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 NOVEMBER 16, 2016 10 11 SALES AND USE TAX APPEAL HEARING 12 APPEAL OF 13 D & H DISTRIBUTING 14 NO. 916046, 977893, 997311 (OH) 15 AGAINST PROPOSED ASSESSMENT OF 16 SALES AND USE TAX 17 18 19 20 21 22 23 24 25 26 27 Reported by: Jillian 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 Sen. George Runner (Ret.) 6 Member 7 Yvette Stowers Appearing for Betty T. 8 Yee, State Controller (per Government Code 9 Section 7.9) 10 Joann Richmond Chief 11 Board Proceedings Division 12 For California 13 Department of Tax and Fee Administration: 14 Scott Claremon Tax Counsel 15 Steven Smith Tax Counsel 16 Kevin Hanks Tax Counsel 17 18 For Appellants: Marty Dakessian Attorney 19 Robert Miller Representative 20 21 ---oOo--- 22 23 24 25 26 27 28 2 1 5901 GREEN VALLEY CIRCLE 2 LOS ANGELES, CALIFORNIA 3 NOVEMBER 16, 2017 4 ---oOo--- 5 MS. RICHMOND: C13, D & H Distributing. 6 This case was granted an additional ten minutes for 7 the opening brief -- for the opening presentation, 8 and an additional five minutes on rebuttal. 9 MS. HARKEY: Thank you very much. Let's get 10 the Department all set up here. 11 Are we good? 12 Yeah. So it's 20 minutes. All right. 13 Mr. Angeja, the items in this case. 14 MR. ANGEJA: Madam Chair and Members, the 15 appeal before you involves two unresolved issues, 16 which are whether additional adjustments to the 17 measure of disallowed, claimed nontaxable sales are 18 warranted. 19 And second, whether petitioner has 20 established and is entitled to relief of its 21 liability for the tax from drop-shipment sales due to 22 its reliance on erroneous written advice. 23 MS. HARKEY: Thank you. 24 Welcome to the Board of Equalization. You 25 have 20 minutes to present your case. The Department 26 will then have 20 minutes, and you'll have 15 minutes 27 on rebuttal. So -- or -- no -- 10 minutes, I guess, 28 on rebuttal, is it? Ten minutes on rebuttal. 3 1 And so please introduce yourself for the 2 record, and you may begin. 3 MR. DAKESSIAN: Thank you. And good 4 afternoon, Madam Chair and Members of the Board. My 5 name is Marty Dakessian. Seated to my left is 6 Mr. Robert Miller, who is the Vice President of 7 Finance at D & H Distributing. We also have in the 8 audience Mr. Ernest Meisel, who is D & H's 9 controller. Both Mr. Miller and Mr. Meisel flew out 10 here from Harrisburg, Pennsylvania to be here with us 11 today. 12 And we also have from my firm, Mr. Lucian 13 Kahn, and Mr. Ruban Sislyan sitting in the audience. 14 So I know that Mr. Angeja mentioned that 15 there are two issues before the Board. And we are 16 only going to present the second issue to the Board 17 today, which is the 6596 issue. 18 We are not going to be speaking to issue 19 one, we're going to be speaking only to whether D & H 20 is entitled, as we believe they are, to relief from 21 tax interest and penalties for the entire assessment 22 based on reasonable reliance on written advice from 23 the Board. 24 By way of background, D & H is an 25 employee-owned company, headquartered in Harrisburg, 26 Pennsylvania. D & H is a wholesale distributor of 27 consumer products, mostly computer products, which 28 include computers, computer parts, peripheral such as 4 1 monitors, printers, modems and video games. 2 In addition to its Harrisburg headquarters, 3 D & H has a number of distribution centers in the 4 United States. As relevant to this discussion, it 5 has a distribution center in Fresno, California where 6 it has about 100 employees. During the audit period, 7 it also had a distribution center in Ontario. 8 Members of the Board, I think it's important 9 to impress that conscientious taxpayers like D & H 10 work very hard to report and pay the correct amount 11 of tax. And as we all know, it's not an easy thing 12 to do in this day and age. 13 In addition to their federal filing of 14 compliance obligations, D & H has tax filing and 15 compliance obligations in all 50 states, and the 16 District of Columbia, as well as countless local 17 jurisdictions. 18 And as we know all too well here in 19 California, things are constantly changing. Things 20 are dynamic, things are in flux. So it's not easy. 21 In fact, it's very daunting to keep up with all of 22 this. 23 All the same, the taxpayers, conscientious 24 taxpayers, work very hard to keep up with all this. 25 And like any good corporate citizen, when a company 26 like this is audited, they rely upon the results of 27 an audit whether good or bad in an effort to get 28 things right. 5 1 That's where the -- that's what the name of 2 the game is for companies like D & H. It's about 3 getting things right. Because if you don't really 4 make a conscientious effort, there's peril waiting on 5 both ends of the spectrum, right? If you 6 inadvertently under-report, then you're subject to 7 tax assessment penalties. And if you inadvertently 8 over-report, there are consequences in the way of 9 consumer actions, as we've been seeing here in 10 California. 11 So this is the world in which companies like 12 D & H are trying to get things right. And getting 13 things right brings us to the underlying substance of 14 the issue today, which has to do with drop-ship 15 resale transactions. 16 And inside your binder you will find on the 17 inside flap a diagram that looks like this. Which is 18 just -- just to take a minute to go over the basic 19 structure of transaction, which is essentially a sale 20 for resale transaction. 21 In this transaction, you've got a 22 wholesaler, you've got a retailer, and then you've 23 got a consumer. And the wholesaler sells to the 24 retailer, the retailer sells to the consumer, and the 25 tangible personal property, in a typical sale for 26 resale, follows the chain of sale. It flows from 27 wholesaler to distributor -- wholesaler to retailer 28 to consumer. 6 1 What makes drop-ship transactions different 2 from ordinary sales for resale is -- and I'm making 3 an arrow here from the wholesaler diagonally down to 4 the consumer. There is a shipping component that 5 makes these transactions different from normal sales 6 for resale. And that's what creates a trap for the 7 unweary, is California's drop-ship rules, which 8 differ from normal resale rules for this specific 9 fact pattern. 10 And obviously there's a reason for doing 11 drop shipments. It's efficiency. And as long as 12 people have been shipping products in interstate 13 commerce, there have been drop shipments. It's 14 efficient. It's quicker. The end-user gets the 15 product at a less expensive price more quickly. And 16 that's -- that's sort of the rational behind it. 17 Also inside your flap I kind of created a 18 little example of what a drop-ship transaction might 19 look like. And this is just sort of a basic example. 20 And in this example we have a sale being made from 21 D & H's Harrisburg headquarters to a retailer. 22 In this case -- in this example, the 23 retailer is located in Minnesota. The retail for the 24 purposes of this example has no nexus with 25 California, and is taking the product that is 26 being -- that has entered the sale that it's entered 27 into between D & H and the retailer. And they're 28 making a resale to the end-user here in California, 7 1 right? 2 And, again, the TPP, the tangible personal 3 property, is not following that chain of sale. It's, 4 instead, for efficiency purposes, in this example, 5 D & H is using its Fresno distribution center to make 6 the shipment directly to the customer, right? 7 And under the normal resale rules, if we 8 didn't have a drop-ship resale rule, which is the 9 case in the vast majority of states in the union -- 10 if we didn't have a drop-ship resale rule, the tax 11 treatment of this would be as follows: D & H would 12 not be subject to tax, because it is a wholesaler. 13 And the tangible -- and the sales tax is based on the 14 retail sale of tangible personal property. 15 The Minnesota retailer would not be subject 16 to any tax collection obligation, because it has no 17 nexus with California. 18 And so under normal circumstances, the 19 consumer would be required to self-report the use 20 tax. But that's not the rule in California. 21 In California, the wholesaler, D & H, is 22 deemed to be the retailer. And that's what creates 23 confusion and is a trap for a lot of unweary, 24 although well-meaning, taxpayers. And it's 25 counterintuitive. You're being deemed the retailer 26 even though you're not the retailer in the true sense 27 of the term. And it's also not the norm in most 28 states. 8 1 In most states -- in fact, in 86 percent of 2 states in jurisdictions including the District of 3 Columbia and the Unite States, 86 percent of states 4 would not subject D & H to tax in this transaction, 5 including D & H's homestate of Harrisburg, 6 Pennsylvania, and the other locations in which it has 7 distribution centers. 8 Okay. California is just only one of seven 9 states, about thirteen percent, seven states out of 10 fifty-one jurisdictions -- again, including DC -- 11 that tax these transactions. 12 So when you combine this unusual rule that 13 California has with the fact that this is really sort 14 of counterintuitive, a wholesaler being deemed a 15 retailer, it creates a lot of confusion for 16 taxpayers. 17 And that leads us to why we're here today. 18 We're here today, Members of the Board, not because 19 D & H refused to follow the advice of the Department; 20 we're here because of the Department. We're here 21 precisely because D & H did follow the advice of the 22 Department. 23 D & H listened to, trusted, and implemented 24 the advice of the Department. And that advice came 25 in the form of an audit back in 1993 where the 26 Department examined D & H's claimed exempt sales for 27 resale, which included resales that had the drop-ship 28 component. 9 1 The Department, at that time, gave D & H a 2 clean bill of health and said there was no change to 3 be made to D & H's practices. 4 D & H implemented that advice until several 5 years later when the Department came back, examined 6 the same transactions, and came to the opposite 7 conclusion, assessing D & H into the millions of 8 dollars. And we have a problem with that. We have a 9 problem with that because that's not how the law 10 works here in California. 11 Under California law we have the protection 12 for taxpayers who find themselves in this 13 predicament, and it's called Rev and Tax Code Section 14 6596. And I'm sure this Board is well familiar with 15 that rule. But 6596 essentially says that the Board 16 has authority to relieve a taxpayer from tax interest 17 and penalties if a taxpayer reasonably relies on 18 written advice from the Board. 19 That's what it is at its core. And you also 20 have a regulation under 6596 called Regulation 1705, 21 that this Board drafted and promulgated. Probably 22 one of the most important things that this elected 23 Board has ever done, in my estimation, is to draft 24 and promulgate Regulation 1705. Not just because 25 it's an important protection for taxpayers, but 26 because it expresses the will of this Board to hold 27 the Department accountable in situations such as 28 these. 10 1 And the Board drafted and promulgated 2 Regulation 1705 for the exact reason that we're here 3 today, a common and repeating occurrence where a 4 taxpayer is audited by the Department, the Department 5 gives them a clean bill of health, only to come back 6 several years later and take an opposite position and 7 hit the taxpayer with a big tax bill. That's what 8 Regulation 1705 is designed to prevent, or at least 9 to remedy. 10 And Regulation 1705 -- and it's behind tab, 11 I believe, five of your materials. Tab 5 page 2 of 12 your materials. 13 Regulation 1705 is a rather detailed 14 regulation, but the heart of it is the part that I've 15 highlighted. Which is that audit work papers, which 16 reflect that the activity or transaction in question 17 was properly reported and no amount was due, are 18 sufficient for a finding for relief from liability. 19 If you break that down into a checklist, 20 these are the three elements. 21 Let me stand on the side so the Department 22 can see it. 23 You have to show, in order to obtain relief 24 under Regulation 1705, written evidence and a prior 25 audit report. That evidence has to reflect that the 26 transaction or activity in question was examined, and 27 you have to show that no amount was due. 28 If you can satisfy these three requirements, 11 1 you're entitled to relief under Regulation 1705. And 2 we're going to prove to you that we meet each of 3 these three requirements. 4 First -- this is harder than I thought -- 5 let's take a look as to whether we actually have 6 written evidence in the form of prior audit. We 7 actually do. We have written evidence. 8 Not working too well, but that's a 9 checkmark. 10 Let's skip No. 2 for a second, because I 11 suspect that's where the Department is going to have 12 the most contention here. And let's move to No. 3 13 for just a moment. 14 We show that no amount was due. Yes, we 15 can. We can show no amount was due just by looking 16 in the upper left-hand corner of the first page of 17 the audit report. There we see a notation for BOE 18 form 414-C. 19 Why is that important? Because BOE form 20 414-C -- you can't see this, but it is behind -- it 21 is behind tab 6 of your materials. 22 BOE form 414-C is used for every audit, 23 active or closed out, made of a taxpayer's records, 24 which result in a no-change recommendation. 25 So just based on the fact that it's on that 26 form, we know that a no-change was entered. That may 27 be stating the obvious at this point. But there's a 28 couple of other things in this section of the audit 12 1 manual that I'm calling out, Section 0211.03 and .06, 2 that are very important. 3 It says here that the Department should 4 be -- it is very important that all comments 5 supporting exempt transactions on this form be 6 accurate and fully supported, as this information may 7 be used by the taxpayer at a later date to seek 8 relief from liability under Regulation 1705 and Code 9 Section 6596. 10 So let's just let that marinate for a 11 moment. We have here a form that is only used for 12 no-change audits, and that your Board fully expects 13 taxpayers will rely upon, and expects to relieve 14 taxpayers from tax interest and penalties if they 15 rely on this form. This is a very important part of 16 the audit manual. 17 So we can check off the second box -- the 18 third box, rather. No amount was due. 19 And that leaves No. 2. Can we show that the 20 transaction in question was examined, and it was 21 shown that in the examination was properly recorded? 22 Yes, we can. And our evidence to prove this 23 second prong of the test is in three categories, 24 documentation in the form of the prior audit report, 25 attestation in the form of Robert Miller's testimony, 26 and a concession on the part of the Department that 27 we'll get to late in our presentation in our case in 28 chief. 13 1 So first let's go over our documentation 2 again. Behind tab 1 we have the no-change audit 3 report. And in the no-change audit report, I'll call 4 your attention to about two-thirds of the way down on 5 the first page where we see that resale transactions 6 were examined. 7 Why is that important? Because D & H 8 claimed these drop-shift transactions as exempt sales 9 for resale on its return. And this was a category of 10 transactions that was examined. So very important. 11 I would submit to you that just based on 12 this first sheet of the audit report, we're done. We 13 have shown the category of transactions was examined, 14 drop ships were in that mix of transactions. I think 15 we're finished. But let's continue on and look at 16 the third page behind tab 1 where the Department 17 explains its process, right? 18 It says resales were verified by auditor 19 spot test covering fourth quarter of '91 and third 20 quarter of '92. So we know that a spot test was 21 conducted for basically a half-a-year's worth of 22 transactions. 23 And we also know that based on Mr. Miller's 24 testimony, which he will -- he will reaffirm later 25 today, that drop ships were part of that mix. In 26 fact, in the current audit, drop ships were basically 27 one in every four transactions, right? 