1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 9 REPORTER'S TRANSCRIPT 10 JUNE 20, 2017 11 12 13 14 15 SPECIAL TAX APPEAL HEARING 16 APPEAL OF 17 McFLOWER CORPORATION 18 NO. 647417 19 AGAINST PROPOSED ASSESSMENT OF 20 SALES AND USE TAX 21 22 23 24 25 26 27 REPORTED BY: Jillian M. Sumner 28 CSR NO. 13619 1 1 P R E S E N T 2 For the Board of Equalization: Diane L. Harkey 3 Chair 4 Fiona Ma, CPA Member 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: Jeff Angeja 15 Tax Counsel IV Legal Department 16 For the Department: Scott Lambert 17 Business Taxes Specialist III 18 Business Tax & Fee Department 19 Andrei Shkidt 20 Supervising Tax Auditor III 21 Business Tax & Fee Department 22 Stephen Smith 23 Tax Counsel IV Legal Department 24 For Petitioner: Mitchell Stradford 25 Representative 26 Jesse McClellan Attorney 27 28 ---oOo--- 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 JUNE 20, 2017 4 ---oOo--- 5 MS. HARKEY: Okay. The next case, 6 Ms. Richmond. 7 MS. RICHMOND: Our next case is C3, McFlower 8 Corporation. 9 Please come forward. 10 Oh, I see you are here. 11 MR. McCLELLAN: We got a head start. 12 MS. HARKEY: Okay. Thank you. 13 Mr. Angeja, will you please introduce the 14 issues in this case. 15 MR. ANGEJA: Madam Chair and Members, the 16 appeal before you presents two unresolved issues, 17 which are whether additional adjustments to the 18 amount of unreported taxable sales are warranted, and 19 whether petitioner was negligent. 20 MS. HARKEY: Thank you. 21 Welcome to the State Board of Equalization. 22 You -- please introduce yourself for the record. You 23 have 10 minutes, and then we'll defer to the 24 Department, which will also have 10 minutes. And you 25 have five minutes on rebuttal. 26 Thank you. 27 MR. McCLELLAN: Thank you, Madam Chairwoman 28 and Members of the Board. 3 1 My name is Jesse McClellan on behalf of 2 petitioner McFlowers Corporation. I'm also joined by 3 Mitchell Stradford, with McClellan Davis, also on 4 behalf of petitioner. 5 This case involves a medical marijuana 6 dispensary, and an audit of the business for the 7 period of first quarter of 2008 through second 8 quarter 2011. And the timeframe is important, 9 because there were some significant changes locally 10 and within the business itself that have an impact on 11 the audit. 12 The audit was performed based on an 13 observation test. There's a lot of details that go 14 into it, which I'm going to allow -- mention to 15 elaborate on. 16 But, in summary, the test, as we sit here 17 today, only includes one full day. And then it 18 includes a number of random days where there was one 19 or two hours of observation that was performed. 20 It's our contention, and has been our 21 contention, that the test should be performed by 22 using at least one additional day, full day, of 23 observation. 24 And the decision and recommendation actually 25 made that directive to the audit staff. The audit 26 staff did not follow that recommendation. 27 There's also records that are relied upon in 28 the audit as it pertains to credit card deposits, but 4 1 only for a portion of the period for which those 2 records are relied upon. Or I should say only for a 3 portion for which those records are available. 4 We think that those records, to the extent 5 they are available, should be used in their entirety 6 to compute the audit liability. 7 We do concede there is a liability. We 8 think it's lower than what's asserted. And 9 ultimately we've presented an alternative methodology 10 that computes the obligation, which we are asking the 11 Board to direct staff to use. 12 And with that, I'll turn it over to Mitch, 13 that will share some details. 14 MR. STRADFORD: Thank you, Jesse. 15 Board Members, before I get into the 16 specifics of our alternative computation, I just kind 17 of want to walk you through some of the procedural 18 things that we went through with the Department once 19 the D&R was issued. 20 So basically the D&R was issued in November 21 of 2014, which recommended that two full days be 22 performed. 23 I reached out to the Department on three 24 separate occasions in January, February and March of 25 2015, and my requests were ignored. 26 For my third request, the audit supervisor 27 contacted me, and we discussed how the observation 28 test was going to be performed. Namely that the 5 1 auditor would be out sitting in his car, he would 2 count the number of customers that entered the 3 dispensary, and that the taxpayer would be there and 4 provide the individual sale receipts for that day. 5 So after we had that conversation, I agreed 6 I'd contact the taxpayer, see which days would be 7 best for the Department to come out and perform the 8 observation. I think we provided nine days to the 9 audit staff in the coming month when the taxpayer 10 would be available. 11 A week went by and a few of the days had 12 lapsed, so I reached out to the auditor on three 13 separate occasions to ask him which day they would be 14 performing the observation test. And he told me he 15 was going to refuse to answer my question, and that 16 they would just show up whenever they decided it was 17 appropriate. 18 That's pretty uncommon in my experience, so 19 I reached out to the Audit Supervisor. And she 20 basically had the same story. "We're going to come 21 out. There's no need for you to know." 22 Finally I contacted the District Principal 23 Auditor, because it's really uncommon. Normally the 24 Department does meet with the taxpayer and schedules 25 a day. And the District Principal Auditor also 26 refused to disclose which day. 27 And it just so happens, as I was talking to 28 her, the tax -- or excuse me -- the auditor left me a 6 1 message on my voicemail and said, "I'm here." 2 So we called the taxpayer and basically 3 drove out to the business. They performed a full day 4 of observation that day. 5 A couple weeks later I reached out to the 6 auditor, and I said, "Can you please send me the 7 results of the first day of observation? Let's work 8 on scheduling a second day, you know, within 9 accordance with the D&R." 10 The auditor responded by sending me reaudit 11 working papers in which it included the full day of 12 observation, and then 21 hours of disjointed one- to- 13 two- hour observations that were performed actually 14 while I was attempting to contact them regarding the 15 observation, mainly in February and March, before the 16 full day was performed. 17 We set up a call with the DPA to request 18 they perform the audit in accordance with the D&R. 19 And the Department felt the observation they 20 performed was sufficient, and they did not want to 21 perform a second day. 22 At that point we prepared a request for 23 reconsideration to the Appeals Division. When we 24 requested it, they instructed Department to perform 25 the reaudit in accordance with the D&R. 26 At that point the Department responded and 27 stated that due to safety concerns, they would be 28 unable to perform additional observations, and the 7 1 supplemental decision and recommendation upheld the 2 observation as it was performed. 3 What's particularly concerning to us with 4 the safety concerns is the marijuana dispensary is 5 located on a six-lane street. It's on Van Nuys 6 Boulevard in Van Nuys. It's next to a furniture 7 store. 8 In addition, the safety concerns weren't 9 raised when they were performing the observation 10 undercover, and the safety concerns weren't raised 11 when they performed the first full day. 12 So from our perspective, it appears the 13 safety concerns are really just an excuse not to 14 perform the observation in accordance with the D&R, 15 and also the Board's own published procedures. 16 That being said, we have presented an 17 alternative computation, which would preclude the 18 need for additional observation testing. Basically 19 what we did is we provided -- well, the taxpayer 20 provided five months of sales records during the 21 audit, which include their cash and credit card 22 sales. So instead of using the observation test, we 23 used the taxpayer's own records to compute the 24 cash/credit card ratio. 25 In order to support that approach, we 26 verified that the credit card sale from the 27 taxpayer's records matched the credit card deposits 28 in the bank statements. We also took the one full 8 1 day of observation that was performed by the 2 Department and multiplied it times 150 for this 3 five-month period. And it came in within three 4 percent of the taxpayer's actual recorded sales for 5 these five months. 6 So based on those two analyses, we think the 7 recorded sales are a reasonable way to compute a 8 credit card percentage. 9 The other main difference between our 10 alternative computation and the Department's 11 computation is the use of the taxpayer's credit card 12 deposits for the period of January 2010 through 13 June 2010. 