Our next item is Chief 8 Counsel Matters. Item J Rulemaking; J1 Petition to 9 Repeal Sales and Use Tax Regulation 1585, Cellular 10 Telephones, Pagers and Other Wireless 11 Telecommunication Devices. 12 And we do have speakers for this item, but 13 I believe one has left. 14 MR. HORTON: Members, I would ask -- 15 note that the spe- -- I would ask the speakers to 16 come forward, those that are here. 17 Daniel Hattis. 18 MR. HATTIS: Yes, Hattis. 19 MR. HORTON: Hattis, my apologies. 20 And Samantha Corbin. 21 Ms. Corbin is with the California Tax 22 Reform Association. And Mr. Hattis is attorney with 23 Hattis and Law. 24 Please come forward to my left, please. 25 To my left. 26 MR. HATTIS: To your left. 27 MR. HORTON: And welcome to the Board of 28 Equalization. I'll take the testimonies first. 4 1 ---oOo--- 2 ED HOWARD 3 ---oOo--- 4 MR. HOWARD: Mr. Chairman, Members, I am 5 not in fact Samantha Corbin. My name is Ed Howard 6 with the California Tax Reform Association. Good 7 afternoon. 8 We submitted written comments in opposition 9 to granting the petition. We really don't have a 10 whole lot to add to what we think is an excellent 11 staff analysis. But for all of the reasons stated 12 in the staff analysis, we do believe the petition is 13 not well-founded. And not only not well-founded 14 lawfully but would also result in a very significant 15 impact to the General Fund. And we would encourage 16 you to respectfully reject the petition. 17 MR. HORTON: Sir. 18 ---oOo--- 19 DANIEL HATTIS 20 ---oOo--- 21 MR. HATTIS: Okay. Mr. Chairman, Board 22 Members, my name is Dan Hattis. I'm an attorney. 23 I'm here on behalf of my client Ms. Lee and on 24 behalf of your constituents, the consumer taxpayers, 25 who bear the brunt of this unlawful tax. 26 Regulation 1585 is bad policy, one of the 27 most unpopular and confusing regulations out there 28 and affects everyone. 5 1 Actually the reasons why it's bad policy, 2 Senator Runner has -- has done an excellent in a 3 letter he wrote in 2011 to Assemblyman Garrett in 4 support of a bill to avoid that. I've actually got 5 copies of that here, but I'm not going to focus on 6 the policy. 7 The main problem with the bill is that -- 8 I'm sorry, the regulation, is that it's 9 unconstitutional and it institutes a tax beyond the 10 scope of the Board's authority. 11 The Board staff is hiding something from 12 you and they're hoping that you don't notice and 13 that I don't expose it. 14 As the rulemaking file for Regulation 1585 15 reflects and in their memorandum given to you today, 16 the Board staff gives only one legal justification 17 for Regulation 1585, that the tax charged on the, 18 quote, "unbundled sales price" under 1585 is the 19 same amount that would have been charged anyway even 20 if 1585 didn't exist; that is, that it's not an 21 additional tax. 22 That even without 1585 there's two payment 23 streams to the retailer of cellular phones: One, 24 the consumer pays money at the point of sale, let's 25 say $199 for an iPhone; and then two, there's a 26 commission from the wireless service provider four 27 hundred and 50 bucks. And that both of those are 28 gross receipts under 6012. And that accounting for 6 1 these streams is a burden and for a, quote, 2 "administrative ease," use of the unbundled price -- 3 which is equivalent anyways because say the 4 unbundled price is 650, you add those two, 199 plus 5 450 is 650, it's good enough and it's reasonable to 6 do that. 7 There -- there's a huge flaw in the staff's 8 argument. The scenario the staff describes where 9 there's a consumer payment to the retailer and a 10 commission from the wireless provider only occurs in 11 a minority of the transactions, those that are third 12 party retailers like Best Buy. In fact, 66 percent 13 of cell phones are sold direct in carrier-owned 14 stores; i.e. the Verizon store, the AT&T store 15 T-mobile, Sprint. That's a statistic from the NPD 16 study in 2010. 17 Like in the case of my client Ms. Lee, the 18 AT&T store is where she bought her phone, direct, 19 paid 199 to AT&T and zero commission was paid. AT&T 20 did not pay a commission to itself. There were no 21 gross receipts per tax section 6012 beyond the 199 22 paid for the phone. 23 My question for the Chief Counsel's office 24 is the question the Board staff has avoiding and 25 hiding and praying for years that no one would ever 26 answer -- ask. And that is, what is the legal 27 rationale for charging sales tax on more than the 28 $199 that was paid to AT&T? Where do you find the 7 1 additional $450 of gross receipts per section 6012 2 of the code? 3 I anticipate that the staff is going to 4 respond that they want to reclassify some of the 5 service revenue for product. Well, first, that's 6 not allowed, and it ends up to be double taxation. 