1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 JUNE 24, 2015 10 11 SALES AND USE TAX APPEAL HEARING 12 APPEAL OF 13 G & C EQUIPMENT CORPORATION 14 NO. 373826 (AS) 15 AGAINST PROPOSED ASSESSMENT OF 16 SALES AND USE TAX 17 18 19 20 21 22 23 24 Reported by: Juli Price Jackson 25 CSR No. 5214 26 Kathleen Skidgel 27 CSR No. 9039 28 1 1 P R E S E N T 2 For the Board Jerome E. Horton of Equalization: Chairman 3 Sen. George Runner (Ret.) 4 Vice-Chairman 5 Fiona Ma, CPA Member 6 Diane L. Harkey 7 Member 8 Yvette Stowers Appearing for Betty Yee, 9 State Controller (per Government Code 10 Section 7.9) 11 Claudia Lopez Staff Services Manager II 12 Board Proceedings Division 13 For Appeals Division: Lisa Burke 14 Business Tax Specialist III 15 Legal Department 16 Jeff Angeja Tax Counsel IV 17 Legal Department 18 For Board: Scott Lambert Hearing Representative 19 Kevin Hanks 20 Chief, Sales and Use Tax Department 21 Stephen Smith 22 Tax Counsel IV 23 For Petitioner: Marty Dakessian Attorney 24 Mike Shaikh 25 Attorney 26 Gene Hale Taxpayer 27 Bill DuFour 28 CFO 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 JUNE 24, 2015 4 ---oOo--- 5 MR. HORTON: Ms. Lopez, what is our next 6 matter? 7 MS. LOPEZ: Okay. Our next item is C4, 8 G & C Equipment Corporation. Please come forward. 9 MR. HORTON: Ms. Burke, as the taxpayer 10 comes forward, would you please introduce the issues 11 in this case? 12 MS. BURKE: The issue in this case is the 13 amount of disallowed claims, nontaxable sales, for 14 the second quarter of 2002. 15 MR. HORTON: As the taxpayer settles in, I 16 would advise the taxpayer and their representatives 17 that they have ten minutes to make their 18 presentation. And we would ask that they commence 19 with the introduction of their team. 20 And we would ask staff that they provide 21 additional chairs where necessary. 22 And please be advised that we will return 23 and allow you five minutes on rebuttal and 24 additional times -- time will probably be allowed as 25 we try to figure out what all these -- 26 MS. HARKEY: Exhibits. 27 MR. HORTON: -- exhibits are. 28 Let me see -- 3 1 MS. HARKEY: I can read them. 2 MR. HORTON: -- okay. Welcome to the Board 3 of Equalization. Please introduce yourselves for 4 the record. 5 MR. DAKESSIAN: Good morning, Mr. Chair -- 6 Chairman and Members. My name is Marty Dakessian. 7 And I'm with the law firm of Reed Smith, and I 8 represent the taxpayer in this case, G & C Equipment 9 Corporation. 10 Seated with me at the counsel table is 11 Mr. Gene Hale, President and CEO of G & C Equipment 12 Corporation, and seated to his left is my Reed Smith 13 colleague, Mr. Mike Shaikh. 14 MR. HORTON: Let me have Mr. Shaikh angle 15 his mike just a little bit so that he doesn't have 16 to bend in. You can pull it forward. There you go. 17 Okay, at your convenience. 18 MR. DAKESSIAN: Mr. Chairman and Members, 19 G & C Equipment Corporation is in the business of 20 leasing construction equipment and providing 21 personnel for various construction projects and job 22 sites throughout the country. 23 The nature of the business is such that the 24 projects and the mix of goods and services provided 25 for a given job site differ from contract to 26 contract and from quarter to quarter based on the 27 location, the needs of the particular client, and 28 customer and so forth. 4 1 And those differences are, in fact, 2 reflected on the sales tax returns and the way that 3 the numbers flow from quarter to quarter throughout 4 the audit period. 5 The audit period here is from the second 6 quarter of 2002 until the first quarter of 2005. 7 And, if I may, the timeline that we have up 8 here shows the events that led up to where we are 9 today -- the point in time that we are today. 10 As you can see up here -- and this is also 11 behind Tab 1 of the materials that we provided in 12 the case, this print is a little hard to read -- the 13 audit began back in July of 2005, ten years ago. 14 And throughout the course of the ten years 15 that have ensued that lead up to today, there is one 16 issue left that's before the Board. And this is 17 issue is claimed exempt sales for the second quarter 18 of 2002. 19 Now the second quarter of 2002, you may 20 recall from our briefing, is the quarter where we 21 had the missing records. We had a computer crash 22 that was the result of an accounting software 23 transition that resulted in the loss of the 24 overwhelming amount of data that would have 25 ordinarily been available for the second quarter of 26 2002. 27 And the issue in this case is how do we 28 treat claimed exempt sales for that second quarter 5 1 with the missing records? 2 With respect to the 11 out of 12 quarters 3 where we did have records, the Department tested for 4 claimed exempt sales using a statistical sample that 5 was within the guidelines provided by this Board. 6 It was conducted with a computer audit specialist 7 within the margins of error that this Board allows. 8 And the results of that statistical sample 9 that tested transactions randomly over the course of 10 the 11 quarters with records was a composite 1.67 11 percent error rate. 12 And what the Department did with respect to 13 the 11 quarters with records is it took the results 14 of that sample and projected it across all the 15 transactions for the 11 quarters, using the 1.67 16 percent error rate. 17 So, now the question becomes what do we do 18 in a situation where we don't have records? 19 Fortunately, your Board has provided 20 guidance for taxpayers. This is presumably not the 21 first time records have been lost because there's an 22 audit manual section that your Board has published 23 and provided to the staff as guidance for precisely 24 this type of a situation. 25 And what we do have up there, to your 26 right, is a blown-up portion of the audit manual. 27 It is also behind Tab 2 of your materials. 28 And what it states quite simply, in the 6 1 highlighted portion, 2 "In some instances, results from a 3 statistical sample are projected to areas 4 outside the defined population. This might 5 occur if only one or two years of 6 documentation are available in a three-year 7 audit period." 8 That's what the audit manual says, 9 essentially, take the results of the sample and 10 apply it to the period with the missing records. 11 Now the audit manual contemplates lost 12 records in a much larger quantity than we have here. 13 In fact, if you continue to read this relevant 14 portion of the audit manual, it says that you can 15 project as few as four quarters in an audit period 16 onto eight. 17 And what we've asked staff to do here in 18 this situation is project 11 quarters, the results 19 of a statistical sample for 11 quarters, onto just 20 one -- clearly within the guidance provided by the 21 Board. 22 And if you were to do that, then that's 23 where this chart in the middle comes in. It's 24 behind Tab 4 in your materials. 25 The green represents the results of the 26 statistical sample for claimed exempt sales. The 27 purple represents what would have happened if the 28 staff had simply projected the results of the error 7 1 onto the second quarter of 2002. And the red 2 represents what staff actually did. 3 Now the staff explains why it didn't 4 project the results of the stat sample. And if you 5 look behind Tab 3 of your materials, you can see 6 exactly why. 7 This is dated July 5th, 2006, and it's 8 Schedule 12F. If you look at the second box on the 9 bottom it says, 10 "The results of statistical sampling 11 for exempt sales are not applied to 2Q02 12 because the taxable sales and exempt sales 13 for 2Q02 are based on actual basis." 14 And that was the position of the Department 15 back in 2006, and that was the position of the 16 Department for the ensuing eight years, all the way 17 up until when? 18 Up until this case was ready for hearing 19 last year in February of 2014. The Department took 20 another look at this issue. We've been saying it 21 'til we're blue in the face, there was no actual 22 basis audit. 23 And why am I -- I'm not saying that to 24 throw stones at the Department. I'm saying that 25 because that was the stated reason for not applying 26 the sample. 27 Okay. The Department took a look at this 28 again in February of last year, and, lo and behold 8 1 -- turn to Tab 7 -- pulled the case, and said, 2 "Based on additional review," this is in the box at 3 the bottom, 4 "The Department concluded that not all 5 sales invoices for the second quarter 2002 6 had been reviewed." 7 So, the natural conclusion that we thought 8 would happen from that point forward -- that's the 9 stated reason for not applying the sample; that 10 reason no longer exists, we're going to apply the 11 sample, right? Case is over. Should have been 12 over, but that's not what happened. 13 Instead, this is what happened -- again 14 nothing has changed on the legend. The red 15 represents what the staff did. 16 The purple represents what the results of 17 the statistical sample would have produced in terms 18 of claimed exempt sales for the second quarter of 19 '02. 20 And you can see the green, which is the ebb 21 and flow of the claimed exempt sales error based on 22 the stat sample for the remaining 11 quarters. 23 And, as you can see, what we've proposed is 24 consistent and reasonable and within the ebb and 25 flow and is in sync with the rest of the audit 26 period. 27 What staff has proposed has not -- is not. 28 They went from 2.8 million in claimed exempt sales 9 1 in the first go-round, which, by the way, is more 2 than twice the amount of claimed exempt sales error 3 for the other 11 quarters combined, and they went 4 down to a slightly less unreasonable 1.4 million, 5 which is again more than the error for the other 11 6 quarters combined -- 1.3 million for the other 11 7 quarters. 8 And, so, why did they do that? We don't 9 know. And I'm sure the Department -- you know, I'm 10 not going to be presumptuous and will wait to hear 11 what they have to say -- but this is what we have in 12 the record as the reason as to why it didn't apply 13 the sample. 14 It's just as simple as this -- if you 15 continue to read behind tab 7 in the little box, it 16 just says, 17 "The Department concludes that the 18 audited taxable sales -- the audited 19 taxable percentage from the subsequent 20 periods with records would be more accurate 21 to establish the second quarter 2002's 22 audited taxable measure at this time." 23 We really don't know what that means, but 24 what we know -- we know what it represents and it 25 represents $1.4 million worth of error. 26 This is about claimed exempt sales, not 27 audited taxable measure. The case is a simple one. 28 It's very straightforward. 10 1 We're asking for staff to simply implement 2 this Board's guidance as set forth in the audit 3 manual. And if you do that, the measure of tax 4 works out to around $70,000. And that's what we 5 would respectfully request. 6 And we'll reserve all further time for 7 questions from the Members. Thank you. 8 MR. HORTON: Members, we'll now go to the 9 Department. The Department has ten minutes to make 10 their -- their presentation. We'd ask that you 11 introduce yourself for the record. 12 MR. LAMBERT: Thank you, Chairman Horton 13 and Members. 14 My name is Scott Lambert. To my right is 15 Kevin Hanks, and to Mr. Hanks' right is Stephen 16 Smith, representing staff. 17 In this particular case we agree with the 18 taxpayer that the result was fairly straightforward. 19 We arrived at a completely different conclusion. 20 And I'll explain why we believe the results 21 that we have arrived at are both fair and very 22 reasonable. 