14 The way the audit's currently computed, they 15 use the actual credit card deposits in third quarter 16 2010, and then they reduce it by 10 percent going 17 backwards. Even though the bank statements are 18 available and they have the credit card deposits. 19 The reason the Department is -- at least I 20 speculate the reason why they're not using them is 21 because the credit card deposits are much lower in 22 the first six months of 2010 as compared to third 23 quarter 2010. 24 The reason that is, is because on June 7th, 25 2010 local ordinance 181069 was passed, which 26 basically forced the closure of hundreds of 27 dispensaries within the Los Angeles area. There were 28 only 167 collectives that were eligible to remain 9 1 open when this ordinance passed, one of which is 2 McFlowers Corporation. 3 They sent a letter out to all the 4 dispensaries that were operating illegally, and 5 basically said, If you continue to operate, there's 6 going to be a $2,500 per day fine, and you could face 7 six months of jail time. 8 As a result of the local ordinance and the 9 subsequent implementation by the city, hundreds of 10 dispensaries closed. And as a result, McFlowers 11 Corporation's sales rose dramatically. 12 For that reason, we think the actual credit 13 card deposits from January to June 2010 are an 14 accurate reflection of the business credit card 15 sales, and, in turn, should be used in the audit 16 computations. 17 On a final note, we note that the 10 percent 18 penalty for negligence was applied. This was the 19 first audit of the taxpayer, and, in general, the 20 negligence penalty isn't applied on the first audit 21 of the taxpayer. We request that the penalty be 22 abated. 23 Thank you. 24 MS. HARKEY: Thank you. 25 Okay. Department, please introduce yourself 26 for the record. You have 10 minutes. 27 MR. LAMBERT: Thank you, Chairwoman Harkey. 28 My name is Scott Lambert. To my right is 10 1 Andrei Shkidt. And to Mr. Shkidt's right is 2 Stephen Smith, representing staff. 3 In this particular case the taxpayer does 4 operate a medical marijuana dispensary. The audit 5 period covers a three-year period from 2008 through 6 June of 2011. 7 The taxpayer provided limited records at the 8 start of the audit. There were some bank statements 9 that were provided. There were income tax returns, 10 P&Ls. There were five sales summary journals that 11 were provided for 2011. 12 But since the taxpayer is mainly a cash 13 business up until October of 2009, it is very 14 difficult to conduct an audit on medical marijuana 15 dispensaries when they do not retain records. So the 16 Department decided to conduct observation tests. 17 They conducted six one-hour tests before the 18 audit was completed. Based on that, it showed there 19 were 12 customers per hour that came in on average 20 during those six hours of testing. 21 Subsequently it did go to an appeals 22 conference. The conference holder directed the 23 Department to conduct two additional days, one day 24 being a weekday, and one day being a weekend. 25 The Department was concerned about the 26 safety of the employees in conducting a full-day 27 test, regardless of where the dispensary is located. 28 Generally, you'll find with dispensaries, they have 11 1 an armed guard at the door. And there's a reason why 2 they have an armed guard. The auditors are not 3 safety -- members of safety, and it's a concern to 4 the Department. 5 Also, it's a concern regarding the fumes. 6 And so a lot of the districts prefer to conduct the 7 observation test from a distance instead of being 8 inside. 9 And in addition to that, a lot of the 10 taxpayers do not like the Board employees being 11 inside the business for a variety of reasons. 12 In this particular case, the taxpayer did 13 not want the auditor inside the business, and the 14 Department did not want to place an auditor inside 15 the business. And so, therefore, the observations 16 were conducted from the outside. 17 The majority of the observations were 18 conducted unannounced. There was 21 hours after the 19 decision and recommendation was issued that the 20 auditor was out there over various times. I believe 21 there was 11 times that they went out that covered 21 22 hours. In addition, they did cover one entire day, 23 which was April 14th of 2015. 24 The results of adding all of those 25 observation tests together was that the taxpayer was 26 selling to approximately 10 customers per hour. 27 The taxpayer also provided what they call 28 guest -- I'm going to call them sales invoices. 12 1 Guest checks is what they provide, or how they show 2 the sales. Those were provided to the Department in 3 two different -- at basically two different times for 4 that same day. Initially, they gave us 68 guest 5 checks, and then they gave us an additional 13 at a 6 later -- well, they gave us a schedule that listed 13 7 additional ones at a later time. 8 The results of that was the average sale was 9 calculated at $47.99. Which is somewhat below what 10 the average dispensary in Southern California sells 11 per transaction. The average, based on Marijuana 12 Business Daily, for 2015 is $70 an hour. So we're at 13 just under $48 for this audit. 14 The credit card receipts, the taxpayer 15 started collecting -- or started accepting credit 16 cards in October of 2009. Now, this isn't something 17 that's usually done in this particular industry, just 18 because of the banking laws, that the credit card 19 companies will not issue or allow credit cards to be 20 used if they know that you're in the business of 21 selling marijuana. But in this case they did accept 22 credit cards starting in 20 -- I'm sorry -- 2009, 23 October. 24 It appears based on the receipts from the 25 credit cards that it was ramping up and became fully 26 implemented, I would say, in the third quarter of 27 2010. And that's really what a lot of -- a lot of 28 the dispute comes over. Not all the dispute. 13 1 There's more to how the taxpayer calculated that the 2 Department disputes. 3 But the first quarter and second quarter 4 2010 credit card receipts were substantially below 5 what it was in the rest of the audit period, the 6 remaining audit period. 7 The Department used what the -- we used a 8 credit card percentage using the first quarter of 9 2011. And so what we did is we established what the 10 sales were for the first quarter by taking 10 sales 11 an hour, and they're open for 10 hours a day, and 12 they were open 89 days in the first quarter of 2011. 13 So we took 10 times 10 times 89 to come up 14 with the sales worth for that quarter. We subtracted 15 out what the credit card receipts were, came up with 16 a difference, which we considered to be cash sales, 17 and then established a credit card percentage. 18 Now, using the first quarter -- for the four 19 quarters that we used, using the first quarter of 20 2011 to establish the percentage was in the 21 taxpayer's favor, because that was the highest amount 22 of credit cards that they had received during that 23 one-year fiscal period. 24 So the one -- so to go backwards, the 25 Department did take into consideration that the 26 business was building up. And how we did that is we 27 took the established audited sales for the third 28 quarter of 2010 and subtracted 10 percent of that and 14 1 used basically 90 percent of those sales for the 2 second quarter of 2010. And we kept doing that for 3 each quarter until we got back to the first quarter 4 of 2008. 5 So there was a substantial reduction in 6 sales from the first period of the audit period 7 through the second quarter of 2011. 8 The taxpayer uses in their analysis our 9 sales for Tuesday to justify their sales. On these 10 type of businesses generally the sales on Sunday, 11 Monday and Tuesday are your lower days of sales. 12 It's somewhat similar to the restaurant industry in 13 that starting on a Tuesday through Saturday generally 14 the sales are ramping up. And then they come back 15 down after the weekend. 16 So in regards to the penalty, a penalty was 17 applied. This is the taxpayer's first audit. The 18 reason that it was applied, the understatement cannot 19 be attributed to the taxpayer's bona fide and 20 reasonable belief that the bookkeeping and reporting 21 practices were sufficiently compliant with the 22 requirements of the sales and use tax law. The 23 percentage of error based on the Department's 24 calculation is 371 percent. Even using the 25 taxpayer's -- or the figures they came up with, the 26 percentage of error is still 160 percent. 27 For -- when the taxpayer was notified of 28 audit, they reported in the second quarter of 2011 15 1 $304,000 in sales. Their average sales before that 2 was $31,000. And the quarter right before the first 3 quarter of 2011 was just $100-and-something thousand. 