1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 JANUARY 24, 2017 10 CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING 11 APPEAL OF 12 AMERISTAR CASINOS, INC. & SUBS. 13 NO. 605227, 841016 14 AGAINST PROPOSED ASSESSMENT OF 15 ADDITIONAL INCOME TAX 16 17 18 19 20 21 22 23 24 25 26 27 Reported by: Kathleen Skidgel 28 CSR No. 9039 1 1 P R E S E N T 2 For the Board of Equalization: Fiona Ma, CPA 3 Chairwoman 4 Diane L. Harkey Vice Chair 5 Jerome E. Horton 6 Member 7 Sen. George Runner (Ret.) Member 8 Yvette Stowers 9 Appearing for Betty T. Yee, State Controller 10 (per Government Code Section 7.9) 11 Joann Richmond 12 Chief Board Proceedings 13 Division 14 For Board of 15 Equalization Staff: Lou Ambrose Tax Counsel IV 16 Legal Department 17 For Franchise Tax Board: Jenna Lewis 18 Tax Counsel 19 Shane Hofeling Tax Counsel 20 21 For Appellant: Scot Grierson Representative 22 Tom Bertino 23 Representative 24 ---oOo--- 25 26 27 28 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 JANUARY 24, 2017 4 ---oOo--- 5 MS. MA: Okay. Ms. Richmond, please call 6 the next case. 7 MS. RICHMOND: Our next case is B3 8 Ameristar Casinos, Inc. & Subs. 9 Please come forward. 10 MS. MA: Okay. Okay. Seems everyone's 11 settled. 12 Ms. Richmond, please introduce -- 13 Oh, you did call the -- the item. 14 MS. RICHMOND: Yes. 15 MS. MA: So, Mr. Ambrose, please introduce 16 the item, the issues in this case. 17 MR. AMBROSE: The -- the sole issue in this 18 case is whether appellant is entitled to a deduction 19 for various wagering taxes paid to other states for 20 the years in issue. 21 MS. MA: Okay. Welcome to the Board of 22 Equalization. You will have ten minutes on your 23 initial presentation, five minutes on appeal. 24 Please introduce yourself for the record. 25 MR. BERTINO: I am Tom Bertino with KPMG, 26 and I represent the taxpayer Ameristar Casino. 27 MS. MA: Okay. 28 MR. GRIERSON: And, uh, Scot Grierson with 3 1 KPMG, representative for Ameristar. 2 MS. MA: Okay. Please begin your 3 presentation. 4 MR. BERTINO: Good af- -- good afternoon. 5 We are here today to discern, uh, between taxes on 6 gross receipts and a tax on gross income; because a 7 tax on gross receipts is a deductible tax under 8 24345 where the tax on income is not. 9 The regulations to 24345 do provide various 10 gross receipts taxes that are deductible, such as 11 business and privilege or license taxes. 12 Ameristar Casinos is involved in the casino 13 gaming business. And because of that, they are 14 highly regulated by every single state in which they 15 do business. These states impose a privilege tax 16 for the right to operate a casino and, um, in order 17 to fund the regulation of -- of the -- of the 18 industry. 19 The gaming tax base for this purpose is -- 20 is -- is based on casino win. And win is defined as 21 "gross gaming receipts, less payout to patrons for 22 winning." 23 A real basic example of what this would be 24 is if you had a bunch of people go into a room and 25 surround this very pretty glass bowl and put all of 26 their money into it, there -- there's a few lucky 27 individuals who get to go in and take some money out 28 of that bowl. At the end of the day the casino 4 1 counts what's left, and that becomes their gross 2 receipts for the casino gaming tax purposes. 3 They do not get any deduction whatsoever 4 for cost of operations, such as depreciation, wages 5 or other elements of a return of capital. 6 The case law -- the -- the relevant case 7 law in this case have held that a tax that has a tax 8 base that includes a return of capital is a tax on 9 gross receipts. 10 The California Supreme Court in Beamer held 11 that when a -- a taxpayer includes cost of goods 12 sold in their tax base, then it is a gross receipt. 13 The State Board of Equalization has also 14 held -- similarly held in two cases, the Appeal of 15 Dayton Hudson and the Appeal of Kelly Services, with 16 Dayton Hudson saying that when there is an -- for 17 the deductibility of the Michigan business tax, uh, 18 when there is a inclusion of that cost of goods sold 19 in that tax base, then that tax is on gross 20 receipts, and therefore deductible. 21 Kelly Services extended the -- the argument 22 to heavily extensive labor businesses and -- and 23 also held that when there is a inclusion of wager -- 24 of waging or compensation in the tax base, then that 25 tax is on gross receipts. 