23 In this particular case, as the taxpayer 24 has explained, they had electronic records for 11 25 out of the 12 quarters. The 11 quarters were tested 26 using statistical sampling and the results were 27 arrived at. And we all agree on the 11 quarters. 28 So, what's at question is the second 11 1 quarter of 2002 and how you arrive at that 2 liability. 3 And I'll go back just to give a little bit 4 of understanding of how we arrived at where we're 5 at. 6 When the statistical sampling was complete, 7 the auditor tried to determine how they were going 8 to establish the liability for the second quarter of 9 2002. They used the audited taxable measure average 10 quarterly amount. So, in other words, for those 11 11 quarters the measure was 5.7 million audited. 12 That's what we -- that's the amount that 13 was used, and it was submitted for review. 14 During the review process there were some 15 questions in that amount for using that approach and 16 the auditor went back to the taxpayer to try to 17 develop a better amount or better way to calculate 18 the amount. 19 And what the taxpayer stated is that they 20 could use an actual basis for that period. So, what 21 they did is they went back and they were able to get 22 a history of revenue for that quarter. So, we used 23 that and that was $6.6 million. 24 The taxpayer had reported on their return 25 6.2 million. We don't know where that amount came 26 from. I don't think it's in dispute that the 6.6 is 27 is the amount. And there's also no dispute as to 28 the amount that they reported. They reported -- for 12 1 the second quarter of 2002, they reported 2,083,000 2 in taxable sales. And I'll get into a minute what 3 exactly that -- that is made up of. 4 So, we have the revenue of $6.6 million. 5 The taxpayer then went back through their records. 6 And, remember, they lost their electronic records, 7 so, it was -- it -- doing a statistical sample 8 without the electronic records was difficult to do. 9 The taxpayer stated they were going to go 10 back through their contracts. They still had their 11 contracts. They had their contract files, which 12 included invoices. They went through those. They 13 provided the documentation and what they could 14 support as nontaxable sales were allowed in the 15 audit. The difference came out to $2.8 million in 16 taxable sales. 17 In preparing for this case, it -- the 18 argument was made that not all invoices were 19 reviewed for the second quarter of 2002 and, 20 therefore, there were nontaxable transactions -- 21 additional nontaxable transactions that should be 22 allowed. 23 Based on that, the Department came to the 24 conclusion not that the audit wasn't conducted on a 25 consensus basis for 2002, but that there was 26 questions as to, in fact, there may be other tax or 27 there may be other nontaxable sales that the 28 taxpayer can't provide. 13 1 In consideration of that, the Department 2 changed the methodology for conducting the audit for 3 the second quarter of 2002. And what we did was use 4 the audited taxable percentage from the 11 quarters 5 and applied it to that second quarter of 2002. 6 So -- and what we also did -- and I'll 7 explain some -- some of the questions, like why did 8 we accept what was recorded and reported for the -- 9 for the second quarter of 2002? 10 I think what's important is that we need to 11 understand how the stat sample was conducted for the 12 11 quarters. We were able to take out is he 13 transactions that had sales tax on them of at least 14 7 and a quarter percent. So, all of those were 15 removed before testing. And that turned to be about 16 50 percent of the sales that were taken out. They 17 weren't tested. 18 Only 50 percent of the transactions during 19 the 11 quarters were tested. There was no point in 20 testing the other 50 percent because it had been 21 taxed. 22 So, what -- what's important here is -- and 23 this is the main importance, our -- the Department's 24 entire case, which is, the taxpayer was reporting on 25 a cash basis. 26 We put the taxpayer on the accrual basis so 27 that the taxpayer's argument is that if you take our 28 $6.6 million, you subtract out what was reported as 14 1 taxable, 2,083,000, you are going to come up with 2 400 -- $4.6 million. And they're saying all of 3 those sales were not taxed. 4 That's the only conclusion that you can 5 come to with their argument. Because, otherwise, if 6 they were taxed, you shouldn't be applying a 7 percentage of error. That percentage of error was 8 developed on nontaxable transactions, not on taxable 9 transactions. 10 So, the question comes down to, do they 11 have other transactions that were taxable during the 12 second quarter of 2002? Our conclusion is that they 13 did. And, so, you are saying, well, how -- how can 14 you prove that? 15 Well, there was about -- out of the amount 16 of sales that were reported, there were 56 17 contracts. And there's no question -- both of us 18 agree, that there were, in fact, 56 contracts during 19 this period. 20 We were able to develop -- or determine 21 each one of those contracts. So, two of those 22 contracts were out-of-state sales; two of them were 23 service only contracts; and there were two other -- 24 or there may have been more, but there was at least 25 two sales that were reported as taxable. That's 26 going to leave about 50 contracts that the 27 taxpayer's arguing they didn't collect tax on 28 any one of those transactions. 15 1 Because, remember, we're applying the 2 percentage of error from the nontaxable sales. 3 So -- which -- the evidence the Department has -- 4 and I don't know if you have this front of you 5 (indicating)? 6 MR. DAKESSIAN: I'm not sure this was 7 provided to us. 8 MS. HARKEY: Do we know what it is? 9 MR. HORTON: Board Proceedings -- let's 10 first take the documents shared with the taxpayer, 11 resolve whether they have had an opportunity to see 12 it. 13 Then I believe we have it, but just in 14 case, make another copy. 15 MS. HARKEY: Is it Department's Exhibit 1, 16 page 1 of 5? 17 MR. LAMBERT: Yes. 18 MS. HARKEY: Thank you. We have it. 19 MR. HORTON: Have you seen it -- 20 MR. DAKESSIAN: What is it? 21 MR. HORTON: -- Mr. Dakessian? 22 MR. DAKESSIAN: What is this that we're 23 talking about here? 24 MR. LAMBERT: Most of this information, 25 other than three documents, the taxpayer has all of 26 them. In fact, a few of them are -- actually, we 27 have the same exhibits for this. 28 You can interpret them somewhat 16 1 differently, but other than three invoices, 2 everything in here was either provided to or 3 obtained from the taxpayer. 4 But I'm fine with waiting. 5 MR. HORTON: Go ahead. Seems like 6 everyone's on the same page. 7 MR. LAMBERT: Okay. This -- the 8 Department's Exhibit 1, page 1 of 5, is a list of 9 each one of these contracts that we have, and that 10 you see the bottom line adds up to $6.6 million 11 on -- actually, on page 4 of 5 of Exhibit 1. 12 So, if you -- if you go back to take a look 13 at what was reported on here, this is -- this is the 14 contract, the $6.6 million. 15 It's broken down. If you look at Column E, 16 Column F and Column G, that's the revenue by month 17 for each contract. 18 So, you take a look at what amounts were 19 reported as taxable. Column J is the amount that 20 was reported. And what you'll see is out of that 21 $2,083,000, you'll see that most of it is for that 22 first contract, the Tutor-Saliba contract. 23 If you look down on page 2, if you go to 24 the left-hand column down to L, 12-19, you'll see LA 25 Power. 26 If you look at Exhibit 5, pages 1, 2 and 3, 27 what you'll see is is that the date of the invoice 28 is during the second quarter of 2002 and the amounts 17 1 have sales tax on them. 2 Now what we're not trying to show is that 3 the liability should be higher. We are not trying 4 to show that the $2.8 million is the right amount. 5 What we're trying to say is that there are 6 taxable transactions in this quarter and that you 7 can't apply the percentage of error because these 8 haven't been subtracted out the same way that 9 they've been subtracted out of the statistical 10 sample. That's mainly it. 11 Now when you come down to -- which a 12 term -- the key point is the cash versus the accrual 13 method. So, they give you a whole semester or more 14 in college on accounting, the difference between 15 cash and accrual. 16 But really what it comes down to is that 17 even if these amounts were reported in a later 18 period -- and there's no question that they were not 19 reported in this period, 'cause if you remember, the 20 first contract had the majority of the liability. 21 That one contract for 800 and something thousand 22 dollars was not reported. That contract was 23 performed in LA County. 24 And the most that was reported for LA 25 County in that quarter -- well, actually, the actual 26 amount was $112,000. The amount wasn't reported. 27 It has to be subtracted out. You can't apply a 28 percentage of error. 18 1 So, let's say you're saying, well, that 2 sale was reported in a later period. And I believe 3 it was. But the question comes down to, how did 4 that sale ever end up in our taxable figures? 5 If it's being billed in the second quarter 6 of 2003, and it's not reported in the second quarter 7 of 2003, that sale never would have shown up in our 8 audited taxable measure in the next 11 quarters. 9 Now the amount reported would show up and they 10 received full credit for that amount that was 11 reported. 12 But since we went to the accrual method it 13 had to have been -- it has to be included in the 14 second quarter of 2002, because it wouldn't have 15 been included in any other period. 16 Therefore, the amount that we came up -- 17 that the Department's arrived at is $1.3 million or 18 $1.4 million. 19 Just that one contract of $800,000 is the 20 majority of that. And you're -- what you're saying 21 is that there's 49 other contracts that were not 22 reported in the second quarter of 2003 as taxable. 23 And the taxpayer's argument is that those 24 are all nontaxable sales. We didn't charge any tax 25 on them. 26 Now we went back to look at periods where 27 the statistical sample was applied we found two 28 contracts that there were errors in. And one was 19 1 the Saliba account and the second one was the LA 2 Power Joint Venture account. Both of those turned 3 up in later times for billings, that -- where the 4 tax was not reported. 5 And there's one on Saliba, they charged the 6 wrong tax rate on the invoice. They charged 4.5 7 percent. 8 On the LA, the one invoice that we have, it 9 was a tax included amount. So, the amount never got 10 into the accrual account. 11 Now I can also explain why we made the 12 comments we did as far as the second -- we accepting 13 the second quarter reported and recorded equaled 14 each other. Because what we were doing is we were 15 doing the audit on a -- on what we believed was an 16 actual basis. 17 Therefore, the only adjustment that you 18 would have is whether that amount was higher or 19 lower. In other words, did you have more sales that 20 you made tax on or did you have more sales that you 21 received the tax money? Because that's how they 22 were reporting was on the cash basis. 23 So, that's why we put that comment. If you 24 think why -- or how could we say that the recorded 25 equals the reported if, 1, we didn't have the 26 accrual account and, 2, we didn't have the invoices? 27 So, the only reason we made that comment is 28 because we weren't including any extra taxable sales 20 1 for that quarter and we were strictly relying upon 2 our actual basis audit or consensus audit at that 3 time. 4 And I'll point out during this period, 5 which was sometime ago, that -- 6 MS. LOPEZ: Time has expired. 