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 APRIL 26, 2016 10 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 11 APPEAL OF 12 BRIAN N. KHOURY, 867810 13 JASON B. KHOURY and LISA B. KHOURY, 867855 14 NOELLE K. LUDWIG and TIMOTHY S. LUDWIG, 867874 15 16 AGAINST PROPOSED ASSESSMENT OF 17 ADDITIONAL INCOME TAX 18 19 20 21 22 23 24 25 26 27 Reported by: Kathleen Skidgel 28 CSR No. 9039 1 1 P R E S E N T 2 For the Board of Equalization: Fiona Ma, CPA 3 Chairwoman 4 Diane L. Harkey Vice Chair 5 Jerome E. Horton 6 Member 7 Sen. George Runner (Ret.) Member 8 Yvette Stowers 9 Appearing for Betty T Yee, State Controller 10 (per Government Code Section 7.9) 11 Joann Richmond 12 Chief Board Proceedings 13 Division 14 For Board of Equalization Staff: Grant Thompson 15 Tax Counsel IV Legal Department 16 For Franchise Tax 17 Board: Roman Johnston Tax Counsel 18 Michael Cornez 19 Tax Counsel 20 For Appellant: Michael C. Hamersley Attorney 21 Tawfiq Khoury 22 Witness 23 Ken Van Damme II Witness 24 25 ---oOo--- 26 27 28 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 APRIL 26, 2016 4 ---oOo--- 5 MS. MA: Good afternoon. The meeting of 6 the Board of Equalization is hereby reconvened. 7 Ms. Richmond, please introduce the next 8 item. 9 MS. RICHMOND: Our next item on this 10 afternoon's agenda is Item B5a Brian N. Khoury, B5b 11 Jason B. Khoury and Lisa B. Khoury, and B5c Noelle 12 K. Ludwig and Timothy S. Ludwig. 13 Please come forward. I see they're here 14 already. 15 MS. MA: Okay. Mr. Thompson, please 16 introduce the issues in this case. 17 MR. THOMPSON: Yes, good afternoon. There 18 are several issues in this case as indicated in the 19 Hearing Summary. 20 MS. MA: Can we -- can we close the door 21 back here? 22 MR. HORTON: I'll get it. 23 MS. MA: I'm sorry. 24 MR. HORTON: Oh, okay. Thank you. 25 MR. THOMPSON: They're summarized in 26 appellants' chart here. But there's a threshold 27 issue of whether appellants' consents to extend the 28 statute of limitations are valid; 3 1 And then there's the issue of whether 2 appellants' transactions should be disallowed under 3 the Economic Substance Doctrine or under other 4 judicial doctrines, such as the Roberts and Rushing 5 analysis; 6 Whether IRC section 453(e) applies to 7 disallow appellants' transaction; 8 Whether the partnership anti-abuse 9 regulations apply to disallow appellants' 10 transaction; 11 Whether penalties are applicable or should 12 be abated; 13 And whether interest suspension applies. 14 MS. MA: Okay. Seven items. Okay, thank 15 you. 16 To the appellant, welcome to the Board of 17 Equalization. You will have ten minutes to make 18 your initial presentation, and then you will have an 19 additional five minutes on rebuttal. 20 Please introduce yourselves for the 21 record. 22 MR. HAMERSLEY: Good afternoon, Chairwoman 23 Ma, Members of the Board. My name is Michael C. 24 Hamersley. I represent the appellants in this 25 matter. 26 You can -- yeah, you can use that one. 27 I've got one here. 28 Um, thank you for hearing our appeal today. 4 1 Um, to my left, my immediate left, is 2 Tawfiq N. Khoury, the father of the appellants. And 3 to his left is Kenneth Van Damme, the CPA business 4 and tax advisor for the family. I will go ahead and 5 turn it over to them to introduce themselves. 6 MR. KHOURY: My name is Tawfiq Khoury. I 7 am the father of the three appellants. I thank you 8 for the opportunity to the address you. 9 MR. VAN DAMME II: My name's Ken Van Damme. 10 I go by Ken. I am the long-time CPA and advisor to 11 the Khoury family, been working with them for 12 25-plus years. I advised them on this transaction 13 before, during, and after. 14 MS. MA: Okay, great. 15 MR. HAMERSLEY: Okay. So the, uh -- the, 16 uh -- Mr. Thompson had laid out the seven issues in 17 the Hearing Summary. 18 The -- the gist of the analysis is on the 19 transaction and installment sale where NBJ 20 Associates LP, which is owned by the appellants, 21 sold its 48.51 percent limited partnership interests 22 in RSD Group LP to Sundance-K in exchange for 23 $500,000 cash payments, and a $14.26 million 24 installment note, calling for sixty -- $60,000 a 25 month installment payments and principal repayment 26 at the end of the term, the 30-year term. This, uh, 27 installment sale transaction has been referred to in 28 the documents as the RSD interest sale. 5 1 Um, the -- for the past 10 years, the 2 appellants and NBJ have been -- recognized the 3 income on that installment sale under section 453, 4 the installment method, as the income is received 5 and paid in the installment payments. And that 6 income is passed through to its owners, to NBJ's 7 owners, the partners, the appellants. 8 Now, I've, uh -- I, um -- to assist the 9 Board in its review of this matter, I would refer 10 you to the six slides that were distributed by Board 11 staff last week that should start off with a slide 12 that looks like this (indicating). That, uh -- I 13 think that'll be helpful in following some of the 14 transactional descriptions. 15 So the first slide is that ownership slide 16 which I've also reproduced in the large chart that's 17 up here in the front, to my left. And the -- the 18 red -- there's a legend on the lower left. The red 19 are the, uh, the estate planning and the parents' 20 businesses. The right, in the blue, are the 21 appellants. 22 The second slide is the RSD real estate 23 sale. So this gives you an idea what was -- what 24 were the circumstances that existed when the 25 appellants' parents and appellants, decided to 26 consummate the RSD -- the RSD interest sale. 27 Well, pending was a February 7th closing of 28 real estate owned by RSD -- which we refer to as the 6 1 RSD real estate sale -- which net proceeds of 2 approximately 30 -- a little over $30 million were 3 about to flow into RSD. And if nothing was done, 4 approximately 15 million, 48.51 percent, would have 5 been distributed to NBJ, owned by the appellants. 6 So the parents had grave concerns about 7 that exodus of cash out of the family business; and 8 Mr. Khoury and Mrs. Khoury can speak to that today. 9 We've also provided a total of eight declarations 10 and affidavits that speak to those events and the 11 concerns as well. 12 But, essentially, it boils down to the 13 vital cash resources of the family business and 14 jeopardizing the parents' legacy and estate planning 15 for their grandchildren if, as Mr. Khoury puts it, 16 you can see the view on what the money was going to 17 be spent on and not available for the business. 18 Slides 4 and 5. Slide 4 illustrates the 19 exchange that took place in the installment sale. 20 And that shows the transfer by NBJ of the 48.51 21 percent interest and the payment by Sundance-K. 22 Um, I should point out that the parents in 23 terms of -- the parents had no tax savings from 24 that -- that sale. 25 Slide 5 illustrates, after the RSD interest 26 sale was consummated, where the money flowed 27 instead. And the money flowed out to Sundance-K, 28 which was invested, and not to the appellants. 7 1 So the RSD interest sale addressed the 2 parents' concerns, to prevent that outflow of a big 3 number on cash. And the appellants have not 4 accessed that cash in the 10 years since that 5 transaction. So it's been effective and it's 6 worked. 7 The, um, respondent disallowed NBJ's 8 installment sale treatment, um, in the November 7th, 9 2012 NPAs; requiring, instead, that the full amount 10 of gain on the income on the sale, that RSD interest 11 sale be recognized in the year of the transaction 12 2006, notwithstanding the fact that we now know in 13 hindsight, 10 years they haven't received the money. 14 And that seems completely incongruent with the 15 installment method and the policy behind section 16 453. 17 Um, the -- the reason for that in a 18 nutshell that's been put forward is that the 19 deferral is, quote, "too good to be true." The FTB 20 asserts that the RSD interest sale was principally 21 motivated by tax avoidance, despite the 22 declarations, despite the family meeting, you know, 23 discussion that resulted in parents convincing 24 appellants to approve and do the transaction. 25 And they say that the appellants retained 26 possession, quote, "possession, control and 27 enjoyment" of the funds. 28 The issues, as I said, on appeal, we see up 8 1 here the focus really -- you know, the red lines on 2 that chart indicate the threshold issue. And then 3 the issues 2, 3 and 4, and primarily 2 and 3, really 4 show where the focus is on the law. The 5, 6 and 7 5 assume that there's an assessment and their issues 6 with the penalties and interest as well. 7 The -- so the focus is really in 2 and 3. 8 The interesting thing is, you know, we -- 9 we've discussed each of the elements for all of the 10 law applicable in 2 and 3 in our briefs, 11 extensively. But when you -- when you cut to the 12 chase, um, if you believed the appellants' non tax 13 purpose for consummating the RSD interest sale, the 14 rest of it falls away. 15 There are other things that would make the 16 assessment not -- not stick, but 453(e)(7) in 17 particular for the statute, and then when you look 18 at Roberts and Rushing, the premises in those case 19 of principal purpose of tax avoidance and other 20 premises would not exist. 21 Um, finally, the -- you know, the first 22 issue, the statute of limitations issue, given the 23 time allotted for the opening statement, I really 24 won't elaborate on that here. I'd be glad to answer 25 any questions that you might have on that. 26 Obviously, the remainder of the appeal 27 issues would be moot if -- if, uh, you found in our 28 favor on that. 9 1 So we ask that you -- you grant appellants' 2 appeal. And I thank you, Chairman Ma and Members. 3 I would be glad to answer any questions that you 4 might have. 5 MS. MA: Okay, thank you. 6 FTB will have ten minutes to make your 7 presentation. Then we will return to the appellant 8 for rebuttal. 9 Please introduce yourselves for the 10 record. 11 MR. JOHNSTON: Good afternoon, Chairwoman 12 Ma and Members of the Board. 13 Excuse me. 14 My name is Roman Johnston, and seated 15 beside me is Michael Cornez; we represent the 16 Franchise Tax Board in this matter. 17 I provided your Board with a chart last 18 week that shows the related entities at issue in 19 this appeal. 20 Appellants were indirect owners of 21 partnership RSD, which had contracted to sell its 22 California apartment building for cash, a 23 transaction which would require appellants to 24 recognize more than $14 million of taxable income. 25 During the one-month time period waiting 26 for the sale to close, appellants engaged in tax 27 planning to avoid having to recognize substantially 28 all of this income. 10 1 To accomplish the avoidance of this taxable 2 income, appellants' partnership NBJ sold its 3 interest in partnership RSD for an installment note 4 due in 30 years to another partnership, Sundance-K. 5 Appellants owned Sundance-K's general 6 partner and were beneficiaries of Sundance-K's 7 limited partner, the Khoury Family Irrevocable 8 Trust. As a result of the installment sale of the 9 partnership RSD interest, followed by a partnership 10 RSD sale of the apartment building, RSD received a 11 step-up in basis in the apartment building that 12 eliminated substantially all of appellants' gain 13 that would have passed to them. Yet, Sundance-K 14 received the gain in cash, which it then loaned out 15 to various entities owned by, and/or controlled by, 16 appellants. 17 Without its apartment building, the 18 partnership RSD had little left to do and began to 19 wind down its operations. 20 In 2008, partnership RSD completed its 21 formal dissolution. For the reasons I will discuss, 22 the transaction lacked economic substance and, thus, 23 the FTB properly characterized the transaction as an 24 abusive tax avoidance transaction. The FTB properly 25 assessed additional tax and imposed the noneconomic 26 substance transaction, known as the NEST penalty, 27 and the interest base penalty. 28 Appellants argue that their one-month 11 1 waiver of the statute -- statute of limitations is 2 not valid. The four-year statute of limitations was 3 set to expire on October 15th, 2011. 4 In 2011, appellants were considering VCI-2, 5 signed a one-year waiver extending the statute of 6 limitations to October 15th, 2012 and also stated 7 that they would provide an additional statute of 8 limitations waiver in the future. 9 When respondent's auditor requested a 10 four-month waiver in 2012, appellants declined and 11 offered a -- offered to provide a one-month waiver 12 if several conditions were met. 13 Respondent does not accept waivers with 14 conditions. After some back-and-forth with 15 respondent's auditors, appellants agreed to provide 16 an unconditional one-month waiver of the statute of 17 limitations. Respondent did not fraudulently induce 18 appellants to sign a waiver. 