28 And so we know that -- at least common sense 14 1 would tell us that if the taxpayer claimed exempt 2 sales for resale on the return, that drop shipments 3 were included in that claimed exemption. And the 4 Department examined a half-a-year's worth of 5 transactions, the drop ships are gonna be in there. 6 Okay? 7 We have down here, if we continue on, we can 8 see what the Department looked at. And this is also 9 important. It says the auditor obtained 10 substantiation such as a properly completed resale 11 certificate or a purchase order indicating that the 12 products were for resale. No exceptions were noted. 13 So now we know that the Department, by 14 virtue of examining resale certificates and purchase 15 orders, had all the documents they needed to make a 16 determination as to whether these drop-ship retails 17 were subject to tax. They had the documents they 18 needed. 19 And if you go down here -- this is back on 20 page 2 behind tab 1, which I've highlighted. This is 21 the verification of the reported taxable measure. No 22 errors were noted in the reported taxable measure. 23 Had the reported taxable measure been off, then staff 24 would have made that notation. 25 The drop ships were disallowed in this 26 audit, then the claimed exempt resales would have 27 gone down and the reported taxable measure should 28 have gone up. So we have some important pieces of 15 1 information here. 2 The other thing I would note about this is 3 that this audit was certified by three different 4 employees of the Department. The auditor David 5 Perlow (phonetic), the supervisor Michael Cobb 6 (phonetic) and the district reviewer Landon Carr 7 (phonetic). So this audit was reviewed and certified 8 by three people in the Department. So we think 9 that's very important to note as well. 10 So we believe we have sufficient 11 documentation to be entitled to relief under 12 Regulation 1705. 13 The second category of evidence we have is 14 Mr. Robert Miller's testimony. Mr. Miller is here 15 today to reaffirm the written testimony he has 16 already provided to the Department in the form of 17 declarations, which you should have in your 18 materials. 19 And Mr. Miller's testimony falls into three 20 basic points, right? Mr. Miller will testify that 21 the drop-ship resales were claimed as an exemption on 22 the tax return. Mr. Miller will testify that the 23 Department, during its examination, must have come 24 across drop-ship resales because of the prevalence of 25 drop-ship resales during the prior audit. 26 And Mr. Miller will further testify that 27 D & H faithfully implemented the Department's advice 28 going forward, until, of course, the prior audit, 16 1 when they were notified they were not doing things 2 correctly with respect to drop shipments. 3 And then, Members of the Board, the last 4 piece of evidence we want to bring to your attention 5 has to do with something that struck me as very, very 6 important that the Department wrote in response to 7 our briefing at the lower level. And this is -- let 8 me call your attention to tab 3 of your materials. 9 The Department basically says that drop 10 shipments probably occurred in the prior audit. 11 So let's just -- let's just process that and let that 12 sink in. Right? 13 The Department examined a half-a-year's 14 worth of claimed exempt resales, the Department 15 acknowledges the drop shipments were probably a part 16 of that audit, and the Department entered a no 17 change. What more is there to discuss really? 18 MS. RICHMOND: Time's expired. 19 MR. DAKESSIAN: Well, we can end on that 20 note. 21 MS. HARKEY: Thank you. 22 To the Department, please announce yourself 23 for the record and then begin. 24 MR. CLAREMON: Thank you. 25 Good afternoon, Chairwoman Harkey and 26 Members of the Board. I'm Scott Claremon with the 27 Department of Tax and Fee Administration. With me 28 are Steven Smith and Kevin Hanks. 17 1 We concur with the recommendation of the 2 Appeals Bureau that no further adjustment is 3 warranted to the audited measure of tax. 4 Petitioner sells consumer products mostly 5 for resale, and ships these products to facilities 6 located within and outside of California. For the 7 audit period from 2008 to 2011, petitioner claimed 8 almost all of its reported sales, over $759 million 9 as nontaxable, using a stratified statistical 10 sampling method. 11 And after adjustments were made upon 12 re-audit, audit staff disallowed $57 million in 13 claimed nontaxable sales for resale on the basis that 14 petitioner was the drop shipper. And, thus, the 15 retailer pursued Revenue Taxation Code Section 6007. 16 Under Section 6007 and Regulation 1706, as 17 eluded to by the petitioner, if the retailer engaged 18 in business in the state, makes a sale for resale to 19 a person that is not engaged in business in this 20 state, and then pursuant to the instruction of that 21 person, delivers the property directly to a 22 California consumer, then it is a drop-shipper and is 23 considered to be the retailer on the transaction, and 24 is liable for the applicable sales or use tax. 25 Here, petitioner is arguing that it received 26 written advice from the Department staff in a prior 27 audit from 1993, which it relied on in failing to 28 report the $57 million in taxable drop shipments 18 1 during this audit period and presumably on its drop 2 shipments for the intervening 15-year period between 3 that audit and this audit period. 4 Under Section 6596 a person is relieved from 5 liability if they requested and received written 6 advice from the Department regarding, quote, "the 7 specific facts and circumstances of the activity or 8 transaction fully described in the request," end 9 quote. And then relied on that advice with regard to 10 that described activity. 11 With specific regard to audited advice, 12 Regulation 1705(c) requires written evidence that the 13 issue in question was examined, and in order to be 14 relied on, the facts and circumstances related to the 15 activity must not have changed since the audit 16 period. 17 Section 6596 further states that such advice 18 may not be relied on after a change in the applicable 19 statutes, or regulations render such advice no longer 20 valid. Likewise, Regulation 1705 states that written 21 advice may not be relied upon subsequent to the 22 effective date of a change in statute or regulation, 23 or after the person receives notice that the advice 24 was not valid. 25 Turning to the matter before you, there are 26 several independent reasons why petitioner is not 27 entitled to relief under Section 6596. 28 First, there is no written evidence that 19 1 drop shipments were examined in the 1993 audit. 2 Petitioner had no writing from that audit at all in 3 its possession. But during the appeal's process, 4 Department staff was able to produce this audit 5 report, which stated that resales were verified by a 6 spot test or spot check. That they were either 7 obvious resales to well-known electronics retailers, 8 or were supported by completed resale certificates or 9 purchase orders. 10 On its face, there is no mention that drop 11 shipments were noted, nor was there any mention that 12 any of the purchasers that they're describing here 13 were not registered, or do not hold a permit with the 14 Board, or that in any of these transactions there was 15 a different "bill to" and "ship to" address. Those 16 latter two things would have been indications that 17 there was a possible drop-shipment. Those are not 18 mentioned here. 19 Moreover, as a matter of inference, the 20 clearest indication made by this document is that the 21 auditor's spot check of resales only uncovered sales 22 to permitted retailers, which cannot, by definition, 23 have included drop shipments. A, quote, properly 24 completed resale certificate, as noted in this 25 report, must contain a valid seller's permit number. 26 It is extremely unlikely that the reference 27 to, quote, "obvious resales to well-known dealers," 28 would include sales to non-permitted retailers. Or, 20 1 similarly, that the auditor would accept a purchase 2 order from a non-permitted retailer as a verification 3 of a resale. 4 As such, there is no written evidence that 5 petitioner received written advice during the 1993 6 audit, erroneous or otherwise, regarding drop 7 shipments. 8 With regard to the statement petitioner just 9 read, that's not to say that some drop shipments 10 didn't take place. Although, as we'll discuss in 11 more detail, the petitioner has noted that their 12 business model was different in 1993 than it is now. 13 So I'm not sure that the percentage of drop shipments 14 now has any bearing on 1993. But the fact is there 15 is no written evidence that it was reviewed in the 16 prior audit. 17 Petitioner's declaration states that during 18 the prior audit from 1990 to 1992, its drop shipments 19 consisted of sales in the membership-based consumer 20 services sector, which advertised in magazines and 21 presumably took orders by mail and over the phone. 22 In contrast, at issue here, are sales made 23 over the Internet 20 years later or almost 15 years 24 later, through, for example, the complex fulfillment 25 arrangements described in petitioner's submissions. 26 So petitioner is essentially arguing that it 27 is merely sufficient that both transactions be drop 28 shipments. And that's the end of the discussion. 21 1 That if the audit staff doesn't pick up a drop 2 shipment in 1993, essentially the drop-shipment rules 3 don't apply to that taxpayer until it's been 4 corrected for any drop shipment. 5 That is contrary to the explicit language of 6 Section 6596, which states the transaction must 7 involve the same specific facts and circumstances as 8 fully described in the request. 9 That's not the case here, and, therefore, 10 even if erroneous advice may have been given, it 11 would not be the basis for relief -- it would not be 12 a basis for relief in the transactions at issue. 13 Finally, Regulation 1706, which implements 14 Section 6007, did not exist during 1990 to 1992 15 audit. It was promulgated in December of 2000, 16 again, pursuant to the plain language of Section 6596 17 and Regulation 1705. 18 The amendment to the -- or excuse me -- the 19 implementation of the regulation constitutes a change 20 in the applicable law after which any alleged advice 21 could not be relied upon. It is also noted in the 22 hearing materials, all permit holders received 23 notices pursuant -- excuse me -- pertaining to the 24 new regulations, including the December 2002 tax 25 information bulletin, which would have constituted 26 written notice of any erroneous advice pertaining to 27 drop shipments was no longer valid. Which is another 28 final independent reason why petitioner is not 22 1 entitled to relief under Section 6596. 2 We are prepared to answer any questions the 3 Board may have as to some of the other issues that 4 have been raised. But as petitioner is not bringing 5 up, we will leave that to the Board Members' 6 questions. 7 Thank you. 8 MS. HARKEY: Thank you. 9 Okay. You now have some rebuttal time. Ten 10 minutes, I believe. 11 MR. DAKESSIAN: Thank you, Madam Chair. 12 So a number of comments. 13 First of all, in terms of the law change, if 14 you read Regulation 1705, that really only applies to 15 a true law change, first of all. Which the 16 Department hasn't identified here. 17 And second of all, that is meant to prevent 18 taxpayers from relying on correct advice that was 19 later overturned by a statute, regulation, court 20 case, and so forth. That's not the circumstances we 21 have here. 22 In terms of the change of the business, I 23 will let Mr. Miller elaborate on that. 24 But before we get to that, general bulletins 25 that are sent to taxpayers are absolutely no 26 substitute for specific -- a specific examination at 27 a taxpayer's place of business based on books and 28 records provided by a taxpayer. That's what 23 1 Section 6596 and Regulation 1705 are there to 2 protect. 3 And there's absolutely nothing in the 4 regulation that requires that the words "drop 5 shipment" be there. It requires that we provide 6 written evidence showing that the transactions in 7 question were examined. 8 Let's not forget, these transactions were 9 claimed on the return as exempt sales for resale. 10 Drop-shipment transactions -- that's a technical tax 11 nomenclature that describes this particular fact out 12 of it -- they were claimed on the return as exempt 13 sales for resale. 14 And the Department -- it is undisputed that 15 the Department examined exempt sales for resale. So 16 we're not asking that the drop-shipment rules are not 17 applied to the taxpayer, we're asking that 1705, that 18 regulation actually apply. 19 So I will now turn it over to Mr. Miller to 20 describe perhaps the differences in the business now 21 versus then. 22 MR. MILLER: So the business, when you think 23 about it, I guess it's, um, 20-some years different. 24 Maybe even a little bit more than that. 25 Shipments to our customers were made through 26 various warehouses across the country. The concept 27 of a drop shipment existed at the time of the audit, 28 as well as it does today. 24 1 The difference would be scale. The sales 2 in -- the average sales for the period of the first 3 audit was about 176 million for the company as a 4 whole. The sales on average for the company in the 5 second audit was about 2.3 billion. So clearly the 6 company grew quite a bit over that timer. 7 But the nature of the transactions that 8 existed at the time were similar. Drop shipments 9 tend to be higher in the fourth quarter of a year, 10 typically around the holidays, as you might expect. 11 But they happen throughout the year nonetheless. 12 In our business, we sold computer 13 components. So if you think about that, back in the 14 1990s, it was things like CPUs, memory, hard drives, 15 video cards, and the like -- modems. So all small 16 things that could easily be shipped via parcel 17 anywhere across the country. 18 There were three trade magazines at the 19 time, Computer Shopper, PC World and PC Magazine. 20 Both our vendors and customers would advertise in 21 those magazines. And there would be 800 numbers that 22 would be presented from our customers where anyone 23 across the country could call up and actually order 24 that product and have it shipped to them. 25 As part of our service to our customers, 26 because we handle occasions in California, we would 27 ship to customers appropriately. 28 Now, again, the scale was certainly 25 1 different. We were talking about 176 million versus 2 2.3 billion from the second audit, so there's no 3 denying that. But the nature of the transactions 4 were still, in character, the same. 5 MR. DAKESSIAN: So just to tie this into 6 what the law requires, the law does not require that 7 a business remain completely static. If that were 8 the case, no one would ever qualify for relief under 9 Section 6596 or Regulation 1705. It requires that 10 the transactions be substantially the same. Okay? 11 And we have here changes in scale and changes in 12 technology, but these drop-ship type transactions 13 have always been a part of the D & H business model, 14 back then as they are now. 15 I will also just add one final point, which 16 is, there was a point made about "bill to," "ship to" 17 addresses not being obvious or something. If you 18 have a sales invoice or purchase order, that will 19 have on it a "bill to" and a "ship to." Between 20 that -- the difference between those two will alert 21 an auditor that a potential drop-ship transaction 22 exists. And between that and the resale 23 certificates, they had everything they need to make 24 the correct determination. They did not. That's not 25 on us. 26 We have nothing further. 27 MS. HARKEY: All right. 28 Members? Who wishes to start with 26 1 questions? 2 Are we all silent? This is a big case. I'm 3 hoping for some questions here. 4 MR. HORTON: A couple of questions, Madam 5 Chair, just for clarification while you do the 6 research. 7 To the Department, you indicated or seemed 8 to imply that bulletins were issued to inform 9 taxpayers that if any previous communication advice 10 was to basically repeal that advice. Was that your 11 testimony? 12 MR. CLAREMON: The -- a bulletin was -- 13 sorry. 