7 MR. LAMBERT: -- 6091 says that a sale is 8 taxable until proven otherwise. And that's the 9 basis that we -- that we went upon. 10 So, there's a lot more to this. That's my 11 basic entry comments. I can answer any questions 12 that you have, or hopefully. 13 So, with that, I concur with the Appeals 14 Division decision and recommendation. 15 MR. RUNNER: Round 2. 16 MR. HORTON: On rebuttal. 17 MR. DAKESSIAN: Thank you, Mr. Chairman. 18 You know there have been a lot of points 19 that were made. And, so, I'm going to try to 20 address the points that we think are the most 21 important. 22 First of all, the issue before the Board is 23 disallowed exempt sales for the second quarter of 24 '02. If you look behind Tab 7, you can see how 25 these issues are laid out in the audit work papers. 26 We're not talking about recorded versus 27 reported, although I can address that as well, we're 28 talking about disallowed claimed exempt sales. 21 1 And why we are revisiting an issue eight -- 2 nine years later, when on July 5th of 2006 the 3 Department said that the reason that we didn't apply 4 the sample, i.e., the reason we didn't follow the 5 Board's instructions in the audit manual, is because 6 we conducted the audit on an actual basis. That was 7 the stated reason. 8 The clear implication is, were that not the 9 case, we should be projecting the results of the 10 sample. 11 And we have February of 2014, with that 12 ocean of blue that you see behind us passing. The 13 Department coming to the realization that we didn't 14 examine the transaction on an actual basis. And the 15 56 transactions consist of scores of invoices per 16 project. 17 So, it's not enough to say we looked at 56 18 transactions, ergo, therefore, this is an actual 19 basis audit. It wasn't. So, in the absence of an 20 actual basis, you should be projecting. That's what 21 the audit manual says. And you can see the results 22 sort of speak for themselves. 23 I mean, what we're requesting is within the 24 range of reasonableness. Some periods are higher, 25 yeah, some periods are lower. 26 But what the Department is proposing is out 27 of all proportion to the claimed exempt sales for 28 the remainder of the audit period. It just doesn't 22 1 make any sense. So, I'm still at a loss as to why 2 this method was applied. 3 And, you know, with respect to the recorded 4 versus reported difference, I didn't bring this up 5 in my opening, but again this issue was decided back 6 in July of 2006. 7 If you go in, you look behind Tab 3 and you 8 look at the top quote that's highlighted, it says, 9 "Reconciliation of recorded taxable 10 sales to the reported resulted in zero 11 difference." 12 This was the result after an audit that 13 took place of this taxpayer that was about a year 14 and change. Back in '06 this was the position of 15 the Department. 16 Why are we re-visiting this now? I don't 17 have an answer. 18 I don't know if my colleague, Mr. Shaikh 19 has anything to add based on what was said? 20 MR. SHAIKH: Yeah, just to add, about 21 these -- the $2 million of sales, the 2.8 million 22 for one contract and all that good stuff, it seems 23 to me that the Department's position is that we 24 should start with, as a baseline, the $2 million 25 that were reported. And we're just ignoring that 26 entirely. On top of that we should add 2. -- 27 originally $2.8 million of sales in the first chart. 28 And when we add everything together, we end 23 1 up with a -- with a taxable percentage of well over 2 100 percent. 3 And that's just not the way we're doing it 4 because -- that's not the appropriate way of doing 5 it because what we're doing is comparing apples and 6 oranges. 7 The sale that was brought up, I believe 8 there was a direct pay arrangement with -- and 9 Mr. Hale can testify to this -- but there was a 10 direct sale agreement with the customer, with 11 Tutor-Saliba. So, those taxes were paid directly to 12 the Board. Those are not G & C Equipment 13 liabilities. 14 So, we're just starting at our baseline of 15 $2.83 million that was reported and just trying to 16 add to it. And we end up well over 100 percent and 17 that's just not the appropriate way of doing it. 18 The Board has recognized that that's not 19 the appropriate way when records are lost. And 20 that's why we have that language back there in the 21 audit manual. 22 That's all I wanted to add. 23 MR. DAKESSIAN: One last comment on the 24 recorded versus reported, you know, you will note as 25 you go through that line item -- even though it's 26 not at issue, even though it was resolved back in 27 2006 -- that on substance there are wild swings from 28 quarter to quarter based on this cash versus accrual 24 1 point that Mr. Lambert was making. 2 So, it's totally unfair to try and 3 attribute any sort of positive adjustment in favor 4 of the Department on that when it's just as 5 likely -- as you look you can see many negative 6 adjustments, it is just as likely, perhaps even more 7 so, that there was a negative adjustment in that 8 quarter. And, ultimately, that's why I have to 9 believe that was left at zero back in 2006. 10 MR. HORTON: Thank you. 11 Just a question of clarification of the 12 Department. When you attempted to convert from an 13 accrual to a cash basis, did you also look at the 14 previous and subsequent quarters and adjust those? 15 MR. LAMBERT: Right. At the beginning of 16 the audit period, we -- we did not do that. There 17 was no adjustment. We did not have the accounts 18 receivable to do that. 19 But it -- if you were doing -- if we had 20 that information, we would have made -- we would 21 have made that adjustment. 22 And, so, the question comes down to -- 23 which was just argued -- a negative adjustment. 24 You're not going to get -- you will not receive a 25 negative adjustment in that second quarter. 26 MR. HORTON: Well, it might be more telling 27 in that when you convert from a -- from a cash to an 28 accrual basis, I mean as I look at the previous 25 1 quarters it appears that they had different methods 2 of reporting. 3 At one point they seem to have reported 4 gross sales, net any claims, exempt sales. And then 5 during the audit period there they seem to have 6 reported total sales. And it seems to be a 7 combination of cash versus accrual. 8 So, if there was, in fact, a -- an accrual 9 transaction or cash transaction in an earlier period 10 that was recognized in the subsequent period during 11 the audit period, then, in fact, it would bring more 12 clarity why that earlier quarter has an issue. 13 And the concern is that it could happen on 14 the opposite side if on the subsequent period, 15 subsequent to the audit, if, in fact, that was the 16 case. 17 MR. LAMBERT: Well, there's a lot of things 18 going -- I mean, you brought up a lot of different 19 areas. I'll try to address. 20 MR. HORTON: Just one -- just one, accrual 21 versus cash. 22 MR. LAMBERT: Right. Well, there's one 23 area, there's numerous subsets to that one area. 24 So, you are -- you are correct in the 25 subsequent period, at the end of the audit period, 26 the taxpayer was put on the accrual method. 27 They continued to stay on the cash method 28 of reporting, which, in a sense, means we included 26 1 the taxable sale in our audit, but they reported the 2 taxable sale subsequent to that audit. 3 There was a subsequent audit that was 4 conducted where that issue was brought out and the 5 taxpayer was given a substantial refund for that 6 period to effectively -- 7 MR. HORTON: My apologies for interrupting, 8 but I'm actually discussing the previous period. 9 I mean, I just threw the subsequent period 10 in, but the period in question is the second quarter 11 of 2002. 12 MR. LAMBERT: Okay. 13 MR. HORTON: And, so, when you convert from 14 an accrual basis to a cash basis, what the book 15 requires is that not only do you convert the period 16 in question, but you convert the beginning periods 17 and the ending periods as well, because if you -- if 18 you don't, then you could have what -- I am going to 19 use the term for the lack of the accounting term -- 20 you could have a bleedover into the subsequent 21 period, which would cause this high -- could cause 22 this variation in the -- in the period in question. 23 MR. LAMBERT: You're absolutely right, but 24 let me explain that and why you would not receive a 25 credit for that period. 26 And I'll explain it this way: If you had a 27 sale that was taxable in the first quarter of 2002, 28 which is outside of our audit period, and you had 27 1 $100,000 taxable sale, but you didn't receive the 2 cash or the sales tax for that until the second 3 quarter of 2002, that amount would have been 4 reported in the second quarter of 2002. 5 MR. HORTON: Let me give you the actual 6 numbers because I'm really looking at the reverse 7 situation in the -- this doesn't reflect -- anyway, 8 go ahead. Sorry. 9 MR. LAMBERT: Okay. We'll get back to -- 10 we can address their number 7, which will show that 11 there was a problem. 12 But, so, anyway, you had a $100,000 sale 13 that took place in the first quarter of 2002. And 14 it was reported in the second quarter of 2002. This 15 is just the example. 16 If we did the audit, which was for the 17 subsequent three years, and let's say they had no 18 taxable sales during that time period. 19 MR. HORTON: Previous -- let's look at the 20 period -- the -- I believe the audit manual, 21 certainly all of the classes that I've taken in 22 regards to it, it says that you have to look at the 23 period that's closest to the period in question. 24 In this case, the period closest to the 25 second quarter of 2002, which is the period in 26 question, is the fourth quarter of 2001, third 27 quarter of 2001. 28 And what we have there is they reported 28 1 635,000 in those periods, 488,000 in those periods. 2 So, if they're reporting on a cash basis 3 during those periods, theoretically they would have 4 reported the cash during those periods. And then in 5 the -- in the quarter in question, which is the 6 second quarter, we would have seen that the accrual 7 transactions, when you actually see the invoice in 8 the accrual is what we're picking up, which would 9 indicate that there should have been some sort of 10 offset if we converted the previous periods from a 11 cash basis to an accrual basis. 12 MR. LAMBERT: Okay. Well, there was only 13 $2,083,000 in taxable sales that were reported in 14 the second quarter of 2002. 15 If you take a look at it, 1.97 million is 16 from Tutor-Saliba. And that is more than made up 17 with the $2.4 million in sales for that particular 18 period. 19 So, if the argument is that the 1.97 came 20 from sales before the start of the audit period, my 21 argument would be it's even worse for them because 22 then they had $2.4 million in sales, and the 1.9 was 23 from sales that are not included in our audit 24 period, but were payments that were made in our 25 audit period. And, in effect, those payments should 26 be taken out of the amount and -- because those 27 sales weren't included in our taxable sales. 28 So, in effect, what you would be saying is 29 1 if you had a sale that took place beforehand and it 2 was reported during this period, in effect -- 3 MR. HORTON: No, no. 4 MR. LAMBERT: -- that sale never took 5 place. 6 MR. HORTON: Let me say what I'm saying. 7 MR. LAMBERT: Okay. 8 MR. HORTON: Or what the records reflect 9 is -- that the records reflect that they had 636,000 10 reported taxable sales during the third quarter of 11 2001. 