19 Appellants have failed to demonstrate that 20 NBJ's sale of the RSD partnership interests 21 possessed sufficient economic substance and business 22 purpose to be respected for tax purposes. 23 RSD had owned the apartment buildings since 24 1987 and engaged in a valid transaction to sell it 25 to a third party, which would result in taxable 26 income passing to appellants. 27 One month before the sale closed, 28 appellants inserted a hollow step for sale of the 12 1 RSD interest to substantially reduce appellants' 2 taxable income while appellants retained control of 3 the cash. It is this sale of the RSD interest that 4 lacks economic substance. 5 It is important to analyze Sundance-K's 6 role in this transaction when evaluating economic 7 substance. Appellants did not intend for Sundance-K 8 to become part of an ongoing partnership as RSD was 9 already in contract to sell its apartment building. 10 Instead, appellants expected RSD to distribute more 11 than $14 million to Sundance-K from the sales 12 proceeds that appellants could then cause Sundance-K 13 to loan to entities controlled and/or owned by 14 appellants. 15 The transaction lacked economic substance 16 because Sundance-K simply popped in, eliminated 17 significant gain -- excuse me -- for appellants and 18 then popped out, with no further liability for RSD 19 because Sundance-K was a limited partner. 20 The interest payments from Sundance-K to 21 NBJ do not imbue the transaction's economic 22 substance. In fact, the offsetting tax treatment of 23 the interest payments from Sundance-K to NBJ 24 demonstrate how the installment sale lacks economic 25 substance. 26 NBJ and appellants recognize the five 27 percent interest NBJ received from Sundance-K. 28 Sundance-K deducted the five percent interest 13 1 against other incomes and interest expense. This 2 would benefit appellants, appellants' corporation, 3 and appellants' family's irrevocable trust because 4 Sundance-K's taxable income would be reduced. 5 Furthermore, Sundance-K was given more than 6 $14 million cash from RSD. Sundance-K loaned the 7 cash to entities related to, controlled by, and/or 8 owned by appellants at 10 percent interest. These 9 entities deducted, capitalized, or carried the 10 interest expense forward for use in a future tax 11 year. This also benefited appellants. Thus, while 12 appellants recognized taxable income, they also were 13 able to offset it from the tax benefits. 14 Appellants have not demonstrated the 15 transaction possessed a valid business purpose. One 16 might expect to hear that Sundance-K and its 17 partners wanted to invest in a real estate limited 18 partnership because they believed the real estate 19 market was a good investment opportunity. But here, 20 in 2005, appellants believed the real estate market 21 was at a peak and it was a good time for RSD to sell 22 the apartment building. 23 Sundance-K's purchase of the limited 24 partnership interest in this partnership was at odds 25 with appellants' reasons for instructing RSD to sell 26 its apartment building. When respondent asked for 27 the business purpose of this transaction, appellants 28 stated that there are concerns that one of the 14 1 siblings may squander the cash from RSD's sale of 2 the apartment building. 3 Concerns about a partner squandering of a 4 potential distribution do not constitute a business 5 purpose for an entity's sale or purchase of a 6 partnership interest. 7 In analysis of this purpose, respondent 8 learned that the cash from RSD's sale of its 9 apartment building was distributed to Sundance-K and 10 ultimately loaned to entities related to, controlled 11 by, and/or owned by appellants. 12 Appellants own 100 percent of Sundance-K's 13 general partner, which would make Sundance-K's 14 decisions. These facts are not consistent with 15 engaging in the transaction due to the concerns 16 about squandering the proceeds. 17 Appellants later asserted that Sundance-K 18 wanted to get involved in interest rate arbitrage by 19 borrowing at five percent and loaning at 10 percent. 20 It does not make sense to purchase a limited 21 partnership interest which is illiquid and not 22 easily marketable to engage in interest rate 23 arbitrage. Sundance-K also did not act like an 24 arbiter when it agreed to reduce the interest 25 currently receivable to five and a half percent and 26 accrue the remaining four and a half percent 27 interest for the life of the loan. 28 It also became apparent that if appellants 15 1 designed the installment sale to satisfy concerns 2 about squandering the proceeds and to devise 3 strategies for interest rate arbitrage, then 4 appellants did not design the transaction for 5 Sundance-K to actually take on an ongoing role as a 6 limited partner. These purposes highlight that the 7 installment sale should not be respected for tax 8 purposes. 9 As an alternative argument, the installment 10 sale is taxable to appellants under the related 11 party exception to the installment sale treatment. 12 A seller of an asset on installment basis to a 13 related person must recognize gain if the related 14 person disposes of the asset within two years. 15 NBJ and Sundance-K were related parties. 16 There was a second disposition of the RSD interest 17 in 2006 when Sundance-K received its only 18 distributions from RSD, totaling more than 19 $14.8 million. 20 The installment sale also violated the 21 partnership anti-abuse rules. Neither Congress nor 22 the IRS intend taxpayers to utilize the partnership 23 form to improperly defer or eliminate taxable 24 income. The anti-abuse rules apply when the 25 principal purpose of the use of the partnership is 26 to substantially reduce the present value of the 27 partner's aggregate federal tax liability in a 28 manner that is inconsistent with the intent of 16 1 Subchapter K. The tax agency can reallocate the 2 partnership's item of income appropriately. 3 NBJ engaged in this transaction with 4 Sundance-K to improperly obtain a stepped up basis 5 under the partnership laws. RSD was not directly 6 involved in this transaction. The outstanding issue 7 is whether the anti-abuse rules are restricted to 8 transactions between a partner and a partnership. 9 The answer is clearly no. 10 Example 7 in the regulations illustrate how 11 the anti-abuse rules are applicable, even in the 12 absence of a transaction between a partner and a 13 partnership. California law provides a 40 percent 14 penalty for an understatement due to a noneconomic 15 substance transaction. 16 As explained earlier, this transaction 17 lacked economic substance and it caused an 18 understatement. Thus, respondent properly imposed a 19 NEST penalty. 20 Because appellants and NBJ did not properly 21 disclose the transaction, the penalty is not reduced 22 to 20 percent. Although the filing of tax forms 23 alone is generally not sufficient for adequate 24 disclosure because the tax forms do not disclose all 25 of the elements and facts, NBJ incorrectly 26 represented that the installment sale was not to a 27 related person and that the source of the gain from 28 the installment sale was non California source and 17 1 non business income. 2 The interest-based penalty applies because 3 there was a deficiency that is subject to the NEST 4 penalty and respondent contacted RSD and appellants 5 regarding the transaction multiple times during the 6 audit. Appellants are not entitled to interest 7 suspension pursuant to California law. Interest 8 suspension does not apply to interest related to any 9 tax -- abusive tax avoidance transaction. 10 Thank you for your time this afternoon. I 11 am available to answer questions after appellants' 12 rebuttal. 13 MS. MA: Okay. 14 Mr. Hamersley, five minutes. 15 MR. HAMERSLEY: Okay. I'm not sure I can 16 do it in five minutes, but I will give it a shot. 17 That's a lot of -- lot of mud. 18 First, inherent in that with respect to the 19 facts and the law, appellants were not the ones who 20 came up with the idea. That's implicit in the 21 analysis there. Their parents were, and the 22 declarations and testimony will show that. 23 Second, a large portion of the position 24 appears to be related to the abandoned BOB position 25 in AIPS 1 that, regarding RSD's gain and its 26 stepped-up basis under section 754 and 743(b), 27 that's not on the NPA. It's a different item of 28 income for a different entity. I don't know how you 18 1 could affirm an NPA for if NBJ's item of income on 2 the installment sale based on RSD's failure to 3 properly report, if it were true, the property gain. 4 That's inherently problematic. 5 Um, hollow step, the Rushing and Roberts, 6 or the case law that looks at whether that step was 7 in fact hollow, the RSD interest purpose, and it 8 clear -- interest sale and it clearly was not. 9 On the -- on the fact that if the Economic 10 Substance Doctrine were applicable -- and I'll 11 explain as we did in our briefs why if you applied 12 it, it cannot produce the result in the NPA either. 13 That's presumably why they're looking to a different 14 item of income because it could produce that item of 15 income if that were on the NPA and there was a lack 16 of economic substance. 17 We spoke to that in both our -- in audit 18 and in protest and in our briefs regarding the 19 transaction had both objective and subjective 20 economic substance, the two prongs, that that 21 being -- the subjective prong of economic substance 22 is, Did it have a non tax purpose? We spoke to 23 that. 24 The objective prong of Economic Substance 25 Doctrine is, Did it meaningful alter the economic 26 position of the parties? The Roberts Doctrine gets 27 into that as well. It clearly did. There's no 28 question that Sundance-K obtained the benefits and 19 1 burdens of ownership, of purchasing that 48.51 2 percent limited partnership interest. How else 3 would they have been able to receive the 4 distribution of the proceeds instead of -- instead 5 of NBJ? 6 Uh, the transaction clearly meaningfully 7 altered the economic position of all the parties. 8 The appellants were receiving $20,000 a month 9 instead of $15 million lump sum. That's a 10 difference. 11 Um, 453(e), it seems like there was a prong 12 left out. There was the discussion of the related 13 party. There's three prongs to it, related party -- 14 it's up on the chart -- related person. Second 15 disposition. And then the principal purpose 16 exception if it's not tax avoidance; that's what we 17 said. The other two prongs you don't get to. 18 The first one, it's arguable the 19 appellant -- the respondent's position seems to be 20 that if you're even one percent related, under 21 section 318(a), which is the -- the rule that's used 22 by reference, that that's enough. We don't agree. 23 We don't agree that that's consistent with the 24 legislative history or the rule. 25 They argue that there's an indirect second 26 disposition. I didn't hear it there, but under the 27 case Shelton, which was a corporate liquidation. 28 And there was an actual and direct exchange in 20 1 Shelton that we do not have here. It is -- and 2 they're arguing that, in effect, you had the same 3 thing. 4 The legislative history, they had the words 5 "directly" or "indirectly" in the legislative 6 history and they were removed. It would be enough 7 to say that Congress knew how to use those terms and 8 didn't, but it was actually in the prior bill and 9 removed. 10 That's my rebuttal. 11 MS. MA: Okay, Members? Who would like to 12 start? 13 Ms. Harkey. 14 MS. HARKEY: I'll go first, only because 15 I -- I reserve the right to come back. 16 I just want to get this rolling 'cause 17 there's a lot going on here. And I find, uh, 18 there's two issues that I wanted further explored. 19 All of the other stuff -- I am not an attorney, so 20 reciting all of this does only so much good to me. 21 I kind of look to, What are we really 22 talking about here? And when I looked at all of 23 these charts and all of these graphs and read 24 through all of the analysis and read through all of 25 the -- the different parts of the law and I -- I 26 finally came down to, okay, there's two issues for 27 me. 28 One is, Why would NBJ agree to it? Because 21 1 that's really what we're talking about here. NBJ 2 agreed to an installment sale instead of taking 3 14 million now, because they admitted they couldn't 4 handle money? 5 So what I want to know is why did they do 6 that? And I will ask the appellants. 7 MR. HAMERSLEY: Okay, and I will briefly 8 speak. And I think, you know, the appellants' 9 parent is in a position to answer that. 10 That's discussed in the -- in the, um -- 11 the -- 12 MS. HARKEY: Right. I just want to hear it 13 out loud. 14 MR. HAMERSLEY: Yeah. 15 MS. HARKEY: I want to hear more than just 16 well, you know, we thought -- we thought, um -- the 17 dad thought that it was a problem. 18 MR. HAMERSLEY: Right. 