4 So there was a substantial increase in sales after 5 they were notified of audit. 6 The taxpayer had not claimed any deductions 7 during the audit period, there was no evidence on 8 their application that they showed that any sales 9 would be exempt from tax. The credit card receipts 10 for three-year -- I'm sorry -- three-quarter period 11 was 362,000 for the third quarter '10, fourth quarter 12 '10, and first quarter of '11. The taxpayer reported 13 209,000 in sales. So not only did they not report 14 any cash sales, they didn't report all of their 15 credit card sales. 16 For the earlier periods of the audit, some 17 periods they reported only $6,000 for an entire 18 quarter. They were open essentially 900 hours. So 19 when you do the math, it doesn't come anywhere close 20 to what their sales would have been. 21 Even in the earlier periods when you have 22 the sales reported of $38,000 for a quarter, based on 23 being open for 900 hours during the quarter, it only 24 comes out to an average of $40 an hour in sales. 25 If customers are purchasing on an average of 26 $47 a transaction, or $48 a transaction, they had 27 less than one customer an hour that they reported 28 sales on. 16 1 So, accordingly, the Department concurs with 2 the Appeals Division decision and recommendation. 3 MS. HARKEY: Thank you. 4 You have five minutes for rebuttal. 5 MR. McCLELLAN: Thank you. 6 I certainly agree with the Department in 7 some respects in this case. One being auditor 8 safety. It wouldn't be fair to force an auditor to 9 be in a position where their safety was compromised, 10 no matter what the liability at stake would be, in my 11 opinion. 12 But in this case the Department performed 13 the one- to- two- hour tests prior to performing the 14 full day. So, to me, if there was a concern for 15 their safety, then they wouldn't have sat there for 16 an entire day. 17 Of course it was agreed that the auditor 18 could remain in their vehicle or somewhere else 19 outside of the store. That wasn't disputed. 20 So we don't really see that there was any 21 evidence, I suppose, that supports that there was a 22 legitimate safety risk for the auditor. 23 Ultimately, the Department published a 24 memorandum dated October 28th, 2015 to address these 25 very issues. A sit-in test inherently is flawed. 26 And we can see that this business and our client 27 concedes that it didn't do a great job maintaining 28 records. It was a relatively new business; a 17 1 relatively new industry. 2 The ownership did change towards the end of 3 2009. And you can see a change in the reporting. 4 You can see that there were, from that point forward, 5 a better effort and better records that were 6 maintained. 7 But ultimately what we're asking here in 8 part is that the decision of recommendation be 9 followed. Which is odd, because most of the times we 10 come here, we're arguing against the D&R. 11 And we're also asking that the procedures 12 that are in place to try to help avoid these sorts of 13 scenarios -- there's always unique circumstances. 14 But ultimately, the way I see it is policy is 15 established in an effort to come up with the best 16 possible solution, maintaining some efficiency. So 17 where that landed was a full three days of time that 18 the observation be performed. 19 And even three days, when you look at it in 20 the context of a three-year audit period, it's less 21 than one percent. And it's typically always being 22 performed after the fact. So a period in which the 23 test is being performed where the auditor is actually 24 there, you have to think about and consider whether 25 or not it was different before the auditor was there 26 during the audit period. 27 And in this case we have a significant 28 change in that approximately 60 percent of the 18 1 dispensaries closed after the timeframe in which the 2 auditor showed up. So there's much less competition. 3 In the memorandum it -- what it states is 4 that the purpose of establishing the three-day rule, 5 and making certain that there's three full days, is 6 when you're avoiding the fluctuations in a single 7 day. Of course in business we will have times where 8 it's busy during the day, and times that it's slow 9 during the day. And we can't find any science behind 10 or any meaning behind the random days that were 11 selected in the short periods of time where the tests 12 were performed. 13 Ultimately, the purpose of the memo was to 14 promote consistency and prove efficiency, and to 15 involve the taxpayer in the testing process. 16 We had discussed with the Department our 17 desire to have the taxpayer involved, because we 18 wanted to assure that it was as accurate as possible. 19 So what we discussed was having the taxpayer present. 20 And on what we proposed was on an hourly basis, that 21 that person take receipts that are generated, as 22 they're generated, out to the auditor, so the auditor 23 could record them. With the idea that if somebody 24 came into the location but didn't actually buy 25 something, that that would be noticed through the 26 receipts. And that ultimately the test, in our eyes, 27 would be more reliable for that purpose. 28 There's no conceivable reason not to 19 1 disclose in this particular case, that we can think 2 of, not to disclose the time and the date that the 3 auditor would be there. Because ultimately the test 4 was intended to and designed to count the number of 5 people that were coming into the store. So I don't 6 know how you can possibly affect that as a taxpayer. 7 Ultimately the people who are going to come are going 8 to show up no matter what. 9 In the end, I think to some degree this 10 boils down to a -- I suppose a difference in the 11 interpretation or the impact of the change after the 12 ordinance. 13 We think it had a greater impact. The 14 Department concedes there was an impact, makes an 15 allowance for 10 percent each quarter going back, and 16 we think when you look at the credit card deposits, 17 it's not a situation where people were getting used 18 to ramping up their credit card sales. 19 If you look at the credit card deposits, for 20 example, from January 2010 -- or from, I'm sorry, 21 March of 2010 through May of 2010, so a three-month 22 timeframe, there -- there are 12,221, 12,209, 12,269. 23 Then this ordinance takes effect, and the credit card 24 sales are 25,210. And they go up from there. 25 So it seems to us it's very clear the 26 reduced competition coincides with the significant 27 increase in the credit card deposits, which can't 28 really be disturbed by the taxpayer in any known way. 20 1 It's third-party information, and that it's reliable 2 information, and should be relied upon in the audit. 3 And we do rely upon it in the alternative approach 4 that we made. 5 Unless Mitch has something to add, we would 6 ask you to grant our request to apply or establish 7 the audit liability based on our alternative 8 approach. 9 Thank you. 10 MS. HARKEY: Members, any questions? 11 MS. MA: Question. 12 MS. HARKEY: Yes, Member Ma. 13 MS. MA: Yeah, I have a question. 14 So in the -- to the Department, in the D&R 15 appeals conference it says was held on July 1st, 16 2014. Decision of recommendation was issued 17 November 21st, 2014 recommending the Department 18 prepare a reaudit to conduct an observation test that 19 includes two entire days, one of which should be a 20 weekday, and a weekend day, right? 21 And then it appears that the Department 22 disregarded that and just did whatever they wanted to 23 do; is that correct, or -- 24 MR. LAMBERT: No, I wouldn't say that's 25 correct. Well, I would say it appears that way, yes. 26 So I would agree with you there. 27 MS. MA: Okay. 28 MR. LAMBERT: That's not what happened. 21 1 We -- it's not just with this taxpayer, it's with 2 this industry overall that we have concerns about the 3 safety of employees. And so the conference holder 4 was contacted and was discussed this before the 5 observation tests were conducted. So Appeals was 6 aware of us not agreeing with doing complete days. 7 We did look -- we did, on the 21 hours, 8 include some weekend days during our observations 9 that we went out there. But the whole reason we 10 didn't do it is because of the safety. And the 11 conference holder was made aware of that 12 beforehand. 13 MS. MA: Okay. I know we've had cases 14 about, you know, consistent days and, you know, not 15 whatever hours during the day of the weeks. I mean, 16 that doesn't seem that it's consistent. 17 And then this October the 28th, 2015 memo -- 18 MR. LAMBERT: Yeah. 19 MS. MA: -- that was written by our 20 Department saying that we are following, you know, 21 full days, right? 22 MR. LAMBERT: That's correct. 