12 In the fourth quarter for 2001 they had a 13 488,000 that they actually reported to the Board, 14 for a total of almost 2 million -- 6, 4 -- $2 15 million dollars in the previous period. 16 So, if they reported -- if they're 17 reporting on a cash basis during those periods and 18 the Department examined that. And they saw that 19 there was the Tutor-Saliba Tudor, or any of these 20 other contracts actually paid him during those 21 periods, so, those sales would have gotten into that 22 $2 million sales reported prior to the audit, 23 because it's being reported on a cash basis when 24 they received the cash. 25 And then they continue and they only 26 received a portion of it, theoretically, following 27 this mathematical theory, in the second quarter, 28 which would have indicated that you would have had a 30 1 lower number reported in the second quarter for the 2 same contract, which they appeared to have had, 3 which is the $2 million. 4 And, so, if we don't adjust -- if we don't 5 look at it to determine if we need to adjust for it, 6 it throws us -- it throws our numbers off in the 7 period in question. 8 MR. LAMBERT: Okay. The -- the numbers 9 don't reflect that. And I think the argument -- 10 MR. HORTON: This is from -- from our 11 records? 12 MR. LAMBERT: No, I -- 13 MR. HORTON: This is not the taxpayer's 14 records? 15 MR. LAMBERT: -- I agree with that. 16 I think the premise is that generally you 17 bill the customer. And it takes a while for them to 18 pay you. And that's generally the lag between the 19 accrual and the cash methods. 20 It's not usually they pay you first and 21 then you invoice them for the work. That -- that's 22 not the way that it takes place. It is first the 23 invoice, then the payment. 24 So, if that's the case here, and out of the 25 1.97, if there are previous payments for that, 26 that -- those -- the sales associated with those 27 payments are not included in our taxable sales. 28 But that's -- that's not the argument that 31 1 we're making, 'cause we're basically saying that 2 we'll just accept whatever was -- was reported for 3 that amount -- that on the cash basis, those amounts 4 that were reported as taxable were the amounts that 5 were accrued. 6 And that's what our schedule is saying, 7 because we were going to take care of it on an 8 actual basis. 9 So, that's -- the whole premise is that 10 there's other sales that took place in the second 11 quarter of 2002 that they weren't paid until later. 12 And we don't disagree with the taxpayer 13 that, yeah, if you could identify just nontaxable 14 transactions, we agree with them, you should apply 15 that percentage of error to them. There's no 16 question about that. 17 But the evidence that we've provided 18 indicates that's not what -- that's not what has 19 taken place. 20 And if you look at their Exhibit No. 7, 21 this will -- I'm sorry, No. 5 -- if you look in the 22 amount in Column E for the third quarter of '02, 23 that's 200 -- a negative 298,000. It's a little bit 24 hard to read, but it's a negative amount. 25 So, what does that mean? That means that 26 the sales that you reported in taxable in the second 27 quarter of 2002 were less than the sales that -- the 28 taxable sales that you made. 32 1 So, in other words, you got paid in the 2 third quarter of '02 more -- $300,000 more than what 3 you billed. 4 So, at a minimum, this $300,000 is coming 5 from the second quarter of '02 or earlier periods. 6 There can't be -- 7 MR. HORTON: I mean, if that's the case, 8 then -- then your argument says that the third 9 quarter reflects the sales that took place in the 10 second quarter, which means it's reflected in the 11 computation over the statistical sample period, 12 which means you should have projected. 13 Because now you're saying that some of the 14 variables that existed in the second quarter of 2002 15 rolled over into the third quarter, which is part of 16 the challenge. 17 And then the second challenge that comes 18 into play is -- I think it was your testimony that 19 there was a credit in the subsequent audit. Which 20 means when you've got a taxpayer that's converting 21 from a cash to accrual, back to a cash, back to 22 accrual again, if you don't take the beginning of 23 those -- of the period and the end of the period and 24 adjust all of the way, we never get to what the real 25 picture is. 26 And, in fact, arguably, the subsequent 27 period where he received the refund, maybe the 28 refund shouldn't have been that high because you 33 1 should have adjusted backwards, which is not under 2 consideration here. 3 In the earlier period, which we didn't 4 audit, and the taxable sales were higher, maybe 5 there should have been an adjustment there. Therein 6 is the inherent challenge. 7 And, so, when you have a situation -- in 8 addition to this, when you a situation statistically 9 when the pendulum -- when the pendulum swings from 10 one end to the other, they say take a look at the 11 median or try to figure it out. But, theoretically, 12 that test should reflect the entire audit period, I 13 think, you know, I mean -- which is really 14 challenging at this point to try to figure this out. 15 Anyway, enough on the clarification. 16 Discussion? Member Harkey. 17 MS. HARKEY: Hi, I have an exhibit that I'd 18 like to pass out. I've got a couple of them up 19 here, but we have more for you. 20 It's not. 21 MR. HORTON: Is this already part of the 22 record? 23 MS. HARKEY: No, it is not. 24 MR. HORTON: Let's submit this to both 25 counsel and the taxpayer. Let's have them review it 26 and -- 27 MS. HARKEY: I have two extra copies here. 28 I'm not sure how I got those, but if you need 34 1 extras, I've got them. 2 I think we're good. 3 MR. HORTON: We're going to allow a few 4 minutes for them to -- 5 MS. HARKEY: It's -- it's from the audit 6 papers. 7 MR. HORTON: -- so, it is part of the 8 record? 9 MS. HARKEY: Right, the record -- well, the 10 last column in yellow is not, and my -- my analysis 11 is not. 12 So, I wanted to be sure everybody could 13 just follow. It's the reconciliation explanation of 14 the second re-audit adjustment. 15 Now, what I'm showing under (A are the 16 three strata that were used by the audit and the 17 disallowed exempt of 1.4 -- 1.4 million -- 1.417306. 18 Then -- so, that's the 1.667 or 1.67 19 adjustment. 20 But then for some reason in 2Q, which is 21 what I think is being pointed out here by the Chair 22 as well, is that we've got 1.417. 23 And Exhibit 1, page 5 of 5 of the staff -- 24 staff exhibits says that there were zero difference, 25 which we've heard time and time again that the 26 reason -- okay, it says -- it says that the recorded 27 taxable sales assumed as the reported taxable -- 28 excuse me, the recorded taxable sales assumed as the 35 1 reported taxable sales, therefore, reconciliation of 2 recorded taxable sales to the reported resulted in 3 zero difference. 4 So, just looking at this (indicating), I 5 have to say that if we're going to assign such a 6 huge error to that one quarter, that the whole thing 7 is wrong. 8 And since we have this adjustment, these 9 are the three stratas here in yellow, all three 10 combined to show the 1.667. I don't know how you 11 can arrive at some other adjustment unless you go 12 back another year to check all of '02, or maybe drop 13 '02 and go forward one more quarter into '05. 14 I just -- you know, to just pick this out 15 of the sky, I'm having a real hard time with because 16 it is so obviously aberrant from the rest of the 17 data. 18 And I do understand how the Department 19 arrived at it, but what I'm saying is to do for one 20 Q what was supposed to be an actual, that we 21 discover wasn't an actual and then to go back and 22 re-do it several years later, I guess it was 2013, 23 with another -- another formula, just doesn't make 24 sense to me. 25 I would have, if I were in banking or 26 anything else and looking at a client and trying to 27 figure out a loan, which you, quite honestly, look 28 at -- you scrutinize very carefully 'cause you want 36 1 to be sure you're not on the short end if you have 2 to pull your collateral or take the receivables or 3 start collecting on them. I would have either gone 4 forward a quarter or gone back a whole year to see 5 what the other one was, but I certainly wouldn't 6 have just picked something out of the sky. 7 So, this is the most important document to 8 me is what this document shows is that we have got a 9 1.667 error ratio. And because of the audit manual 10 explanation and the quarterly errors, the way that's 11 popping up, you can see that it's totally aberrant, 12 even on the adjusted. 13 And I just don't understand how we can get 14 this far in an appeal process and not just have 15 reconciled with the 1.67. 16 Can you explain? I mean, you've been 17 through a huge explanation, but just shortly? 18 MR. LAMBERT: I will try to. 19 MS. HARKEY: Does this happen -- I guess my 20 question is, is this a typical audit procedure to do 21 something like this? 22 MR. LAMBERT: Is it typical? 23 I can say that I've run across this on, I 24 wouldn't say numerous, but several occasions, and 25 this isn't that unusual. 26 But, of course -- so, with that said, what 27 I'll try to explain is the disallowed exempt sales, 28 right? 37 1 Because your problem with it is is like 2 take a look at the amount in Column J, which is 3 1.4 million, and compare it to the amount in 4 Column L. And those figures -- they don't match, 5 they -- 6 MS. HARKEY: Right. 7 MR. LAMBERT: -- and we agree. We agree, 8 but there's an explanation for what -- for why that 9 is. 10 If you remember, the second quarter of 2002 11 is the only period that the taxpayer had claimed 12 substantial nontaxable sales. They claimed 13 out-of-state sales of $4 million. They didn't claim 14 out-of-state sales in any other periods. They did 15 claim some labor exemptions for the next two 16 periods. 17 So, that's the reason why we show it as 18 disallowed claimed exempt sales. That -- that's the 19 reason, because they claim that as exempt sales. 20 We don't believe that those were actually 21 exempt sales that you put down as out-of-state 22 sales. 23 MS. HARKEY: I understand that. 24 MR. LAMBERT: Okay. 25 MS. HARKEY: But what I'm saying to you is 26 that if this is a typical way to do an audit, is to 27 just extrapolate one quarter when you've got 11 28 quarters of data -- 38 1 MR. LAMBERT: Right. 2 MS. HARKEY: -- that's on an accrual basis, 3 that's moving forward -- sometimes negative, 4 sometimes positive -- but overall having a 1.67 5 ratio, and then if you were to do that 1.4 million, 6 that's the -- just the one stray quarter at the same 7 error ration, you'd come up with roughly 69 to 8 70,000. And if you look the numbers, which are 9 graphed, you can see that they're kind of in the 10 ballpark there. 11 And I understand what the Department did, I 12 just don't understand why you would do that. I -- 13 you know, I mean, you'd either go -- does the 14 Department have the ability to go to 2Q05 and 15 make -- 16 MR. LAMBERT: We did. 17 MS. HARKEY: -- okay, you had 1Q05. Did -- 18 the Department -- couldn't they have gone forward 19 one more quarter and just used the new quarter and 20 exempted that 2Q02 altogether? 21 MR. LAMBERT: Yeah. Well, what I would 22 point out is that if you take a look at the taxable 23 sales that were reported for this quarter, it was 24 $2,083,000. That's the lowest period of the entire 25 three years. 