19 MS. HARKEY: I mean what -- what -- these 20 were separate individuals that each owned 33 21 percent, or separate units, each owned 33.3 percent. 22 Why did they agree to that? 23 MR. HAMERSLEY: Yeah. I'll briefly speak 24 and please feel free to -- 25 MS. HARKEY: Sure. 26 MR. HAMERSLEY: -- correct me where I get 27 any of the facts not completely accurate. 28 Um, the -- you know, their -- their parents 22 1 started the business. And so, you'll see in the 2 chart that the business was passed over. Mr. Khoury 3 and Mrs. Khoury are, you know, not as young as they 4 once were. 5 MS. HARKEY: Let -- let me just help you 6 here. 7 MR. HAMERSLEY: Yeah. 8 MS. HARKEY: RSD, the sale of RSD was an 9 apartment complex or more than that? 10 MR. HAMERSLEY: Apartment complex. 11 MR. KHOURY: Apartment complex. 12 MS. HARKEY: Mr. Khoury, yeah, you may 13 answer. It's an apartment complex. 14 MR. KHOURY: Yes. 15 MS. HARKEY: Did you have to sell that 16 apartment complex or did you just want to sell it 17 because the market was good? 18 MR. KHOURY: We wanted to because in my 19 many years of the business I learned to go by my gut 20 feel for the ups and downs. 21 In 2005/2006, the market was super heated. 22 And as hindsight tells us in 2008, or seven even, I 23 proved to be right. The market crashed big time and 24 many people lost everything they had and more. 25 So the decision was made because it was 26 prudent to sell at that time at the height of the 27 market, in my opinion. 28 MS. HARKEY: Okay. And tell me what 23 1 leverage did you have over the children such that 2 they would agree not to take the money now? 3 MR. KHOURY: How much time do you have? 4 MS. HARKEY: As much time as you want. You 5 are not on five minutes here. You can tell me one, 6 two, three issues that -- that, you know, convinced 7 them that this was in their best interest. 8 MR. KHOURY: I'll make it brief. 9 I have to start out at the beginning. I 10 came to the United States in 1950 as an immigrant, 11 penniless. I worked at Buick Motor Factory for two 12 years as a drilling machine operator. 13 I went to the University of Michigan and 14 worked two full-time jobs while going to school 15 full-time; I was a janitor in the hospital and I was 16 a dishwasher at a restaurant. 17 I've moved on. I got a series of jobs, and 18 I met my wife who came from the Philippines. She 19 was born to a family that had literally dirt floors 20 in a small village. Her father became the hero of 21 the Philippine resistance to the Japanese invasion. 22 There are statues for him all over there. He 23 sacrificed everything to make her a doctor. She 24 came to the U.S. to specialize. 25 We met in 1966. We married 50 years ago. 26 Together, we decided to move to California because 27 we did not like Chicago, weather and everything 28 else. 24 1 MS. HARKEY: I agree. 2 MR. KHOURY: In 1971 I was 41 years old. 3 We started a small company called Pacific Scene with 4 a thousand dollars in savings and $4,000 borrowed 5 from friends and relatives. 6 We worked hard. We survived some major 7 crashes in the real estate market, which, as all of 8 you know, has its ups and downs. 9 1974, we barely hung on. 1982, when 10 interest rates hit 22 percent, we barely survived. 11 We did. 12 1984, I was selected National Builder of 13 the Year. We went on to build and sell over 20,000 14 homes, employed thousands of people, built many 15 apartments, shopping centers, industrial parks, 16 office buildings. 17 And in 1989, we decided another crash was 18 coming and we stopped, just in time for the savings 19 and loan to collapse. Some people called me a 20 genius, I said I was lucky. I'd rather be lucky 21 than smart any day. 22 In 2005, we felt the market was frothy. 23 This apartment complex was a major holding for our 24 family, and so we thought it was time to sell it. 25 We told our kids that and they agreed. 26 Throughout the years, although they owned 27 business, my wife and I, together with many 28 excellent professionals whom we have trained, people 25 1 who are now major offices in most of the successful 2 companies in the country, we trained them, everybody 3 wanted them. They stayed with us as long as we were 4 active. 5 Came the sale, and I had three reasons, my 6 wife and I had three reasons for the transaction 7 that we implemented: 8 One, our kids at that time were not 9 competent with money. I can go into painful details 10 if you wish, and I will answer them. The two boys 11 were finishing with divorces. Spending habits were 12 dangerous. Gambling habits were dangerous. Our 13 youngest daughter had married a person and together 14 they wanted to start all kinds of businesses and we 15 were not sure about his abilities. Reason one; 16 Reason two, we could see the market going 17 down and we could see that there were personal 18 guarantees and liabilities that the various 19 companies and businesses had which needed cash 20 available if they are going to survive, let alone 21 possibly invest in opportunities and prosper their 22 money; 23 Number three, which to us was very 24 important -- excuse me -- having given you the 25 background where we came from, our families, it was 26 important for us to provide for our grandkids. 27 In 1999, seven years before this 28 transaction, we had set up a trust for our grandkids 26 1 with Wells Fargo as trustee. And I don't know the 2 law either, I'm not an attorney. But I can tell you 3 that the only thing that the money that went into 4 that trust has been used for, for the past 10 years, 5 is exactly the purpose we specified, which is 6 education of the grandkids. 7 Now, we're fortunate that my wife and I 8 have been able to legally pay for their tuition 9 fees. So the only thing that has been spent by that 10 trust in 10 years is for swimming lessons and piano 11 lessons, and minor incidental things of that nature. 12 The invoice goes to Wells Fargo, they issue the 13 payment in accordance with the terms of the trust. 14 Those were the three business reasons and 15 the only three reasons why this transaction was 16 entered into. 17 Why did the kids go along? Well, every 18 year on the date, that anniversary date of my 19 father's death and her father's death the family 20 spent time talking about them. Familial priority, 21 cohesiveness, bonding together, obeying your 22 parents, and more important, listening to them and 23 realizing that you are where you are, you have the 24 benefits you're enjoying, the life you are enjoying 25 was caused by them. And for that bond to break 26 would have consequences that you -- unless you're 27 crazy -- do not want to face. 28 Somebody said, "Well, they could have fired 27 1 the board of directors. We had professionals on the 2 board of directors. We had professionals, CFOs. 3 This was not a mom-and-pop operation that you sneak 4 under the table and create a transaction out of thin 5 air. These were real businesses that they had no 6 way of knowing how to -- how to administer, how to 7 guide, how to govern. It would have been suicide 8 for them to cut ties with us, have all these 9 officers who believed in us leave the jobs. They 10 were very much in demand. They would stay as long 11 as we stayed and not beyond that. 12 So there was a business rationale why they 13 would not do it. But even more important, there was 14 a emotional family rationale which to this day 15 governs. 16 And after the initial anger -- it was a 17 horrible meeting on January 4th. I'll never forget 18 it. Cries, tears. Finally their mother said, 19 "Stop. Do you want to stay with this family or do 20 you want to go?" And that ended it. 21 A few days later they realized it was dumb. 22 What we had advocated, a, their kids have a future, 23 they have money, legally, and, they themselves are 24 getting 20,000 a month for 30 years, solid, 25 wonderful. Now they can go out. Not only live 26 well, but also seek other things, do other things 27 with their lives to create a fortune for themselves. 28 Or if they want to play ukulele on the beach in 28 1 Hawaii, so be it. 2 Their kids are taken care of. Their kids' 3 education is taken care of. That's what matters to 4 us. Without education, I'd still be drilling piston 5 machines in the Buick Motor Factory, except 6 unfortunately that job is gone, and poor Flint, 7 Michigan is no more. They only have lead pipes. 8 I'm sorry I took so long. Thank you. 9 MS. HARKEY: That's okay. That was very 10 informative. It was the best reason I've had out of 11 all of the consultants and people that we've spoken 12 with and my own staff trying to get down to the 13 bottom of what really was at stake here. 14 MR. KHOURY: Ms. Harkey, there's only one 15 version to the truth. No more. 16 MS. HARKEY: That's right. You told it 17 very well, and I'm very, very pleased that you 18 showed up. And I think that it does make sense that 19 the children would decide, which is -- that's the 20 key issue is, NBJ, why did they decide to take an 21 installment sale? Was it just for tax evasion or 22 were there other reasons? And I think you've 23 explained it. 24 MR. KHOURY: They wanted to pay taxes. We 25 have that on the record, ma'am. 26 MS. HARKEY: Okay. I think we've got that. 27 I think I got that finally to my comfort level, that 28 there were other reasons. And that, in fact, you 29 1 know, with them going through divorces and other 2 things, there were probably a lot of reasons to, 3 uh -- to defer this. 4 So, I -- I've got -- I've got one more 5 item. And the next issue for me is -- the next 6 issue for me, if we determine that, that it's not 7 for tax avoidance, a lot of this stuff goes away. 8 So I don't have to get into it. 9 But the other issue that I wanted to bring 10 up, the other point I wanted to bring up is I've got 11 some graphs here that I will share, once again, with 12 everyone. Let me just put these down here. 13 And I think it's really simple. But I went 14 through as to what the tax payments would have 15 been -- you can give one to each -- what the tax 16 payments would have been versus what, um -- what 17 they are. 18 And, as you can see, and I'll share that 19 copy that you've got, Mr. Runner. 20 MR. RUNNER: Oh, go ahead. 21 MS. HARKEY: Okay. As you can see in 22 this -- in this exhibit that I've got here -- and 23 I've just got this for simplicity case. I had 24 one of -- 25 Do you -- yes. 26 Oh, sure. Excuse me. Do we have another 27 copy of this so they can make copies? 28 MR. HORTON: They can have mine. 30 1 MS. STOWERS: They can have Mr. Horton's. 2 MS. HARKEY: Okay. If we can share one, 3 that'd be good. I thought I had 10 and I didn't. I 4 only had six. 5 So -- and I think I've got something else 6 in my book. But I just thought this was really 7 important for me because I wanted to cement in my 8 head what the tax consequences really are. 9 Now, if the -- if the gain on sale was 10 totally realized, the total tax would have been 11 1,495,438. And the detail for that is down below; 12 you'll see it in yellow. That's -- that's really 13 what we're quibbling over here, is this would have 14 been paid upfront upon the sale. 15 The second page shows you that over the 16 course of 10 years, because we've got a 30-year 17 note, over the course of 10 years, roughly a million 18 has been -- has already been paid on the interest 19 payments. And the one four nine five will be paid 20 at the end of 30, so another 20 years. And the 21 total tax to the State will actually be 4,438,063, 22 by my calculations. And that, if that is for tax 23 avoidance, you did a real lousy job. 24 MR. HAMERSLEY: We've told them that. 25 MR. VAN DAMME II: Yes, I did. 26 MS. HARKEY: So those were my two issues. 27 I wanted to know why NBJ would agree to that. 28 Because they could have the money now and it really 31 1 is there, the appellants. And then I wanted to see 2 what the tax consequences were. 3 So I'll be glad to come back, but those 4 were my two points. 5 Thank you. 6 MS. MA: Mr. Runner. 7 MR. RUNNER: Yeah, just a couple of 8 followups on -- on some of the discussion. And -- 9 and actually the concern that -- or the -- the 10 material that Member Harkey brought out, I think was 11 also at least one of my thoughts and concerns. And 12 that is, how much tax was actually paid during these 13 installments, uhm, as a result of the -- the -- the 14 process? 15 Because, I guess really what we're trying 16 to deal with is that, again, is this -- is this a 17 tax avoidance scheme? Or is this a good tax 18 deferral scheme, or plan? 19 MR. VAN DAMME II: Right. 20 MR. RUNNER: I think that becomes the 21 issue. 22 Uhm, it was interesting, uhm -- 23 In fact, I'm going to go to -- to -- to, 24 uh -- 25 MR. VAN DAMME II: Ken Van Damme. 