26 And these taxes at issue for the gaming 27 privilege taxes at issue are not unlike the City of 28 San Francisco and Los Angeles business license taxes 5 1 which require taxpayers doing business in these 2 jurisdictions to pay a tax on gross receipts. And 3 the FTB has held that these taxes are deductible. 4 And it's interesting to note that if -- if 5 Ameristar was also doing businesses in these 6 jurisdictions, that they would be, uh -- they would 7 pay a city business license tax for the privilege to 8 conduct their operations in the city and they would 9 have a deductible tax on gross receipts in that 10 basis. 11 So it's the same argument in the gaming tax 12 world that this is a privilege tax, it's on gross 13 receipts, and it should be deductible. 14 So the taxpayer asks and respectfully 15 requests this Board to hold that these gaming 16 privilege license tax paid are on gross receipts and 17 deductible under 24345. 18 MR. GRIERSON: And, um, if I could please 19 just address the Board with a couple additional 20 comments on that point. The key, in my view on this 21 case, deals with the Board's decisions in Kelly 22 Services and Dayton Hudson, which Mr. Bertino 23 already referenced. Those cases look to the 24 Michigan tax to determine whether or not there's 25 a -- the taxpayer's entitled to a deduction for cost 26 of labor. 27 Um, the Dayton Hudson case, the first case 28 in the -- in the duo, it started out it was a 6 1 manufacturer. The manufacturer, uh, was a taxpayer 2 who deducted the Michigan tax. FTB disallowed the 3 deduction on the basis that it was, uh -- that they 4 had no, um -- that the tax base was on gross income. 5 And the taxpayer successfully argued, and the Board 6 approved the deduction on the basis that because the 7 Michigan tax did not allow a deduction for cost 8 of -- of labor. 9 And -- and this is the same fact pattern we 10 have here relative to the gaming taxes, is there is 11 not a deduction for appellant's cost of labor. 12 Uh, the Kelly Services case then comes up 13 and you have specifically a taxpayer who is engaged 14 in the business of providing services. And the 15 FTB's position in that case was a little different, 16 but maybe a little bit of old wine in new bottle in 17 terms of taking another tack. The argument by FTB 18 there was that because -- that they would only allow 19 a deduction for the Michigan tax if you could prove 20 you had, uh, and they were subject to a deduction 21 for cost of labor as a taxpayer. 22 This Board ruled in favor of the taxpayer 23 in that case, stating as follows, and I'll -- I'll 24 roughly quote it if you'll indulge me. 25 The Michigan tax may be deducted on a 26 California franchise tax return when the ultimate 27 base upon which the tax is measured does not 28 retain -- contain a return of capital in the context 7 1 of a service business. We affirm Dayton Hudson and 2 clarify that the holding applies equally to service 3 businesses. 4 And the Board continued: Gross income for 5 federal income tax purposes in a manufacturing, 6 merchandising or mining business is defined as gross 7 receipts less cost of goods sold. Although the 8 Michigan tax does not include a cost of goods sold 9 for material acquisition when determining the tax 10 base, it does include the cost of labor. 11 So -- and this is the important part: For 12 that reason, in Dayton Hudson we held that the 13 imposition of the Michigan tax against a base which 14 includes cost of labor, without exclusion of the 15 labor cost of goods sold, results in a tax which is 16 measured by something other than gross income. 17 And as a tax on something other than gross 18 income, it was a tax that was deemed to be a 19 deductible tax. 20 So no further comments -- 21 MS. MA: Okay. 22 MR. GRIERSON: -- at this point. 23 MS. MA: Thank you. 24 Franchise Tax Board, you have ten minutes. 25 Please introduce yourself for the record and you may 26 begin. 27 MS. LEWIS: Good afternoon, Chairwoman Ma, 28 Members of the Board. My name is Jenna Lewis; to my 8 1 right is Shane Hofeling, and we represent the 2 Franchise Tax Board in this matter. 3 The issue here is whether appellant is 4 entitled to deduct wagering taxes if paid to other 5 states. Under California law, corporate taxpayers 6 cannot deduct taxes paid to other states if they are 7 on or measured by income. 