26 If you look at -- for -- if you look at the 27 audited taxable sales, the next lowest quarter is 28 almost $3 million. The two quarter -- the second 39 1 quarter of '02 is $900,000 lower than the next 2 lowest quarter. 3 And, so, the question really comes down to, 4 if you want to apply that percentage of error, 5 which -- and I would say that the taxpayer's 6 developed 1.66 -- it's not right, but it should be 7 2.06. 8 MR. DAKESSIAN: That's from the audit work 9 papers. 10 MR. HORTON: My -- 11 MS. HARKEY: I'm sorry, It is in the audit 12 work papers. 13 So, we've got -- okay. 14 MR. LAMBERT: Right. 15 MS. HARKEY: I'm not sure what you're 16 looking at because I'm not seeing your -- anyway. 17 MR. LAMBERT: Yeah, but I just find the -- 18 MR. HORTON: Clarification, may I, Member 19 Harkey? 20 I mean, the -- the previous quarters have 21 almost 11 million, which is higher than many of the 22 quarters on the -- that's being tested. 23 And, so, you might want to consider that. 24 MR. LAMBERT: Right. And there's 25 substantially -- substantially higher quarters in 26 there as well compared to this particular quarter. 27 But what I come back to is that we have all 28 the contracts, 56 contracts. We know who they're 40 1 to. We know that there is taxable transactions in 2 there that have not been reported. 3 If you took a look at LA Power Joint 4 Venture, there's over $800,000 in there. And we 5 have the invoices from that support that. How do 6 you apply a 2 percent of error to that $800,000 7 when, in fact, that we know that that is a taxable 8 transaction? 9 And, so, what we're trying to say is that 10 the -- the fairest way of doing it, the most 11 reasonable, is taking the audited taxable percentage 12 and applying it to that quarter. 13 And when you look at that $1.4 million, 14 what that's made up of is both taxable sales that 15 weren't reported because of the accrual versus cash 16 method, and also nontaxable sales that have been 17 disallowed. 18 But you're right, the nontaxable sales 19 portion of that that's disallowed is just a small 20 portion of that $1.4 million. 21 MR. HANKS: If I could add, Ms. Harkey, 22 too, I think, one other comment? 23 Mr. Lambert has been referring to this 24 before, but, really what we're saying too is that 25 the disallowed exempt sales for all of the other 26 periods in the Columns G and Column H, they're 27 relatively small numbers. 28 The $1.4 million that we've calculated 41 1 really relates to Column F. It's basically a 2 reconciliation of recorded versus reported sales. 3 That's -- that's the vast -- largest part 4 of the understatement that we've calculated in this 5 audit. 6 It really is just a comparison of their 7 recorded sales with their reported sales. So, it 8 doesn't really relate to disallowed exempt sales, 9 especially from the standpoint we've seen the 10 contracts; we've seen the invoices from the second 11 quarter of '02. We know that they're taxable 12 contracts. We know that they're taxable invoices 13 where tax reimbursement was charged and paid to the 14 taxpayer. 15 So, all we're saying is we need to account 16 for those transactions in that taxable sales column, 17 rather than the exempt sales column. 18 It's not an not examination of exempt sales 19 that we're looking at for second quarter of '02, in 20 other words. 21 MS. HARKEY: I understand, I think. 22 But I still have to go back to how aberrant 23 it is. 24 So, for the taxpayer, will you explain one 25 time again how it is that Tutor-Perrini (sic) 26 contract and the LA Power contract were reported? 27 MR. DAKESSIAN: Well, what I can tell you 28 about the Tutor-Saliba contract is that it was a 42 1 direct pay arrangement. 2 MS. HARKEY: Okay. So, that was not 3 taxable? 4 MR. DAKESSIAN: Than was not taxable. 5 Those payments were made directly to the Board. 6 MS. HARKEY: Okay. And what about -- so, 7 that would have been exempted in here in the audit 8 period, right? You would have -- 9 MR. LAMBERT: No. 10 MS. HARKEY: -- okay, let's not go into all 11 that. 12 But that would not have been -- that would 13 not have been included in taxable sales because it 14 was not required to be. 15 And this is a sales and use tax audit, 16 okay. 17 What about the LA Power? 18 MR. DAKESSIAN: The LA Power contract 19 specifically? 20 MR. DU FOUR: Can I speak to the LAP? 21 MS. HARKEY: Can you come up to the mike? 22 Thank you, if you understand. 23 Those seem to be the two major bones of 24 contention. 25 MR. DAKESSIAN: For -- for the courtesy of 26 the court reporter here, this is Bill DuFour, who is 27 with G & C Equipment Corporation, the CFO. 28 MS. HARKEY: Thank you. Hi. 43 1 MR. DU FOUR: Pleasure. 2 We do record it. While I did not prepare 3 that return, part of the $2 million worth of sales 4 that we were reporting, LA Power is part of that. 5 MS. HARKEY: Okay. So, it was reported? 6 MR. DU FOUR: Yes. 7 MS. HARKEY: Okay. 8 MR. LAMBERT: We can respond, if you'd -- 9 MS. HARKEY: I know. But this just keeps 10 going, it's like a ping pong ball. 11 MR. LAMBERT: -- I think I can make this 12 easy. 13 MS. HARKEY: You haven't -- you haven't to 14 date. I don't know how this -- I'll let you. 15 Okay, Scott, go ahead. 16 MR. LAMBERT: All right. If you take a 17 look at the Tutor-Saliba and you see the reported 18 taxable sales in Column J, it's $1.9 million. 19 And the reason we know that that goes -- 20 that was reported, and the reason we know it was 21 reported for Tutor-Saliba is because that's the only 22 contract that was in Contra Costa County. That's 23 the only one that shows up. 24 If you see the breakdown, it's all broken 25 down by county. 26 MS. HARKEY: Okay. 27 MR. LAMBERT: So, when you look at 28 Tutor-Saliba, and you see the 1.97, if -- and I 44 1 didn't include it here, but I did have the 2 contract -- I am sorry, their return -- there is no 3 question that the 1.97 went to the Tutor-Saliba. 4 It was not LA Power because there was only 5 $112,000 that was reported for sales in LA County. 6 And how you can prove that is you go to 7 Exhibit 1, page 3, Column J. And you'll see for 8 Los Angeles, that's the total for that county is 9 $112,000. 10 The Tutor -- the LA Power Joint Venture can 11 not have been reported because it was in LA County 12 and it's $800,000. 13 They're -- I think what they're referring 14 to with the 1.97, those payments were made directly 15 to the Board of Equalization. And the taxpayer was 16 given credit for that. 17 But those sales were reported on their 18 return, on the taxpayer's return. And that's the 19 1.97, which was from Tutor-Saliba. 20 There's no question about that. 21 That's very straightforward. 22 MR. DAKESSIAN: What's perhaps -- what's 23 perhaps even more straightforward is that this issue 24 was examined back in 2006. And I don't know why we 25 are revisiting issues that were already determined 26 at audit, like recorded versus reported sales, 27 because the Department feels like it right now. 28 That's not -- that's not appropriate tax 45 1 policy or procedure, nor is it reasonable, given 2 what we know. 3 And what we know is that the Department 4 said in 2006 this audit is being conducted on an 5 actual basis, otherwise we'd be applying the sample. 6 I cannot let the Department run from that 7 right now. They need to own up to that. In 2006 8 that's what they said. 9 Now they 'fess up, eight years later, after 10 my client has been through -- very patient -- been 11 through a long administrative process. And now 12 their position is okay, oops, we didn't do it on an 13 actual basis, but we're still not going to follow 14 the audit manual. 15 And that's how we see the case right now. 16 MS. HARKEY: Thank you. 17 MR. HALE: I'd just like to make one 18 statement, if I can? 19 In this industry, it's very -- it runs in 20 cycles. You may get an order today for a product. 21 You may not deliver that product until eight months 22 later. 23 And I think that if the Department were to 24 go back and look at some of previous audits they 25 have done, like in 2001, 2002, they will see that we 26 had a recession which started March 2001. And we 27 didn't come out of the recession until the first of 28 the year, beginning of 2002. So, obviously, you 46 1 know, people started to generate more revenues when 2 you're coming out of recession. 3 And when you don't -- when you're in a 4 recession, of course, your revenues go down. So, 5 you're going to have these swings. 6 And, so, I am just believing that there are 7 a number of ways where -- and we're still in the 8 range. When you look at the numbers, we're still in 9 the range. 10 But again you have to consider that there 11 was a recession in 2001, which generates revenues up 12 and down. And then I think that way you can get to 13 a point of trying to satisfy yourself as to why you 14 would have these swings. 15 I'm not saying that is the only reason, but 16 that could be one of the reasons. 17 MS. HARKEY: Thank you. 18 MR. HORTON: Mr. Runner. 19 MR. RUNNER: Yeah, actually I have just a 20 procedure thought or question that I'm just trying 21 to kind of get through. 22 And that is, I'm -- I guess I'm concerned 23 in the fact that we would be in an audit where we 24 would have a taxpayer in a process under one audit 25 method for a fairly long period of time -- you know, 26 even through the Appeals conferences and all the 27 issues that take place. 28 And then we would, all of a sudden, adjust 47 1 our audit method -- even after all the Appeals 2 conferences and whatnot. 3 I just -- I guess I'm struggling with that 4 in terms of just a -- just a, you know, a fairness 5 aspect. 6 And, you know, I'm trying to remember if -- 7 how -- it doesn't seem I have been up here very 8 often where we've actually kind of done that, 9 where -- you know, where the field auditor has made 10 their audit. They have gone through their 11 assumptions and the processes. And they use this. 12 And then, all of a sudden, we go through 13 this long process and through, you know, a lot 14 exchange of information. And we go through Appeals 15 conferences. 16 And then, all of a sudden, we take -- the 17 Department takes something off the schedule and then 18 starts with kind of a new game plan. 19 Should I be -- I mean, you see where my 20 concern is? 21 MR. LAMBERT: I understand your concern. 22 MR. RUNNER: Why shouldn't that be a 23 concern? 24 MR. LAMBERT: Why? 25 And I'll explain it. I'll explain what we 26 did and why we did it and why -- 27 MR. RUNNER: No, that's not what I asked, 28 though. 48 1 I asked should I be concerned about a 2 change of method? 3 MR. LAMBERT: I think you have to 4 understand the whole process in order to get to 5 the -- to the end result. 6 So, to just say that we changed methods -- 7 MR. RUNNER: Uh-huh. 8 MR. LAMBERT: -- it doesn't explain the 9 whole thing. 10 And really to relieve your concern, you 11 would have to know the reason why we changed that 12 process and -- because that's the whole explanation 13 for it. 14 MR. RUNNER: Let me ask Appeals. 15 Is that -- I mean, is that -- in terms of a 16 process, in terms of how we deal with taxpayers, you 17 know, to take them through a whole process with one 18 audit method, all of the way up to the point to 19 where we end up with Appeals conferences and 20 scheduled for hearing. 21 MR. ANGEJA: Ideally -- ideally we'd like 22 to get it right from the beginning. 23 I don't know if this is on. 24 MR. RUNNER: Okay. 25 MR. ANGEJA: Ideally we'd like to get it 26 right from the beginning. 27 In this case, when this was last scheduled 28 for Board hearing -- mike's on. 49 1 MR. RUNNER: It's on now. 2 MR. ANGEJA: When it was last scheduled for 3 Board hearing, it was communications from the 4 taxpayer's rep to Ms. Mandel, at least those were 5 the e-mails that I saw, that pointed out that the 6 Department didn't have the correct method, that 7 there was this discrepancy. 