26 MR. RUNNER: -- the appellants' CPA for a 27 moment as you were trying to work through this. 28 Uhm, because it's our understanding from -- from 32 1 conversations and from what you've said is that 2 you -- you understood the concerns that the family 3 had and, therefore, tried to structure a -- a -- a 4 deal that would indeed meet the concern of the 5 parents, uhm, but also then properly include the 6 proper tax obligations in that process. Is that a 7 fair -- 8 MR. VAN DAMME II: That's very fair, yes. 9 You want me to speak to my -- 10 MR. RUNNER: Yeah, go ahead and make a 11 comment in regards to how you structured your 12 intentions. 13 MR. VAN DAMME II: Well, in the summer of 14 2005 when I was informed by the CFO that the 15 property was likely to be sold, being the CPA and 16 the tax guy, my natural instinct was, well, let me 17 quantify the tax liability and -- and advise the, 18 uh -- advise the family. 19 And when I -- and I came up with an idea 20 that would have deferred all of the tax gain using a 21 1031 Exchange with a triple net property. You buy a 22 replacement property that's triple net. You go to 23 Wall Street, you get 90 percent loan to value 24 financing, and you got your cash tax-free from 25 refinancing and it avoids all income taxes. 26 When I presented that to Mr. and 27 Mrs. Khoury sometime in 2005, their reaction was, 28 "That's great, but that's not my concern. My 33 1 concern is, is that I cannot distribute out that 2 money to my three kids." 3 I've known Mr. and Mrs. Khoury for 25 4 years, and their kids. Their kids are just a few 5 years younger than me, so I've developed personal 6 relationships with them. And I know all too well 7 the concerns that Mr. and Mrs. Khoury have with the 8 kids. They're good -- back -- they're good kids, 9 but I knew the concerns. They were legitimate 10 spendthrift issues. 11 And I also knew that the focus of all 12 estate planning since 1999 has been the 13 grandchildren. Mr. and Mrs. Khoury has told me on 14 more than one occasions they've done enough estate 15 planning for their kids, it's time to focus on the 16 grandkids. 17 So in that meeting we came up with this 18 transaction. And it seemed -- it seemed to satisfy 19 all concerns. It prevented Jason, Brian, Noelle, 20 the three appellants, from receiving the cash. It 21 gave them a $20,000 per month monthly payment in the 22 form of interest. Called it an allowance, but 23 basically that will supplement, if not -- supplement 24 their lifestyle, and allow them to live the 25 lifestyle that they're accustomed to and do that for 26 30 years. 27 But that estate planning technique for 28 grandchildren is powerful. That is a lot of money 34 1 going into the 1999 trust. And the arbitrage over 2 the years to the -- to the grandchildren have been 3 millions, that are now legitimately and legally 4 outside of the taxable state and not subject to 5 estate taxes upon Mr. and Mrs. Khoury's death. 6 It was a ideal solution. And that was -- 7 that was the impetus for this transaction. And then 8 we went to the appellants and that awful meeting on 9 January 4th. 10 MR. RUNNER: What about -- what about 11 the -- what about, was there a concern, or how do 12 you answer the issue in regards to the access that 13 the siblings had, uhm, either -- in two different 14 ways. One is I think they had some direct access 15 through Sundance Financial, Inc., uh, right? 16 MR. VAN DAMME II: Well, Sundance 17 Financial, Inc. was 20 percent owner of Sundance-K, 18 general partner. 19 MR. RUNNER: Yeah. So they had -- and 20 they -- and they controlled that, right? They 21 had -- 22 MR. VAN DAMME II: Well, I don't know how 23 you'd define "control." They -- they certainly 24 owned the stock of Sundance Financial, Inc. 25 MR. RUNNER: Okay. 26 MR. VAN DAMME II: But they're not on the 27 board of directors. 28 MR. HAMERSLEY: The law defines it as board 35 1 of directors. 2 MR. RUNNER: Okay. 3 MR. VAN DAMME II: And, as a practical 4 matter, Mr. Khoury here calls all shots on large 5 money transactions. 6 MR. RUNNER: Okay. 7 MR. VAN DAMME II: There is a CFO -- 8 actually two CFOs. They would -- they would discuss 9 the -- the business needs and purposes and, you 10 know, where to get the money. And they would 11 propose the idea to Mr. Khoury, and Mr. Khoury would 12 say yes or no. 13 MR. RUNNER: Okay. Let me ask you this 14 then, the issue of the fact of the -- of the, uhm -- 15 the fact that on Sundance-K that the siblings were a 16 part of the investment decisions, uh, within that, 17 and therefore could then secondhand benefit -- 18 MR. VAN DAMME II: That's not the -- that's 19 not the same as unfettered access. 20 MR. RUNNER: Right. Go ahead, just tell 21 me. 22 MR. VAN DAMME II: If they take the money, 23 Wells Fargo would be coming after them for their 80 24 percent piece. They -- they -- sure, they had some 25 authority over investment decisions, but they 26 couldn't take the money for personal use. 27 MR. HAMERSLEY: What to spend it on, not 28 actually getting the money. 36 1 MR. KHOURY: Not on distribution. 2 MR. VAN DAMME II: No, they weren't on 3 distribution. 4 MR. RUNNER: Okay. Let me -- let me go 5 back to -- to the FTB because a lot of what I 6 understand from the FTB was, was phrased as what 7 they could have done, uhm, in terms of access to 8 dollars, move things around or whatever. 9 MR. JOHNSTON: Sundance-K received the 10 distributions from RSD after RSD sold its apartment 11 building. 12 MR. RUNNER: Uh-huh. 13 MR. JOHNSTON: Sundance-K then loaned the 14 money to appellants' other entities. 15 MR. RUNNER: Right. 16 MR. JOHNSTON: And so it was within grasp 17 of the appellants. And appellants were able to 18 use -- 19 MR. RUNNER: Within grasp. 20 MR. JOHNSTON: Yes. They -- they were able 21 to use it to fund their other ventures, to go and 22 have their other entities utilize that cash. 23 MR. RUNNER: And is that -- and -- and -- 24 and -- well, let me ask either the accountant or the 25 representative, does that satisfy, in your minds 26 then, the ability for them to control that cash? 27 MR. HAMERSLEY: No. 28 MR. RUNNER: Why not? 37 1 MR. HAMERSLEY: Absolutely not. And it's 2 not factually accurate. 3 The bulk of that -- those loans -- we're 4 moving from one place to the other here, but the 5 investment loans to the investments he's referring 6 to was owned 70 percent, Grossmont, by an unrelated 7 third party. 8 So, you know, does it put 'em in a position 9 as though they had full access to the proceeds as if 10 they sold it directly? Absolutely not. 11 MR. VAN DAMME II: And may I say -- 12 MR. RUNNER: Go ahead. 13 MR. VAN DAMME II: I'm sorry. 14 MR. RUNNER: Sure, go ahead. 15 MR. VAN DAMME II: My understanding of 16 the -- of the statute and judicial doctrine is, is 17 that it's control and benefits. And when you read 18 the Rushing line of cases, that means that was 19 Sundance-K a conduit, an alter ego of Jason, Brian, 20 Noelle? Sundance-K is not an alter ego of Jason, 21 Brian, Noelle. It's a valid entity, been around for 22 seven years, and is 80 percent for the benefit of 23 the grandchildren. 24 MR. RUNNER: Okay. Let me go back to FTB 25 in regards to the issue of the taxes that were paid. 26 Um, it seems to me that if indeed we go back and -- 27 and identify the original transaction, uhm, as a 28 taxable event, that it -- that in reality there was 38 1 a lot of tax paid -- 2 MR. HAMERSLEY: Yes, there was. 3 MR. RUNNER: -- during that -- during -- 4 between then and -- and now. 5 MR. JOHNSTON: Those are -- 6 MR. RUNNER: And how do we rec- -- why 7 don't we -- what's the purpose -- what's the -- 8 isn't there a concern in regards to, again, almost a 9 double taxation, recognizing that as a part of what 10 was taking place? 11 MR. JOHNSTON: Those are earnings from the 12 cash proceeds. So that's a different type of 13 income. The income we're looking at right now is 14 the distribution from RSD for -- what represents 15 RSD's gain in the apartment building. 16 If the distribution had gone to NBJ instead 17 of Sundance-K, NBJ presumably would have invested 18 that money in some type of investment and earned 19 interest or dividends or income off of that money 20 going to NBJ. 21 So those are two different types of income 22 we're looking at. 23 MR. RUNNER: Let me ask you, from the 24 representative or the CPA, how do you look at that 25 income? 26 MR. HAMERSLEY: Completely disagree. It's 27 more would've, could've, should've. They're arguing 28 that the purported abuse was the avoidance of gain 39 1 at RSD. That's the -- that's the gain we're talking 2 about. The other partners of RSD paid 57 percent of 3 the tax, a lot of tax. 4 MR. RUNNER: At that time. 5 MR. HAMERSLEY: In the year of the sale. 6 Yeah. 7 They're -- they're migrating back from 8 piece to piece to avoid -- yes, a lot of tax was 9 paid on this transaction. 10 MR. VAN DAMME II: Can I -- can I 11 interrupt? Just -- 12 MR. RUNNER: Go ahead. Let him finish and 13 then I'll let you -- 14 MR. HAMERSLEY: I'm finished. 15 MR. RUNNER: Go ahead. 16 MR. VAN DAMME II: The tax was paid in 2006 17 was four and a half million dollars by the Khoury 18 family. I don't think you'll have ever see a tax 19 shelter, abuse of tax shelter that pays a dollar of 20 tax, let alone four and a half million dollars of 21 tax that was paid. And that's federal -- 22 MR. RUNNER: The point would be, if it was 23 a tax avoidance gain then you didn't give good 24 advice in regards how to do it. 25 MR. VAN DAMME II: It's the worst one. And 26 please bear in mind, I had a 1031 triple net that 27 would have resulted in zero tax paid. 28 MR. RUNNER: If indeed -- if indeed the 40 1 goal was to -- 2 MR. VAN DAMME II: Yeah. 3 MR. RUNNER: -- actually get a lump sum of 4 money. 5 MR. VAN DAMME II: In addition, also, there 6 was $17 million of tax loss carryovers. We're 7 talking about capital loss carryovers, passive 8 activity loss carryovers, from prior years that were 9 used in 2006 because of this transaction, all that 10 gain recognized. 11 If we wouldn't have used the $17 million of 12 loss carryovers, I think it's possible that Mr. and 13 Mrs. Khoury, and maybe the appellants, wouldn't have 14 paid taxes for -- well, maybe the rest of their 15 lives, for the foreseeable future. And instead, 16 since then, they've been paying taxes. 17 MR. RUNNER: Again, this was -- this was a 18 large transaction, complicated transaction. I 19 assume it was also reflected then on some federal 20 income tax returns. 21 MR. VAN DAMME II: Oh, yes. 22 MR. RUNNER: Well, how did -- how did the 23 IRS deal with this particular issue? 24 MR. VAN DAMME II: Mr. -- Mike, you might 25 be better -- 26 MR. HAMERSLEY: Yeah. Well, that issue 27 being the original -- 28 MR. RUNNER: Yeah. 41 1 MR. HAMERSLEY: -- AIPS position. The 2 IRS -- the AIPS 1, as we refer to it as, 3 characterized this in the VCI contact, and that's 4 one of the issues in the penalties. We were 5 contacted, told this was a BOB. RSD had a BOB. And 6 shortly after AIPS 1, the correspondence from the 7 auditors were, "Stop calling it a BOB. It's not a 8 BOB." 9 MS. MA: Can you define BOB and AIP? 10 MR. RUNNER: Yeah. 11 MR. HAMERSLEY: Yeah, BOB is -- BOB is 12 what's referred to, it's a -- there's a coordinated 13 issue paper that the IRS put out. BOB stands for 14 Bogus Optional Basis, BOB. 15 So section 754 of the Internal Revenue Code 16 provides for an optional basis adjustment upon one 17 of two events: A section 734(b) or 743(b) event. 18 This was a 743(b) event, a change of a 19 partner or sale of a partnership interest. That 20 triggers the 754 stepup. 21 The FTB differs from the IRS. The IRS is 22 far more judicious in its approach to optional basis 23 adjustments and has certain indicia of tax shelters 24 before they'll call it a BOB. 25 The FTB put out a notice, 2008-4, on their 26 position on calling optional basis adjustments BOB. 27 They essentially say all optional basis adjustments 28 that occur in connection with a sale of property are 42 1 bogus. 2 That's the difference. So the F -- we 3 provided the coordinated issue paper to the FTB 4 during AIPS 1. And we showed them that the IRS did 5 not agree -- agree with them in general. 6 We believe that the item -- the matter was 7 referred to the IRS, trying to get them to take up 8 the battle. We put that in our brief. There's been 9 no response. Um, there's a reason. It doesn't -- 10 in the coordinated issue paper, it doesn't have any 11 of that indicia. 12 So that's when the arguments shifted. And 13 what was left out of AIPS 1 that was provided to you 14 from the FTB's brief are the last 17 pages. That's 15 material. That's the shift from the BOB to the 453 16 argument. It's missing. We provided it in ours. 17 So the -- that gain, the focus was on the 18 RSD level of gain and an enormous amount of tax was 19 paid in year of the sale. 20 MR. RUNNER: So -- so -- so at this point 21 then, the IRS was actively engaged in reviewing this 22 transaction. 23 MR. HAMERSLEY: Well, we don't know for 24 sure. We haven't requested those documents. But, 25 what we do know is that their general -- the 26 coordinated issue paper as well as the general 27 accounting. 