8 After the initial hearing in this matter 9 your Board properly sustained the Franchise Tax 10 Board's denial of the deduction claimed by appellant 11 for wagering taxes paid because they are income 12 taxes under California law. 13 As you may recall, the parties agreed that 14 the wagering taxes paid by appellant only applied to 15 gaming activity and were based on the amounts 16 wagered, less payouts. In other words, the tax base 17 consists of a specified percentage of the amount 18 gamblers bet or put into a machine, less what 19 gamblers won or got out of a machine. 20 In considering the deduction for taxes 21 paid, the California Supreme Court instructs that 22 the term "income" means "gross income" as defined 23 under the Internal Revenue Code. 24 The Internal Revenue Code defines gross 25 income very broadly as all income from whatever 26 source derived unless expressly excluded. The 27 statute also provides a nonexhaustive list of 28 certain items of income which fall under the 9 1 definition of gross income. For example, it lists 2 compensation for services, gross income derived from 3 business, interest, rents and royalties. 4 For most of the items of income, gross 5 income consists of total receipts. For example, all 6 rents received are considered gross income even if 7 the taxpayer incurs expenses in generating the rent. 8 However, in defining gross income from business, the 9 regulations create a limited exception to this 10 general rule. With respect to manufacturing, 11 merchandising and mining activity only, gross income 12 means total sales less cost of goods sold. 13 The courts and your Board have explained 14 how the definition of gross income applies in 15 analyzing various taxes paid to other states. These 16 decisions illustrate that with respect to a tax that 17 applies to business activities including 18 manufacturing, merchandising and/or mining, the tax 19 will only be an income tax if cost of goods sold is 20 excluded from the tax base. 21 However, where a tax does not apply to 22 business activities including manufacturing, 23 merchandising or mining, like the wagering taxes at 24 issue here, courts have determined that cost of 25 goods sold is irrelevant as it will never be in the 26 tax base and such a tax will be an income tax even 27 if it consists of total receipts. 28 At the first hearing questions were raised 10 1 with respect to the LA city business tax and the 2 San Francisco gross receipts tax. Since the 3 characterization of one tax does not determine the 4 characterization of another, your Board voted to 5 sustain the Franchise Tax Board. 6 Nevertheless, appellant now argues that 7 because the LA city business tax and San Francisco 8 gross receipts tax are generally deductible, the 9 wagering taxes here must be deductible as well. 10 However, as noted in the hearing summary, appellant 11 fails to acknowledge a critical distinction between 12 the LA and San Francisco taxes and the wagering 13 taxes. The LA and San Francisco taxes apply to 14 business activities, including manufacturing, 15 merchandising or mining. 16 As previously explained, when a tax applies 17 to business activities that include manufacturing, 18 merchandising or mining, the question becomes 19 whether an element of cost of goods sold is in the 20 tax base. In contrast, where a tax does not apply 21 to manufacturing, merchandising or mining, like the 22 wagering taxes here, the tax is an income tax, even 23 if it consists of total receipts. 24 The same distinction applies for the Texas 25 occupation tax analyzed in the Beamer decision and 26 the Michigan single business tax analyzed in the 27 Dayton Hudson and Kelly Service appeals. 28 In the first hearing and here in the 11 1 opening remarks, appellant placed a lot of emphasis 2 on the Kelly Service appeal. In the appeal of Kelly 3 Service the taxpayer was a service business without 4 any cost of goods sold in its own tax base. But 5 your Board determined that the tax was deductible 6 because the analysis is whether the tax base 7 contains an element of cost of goods sold under the 8 law, not whether the individual taxpayer has costs 9 of goods sold in its tax base. 10 Since the Michigan single business tax 11 applied to the manufacturing, merchandising and 12 mining without a deduction for labor costs of goods 13 sold, your Board determined that an element of cost 14 of goods sold remained in the tax base and the tax 15 was deductible. 