8 So, the statute, Section 7081, requires 9 this agency to get the most correct and most 10 accurate determination of tax. 11 So, to answer your question about process, 12 if we discover that we have an inaccurate or a less 13 than ideally accurate method, we should change that. 14 You wouldn't want someone to stick with an 15 incorrect, overstated method just the sake of 16 sticking with a method consistently. 17 We'd like to get it right from the 18 beginning. 19 MR. RUNNER: Uh-huh. 20 MR. ANGEJA: If we don't, and we see better 21 evidence and make a more accurate determination, 22 we're bound by statute to make that change. 23 MR. RUNNER: Let me ask from the taxpayer's 24 perspective in regards to that kind of an analysis. 25 MR. ANGEJA: I might add, if I can, the 26 Department has reduced the measure of tax based on 27 that change. 28 MR. RUNNER: Yeah, right, right, right, I 50 1 remember that, by about half. 2 MR. DAKESSIAN: I can appreciate the 3 comment from Appeals. The goal of the agency is to 4 get it right whenever you can -- if that happens 5 earlier or later in the process. 6 Here's our concern, from the moment that we 7 were involved in this case, and even before that, 8 this issue stuck out as a sore thumb. 9 This was something that we picked up on 10 right away and brought to the attention of whoever 11 would listen to us at that time. Believe me, we 12 brought it up repeatedly throughout the process. 13 And it fell on deaf ears. 14 I'm grateful that on the eve of the hearing 15 the Department owned up and said, yeah, guess what? 16 We made a mistake, we didn't review it on an actual 17 basis. 18 But for them to then just shift the method 19 and -- and go away from what they had said several 20 years earlier about the reason why they didn't apply 21 the sample and come up with a new theory, that's 22 where I think it becomes difficult for taxpayers and 23 their representatives. 24 So, better late than never, perhaps. But I 25 still don't think we got it right. 26 And I -- yeah, and, so, there was even 27 dissension within the Department as to whether this 28 was the appropriate methodology. 51 1 But that's behind us. That's long since 2 past. And we're here today trying to get it right. 3 And we believe the method that we proposed is -- 4 MR. RUNNER: Is there anything like a -- 5 you know, like once you then assume a new method and 6 whatnot, that you go back into Appeals conferences 7 to kind of start, you know, backtrack a bit with 8 those -- with the taxpayer and whatnot? 9 What -- 10 MR. ANGEJA: That is a possibility. And 11 that occurred in this case, not as to this specific 12 issue. 13 We haven't had an Appeals conference since 14 the epiphany that we didn't have it right. 15 MR. RUNNER: Right, right. There has been 16 one since the new method was applied? 17 MR. ANGEJA: Right. 18 MR. RUNNER: Okay, thank you. 19 MR. HORTON: Member Ma. 20 MS. MA: Well, I just kind of find it, you 21 know -- here we have an audit manual and it seeks to 22 address when taxpayers lose records. And we're 23 supposed to use statistical sampling. 24 And I think the taxpayer has more than even 25 the required amounts. And I find that all the 26 hearings that we have when taxpayers don't have 27 their records, the Board -- we use statistical 28 sampling or averages, you know, based on similar 52 1 businesses. 2 And here, you know, the taxpayer does 3 provide it in, you know, more than the required, yet 4 we don't want to use that number. And we want to 5 try to find some other way to figure it out. 6 So, I find that kind of troubling, 'cause 7 that's kind of how we've been basing it. All the 8 cases that we've heard is based on sampling and 9 averages. And, you know, that's how we're defending 10 our work in our cases. 11 Secondly, like switching from cash to 12 accrual, I mean, you're supposed to follow the 13 taxpayer's books and records. 14 And I also find it troubling when you pick 15 and choose which method to use so that the numbers 16 come out higher. I mean, that is not, to me, good 17 accounting or, you know, proper review of the 18 taxpayer's books and records to be changing what 19 they are actually reporting and have been reporting 20 consistently to now the Board using another method. 21 That, to me, is also a little bit baffling. 22 MR. HANKS: Ms. Ma, if I could respond to 23 some of those concerns? 24 The first concern that you raised dealt 25 with reporting on a cash basis versus accrual basis. 26 Actually, the sales and use tax law has a 27 requirement that the taxpayer report on an accrual 28 basis. 53 1 So, we are under the statute to correct for 2 the taxpayer's failure to actually report on a cash 3 basis. So, that -- that deals with that topic. 4 Secondly, we do encourage our auditors to 5 perform statistical samples and perform testing 6 where it's appropriate. 7 And where we can make inferences and apply 8 factors of errors to other periods, we certainly do 9 that. 10 In this case we did not because we more or 11 less looked at the second quarter of 2002 on an 12 actual basis. This wasn't an unusual examination. 13 We had a certain part of the audit period that was 14 covered under a statistical sample test basis. 15 We did not test the second quarter of '02 16 because we didn't have the records from which we 17 could -- we could reasonably perform testing. 18 We had a census review of all the contracts 19 from 2002. So, it was very simple, actually, for us 20 to look at each of those contracts and identify 21 which ones related to taxable transactions, which 22 ones were supported as exempt sales, which the 23 Petitioner was able to document with us. 24 But it left these other contracts that 25 indicated that these were taxable contracts. We 26 don't apply statistical error factors to contracts 27 that we know are taxable. We only apply error 28 factors to exempt sales and test exempt populations 54 1 of sales transactions. 2 Here we've developed secondary support for 3 the $1.4 million understatement in the second 4 quarter of '02 based on our examination of just 5 these two contracts. 6 Just looking at Saliba and looking at LA 7 Power indicates that for Saliba there is an apparent 8 under reporting measured by approximately half a 9 million dollars. 10 We know tax wasn't -- or we didn't account 11 for the $800,000 LA Power contract as a taxable 12 contract in the second quarter of '02. We're saying 13 that we need to for both of these contracts because 14 the taxpayer recognizes that those were taxable 15 contracts. 16 So, if you add up the difference in the 17 under reporting -- under reporting for those two 18 contracts alone, notwithstanding the other 50 that 19 were in question originally, we find that there is 20 $1.2 million in unreported taxable sales just 21 associated with those two contracts -- $500,000, 22 approximately, wasn't reported for the Saliba 23 contract, $800,000 wasn't reported for the LA Power 24 contract. 25 No questions about those two contracts. 26 And it's just secondary support for our position. 27 MS. MA: So, I'm going to ask taxpayer to 28 respond to that again. 55 1 But when you talk about our sales and use 2 tax reports, they all have to be on an accrual 3 basis? 4 MR. HANKS: Correct, correct. All of our 5 examinations are -- 6 MS. MA: Really? I mean, all these little 7 mom and pops, you think they're on an accrual basis? 8 MR. LAMBERT: Yes. 9 MR. HANKS: Yes, all of them. It's a 10 requirement under the law that everyone report on an 11 accrual basis. 12 MR. LAMBERT: On income tax they can report 13 on cash or accrual, but sales tax is all on the 14 accrual basis. 15 MS. MA: Well, then -- okay. So, then how 16 come when we have analysis, it says, well, based on 17 the tax returns, the tax returns tie to the sales 18 tax reports, when tax returns are on a cash basis. 19 And you're telling -- accrual has to be -- 20 you know, the accrual is the method. 21 So, why are we even looking at people's tax 22 returns? 23 MR. LAMBERT: Well, you'd have to look on 24 the tax returns to see whether it's cash or accrual. 25 That -- that would be your determining factor. But 26 the Department -- 27 MS. MA: So, if it's not accrual, then 28 what? Do you guys go back and re-do their -- like 56 1 figure out their taxes? 2 MR. LAMBERT: And that's what we've done 3 here. 4 They've had -- we've had to put them on an 5 accrual basis. But we didn't mix and match. We 6 didn't mix like sometimes it's cash, sometimes 7 accrual. We put them on totally an accrual basis. 8 And this happens occasionally. 9 And I would point out that they were 10 audited before as another entity before this one, 11 and at the same issue. 12 They had a cash and accrual reporting 13 basis, and they were put onto the accrual basis for 14 that period. 15 When they took out this permit, then they 16 switched back to the cash reporting basis. 17 MS. MA: Okay. So, I think Ms. Harkey had 18 asked how come you didn't go -- how many quarters 19 did you go back? 20 MR. LAMBERT: Well, we can only -- the 21 statute of limitations -- there is a three-year 22 statute of limitations. We can only go back so far. 23 We -- the second quarter of '02 was the 24 only period that was open to statute. So, that's 25 the only period that we could go back to. 26 MS. MA: But if you're taking a sample and 27 adjusting their as books and records, wouldn't you 28 go back -- I mean, you can't take one quarter -- 57 1 MR. LAMBERT: We -- 2 MS. MA: -- if they're reporting on cash 3 and you're going to adjust for accrual for one 4 quarter? 5 MR. LAMBERT: Right. Well, no. 6 We -- we adjusted for accrual for all 7 quarters, all quarters. 8 MS. MA: That's what I asked, how many 9 quarters? 10 MR. LAMBERT: Twelve. 11 MR. HANKS: Three years. 12 MR. LAMBERT: Three years. 13 MS. MA: Three years going forward. 14 MR. LAMBERT: Three years in this audit 15 period they were on the accrual basis. 16 Maybe I'm not understanding your question. 17 As far as -- the entire audit lia -- the entire 18 audit was conducted on the accrual basis. 19 MS. MA: I know, but you have to go back 20 also, before -- 21 MR. LAMBERT: Before you start. 22 MS. MA: -- before you start, right? I 23 mean -- 24 MR. LAMBERT: Uh-huh. 25 MS. MA: -- if you're going to go to 26 accrual and adjust everything, you kind of have to 27 start from the beginning? 28 MR. LAMBERT: Absolutely, you should. 58 1 And we couldn't do that because we didn't 2 have the accrual account. And, so, what that does 3 is, it works in the taxpayer's favor. 4 Because what would happen is anything in 5 accounts receivable as taxable that had not been 6 reported as of March 31st of '02, that was reported 7 in a later period. 8 You were given full credit for that even 9 though that sale did not show up in our audited 10 taxable measure, because it was outside of our audit 11 period. 12 So, the fact that we didn't do anything 13 with the beginning accounts receivable was to the 14 taxpayer's benefit. 15 ---oOo--- 16 17 18 19 20 21 22 23 24 25 26 27 28 59 1 ---oOo--- 2 MS. MA: Not necessarily. Depends on how 3 much was in the accounts receivable. 4 MR. LAMBERT: It -- it wouldn't matter. 5 If there's taxable sales that had not been 6 reported and they're subsequently reported, those 7 sales, because they took place before the audit 8 period, would not be in our audited taxable 9 measures. So -- and that was the -- 10 MS. MA: But that doesn't make sense either 11 because if you're going to report an accrual, you 12 got to report on accrual. You can't just start on a 13 certain day and then go, oh, we're not going to take 14 into account this, but we're going to take into 15 account that. I mean you have to look at the whole 16 picture for all these contracts. 