28 MR. RUNNER: Okay. Okay. But not on this 43 1 particular transaction. 2 MR. HAMERSLEY: Well, we believe, based on 3 what happened in the audit, that it was actually 4 referred and rejected, yes. It was never audited by 5 the IRS, but we believe it wasn't for a lack of 6 trying by the FTB. 7 MR. RUNNER: Let me ask you -- I don't know 8 if -- you probably don't know the answer to this. 9 But it would be typical for us to have a 10 relationship with the IRS in regards to tran -- 11 sharing of information? 12 MR. CORNEZ: It's pretty much in our 13 direction. The IRS gives us information about cases 14 after they've completed their examination. 15 I don't, on a -- we don't have any formal 16 program, sharing information with the IRS, 17 especially because at the time that this transaction 18 occurred and the audits were occurring, the IRS only 19 had a normal four-year, six-year statute. Now that 20 they have a slightly longer one, the IRS might look 21 at it independently. But we don't formally share 22 stuff with the IRS. 23 MR. RUNNER: When you say "formally," I 24 don't understand. 25 MR. CORNEZ: Well, I mean I don't know 26 anything in this file. We don't have an informal 27 program. 28 MR. RUNNER: Do you share information with 44 1 the IRS? 2 MR. CORNEZ: Not that I'm aware of. 3 MR. RUNNER: Okay. 4 MR. HAMERSLEY: I would respectfully 5 disagree. I worked there for five years on the 6 abusive tax shelter task force. 7 MR. RUNNER: You -- you worked where? 8 MR. HAMERSLEY: In FTB Legal, 9 specifically. 10 MR. RUNNER: In FTB Legal, when you were 11 there, you shared information with the IRS? 12 MR. HAMERSLEY: That's correct. 13 Regularly. 14 MR. RUNNER: Okay. Thank you. I may come 15 back. 16 MS. STOWERS: Okay. I guess it's my turn. 17 MS. MA: Okay. 18 MS. STOWERS: Okay. I always go in 19 reverse. 20 MS. MA: Okay. Ms. Stowers. 21 MS. STOWERS: To the appellant, you just 22 said something, you worked for FTB Legal, and when 23 you were there they shared info- -- shared 24 information with the IRS. 25 Were they sharing information about ongoing 26 audits or were they sharing information about legal 27 strategies? 28 MR. HAMERSLEY: Both. If legal strategies 45 1 being abusive tax shelters, the IRS puts out a list 2 of abusive tax shelters and they coordinated. There 3 were task forces set up. 4 So they were sharing both, specific audits 5 and broader, you know, strategies. 6 MS. STOWERS: So -- so when you were there, 7 you had knowledge of, if there was an audit going on 8 by the Franchise Tax Board, the Franchise Tax Board 9 would seek IRS to do the same audit or -- 10 MR. HAMERSLEY: To take it up for them. 11 MS. STOWERS: To take it up. 12 MR. HAMERSLEY: If the statute was open, 13 which it was at the timing here, yes. 14 MS. STOWERS: Do you have anything in your 15 files that show that they did this for your client? 16 MR. HAMERSLEY: We -- we don't. I mean 17 that would be the internal docs at the FTB. We can 18 certainly do a California Public Records Act request 19 to try to get it. But the answer's no. 20 MS. STOWERS: Did -- but you did not do a 21 PRA? 22 MR. HAMERSLEY: No. 23 MR. CORNEZ: That's actually incorrect. We 24 gave 'em the complete audit file in this case. 25 MS. STOWERS: Did you see anything in the 26 complete audit file that indicated that they 27 contacted the IRS and asked for them to conduct an 28 audit on this issue? 46 1 MR. HAMERSLEY: During the audit, we did. 2 And I would -- I would just beg to differ. It's 3 getting off on a tangent. But the -- it was not 4 complete. 5 There was a process during the protest 6 called the audit file integrity matter to verify 7 that. There were a number of documents that were 8 missing, and I would just respectfully disagree with 9 that statement. 10 MS. STOWERS: Okay, that's fine. Okay. I 11 just wanted to close the loop on that. 12 Let's see. Mr. Khoury, you indicated 13 that -- 14 Give me a second. I don't want to go to 15 you first. 16 I want to talk to the Franchise Tax Board. 17 You received Ms. Harkey's schedule? 18 MR. JOHNSTON: Yes, we did. 19 MS. STOWERS: And on page 2, she's showing 20 total tax interest of payments 2.9 million, 21 calculating what the interest -- the tax on the 22 interest would have been over a 30-year period. 23 MR. JOHNSTON: I see that there. 24 MS. STOWERS: And that's based on the five 25 percent interest payment. I guess -- I guess it's 26 just an observation for me. I'm not sure if I even 27 have a question. 28 There seems to be offsetting interest 47 1 income and interest expense with these 2 transactions. 3 MR. JOHNSTON: That's correct. 4 MS. STOWERS: So I don't see where this 2.9 5 is completely, um, accurate if they got interest 6 expense deductions as well. Can you speak to that, 7 please? 8 MR. JOHNSTON: Yes. NBJ essentially loaned 9 $14.2 million to Sundance-K for the RSD interests, 10 five percent interest. NBJ would recognize the 11 income. Sundance-K would have an offsetting 12 interest expense for the interest it paid. 13 Sundance-K then took the $14.8 million 14 distribution from RSD and spread it out amongst four 15 entities related to appellants or controlled by 16 them, owned by them. Those entities would also have 17 some type of a tax benefit as they paid the ten 18 percent interest back to Sundance-K. 19 Sometimes it would be deducted. It may be 20 capitalized if they used the loan to build real 21 property. Or it could be carried forward if there 22 were at-risk limitations or other types of 23 limitations on use of that interest now. 24 So there would be offsetting tax benefits 25 to the recognition of the interests through NBJ. 26 MS. STOWERS: Okay. 27 Um, I want to talk about the Rushing case, 28 and I want to talk about the first Board Member 48 1 inquiry. 2 In that first Board Member inquiry that I 3 sent out, I was questioning, you know, the ownership 4 structure. And -- and I was really looking at did 5 they -- did appellants have any ownership interests 6 in the entities where the investments were made? 7 And that would be on your slide 5 where 8 you're showing in '06 and '07 Sundance-K invested 9 potentially all of the $14 million from the RSD's 10 real estate sale to these various entities. 11 Are -- are -- do you agree that the -- to 12 the appellant, do you agree that your clients had a 13 ownership interest in these companies? 14 MR. HAMERSLEY: I -- I think that's 15 accurate. The, uh -- I'll let Ken speak to that. I 16 don't have that chart. The information we gave you 17 on the ownership is the ownership. 18 MS. STOWERS: Okay. 19 MR. HAMERSLEY: The -- the -- the largest 20 of those, Grossmont, they had a 30 percent interest 21 in. And unrelated third party on the majority, 70 22 percent. 23 But, Ken, you want to speak to the 24 specifics on that? 25 MR. VAN DAMME II: Sure. Grossmont 26 partners, 70 -- as Mike said, 70 percent was 27 owned -- 28 MS. STOWERS: I'm sorry. When you -- when 49 1 you, uh -- just so we can be clear. When you give 2 the percentage, would you please also give the 3 amount of the loan slash investment that was made to 4 them? 5 MR. HAMERSLEY: Do you have that 6 information? 7 MR. VAN DAMME II: I don't think I have 8 that information in front of me -- 9 MS. STOWERS: Okay. 10 MR. VAN DAMME II: -- the amount of the 11 loan. I know it's in the AIPS -- 12 MR. HAMERSLEY: Yeah. 13 MR. VAN DAMME II: -- the briefs. 14 MR. HAMERSLEY: Yeah. One of the 15 documents, the exhibits in the respondent's opening 16 brief was a marked up -- not in color, it was 17 color-coded when we provided it -- but a marked up 18 response, one of the five responses. There were 19 five exhibits to AIPS 1. And the exact numbers on 20 the loans and the percentages are in there as 21 well. 22 MS. STOWERS: Okay. Then go ahead, sir, 23 and give me the ownership percentage. And maybe 24 Franchise Tax Board could let me know how much of an 25 investment we're looking at. 26 MR. VAN DAMME II: Sure. Grossmont 27 partners, as Mike Hamersley just mentioned, 30 28 percent was owned by -- indirectly by the 50 1 appellants, 70 percent was owned by a non-family 2 unrelated third party. KLH Land Holdings, Inc. was 3 owned 25 percent by the appellants each, for a total 4 of 75 percent. And the last 25 percent was owned by 5 Mr. and Mrs. Khoury, the parents. 6 Legacy Building Services is owned 100 7 percent by the appellants, and Loma Verde, Inc. is 8 100 percent owned by the appellants. 9 MS. STOWERS: Okay. 10 MR. HAMERSLEY: And on the numbers, it was, 11 what, over half that went to Grossmont, 70 percent. 12 MR. VAN DAMME II: It was, by far, the 13 biggest loan went to Grossmont, which only 30 14 percent was owned by the appellants, which speaks to 15 the issue of this interest offset. Mathematically, 16 it's not possible for the interest expense to be 17 offset on appellants because they only get 30 18 percent of that interest expense on the biggest 19 loan. 20 So, although I couldn't share the numbers 21 with you, I think it's -- it would be inappropriate 22 to say that the interest income that the case -- 23 that appellants are recognized are offset by 24 interest expense. 25 MS. STOWERS: Okay. 26 MR. VAN DAMME II: I'm sure there's some, 27 but not all. 28 MS. STOWERS: Okay. 51 1 MR. VAN DAMME II: Not even close to all. 2 MS. STOWERS: I'm going to wait -- I'm 3 going to wait for FTB to give me the dollar amounts, 4 but I wanted to say something to Mr. Khoury. And 5 this is that one of the things that you said was 6 that you wanted to have -- one of the business 7 reasons why you were doing this transaction was that 8 you wanted to have funds available to make 9 investments in the other family-related businesses. 10 Does that -- does that summarize that properly? 11 MR. KHOURY: I said we'd like to have some 12 cash available if loan guarantees were called, 13 personal guarantees were called. And if an 14 opportunity arises, to benefit from the drop in real 15 estate prices. All of those were part of the 16 business reason, yes. 17 MS. STOWERS: Okay. So would you think 18 making the loans to those four entities satisfied 19 one of your intents? 20 MR. KHOURY: In some cases where personal 21 guarantees and loan guarantees were called by the 22 banks, yes, it happened. 23 MR. VAN DAMME II: Can I just give an 24 example? The loan to Legacy Building Services was 25 caused by the bonding company requiring, making a 26 capital call on Legacy Building Services. That's -- 27 that's one example of that. 28 MR. HAMERSLEY: Which did not even -- was 52 1 not known at the time of the RSD interest sale; is 2 that correct? 3 MR. KHOURY: Legacy Building Services came 4 into effect -- into being much later. I think in -- 5 MR. VAN DAMME II: Well, I don't know when 6 Legacy Building -- I don't remember what year, but 7 it was around 2006. 8 MR. KHOURY: I think later. 9 MS. STOWERS: Okay. I think I understand. 10 Something else, and I'm not sure when we're 11 talking about it, where there was an issue where 12 your children are the general partners for 13 Sundance-K through their ownership and Sundance 14 Financial. And one of the -- one of them, I think 15 it's your son-in-law, is the president of Sundance 16 Financial, according to the latest information that 17 was submitted. 18 MS. MA: Timothy Ludwig? 19 MS. STOWERS: Yes. And I have notes here 20 that at the board of directors meeting in January 21 2006 he provided the board of directors with the 22 report on the condition of the company, and he spoke 23 about the RSD San Diego property and another 24 property. The board accepted his report and 25 directed him to pursue his outlying strategies 26 during 2006. 27 All right. Is anyone familiar with -- with 28 those minutes? 53 1 MR. VAN DAMME II: I don't have them in 2 front of me. 3 MR. KHOURY: That's the January 3? 4 MS. STOWERS: Yes. 5 MS. MA: 2006. 6 MR. KHOURY: Yes. 7 MS. STOWERS: January 3, 2006. 8 MR. KHOURY: Yes, that's when the 9 transaction was approved by the board. And then we 10 had the meeting with the owners the following day, 11 January 4th. 12 MS. STOWERS: Do you recall what his 13 strategy was that you guys approved? It's stated 14 here that he provided a strategy and the board of 15 directors approved his strategy. I know it's a long 16 time. 17 MR. KHOURY: It was implemented. It's the 18 transaction -- 19 MS. STOWERS: It's the transaction -- 20 MR. KHOURY: Yes. 21 MS. STOWERS: He presented the strategy to 22 do the installment sale and the board of directors 23 approved it? 24 MR. KHOURY: Ken and myself did, yes. 25 MR. VAN DAMME II: Not Timothy. 26 MR. KHOURY: Pardon? 27 MR. VAN DAMME II: Timothy did not -- 28 MR. KHOURY: No. 54 1 MR. VAN DAMME II: -- propose. 2 MR. KHOURY: Ken and myself presented -- 3 MS. STOWERS: The strategy. 4 MR. KHOURY: -- the transaction, yes. 5 MS. STOWERS: That's what I thought. I 6 thought that in the prior emails when you had 7 reached out to your tax provider about selling the 8 property, um -- um, a question came up was this -- 9 was it -- was Sundance Financial still sheltered? 