7 I think all of you probably have cell 8 phones and you probably get your bills. And you 9 notice there's a lot of tax on your cell phone bill. 10 In fact, there's a tax of approximately six -- 16 11 percent, 16.04 percent of tax. And that's on 12 services. 13 And so if the Board is going to argue here 14 that we want to reclassify $450 of what was paid for 15 cell phone service as -- as product, well, first, 16 they don't have the power to do that. You can only 17 do what -- you know, what you're empowered to do. 18 And second, well, we got paid 16 percent in taxes on 19 service. The federal government, all the state 20 agencies, the PUC, the city government, all have 21 been taxing it as service. That's double taxation. 22 And in fact, if that actually goes through and that 23 was approved, I'm going to have to go after, on 24 behalf of the constituents, all of the other folks 25 and say you guys overcharged tax because this is on 26 product, not service. 27 Second, there's another grounds for vio- -- 28 that the regulation should be voided, and that's a 8 1 procedural one. The Board staff did not perform a 2 sufficient economic impact study. The staff 3 outright misrepresented to the Board and the Office 4 of Administrative Law -- and this was in 1997, and 5 there -- and '98, when they presented it -- and they 6 said that there was going to be no revenue impact 7 and no additional tax burden under the regulation. 8 And you'll see this in the rulemaking file, which I 9 requested and I read entirely through. 10 Yet the staff has, in fact, admitted in an 11 offhand comment -- and it's actually in the issue 12 paper before you -- that it knew there was an 13 impact, quote, the service providers also agreed -- 14 and the service providers are the carriers -- also 15 agreed to this pricing structure as they did not 16 want two standards giving them a competitive 17 advantage over retailers. 18 That is, the staff just offhandedly 19 admitted that under 1585 the carriers are going to 20 pay more sales tax than they would have otherwise. 21 This failure to honestly assess the economic impact 22 is independent grounds on its own per the recent 23 2013 supreme court Western State's Petroleum to void 24 the regulation entirely. 25 It appears the staff's sole effort to 26 assess the economic impact was to ask the carriers, 27 "Hey, carriers, do you care if we apply this tax to 28 you and increase your -- increase the sales tax you 9 1 have to charge?" 2 And the carriers said, "No, we don't care. 3 We pass it through to consumers anyway." 4 Well, I'll tell you who cares, your 5 constituents care, the consumer taxpayers who brunt 6 the force of the tax care and they were never 7 represented in the process. 8 MS. RICHMOND: Time's expired. 9 MR. HATTIS: Okay. If you indulge me, I 10 have just maybe 30 seconds more. 11 MR. HORTON: Uh, yes, go ahead. 12 MR. HATTIS: I appreciate it. 13 I also hope the Board asks me some 14 questions or grants me some additional time to 15 explain my plans regarding filing a class action 16 lawsuit, which I will be filing against the Board to 17 recover the overpaid sales taxes on behalf of your 18 constituents, the consumer taxpayers. 19 Now, today you have the opportunity to 20 revoke 1585 before a court does it for. As Board 21 Members, I urge you not to be on the wrong side of 22 history here. Don't put yourself in a position of 23 having to explain to your constituents why you voted 24 here today after finally getting the full story of 25 this tax and its legality and still upvoting to 26 uphold this illegal tax that consumers bear the 27 brunt of. A tax that I can assure you is 28 consequently going to be found unconstitutional and 10 1 invalid on its face. 2 MR. HORTON: Thank you. 3 Welcome, Mr. Heller. Would you please 4 introduce yourself for the record in the case -- 5 MR. HELLER: Sure. Thank you, Mr. 6 Horton. 7 MR. HORTON: -- the matter before us. 8 MR. HELLER: Good afternoon, Chairman 9 Horton, Members of the Board. I'm Bradley Heller 10 from the Board's Legal Department. 11 I'm here to provide the Legal Department's 12 recommendation that the Board deny the petition from 13 Ms. Lee requesting that the Board repeal Regulation 14 1585, cellular telephones, pagers and other wireless 15 telecommunication devices or the portions of the 16 regulation clarifying the measure of tax with regard 17 to sales of wireless telecommunication devices and 18 bundled transaction. 