23 MS. MA: Because I think we've had a lot of 24 issues here at the Board, you know, with partial 25 days. And this is the first time I've actually heard 26 just hours in a day -- 27 MR. LAMBERT: Right. 28 MS. MA: -- that the auditors have been out 22 1 there. Which is a little bit, you know, weird for 2 me -- 3 MR. LAMBERT: Okay. 4 MS. MA: -- just to pick hours where they 5 sit there for an hour, and then they come back. Sit 6 for an hour, come back another day. How is that good 7 audit policy? 8 MR. LAMBERT: Well, here's -- the problem 9 is, you know, kind of the circumstances dictate what 10 the problem is. And, you know, having the situation 11 where you can't rely upon the taxpayer's records 12 causes us to verify the figures in some other manner. 13 The problem is in this type of industry, 14 because it's mainly cash that's used, the receipts 15 are difficult to trace. There's not a name on the 16 receipts when you purchase something from them. 17 Well, when they -- when the dispensary purchases 18 their supply, it's hard to verify the purchases that 19 are being made. 20 MS. MA: No, I -- I understand that. 21 MR. LAMBERT: Yeah. 22 MS. MA: But I'm just saying when you sit 23 outside for an hour -- 24 MR. LAMBERT: Right. And so this is the 25 way -- 26 MS. MA: -- at a time, why wouldn't we, you 27 know, like any business -- cause I know we've done 28 that before. We've sat outside restaurants, and 23 1 we've said, "Hey, are we -- 2 MS. HARKEY: It's not a restaurant. 3 MS. MA: I get it's not a restaurant. But 4 how is that -- 5 MR. LAMBERT: Right. 6 MS. MA: Is this the new procedure that the 7 auditors are -- 8 MR. LAMBERT: I believe it is. And this is 9 the way that it should go -- that the Department 10 believes it should go, because the concern is that 11 there should be three days of testing, and they 12 should cover all hours of the day. 13 So you would have -- say you're open from 14 10:00 in the morning until 8:00 o'clock at night, you 15 should have three hours in your testing that covers 16 the period 10:00 to 11:00 o'clock. And the same 17 thing with 11:00 to 12:00. They're just going to be 18 on different days at different times. 19 But I don't -- unfortunately, that's kind of 20 where we are, because of the safety issue that -- and 21 if you can get by the safety issue, and there are 22 situations where the taxpayer will let us inside, and 23 the Department is willing to go inside, then I think 24 it's okay to do the three-day test. 25 But when you have situations where people 26 either feel unsafe both to their person and to their 27 health, then you're in the situation where we're 28 trying to make the best of what we have. 24 1 MS. MA: And how many people sit outside 2 during the observation test? 3 MR. LAMBERT: As far as -- in terms of our 4 auditors? 5 MS. MA: Mm-hm. 6 MR. LAMBERT: Well, there were two, but they 7 switched. So one did it for a period of time, and 8 then another one came and took over for them at least 9 for the full day. 10 MS. MA: I'm just trying to verify that 11 these numbers are right. When people are driving by, 12 you know, they can say, "Oh, yeah, 12 people went 13 by," or, you know -- are there two people like 14 verifying how many people are going in and out? 15 MR. LAMBERT: It's not my understanding 16 that -- during the 6 hours of testing and the 21 17 hours of testing, I do not believe there were two 18 people there. And, in fact, the 10-hour testing, it 19 was one person at a time, but they were there at 20 different times. 21 Now for the 10-hour, we did go back and take 22 a look at the taxpayer, ultimately, the records they 23 gave to us, and it matched the number of people that 24 were said to have gone in there and made purchases. 25 MS. MA: Okay. 26 MR. LAMBERT: So that verified. 27 But from the auditor and what I discussed 28 with him, or what he told me is he takes a look, in 25 1 this particular case, the people that went into the 2 business, and the ones that came out with a bag. And 3 that he recorded that as a sale for that. And so 4 that's how he did it. 5 MS. MA: Okay. I'm sure there's 6 questions. 7 MS. STOWERS: Madam Chair. 8 MS. HARKEY: Yes, Member Stowers. 9 MS. STOWERS: Thank you. 10 To the Department, you said something about 11 the customers going in and coming out with a bag, and 12 that's how it was decided at least for the hourly 13 test. 14 MR. LAMBERT: Right. 15 MS. STOWERS: That it was a sale. Have you 16 guys established that as a policy? Because I recall 17 at least prepping for a case, and the observation 18 test was based on customers coming in and customers 19 coming out with a bag. And I also believe that it 20 was not three full days of observation, it was 21 somewhat sporadic like this particular case. 22 MR. LAMBERT: Right. Well, there's a 23 difference in the audits took place. Because 24 actually this audit took place before the memo went 25 out. So at that time it was only required for two 26 days was a minimum. And then it was increased to 27 three days in 2015. 28 And we've tried to change -- well, we've 26 1 changed our procedures. But for the ones that 2 were -- the audits that started before the memo came 3 out, if we came back to that, we would try to do an 4 additional test, if that was at all possible to do. 5 So this one took place before the three-day 6 memo was out. And so they only told us to do two 7 days. But in effect what we've done is 3.7 days. 8 Because we've tested 6 hours, and then 21 hours, and 9 then the full day of 10 hours. So that adds up to 37 10 hours of testing. So we're at 3.7. 11 MS. STOWERS: Okay. So in -- my notes also 12 indicated that when you guys did do the observation 13 test in addition to noting the bag, you also noted 14 the description of the customer, and whether or 15 not -- kind of give it some accuracy that this 16 customer had on a blue shirt, and then another 17 customer went in and had on a purple shirt. 18 MR. LAMBERT: That's my understanding for 19 the 10-hour day, that that was written down for that 20 period of time. I did not see that detail for the 21 other periods. 22 MS. STOWERS: Okay. And I understand that 23 the D&R recommended to do the two days. 24 MR. LAMBERT: That's correct. 25 MS. STOWERS: To the Appeals Division -- 26 MR. LAMBERT: That's correct. 27 MS. STOWERS: -- did you guys know of the 28 Department's policy of doing only hourly observation 27 1 tests? Did you eventually agree with the Department 2 that what they did with the total of 37 hours was 3 reasonable? 4 MR. ANGEJA: We did an SD&R, in which we 5 agreed with the method that they have of accumulating 6 the proper number of hours. 7 And as Mr. Lambert had said, the Board 8 basically established and made it the policy that we 9 do three days. That was late 2015. Most of the 10 observation tests weren't yet then compliant. 11 They came up with this, hence our D&R that 12 says, go out and get the two observation days. They 13 had this policy specific to the marijuana industry, 14 which we understand to be their policy for the safety 15 concerns. And Appeals has adopted that. If it meets 16 that standard, it's acceptable to us. Not just for 17 this case, but for the other D&Rs. So we are 18 consistently allowing that policy to be the matter. 19 The Board has -- I can't remember names. 20 But the Board has had cases come before it where that 21 has been the method. And at least in prior hearings 22 it didn't come up as an objection. So we're 23 consistently applying that. 24 MR. HORTON: Madam Chair. 25 MS. HARKEY: Yes, Member Runner. 26 MR. RUNNER: Just a quick question on 27 regards to the safety issue. 28 Were there notes from the -- from the 28 1 auditor in regards to concern for safety? 2 MR. LAMBERT: Notes? 3 MR. RUNNER: Any notes that said, "I don't 4 want to do a whole day, because I'm concerned this 5 location is -- it's unsafe"? Any notes that -- 6 contemporaneous notes at that point? 7 MR. LAMBERT: I do not believe I've 8 sought -- well, I'll take that back. 9 MR. SHKIDT: There was a mention of the 10 fumes. 11 MR. RUNNER: The what? 12 MR. SHKIDT: Of the fumes and the decision 13 to test from the outside. 14 MR. LAMBERT: Right. In the, I believe -- 15 if I go back to the full 14z, I believe there were 16 those issues, but they were discussed internally. It 17 was also, the supervisor was in contact with the 18 headquarters Operations Division Chief, and discussed 19 this issue with them before the observations were 20 conducted. 21 MR. RUNNER: Okay. 22 MR. LAMBERT: And that's when it was 23 discussed with the conference holder. 24 MR. RUNNER: Tell me about what it is that a 25 taxpayer says, Okay, yeah, let's do it. And I'll 26 meet you there, and we can work this out, or, I'll 27 have my representatives there. Why is it that we 28 don't then say, Okay. Let's do that? 29 1 MR. LAMBERT: Right. In this particular 2 case, the -- or cases, the Department felt that the 3 test can be manipulated, and that's why they did not 4 notify them in advance. 