10 And there's nothing wrong with having your 11 income sheltered. But it turned out that Sundance 12 Financial, or your ownership in RSD Group, was not 13 going to have to pay a significant amount of tax 14 because of operating losses. 15 But the children's ownership interest in 16 RSD Group through NBJ, did they have operating 17 losses as well that was going to be used to offset? 18 MR. VAN DAMME II: Yeah. All three 19 appellants, as well as Mr. and Mrs. Khoury, had loss 20 carryovers, so -- 21 MS. STOWERS: From -- from RSD Group? 22 MR. VAN DAMME II: From RSD Group? Uh, it 23 wouldn't be a lot of loss carryover. I don't know 24 the number, but there wouldn't have been a lot of 25 loss carryovers from RSD Group. 26 MS. STOWERS: But they had in the past 27 received some type of flow-through loss from RSD 28 Group? 55 1 MR. VAN DAMME II: The history of RSD Group 2 from a taxable income and loss perspective, some 3 years were income, some years were losses. It was 4 kind of a mixed bag year by year. 5 MS. STOWERS: Okay. So kind of back -- 6 MR. VAN DAMME II: But it's not like there 7 was hundreds of thousands or millions of dollars of 8 losses building up over that 20-year time -- 9 MS. STOWERS: Okay. 10 MR. VAN DAMME II: -- that they owned the 11 RSD real estate. It wasn't like that. There was -- 12 MS. STOWERS: But they did have some. They 13 had basically the benefit of ownership, tax losses, 14 tax gains, depending on -- 15 MR. VAN DAMME II: Yeah. All the -- all 16 the taxable losses and all the taxable gains from 17 RSD was properly reported on the appellants' 18 returns. 19 MS. STOWERS: Okay. One more question to 20 you, sir. You said that the family paid 21 $4.1 million in taxes from the -- the transaction. 22 Are you talking about from the sale of the apartment 23 complex the family paid 4.1 in taxes? 24 MR. VAN DAMME II: Yes. So the -- it's -- 25 it's actually, my numbers are $4.6 million. And 26 that is the tax on both gains. That's the tax on 27 the installment sale gain. There was gain 28 recognized on that installment sale, that trans- -- 56 1 that installment sale transaction. But the 2 $4.6 million also represents the tax on the real 3 estate property sale that was also paid. 4 MS. STOWERS: How much did the appellants 5 recognize? 6 MR. VAN DAMME II: Hmm? 7 MS. STOWERS: How much tax did the 8 appellants pay of this 4.6? 9 MR. VAN DAMME II: They paid approximately 10 $3 million; that's federal and state taxes 11 combined. 12 MS. STOWERS: Okay. How much state income 13 tax did they pay? 14 MR. VAN DAMME II: State income tax? That 15 would be roughly $1.2 million. 16 MS. STOWERS: Total, all three of them? 17 MR. VAN DAMME II: All three of them 18 combined. 19 MS. STOWERS: Okay. Thank you very much. 20 Franchise Tax Board, I would like to know 21 the amount of loans or investment made into these 22 four entities. Do you guys have that? 23 MR. JOHNSTON: We're looking for that at 24 this time. 25 MR. CORNEZ: I'm doing the arithmetic right 26 now. 27 MS. STOWERS: Okay. Okay. Then, 28 Michael -- I should call you -- Mr. Hamersley, let's 57 1 talk about the Rushing case. Let me let you know 2 where I'm at. 3 I'm reading the Rushing case to say that 4 you recognize an installment transaction if the 5 seller, prior to installment transaction, does not 6 have control or benefit. 7 MR. HAMERSLEY: That's the literal language 8 in Rushing, yes, that's correct. The Fifth Circuit 9 Rushing. 10 MS. STOWERS: Okay. 11 MR. HAMERSLEY: That's not how it was 12 adopted in the Ninth Circuit and that's not what 13 they meant. I can elaborate if you'd like. 14 MS. STOWERS: So when you say the Ninth 15 Circuit, you're now talking about the, um -- 16 MR. HAMERSLEY: Roberts. 17 MS. STOWERS: -- Roberts case? 18 MR. HAMERSLEY: Yes. 19 MS. STOWERS: But they cite Rushing. 20 MR. HAMERSLEY: They do, and they adopt an 21 "and" test, and say that Rushing stood for an "and" 22 because they were saying "control over the benefits" 23 essentially. 24 MS. STOWERS: Where do they adopt that 25 "and" test? 26 MR. HAMERSLEY: It's in, uh -- it's in 27 Roberts. And there's more prongs to the test as 28 well. Because it's a conduit test to disregard the 58 1 buyer, the related party buyer as a mere conduit of 2 the seller, an intermediary. And there are other 3 parts, such as principal purpose of tax avoidance, 4 such as, it's not an entity of real significance, 5 economic significance. 6 Our entity was around since '99 -- 1999, 7 for seven years. They didn't have a principal 8 tax -- tax avoidance. Um, so there are other 9 aspects to that. 10 And then what the test is ultimately 11 getting to, Member Stowers, is, did that -- in 12 disregarding the conduit, the -- in our case 13 Sundance-K would be the entity in question -- did it 14 meaningfully alter, was its participation merely to 15 come in, receive the interest, engage in a second 16 disposition, sell it, to put the related-party 17 seller that sold it to them in the same economic 18 position as though they received the full proceeds 19 of selling it directly to the ultimate buyer? 20 And we can say in our case that's -- that 21 that's what the "control and" or "control or" 22 benefit ultimately gets to. Do you -- can you sham 23 installment sale buyer as a -- as a mere conduit? 24 And so none of the premises are there; but, 25 moreover, when you look at the ownership chain, 26 uh -- you know, it's funny because the FTB argues in 27 their briefs that, um, hey, you know, you didn't 28 really need to do the installment sale because many 59 1 steps -- quote, "many steps" had to occur for the 2 appellants to get their hands on the money in NBJ 3 from the sale. 4 Well, they're the 99 percent direct owners 5 and a hundred percent -- they own -- the GP, I don't 6 know what the many steps would have to be, but when 7 you compare that to where they're -- it's as good as 8 in their pocket, according to the FTB, the buyer, 9 Sundance-K, they only have a remote -- they're the 10 GP, but they're not on the board of directors of the 11 corp. that has the GP. And they say that that's -- 12 you know, those are completely at odds. 13 And, um, so the question is would you -- if 14 the appellants and that you were really -- the test 15 really should be looking at NBJ, that's the 16 installment sale seller. We're short-handing it to 17 the appellants because they're the owners. You'd 18 have to construct an additional step. But the 19 question is, when NBJ sold its 48.51 percent 20 partnership interest to Sundance-K, the other 21 implication, the other assumed fact is that there 22 was an immediate or prompt subsequent disposition of 23 the property they just bought. That also did not 24 happen in our case. There's no second disposition 25 of the property. 26 So the question is, if they did all of that 27 that we don't have, then you get to the issue of 28 whether the appellants, the installment sale seller, 60 1 NBJ, had control and benefit under Roberts to put 2 the appellants in the same position as though they 3 had sold it directly to the ultimate purchaser in 4 the second disposition and received the full 5 proceeds. And that's clearly not the case here. 6 MS. STOWERS: Okay. All right. Thank you. 7 Appeals, is -- can you give me a reading on 8 what the Roberts case is saying as far as control 9 and/or benefit? 10 MR. THOMPSON: Well, the Roberts and 11 Rushing cases, I think they emphasize control. And 12 both of them state that even if a taxpayer is 13 motivated by tax purposes, uh, they're entitled to 14 installment sale treatment if they actually 15 accomplish an installment sale, if it goes to an 16 uncontrolled party. 17 But the focus, as I read these cases, is on 18 whether the taxpayer continued, uh, to control or 19 benefit -- have benefit over the assets. 20 MS. STOWERS: "Control and" or "control or" 21 benefit of the assets? 22 MR. THOMPSON: Control or benefit is, as 23 you pointed out, what's stated in Rushing and also 24 as what the Board stated in Forsell, control or 25 benefit. Um, and I don't -- honestly, I think 26 they're talking about both sides of the same coin. 27 If you control something, then presumably you're 28 able to benefit from it in some fashion. 61 1 We heard a discussion about a capital call 2 that was made on one of these entities which 3 appellants owned. I don't know if appellants would 4 have been liable on that capital call. But if it 5 had been the case, they would have been liable 6 and -- and they were able to satisfy that capital 7 call with -- with a loan from Sundance-K, then that 8 might be an aspect of control or benefit over the 9 proceeds. 10 MS. STOWERS: Okay. 11 Franchise Tax Board, do you have those 12 figures yet? 13 MR. CORNEZ: Well, we have Exhibits CC 14 through EE of our opening brief. 15 MR. JOHNSTON: That's correct. 16 MR. CORNEZ: Of our opening brief, our 17 promissory notes. And Loma Verde, Legacy, and KLH, 18 the three of them together borrowed -- have 19 promissory notes that they signed for $6.3 million. 20 Grossmont Limited Partnership, in which 21 Loma Verde is the general partner, has a 22 promissory -- two promissory notes for about 23 7.2 million. 24 There's a lot of -- there's a fair number 25 of much smaller notes that I didn't add up, but 26 those are the main large balances. 27 So Loma Verde borrowed 1.9 million from 28 Sundance-K, according to these promissory notes. 62 1 Legacy -- I don't know the full name of 2 that entity -- borrowed $2 million from Sundance-K. 3 And KLH Land borrowed 2.4 million from 4 Sundance-K. 5 Grossmont Limited Partnership, which Loma 6 Verde is the general partner, had two loans: One 7 for 5.2 million, and one for 2 million. 8 MS. STOWERS: Okay. 9 MR. CORNEZ: All around December, January, 10 February, March of 2006. 11 MS. STOWERS: And Loma Verde is the general 12 partner of Grossmont; and appellants owned Grossmont 13 a hundred percent? 14 MR. CORNEZ: No. 15 MS. STOWERS: Yes, that's what we all 16 agree -- I think we agreed on that, right? 17 MR. CORNEZ: No. Appellant -- 18 MS. STOWERS: Does appellant own Loma 19 Verde? 20 MR. CORNEZ: Yes. Not Grossmont. 21 MS. STOWERS: They own Loma Verde a hundred 22 percent. 23 MR. CORNEZ: Correct. 24 MS. STOWERS: And Loma Verde's a general 25 partner in Grossmont. 26 MR. CORNEZ: Correct. 27 MS. STOWERS: What's their partnership 28 interest in that one? 63 1 MR. CORNEZ: 14.4 percent. 2 MR. JOHNSTON: In Grossmont co-tenants. 3 MR. HAMERSLEY: Yeah. 4 MS. STOWERS: Okay. Thank you. 5 MR. HAMERSLEY: That's correct. 6 MR. JOHNSTON: Board Member Stowers? 7 MS. STOWERS: Go right ahead, sir. 8 MR. JOHNSTON: May I make a comment on the 9 Rushing case? 10 MS. STOWERS: Yes. I meant to ask for your 11 take on the Rushing case as well. 12 MR. JOHNSTON: In Rushing, the installment 13 sale was made to the trust that had an independent 14 trustee, which is significantly different than what 15 happened here. 16 This installment sale was made to a 17 partnership with a limited partner that was an 18 irrevocable trust, and the general partner being 19 a -- owned by appellants. That's a lot of control 20 that does not show up in the Rushing case. 21 MS. STOWERS: Okay. The facts are somewhat 22 different, I understand that. 23 MR. JOHNSTON: Thank you. 24 MR. HAMERSLEY: May I add one more point to 25 that? Well, I can -- I can -- 26 MS. STOWERS: No, you have that right. Go 27 right ahead. 28 MR. HAMERSLEY: I was just going to say, if 64 1 you want to take that to its ultimate test, go look 2 at the Nye case cited in Forsell and other cases. 3 Nye was a husband and wife, a doctor and a 4 lawyer, and they held that a sale from one to the 5 other was a independent economic entity. 6 So it -- it -- it gives some flavor to what 7 that term means. And, you know, ordinarily -- and 8 the court says, "Whoa, ordinarily you'd say, 'Wait a 9 minute, husband to wife?'" They lay out exactly why 10 they reached that conclusion. 11 MS. STOWERS: Okay. I will look at that 12 case when we take a break. 13 MR. HORTON: I think Appeals -- 14 MS. STOWERS: Appeals? 15 MR. THOMPSON: Well, I was just going to 16 comment. They also distinguish another husband and 17 wife case where the opposite was achieved. And I 18 think in Nye what they were focused on is that the 19 husband and wife were independent economic actors 20 with separate professions and incomes. And they 21 distinguished the other case in which the taxpayers 22 lost because those factors weren't present. 23 So it -- it depends, you know, on analysis 24 of the facts and the practical realities of the 25 situation. 26 MS. STOWERS: Mr. Thompson, I read a lot, a 27 lot. So did you say something about there's a BOE 28 case? 65 1 MR. THOMPSON: Uh, For- -- excuse me, 2 Forsell? 3 MS. STOWERS: Would you give me a little 4 summary on that one, please? 5 I'm sure it's in the summary. 