19 In her petition, Ms. Lee expresses her 20 belief that the regulation is inconsistent with the 21 statutory definition of gross receipts in Revenue 22 and Taxation Code Section 6012. Ms. Lee has 23 standing to bring this petition under the California 24 Administrative Procedure Act and the Board is 25 required to take a timely action on the petition. 26 As relevant here, Revenue and Taxation Code 27 Section 6012 provides that gross receipts mean the 28 total amount of the sale or lease or rental price of 11 1 the retail sales of retailers valued in money, 2 whether received in money or otherwise. 3 Section 6012 further provides that the 4 total amount of the sale or lease price includes any 5 services that are part of the sale, all receipts, 6 cash, credits or any -- excuse me, all receipts, 7 cash, credits, and property of any kind, and any 8 amount for which credit is allowed by the seller to 9 the purchaser. 10 And the California courts' and the Board's 11 longstanding interpretation of section 6012 are that 12 retailer's gross receipts include all of the 13 retailer's receipts from the sale of tangible 14 personal property, not solely amounts that the 15 retailer actually received directly from a consumer. 16 This longstanding interpretation is also 17 the basis for the Board's rules regarding 18 manufacturer coupons and rebates and incentives 19 issued by manufacturers to retailers which also 20 result in third party considera- -- third party 21 payments included in retailer's gross receipts as 22 set forth in Regulation 1671.1, Discounts, Coupons, 23 Rebates and Other Incentives. 24 A retailer commonly sells wireless 25 telecommunication devices to customers in one of two 26 different ways: 27 The retailer will sell the -- will sell the 28 device to a customer for a fair retail selling 12 1 price, which includes the retailer's wholesale cost 2 for the device, plus a markup to cover the 3 retailer's expenses and provide a profit in an 4 unbundled transaction in which the customer is not 5 required to activate or contract for wireless 6 telecommunication services as a condition of the 7 sale. 8 The retailer will also sell the same device 9 to a customer for a discounted price in a bundled 10 transaction in which the customer is required to 11 activate or contract for cellular service as a 12 condition of the sale, and the retailer will give 13 the customer the discount because the retailer will 14 receive a rebate or commission from a wireless 15 telecommunications provider for selling the device 16 to the customer for the discounted price with the 17 wireless telecommunication services. 18 When a wireless telecommunications device 19 is sold in an unbundled transaction, Regulation 1585 20 provides that sales or use tax applies to the actual 21 gross receipts received by the retailer from the end 22 use customer from the sale of that device because 23 those are the retailer's only gross receipts from 24 such sale. 25 When a wireless telecommu- -- excuse me, 26 wireless telecommunication device is sold in a 27 bundled transaction, Regulation 1585 provides that 28 the sales or use tax will still apply to the 13 1 unbundled sales price of the device which is the 2 actual price at which the retailer sold the same 3 wireless telecommunication device to customers who 4 are not required to activate service or contract for 5 service as a condition of the sale. And this 6 measure counts for both the consideration received 7 from the end use customer for the sale of that 8 device and the rebate or commission from the 9 wireless telecommunication service provider for 10 selling the device at a discounted price. 11 In addition, when a retailer has not made 12 any unbundled sales of the device to use as a direct 13 and objective measure of tax, Regulation 1585 14 provides needs certainty to retailers and retailer's 15 customers by providing the tax applies to the fair 16 retail selling price of the device, which is 17 generally the wholesale cost of the device to the 18 retailer plus an 18 percent markup. 19 Regulation 1585's provisions providing the 20 sales and use tax applies to the unbundled sales 21 price of wireless telecommunications devices sold in 22 bundled transactions are reasonable and consistent 23 with the definition of gross receipts in Revenue and 24 Taxation Code 6012 as interpreted by the courts and 25 the Board. 26 Ms. Lee's petition only generally alleges 27 that Regulation 1585 conflicts with Section 6012. 