5 MR. RUNNER: So we decide at that point -- 6 how would they -- that could be manipulated. Do you 7 mean if -- I mean, if you're there with the taxpayer 8 representative -- 9 MR. LAMBERT: Right. 10 MR. RUNNER: -- and doing the -- how does 11 that -- how does that -- what is -- and why wouldn't 12 we just, in the -- okay. Well, tell me how that 13 would have happened. 14 MR. LAMBERT: How it would happen? I'm 15 trying to decide how much I want to say as far as 16 letting other taxpayers know. But basically, maybe 17 the customers that show up don't end up going into 18 the business. 19 MR. RUNNER: But you're sitting outside the 20 business. What do you mean, somebody is waving them 21 off? 22 MR. LAMBERT: Well, when they're inside the 23 business, that they don't. But if you were 24 outside -- 25 MR. RUNNER: Okay. Why wouldn't we just 26 tell the taxpayer and the taxpayer representative 27 that then? Just say, "Hey, look, you know, thank you 28 for your offer, but you know what, we're not 30 1 comfortable doing it that way." Rather than just not 2 responding back? 3 MR. LAMBERT: I'm not sure the answer to 4 that question. I believe what they wanted to do was 5 an unannounced observation, which they felt would be 6 the true sales. 7 MR. RUNNER: Let me go with the taxpayer 8 representative. 9 Did the auditors or the staff ever indicate 10 to you, Hey, we don't want you there, we'd rather do 11 these unannounced? Did they give you what their 12 audit plan was at that point? 13 MR. McCLELLAN?: So the understood agreement 14 that was communicated with us, it sounds like the 15 Department communicated with Appeals after the 16 decision was written, without our knowledge, until we 17 sit here today. Which is a little frustrating. 18 But, no, we had a -- I thought a 19 professional understanding that we would have the 20 taxpayer -- we didn't anticipate going down there 21 ourselves. But have the taxpayer in the business to 22 make certain that there was a control in place so 23 that the taxpayer could periodically, every hour, go 24 out and deliver the receipts that he was receiving 25 from the customers that were walking in. So we can 26 make certain that we weren't capturing people that 27 weren't buying stuff. 28 As the Department notes, there are some 31 1 recognition of that in the test they performed. That 2 people are showing up, but they're not always buying 3 things. So Mitch called the Department numerous 4 times and e-mailed them. They had already performed 5 these one- and two- hour tests during that period of 6 communication. 7 And then on one of the last calls that he 8 had where he took it up to the supervise, took it out 9 to the District Principal Auditor, and ultimately 10 said, What's going on here? Are we going to carry 11 out the directors of the D&R? It ends up the auditor 12 is actually at the place of business performing the 13 full day. So that's how all of this transpired. 14 We felt like there was a significant lack of 15 transparency. And we couldn't figure out a reason 16 why. I don't see that there was a -- I understand 17 that sometimes there needs to be audit methodologies 18 where the taxpayer isn't tied into that. I get that. 19 This just doesn't seem like one of those cases to me. 20 I don't understand how somebody would be 21 waved away, I mean, if the auditor is sitting in the 22 vehicle. It doesn't make sense. 23 MR. RUNNER: I guess I worry -- I guess -- I 24 don't know. I mean, this is going to be somebody 25 else's problem starting the 1st. 26 But I guess I worry about an attitude that 27 says, You know what, we don't trust the taxpayer 28 representatives. I worry about an atmosphere and an 32 1 attitude of the State that has that kind of attitude. 2 We think they're going to cheat us, so we need to not 3 deal with them. 4 I would hope that we have a better 5 relationship between taxpayer reps in the state of 6 California that assume that they're going to cheat 7 us. And that seems to me the only reason why I guess 8 we chose to do it that way. 9 It just doesn't seem healthy. Especially, I 10 guess, if there's no record of any problem with that 11 particular, you know, location and whatnot. It just 12 doesn't seem like a very healthy relationship between 13 the state of California and the businesses of 14 California. I don't know. 15 MS. HARKEY: I would just like to insert 16 here before Member Horton goes. 17 The taxpayer did not keep sales records, did 18 not keep purchase records, did not report all their 19 sales to the BOE or IRS. Taxpayer only kept sales 20 invoices, guest checks for one-day observation test. 21 They run a mostly cash business, and they 22 know they are target for robbery, which is why they 23 have armed guards. 24 So just for the record I would like to lay 25 that out there. 26 And then, Member Horton, would you like 27 to -- 28 MR. HORTON: Thank you, Madam Chair. 33 1 Well, just a follow up on the records. 2 Court's have consistently held that there are no 3 prescribed methods in which the taxpayer has to keep 4 their records. It's a prescribed method in which 5 they have to report their information. So if they 6 put it in a shoe box, that is sufficient if the 7 reporting amount is correct. 8 So the D&R that was issued, was that 9 withdrawn? 10 MR. LAMBERT: It was not. 11 MR. HORTON: We issued a communication to 12 the taxpayer as to how the agency was going to 13 perform; we didn't withdraw that? So as far as the 14 taxpayer's aware, that was the agreement that the 15 agency entered into with them? 16 MR. LAMBERT: Well, what happened was there 17 was a D&R, and then subsequently there was an SD&R, 18 supplemental decision and recommendation. 19 MR. HORTON: And the supplemental was sent 20 to the taxpayer? 21 MR. LAMBERT: It was. 22 MR. HORTON: And so the taxpayer was aware 23 that the -- 24 To the taxpayer, you were aware that as a 25 result of the supplemental D&R that the previous 26 agreement was no longer in place? That they had a 27 new -- 28 MR. McCLELLAN: It was -- it was sent to us 34 1 after the fact. So we requested -- so the first day 2 was performed. We discovered that the first day was 3 performed, and then we followed up to say, "Let's 4 schedule a second day to get this done." What we got 5 in response was a reaudit, which incorporated these 6 one-hour and two-hour segments. 7 MR. HORTON: Not to interrupt you, but in 8 your time line -- 9 MR. McCLELLAN: And then we request 10 reconsideration at that point and said, "Look. You 11 didn't follow the D&R. The Department should be made 12 to follow the D&R." The supplemental then was issued 13 to confirm or to accept the Department's disregard of 14 the D&R. 15 MR. HORTON: Subsequent to the action? 16 MR. McCLELLAN: Subsequent to the reaudit, 17 correct. 18 MR. HORTON: Question to the Department. 19 Of the -- the taxpayers indicated that they 20 have a five-month test that they perform; is that 21 correct? 22 MR. McCLELLAN: What it consists of is five 23 months of sales data and credit card deposits. So 24 what we're saying is that if you use the 25 alternative -- 26 MR. HORTON: And how is that sales data and 27 credit cards developed? 28 MR. McCLELLAN: Bank deposits. 35 1 MR. HORTON: Bank deposits? 2 MR. McCLELLAN: Yes. So bank statements. 3 MR. HORTON: Did Department impeach that 4 data? 5 MR. LAMBERT: Well, the problem with it is 6 you can't verify what the sales are as far as -- 7 MR. HORTON: That's my question. Did the 8 Department impeach the data? And tell me how they 9 did that. 10 MR. LAMBERT: We didn't accept it. And the 11 reason we didn't accept it was it was inconsistent 12 with the observations that we had conducted. That 13 information was inconsistent with it. 14 And to take it one step further, there was 15 no detail on how those amounts were arrived at. 16 There's no way to verify that all the cash sales were 17 actually recorded as the cash sales. There were no 18 guest checks that were provided for those periods. 19 MR. HORTON: What was provided? 20 MR. LAMBERT: My understanding is a sales -- 21 MR. HORTON: Sales journal. 22 MR. LAMBERT: Sales summaries is my -- 23 MR. HORTON: You have the guest checks to 24 support the summary? 25 MR. STRADFORD: So we - we don't have the 26 individual guest checks which support the summary 27 data. Basically our position is even if we have all 28 the guest checks, the Department would still need to 36 1 perform some sort of a reasonability analysis to 2 determine that the recorded figures are reasonable. 3 So we provided two reasonability analyses. 