14 What Regulation 1705 states is that if 15 notice -- written notice to the taxpayer is provided 16 that the advice is no longer valid or is erroneous, 17 then that would -- subsequent to that, the taxpayer 18 would not be able to rely on such advice. 19 If they received tax information bulletin, 20 which laid out the correct drop-shipment rules, and 21 laid out that if they were a drop-shipper making 22 sales to California customers, that those are 23 taxable -- that they are -- they are responsible for 24 the tax on those transactions, then they would not 25 have been able to rely on any previous advice after 26 having received that written notice. 27 MR. HORTON: So does the Department have 28 evidence that that occurred? 27 1 MR. CLAREMON: I don't think we have 2 specific evidence. But those were sent out to all 3 permit holders. 4 MR. SMITH: Because -- because the 5 regulation regarding drop shipments was promulgated 6 in 2000, which was after this audit period. After 7 the prior audit work papers, but before this audit. 8 MR. HORTON: So I'm not -- on the timeline 9 here -- 10 MR. SMITH: There was a -- 11 MR. HORTON: -- subsequent to the audit -- 12 MR. SMITH: To the 1992 audit, subsequent to 13 that, the Board promulgated a regulation regarding 14 drop shipments in 2000, which is well before this 15 audit period. And that would have been well noticed 16 to the retailer community. 17 MR. DAKESSIAN: Mr. Horton. 18 MR. HORTON: Yes. 19 MR. DAKESSIAN: May I respond to that point? 20 MR. HORTON: Sure. 21 MR. DAKESSIAN: So the regulation says that 22 talks of a writing -- a subsequent writing notifying 23 a person that the advice was not valid at the time it 24 was issued. I think it is incredibly unfair to 25 consider a general bulletin that's issued to the 26 general public regarding a black letter restatement 27 of the law as writing notifying the taxpayer. 28 I think what the regulation is referring to 28 1 is a subsequent writing -- and I've had this happen 2 in cases -- a subsequent writing revoking the prior 3 written advice. That's what this is talking about, 4 not a bulletin. 5 MR. HORTON: So it's the Department's 6 position that the alleged bulletin that was issued -- 7 I'm only saying that because you didn't necessarily 8 agree that a bulletin was issued. 9 So the bulletin that was issued would have 10 restated the law or said something different than the 11 law prior to this.? 12 MR. CLAREMON: It would have stated the 13 correct application of the drop-shipment law, which 14 would have been contrary to any erroneous advice that 15 had been provided. 16 So it would have put the taxpayer on notice 17 that the advice prior -- the alleged advice they had 18 received in 1993 was erroneous and could not be 19 relied upon. 20 MR. SMITH: And to emphasize, we don't 21 concede there was any erroneous written advice. 22 Because those work papers talk about their sales for 23 resale being supported with resale certificates, 24 which wouldn't exist in a drop shipment. 25 MR. HORTON: Okay. Um, I'm having a bit of 26 a problem distinguishing -- the Department issues a 27 general bulletin that basically reinforce existing 28 law, which is -- would have been known irrespective 29 1 of the bulletin as revoking -- presuming -- I'm not 2 necessarily there that this is written advice yet. 3 But presuming that it was written advice, what's the 4 basis that that actually -- that's just restating 5 existing law? 6 MR. CLAREMON: Because, as the petitioner is 7 testifying, at that time that they would have 8 received that notice, their understanding of the law 9 was incorrect. They believed that -- what they're 10 testifying to is that they did not think drop 11 shipments were taxable, and they were not collecting 12 tax on drop shipments. 13 So if they were to receive a notice that 14 said drop shipments are taxable, that would conflict 15 with their understanding based on their alleged 16 erroneous advice. And they would not -- and once 17 they received that conflicting correct legal advice, 18 they could no longer rely on any prior alleged 19 erroneous advice. 20 MR. HORTON: And when was the prior audit 21 completed? 22 MR. CLAREMON: It's March of 1993 is the 23 date of that document. 24 MR. HORTON: All right. 25 No further questions at this time. 26 MS. STOWERS: Madam Chair. 27 MS. HARKEY: Yes. 28 MS. STOWERS: To the Department, the prior 30 1 audit completed in March of 1993, you're saying that 2 a bulletin went out after that fact. Did you also 3 say something triggered issuing that bulletin? 4 MR. CLAREMON: So that's a separate issue, 5 right? The notice to them is one reason why they 6 cannot rely on 6596. The other reason is the 7 implementation of the regulation in and of itself. 8 MS. STOWERS: What's the time -- what's the 9 date -- 10 MR. CLAREMON: That was implemented, I 11 believe, in 2000. I think it's December of 2000 was 12 the effective date of Regulation 1706. It's -- 13 MR. DAKESSIAN: December 28 -- 14 MR. CLAREMON: December 28th -- 15 MR. DAKESSIAN: -- 2000. 16 MR. CLAREMON: -- 2000. 17 MS. STOWERS: Explaining the drop shipments? 18 MR. CLAREMON: Yes. 19 MS. STOWERS: The taxation of drop 20 shipments. 21 MR. CLAREMON: Section 6007 is about two -- 22 this -- the drop-shipment rule is about two sentences 23 long. So this is explaining everything we're talking 24 about. 25 MR. SMITH: I think it made modifications to 26 the rule that the drop-shipper doesn't necessarily 27 know the true retail price. And so it created safe 28 harbors like you can assume that the true retail 31 1 price is 10 percent more than the wholesale price. 2 That's what the regulation did. 3 MR. HORTON: Right. 4 MR. DAKESSIAN: But, again, I would submit 5 to the Board that if we're talking about a law 6 change, I mean -- you know, which is it? 7 The taxpayer relied on the results of the 8 audit -- okay -- whether correct or incorrect. They 9 did not -- this rule that's in here about statutory 10 and regulatory changes is there so that taxpayers 11 don't continue to rely on a written advice from the 12 Board when that law has changed. Right? 13 So if we now have a rule in California that 14 subjects drop-shippers to double the tax that they 15 would, then you can't rely on the state of the law 16 before that in relying upon the written advice. 17 But that's not what we have here today. We 18 don't have a change in the law. We have the 19 promulgation of a regulation interpreting the law. 20 We do not have a change in the law. If we did have a 21 change in the law, that would have to occur based on 22 statute or constitution. 23 MR. CLAREMON: That's not true. The -- it 24 states a change in the statute or the regulation, or 25 the event of a Board opinion. 26 MS. STOWERS: Okay. Let me move to my next 27 question, which is the alleged written advice. 28 And, Mr. Dakessian, you're saying that the 32 1 fact that they looked at the sales for resales, 2 that's sufficient to say that they looked at the 3 drop-shipment transactions? 4 MR. DAKESSIAN: Yes, I am. Because the 5 drop-ship transactions were claimed under the resale 6 exemption and constituted a significant chunk of the 7 sales for resale during that period and during the 8 current audit period. 9 MS. STOWERS: To the Department, could you 10 restate to me why you believe that it needs to be a 11 little bit more detailed than that? 12 MR. CLAREMON: Yeah. I think there's 13 several things. 14 First of all, there's been no testimony that 15 it constituted a significant chunk of the resales. 16 They've had the opportunity to say that, but I 17 don't -- I haven't heard that. 18 MR. HORTON: He just said it. 19 MR. CLAREMON: Well, he said it during the 20 testimony of the -- of the petitioner. 21 Um, secondly, it's -- it states on that 22 document that there was a spot check done. And I 23 think Mr. Hanks can explain in more detail exactly 24 what a spot check constitutes. 25 MR. HANKS: Ms. Stowers, right, on manual 26 Section 403.25 is actually the section of the audit 27 manual that deals with this type of examination. A 28 spot test examination is really a cursory review of 33 1 these transactions. 2 And specifically this section identifies 3 that under preliminary testing, that the auditor now 4 has reached the point where a decision must be made 5 to proceed with the audit, or whether the audit 6 should be waived as nonproductive. 7 Informal spot or random test of records and 8 returns should be made for the purpose of evaluating 9 each of the components, the reported amounts, to 10 determine which areas are likely to contain a 11 material amount of understatement or overstatement of 12 the taxable measure. 13 So those are really the operating guidelines 14 that the auditor has in performing a spot test. 15 Now, if we look at the audit work paper 16 comments themselves -- and if I can, I'd like to 17 point out a couple of elements from the audit report 18 I think that are really significant. 19 So in this -- in this audit report, the 20 auditor is identifying the nature of the business, 21 No. 1. We know that the taxpayers reported more than 22 99 percent of the sales as exempt sales. And we know 23 that to be the case, because they're registered under 24 this business code, and they're identified here as a 25 class of business of the wholesaler. 26 So that's the first indication to the 27 auditor that basically the retails -- 28 MS. HARKEY: Why don't you use the 34 1 microphone. Thank you. 2 MR. HANKS: So that indicates to the auditor 3 that for all intensive purposes they need to 4 concentrate on other areas of the audit. What they 5 need to do is to really concentrate on use tax items 6 that might be owing for this class of business. 7 They're not a retailer of property that's going to be 8 subject to sales tax, generally. 9 And so that's what the auditor has done in 10 this case. They've looked at a spot test of claimed 11 resales, which are the largest component of the 12 exempt sales. 13 In the comments over here, they identify -- 14 resales are verified by auditor's spot test in 15 accordance with the audit manual guidelines covering 16 those quarters. But what's significant is they 17 identify nearly all the ex tax sales are obvious 18 resales to well-known consumer electronics or 19 household appliance dealers. 20 So the auditor sustained substantiation such 21 as a properly completed resales certificate or a 22 purchase order indicating that the products were for 23 resale. 24 So that indicates that the sales being made 25 are to other businesses, to well-known electronic 26 stores establishments. And so those are the types of 27 transactions that the auditor is reviewing. 28 If there's a purchase order that's -- that's 35 1 being examined in this -- in this test, by definition 2 it means that we're not talking about a 3 drop-ship-type transaction. They're not looking at 4 sales to consumers, they're looking at sales to other 5 retailers that are going to be reselling the 6 property. 7 Now, another thing to hone in on in this 8 audit report is, notice that the no-change audit 9 report, the auditors charge 18 hours to this audit 10 assignment. The bulk of the audit examination is 11 going to be looking at use tax, inventory 12 withdrawals, consumer supplies, advertising-type 13 property that might be acquired. They're going to be 14 looking at the books and records, reconciling the 15 sales and use tax account, the accrual account. But 16 that's the bulk of the examination, and the bulk of 17 the time spent really in this audit. 18 And ultimately, at the end of the day, they 19 determine in their spot test some of these resale 20 transactions. There were no drop-ship-type 21 transactions that were accounted. These were all 22 sales to known retailers. And that's why the auditor 23 is making a recommendation to no change the audit. 24 MR. CLAREMON: And to sum up and answer your 25 question, the answer is, in doing that spot test, 26 there is no written evidence that they saw a drop 27 shipment. There's no written evidence that they saw 28 a drop shipment. 36 1 And that's where we get into if they had 2 picked up an invoice, and one of those invoices had a 3 different "ship to" or "bill to" date that we saw 4 that there was evidence of that, that would be 5 evidence they saw a drop shipment. But there is no 6 written evidence that drop shipments were examined in 7 that spot test. 8 MS. STOWERS: I think Mr. Dakessian -- 9 MR. HORTON: That argument is contradict to 10 just about any testing procedure. If you test 11 something -- and a spot test is not a quantitative 12 test. It's not a test based on the number of 13 transaction, it's a quantitative test where you go in 14 and you test the various transactions. 15 Now I'm not arguing whether it was there or 16 not. But I don't think it's fair to -- to -- to say 17 that a spot test is a test that wouldn't disclose all 18 the transactions involved. 19 For example, I mean, you're required 20 pursuant to the audit manual, if you have exempt 21 sales, you have to test each category of exempt 22 sales. The same thing with resales. And these sales 23 wouldn't be treated by the normal retailer as a sale 24 to consumer, because their thoughts on this is that 25 they're actually interacting -- they actually have a 26 transaction with an out-of-state entity that is 27 actually selling to the consumer, and all they're 28 doing is drop shipping. Which is the inherent. 37 1 For me, it's always been a little unfair 2 with this whole drop ship. But I comply with the 3 law -- is that the in-state drop-shipper -- the 4 out-of-state retailer can actually sell the product 5 to the consumer for $500, and the in-state drop 6 shipper would have sold it to the retailer for $300. 7 But yet still the drop-shipper is liable for the 8 entire $500, even though they don't know the amount 9 of the sale. 10 So they're not making a sale to the 11 customer. It would have been properly recorded as a 12 sale for resale. 13 MR. DAKESSIAN: Mm-hm, that's correct. 14 MR. HANKS: Respectfully, I don't agree. 15 Just from the standpoint that when you're doing a 16 spot test there could be categories of sales that you 17 aren't necessarily going to see. And 18 hours -- 18 MR. HORTON: I did this for 20 -- 21 years. 19 MR. HANKS: But 18 hours were spent in this 20 examination, a majority of which were not spent 21 looking at resales. 22 MR. HORTON: I mean, how -- how can you 23 argue, because the auditor decided not to spend "x" 24 number of hours, that it's based on the hours? In 25 fact, the Taxpayer Bill of Rights says these hours, 26 hours pick up or hours so forth shouldn't even be 27 considered in the assessment or the evaluation of the 28 audit. 38 1 So to go in and do a spot test, that would 2 call into question -- if we were to say that is true, 3 that would call into question every spot test the 4 agency has ever done as having the potential of being 5 inappropriate. 6 Now, I'm not -- again, I'm not debating 7 whether or not there's sufficient evidence here to 8 the 6596. But I just hate to have that out there. 9 MS. HARKEY: Member Runner. 10 MR. RUNNER: Yeah. 11 Going down that path just a little bit 12 before I go onto something else, then. I guess I 13 need context then to the statement in the letter of 14 March 24th where the Department acknowledges the drop 15 shipments probably occurred in the prior audit. 16 MR. CLAREMON: Um, again, if there was a 17 spot test done of resales -- 18 MR. RUNNER: Uh-huh. 19 MR. CLAREMON: -- and we're not talking 20 about whether that entire population of resale 21 invoices had or didn't have a drop shipment -- a drop 22 shipment or some percent of drop shipments, the 23 question is, is there written evidence that the 24 auditor saw one of those examples of a drop shipment? 25 So if the person who wrote that letter is 26 responding to the declaration of the taxpayer and 27 saying, Okay. I'll believe that there were some 28 small percentage of drop shipments. It's not germane 39 1 to whether there's written evidence that in looking 2 at all the resales, those drop shipments, those 3 transactions -- those specific transactions are an 4 example of those transactions picked up. 5 MR. RUNNER: I guess, why would the taxpayer 6 not assume that they were there? 7 MR. CLAREMON: Well, again, the standard 8 here is we're talking about written advice from the 9 Board. So it's -- they can only rely on it if 10 there's written evidence. 