16 Uh, I would just note that appellants have 17 stated that labor costs is what the Board was 18 looking at. In Kelly Service they found that it was 19 deductible because labor cost of goods sold were 20 actually in the tax base. So it's not just all 21 labor costs. We're looking at cost of goods sold. 22 Unlike the Michigan single business tax, 23 the wagering taxes at issue here do not apply to 24 manufacturing, merchandising or mining. Therefore, 25 there is no cost of goods sold in the tax base and 26 the wagering taxes are nondeductible income taxes. 27 Appellant also argues that the deduction 28 should be allowed because the wagering taxes are 12 1 privilege taxes. In support of its position, 2 appellant cites the regulation on the deduction for 3 taxes paid, which provides some examples of the 4 types of taxes that might be deductible. 5 The fact that privilege taxes are listed 6 does not mean they are per se deductible. If a 7 privilege tax is an income tax, it cannot be 8 deducted based on the clear language of the statute. 9 For example, in the Robinson case it was 10 determined that a tax on rent was not deductible 11 because it was an income tax. Your Board 12 subsequently referred to the tax in Robinson as a 13 privilege tax that was not deductible. 14 While appellant has cited some cases that 15 found privilege taxes to be deductible because they 16 were not income taxes, appellant has not cited a 17 case where a tax was determined to be deductible 18 because it was a privilege tax. 19 At the prior hearing, appellant also 20 asserted that while the clear language of the 21 statute disallows all taxes paid to other states 22 that are on or measured by income, the wagering 23 taxes at issue here should be treated differently 24 because they were in addition to other taxes 25 appellant paid to the other states. 26 The statute simply does not allow for this 27 treatment. Only the Legislature can change the 28 clear statutory language to allow an exception where 13 1 more than one tax is paid to another state. 2 To quickly summarize, the law is clear that 3 taxes on or measured by income cannot be deducted. 4 Based on the statutory definition of gross income 5 and the cases interpreting that definition, the 6 wagering taxes at issue here are nondeductible 7 income taxes. It is undisputed that the wagering 8 taxes only apply to gaming activity and the tax base 9 does not include any cost of goods sold. 10 Since the tax base does not include any 11 cost of goods sold, California law compels the 12 conclusion that the wagering taxes are income taxes, 13 which cannot be deducted. Therefore, respondent 14 respectfully requests that you again determine its 15 action should be sustained. 16 I'd be happy to answer any questions. 17 MS. MA: Okay. Thank you. 18 Okay, to the appellants, five minutes on 19 rebuttal. 20 MR. GRIERSON: Yes, thank you. 21 To -- in -- in reply to the FTB's position, 22 couple of points that are -- that are critical to 23 the analysis and -- and hopefully useful in your 24 making a decision. 25 FTB has characterized your Board as having 26 concluded that a tax applies -- that when a tax 27 applies only to a business activity that does not 28 have a cost of goods associated with it, cost of 14 1 goods can never be in the tax base, which means that 2 the tax must always be on income, even where the tax 3 base consists of total receipts, and is attempting, 4 essentially, to cast a rule that I think is a 5 misinterpretation, first, of the Kelly decision, as 6 well as a rule that would essentially swallow the 7 deduction for a massive, uh, portion of the service 8 economy. 9 In fact, the cases and the courts relied 10 upon in FTB's briefs include MCA and Robinson. The 11 MCA case was a case that involved, um, services. It 12 was a tax on film royalties, uh, where there was no 13 cost of labor involved, which is distinguishable 14 from the Board's decision in Kelly Services where 15 cost of labor was involved. 16 Second, Robinson dealt, uh -- the second 17 case Robinson dealt with the Hawaii excise tax on 18 services and concluded that, uh -- the Board 19 concluded that the tax regime itself had different 20 standards that were applied depending on the 21 activity undertaken by the taxpayer. For 22 manufacturers, they were taxed on gross proceeds 23 from sales, uh, whereas service providers were taxed 24 on -- specifically on gross income. 