4 First, the recorded credit card sales in 5 their sales journal reconciles with actual credit 6 card deposits in their bank. So credit card sales 7 are fine. 8 So then it becomes a matter of whether the 9 cash sales are accurate. So what we did is we took 10 the one full day that the Department performed, and 11 we multiplied that times the 150 days for this 12 five-month period. And it's within three percent. 13 So on that basis, you know, if the credit card is 14 good and the total is good, then the cash also would 15 be good. 16 So for those reasons, we felt that those 17 recorded sales could be relied upon. 18 MR. HORTON: Would the Department agree that 19 the credit card sales were somewhat controlled? 20 MR. LAMBERT: Yes. 21 MR. HORTON: And did you compare the credit 22 card sales in the five-month test to the credit card 23 sales in the observation test to see if they were 24 consistent, relative? 25 I mean, it would have been one way to say, 26 Okay, this data at least has some merit as it relates 27 to the credit card sales. 28 MR. LAMBERT: Well, there's no question 37 1 that -- we're not disputing the credit card sales. 2 MR. HORTON: That's not my question. 3 MR. LAMBERT: Okay. I -- 4 MR. HORTON: I -- let me share with you 5 the -- what I'm trying to get a better understanding, 6 and I'll share why. 7 There are a number of cases that this same 8 discussion has taken place in the courts. And the 9 courts have kind of fell down on the side that one 10 estimate is just as good as another estimate, unless 11 the other has been impeached. 12 And so when there's a level of consistency 13 in the credit card computations, that, in and of 14 itself, generally would cause the agency now to have 15 to sort of take another step, another look at the 16 cash somehow. At least ask some questions. 17 Otherwise, you know, one test is -- estimate is just 18 as good as another, because we're just trying to get 19 in the ball park. 20 MR. LAMBERT: Right. 21 MR. HORTON: So, again, the credit cards, 22 did the Department take a look at the credit card 23 computation during the five-month test to determine 24 if that, in and of itself, was consistent with the 25 credit card summaries examined during the -- 26 MR. LAMBERT: Not that I'm aware of did we 27 do that. 28 MR. HORTON: Okay. Did the Department take 38 1 any action to impeach the cash sales? 2 MR. LAMBERT: Yes. 3 MR. HORTON: And that was unreasonable? 4 MR. LAMBERT: Well, it showed -- how they 5 did the analysis, they used the sales from -- one of 6 the analyses, they used the sales from that test on 7 April 14th of 2015, it was approximately $3,800. And 8 so when they times it by 150 times for the number of 9 days in that five-month period, it -- it doesn't 10 match up to the sales that we have. 11 In other words -- well, it does match up 12 within three percent. The problem is that it's a 13 Tuesday, and you're using a low sales day to try to 14 verify the recorded sales for those 150 days. So it 15 would be the same thing as a restaurant. 16 MR. HORTON: Let me understand your concern. 17 Are you concerned with the methodology? Sounds like 18 you're not concerned with the methodology, you're 19 more concerned with it reconciling to the test. One 20 test is not supposed to reconcile to the other. They 21 generally don't. I mean, we're just trying to be 22 reasonable. 23 MR. LAMBERT: That's right. And so what 24 we're trying to do is take a look at the sales that 25 were made on that one observation day that was almost 26 $3,800. On the average for those five days the sales 27 is $3,200 for the average Tuesdays. And the overall 28 sales are -- average daily sales are significantly 39 1 more than that. 2 So when you take a look at the credit card 3 percentage that they come up with, and then the 4 credit card percentage that we calculated, the two 5 don't -- they're significantly different from the 6 two. And the -- 7 MR. HORTON: And you attribute that to the 8 use of a Tuesday as opposed to -- what day did the 9 Department use? 10 MR. LAMBERT: Well, we used a Tuesday. 11 That's what they're using. They're using that same 12 day to justify their figures. So we tested. 13 MR. HORTON: So every Tuesday you're 14 supposed to have the similar -- 15 MR. LAMBERT: No. 16 MR. HORTON: What's the margin of 17 difference? 18 MR. LAMBERT: Twenty percent between our 19 Tuesday and their average Tuesdays. But what they're 20 doing is they're taking that Tuesday and they're 21 saying that's an average sale for the entire 150 22 days. So they're using a low -- 23 MR. HORTON: They're extrapolating a 24 Tuesday. 25 MR. LAMBERT: Exactly. 26 MS. HARKEY: One day. 27 MR. McCLELLAN: My -- my point would be that 28 if you look at the average of the information we 40 1 have, Tuesday is right on par with three other days 2 in the week. 3 And I think it's noteworthy to point out 4 that the Department is essentially attacking the use 5 of a Tuesday as not being representative because 6 there's other days in the week. And perhaps we 7 should have other full days that are being looked at. 8 And that's our argument. 9 MR. HORTON: Well, I think that the -- the 10 Department can speak for itself. But what I hear 11 that the testimony was is that they're concerned 12 about extrapolating the other Tuesday. 13 And I get your argument that the Tuesday 14 reflects three other days, but there's seven days in 15 a week. And so those other four days may have a 16 higher margin, which should have been some 17 adjustment. 18 But even in making that adjustment, we don't 19 know what it would have been. But it seems to me 20 that if you accept their Tuesday, and accept their 21 logic that it reflects three days out of the week, 22 then we could have made an adjustment to their test 23 for the other periods that we have test periods on, 24 and came up with another estimate that would have 25 been -- I don't know what it would have been. 26 But it doesn't sound as if, though, we've 27 done enough to actually impeach their test. I 28 don't -- well, strike that statement. 41 1 It doesn't sound enough as if, though, we've 2 done enough to -- you've impeached the methodology, 3 but not necessarily that Tuesday as being 4 representative of at least three days out of the 5 week. 6 MR. LAMBERT: Right. So maybe I didn't make 7 it clear, and I'm certain I didn't, that it's not 8 really a test. It's the records. What they're doing 9 is they're using their records for five months in 10 trying to show that their records are accurate. So 11 they never tested that. That was after the fact. 12 They're coming up with what they call their 13 sales summaries that have cash sales, but you don't 14 know where the cash sales came from, if all of them 15 are recorded. And what they're trying to do is say, 16 I have all of them there. 17 And I would point out when we actually did 18 the one-day test in April 14th of 2015, they -- and 19 this was after that one-day test. They came out and 20 gave us 68 invoices. It wasn't until months later 21 that they gave us additional invoices for that. 22 Which calls into question, then, that they would have 23 their sales recorded properly for other periods. 24 MR. HORTON: So security issue. 25 MR. STRADFORD: Mr. Horton, if I may. 26 MR. HORTON: Sure. 27 MR. STRADFORD: The reason the additional 28 guest checks weren't provided on the day of the 42 1 observation is we were waiting for the reaudit to be 2 formalized to prepare a request for reconsideration. 3 And one of the issues in the reaudit is 4 they -- the D&R didn't say to change the average 5 selling price, but they computed an average from the 6 guest checks that were provided, and it went up. 7 So as part of our request for 8 reconsideration, I noticed they didn't have all the 9 guest checks. And at that point that's when we 10 provided them to the Department. 11 So it wasn't really -- it was just a 12 miscommunication. I think the auditor probably left 13 before the taxpayer came out with like the last bunch 14 of receipts. 15 MR. HORTON: Okay. 16 MR. LAMBERT: Well, what I would point out 17 at the -- when the reaudit was performed they 18 argued -- their argument was the number of customers 19 was lower than what we had recorded, and they 20 believed that we were recording sales that didn't 21 actually take place. 22 When the 13 came in, it was basically to 23 lower the average sales from $50 down to 47.99. 24 Actually they wanted, I believe, $45. But Appeals 25 adjusted it. 26 MR. HORTON: Yeah. I mean, the Department 27 has put -- in my mind, put the Board at somewhat of a 28 disadvantage. And what we may want to consider is 43 1 establishing a process by which we do these types of 2 tests. At least in my experience when you have these 3 kinds of discrepancies, we take it to another level, 4 say, Well, okay. Let's do a cost of living analysis. 5 Let's do another observation. 