17 MR. LAMBERT: Well, we should -- we should 18 have taken accounts receivable into account. We did 19 not have it because they had lost their records. 20 But it is completely in the taxpayer's favor, any 21 way that it goes, because they're reporting an 22 amount from sales that took place before the start 23 of our audit period. And there's no -- there's no 24 other way to analyze it. 25 MS. MA: Okay. Maybe to the taxpayer. 26 Maybe you can -- oh, forget it. 27 MR. HORTON: Member Stowers. 28 MS. STOWERS: Okay. I'm kind of with 60 1 Senator Runner on the change of method. 2 Starting in -- the audit started in 2005, 3 and looks like sometime in 2014 the method changed 4 and that's a big gap. 5 My apologies. But, to the Department, can 6 you explain what happened? Why from 2005 to 2014 7 you -- the Department was arguing that it was on an 8 actual basis, and at what point did you come to a 9 conclusion that it was not, and how did you come to 10 that conclusion? 11 MR. LAMBERT: Sure. That's an excellent 12 question. 13 What we did -- I had described originally 14 what we had -- what the Department had used was the 15 average audited taxable measure that -- which was 16 $5.7 million. 17 We went back to the taxpayer at that point 18 when the audit was still being processed and we 19 discussed it with them. And they said, I think I 20 can get you the actual figures for the second 21 quarter of 2002. So we said okay. 22 They went back. They were able to get a 23 customer sales history list for that particular 24 quarter, which is the Department's Exhibit 1, which 25 is the 56 contracts that took place during that 26 quarter and then has the income by month, totals, 27 and then the figures that were reported. And it's 28 broken down by county, to determine what was 61 1 reported in there. 2 So what the taxpayer at that point did is 3 they went back to their files. Because if you 4 remember, they lost their electronic records. They 5 did not lose their paper records. 6 So the taxpayer is the one that went back 7 into their records and they looked for the 8 nontaxable transactions and they provided 'em to us. 9 And the tax -- and the auditor allowed all those 10 transactions that they could support as nontaxable. 11 The remaining difference was $2.8 million. 12 And I'll point out at that particular time, in the 13 first audit, the taxpayer agreed with the audit. It 14 was submitted as agreed. 15 It wasn't until October 1st of 2009 that 16 the taxpayer advanced the argument that the 17 percentage of error should be applied against the -- 18 I'll put it the exempt sales or sales that were 19 claimed as exempt. 20 And -- and what I'll point out in this 21 period was they claimed over $4 million during this 22 period, the only period that they claimed as 23 nontaxable. So the auditor was under the impression 24 and still -- still believes, the auditor's adamant 25 that that was an actual basis, that they had all the 26 documentation, this is what they provided. 27 And so that's when we went -- that's why it 28 was argued that it was on an actual basis. It was 62 1 not done on a test basis. There's either a 2 consensus or a test. And this was not on a test. 3 This was not a test basis. 4 So I'll read something. This was written 5 from our petition section in June 1st of 2009. 6 And -- and they identify the $1.4 million that's 7 disallowed, the explanation that it's a disallowed 8 claim, and they recognize that -- the description of 9 that, as misleading. 10 It says: 11 "The label used in the audit, quote, 12 'disallowed exempt sales in 2002' is not 13 quite accurate since the differences 14 assessed in the second quarter of '02 is 15 not presumed to be all attributable to 16 disallowed claimed and netted exempt sales. 17 In the other 11 quarters of the audit 18 period, the differences assessed consisted 19 of disallowed claimed, netted exempt sales 20 based on a statistical sampling and 21 understated taxable sales based on analysis 22 of the sales tax accrual account with the 23 majority of the differences attributable to 24 the later." 25 So there -- then they read on: 26 "It is therefore not reasonable to 27 establish the total understatement in 28 reported taxable measure in the second 63 1 quarter 2002 by projecting an error rate of 2 1.667 from the statistical sample." 3 So they identify -- they recognize that 4 that explanation, that "disallowed" is made up of 5 two different categories: It is taxable sales and 6 nontaxable sales. And the difference -- and the 7 reason is, is because of the cash and the accrual 8 method of reporting. 9 So then we come to the point of February of 10 2014 and we're getting ready for the hearing at that 11 time. It was described to me that there were 12 numerous invoices, and the argument was made that we 13 did not look at all of those invoices and that there 14 are other nontaxable transactions that they were not 15 allowed credit for. 16 And at that point I made the decision that 17 they were right. We didn't look at every 18 transaction because we had asked the taxpayer to go 19 through their files. We can't say for certain that 20 every invoice was there. 21 And at that point we gave them the benefit 22 of the doubt and we said, we will move to the 23 audited taxable percentage method to give them a 24 reasonable -- I guess a reasonable benefit of the 25 doubt. 26 But if you ask the auditor, the auditor's 27 still adamant that was done -- they had the records, 28 I was out there auditing, they had 'em, they looked 64 1 at 'em. But -- but that's not our argument. That's 2 the reason why we changed methods is because that 3 argument was brought to our attention and it was 4 true that we had not looked at every single invoice 5 for that. But that's the whole explanation. 6 MS. STOWERS: Petitioner, is that -- does 7 that -- I mean I think -- Marty, I was going to call 8 you Marty. You said something about how you had 9 been saying all along that it wasn't done on an 10 actual basis and you were calling whoever you could 11 call or write? 12 MR. DAKESSIAN: Yes. 13 MS. STOWERS: When did you start that 14 process; was it in '09? 15 MR. DAKESSIAN: We weren't -- we weren't 16 involved in the initial decision and recommendation. 17 We came in shortly after it was issued. 18 And in our response, when we requested 19 reconsideration, we made the point that it wasn't 20 done on an actual basis. How could it? The records 21 were lost for that quarter. 22 So what are we -- what are we talking 23 about? We have a sales history report, yes. That 24 shows contracts. It shows invoice numbers and 25 invoice amounts, but it doesn't show actual 26 invoices. We did the best we could and provided 27 what we could. 28 And -- and for the Department now, I think 65 1 the call of the question was, why change now? You 2 know, and I didn't hear a satisfactory answer to 3 that. I mean, is there -- was there any other 4 portion of that that you'd like to -- 5 MS. STOWERS: No. I -- I -- I'm good. I 6 just wanted to get an understanding on why the 7 change. 8 And then just finally, back to the 9 Department, I want to make sure I understood when we 10 were just having the conversation with Ms. Ma about 11 sometimes the Department will take a look at the 12 federal income tax returns and use those returns to 13 look at the cost of goods sold, look at reported 14 sales. And a concern was raised, well, if the tax 15 returns are on a cash basis but taxpayers are 16 required to report their sales tax on accrual basis, 17 I missed something here on how do you reconcile 18 that? Do you look at the prior year or the 19 subsequent year? Do you -- what happens? 20 MR. LAMBERT: Well, if that in fact is the 21 case -- and most of the time we find that it isn't 22 the case. Most of these taxpayers are reporting on 23 the accrual method. In other words, the sales 24 reported to us and the sales reported to the -- for 25 income tax return, match up. 26 If they don't -- if there is a difference 27 between cash and accrual, that has to be accounted 28 for. And how you would account for it is by taking 66 1 the accounts receivable and the beginning and 2 ending, and you would have to adjust for it. I mean 3 that -- that -- that's the only way that you would 4 be able to do that. And that's how we would do it 5 if that in fact is the case. 6 Now, a lot of times what -- what we're 7 doing -- you know, the audits that we're doing, or 8 at least the ones that are before you for our, you 9 know, stores that don't necessarily have an accrual 10 basis, it's like, you know, gas stations, liquor 11 stores, those type of those that they don't. 12 But -- but there's no question if the 13 taxpayer's reporting their income tax returns on a 14 cash basis, there's an issue there as far as a 15 difference between the two because they're not 16 necessarily going to be the same if -- well, they 17 won't be the same if there's a difference in the 18 accrual account. And that's on a case-by-case basis 19 that we would take into consideration. 20 MS. STOWERS: Okay. No questions for me 21 anymore. 22 MR. HORTON: Thank you. 23 Wow. In the -- in the period where the 24 statistical sample was taken, did the Department 25 adjust for bad debts? 26 MR. LAMBERT: Bad debts? I'm not -- I'm 27 not certain. I'm not sure. I'm not sure if they 28 were or not. 67 1 MR. HORTON: Okay. The Department 2 indicated that if they were to adjust from accrual 3 to a cash basis correctly -- I mean, not correctly 4 but most appropriately, they would have to adjust 5 for beginning and ending accounts receivables. Did 6 they do that? 7 MR. LAMBERT: The ending in effect was -- 8 because of the length of the time that they were put 9 on the accrual basis, it would have effectively 10 taken care of that. 11 As far as the beginning period, my 12 testimony's been that it was not adjusted and that 13 that was to the taxpayer's benefit. 14 MR. HORTON: You believe because -- the 15 only -- you believe because you tested a 12-month -- 16 I mean, a three-year period, minus a quarter, that 17 adjusts for ending receivables? 18 MR. LAMBERT: Well, I would -- two points. 19 One, that -- 20 MR. HORTON: Before you answer, let me -- 21 let me encourage you to think about how the 22 Department suggests the treatment of 23 beginning/ending inventory which has similar 24 relationship. 25 Now you can answer. 26 MR. LAMBERT: Okay. They -- they reported 27 on the cash basis. They -- for the entire audit 28 period. They continued reporting on the cash basis 68 1 until halfway or so through the subsequent audit. 2 So by putting them on the accrual basis, you're only 3 including sales that took place as of July 1st, 2002 4 through March 31st of '05. 5 So I would, based on that, come to the 6 conclusion that there were no accounts receivable 7 during that period because you've only included -- 8 or if there are, it doesn't -- it would not matter 9 because you've included sales on a accrual basis 10 and -- and anything that was in the accounts 11 receivable at that point would have already been 12 included in the audit. 