6 MR. THOMPSON: Oh, it's right in front of 7 me. 8 MS. STOWERS: The cliff notes would be 9 fine. 10 MR. THOMPSON: Uh, yes. Forsell was also a 11 husband and wife. And the Board distinguished the 12 Nye case and cited Rushing. 13 And as we've noted, the Board quoted the 14 language of Rushing. And what it found was that the 15 purpose of the installment sale provisions was to 16 defer tax where, uh, control and receipt of the gain 17 was also deferred. So you don't get tax in advance 18 of getting the money. 19 And on the facts of Forsell, the Board 20 found that the installment sale treatment was not 21 appropriate, uh -- uh, because control was not 22 relinquished. Uh, therefore, there was not 23 effectively deferral of receipt of the proceeds, and 24 there shouldn't be therefore deferral of the receipt 25 of the tax as well, or payment of tax rather. 26 MR. HAMERSLEY: Member Stowers, I'm not 27 sure those facts are correct. 28 It was a father that sold to his son living 66 1 under the same roof. 2 MR. THOMPSON: I'm sorry. He's correct. 3 MS. STOWERS: Okay. I have some more 4 reading to do. 5 Thank you, Madam Chair. 6 MS. MA: Okay. I do have a question. 7 So I -- I didn't hear the answer to this. 8 Was Timothy Ludwig, is he the president and CEO of 9 Sundance Financial? 10 MR. HAMERSLEY: I believe that's correct. 11 It was in our -- it was in our response to the 12 inquiries. I believe that's correct. 13 MS. MA: Is he still president and CEO? 14 MR. KHOURY: No. 15 MS. MA: Okay. And then back then I think 16 Jason and Brian were the vice presidents. 17 MR. HAMERSLEY: Yeah. 18 MS. MA: Are they vice presidents still? 19 MR. HAMERSLEY: Yeah. If you were looking 20 at -- I believe that's the case. If you were 21 looking at the -- the minutes that I believe Member 22 Stowers cited, the January 3rd, they were removed 23 from the board of directors. I believe they were 24 vice presidents. I don't remember exactly what. 25 But, yes. 26 MS. MA: Okay. So who is involved in 27 Sundance Financial right now? 28 MR. HAMERSLEY: Right now? 67 1 MS. MA: Right now. 2 MR. VAN DAMME II: Well, as a practical 3 matter there's -- there's board of directors which 4 still doesn't include the three appellants. Tammy 5 Miller is the CFO. I honestly don't know who are 6 the other officers. But I think it's fair to say 7 the appellants don't come to the office very much. 8 MR. KHOURY: They do not. 9 MR. VAN DAMME II: The, um -- 10 MR. KHOURY: My wife and I are on the 11 board. 12 MS. MA: Of Sundance Financial? Of 13 Sundance Financial? 14 MR. KHOURY: Sundance-K. 15 MR. VAN DAMME II: No, Sundance Financial. 16 MS. MA: No, no, no. 17 MR. KHOURY: Sundance Financial. Yes, Russ 18 Richard, my wife and myself. 19 MS. MA: Who? You, your wife and -- 20 MR. HAMERSLEY: And -- Russell R. Richard, 21 he gave an affidavit as well. 22 MS. MA: So you all are on the board. 23 MR. KHOURY: Three of us. 24 MS. MA: And then who's running the 25 organization? 26 MR. KHOURY: By running -- the 27 organization's primarily the owner of several 28 income-producing properties which kind of run 68 1 themselves with professional managers. And Tammy 2 Miller who is the CFO oversees all of that. When 3 there are refinancing decisions to be made and/or 4 potential sale or acquisition of property, then the 5 board is involved. 6 Russ Richard handles the day-to-day 7 operation as CEO. 8 MS. MA: And is -- 9 MR. KHOURY: But eventually the buck stops 10 with us, my wife and I. 11 MS. MA: Okay. But is Russ Richard or 12 Tammy Miller related to you in any way? 13 MR. KHOURY: No. No. 14 MS. MA: Okay. 15 MR. KHOURY: They look totally different. 16 MS. MA: Okay. 17 MR. HAMERSLEY: By the way, Ms. Miller, her 18 name is -- it's referred to in there, that's her 19 nickname, Ms. Miller. She's also known as the 20 gatekeeper, by the way. 21 MS. MA: Okay. Okay. 22 I guess that was one of my concerns is that 23 Sundance Financial is the general partner in 24 Sundance-K. And, you know, as a general partner you 25 have more latitude and rights in terms of operations 26 and how you can disburse money. 27 And so, you know, my initial question or 28 concern was, if the kids were involved still with 69 1 Sundance Financial, or their spouses, that they 2 could essentially withdraw the money, you know, out 3 of Sundance-K. 4 How do we -- how do you assure that the 5 assets stay in Sundance-K and that the general 6 partner for Sundance Financial isn't able to take 7 the money out of the corpus? 8 MR. KHOURY: How would they take it out? 9 MR. HAMERSLEY: Yeah. 10 MR. KHOURY: They can't write a check. 11 MS. MA: Why? 12 MR. KHOURY: They cannot write a check on 13 it, on the account. 14 MS. MA: Okay. But that's what I'm saying. 15 So I'm saying so now -- because that was a concern 16 that if Timothy Ludwig was president/CEO and the 17 kids were vice president, essentially they could 18 write checks. So you're saying that the kids -- 19 MR. KHOURY: Timothy Ludwig is long gone. 20 MS. MA: Okay. 21 MR. KHOURY: And the kids cannot write a 22 check. 23 MS. MA: Okay. So they have no signature 24 power or anything over any of the assets for 25 Sundance Financial? 26 MR. VAN DAMME II: In addition, the cash is 27 not in Sundance-K's bank account. 28 MR. KHOURY: Yeah. I mean if they wrote a 70 1 check on Sundance K bank account, it will bounce. 2 MS. MA: So where's the cash? 3 MR. VAN DAMME II: It's loaned out to the 4 entities that -- 5 MR. HAMERSLEY: The Grossmont, the 6 investment. 7 MR. VAN DAMME II: The Grossmont. 8 MA. MA: Right. 9 MR. VAN DAMME II: The Legacies. 10 MS. MA: But if -- if everyone paid back 11 the money, it would go back into the bank account -- 12 MR. HAMERSLEY: Yeah. 13 MS. MA: -- for Sundance-K. 14 MR. HAMERSLEY: A few points. One it would 15 be a taxable distribution or a transfer. 16 Two, the -- so, yes, absolutely true the 17 SFI, Sundance Financial is the general partner and 18 has the authority to manage affairs. But in the 19 same -- same token, the Board of Directors for SFI 20 does the same roll as the general partner. They 21 vote and decide those matters. And the kids were 22 specifically, as part of this transaction, taken off 23 the board to make sure they could not. 24 MS. MA: Okay. Um, okay, so I have a 25 question about the trust, the '99 irrevocable trust. 26 Who was on the investment committee? 27 MR. HAMERSLEY: I believe -- go ahead. 28 MR. VAN DAMME II: That's Mr. and Mrs. 71 1 Khoury as well as the three appellants are on the 2 investment committee. 3 MS. MA: And then how about the 4 distribution committee? 5 MR. VAN DAMME II: I think it's just 6 Mr. and Mrs. Khoury. 7 MR. HAMERSLEY: Yeah, the appellants are 8 not on the distribution committee. 9 MR. VAN DAMME II: And just so you know, 10 the -- the trust instrument has those committees as 11 advisory committees. Basically that means that any 12 distribution recommendations have to be presented to 13 Wells Fargo and Wells Fargo has the ultimate 14 decision, yes or no, is it in line with the trust 15 instrument? 16 MS. MA: Okay. And then who can remove the 17 trustee? 18 MR. VAN DAMME II: I do not know that 19 one. 20 MR. HAMERSLEY: Yeah, it's in the -- it's 21 in the trust document. 22 MS. MA: Okay. I have the trust document. 23 Page 14, "Removal of trustee. The 24 investment committee acting by majority vote shall 25 have the power to remove any trustee, with or 26 without cause." 27 Is that still -- 28 MR. HAMERSLEY: I would think it presumably 72 1 replaces the trustee that performs the fiduciary 2 duty of the trust document. Yeah. That may be 3 right on -- in term of who would remove, yeah. I'd 4 have to review it. 5 MS. MA: So -- so right now the investment 6 committee is Mr. and Mrs. Khoury and the three 7 kids. 8 MR. HAMERSLEY: I believe that's correct. 9 MS. MA: And by the majority vote they can 10 remove the trustee. 11 MR. HAMERSLEY: But not do things 12 incongruent with the fiduciary duties of the -- of 13 the trustee. They'd replace them, I would presume. 14 I'd have to review the trust document. 15 MS. MA: Okay. 16 MR. HAMERSLEY: But to just take over and 17 start doing things incon- -- you know, inconsistent 18 or incongruent with the trust, no, they couldn't do 19 that. 20 MS. MA: Well, I was -- I was just, as I'm 21 reviewing the generation-skipping trust and the 22 reason Mr. and Mr. Khoury set up the trust, it seems 23 that it would not benefit them to have the kids on 24 there if the intention is to preserve it for the 25 grandkids. Why wouldn't you put independent people 26 or your CPA, your lawyers, instead of your kids on 27 the investment committee? Just asking. 28 MR. KHOURY: Because as long as we are 73 1 alive, they will do what we tell them to do. That's 2 been the fact of life all along. There is no law 3 that can change that in my family. And we wanted 4 them to grow up with it, become responsible with our 5 guidance. Because even though I'm 86 and intend to 6 live to a hundred, some day I'm not going to be with 7 them anymore. 8 MS. MA: Okay. And so far they've been 9 responsible. 10 MR. KHOURY: They have become much more -- 11 they have become much more responsible, Ms. Ma. 12 MS. MA: Okay, good. And I have one 13 last -- 14 MR. KHOURY: Thank God. 15 MS. MA: I have one last question. 16 I understand that the trust distributions 17 in 2008 there were K-1s distributed to Jason showing 18 a distribution of 60,939, Noelle got 19,431, and 19 Brian did not get anything. And then none of the 20 grandkids, also, did not get any. 21 So, how did these distributions work? 22 MR. HAMERSLEY: I'll let Ken speak to this, 23 but I believe you're referring to the, uh -- the 24 reimbursements for the educational expenses that 25 they pay for out-of-pocket? 26 MR. VAN DAMME II: That's -- that's exactly 27 right. The -- in some cases the appellants would 28 write the -- would pay the tuition or the swim 74 1 lessons, or whatever the expenses are, submit the 2 invoices to Tammy Miller, the CFO gatekeeper, who 3 would then compile them and submit 'em to Wells 4 Fargo. And then Wells Fargo would reimburse the -- 5 the, uh -- the reimbursements. 6 As the preparer of the tax returns, I 7 issued the K-1 to Jason, Brian and Noelle who 8 received the reimbursements. That doesn't mean that 9 Jason, Brian and Noelle received distributions that 10 benefited them. It was just reimbursements of the 11 grandchildren's expenses. 12 MS. MA: Okay. 13 MR. KHOURY: There were invoices that 14 complied with the terms of the trust. 15 MS. MA: Okay. 16 MR. KHOURY: And so Wells Fargo was able to 17 distribute them or to pay out the money legally. 18 In Jason's case the reason why it was so 19 high, I believe the son was having some medical 20 issues at that time and tuition and issues because 21 of learning disabilities and things of that 22 nature. 23 MS. MA: Okay. I think those were my 24 initial questions. 25 Members, any more questions? 26 Ms. Harkey. 27 MS. HARKEY: I just have -- I just have one 28 thing to clarify. 75 1 When I showed this, I said it was ducky 2 bunny. I wanted to keep it really simple because we 3 can get very convoluted like this with all these 4 little arrows and boxes. But the bottom line is, is 5 why did NBJ agree? Because they had to agree for 6 the installment sale. And was it for tax evasion? 7 And it appears to me that even if you 8 offset the interest income, you know, taxable to the 9 appellants as individuals and the offsets, the 10 bottom line is that the sale produced taxable 11 interest payments to NBJ in addition to just the 12 gain. 13 So I didn't want to go into every last 14 little detail. And I understand that there were 15 some offsets. But I think we can still see real 16 simply that there were other reasons to do this 17 besides just to defer taxes. 18 I think that they -- paying 4.6 million in 19 taxes and then the three siblings 1.2 million just 20 in state taxes, you know, clearly define that. And 21 then the interest that has been paid for the last 10 22 years, or the taxes that have been paid for the last 23 10 years on the interest payments have been quite 24 hefty. 25 I also want to point out that I know we're 26 trying to -- we're trying to define definitely that 27 there was no ownership interest or no ability to 28 control Sundance-K. But Sundance-K had the 76 1 grandparents' trust as 80 percent owner, correct? 2 MR. HAMERSLEY: Right. 3 MS. HARKEY: And SFI was a general but only 4 20 percent, which was quite different from NBJ's 5 control of that -- of those funds prior to the 6 sale. 7 MR. HAMERSLEY: That's correct. 8 MS. HARKEY: Because prior to the sale, 9 they had a hundred percent control of those funds. 10 After the sale they only had a 20 percent interest 11 in the trust, and 80 percent was the -- was the 12 parents. 