11 MR. RUNNER: Well, maybe I'm getting this 12 wrong though, but they thought since they were doing 13 drop shipment, that they did have that written 14 evidence. 15 MR. CLAREMON: Yes. The drop shipments -- 16 MR. RUNNER: I mean, I think that's what 17 they're arguing is, yes, they were; therefore, this 18 did apply. 19 MR. CLAREMON: Well, so essentially that's 20 saying if the Board misses something, a taxpayer can 21 always rely on it. And that's why that's not the 22 standard. 23 MR. DAKESSIAN: I don't disagree -- I 24 disagree with that, but I would phrase it 25 differently. I mean, there's a regulation here for a 26 purpose. This is a taxpayer-protection regulation. 27 This is not here -- we're not here to draw the 28 raiser-thin distinctions that the Department is 40 1 trying to draw here. 2 We've already shown you that 86 percent of 3 states don't tax as transaction, including the 4 homestate of Pennsylvania for D & H. 5 We told you that they have had drop 6 shipments, the Department acknowledges they've had 7 drop shipments in the prior audit, and they were 8 claimed as exempt sales for resale. 9 What I hear right now is the Department 10 attempting to walk away from the prior audit and 11 distance itself and disavow the prior audit. And 12 that, to me, is completely contrary to the letter and 13 the spirit of 1705. 14 MR. RUNNER: I guess what my concern is, and 15 I think -- I guess it depends, in that process, in 16 terms of how broadly or how narrowly you interpret 17 that. And, again, given the nature of -- I guess -- 18 your view. And I guess that's why it's here before 19 us. And that is the Department is taking the very 20 narrowest view. 21 And the question for me, then, is that 22 narrow view too narrow given the fact that the 23 intention there is to protect the taxpayer? 24 Let me just follow up in regards to the 25 notice issue. The bulletin -- or the regulation that 26 was -- or the change in the drop-shipment issue, was 27 that just -- was that a -- that was a clarification 28 of a portion of drop shipment? 41 1 Is that a fair -- I mean, there was not a 2 change in the drop-shipment regulation, that was a 3 clarification of a portion of it. 4 MR. CLAREMON: Well, it was -- the 5 regulation didn't exist before 2000 -- during the 6 prior audit. There was no regulation until 2000. 7 MR. RUNNER: So the statement of it -- it 8 was the whole statement of drop shipments. 9 MR. CLAREMON: The entire full statement of 10 drop-shipment rules in 1706 did not exist during the 11 prior audit. It was -- it was effective December 28, 12 2000. 13 MR. DAKESSIAN: But you can't read those 14 words in a vacuum. Those words are there. A change 15 in the constitution, a change in the statute, a 16 change in the regulation is there to prevent 17 taxpayers from continuing to rely on an old law. 18 That's why that's there. That's not because, you 19 know, we're going to clarify -- 20 MR. RUNNER: So -- just a minute. 21 So your statement is, and your belief is, 22 because it was not referring to a change, it was only 23 referring to the existing law -- 24 MR. DAKESSIAN: Correct. 25 MR. RUNNER: -- therefore it did not meet 26 the notification issue, because the notification 27 issue talks about the fact of a change of law or 28 regulation. 42 1 MR. DAKESSIAN: For that -- yeah, and that 2 we were relying on the old law, right? 3 MR. RUNNER: Mm-hm. 4 MR. DAKESSIAN: The drop-ship rules have 5 been in place for decades. And there's a court case 6 called Lyon Metal Products versus State Board of 7 Equalization that says that it's been in place for 8 decades with minor amendments. 9 The regulations can't change the statute, 10 they can clarify certain aspects of it. But this is 11 not a law change within the meaning of this 12 regulation and what it was intended to do. 13 If I relied on -- if I took -- 14 MR. RUNNER: Take me to that language -- 15 take me -- take me -- 16 MR. DAKESSIAN: Sure. 17 MR. RUNNER: Again, in your -- take me to 18 the language of the notification issue in your -- in 19 your -- 20 MR. DAKESSIAN: It's behind tab 5. And if 21 you see the highlighted language -- 22 MR. RUNNER: Audit comments, schedules, that 23 one? 24 MR. DAKESSIAN: Yes. Oh, no, no. I'm 25 sorry. It's Exhibit 5. 26 MR. RUNNER: Exhibit 5. 27 MR. DAKESSIAN: It's Regulation 1705. 28 MR. RUNNER: Is it the blue highlighted? 43 1 MR. DAKESSIAN: No, it should be yellow 2 highlighted. Regulation 17 -- 3 MR. RUNNER: Exhibit 5 -- I looked at 5. 4 MS. HARKEY: Just so you know, 5 is blue 5 highlighted. 6 MR. DAKESSIAN: Oh, it is? 7 MS. HARKEY: There's no yellow highlight. 8 MR. DAKESSIAN: Oh, okay. I'm sorry. 9 Yellow highlight is mine. 10 MR. RUNNER: So starts with audit comments, 11 schedules, other writings prepared, is that where 12 I'm -- 13 MR. DAKESSIAN: You're going to have to go 14 back to the first page, and you're going to have to 15 go to the paragraph beginning with the term "written 16 advice." 17 MR. RUNNER: On the full first paragraph, 18 the written advice from the Board? 19 MR. DAKESSIAN: Yes. That's the paragraph 20 that discusses this. 21 MR. RUNNER: And the point that you're 22 saying that identifies the fact that it's identifying 23 law or regulation changes -- 24 MR. DAKESSIAN: Yeah, like if you -- yeah. 25 My point is that if you relied on audit advice, and 26 the Board decided that it was going to make a change 27 to the law, then you can no longer rely on that audit 28 advice. If they decide to make a change to the law 44 1 or specifically notify the taxpayer, the previous 2 legal position -- 3 MR. RUNNER: You're talking about Item 1, 4 which it says that the communication, the effective 5 date of change in statutory or constitutional law -- 6 MR. DAKESSIAN: And regulations. 7 MR. RUNNER: -- and Board regulation or date 8 of final decision of court or a competent 9 jurisdiction, regardless the Board did not provide 10 notice of such action. 11 MR. DAKESSIAN: Correct. 12 MR. RUNNER: What you're saying is that the 13 notice that was given was just a restatement of the 14 law and did not meet that particular idea? 15 MR. DAKESSIAN: As to the bulletin, yes. 16 MR. RUNNER: Okay. Let me go back to the -- 17 MR. CLAREMON: Again, it says regardless 18 that the Board did not provide notice of that action. 19 So actually there are two separate grounds 20 where relief should be denied here. One, the 21 implementation of the regulation. The change in the 22 law means you cannot rely on the advice. Two -- 23 MR. RUNNER: Was there a change in the law? 24 MR. CLAREMON: Yeah, there was an 25 implementation of the regulation. 6596 specifically 26 says that it can only be relied on before a change in 27 statutory constitutional law, a change in the Board's 28 regulation. 45 1 This regulation was not implemented until 2 after the alleged advice was given . 3 MR. DAKESSIAN: If you want to read it -- 4 MR. RUNNER: Hang on. 5 MR. CLAREMON: That's what it says. 6 MR. RUNNER: So your belief would be that 7 because there was -- because there was no regulation, 8 that indeed this is the regulation; therefore, that's 9 what trips the issue? 10 MR. CLAREMON: That's a change in the 11 Board's -- I would think that that would be a change 12 in the Board's regulation. 13 And then also, as an independent reason, the 14 notice -- 15 MR. RUNNER: Is that a change in the Board's 16 regulation, or is that just a statement of what -- of 17 what -- of what -- of what the law was? 18 MS. HARKEY: It's a new regulation. 19 MR. CLAREMON: It's a new regulation, so 20 it's a -- I mean, it's sort of, by definition, a 21 change, because there wasn't a regulation before. 22 MR. RUNNER: Okay. 23 MR. CLAREMON: But in the notice itself -- 24 but that is, as it states in that sub one, regardless 25 of whether the Board did not provide notice of such 26 action. So then the sub two, or if such notice is 27 provided, that is also a grounds to deny relief. 28 MR. RUNNER: Okay. 46 1 MR. CLAREMON: So we're actually talking 2 about two separate grounds. 3 MR. RUNNER: Let me go open a different 4 issue on that same issue in regards to the 5 notification aspect. 6 Um, you would believe, then, that any normal 7 notification, a bulletin for instance, meets the 8 notification requirement? 9 MR. CLAREMON: Correct. 10 MR. RUNNER: Not in terms of notifying 11 specific taxpayers who were engaged in these issues 12 before about a change, but just a general bulletin 13 meets that identification -- that requirement. 14 MR. CLAREMON: Correct. 15 MR. RUNNER: And do we have a copy of that 16 bulletin? 17 MR. CLAREMON: I don't -- I don't think -- 18 I'm not sure if we have a copy, actually. 19 MR. RUNNER: Okay. What are we -- I mean, 20 do we actually know that the bulletin went out? 21 Other than "that's our process," do we actually know 22 that a bulletin went out? 23 MR. CLAREMON: Yeah. According to the 24 hearing materials, the bulletin went out in 2002, in 25 December of 2002. 26 MR. RUNNER: The hearing materials includes 27 the copy of the bulletin or -- 28 MR. ANGEJA: The copy's not in there, but 47 1 the tax information bulletins get mailed to all 2 permit holders with their tax returns in the U.S. 3 mail that they fill out and mail back. 4 MR. RUNNER: Do we know what was included in 5 that bulletin? 6 MR. ANGEJA: I actually have it on e-mail. 7 It was 2001 -- 8 MR. RUNNER: Okay. Well, if it's 9 included -- just tell me if it's -- if that 10 regulation is included -- 11 MR. ANGEJA: It discusses it. 12 MR. RUNNER: Okay. That's all I need to -- 13 MR. ANGEJA: And it would have been included 14 in the mailing of their tax return to this 15 taxpayer. 16 MR. RUNNER: Okay. So we'll get that -- 17 we'll get that to us. 18 MS. STOWERS: Are you saying the bulletin 19 from actual 2002, or are you sending a current 20 bulletin? 21 MS. HARKEY: We update them. 22 MR. ANGEJA: 2001. 23 MR. HANKS: 2001. 24 MR. DAKESSIAN: So we need to -- 25 MR. RUNNER: Okay. Go ahead. 26 MR. RUNNER: Yes. We need to take a step 27 back. 28 So first let's just think about what we're 48 1 saying here. We had a specific audit of a taxpayer's 2 books and records. 3 MR. RUNNER: Mm-hm. 4 MR. DAKESSIAN: And we're relying on mass 5 mailings to thousands of taxpayers restating the 6 black letter law as somehow the taxpayer is now going 7 to take that and trump the advice that's been given 8 to them in the prior audit. 9 So just as a conceptual matter, that is just 10 completely incorrect. This notification 11 requirement -- and I have had cases where we have had 12 6596 relief, and we have received specific advice 13 that as of this date forward you are not to rely -- 14 this is incorrect advice, you are not to rely on the 15 law as of this point forward. 16 This is not meant to encompass general 17 bulletins. That's the Department's position. You 18 elicited that from them. They admit that's their 19 position. 20 And then if we really want to get textual -- 21 if we really want to get hypertextual, as the 22 Department seems inclined to do, let's look at the 23 reg. It says a change in statutory or constitutional 24 law and Board regulations. 25 And I think that's there because there's an 26 acknowledgment that regulations cannot change the 27 law. They can clarify the law, they can describe the 28 law, they can provide further detail. So you have to 49 1 have both. You have to have both the statutory and 2 regulatory change under 1705, and we do not have that 3 here. 4 MS. STOWERS: Um, Madam Chair. 5 MR. RUNNER: Okay. I'm done. 6 MS. HARKEY: Yes. 7 MS. STOWERS: I understand what you're 8 saying, Mr. Dakessian. You're saying you have to 9 have a change in law in order for the alleged prior 10 advice not to apply. 11 MR. DAKESSIAN: Correct. 12 MS. STOWERS: Correct. 13 The work-up that you've provided to us shows 14 that they spot check fourth quarter '91 to third 15 quarter '92. 16 MR. DAKESSIAN: Correct. 17 MS. STOWERS: My notes are indicating that 18 there was a change in law -- go back to my notes -- 19 that there was a change of law in 1993 making drop 20 shipments taxable. 21 MR. DAKESSIAN: Yes, Ms. Stowers. 22 MS. HARKEY: I believe you addressed that in 23 the -- in the taxpayer's response. I think it's 24 in -- it's in your pleading 25 MS. STOWERS: Can you -- so -- but so if 26 there was a change in law, and they looked at these 27 earlier quarters, it seems to me that that asserted 28 written advice -- alleged written advice no longer 50 1 applies. 2 MR. DAKESSIAN: I have it right here, and I 3 have the response for you. 4 First of all, I would disagree with the 5 characterization of that as a change in law that 6 would impact this case. I think that the Department 7 may differ. But regardless, let me -- I've got a 8 specific response to that. Let me go through my 9 materials. 10 MS. HARKEY: It's in your opening brief, 11 because I've reviewed it. 12 MR. DAKESSIAN: The new statute was added 13 effective September 25, 1992, and the date of the 14 report is March 16, 1993. 15 But regardless, that was not a change in the 16 drop-shipment law, it was a clarification that the 17 drop shipment was also applied to those drop-shipping 18 from out of state. 19 So that -- that to me is -- it was 20 after -- you know, it was -- the law change occurred 21 effective September 25, 1992. The date of the audit 22 report was 1993. So the auditor had that 23 information. 24 MS. STOWERS: To the Department, do you -- 25 MR. CLAREMON: Well, it is a change, because 26 some of these sales are in-state sales tax drop 27 shipments, and some of these sales are out-of-state 28 use tax drop shipments. So that would have been a 51 1 change to -- that affected the transactions at 2 issue. 3 MR. DAKESSIAN: But the fact that no 4 distinction was made between drop shipments and the 5 general sales for resale in this audit, they were 6 given a clean bill of health. There was no attempt 7 to distinguish between in-state or out of state. And 8 I'm just -- I think that's just a distraction. 9 MS. STOWERS: Okay. Thank you both. 10 MS. HARKEY: Do you have any questions, 11 Ms. Ma? 12 Well, that was one of my big questions. I 13 wanted some clarification on that -- on the statute. 14 Because it was noted in the petitioner's brief. So I 15 just wanted to be sure that that got out somehow. 16 Because if we're reading 1705, it does say 17 effective date change and statute of constitutional 18 law. But if the audit came out after that date, 19 then -- can somebody explain to me -- going back to 20 1705, we have these conflicts. The effective date in 21 change of statutory constitutional law. But then for 22 written advice, not working for you. But then we 23 have the written advice provided in a prior audit, 24 audit comment schedules and other writings. 25 So if the audit came out in '93 -- was 26 completed in '93, but it was for -- for what years 27 was that? 28 MR. DAKESSIAN: '90 to '92. 52 1 MS. HARKEY: '90 to '92. 2 And the law changed in -- 3 MR. CLAREMON: '93. 4 MS. HARKEY: Can you -- can you -- 5 MR. SMITH: So prior to '92, a drop-shipper 6 located in California could be liable for a sales tax 7 transaction. But beginning in 1993, the statute 8 changed so the drop-shippers could also be liable for 9 tax, and out-of-state drop-shippers liable for use 10 tax. 11 And in this audit, many of the transactions 12 in issue are use tax transactions, because they ship 13 from their Pennsylvania warehouse and their Georgia 14 warehouse. So at the time of the earlier audit 15 period, for those sales coming out of Pennsylvania or 16 Georgia, they wouldn't have been liable for use tax. 17 But because of a statutory change, they are beginning 18 1993. 19 MS. HARKEY: So we are kind of down to the 20 prior written advice argument. 21 What about -- there was a case made for 22 borders online. Is that off the table? 23 MR. DAKESSIAN: That's off the table today. 24 MS. HARKEY: Okay. 25 Is -- the law changed in '93? 26 Um, I actually have a couple -- hang on. I 27 don't know -- it's SB 1608 -- SB 1608. And I don't 28 know exactly when that was. This is a 1992 Summary 53 1 Digest. Because that was the end of the year, and it 2 took effect, I imagine, in '93. SB 1608. And I 3 think it's here. 4 MR. DAKESSIAN: I have the effective date of 5 that bill as September 25, 1992. 6 MS. HARKEY: September 25th, 1992. 