25 So clearly a different standard for 26 manufacturers who are taxed on gross receipts, 27 whereas service providers were taxed on gross income 28 and, therefore, were not permitted a deduction in 15 1 that case. 2 Dayton Hudson and Kelly Services are the 3 appropriate standards to apply and are the cases 4 that taxpayers have been relying on ever since those 5 decisions. 6 The Board in those cases appropriately 7 defined the deductibility of the tax based on 8 service -- tax imposed on services going beyond the 9 specific circumstances that existed in Beamer. And 10 FTB's arguments draw largely from a recitation of 11 Internal Revenue Code section 61, definitions of 12 income, and the limitation there on a deduction for 13 cost of goods sold, which only applies to 14 manufacturing, merchandising and mining activities. 15 Um, in the -- in the context of services, 16 again, as I read into the record, the Board's 17 decision in Kelly Services concluded that because 18 there was no cost of service or costs of labor 19 deduction in the Michigan tax, it was therefore a 20 deductible tax. 21 Um, in our view, adopting the FTB's 22 restrictive, uh, interpretation denies deductions 23 for business license and privilege taxes that would 24 be paid from -- by businesses, ranging from, you 25 know, dry cleaners and barbers, all the way to data 26 center services or cloud computing. 27 These are important issues to broad swaths 28 of a largely service economy. And, um, there's 16 1 certainly authority on Dayton Hudson and Kelly 2 Services for this Board to rule in favor of 3 deduction in this case. 4 Um, in terms of the FTB regulation, I think 5 it is important to note that the taxpayer does not 6 believe that, uh, if you have a tax that's 7 enumerated in the regulation that it is per se 8 deductible. But we've got to read that regulation 9 as having some meaning in terms of what it's trying 10 to accomplish. 11 And -- and if you look at the regulation, 12 it was initially promulgated in 1965 and amended 13 in -- in the '80s. And it essentially calls out 14 general taxes and licenses that are imposed on 15 businesses. And these are licenses -- license 16 taxes, city license fees, alcohol/beverage taxes, 17 and business privilege taxes that taxpayers 18 generally pay on a gross basis. 19 And I think if we -- if we read that 20 regulation in that context, and there is a special 21 deference or an interpretation of a business 22 privilege tax where you'd look at that carefully and 23 say, "Okay, is this a tax on gross receipts or is it 24 in fact a tax on income?" 25 And applying that test the way the, uh, 26 respondent is suggesting is saying that every 27 taxpayer who reads that regulation and says I have a 28 business privilege tax, I paid it on my gross gaming 17 1 receipts, therefore, I think I should be able to 2 deduct it. 3 What respondent's argument is, outside of 4 the corners of that regulation, is you'd have to dig 5 down to the nuances of, okay, now I have to step 6 back and look at the taxing regime I'm in. And if 7 there are no manufacturers, merchandisers or miners 8 that are subject to that taxing scheme, I won't get 9 a deduction for this tax. 10 And if that's the case, we would suggest 11 that that would be something that would be clear 12 from the regulation and not being argued based on 13 strict or restrictive interpretation of the rules. 14 Thank you. 15 MS. MA: Okay. Ms. Harkey. 16 MS. HARKEY: Thank you. 17 This is for the appellant. You stated that 18 wagering taxes -- the wagering taxes are imposed on 19 gaming receipts separately for the privilege of 20 conducting gaming; is that correct? 21 MR. GRIERSON: Yes. 22 MS. HARKEY: Okay. Are those same gaming 23 receipts taxed again as a component of income tax in 24 those states that have income tax? 25 MR. GRIERSON: Correct. Yeah, the same 26 receipts that are included in the gaming receipts 27 tax base are then included in gross income for 28 purposes of the, uh -- of the corporate income 18 1 tax. 2 MS. HARKEY: Okay. Next question. Is the 3 wagering tax computed in a way that does not allow 4 for ordinary deductions that are characteristic in 5 an income tax; for example, electricity, staff, 6 repairs, maintenance of casino, and equipment, other 7 overhead costs. 