13 I appreciated Ms. Ma going through who was 14 on the investment committee. I also appreciated 15 hearing who was still in the family and who wasn't. 16 Because I think that at the time this was done the 17 issue was with Mr. Ludwig. And since he's not here 18 anymore, I think you may have accomplished your goal 19 of why the installment sale. 20 I think that the loans to the other 21 entities, there are some ownership, cross-ownership 22 interests. But I seem to recall during that period, 23 I recall the crash and the issues that happened and 24 also when the S and L crisis hit. 25 I was in banking for over 30 years and I 26 lived through a lot of that and I saw many companies 27 go under. I was loaning to a lot of home builders 28 at the time, and that was not pretty. You know, 77 1 their funding, in essence, went away. And then in 2 2008 big lines of credit disappeared, huge lines of 3 credit disappeared. Banks went under. 4 And so, you know, the fact that you still 5 had some funds that you could loan because of your 6 personal guarantees, I give you credit because most 7 people walked from their personal guarantees. And 8 there's only one entity that I know that did not. 9 And so these -- you know, these -- just 10 from a personal standpoint, I found that your 11 argument is extremely trustworthy. There were other 12 reasons for doing the transaction. 13 MR. KHOURY: Thank you. 14 MR. HAMERSLEY: Member Harkey, I will say 15 I've known Mr. Khoury -- I've had the pleasure, if 16 there's one benefit of this case, of knowing him for 17 seven years. I understand exactly why he made the 18 money he did. And, you know, it's obvious to me. 19 MR. HORTON: Madam Chair. 20 MS. MA: Mr. Horton. 21 MR. HORTON: Sorry about that. I can only 22 say much. Little. 23 I would concur that under the economic -- 24 Maybe I shouldn't speak. 25 Under the Economic Substance Doctrine there 26 appears to be some economic substance to the 27 transaction. 28 I was just curious, the de facto law, tell 78 1 me a little bit more about that. 2 MR. HAMERSLEY: I'm sorry. I couldn't -- I 3 couldn't quite catch that. 4 MR. HORTON: Mr. Khoury spoke about a de 5 facto law that gave him and his wife control 6 regardless. I was just curious about that. 7 MR. KHOURY: I'm sorry. I'm very hard of 8 hearing. 9 MR. HAMERSLEY: He's asking -- 10 MR. HORTON: The de facto law. Sorry, I 11 can't speak louder. 12 MS. MA: De facto law, why you and your 13 wife had control over the trust and the companies 14 and -- 15 MR. KHOURY: Why? 16 MS. MA: Yes. 17 MR. HORTON: Just tell me about it. How 18 does it work? 19 MS. HARKEY: How do we get that? 20 MR. KHOURY: We started it. 21 MR. HORTON: I don't have that kind of 22 control. 23 MR. KHOURY: We shed blood for it. We 24 spent sleepless nights nurturing it. We wanted to 25 preserve it for our kids, which we did give them a 26 good life. And for our grandkids, which we hope 27 will have a good life. 28 In the process, Mr. Horton, we employed a 79 1 lot of people. We did a lot of good things. We 2 paid our taxes. We never defaulted on a single 3 loan. And we're still standing before you, asking 4 you to please understand our motives were nothing 5 but what we mention to you. 6 MR. HORTON: Yeah. I, uh -- 7 MR. KHOURY: My kids wanted to pay taxes. 8 We had them yelling and screaming, "I want to pay 9 taxes on the money." 10 And we said, "We don't want you to have the 11 money because there are three reasons why you 12 shouldn't have it today. But you should honor what 13 we are telling you to do." 14 The kids grew up looking up to us for 15 guidance. Kids sometimes accept guidance and 16 sometimes they don't. Eventually ours came around 17 to accept it. And 10 years later, they are still 18 honoring that same plan. They have not tried to 19 take any money out. They will never try to take any 20 money out. 21 I don't know what else I can add really. 22 That's just what is, Mr. Horton. 23 MR. HORTON: I think -- I think that's 24 helpful. 25 I want to go to Appeals now and ask them a 26 question. And it's somewhat redundant, but on the 27 Rushing and Roberts the issue of -- the issue seems 28 to be to boil down to whether or not there exists 80 1 control. 2 And I think that some of the distinguishing 3 factors in this case, some of the distinguishing 4 factors in this case is that, as a general partner, 5 whether or not as a general partner you have control 6 or not. And particularly when the other partner's a 7 limited partner that's a trust and whether or not 8 the control changed from the onset of the contract 9 transaction, then the distribution of the loans to 10 the other parties wherein LVT was a hundred percent 11 owned by the appellants, KHL 75 percent owned by the 12 parents, 20 percent by the kids, LBS a hundred 13 percent, Grossmont 30 percent owned by the 14 parents -- I mean appellants, wherein the appellants 15 were the general partners, 70 percent owned by a 16 trust. And then relative to the payment of taxes, 17 taxes paid on the interest income or the principal. 18 I think I got it out. Sorry, you guys. 19 MR. THOMPSON: I'm sorry, Mr. Horton, the 20 question? 21 MR. HORTON: Oh, you want me to repeat 22 that? 23 MR. THOMPSON: No, I just wasn't sure what 24 you -- I thought it was more of a statement. 25 You just want me to comment on Rushing and 26 Roberts? 27 MR. HORTON: Um, yes, please. I'm not 28 going over that again. 81 1 MR. THOMPSON: Sorry. 2 Yeah, well Rushing and Roberts involved 3 installment sales made directly with an irrevocable 4 trust as opposed to installment sales with a 5 partnership that had a limited partner that was an 6 irrevocable trust. 7 MR. HORTON: So question of the appellant, 8 why not move that directly to a irrevocable trust? 9 MR. HAMERSLEY: Yeah. Same concept. The 10 issue is -- 11 MR. HORTON: Why move it -- why move it 12 into -- why give the appellant complete control over 13 the distribution of the funds by virtue that they 14 are the general partners? 15 MR. HAMERSLEY: Well, they don't have -- 16 you know, there's not a direct link from Sundance-K, 17 that partnership, to the appellants. They have to 18 go through SFI. And the control is lost by not 19 being on the board of directors of SFI. So just 20 because SFI is the -- 21 MR. HORTON: So you believe the board of 22 directors -- 23 MR. HAMERSLEY: As a matter of law and the 24 articles of the incorporation bylaws, yes. 25 MR. HORTON: Oh, okay. Appeals, you agree 26 with that? 27 MR. THOMPSON: Well, ultimately the 28 shareholders control the board and not vice versa. 82 1 However, I think appellants would argue that the 2 facts were different here because the reality on the 3 ground was that the shareholders were unlikely to, 4 uh -- to ask their parents to step down from the 5 board. 6 So, you know, let me just summarize what I 7 think -- 8 MR. HORTON: Go ahead. 9 MR. THOMPSON: --- the pro and con 10 arguments are here. 11 MR. HORTON: Go ahead. Yeah, go ahead. 12 MR. THOMPSON: Well, appellants view this 13 as analogous to Rushing and Roberts in which a sale 14 is made directly to irrevocable trust, I think, 15 because they would say, look, 80 percent of the 16 value ultimately is going to go to the trust, right? 17 And they would say the board exercised a de facto 18 practical influence notwithstanding the fact that 19 ultimately the matter of corporate law, the 20 shareholders -- 21 MR. HAMERSLEY: There's a powers duty in 22 that we gave -- we provided the bylaws for Sundance 23 Financial, Inc. And in there, there's a provision 24 on powers. And they clearly have the power to vote 25 the GP interest. 26 So the board is definitely the one who 27 votes the GP interest. 28 Mr. THOMPSON: Yes. But the shareholders, 83 1 as a matter of corporate law, absolutely control the 2 board. Now you may have a personal family 3 understanding here, right? And that's for the Board 4 to determine, whether -- what they think the 5 practical reality was here, I would say. 6 MR. HAMERSLEY: Agreed. They could -- yes, 7 under that doomsday scenario, could they, you know, 8 do exactly what their parents just tried to prevent 9 them from doing: Fire their parents, take over the 10 board, do all of that and steal the 80 -- by the way 11 steal the 80 percent owned by the trust -- 12 MR. HORTON: Excuse me. I really hadn't 13 planned to do all that talking on this case. But 14 it's just a little uncomfortable the way the 15 appellant is characterizing this. It's a little 16 uncomfortable, and so I think it's important that we 17 clarify this. 18 MR. THOMPSON: Mr. Horton? 19 MR. HORTON: Yes. 20 MR. THOMPSON: If I might add the second 21 half of that equation. Because I was trying, maybe 22 clumsily, to summarize what I saw as the factors 23 that appellants would point to. 24 And then I'd like to also balance that with 25 factors that I believe I understand respondent would 26 point to. 27 MR. HORTON: Please. 28 MR. THOMPSON: And on respondent's side, I 84 1 think they would say that, look what actually 2 happened, which is approximately 9 million of the 3 proceeds received by Sundance-K were in very short 4 order loaned back out to either LVI itself directly, 5 which I believe was wholly owned and controlled by 6 appellants, or by another partnership that was 7 controlled by LVI. 8 So on respondent's side of the argument 9 they would say look at the corporate realities here, 10 that they were the shareholders and controlled. And 11 then look at what the board did, which was allow or 12 cause the loans to be made to other entities that 13 were controlled by appellants and may have benefited 14 appellants by providing funds for those entities. 15 So I think that's the other side of the 16 equation here. 17 MR. HORTON: Yeah, there's my -- there's my 18 concern with the transaction, is that had the -- had 19 the transaction stopped at the initial transferring 20 of the funds due Sundance where there was the 80/20 21 relationship, then the benefit or the actual factual 22 decisions could have been at that point. 23 But then someone made a decision in this 24 case, presumably the general partner, pursuant to 25 contract law, made a decision to now enrich these 26 other three, four different entities with a loan in 27 which you now have a separate, four separate 28 different entities that the appellant now, a hundred 85 1 percent, control as opposed to an 80/20 2 relationship; shifting the ownership of these funds 3 from the 80/20 with the irrevocable trust now half 4 the funds are completely owned, a hundred percent 5 owned by the appellants and theoretically under the 6 contract law control a hundred percent by the 7 appellants by virtue of Grossmont the 30 percent -- 8 the 30 percent is a general partner and the trust is 9 a limited partner. 10 So in effect the appellants went from a 20 11 percent ownership to a hundred percent ownership of 12 all the funds. And the taxes that were paid were 13 paid on the interest income. And if you offset that 14 with the dividend benefit and so the shifting of 15 funds creates a situation where the ownership 16 started out with the appellants and ultimately 17 control started out and control remains the same at 18 the end of the transaction. 19 And I think on the Rush (verbatim) and 20 Roberts and under Forsell it was an issue of 21 control. And therein is where the step transaction 22 sort of comes into play. 23 But I do -- I do -- I do believe that 24 Mr. Khoury had an economic purpose for it and a lot 25 of wisdom in his decision, that it was his intent to 26 benefit his grandkids and at the same time provide 27 some element of financial support or opportunities 28 for the appellants as well. 86 1 With that in mind, I would think that if 2 there is -- under the Economic Substance Doctrine 3 that there is economic substance and the penalties 4 related to this might not -- should not apply 5 necessarily. 6 Anyway, that's about as far as I can go 7 today. 8 MS. MA: Okay. Do I hear a motion? 9 MS. STOWERS: Move to take the matter under 10 submission. 11 MR. HORTON: Second. 12 MA. MA: Let's take it up. 13 MR. HORTON: All right, you want to roll? 14 MS. STOWERS: All right. I'll withdraw my 15 motion. 16 MS. HARKEY: I'll make a motion to grant 17 the appeal. 18 MR. RUNNER: Second. 19 MR. KHOURY: Thank you. 20 MS. MA: Okay. We have a motion by Ms. 21 Harkey, second by Mr. Runner, to grant the appeal. 22 Ms. Richmond, please call the roll. 23 MS. RICHMOND: Ms. Ma. 24 MS. MA: Aye. 25 MS. RICHMOND: Ms. Harkey. 26 MS. HARKEY: Aye. 27 MS. RICHMOND: Mr. Horton. 28 MR. HORTON: No. 87 1 MS. RICHMOND: Mr. Runner. 2 MR. RUNNER: Aye. 3 MS. RICHMOND: Ms. Stowers. 4 MS. STOWERS: No. 5 MS. RICHMOND: Motion carries. 6 MS. MA: Okay. Thank you very much for 7 your time. 8 MS. HARKEY: Congratulations. 9 MR. VAN DAMME II: Thank you. 10 ---oOo--- 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 88 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 April 26, 2016 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 88 constitute 14 a complete and accurate transcription of the 15 shorthand writing. 16 17 Dated: October 31, 2016 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL, CSR #9039 22 Hearing Reporter 23 24 25 26 27 28 89