7 MR. DAKESSIAN: But whether it was effective 8 in September of '92 or January of '93 -- 9 MS. HARKEY: It would have been, because 10 this is the year in -- 11 MR. SMITH: No, because the audit period 12 ended in '92, and the statutory change became 13 effective in January of '93. 14 MR. RUNNER: When did -- when was the -- 15 when did the -- the audit was finished then, but when 16 was the -- the audit review and report given to the 17 taxpayer? 18 MR. SMITH: I think that was March of '93. 19 MR. RUNNER: Well, that's the operative 20 date. 21 MR. SMITH: No, because the operative law is 22 the law in effect at the time of the audit period. 23 But I'd also -- I feel like we've gotten 24 away from, you know, our central position. Which is 25 6596 is -- allows people to rely on written advice. 26 And if you look at what was written in the 27 audit work papers, there's no indication that drop 28 shipments were looked at, or there's nothing about 54 1 drop shipments in there. It's about sales for resale 2 that are supported with resale certificates or 3 purchase orders from large retailers. 4 And, you know, so we don't concede that 5 there was any written -- any erroneous written advice 6 regarding drop-shippers. 7 But if the Board were to make the finding 8 that there was erroneous written advice, which we 9 strenuously reject to, we would say, "Well, then, the 10 law changed in 1993 after the audit period, so 11 there's another independent reason that they can't 12 get relief under 6596." 13 MR. DAKESSIAN: I mean, we obviously 14 disagree with that. We don't think written 15 evidence -- evidence of written advice means that the 16 words "drop shipment" need to be specifically called 17 out. There's no separate line item on a tax return 18 for drop shipments. 19 There's a line item for claimed exempt -- 20 claimed exemptions, and a line item for claimed 21 exempt sales for resale. And that's the category 22 under which these transactions were claimed, and that 23 was what was examined. 24 I mean, this is a taxpayer relief provision. 25 I'm not sure why the Department is construing it so 26 narrowly. 27 MS. HARKEY: Mr. Dakessian, on the audit in 28 question -- and this is for the Department -- it's 55 1 sales for resale that still were categorized, right? 2 MR. DAKESSIAN: Correct. 3 MS. MA: Okay. I have a question. 4 So I'm reading this bulletin, information 5 bulletin. So, No. 3, it says "new reporting method 6 available to drop-shippers." 7 What was the old reporting method? 8 MR. CLAREMON: I believe what that's -- 9 that's referring to what Mr. Smith referred to, which 10 is that -- is the 10 percent markup safe harbor is 11 the new reporting method it's referring to. That 12 drop-shippers could -- because if they -- they know 13 the price that they sold to the retailer -- to the 14 true retailer, but they don't necessarily know what 15 the true retailer's price was to the customer. So if 16 they apply tax, a 10 percent markup of their price, 17 that's a safe harbor. 18 MS. MA: Okay. So it's not a new rule. 19 MR. CLAREMON: Well, that was new as of the 20 implementation of Regulation -- 21 MR. SMITH: Before the regulation, the 22 wholesalers were in a position of having to somehow 23 find out what the actual retail price was. And that 24 was information that wasn't always available to 25 them. 26 MS. MA: Okay. But it still doesn't pertain 27 to the audit or the methodology for the audit in 28 question, right? 56 1 MR. SMITH: No, because if you look at the 2 audit work papers, there are no indications that 3 there were drop shipments. The auditor thought that 4 they were all sales for resale supported by resale 5 certificates. 6 And, again, there wouldn't have been the 7 resale -- 8 MS. MA: But that's what it says. 9 MR. SMITH: -- certificate in a situation of 10 a drop shipment, because by definition you're selling 11 to an unpermitized true retailer. 12 MR. CLAREMON: In a drop shipment. 13 MS. MA: But I think -- I think what you're 14 assuming is because the auditor didn't say that they 15 specifically reviewed drop shipments, then they 16 didn't. 17 And they're saying in the audit, the auditor 18 reviewed everything, just like in an audit. But 19 you're saying that they only reviewed certain things 20 in an audit. 21 MR. CLAREMON: We're saying that because 22 they didn't say that they reviewed drop shipments, 23 because they didn't say that they saw any of the 24 indications of drop shipments, and that based on what 25 they did say, the inference is that they did not see 26 drop shipments, that there's no written evidence that 27 they saw drop shipments. 28 So it's not just that they didn't mention 57 1 drop shipments, it's that they didn't mention the 2 other indicators of drop shipments. And the 3 statements they did make, the most reasonable 4 inference is that they did not. Because they 5 wouldn't call an obvious resale -- they wouldn't call 6 a sale to an unpermitized resaler an obvious resale. 7 And they wouldn't accept a purchase order as evidence 8 of a resaler from an unpermitized resaler. So the 9 inference from those statements is that they did not 10 see drop shipments. 11 MS. MA: Well, but I think what the taxpayer 12 is saying is they went through an audit, and they 13 gave all the paperwork to -- 14 MR. CLAREMON: But it was spot checked, 15 so -- we're talking about millions of dollars of 16 resales, generally. There's no -- 17 MS. MA: Okay. Well, then that goes back to 18 Mr. Horton's point, is if you're saying spot checks 19 are not good, then spot checks are not good. You 20 can't say spot checks are good in some instances, and 21 they're not good in this instance. 22 MR. CLAREMON: Well, we're not saying 23 they're not good or they don't serve a purpose during 24 an audit. What we're saying is that, with regard to 25 forming a basis for -- in this instance, they don't 26 form a basis for 6596 relief. That's a lot different 27 than saying they're not good for the main purpose of 28 the audit, which is to perform an audit. 58 1 MR. HANKS: So that type of preliminary 2 testing is done in every audit, so the determination 3 is made early on whether or not it's going to be 4 productive. And it's determining whether or not the 5 taxpayer has over-reported or under-reported. And if 6 that determination is made just based on that 7 preliminary review, the spot review or cursory review 8 of records that they reported correctly, then they no 9 change the audit. 10 MS. MA: Okay. So in the general comments 11 for the form B -- what is that form -- B 14 C. 12 MR. DAKESSIAN: 414(c). 13 MS. MA: 414(c). General. 14 The auditor writes, D & H Distributing 15 Company is a wholesaler of consumer electronic 16 products and household appliances. Headquarters are 17 in Harrisburg, Pennsylvania. Shipments in California 18 locations are made from a warehouse in Ontario, 19 California. 20 A warehouse in Newark, California was closed 21 in April of 1992. Start date of June 1985 verified. 22 So it looks like the auditor knew that there 23 were drop shipments to -- California locations are 24 made from a warehouse in Ontario, California. So -- 25 MR. CLAREMON: Well, it knew that sales were 26 made from a warehouse -- sales were made. But 27 there's no indication that they saw that drop 28 shipments were made. That's the point. 59 1 MR. HANKS: So they're verifying resales 2 were made to customers in California. But those were 3 all documented as sales for resale. 4 MS. MA: Well, it says, nexus, taxpayer has 5 a sales office and warehouse in Ontario, California. 6 Employees based in Ontario travel throughout the 7 state, including all transit tax districts, to elicit 8 sales. 9 MR. CLAREMON: So the inference that -- what 10 this is saying is that they saw examples of invoices 11 from -- shipped from the Fresno warehouse to, for 12 instance, the Best Buy in Sacramento. So that would 13 be -- 14 MS. MA: Well, that's not -- but that's what 15 you're inferring. But I think when you read this -- 16 I mean, clearly the auditor knew -- 17 MR. CLAREMON: That distributions were made 18 from California, yes. 19 MS. MA: Right. And that the headquarters 20 is in Harrisburg, and they had locations in 21 California, and that they were making shipments to 22 California. And sales -- they had a sales office and 23 a warehouse, so they were making sales. 24 Auditors traced -- under the next one -- 25 auditors traced total sales to sales journals and to 26 the general ledger. No errors were noted. 27 So either the auditor missed it and the 28 supervisor missed it and the district reviewer missed 60 1 it, or -- 2 MR. SMITH: But, again, it's only a drop 3 shipment if that California warehouse sells to a 4 retailer who is not engaged in business in California 5 and delivers the product that they sold to the 6 unpermitized retailer to a California consumer. They 7 have to do that delivery. And there's no evidence 8 from these work papers that -- 9 MS. MA: I know. But you're asking, like, 10 because they didn't say specific things in the audit, 11 that the auditor didn't look at it. 12 That's what you're saying, right? They only 13 looked at resale certificates made to big, well-known 14 companies. Or the ones that they didn't, they 15 actually got resale certificates. That's what it 16 says. 17 But you're saying, "Well, they didn't really 18 do the right audit, because they missed this." 19 I mean, clearly the auditor wrote all of 20 these things down. I mean, they knew this was 21 happening, right? They knew that this was happening. 22 That's what I'm reading this. 23 MR. SMITH: So as petitioner said earlier, 24 the drop-shipment rule is black letter law. And 25 we're saying that in order to give them a 20-year 26 pass on following black letter law, there has to be a 27 writing saying that they don't have to follow black 28 letter law. 61 1 And if you look at those work papers, 2 there's no indication in there that -- of a situation 3 where they were making sales for resale that weren't 4 supported with a resale certificate from someone 5 engaged in California. 6 There's no indication of them ever 7 delivering the product to someone other than to the 8 customer to whom they sold it. There's just nothing 9 in there that says drop ship -- you know, that even 10 hints of drop shipments that would accordingly allow 11 them to ignore black letter law for the next 20 12 years. 13 MR. DAKESSIAN: Except for the fact -- 14 MR. SMITH: And the law changed since 15 then. 16 MR. DAKESSIAN: Except for the fact that 17 these were claimed as exempt sales for resale. We 18 know those were examined. 19 I know the Department doesn't like the 20 concept of a spot test when it doesn't suit them. 21 The fact is that it's part of its standard audit 22 procedures, and this audit manual section that was 23 cited by the Department says that at the close of a 24 spot test, it says -- it says a couple of very 25 important things. 26 It says that the testing techniques examine 27 all facets of the taxpayer's business activity. And 28 it says that at the close of the spot test, if a 62 1 determination is made, that the taxpayer had been 2 properly reporting the tax, the audit report should 3 be completed using the form 414(c). 4 And we know based on our previous discussion 5 that your Board expects taxpayers to rely on form 6 414(c). So I know it's not convenient for them right 7 now, but this is what happened. 8 And we are imputing an awful lot of 9 inference and benefit for the Department, when our 10 standard of proof is proof by a preponderance of the 11 evidence, is it more likely than not that these 12 drop-shipment transactions were examined. 13 This is not a beyond a reasonable doubt, 14 beyond the shadow of any doubt. We believe the 15 weight of evidence is clearly in our favor here. 16 We have written evidence. Not the kind that 17 they like, but we have written evidence that these 18 transactions were examined. That's how they were 19 claimed on the return. That's what the Department 20 examined. And now they want to pass on Regulation 21 1705. 22 MS. HARKEY: Yes. 23 MR. RUNNER: Just real quick. 24 You know, I know, you know, in terms of the 25 first argument and the second argument, but I'm going 26 to go to the second argument because I'm kind of 27 getting -- I'm over the first argument in regards to 28 the law change. 63 1 Um, and help me understand this, how we -- I 2 mean, I guess our best -- our latest estimate of when 3 this became the changed law in regards to drop 4 shipping would be January 1st, 1993. 5 What I'm hearing you all say is that because 6 the audit was done between 1990 to 1992, therefore, 7 that law change was after the audit, and, therefore, 8 that's why that particular issue would apply? 9 MR. SMITH: Well, we're saying the law 10 changed after the audit. 11 MR. RUNNER: After the the audit -- 12 MR. SMITH: After the audit period. 13 MR. RUNNER: After the audit period, but 14 before the audit report, correct? 15 MR. SMITH: Well, I think -- you know, I 16 think the way it would have played out is -- 17 MR. RUNNER: I mean, I guess -- go ahead. 18 MR. SMITH: If the 1993 law had been in 19 effect at the time of the audit period -- 20 MR. RUNNER: Right. 21 MR. SMITH: -- the auditor would have looked 22 at the sales from the out-of-state warehouses, which 23 is a big component of this audit. 24 MR. RUNNER: Right. 25 MR. SMITH: But those drop shipments weren't 26 subject to tax in 1992. But they were -- or they -- 27 the drop-shipper wasn't liable for tax on those 28 transactions in 1992 during the time of the prior 64 1 audit period. But they became liable for those 2 transactions in 1993 because of the statutory 3 change. 4 MR. RUNNER: But isn't the purpose of 5 that -- I guess I'm missing -- maybe I'm missing 6 something, but I thought the purpose of that was 7 helping to protect and notify the taxpayer. 8 So, again, even though the audit period was 9 at that time, the fact is that this report, to which 10 they are relying on -- they say they're relying on, 11 was written after -- was written in -- in -- after -- 12 after the -- after it became law. 13 And so I would assume then, therefore, that 14 any of the reflection -- seems to be reasonable to 15 believe that a taxpayer would assume that the 16 particular audit is reflecting what the current -- if 17 they're depending on the issue of the -- of the 18 language of the audit, that it was reflecting on the 19 current law. 20 I don't know. I just -- it seems like a 21 little -- I don't know. It seems like kind of a, you 22 know, too cute by half kind of response to say, Well, 23 it was, you know, that it's the January 1st is the 24 law, therefore, even if we wrote this and even if 25 these things apply, they don't apply because the law 26 changed, even though our report is after that. 27 MR. SMITH: Well, again, a drop shipment is 28 when the drop-shipper sells to a retailer and 65 1 delivers to someone else the ultimate consumer. 2 MR. RUNNER: Mm-hm. 3 MR. SMITH: And there's no evidence here 4 that the auditor was aware of that. The petitioner 5 says that happened, but -- 6 MR. RUNNER: I think we've heard that, and I 7 understand the position. I believe that just because 8 the auditor didn't write it, or didn't -- didn't, 9 No. 1, identify it. And I'm also persuaded a bit by 10 the fact that we even acknowledge the fact that it 11 probably took place. 12 So I -- you know -- and I get -- so that's 13 kind of -- I'm kind of stuck on -- 14 MR. CLAREMON: We're -- all we have -- I 15 mean, that's a statement that was made. All we have 16 is a declaration by Mr. Miller here. That's it. 17 So -- we -- there's no evidence -- I mean, we're 18 not -- we're not saying -- 19 MR. RUNNER: A statement by the taxpayer is 20 valid. I mean, it's not like it's -- 21 MR. CLAREMON: We have no -- we have no 22 evidence other than the declaration -- a 25-year-old 23 declaration -- or subsequent 25-year declaration that 24 they took place. There's no evidence. 25 MR. RUNNER: Okay. 26 MS. STOWERS: Madam Chair. 27 MS. HARKEY: Yeah. 28 MS. STOWERS: So I understand what 66 1 Member Runner was saying, you know, setting aside 2 whether or not it was demonstrated, it was looked at. 3 Focusing on the loan change. And this is 4 how I'm looking at it. The law changed 1-1-93 or 5 September of '92. The audit period covered 1990 to 6 December '92. 7 So when the auditor was looking at the 8 taxpayer's work papers and invoices and so forth, the 9 auditor was not looking at what was going to be 10 happening in '93. 