6 There's clear discrepancies between the two. 7 But there are discrepancies on the Department side, 8 discrepancies on the side of the taxpayer. That 9 seems to me we could have worked something out and 10 kind of figured all that out. 11 And so in the security issue -- is there a 12 reason we didn't put a keeper in, if the agency -- if 13 the taxpayer would agree to that, put a keeper in, 14 verify the sales. 15 Keeper generally has, you know -- we 16 generally have a highway patrol there playing close 17 so they don't scare away all of the customers, you 18 know, raggly jeans and the whole bit. I don't know. 19 We have to come up with something to be able to 20 address this. 21 I am concerned about the lack of records in 22 this industry. The records don't exist. But it 23 further concerns me that in the absence of the 24 records that the agency doesn't necessarily go the 25 extra mile when there is a disputed test out there. 26 Any way, that's all my comments for now. 27 MR. RUNNER: Ms. Stowers. 28 MS. STOWERS: Thank you, Madam Chair. 44 1 That's interesting. A keeper. Just my 2 thoughts, I thought a keeper was more of a collection 3 tool and not an audit tool. 4 MR. HORTON: Well, we've used it both ways. 5 Under the circumstances where there are security 6 issues, and we've used it -- I mean, I -- both ways 7 not often because of the extra expense and the extra 8 intimidation. 9 MS. STOWERS: Okay. 10 MR. HORTON: But, I mean, if there's 11 security issues, one might think just to protect our 12 employees, we might want to go that extra step. 13 MS. STOWERS: Okay. I want to go back to 14 the petitioner. 15 You said that you did a method of what the 16 sales should be, and that's where you came up with 17 your credit card sales to total sales ratio. And you 18 provided your calculation to the Department. Did you 19 provide any source documents that the Department can 20 verify that amount to? 21 MR. STRADFORD: No, we didn't. The sales 22 journals themselves were actually incorporated in the 23 original audit working papers. So I presume that the 24 sales journals were provided to the auditor at some 25 point in time, but we didn't provide any additional 26 source documentation. 27 MS. STOWERS: To the Department, were you 28 able to verify their method to be correct? Did you 45 1 have any data in your audit work papers to verify it? 2 MR. LAMBERT: You mean their calculations? 3 MS. STOWERS: Their calculation. 4 MR. LAMBERT: Was it arithmetically correct? 5 MS. STOWERS: No. Could you verify what 6 they gave? My notes here indicate that there were no 7 source documents provided to back it up, and that's 8 why you did not accept it. 9 MR. LAMBERT: That's right. There were 10 figures there. So you could write down a number as 11 far as the cash sales, and we'd have no way of 12 verifying that. 13 Now, I will say the credit card sales, you 14 know, there is a way to verify that, because that 15 money is deposited into your bank account. But 16 that's not the issue. The issue is trying to 17 determine what the cash sales were. And there was no 18 sources documents that were provided for that, and 19 there was no way to verify the figures that they've 20 provided. 21 MS. STOWERS: Okay. Okay. Thank you. 22 MS. HARKEY: Okay. I'm -- I'm getting 23 confused. You're both representatives, right? 24 MR. McCLELLAN: Yes, we are. 25 MS. HARKEY: Okay. That's what I thought. 26 The taxpayer's not actually here. 27 MR. McCLELLAN: He was just -- he's been 28 involved in a lot of the details, so he's got a lot 46 1 of the detailed answers. 2 MS. HARKEY: Okay. I just -- I was just -- 3 some of the answers were like "we" and what, and I'm 4 going, okay, did I miss that one? Thank you. 5 I understand this -- this -- and I just have 6 to remind everybody that this audit period was 1/1/08 7 to 6/30/11. That's quite an audit period. And I 8 think a lot of the laws that we're kind of referring 9 to, and things that we're referring to, were not the 10 case back then. 11 So this was a cash business, no books and 12 records. So I'm trying to use what -- the auditor 13 actually did a total of 37 hours. Thirty-seven hours 14 of observation tests, at which 10 hours were straight 15 sit one day. So that's over three days. 16 Store was open between 10:00 to 8:00. 10:00 17 a.m. to 8:00. I think this is just the nature of the 18 industry. We have to -- I mean, I'm sure somewhere 19 down the line BOE -- the new BOE, which is foreign, 20 will make some serious decisions as to exactly how to 21 do this. But this was a long time before we started 22 really hearing these. 23 I understand, you know, that there's a 24 discrepancy here. What I would be willing to offer, 25 because I've read through this again and again and 26 again, and we want to be sure that we're getting the 27 right amount of tax, that we're doing things. We had 28 one 10-hour test. And one 10-hour test does make a 47 1 reduction in the average customers per hour from 10 2 to 8.4. And I have here estimated that it might 3 change the audit measure by 527,000. Which is not 4 huge, but still, I think, you know, gives the -- that 5 way we can get away from circling around these 6 observation tests. We did have one solid 10-hour 7 test. 8 And as I understand it, didn't the taxpayer 9 have some input into that 10-hour test as to who was 10 coming in and out? Were they employees, were they 11 not? 12 MR. LAMBERT: That's right. We -- the 13 auditor met with them beforehand and identified who 14 was -- who was associated with the business. Then 15 they were not counted. 16 MS. HARKEY: Okay. 17 MR. LAMBERT: That's right. 18 MS. HARKEY: It's just kind of inherent. 19 It's very difficult. I'm hoping that we get a little 20 bit more accurate. 21 And the, you know, sitting outside is -- 22 because I would imagine lurking in the parking lot is 23 not necessarily a safe occupation either. So, I 24 mean, I think you have to consider all of the 25 options. 26 And going inside the facility, sometimes I 27 know that the taxpayers don't want you in there, you 28 know, to bring in a bunch of people just to sit 48 1 around might, you know, ruin some of the business. 2 So I'm just -- I am willing to -- I've heard 3 all of this, and I know we're all sympathetic trying 4 to be sure we're doing this right. But I think that 5 will come after we're gone. And this is an old 6 audit. 7 So I would be willing to make a motion to 8 accept the staff recommendation with the exception of 9 using the average customer per hours noted in the 10 full 10-hour test. 11 And that does reduce the liability. And 12 I'll let staff determine by how much. But I have 13 here roughly 527,000 of the audit measure. 14 Is there a second for that? 15 MS. STOWERS: Discussion. 16 MS. HARKEY: Well, I need -- 17 MS. STOWERS: Go ahead and get your second 18 first. I'll be quiet. 19 MS. HARKEY: Okay. If we can get a -- is 20 there a second for that? 21 Nobody. 22 Okay. That dies. 23 Go ahead and discuss. 24 MS. STOWERS: I don't have discussion now 25 because I was going to ask for clarification on your 26 motion. 27 MR. HORTON: Well, Members, I mean, my 28 objective is not to lower or raise the tax. 49 1 MS. HARKEY: Well, mine is not either, and I 2 want to clarify that. I'm trying -- the main bone of 3 contention seems to be the observation test. So I'm 4 trying to get one solid observation test that works 5 that is not -- not split days, is actually 10 hours 6 in the same day, that the taxpayer was aware of, that 7 he was able to -- or she or whoever was able to call 8 out those persons that in fact were not customers. 9 And it seems like a fair deal to me. 10 MR. HORTON: So tell me again -- Madam 11 Chair, may I? 12 MS. HARKEY: Sure. 13 MR. HORTON: Tell me again why there's no -- 14 the security concern was there. Is that going to be 15 consistent throughout the -- is that now the Board's 16 policy that with these retailers, there's going to be 17 a security concern? 18 MR. LAMBERT: That is my understanding. 19 MR. HORTON: Irrespective of where they're 20 located? 21 MR. LAMBERT: Irrespective, right. 22 MR. HORTON: Okay. 23 MR. LAMBERT: It's kind of like a bank being 24 in a good neighborhood and thinking that it won't get 25 robbed. 26 MR. HORTON: They actually get robbed in the 27 better neighborhood to be quite frank with you. They 28 sort of presume there's more money there, you know. 50 1 MR. LAMBERT: So -- right. So it's 2 difficult. I mean, it's just a -- it can -- because 3 of the cash that's involved and the product -- 4 MR. HORTON: No, I'm not arguing. I follow 5 the security concerns. I mean, I think the same 6 level of concern for security at the site should 7 be -- we should pass that onto our employees at each 8 location and make sure that the measures are there. 9 But if that's going to be a standard 10 practice, then we need to have standard alternatives 11 in order to be able to address that. So -- and 12 procedures. Because we sort of made these procedures 13 up on this audit. And that's what's concerning. And 14 I think this may actually be an opportunity to do 15 that where -- what was your credit card to cash 16 ratio? 