8 MR. BERTINO: Correct. There's no other 9 deductions in that base. 10 MS. HARKEY: Thank you. 11 MS. MA: Ms. Stowers? 12 MS. STOWERS: Don't we want to go down the 13 line? 14 MS. MA: Well, usually, but -- 15 MR. RUNNER: Oh. 16 MS. MA: Okay. 17 MS. STOWERS: Yeah, okay, you called me. 18 I'll go. 19 For the states -- to the appellant -- for 20 the states that you have the gaming tax and income 21 tax, like Missouri, does Missouri allow you to 22 deduct the gaming tax on your corporate income tax 23 return? 24 MR. BERTINO: Yes. 25 MS. STOWERS: Do you have that statute? 26 Because when I checked, it stated on their page that 27 taxes paid to the state are added back. 28 MR. BERTINO: Well, in most instances 19 1 income tax paid are added back, but privilege taxes 2 are usually not. So I would have to look at that 3 statute that you're looking at to see. It could be 4 an income tax. 5 MS. STOWERS: Why are you calling it a 6 privilege tax? 7 MR. BERTINO: Because there -- it's a tax 8 paid in order to operate as a casino in all these 9 states. And every single statute -- and I think 10 we've provided it to the Board -- lists them as 11 privileges or license taxes, and they will be 12 revoked if they're not paid. 13 MS. STOWERS: Absolutely. That was on one 14 of my Board Member inquiries. 15 MR. BERTINO: Right. 16 MS. STOWERS: And what you provided was two 17 sets of statutes. I have the licensing statute. 18 MR. BERTINO: Yes. 19 MS. STOWERS: Which definitely include in 20 most cases a "privilege" word or phrase in there. 21 MR. BERTINO: Yes. 22 MS. STOWERS: But the tax at issue here, 23 the gaming statutes, I see nowhere in there the word 24 "privilege." 25 MR. BERTINO: So there's -- there's two 26 operations of that statute. One is it imposes the 27 tax on that business activity. And two, it defines 28 the tax base later on. I think other statutes were 20 1 provided that shows what that tax base is. 2 MS. STOWERS: Right, exactly. And trust 3 me, I -- there's nothing in the gaming statutes that 4 says this tax is being imposed because it's a 5 privilege. 6 It's in your licensing statutes, and all of 7 them -- 8 MR. BERTINO: Yes. 9 MS. STOWERS: -- the phrase "privilege" is 10 referenced. And in some states, like Colorado and 11 Missouri, Ameristar is subject to a license fee and 12 it's either annual or biannually. 13 Under California statute, a license fee 14 would be deductible. But on the flipside, Ameristar 15 is also subject to a gaming tax. And again, I'm not 16 seeing anything that says this gaming tax -- maybe I 17 overlooked it, but I'm not seeing anything that this 18 gaming tax is a privilege tax. 19 MR. GRIERSON: If I could make a quick 20 comment, I think there -- the fact that these taxes 21 were privilege taxes was not in dispute, uh, in the 22 briefing of the matters before the Board. So we did 23 not do a -- a thorough analysis of that issue. 24 However, the record is -- I guess 25 there's -- it's full of evidence, I think, to that 26 effect that the -- that the licensing and privilege 27 taxes are tied to the overall gaming regulatory 28 environment. 21 1 And I'll point specifically to, as an 2 example, to the reply brief in which -- on 3 rehearing, in which we provided the AICPA 4 descriptions of -- of the different regulatory 5 aspects from an accounting perspective, including 6 discussion of the gaming taxes and their purpose and 7 how they were calculated, etcetera. 8 So the -- these are clearly taxes that in 9 most cases, not all, in the states are taxes that 10 are used to raise revenue to fund the -- the 11 regulatory authority that has oversight over very, 12 uh, you know, very tightly regulated industry of 13 gaming. 14 So I think -- I think that's in there. If 15 there needs to be more development, I would be 16 surprised. 17 MS. STOWERS: Okay. Okay, thank you. 18 To the Franchise Tax Board, Ms. Harkey was 19 asking appellants regarding the tax base. And I 20 believe it was indicated that this wagering tax base 21 does not allow for any deductions that you would 22 normally get for computing net income. 23 Can you speak to that with respect to does 24 having or not having deductions that you would 25 normally do for net income, does that change how -- 26 your reading of the law of whether or not this tax 27 is deductible? 28 MS. LEWIS: No. In the statute, and in the 22 1 California Supreme Court case of Beamer, they say 2 that income means gross income. 