11 So when the auditor did the work papers -- 12 and they're now relying on these work papers, the 13 auditor is focusing on the law in effect in 1992. 14 And the law in effect in 1992 did not subject 15 out-of-state state drop-shippers to this tax 16 liability. 17 MR. DAKESSIAN: Actually -- can I make one 18 point of clarification on that? 19 It didn't subject folks -- I think we're 20 getting a little carried away here with what this law 21 change did. 22 The law change didn't all of a sudden make 23 D & H subject to drop shipments. They already were. 24 It made drop shipments from an out-of-state D & H 25 location, on that map that I provided you there with 26 three dots -- so they had made a drop shipment from 27 Atlanta, Georgia into California. That law subjected 28 that sale to tax. 67 1 But they were already subject to the 2 drop-shipment rule from the Fresno location. So 3 there wasn't really -- you know what I'm saying? 4 There wasn't a law change that automatically turned 5 the tax on for D & H. They were already subject for 6 tax. This expanded the amount of transactions that 7 were subject to tax. 8 And our argument is that the Department had 9 looked at the resales, and had everything they needed 10 to make that examination with the evidence they had, 11 performed their spot test and came back and said, 12 "You're okay." And they were not okay. 13 I'm sorry. I'm not done yet. 14 They were not okay whether pre-1992 law 15 change or post-1992 law change. 16 But to Mr. Runner's point, the law change 17 took place before the end of the audit. So -- and 18 the audit was -- I don't know when the taxpayer 19 exactly received the audit. But we know based on 20 that cover page that the data review was May of 1993. 21 So this went through two separate levels of 22 review. Two separate people aside from the audit -- 23 auditor certified that this was correct. 24 MR. HANKS: Ms. Stowers, I just wanted to 25 add that the spot test that occurred actually covered 26 a quarter in 1991 and a third quarter of 1992. So 27 the fourth quarter of 1991, and the third quarter of 28 '92. 68 1 So those were the only quarters where the 2 resale examination occurred. So well before the 3 statute change or the regulation was adopted. 4 MS. STOWERS: All right. Thank you. 5 To the petitioner. 6 MR. DAKESSIAN: But drop shipments in those 7 quarters that were from the California location 8 wouldn't have been subject to tax. 9 MS. HARKEY: They would if they had nexus. 10 MS. STOWERS: And I agree with you on how 11 what the law did as far as the change. But there was 12 a change in law. It didn't turn on the tax. Because 13 California -- in California, it would be separate to 14 that tax. 15 MR. DAKESSIAN: But not a law change, 16 Ms. Stowers, that would have validated the previous 17 advice. If they had turned -- if they had -- the law 18 change expanded the extent to which drop shipments 19 would be taxed. It didn't change it in a way that 20 would have required the taxpayer to not rely. 21 And that's -- when you talk about 1705 and 22 the statutory and regulatory change that's required, 23 that's what it's there for is to prevent taxpayers 24 from relying on advice based on the rule of law. 25 That's not what happened. 26 MS. STOWERS: Thank you. 27 Department. 28 MR. CLAREMON: I would just disagree with 69 1 the characterization that it expanded the tax. Tax 2 is on a transaction-by-transaction basis. So for all 3 transactions that are being delivered from out of 4 state up to December 31st, 1992, tax did not apply. 5 Starting January 1st, 1993, tax applied. So it 6 completely changed the law on those transactions. 7 A taxpayer may have had other transactions 8 that were subject to tax prior to 1993. But to 9 characterize that as not a change in the law to 10 taxpayer because he had other transactions that were 11 subject to tax is a mischaracterization. 12 MR. DAKESSIAN: I apologize. It's a change 13 in the law, but not one that's relevant to this 14 discussion. 15 MS. HARKEY: Member Horton, you have been 16 noticeably quiet throughout this discussion. 17 Are there any other -- 18 MS. STOWERS: For me, I don't feel that the 19 work papers demonstrate that the drop shipments were 20 looked at, and the auditor said it was acceptable. 21 So I'm at the first part of the argument 22 that they were not provided advice on this 23 transaction. 24 I'm also wobbling on the change of law side 25 of it. That's where I'm at so far. 26 MS. HARKEY: Well, I would like to offer a 27 bit of clarification. I was sitting here listening 28 to all of this. But in the audit papers it does say 70 1 that taxpayer has a sales office and warehouse in 2 Ontario, which Member Ma brought up. Employees based 3 in Ontario traveled through the state including all 4 transit [inaudible] to solicit sales. That would 5 have established a nexus. 6 So anything that shipped into Ontario would 7 have been subject to tax. And so now they change 8 their shipping into Fresno without nexus, I guess. I 9 have to figure that out. 10 So I think they were examined. I just think 11 they weren't called drop ships. I'm just trying 12 to -- I'm debating on the law, too. 13 Because we still -- we went into Fresno, 14 right? 15 MR. DAKESSIAN: I beg your pardon? 16 MS. HARKEY: We went into Fresno, correct? 17 MR. DAKESSIAN: Yes. So the company has had 18 nexus in California, has had a seller's permit since 19 1989, had the location in Ontario back then. And its 20 location now is in Fresno. So it's had, you know, 21 it's been making drop shipments from California 22 locations pretty much since it's been in California 23 MS. HARKEY: Which is why I have a -- have a 24 bit of a problem. 25 MR. HORTON: Madam Chair. 26 MS. HARKEY: Yes. 27 MR. HORTON: This is a question of the 28 Department. 71 1 If, in fact, drop ship did exist during the 2 prior audit, is it the Department's position that it 3 shouldn't -- it would have been sufficient enough to 4 do a no change without examining that? 5 MR. HANKS: I think, Mr. Horton, what we'd 6 say is that -- 7 MR. HORTON: Let me elaborate. 8 If there were known to be various different 9 forms of resale, one a direct resale to a California 10 wholesaler, one a drop-shipper retailer, if it 11 existed, would have been appropriate for the auditor 12 to examine it or not? The auditor could have chosen 13 not to examine that on the basis that they presumed 14 that all resales were the same. 15 MR. HANKS: I don't think they would have 16 presumed all the resales were the same. So I think 17 ultimately what they would have been looking at is 18 whether or not the property that was sold was sold to 19 a known retailer that sold that type of property. 20 And whether or not the resale certificates were there 21 to support those types of sales. 22 And obviously if they had made sales, like a 23 hypothetical we gave earlier of a sale to electronic 24 parts to a known retailer like Best Buy, I doubt that 25 we're even going to be looking for a resale 26 certificate. We know that that property is going to 27 be resold. 28 But the audit work paper comments indicate 72 1 that for the questioned transactions that they 2 examined under the resale test, that those tested 3 transactions were supported by resale certificates 4 and -- or purchase orders that indicated that the 5 property was acquired by people that were reselling 6 the property rather than a drop-shipment situation. 7 Because you wouldn't see a purchase order issued in a 8 drop-shipment transaction. 9 So the problem here is we don't see any 10 transactions that relate to drop-shipper-type 11 transactions, or if they were examined, or indeed 12 that they existed at that time. 13 I don't know what their business model was 14 back then. Perhaps drop shipments of the type that 15 we're examining today, perhaps they did not -- 16 it's -- you know, we don't know. 17 MR. HORTON: Question of the appellant. 18 I know this is redundant, because I do 19 recall your testimony. But during the prior audit, 20 were there any drop-ship-type transactions? And if 21 so, what do you estimate the percentage was? 22 MR. MILLER: There would have been drop 23 shipments during that timer. The percentage would be 24 probably hard to calculate. Depending on the season, 25 as I indicated, you have more drop shipments during 26 the holiday timer. So the fourth quarter would have 27 more of those type of transactions. So it would have 28 been more obvious probably then. But to say what 73 1 percentage back then would be hard to answer that 2 question. 3 MR. DAKESSIAN: Were they prevalent? 4 MR. MILLER: Yes, they were. 5 MS. HARKEY: Do Members need some time to 6 review? And we may want to -- I don't know if we 7 should just call for a little recess? I think 8 everybody's deep in study here. 9 Do you want to call for -- just let the 10 Members review this for at least another 15? I don't 11 think you want to take it under submission, but 12 that's always an option, too. 13 Yeah, let's take 15. Well, we can -- we can 14 take 15 minutes up here. I believe you can, with 15 their permission -- we can take 15 minutes. 16 Is that the rule? 17 MR. HORTON: I think so. 18 MS. HARKEY: Okay. 19 Can we take 15 minutes? 20 Thank you. I think people want to kind of 21 review all of the stuff here. There's a lot of data. 22 This is a big case. We want to be sure we get it 23 right. 24 Thank you. 25 (Whereupon a break was taken.) 26 MS. HARKEY: Members, do we have anymore 27 conversation or any questions? Anything else to add? 28 MR. DAKESSIAN: Madam Chair, I was wondering 74 1 if it would be okay to have the taxpayer make a few 2 additional comments that were not -- 3 MS. HARKEY: More than happy. Sure. 4 MR. DAKESSIAN: Okay. Thank you. 5 MR. MILLER: So first just want to describe 6 a typical audit process. We follow -- basically, I 7 was responsible for the audits back then and well 8 into that timer. 9 So the auditor would call us and tell us 10 they want to come into audit. We would discuss, 11 okay, what periods are being audited. We would then 12 ask, how do you want to describe the sample you want 13 to pick from, or the population you want to pick 14 from? And we explained that we had sales journals 15 basically by -- it would be for a whole month. But 16 basically would be indexed by state that would show 17 both the "ship to" and the "sold to" on the sales 18 journal. 19 Um, we would agree on a period of time that 20 the individual wanted to audit. So whether it was a 21 quarter, whether it was a half year, whether it was a 22 whole year, whatever it was. We would then -- when 23 they arrived, we would provide those journals to the 24 individual. They would come and select from that 25 listing. So they basically could see every sale we 26 made related to the state they were involved in. 27 They would pick whatever sales they wanted 28 to see, specific invoices. Because on that journal 75 1 it did not show whether we charge sales tax or not. 2 So literally to find out whether it was taxable or 3 not or whether we needed to provide an exemption 4 certificate, they would have to see the invoice. 5 On our invoices we always have a "sold to" 6 and a "ship to." And if we're charging tax, we make 7 it clear on the invoice as well. 8 So they would get the invoices, then if they 9 needed to have exemption certificates, we would 10 provide that. 11 So, again, the population of what we were 12 doing in any given audit is always available. We 13 provide that information, they pick from it. So 14 whatever they pick, we provide. Okay? So that's 15 No. 1. No. 2 -- 16 MR. DAKESSIAN: Mr. Miller -- and the 17 relevance of that is that if you have different "ship 18 to" and "bill to" addresses, then that would have 19 revealed a drop-ship resale? 20 MR. MILLER: It would have been clearly 21 stated on the sales journal. And then when they got 22 the invoice, it would have been clearly indicated. 23 Then, in addition to that, if you think 24 about what was going on back then -- and, again, this 25 is a period of time in my career where I've been with 26 the company 34 years, and this was probably one of 27 the more exciting times in the company in the '90s 28 because the business was just expanding tremendously. 76 1 Everybody was getting into the computer business, and 2 there was so many different manufacturers, and 3 products were changing constantly. Literally, models 4 would change every three or four months. So it was 5 just a very, very exciting time. 6 So our customers would advertise in national 7 magazines. I mentioned Computer Shopper, PC World, 8 PC Magazine. And they were advertising there because 9 they're trying to hit the whole country. You could 10 go any place and find these magazines. 11 Secondly, we -- at the same time, we were 12 opening up locations throughout the whole country 13 because we understood that it was important to get 14 the products to our customers within two days. 15 So literally in the '90s and the early 16 2000s, we literally opened up or moved 36 times. So 17 as we indicated, we started with two facilities in 18 California; one in the San Francisco area, one in the 19 LA area. We eventually moved that to Visalia, and 20 then eventually moved that to Fresno. Because we 21 figured out we couldn't hit the whole country -- or 22 whole state from one location. 23 So my point would simply be that there's 24 customers that would have been on there -- and there 25 was mention about Best Buy and the like. Well, they 26 more than likely had stores in the state, so 27 people -- we were probably, for those kind of 28 customers, shipping to the stores. 77 1 But there would be other customers like Swan 2 Technologies, Lyco Computer Marketing, 3 MicroWarehouse. So Swan and Lyco were companies in 4 Pennsylvania, MicroWarehouse was in Connecticut, 5 Computer Discount Warehouse, as you guys would know 6 as CDW, was in Illinois. 7 I mean, these are companies that gathered 8 real quick that they can reach the whole country by 9 advertising into these magazines. And, therefore, if 10 they partnered with us, we could deliver their 11 products to those customers in a timely fashion and a 12 cost-effective fashion. 13 Because, again, the business for D & H back 14 then was primarily components. Not -- we did sell 15 like Commodore computers back then. But it was 16 really more about hard drives and video cards and 17 sound cards and the like. 18 So these are things that fit in a UPS -- in 19 a box that you could ship UPS, so you could literally 20 get it to a customer in a day or two depending on 21 where your physical locations are. 22 So the idea that -- when the audit occurred 23 and we went through the audit process, and we felt, 24 D & H, that we got a clean bill of health. And the 25 reason why this is important is that on some of the 26 products we sell, we literally only make three or 27 four percent margin. Our average margin back in that 28 timer was probably in the six or seven percent. 78 1 So literally if we thought we were subject 2 to tax, it would be idiotic of us not to charge tax. 3 Because it's 100 percent of our margin we would be 4 giving away. So I assure you, if we thought we were 5 liable for tax, we would have worked on whatever 6 computer changes we would have to do. Wouldn't have 7 happened overnight, but we would have done that so 8 that we can be compliant. 9 I don't know if that helps, but we thought 10 that might be of some value to -- to this decision. 11 MS. HARKEY: Since this -- since this 12 appeal, are you retooling? 13 MR. MILLER: Say again. 14 MS. HARKEY: Since this appeal, are you 15 retooling? 16 MR. MILLER: Retooling, meaning -- 17 MS. HARKEY: Retooling your -- your -- like 18 you just said, had you known -- 19 MR. MILLER: Oh, we already fixed it. As 20 soon as it came up in the audit. It took a little 21 bit of time because we had to figure out what systems 22 we would do and so forth. But literally we ended up 23 doing the software development system ourselves. We 24 have a Legacy system, so it basically -- we had to do 25 it ourselves. 26 MS. HARKEY: So you truly were relying on 27 6596. 28 MR. MILLER: Absolutely. 79 1 MS. HARKEY: Member Runner, Ms. Ma, Member 2 Horton, does anybody have a motion? Anything they'd 3 like to offer? 