28 It does not quote any specific portion of the 14 1 Section 6012, and it merely makes the assertion that 2 Revenue and Taxation -- excuse me, that the Revenue 3 and Taxation Code requires that all sales taxes are 4 to be calculated based on the gross receipts 5 retailers actually receive at the point of sale, 6 which is just not an accurate interpretation of the 7 law. 8 Moreover, the Petitioner -- excuse me, the 9 petition does not provide any new information 10 regarding the consideration that retailers receive 11 from wireless telecommunication service providers 12 for selling devices at discounted prices and bundled 13 transactions. Therefore, the petition provides no 14 basis for the Legal Department to recommend changes 15 to the regulation. 16 Furthermore, the Legal Department's opinion 17 is that the repeal of Regulation 1585 by itself 18 would not necessarily reduce the measure of tax 19 regarding sales of wireless telecommunication 20 devices and bundled transaction. This is because 21 tax would still apply to all of the retailer's gross 22 receipts from the sale of such devices, including 23 payments from wireless telecommunication service 24 providers for selling the devices at discounted 25 prices. And that would be true whether based upon 26 general application of the statutory definition of 27 gross receipts as interpreted by the courts and the 28 Board, or by application of the existing provisions 15 1 of Regulation 1671.1. 2 Therefore, the Legal Department is 3 concerned that the repeal of sec- -- regulation 4 1585.5 -- excuse me, 1585, excuse me, by itself 5 would create unnecessary confusion and might even 6 increase the measure of tax in some bundled 7 transactions. 8 It should also be noted that Regulation 9 1585 provides a reasonable brightline rule that 10 facilitates ease of reporting, and that industry has 11 supported and continues to support this brightline 12 rule. 13 In addition, I just wanted to mention that, 14 although they're not present today, we did also 15 receive a letter from the Assistant Director of 16 Governmental Relations for the California School 17 Employees Association, which is a member of the 18 AFL-CIO. And the letter provided CSEA's and 19 AFL-CIO's opposition to the petition. 20 And just in response to the comments that 21 I've heard so far this morning, there is authority 22 to -- to tax -- to apply tax to services that are a 23 part -- or, excuse me, to include in the measure of 24 tax charges for services that are part of the sale 25 of tangible personal property. 26 Staff's certainly not hiding anything. 27 And, you know, the actual rulemaking file has been 28 made available, so I don't know -- I don't think 16 1 there's anything to be hidden here. 2 And we still don't have anything specific 3 that explains that there's been any change in the -- 4 the commissions and rebate, so I don't see how we 5 could recommend a change in the measure of tax based 6 on the change and the practice in the industry. 7 And honestly, I don't believe that what 8 I've heard today actually clearly explains that 9 every single -- or that there are retail outlets 10 that are being operated directly by the wireless 11 communication service providers under the exact same 12 entity or that this is like a general practice in 13 the industry. 14 So at this point I did not hear anything 15 that would change the Legal Department's opinion. 16 MR. HORTON: Discussion, Members? 17 Mr. Runner. 18 MR. RUNNER: Yeah. You know, and again, I 19 think you rightfully observed that there's been a 20 series of pieces of legislation that deal with this 21 issue of which I, quite frankly, feel is the right 22 way to deal with it. And I think that that is the 23 best way for the -- the -- the nuances of the law in 24 light of its unique issues in its application to the 25 statute and -- and to be dealt with on the 26 legislative path, which is why I continue to support 27 any kind of bills in the Legislature that do that. 28 The challenge that I think we have before 17 1 us is a little bit different. And that is -- and 2 let me just -- because I'm -- I'm concerned about, 3 as we would move forward with that issue, the -- the 4 likelihood or the potential of some unintended 5 consequences without clear legislative direction in 6 regards to how to deal with that in terms of the 7 fact that there could be -- I mean there is going to 8 be some discussion as to how to fill the void as you 9 clearly have a tangible good. 10 I mean, I think we sometimes talk about the 11 fact of what do you do with a -- you know, a hundred 12 dollar phone that may be worth $300, but the -- and 13 what's the real value, and can debate that. But the 14 real question is, what do you do with a free phone? 15 Because, clearly, a free phone has value to it. And 16 you don't get a free phone unless you actually 17 attach it to a contract. 