17 MR. LAMBERT: Ours was -- they came up with 18 the cash as 1.96 times the credit card. 19 MR. HORTON: And what was -- 20 MR. STRADFORD: So ours was I think like 21 40.7 percent. Which compared to theirs, theirs is 22 about 33 or 34. So 40 to -- theirs was 33 or 34, 23 ours was approximately 40. 24 MR. HORTON: Seven percent margin. 25 MR. STRADFORD: Yes. 26 MR. HORTON: Yeah. In a normal environment 27 I would recommend a 30/30/30, and that the Department 28 establish an agreed-upon method that both parties 51 1 agree to, and that we just live with whatever that 2 method is. 3 And so it provides me a level of concern 4 that there was an agreement, and that agreement was 5 breached for -- I don't know what the reason was, but 6 for concerns of security -- 7 MR. RUNNER: There's no reason for us not to 8 still do that. 9 MR. HORTON: -- of absorbing the product. 10 All of these are going to exist in this industry, and 11 we have got to fix this. I mean, we don't have to, 12 but there have to be standard procedures, standard -- 13 and I think the best way to do that is to establish 14 an agreement in advance and stick to that agreement, 15 whatever it might be. 16 And if there's a deviation from there, that 17 there is a legitimate -- I mean, I don't want to be 18 subjective with legitimacy, but there's a reason, and 19 everyone sort of agrees to the reason that there's a 20 deviation, and then they agree to the subsequent test 21 and procedure, and then we perform it. 22 And typically when you have these, as I said 23 earlier, you take it to the next level in trying to 24 verify that the agency's test is reasonable, and the 25 taxpayer's test is not reasonable. A seven percent 26 margin between credit card sales -- I don't know. 27 I mean, I've seen this in court, and I've 28 seen the judge just throw the Department's out and 52 1 say, Well, one estimate is just as good as another if 2 it hasn't been impeached. 3 I get the argument, and I agree when there's 4 a lack of source documents it calls to question 5 whether that -- but once that's called into question, 6 then the next step is to say, accumulate the source 7 documents, put it on a sales thing, and then we'll 8 consider that. That there are additional work that 9 could have been done by the agency in order to verify 10 or give the taxpayer an opportunity to come up with 11 the source documents, and come up with a test that 12 would have been acceptable. 13 So I really don't know what to do with this. 14 MS. HARKEY: Well, why doesn't somebody make 15 a motion? I think there's some ideas up here. 16 MR. RUNNER: Go through your motion again. 17 MS. HARKEY: My motion -- my motion was to 18 accept the Department's recommendation with the 19 exception of making an adjustment to use the average 20 customer per hour as noted in the full -- full-day 21 10-hour test period. Otherwise accept -- okay. Let 22 me start this again. 23 My motion is to use the average customer per 24 hour as noted in the full 10-hour test period, and 25 otherwise accept the Department's recommendation. 26 MR. ANGEJA: Staff's recommendation. 27 MR. HORTON: And, staff, what's your 28 thoughts on that? 53 1 MR. LAMBERT: Well, my one concern would be 2 that you're using a Tuesday to establish the number 3 of customers for an entire week. And that generally 4 on Sunday, Monday and Tuesday, you're going to have 5 less customers than what you would have throughout 6 the entire week. That would be my concern. 7 MS. HARKEY: I understand. I'm just trying 8 to get to an end here. 9 And so I would -- I would -- you know, I'm 10 trying to amend this. It's also been questioned as 11 to whether we would move the 10 percent negligence 12 penalty. 13 MR. RUNNER: I would second that, with 14 removal of -- 15 MS. HARKEY: So use the 10 hour -- full 10- 16 hour test period, remove the negligence penalty 17 first-time audit, and otherwise go with the staff -- 18 the Department's recommendation. 19 MR. RUNNER: Yup. I second. 20 MS. HARKEY: I have a second for that one. 21 And the 10-hour test is the only day the 22 taxpayer noticed that the results are correct. So 23 that's kind of another reason to go there. 24 MS. STOWERS: Madam Chair. 25 MS. HARKEY: Yes. 26 MS. STOWERS: So staff recommendation 27 included reducing the measure by 651,000. 28 MS. HARKEY: Yeah. I've got a total tax 54 1 interest and penalty of 380,224.09; is that still 2 correct? The total -- the understated taxable sales 3 of 2,596,125. 4 MR. LAMBERT: That's correct. 5 MS. HARKEY: Okay. So I think I've got an 6 updated version. 7 So the updated version says the understated 8 taxable sales of 2,596,125,taxes determined, 9 243,619.79; interest through June of 2017 is 10 112,242.29; 10 percent negligence penalty is 11 24,362.01; total interest -- total tax interest and 12 penalty is 380,224.09. 13 I am suggesting that we reduced the -- that 14 we accept -- or that we use the average customer per 15 hour as noted in the full 10-hour test, which reduces 16 the liability. And we also remove the 10 percent 17 negligence penalty. 18 MS. STOWERS: Can you separate those two 19 motions? 20 MS. HARKEY: Sure. Okay. We can use the -- 21 let's go with the first motion. 22 Motion one -- we're going to bifurcate 23 this. 24 Motion one is to use the average customer 25 per hour as noted in the full 10-hour test. 26 And do I have a -- 27 MR. RUNNER: Second on that. 28 MS. HARKEY: And we have a second on that. 55 1 Is there any objection to that? 2 No, I don't see an objection. 3 Okay. So the next -- the next one is to -- 4 the next motion is in addition then, after motion 5 No. 1, in addition to reduce the liability by the 6 10 percent negligence penalty. Remove the 10 percent 7 negligence penalty. 8 MR. HORTON: Madam Chair, I'd like to hear 9 from the taxpayer's representatives on -- 10 MS. HARKEY: We can't go back. We've got a 11 motion and a second. We're making motions now. So 12 it's not time to go back to the floor. 13 MR. HORTON: Then let me share my objection 14 to the first motion. 15 This seems just to be completely arbitrary. 16 And the methodology, I agree with the Department. 17 That methodology in itself is inconsistent. I don't 18 know if it's higher or lower. That's not my concern. 19 My concern is to assure that we are using an 20 equitable policy, procedures and methods. 21 I actually have some concurrence with the 22 taxpayer's method in that the need to actually go 23 back and verify that and adjust for the differentials 24 in the days, whether slow days and fast days. It 25 just seems to me there could have been more work done 26 to this. And, quite frankly, I would recommend a 27 30/30/30. But I get, you know, a motion is made and 28 so forth. 56 1 MS. HARKEY: We have a motion and a second. 2 Sounds like we have an objection on motion No. 1. 3 Ms. Richmond, will you please call the roll. 4 MS. RICHMOND: Chairwoman Harkey. 5 MS. HARKEY: Aye. 6 MS. RICHMOND: Mr. Runner. 7 MR. RUNNER: Aye. 8 MS. RICHMOND: Mr. Horton. 9 MR. HORTON: No. 10 MS. RICHMOND: Ms. Ma. 11 MS. MA: Aye. 12 MS. RICHMOND: Ms. Stowers. 13 MS. STOWERS: Aye. 14 MS. RICHMOND: Motion carries. 15 MS. HARKEY: Thank you. 16 Okay. The second -- the second item is in 17 addition to what we just voted on, which was to use 18 the average customer per hours noted in the full 10- 19 day hour test, and otherwise accept the staff's 20 recommendation or Department's recommendation. 21 We also want to include second motion is to 22 remove the 10 percent negligence tax penalty. 23 Do I have a second for that? 24 MR. RUNNER: Second. 25 MS. HARKEY: I have a second for that. 26 MS. STOWERS: Objection. 27 MS. HARKEY: One objection. 28 Ms. Richmond, will you please call the 57 1 roll. 2 MS. RICHMOND: Chairwoman Harkey. 3 MS. HARKEY: Aye. 4 MS. RICHMOND: Mr. Runner. 5 MR. RUNNER: Aye. 6 MS. RICHMOND: Mr. Horton. 7 MR. HORTON: Aye. 8 MS. RICHMOND: Ms. Ma. 9 MS. MA: For the motion -- 10 MR. RUNNER: Yes, with the negligence -- 11 MS. MA: Oh, aye. 12 MS. RICHMOND: Ms. Stowers. 13 MS. STOWERS: No. 14 MS. RICHMOND: Motion carries. 15 MS. HARKEY: Okay. So both motions 16 carried 4/1. A little division in the Board. 17 But thank you very much. And thank your 18 staff for your work. 19 ---o0o--- 20 21 22 23 24 25 26 27 28 58 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, Jillian Sumner, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on June 20, 2017 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 20 14 constitute a complete and accurate transcription of 15 the shorthand writing. 16 17 Dated: February 5th, 2020 18 19 20 ____________________________ 21 JILLIAN SUMNER, CSR #13619 22 Hearing Reporter 23 24 25 26 27 28 59