4 Well, if we're gonna sit up here and just 5 think, I'm going to call -- I'm going to ask for a 6 motion to take it under submission. And see if we 7 can't get back to it after our next two cases. 8 MR. RUNNER: Yep. 9 MS. HARKEY: Okay. Motion to take this 10 matter under submission. 11 Member Runner, you're seconding? 12 MR. RUNNER: Second. 13 MS. HARKEY: Is there any objection? 14 Okay. Such will be the order. 15 Thank you. 16 MR. MILLER: Thank you very much. 17 (Whereupon a break in the matter was taken.) 18 MS. HARKEY: Okay. Thank you. 19 All right. Now, Members, we just have -- we 20 have a vote -- an item we took under submission. And 21 that is item -- 22 MS. RICHMOND: C13, D & H Distributing. 23 MS. STOWERS: Madam Chair, I want to ask 24 Appeals clarification. 25 MS. HARKEY: Sure. 26 We're reopening case C13 for the Board 27 Members. 28 Ms. Stowers, you had a question for 80 1 Appeals. 2 MS. STOWERS: To Appeals, this is regarding 3 the law. 4 To the extent that 6596 applies, would it 5 apply only to in-state transactions, or in-state and 6 out-of-state transactions? 7 MR. ANGEJA: So the Department's position 8 was that there was no erroneous advice provided. If 9 it were found that there were erroneous advice 10 provided, everybody agreed the testimony was the law 11 changed in '93 to apply to out-of-state transactions, 12 the use tax. Prior to January 1 of '93, in other 13 words, for this audit period, out-of-state 14 transactions from a drop-shipper were not taxable. 15 So the answer to your question is if 6596 16 relief is found, it covers only the shipments from 17 inside this state. So you would be relieving under 18 6596 transactions that occurred from inside this 19 state, which would be a percentage of the measure, 20 but not the whole. 21 All the other tax -- in other words, there's 22 no erroneous advice provided with respect to use tax 23 transactions, shipments from the out-of-state 24 locations. Those would remain taxable. 25 MS. HARKEY: Um, we have -- we have a strong 26 objection. 27 Am I able to call back, because I'm -- 28 MR. RUNNER: We closed the hearing. 81 1 MS. HARKEY: Yeah, we did close the 2 hearing. 3 MS. MA: So -- so was this calculation based 4 on direct sales to customers, or just sales to their 5 Fresno office, do we know? 6 MR. ANGEJA: I don't think it was the Fresno 7 office at the time. And they picked up -- for the 8 audit that's before you, they picked up all the 9 transactions that are drop shipments. 10 The erroneous relief -- the advice that 11 they're relying on was given in the prior audit. And 12 at that time, the out-of-state transactions were not 13 taxable. So if there's erroneous advice, it could 14 only have been with respect to the in-state 15 transactions. 16 In other words, even if you find for 17 relief -- if you find that relief is warranted under 18 6596, it can't cover transactions that weren't 19 taxable at the time of the advice. 20 MS. STOWERS: They couldn't have given them 21 erroneous advice on something -- 22 MR. ANGEJA: That wasn't taxable. It would 23 have been on the taxable transaction. So that which 24 occurred from inside this state, if you were to find 25 that erroneous relief -- if relief is warranted, it 26 would cover -- 27 MS. HARKEY: It would cover the drop 28 shipments. 82 1 MR. ANGEJA: Well, these are all drop 2 shipments. Some of them occurred from inside the 3 state, from the Fres -- I don't know if it was 4 Fresno, but for now let's say it was Fresno -- 5 occurred from the Fresno location, others came from 6 the Pennsylvania hub. 7 But the ones in the audit period from 1990 8 to 1992, shipments from the Pennsylvania hub would 9 not have been picked, would not have been taxable. 10 There would have been no erroneous advice with 11 respect to those transactions. 12 If any erroneous advice was given, it would 13 be with -- in other words, taxable transactions 14 missed, it would have been for the in-state 15 transactions only. I'm just giving you the 16 parameters of what 6596 would apply to if you find 17 that there's relief warranted under 65 -- it's not a 18 complete grant even under 6596, is my point. 19 MS. HARKEY: Where's my little charts? 20 Because before -- during the audit, during the 21 previous audit, they actually were taxed because they 22 shipped them to their own Ontario. And they had a 23 nexus. So those were taxed. 24 Afterwards, what we're dealing with now is 25 the drop ships. 26 MR. ANGEJA: I thought it was a no change 27 audit that granted their sales for re -- didn't pick 28 up tax. That's the point. They didn't get taxed on 83 1 sales in the prior audit that we're now saying were 2 taxable. So they're saying they're relying -- 3 MS. HARKEY: The drop ship. 4 MR. ANGEJA: Right. And they're saying 5 they're relying on that prior advice to get relief 6 here. 7 MS. HARKEY: So what percentage of this 8 dispute is drop ship? Does anybody have any idea? 9 MR. ANGEJA: All of it's drop ship, the 10 question is how much was drop-shipped from inside 11 this state versus drop-shipped from outside the 12 state. 13 MS. HARKEY: So if it's drop-shipped from 14 inside the state, you're saying, what? 15 MR. ANGEJA: Relief would apply to shipments 16 from within this state, drop shipments from inside 17 this state. 18 MS. HARKEY: So if it went to the Fresno 19 office, it was drop-shipped to Fresno -- 20 MR. ANGEJA: From Fresno to California 21 consumers -- 22 MS. HARKEY: -- to California consumers -- 23 MR. ANGEJA: -- relief would apply to those, 24 if you find that 65 -- 25 MS. HARKEY: Okay. And what's the catch 26 there for the other part? What's -- what's -- 27 MR. ANGEJA: The law changed in '93. There 28 can be no reliance on advice that didn't pertain to 84 1 the transactions in dispute. 2 In other words, they -- tax didn't -- 3 there's no advice given with respect to drop 4 shipments from outside this state. There's nothing 5 you can rely on. We weren't saying they were not 6 taxable. They were already not taxable. So the fact 7 the Department didn't tax it, there's no erroneous 8 advice given with respect to drop shipments from 9 outside the state. Those weren't taxable till '93, 10 which was after the audit period in question. 11 MS. HARKEY: But they did claim they did 12 have drop shipments. But that's the bone of 13 contention. 14 MR. ANGEJA: They're claiming that there was 15 bad advice that they relied on. Bad advice cannot 16 pertain to transactions that wouldn't have been 17 picked up and examined and taxed in the first place. 18 In other words, apples and oranges. You've 19 got in-state transactions, out-of-state transactions. 20 The bad advice -- if it was bad advice, it is 21 disputed -- the bad advice pertained to the apples. 22 Shipments from inside this state could not have 23 applied to transactions they weren't even looking at 24 to tax, because those were not taxable until after 25 the audit period in question, after 1993. 26 MS. HARKEY: Okay. Well, I think -- I think 27 that's where we're getting the rub. 28 MS. STOWERS: That was the change in the 85 1 law, that 6007 did, the Senate bill. I thought the 2 parties did -- I won't say that. Scratch that. 3 MS. HARKEY: Okay. 4 MS. STOWERS: Yeah, it was Senate Bill -- 5 MR. ANGEJA: 1608. 6 MS. STOWERS: -- 1608 that said this bill 7 will provide instead that when tangible personal 8 property is delivered by an owner or from a former 9 owner by a factor or agent, blah, blah, blah -- sorry 10 for that -- the retailer is not engaged in business, 11 and state that person making the delivery shall be 12 deemed a retailer of the property, making it taxable. 13 So that's the change. And from what I'm 14 understanding for the audit period where they may 15 have received the erroneous advice, the law did not 16 make those type of transactions taxable. So if the 17 law did not make them taxable, the auditor could not 18 have given bad advice to something that was not 19 taxable for that audit period. 20 That's why I was trying to get clarification 21 that if it does apply, the auditor would have given 22 bad advice to the in-state drop shipments, but not 23 the out-state drop shipments, to the extent that 24 there was erroneous advice. 25 MS. HARKEY: So I guess -- I'm confused. 26 Because I don't know what the breakdown was of what 27 and what, as to what our dispute is here. I'm trying 28 to figure out if this is -- if this is anything or 86 1 nothing. 2 MR. ANGEJA: If the in-state -- if 6596 3 relief is found applicable, and it applies to the 4 in-state transactions, the measure -- the reduction 5 in measure is 25,467,597. 6 MS. HARKEY: Okay. 7 MR. ANGEJA: Roughly. That's an estimate 8 that we got. 9 MS. HARKEY: I'm going to make a motion to 10 support the taxpayer on 6596. 11 MR. RUNNER: For the whole amount? 12 MS. HARKEY: Well, it's the amount that's 13 in-state, we're being told. So it reduces the 14 measure by 25,467,597. 15 MR. HORTON: Members, let me just ask a 16 quick question, if I may. 17 Question of Appeals, the statutory change in 18 the 1993 -- 19 MS. HARKEY: The audit wasn't completed 20 until May. 21 MR. HORTON: -- um, was prospective. 22 MR. ANGEJA: The change in law was 23 prospective, yes. Prior to that point, the use tax 24 transactions weren't taxable. 25 MR. HORTON: And the audit was concluded 26 when? 27 MR. ANGEJA: I thought the report was given 28 in May of '93. But the audit period that was being 87 1 examined was January 1 of '90 to 12-31 of '92, prior 2 to the change in law. 3 MR. HORTON: So I would imagine that the 4 counterargument -- not that I'm making -- would be 5 that the law changed and advice was rendered 6 subsequent to the law change, given that the -- no 7 change was issued in May, a month after the law 8 change. 9 MS. STOWERS: But they were only given 10 advice with respect to the 1990 to the 1992 years. 11 MR. HORTON: The argument still would be -- 12 is that the auditor didn't take the 1993 into 13 consideration, and -- 14 MR. ANGEJA: But would not have. Where -- 15 they weren't looking. It's prospective as of 16 January 1 of '93. So for the audit period at issue, 17 '90 to '92. 18 MR. HORTON: I'm not disputing that. And 19 I'm just advancing this for consideration, not 20 necessarily arguments. 21 But if the advice was provided in May of 22 1993, and the law changed in April of 1993 -- 23 MR. ANGEJA: The law changed in January. 24 MR. HORTON: January of 1990 -- that's 25 even -- then the advice would have taken into 26 consideration the law change -- 27 MR. ANGEJA: No. 28 MR. HORTON: -- because it was subsequent to 88 1 the issuance of the law change. 2 MR. ANGEJA: No, because the law -- I don't 3 mean to interrupt, but the law was prospective. So 4 that law had no bearing on the audit period in 5 question. 6 Even though the report comes out in May of 7 '93, it's talking about 1990 to '92. And in '90 to 8 '92, half these transactions weren't taxable in the 9 first place. Because use tax didn't apply for the 10 drop-shipper. 11 So the advice that something that was -- the 12 erroneous advice that something wasn't taxable could 13 only apply to something that was taxable in the first 14 instance, which would be the in-state sales tax 15 transactions, not the use tax transactions. 16 MR. HORTON: Because -- 17 MR. ANGEJA: Those weren't taxable until 18 after the audit period. 19 MS. HARKEY: My motion is still hanging out 20 there. Is there going to be a second for me? 21 No second. 22 MR. RUNNER: I've got a question in regards 23 to the -- again, wouldn't -- I get the issue of the 24 timing of the law, but -- I mean, I'm trying to 25 figure out what the role on the responsibility of an 26 auditor is. 27 I mean, the auditor is to audit, see about 28 liabilities, and also to educate taxpayer. So why in 89 1 the world wouldn't -- even if -- it seems to me to be 2 it would be a missed opportunity for the auditor to 3 not, in their notes or direction, say, "Hey, you were 4 audited during this period, but we need to let you 5 know about a law change." Just to give some 6 direction that -- that -- that would be relevant to 7 the taxpayer in order to help them in the future 8 compliance. 9 MR. ANGEJA: Specifically, in this case, 10 that law change wouldn't have applied to the audit in 11 question. 12 MR. RUNNER: Yeah, but the audit -- 13 MR. ANGEJA: So that audit report -- 14 MR. RUNNER: Isn't the purpose of an audit 15 not only to check out whether or not somebody was 16 doing something correctly, but also to educate the 17 business and the taxpayer in terms of their -- in 18 terms of their future activity? 19 MR. ANGEJA: Sure. But in terms of 6596, 20 the failure -- you've got an audit period from '90 to 21 '92 -- 22 MR. RUNNER: Mm-hm. 23 MR. ANGEJA: -- and we come out, and then in 24 '93 there's a law change. To say whether we should 25 or should not have in May of '93 say, "Hey, going 26 forward for periods that are no longer at issue here, 27 remember, it changes now," that still doesn't rise to 28 the level of 6596, erroneous advice for the audit 90 1 period that the law didn't even apply to. 2 MS. HARKEY: The taxpayer's argument, if I 3 might, was that they had drop shipments during the 4 audit period, that all of -- the audit was 5 appropriately performed, items were checked, and they 6 had drop shipments. 7 And so they assumed they were doing things 8 right, they continued on with the written advice that 9 they had in the audit, which was evidence by that 414 10 that it was a no change. And so they went on. 11 And so I think that the law changed, but was 12 not applicable to '93. Unfortunately, the audit did 13 not come out until -- the audit report didn't come 14 out until May of '93. The taxpayer probably had no 15 idea they weren't doing it right because drop ships 16 were drop ships, and they were further defined. But 17 they thought they were doing things right. 18 So that's why I'm willing to grant 6596 for 19 the items that we can. Because I think their 20 argument has merit. 21 MR. RUNNER: But I don't think they're 22 making the argument for that. 23 MS. HARKEY: Well, then you -- you fly a 24 motion then. 25 MR. RUNNER: No, I -- 26 MS. HARKEY: I mean, crying out loud. I'm 27 trying to -- I'm trying to land the plane here. You 28 know, everybody is arguing, but nobody is stepping 91 1 up. I'm stepping up. This is my motion. 6596 for 2 the amount that they can. We were told that it's 3 roughly half of the amount, 25,467,597. I think we 4 have support for doing that. 5 I'm not -- I'm not -- I don't feel like we 6 have support from our legal counsel to do more than 7 that. So this, I think, is a good consideration 8 considering all of the changes and arguments that 9 we -- 10 MR. HORTON: Um, given -- to Mr. Runner's -- 11 January of '93. All right. 12 MS. HARKEY: Okay. Is there an alternate 13 motion? I don't have a second. 14 MR. RUNNER: Yeah. And to keep this moving, 15 I'll make a motion for the taxpayer. 16 MS. HARKEY: On 6596? 17 MR. RUNNER: On the whole -- yes. Well, 18 I'll just make a motion for the taxpayer. 19 MS. HARKEY: Is there any second for that? 20 Okay. Motion dies for lack of a second. 21 MR. RUNNER: So somebody make a motion. 22 MS. STOWERS: I -- I -- I move to adopt 23 staff recommendation. 24 MS. HARKEY: Is there a second for staff 25 recommendation? 26 No? 27 That dies. 28 Okay. I'm going to bring back my motion. 92 1 I'm going to move to grant the taxpayer's request for 2 6596. 3 Is there a second? 4 Okay. You guys don't want to deny the 5 claim, you don't want to give the claim, you don't 6 want to split the claim. What is it you want to do 7 up here? Make a decision. You're paid the big 8 bucks. Come on. 9 Go along with me then, make a second. Then 10 we'll see how it rolls. I mean, I can't believe 11 this. You're all intelligent people. Let's just 12 take a plunge. 13 MR. RUNNER: Again, I'm having trouble -- 14 I'm having trouble quantifying the 6596 issue. And 15 that's a portion of the issue. So maybe Appeals can 16 take me through that. 17 MR. ANGEJA: So prior to 1993, a 18 drop-shipper was only liable for shipments that 19 originated from its California location -- 20 MR. RUNNER: Mm-hm. 21 MR. ANGEJA: -- sales tax transactions. 22 When that same drop-shipper delivered from an 23 out-of-state location, that would have been use tax. 24 That was not taxable during this audit period. 