13 In the subsequent period, they were given 14 credit for those payments that were made subsequent 15 to that and the accounts receivable was taken into 16 account in the subsequent audit when they were given 17 the refund. So -- 18 MR. HORTON: Herein -- herein is the 19 challenge that I believe we somewhat face here, is 20 is that whenever you're estimating, it can fluctuate 21 from one end of the -- the plus or minus to the 22 other. And when you are stratifying, one of the 23 requirements is you have to partition out those 24 stratas; and so you have to say that the 25 relationship in the period that you've stratified 26 out has no relationship to the subsequent periods. 27 So you could have done the audit on an 28 actual basis in the second quarter. But if you 69 1 looked at, let's say, the fourth quarter of '04 and 2 did it on an actual basis, you may find very well 3 that they over reported because you only applied an 4 estimate to that period of time as opposed to 5 looking at it on an actual basis. 6 So if you can't exhaustively exclude those 7 two quarters or the previous periods as well, then 8 it becomes inherently difficult to get to the right 9 point at the right time. 10 I fundamentally believe that the auditor 11 got it right. The question is, did he get it right 12 at the right time? And therein is the concern. 13 Should it be 52 percent, to project the 52 14 percent of error, which the Department did, or 15 should it be one of the lower percentages in the 16 second quarter of '04, somewhere around 32 percent? 17 Or should it be the number that the -- that the -- 18 that the taxpayer is presenting to us? 19 Any one of those numbers are correct at any 20 given time in this period in question if we look at 21 the period prior to the audit and the period 22 subsequent to the audit, which is the inherent 23 challenge. 24 And from my observation, I think over a few 25 years here, the courts have consistently ruled when 26 you have these estimates that swing from one end to 27 another, it is so, so difficult. And it's so 28 difficult to rule against one estimate over the 70 1 other because of that. 2 So therein is the challenge that's before 3 us. But I think we'll end up somewhere, at the end 4 of the day. 5 MS. HARKEY: It is the end of the day. 6 MR. HORTON: Yeah. Without -- 7 Further discussion, Members? 8 Hearing none, is there a motion? 9 MS. HARKEY: Take it under submission. 10 MR. HORTON: Member Harkey moves to take 11 the matter under submission. 12 MS. STOWERS: Second. 13 MR. HORTON: Or -- 14 MS. MA: Vote. 15 MS. HARKEY: I'd rather vote. 16 MR. HORTON: We're at the end of the day. 17 Let's do it. 18 MR. RUNNER: Yeah, this is the end of the 19 day. 20 MR. HORTON: Okay. Member -- 21 MS. HARKEY: I'll make -- I'll make a 22 motion. 23 MR. HORTON: Member -- 24 MS. HARKEY: I move to reduce the 25 disallowed claim nontaxable sales to 69,241 for the 26 second Q of '02, using the overall error ratio of 27 1.67 established in the statistical sample, for the 28 period July 1, 2002 through March 31st, 2005. 71 1 Otherwise, I move to adopt staff 2 recommendation. 3 MS. MA: What? 4 MS. HARKEY: I'm -- I'm using -- what I 5 want to do, I'm moving to use the 1.67 error ratio 6 for 2Q, which is the -- which is what -- 7 MS. MA: What they've been using. 8 MS. HARKEY: What they've been using for 9 the whole 11 quarters, I want to use it for the one 10 quarter of '02 that was missing. 11 MS. MA: Okay. I'll second that. 12 MR. HORTON: Just another number. 13 So there's a motion and a second. 14 Objection, Members? 15 MS. STOWERS: Just let me think about this 16 for a second. 17 So that gives us the error ratio. The 18 error ratio was computed based on the 11 quarters 19 where they had the electronic records. And that's 20 on the -- what they call the exempt sales. 21 MR. HORTON: Well, the -- the Department 22 really didn't use the error ratio. They actually 23 used a percentage of taxable sales. They came up 24 with a 52 percent taxable sales. 25 So the period in -- the period under 26 question is where the parties concurred on the -- on 27 the period in question, which is -- 28 We may be closer to just ruling in favor of 72 1 the -- of the taxpayer. Because if we say we used 2 the calculation, we're going to use the calculation 3 of the Department, that's not what the Department 4 used or what the Department, then the taxpayer, 5 concur to. 6 MS. HARKEY: No, I just wanted to -- 7 MR. HORTON: But here's -- here's the -- 8 we're just $5,000 different. I mean these -- these 9 numbers are -- I believe the taxpayer's projecting 10 somewhere around 74,000 based on their calculations 11 and tests. 12 The 1 point -- to apply the 1.6 percent, we 13 come around 64,000. 14 MS. HARKEY: 69. 15 MR. HORTON: And the Department is 16 projecting a 52-point-some percentage of taxable 17 sales ratio, which gets them to the number. So -- 18 MS. HARKEY: I'm just proposing to use the 19 Audit Manual. Can I make that simpler? To use -- 20 MS. STOWERS: I think I -- I think I 21 understand what you're saying, but I was just trying 22 to go back on the arguments, and I just thought that 23 using that error ratio is not picking up at least 24 those two contracts that we'll discuss, the LA 25 contract and the other one. And I thought the 26 testimony was that those contracts were clearly 27 taxable. 28 So I'm just thinking that to apply that 73 1 ratio, contracts that should be taxable are not 2 going to be taxed. 3 MS. HARKEY: I -- I don't -- I don't think 4 that's -- 5 I think the problem, Ms. Stowers, that we 6 have is that we've got one stray month that's 7 totally different procedure from 11 -- or one 8 straight quarter from 11 quarters. And if in fact 9 we follow the Audit Manual, we would use the 11 10 quarters and extrapolate. 11 Now, the reason that that wasn't done, 12 we've heard for the last two hours, but I believe 13 the reason it wasn't done is because we thought we 14 were using actual -- actual data. And then it was 15 determined that, no, we actually weren't using 16 actual data. 17 So I have to go back to the Audit Manual 18 that says that you use the sampling that you have 19 and you apply it to the missing quarter. 20 MS. STOWERS: Okay. I understand the 21 motion. 22 I object. 23 MR. HORTON: Well, let me -- let me -- let 24 me just add something here. 25 To -- when you're -- when you're testing on 26 a statistical basis, you -- they didn't test 27 statistically the entire 11 quarters. There was a 28 test conducted and that test that was conducted was 74 1 then applied to the -- to the -- to the remaining 2 periods of times, to cover the 11 quarters. 3 So statistically, we don't know whether or 4 not the number can swing from one end of the 5 pendulum to the other. We don't know. And so even 6 though they looked at the numbers on somewhat of an 7 actual basis in the second quarter, we don't know 8 whether or not, if they looked at a subsequent 9 quarter that wasn't part of the test period, if the 10 average would have gone down, would have gone up. 11 In fact, it could have very well ended up being a 12 credit in subsequent periods. And particularly, 13 because of the conversion from cash to accrual, 14 which is -- which is just inherently challenging for 15 the Department and for the courts and anyone else 16 that has to take a look at this. 17 So, and the other issue before us is 18 that -- so that the fact that the contracts in the 19 second quarter, they may very well should have been 20 reported in the second quarter. But you may find in 21 other quarters that there are contracts that didn't 22 get reported because the statistical sample didn't 23 reflect it. 24 And as I sort of attempted, just on a 25 methodology perspective, take a look at when you're 26 converting the accrual basis, the evidence or the 27 reported amount, they reported somewhere around 28 $11 million in previous quarters, those quarters 75 1 being the third quarter of 2001, outside of the 2 audit period arguably, and the fourth quarter of 3 2001 combined is $11 million. 4 So even though it may not be the 5 Tutor-Saliba contract, it may not be the other 6 contract, when we're looking at whether or not the 7 method is correct, the statistical sampling, the 8 method of projection is correct, that tells us that 9 you could have had contracts in those periods that 10 in fact took place in the first quarter of 2000 but 11 didn't get reported until the second quarter of 2000 12 and -- and -- and vice versa. 13 And so that creates an inherent challenge 14 to the Department's argument as it relates to those 15 have to be reported. They don't. That's why you do 16 testing, to project and to average out what the 17 error may have been. 18 So -- and so the motions are -- 19 MR. RUNNER: I got a question. 20 MR. HORTON: A motion and ruling -- 21 MR. RUNNER: Question. 22 MR. HORTON: -- in favor of the taxpayer is 23 not -- is, you know -- would be equally as 24 appropriate. And so when we have a situation like 25 that, we have a tendency to go to what's reflective 26 of the average over the period. 27 Mr. Runner. 28 MR. RUNNER: Just a quick question in 76 1 regards to just to clarify what -- what -- I believe 2 what the taxpayer's started with. 3 MR. HORTON: Wait a minute. Strike that, 4 Mr. Runner. My apologies. 5 We -- we're now in a different part of the 6 hearing. If we want to reopen the hearing, we had a 7 motion -- 8 MR. RUNNER: Oh. 9 MR. HORTON: -- and a second. 10 MR. RUNNER: Motion and second, okay. 11 MR. HORTON: Voted on it. 12 MR. RUNNER: Let me go to Appeals. 13 MR. HORTON: But if you want to ask 14 Appeals. 15 MR. RUNNER: I'll go to Appeals. 16 MR. HORTON: Okay. 17 MR. RUNNER: I'll go to Appeals. 18 I think I heard the taxpayer in the 19 beginning talk about what they believed was the -- 20 was the -- what they believed was the agreed 21 liability? 22 MR. ANGEJA: Yeah, I don't recall that 23 number off the top of my head. 24 MS. HARKEY: It was 70,000. My 25 recommendation is 69241, using the -- 26 MS. BURKE: The taxpayers agreed -- 27 MR. HORTON: They'll come up with it. 28 MS. BURKE: They agreed to $74,095 for that 77 1 second quarter 2002. 2 MR. RUNNER: Okay. And -- and, again, 3 so -- so we have an idea which is a method of 4 calculating which creates the liability at what 5 amount? 6 MS. HARKEY: At roughly -- roughly 70,000, 7 69241. I'm following the Audit Manual. 8 MR. RUNNER: Okay. 9 Let me -- let me -- 10 MS. HARKEY: What's -- 11 MR. RUNNER: I guess I'm -- I'm trying 12 to -- I'm trying to figure out whether or not it's 13 easier to come up and substitute a method, a new 14 method, versus just finding for the taxpayer. 15 MS. HARKEY: Okay. I'll withdraw my motion 16 and I'll -- will you withdraw your second, Fiona -- 17 I mean Ms. Ma? 18 MS. MA: Yes. 19 MS. HARKEY: Okay. 20 MR. HORTON: I accept that as a -- 21 MS. HARKEY: As a motion for the -- for 22 the -- 23 MR. HORTON: -- motion from Mr. Runner, 24 second by Member Ma. 25 MS. HARKEY: Done. 26 MR. HORTON: Without objection, Members, 27 such will be the order. 28 MS. MA: Do you guys know what happened? 78 1 MR. HORTON: Well, they're theoretically 2 not here, so -- 3 ---oOo--- 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 79 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, JULI PRICE JACKSON, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on JUNE 24, 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 59 constitute 14 a complete and accurate transcription of the 15 shorthand writing. 16 17 Dated: September 8, 2015 18 19 20 ____________________________ 21 JULI PRICE JACKSON 22 Hearing Reporter 23 24 25 26 27 28 80 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 June 24, 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 60 through 79 14 constitute a complete and accurate transcription of 15 the shorthand writing. 16 17 Dated: September 9, 2015 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL, CSR #9039 22 Hearing Reporter 23 24 25 26 27 28 81