18 So there was clearly, in terms of the law, 19 a exchange of tangible good there. And you've got 20 to figure out somehow how to value that. And I 21 think that's the challenge that we have. So that's 22 my concern in regards to trying to deal with it 23 here. How -- what would -- what would it be 24 replaced with in regards to out there? And I think 25 that's the unintended consequence I'm concerned 26 about. That's why I do continue to believe that the 27 Legislature is the best place to address this issue. 28 I think it's always important for us to 18 1 address whether or not the current process that we 2 have for assessment is indeed the way that the 3 practice is actually going on in the businesses 4 themselves. And it might be time, at some point, 5 for us to look at that, to see if what's happening 6 in regards to how phones are purchased and bought 7 and financed is actually what -- reflected in our -- 8 in our -- in our regulations. 9 As we all know, things change. And how it 10 is that something was done when this regulation was 11 placed may not be the normal process that people are 12 really buying and selling phones today. 13 So those would be my observations and why I 14 don't feel comfortable in just removing that as a 15 regulation today, but certainly need to continue to 16 both work with the Legislature and for us to review 17 internally what it is that we may want to look at. 18 MR. HORTON: Member Harkey. 19 MS. HARKEY: Thank you, very much. 20 I reviewed this extensively and there were 21 two court cases, one which -- one is Yabsley -- 22 Yabsley versus Cingular, the other is Loeffler 23 versus Target, and I believe they speak to a similar 24 issue or support what was done. 25 I think it's -- for our consumers, it's 26 confusing because they think they're getting a free 27 phone. But if you didn't do that, and we have no 28 other way of -- of assessing what the actual value 19 1 of the component is, if we don't have another 2 regulation to replace this regulation, it could be 3 the wild west. You could have a -- a one-year 4 contract or a two-year contract and pay taxes on the 5 entire contract and then get a free phone, which is, 6 in most cases, probably more than what has been 7 negotiated. 8 I asked for an explanation as to how this 9 was contrived. How -- how did we reach this? And I 10 think you've explained it very, very well. And this 11 is how it was explained to me. 12 So I think maybe a marketing effort is more 13 to the point. I also believe that -- that the 14 phones are now -- now a lot of phones are sold as a 15 unit. You pay your $600 and you can exchange and do 16 things as you need, but you're not -- bundles are 17 kind of going by the wayside, as I understand it. I 18 think there's -- there's an increasing desire to get 19 the latest and greatest phone on an annual basis. 20 So I think that, without anything else in 21 place, we'd be hard-pressed to just repeal this and 22 throw it out. And I do believe the courts would 23 support us in that. And I believe that the 24 explanation as to how this 1585 was arrived, how we 25 arrived at what we charge, how we charge, what is to 26 be charged for sales tax, made perfect sense once it 27 was explained to me. 28 I think the problem is, is that people see 20 1 "free phone" and they expect free phone. But that's 2 not -- the program is you buy the phone with -- 3 because nobody is going to sell a phone or anything 4 else for less than they -- less than it costs them. 5 That's not the purpose of being in business. So 6 there's got to be something else with it. And as 7 you explained, there's the coupon and the 8 reimbursement from -- for the service. 9 So I can't support the petition right now, 10 but I wish you luck. 11 MR. HORTON: Further discussion, Members? 12 Is there a motion? 13 MS. HARKEY: I move to deny the petition. 14 MR. HORTON: Member Harkey moves to deny 15 the petition, second by Member Stow- -- Ma. 16 Without objection, Members, such will be 17 the record. 18 Thank you very much. 19 ---oOo--- 20 21 22 23 24 25 26 27 28 21 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, KATHLEEN SKIDGEL, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on March 26, 2015 I recorded verbatim, in 10 shorthand, to the best of my ability, the 11 proceedings in the above-entitled hearing; that I 12 transcribed the shorthand writing into typewriting; 13 and that the preceding pages 1 through 21 constitute 14 a complete and accurate transcription of the 15 shorthand writing. 16 17 Dated: March 13, 2015 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL 22 Hearing Reporter 23 24 25 26 27 28 22