25 So those drop shipments in this audit period 26 that were subject to use tax, not sales tax, they 27 weren't subject to use tax in the audit period. So 28 any erroneous advice could not have applied to 93 1 transactions that weren't already taxable, because 2 they weren't taxable at that time. 3 MS. HARKEY: I think he makes -- I think he 4 makes a very good case. And I think he makes a very 5 supportable argument that the audit reviewed -- the 6 audit reviewed all of the shipments, found them all 7 complying. And that as of the change in the law or 8 anything that happened, it would only be for drop 9 shipments made out of state that weren't taxable in 10 the audit period, that the taxpayer relied on that 11 audit period to go forward. And I think, um -- 12 that's why I think my -- 13 MR. RUNNER: Do we know what portion we're 14 talking about? 15 MS. HARKEY: Yes, we're talking about 16 25,467,597. 17 MR. RUNNER: That is the -- 18 MS. HARKEY: That's about half of the 19 measure, which is no small change. 20 MR. RUNNER: Right. 21 MR. HORTON: Maybe this will be helpful, 22 Mr. Runner. 23 Again, I'm not arguing one way or the other, 24 but just to -- a 6596 ruling would basically say that 25 the auditor gave the taxpayer correct advice as it 26 relates to the items that were taxable during the 27 audit period. 28 Um, but the law didn't make the use tax 94 1 transaction taxable until January of '93. Which 2 would mean that the advice, presumably, if it's 3 correct and it can be relied on, his advice would 4 have been is that the use tax transactions are not 5 taxable, which would have been the correct advice at 6 the time that it was given. 7 MR. ANGEJA: That's a different way to say 8 it, but that's correct. 9 MR. RUNNER: Well, for the sake of where we 10 are, is the motion still on the floor? 11 MS. HARKEY: The motion's on the floor. 12 MR. RUNNER: Second. 13 MS. HARKEY: There's a second. 14 Is there any objection? 15 MS. STOWERS: Which motion are we seconding? 16 MS. HARKEY: The motion is to grant 6596, 17 taxpayer relief under 6596, which -- that's the 18 motion. 19 MR. ANGEJA: For the in-state 20 transactions. 21 MS. HARKEY: But that was the explanation. 22 For the in-state transactions. 23 We have a motion, we have a second. 24 Do we have an objection? 25 MS. STOWERS: I'm going to object. 26 MR. HORTON: Yeah, me too. 27 MS. HARKEY: We have two objections. 28 Okay. Please call the roll. 95 1 MS. RICHMOND: Chairwoman Harkey. 2 MS. HARKEY: Aye. 3 MS. RICHMOND: Mr. Runner. 4 MR. RUNNER: Aye. 5 MS. RICHMOND: Mr. Horton. 6 MR. HORTON: No. 7 MS. RICHMOND: Ms. Ma. 8 MS. MA: No. 9 MS. RICHMOND: Ms. Stowers. 10 MS. STOWER: No. 11 MR. RUNNER: Okay. Well, then you guys -- 12 MS. HARKEY: Well, then, Fiona, make a 13 motion. Come on, step up. 14 I thought it was a good motion. I think 15 they had a good argument. 16 Make a motion. I mean, I gave it my best 17 shot. I think this was a solid motion. And we had 18 legal support for it. 19 MR. RUNNER: I'm a little confused. 20 MS. HARKEY: Nobody wants to vote no; nobody 21 wants to vote yes. 22 MR. RUNNER: We went for a portion for the 23 taxpayer, where, you know -- 24 MS. STOWERS: Well, I go back to denying 25 6596 relief, period. I do not see where the auditor 26 gave the erroneous advice. I do not see. 27 MS. HARKEY: It doesn't have to be erroneous 28 advice, it just has to be advice. 96 1 MS. STOWERS: Okay. Gave the written 2 advice. The work papers that were presented do not 3 demonstrate to me that written advice was given with 4 respect to the drop shipment. And the way I read the 5 statute and regulation, it has to be explicit written 6 advice for the audit report showing that the auditor 7 looked at that transaction. And the work papers do 8 not convince me that the auditor looked at the 9 transaction. 10 MR. RUNNER: Is that your motion? 11 MS. STOWERS: That is my motion. 12 MS. HARKEY: Her motion is to deny -- or 13 to -- to -- to support -- or -- 14 MS. STOWERS: Deny 6596 relief. 15 MS. MA: Okay. So my issue is the 16 legislation and the new legislation that passed, 17 effective whatever the date was. 18 MR. HORTON: 1-1-93. 19 MS. MA: Yes. 20 And, you know, being on the Legislature, I 21 read it, I think I know what it says, and it was 22 effective 1-1-93. Which means effective that date. 23 It is new legislation, and that taxpayers who 24 drop-ship into California are supposed to collect and 25 reimburse the sales tax. Which is the issue that 26 we're having with a lot of the online retailers right 27 now, that they're not -- 28 MR. DAKESSIAN: The legislation was 97 1 effective September 1992 -- 2 MR. HORTON: Is that true? 3 MS. MA: Was effective September, or -- 4 okay. We didn't get an answer. 5 MS. HARKEY: Effective September of '92. 6 MS. MA: We didn't get an answer. 7 MS. STOWERS: Appeals. 8 MS. MA: When was it effective? 9 MR. ANGEJA: September 25th, 1992, operative 10 January 1 of '93. 11 MR. DAKESSIAN: Effective. 12 MR. ANGEJA: Operative date is the date that 13 the law applies. 14 MR. RUNNER: Yeah. It must have been signed 15 in September. 16 MR. HORTON: Just for the record, Appeals 17 can't talk to the taxpayer. 18 MS. HARKEY: No. 19 MR. ANGEJA: I was answering Ms. Ma's 20 question. 21 MS. HARKEY: Okay. So we have a motion to 22 deny the claim. 23 MS. STOWERS: So, where you at -- Ms. Ma, 24 you're thinking that there's a conflict with a change 25 in the law date, or -- 26 MR. RUNNER: Well -- 27 MS. MA: You guys were all on the 28 Legislature with me too. 98 1 MS. STOWERS: Not me. 2 MR. RUNNER: Well, again, I mean, it's kind 3 of -- it's an interesting argument. And that is the 4 bill was apparently probably signed on that date. 5 And as we all know, new laws, unless it was done with 6 urgency, go into effect at the first of the year. 7 So the question is, if the effective date of 8 the law was indeed the -- January, but in -- but the 9 real effect of the law -- the fact that it was gonna 10 be a law was actually done when the Governor signed 11 the bill. So I guess that's the -- I don't know how 12 nuance that is, but we all know that's what the 13 process is. 14 MS. HARKEY: Okay. Well, we have a motion 15 on the floor to deny the claim. And so do we have a 16 second for that? 17 We don't have a second. 18 Is there a second? 19 There's no second. 20 Okay. So there's no motion. 21 What do you guys want to do? 22 MS. MA: Hold on. 23 MR. RUNNER: Well, I guess the discussion 24 there is, if indeed that's an important point -- the 25 point is that when the Governor signs a bill, signs a 26 bill that is in effect saying that this is going to 27 be the law. Now it has a different effect of the law 28 just as when we know in the Legislature we can sign a 99 1 bill and it can go into effect after January. They 2 can put in a law that goes into effect in June or 3 whatever date in the future. But the question is, 4 is -- does that, in fact, create a -- um, a law -- 5 MS. HARKEY: We can't -- 6 MR. RUNNER: -- that which people have to 7 respond -- 8 MS. HARKEY: We can't engage anymore. 9 MR. ANGEJA: It's closed. 10 MS. HARKEY: We really can't. We're closed. 11 So please just let the Board talk about it. 12 (Inaudible discussion.) 13 MS. STOWERS: But does it -- 14 MR. HORTON: Appeals, quick question. 15 What are your -- what are your thoughts 16 about the change in the regulatory on 1705 -- I 17 think 6? 18 MR. ANGEJA: The Regulation 1706. 19 MR. HORTON: Yeah. 20 MR. ANGEJA: As was testified in the 21 hearing, primarily was a change in the billing. It 22 was -- it didn't -- 6007 was changed operative 23 January 1, 1993. That law didn't change with the 24 regulation, what changed was the 10 percent safe 25 harbor provision. 26 Prior to that, the drop-shipper was liable 27 for the full amount of whatever the markup might have 28 been, subject to the auditor auditing or -- right? 100 1 So the regulation comes out and gives you 2 the 10 percent markup as opposed to higher than that. 3 And gave the taxpayer the opportunity to show there 4 could be less than that 10 percent if they had the 5 evidence. 6 It didn't -- it didn't have any change at 7 all with respect to the taxability of in-state or 8 out-of-state drop shipments. That law did not change 9 since 1993. 10 MR. RUNNER: Typical language, when we talk 11 about the issue of the Governor-signed bills, and we 12 talk about the Governor signed the bill into law. 13 And, in fact, during that period of time was actually 14 when it's chaptered. It actually is chaptered during 15 that time. 16 So that's different than the effect, right? 17 MR. ANGEJA: Well, let's put it in different 18 terms. 19 MR. RUNNER: Okay. 20 MR. ANGEJA: Out-of-state drop shipments 21 weren't taxable in September of 1992. So despite the 22 change of the law, and signing by the Governor, and 23 being chaptered on that day, a taxpayer who is doing 24 out-of-state drop shipments could say, "Hey, these 25 aren't taxable until January 1." 26 MR. RUNNER: Right. 27 MR. ANGEJA: So the law didn't change for 28 the taxability of the transactions at issue in that 101 1 audit period. So it doesn't really make a material 2 difference for our point that there could not have 3 been erroneous -- 4 MR. RUNNER: Well, again, assuming the 5 argument, though, from my colleagues, my colleagues 6 are saying that the law changed. 7 MR. ANGEJA: Yes. But the point that we're 8 saying is that if there's relief warranted on 9 erroneous advice, it could not have applied to 10 transactions that weren't already taxable. And the 11 use tax transactions weren't taxable until 1993, 12 January 1. 13 MR. RUNNER: But isn't the argument that -- 14 what's the -- I guess -- I mean, I hear you. But I 15 thought this part of the discussion was whether or 16 not something became law after. And if you believe 17 that it became law in September of 1992, because it 18 was chaptered then, that's within the audit period. 19 MR. ANGEJA: It didn't make nontaxable 20 transactions taxable until January 1 of '93. And 21 that's the point that we're trying to say. 22 If the Board finds that there was erroneous 23 advice given, advice saying, "Hey, that which is 24 taxable, really isn't, and that's wrong," that can 25 only apply to something that was taxable in the first 26 place. 27 The out-of-state transactions aren't in that 28 bucket. They weren't taxable until January 1 of '93. 102 1 The advice can't apply to it regardless of the 2 chapter date of the bill. 3 MR. RUNNER: Okay. I mean, there's 4 another -- I guess I'd like to hear from the 5 taxpayer. 6 MS. HARKEY: You want to reopen the public 7 hearing? 8 MR. RUNNER: Yeah, I'm going to move to 9 reopen the hearing. 10 MS. STOWERS: Is the Department still here? 11 MR. RUNNER: Well, they better be. 12 MS. HARKEY: No, they're not here. I don't 13 know that you can open the public hearing. 14 MR. RUNNER: Well, I can. I can. If 15 they're not here, that's too bad, I guess. 16 MR. NANJO: In all fairness, you can reopen 17 the hearing. 18 MR. RUNNER: Right. 19 MR. NANJO: But you have to allow the 20 Department's attorneys to be present. Previously, 21 you didn't give them any indication that this might 22 be reopened. So I would caution you that it may not 23 be fair to go forward on that basis. 24 MS. MA: We had an issue -- we had an issue 25 with attorneys leaving early last time. Before you 26 got here, Mr. Nanjo. 27 MR. NANJO: You know, I -- 28 MS. MA: I'm still -- I'm glad you're here. 103 1 MR. NANJO: I'm on the -- 2 MS. MA: Our last legal counsel left on a 3 plane. And we all have planes, too. 4 MR. NANJO: I'm just pointing out the risk. 5 MS. HARKEY: He's just pointing out the 6 risk -- 7 MS. MA: I know. 8 MS. HARKEY: -- that anything we do might 9 not be legal. So -- 10 MR. HORTON: Well, I'm not disputing that. 11 But the Board does have an option of rescinding the 12 vote and continuing it to December. 13 MS. HARKEY: Then nothing's final, and then 14 it goes to OTA. So I think -- 15 MR. HORTON: I'm just giving you the option. 16 MS. HARKEY: I think we probably need to -- 17 we probably need to decide this tonight. Because if 18 we don't, it will continue onto OTA, because nothing 19 goes final in December. 20 MS. MA: Okay. So here's my issue, like, we 21 did not really discuss these 400 transactions. So 22 I'm not sure -- 23 MS. HARKEY: What 400 transactions? 24 MS. MA: Well, I thought there were like 400 25 transactions. So if you're going to say half of it's 26 not taxable, I don't know what these 400 transactions 27 were. 28 MS. HARKEY: The transactions are in-state 104 1 and out-of-state. And the only things that we were 2 told by our counsel, we -- if we granted for 6596 3 would be the in-state. And the in-state is roughly 4 half of the measure. 5 MR. ANGEJA: We do have actual numbers if 6 you wanted that. In stratum 1, it came from 7 out-of-state were -- hold on -- I've got 62 of 82 in 8 stratum one, 16 39 in stratum 2, none in 3 or 4 -- 9 MS. MA: I don't know what you're saying. 10 MR. ANGEJA: My point is we do have actual 11 numbers to know which ones were in-state and which 12 ones were out-of-state. So we -- I've given you the 13 rough estimate. It would require the Department to 14 petition to crunch those numbers if that was the 15 Board's order. I can't be more precise as we sit 16 here. 17 MS. STOWERS: And those numbers would be in 18 the subsequent audit, right? 19 MR. ANGEJA: For the audit in front of you 20 now, yes. 21 MR. RUNNER: I'm not necessarily persuaded 22 by the fact that the -- if we make a decision today, 23 this isn't going to be asked for a rehearing anyhow, 24 no matter what we decide on. So I think no matter 25 what, this is going to be an issue that potential 26 review, you know, with another Board. 27 But it's difficult for me at this point 28 to -- well, obviously difficult for all of us 105 1 apparently to make a decision on this. 2 My preference would have been to reopen the 3 hearing and have some discussion about it. But since 4 the Department is no longer here, I'm kind of stuck. 5 MS. HARKEY: I still consider the motion I 6 made a very fair and equitable motion, taking 7 everything into consideration. I don't believe my 8 motion -- that if we were to do this, it would be 9 really challenged. I think it would be difficult to 10 challenge, given all of the testimony. 11 And because we're at this end of stage for 12 hearings, I don't really want to put this off. I 13 don't think it's wise. I don't think it works to 14 anybody's best interest. 15 MR. RUNNER: Again, that would -- assuming 16 that somebody -- that there's a third vote for 17 that. 18 MS. HARKEY: Yeah, I know. And Ms. Ma's 19 still cogitating. So we would allow her to read 20 here. Well, it's a big decision. I understand that. 21 I understand that. 22 I think they made a good case. There didn't 23 seem to be even a -- there didn't seem to be any 24 votes to deny. So mine's still in the running. 25 There's been no second -- there -- I got a second. 26 So I'm better off than anybody right now. I had a 27 second for mine. 28 We're waiting on you. 106 1 (Inaudible discussion.) 2 MS. MA: I still think that the law became 3 effective January 1st, 1993. 4 MS. HARKEY: Okay. Then we have a motion to 5 grant for the Department that did not have a second. 6 So I don't know. 7 What do you say? 8 MS. MA: Okay. So I guess I'll make the 9 motion. Grant for the Department. 10 MS. HARKEY: Is there a second? 11 MS. STOWERS: Second. 12 MS. HARKEY: There's a motion and a second. 13 Is there objection? 14 MR. RUNNER: Yes. 15 MS. HARKEY: Objection so noted. 16 Please call the roll. 17 MS. RICHMOND: Chairwoman Harkey. 18 MS. HARKEY: No. 19 MS. RICHMOND: Mr. Runner. 20 MR. RUNNER: No. 21 MS. RICHMOND: Mr. Horton. 22 MR. HORTON: Aye. 23 MS. RICHMOND: Ms. Ma. 24 MS. MA: Aye. 25 MS. RICHMOND: Ms. Stowers. 26 MS. STOWERS: Aye. 27 MS. RICHMOND: Motion carries. 28 ---o0o--- 107 1 REPORTER'S CERTIFICATE 2 State of California ) 3 ) ss 4 County of Sacramento ) 5 6 I, Jillian Sumner, Hearing Reporter for 7 the California State Board of Equalization certify 8 that from November 17, 2017 audio, I recorded 9 verbatim, in shorthand, to the best of my ability, 10 the proceedings in the above-entitled hearing; that I 11 transcribed the shorthand writing into typewriting; 12 and that the preceding pages 1 through 108 13 constitute a complete and accurate transcription of 14 the shorthand writing. 15 16 Dated: April 13, 2018 17 18 19 ____________________________ 20 JILLIAN SUMNER, CSR #13619 21 Hearing Reporter 22 23 24 25 26 27 28 108