3 So we're looking at gross as opposed to 4 net. And the expenses that were referred to would 5 be expenses that would be incurred in going from 6 gross income to net income. 7 MS. STOWERS: Okay. I don't have anymore 8 questions right now. 9 MS. MA: Okay. 10 Mr. Runner. 11 MR. RUNNER: Yeah, help -- to the FTB, um, 12 give me some background and on the purpose of the 13 distinction of the, um, the cost of goods sold. 14 MS. LEWIS: Purpose. I'm not sure I can 15 give you background. We don't have a lot of 16 legislative history, if that's what you're looking 17 for. Um, we do have -- 18 MR. RUNNER: What's the need for the 19 distinction? 20 MS. LEWIS: The need for the distinction. 21 So we have IRC section 61 which defines gross 22 income. 23 MR. RUNNER: Mm-hmm. 24 MS. LEWIS: That's all income from whatever 25 source derived, unless it states otherwise. So 26 unless we have something that says otherwise, it's 27 total receipts. 28 In the context of manufacturing, 23 1 merchandising and mining businesses, we have a 2 regulation that states gross income is total sales 3 less cost of goods sold. 4 The case law then says that only those -- a 5 tax applied to only those business activities would 6 have the potential for cost of goods sold to ever be 7 in the tax base, which is how you get to the gross 8 receipts tax. 9 Here, we're only looking at a tax applied 10 to gaming. Gaming does not have cost of goods sold. 11 So cost of goods sold could never be in the tax 12 base. So it's necessarily a tax -- 13 MR. RUNNER: So you would apply that evenly 14 throughout all service industries? 15 MS. LEWIS: Yes. I'm not sure what you're 16 referring to. 17 MR. RUNNER: Well, other -- other 18 industries would have typical kinds of no cost of 19 goods sold. 20 MS. LEWIS: If we were looking at a tax 21 that only applies to a service industry, yes, we'd 22 be looking at the same analysis. 23 If we were looking at a tax like Michigan 24 single business tax or the LA and San Francisco 25 taxes that we've been talking about, those apply to 26 a really wide range of business activities which 27 include the manufacturing, merchandising and mining, 28 which puts us in a different boat where we're 24 1 looking at, Okay, is there a deduction for cost of 2 goods sold or not? 3 MR. RUNNER: In the case law, does the case 4 law -- is it possible that the case law just 5 doesn't -- because of what the -- because of the 6 cases that were before the court, that -- that the 7 omission of the fact that it didn't include an 8 industry that had no cost of goods sold was just not 9 before it? 10 MS. LEWIS: I don't think so. We have the 11 Kelly Service decision, which came after the Dayton 12 Hudson decision. And there's a critical distinction 13 in those cases. 14 So both of those cases were the Michigan 15 single business tax. In Dayton Hudson, the taxpayer 16 was a merchandiser. 17 MR. RUNNER: Mm-hmm. 18 MS. LEWIS: So part of an industry that had 19 cost of goods sold. 20 The Board, your Board, looked at that tax 21 and said it doesn't allow a deduction for labor cost 22 of goods sold. 23 So there's cost of goods sold in the tax 24 base and it's a deductible tax that's not on income. 25 Then a taxpayer came before your Board 26 under the same Michigan single business tax, but 27 that taxpayer was a service provider. But the Board 28 came to the same conclusion because the analysis is 25 1 not whether the taxpayer itself has cost of goods 2 sold. The analysis is whether the tax base under 3 the law as a whole has the potential for cost of 4 goods sold. 5 So it came to the same conclusion with the 6 service provider because they weren't looking at the 7 individual tax base. 8 MR. RUNNER: Let me ask, I think you 9 disagreed with their interpretation of Kelly? 10 MR. GRIERSON: Correct. 11 MR. RUNNER: You want to articulate that? 12 MR. GRIERSON: I'm, uh -- we're struggling 13 to find the language in Kelly that would support the 14 fact that, uh -- or the assertion that the Board 15 ruled in favor of Kelly because they identified the 16 Michigan tax as also applying to manufacturers. 17 In fact, in that case they distinguished 18 MCA and Robinson in coming to the conclusion that -- 19 that because there was no cost of labor deduction, 20 that there was -- that it was a deductible tax. 21 MR. RUNNER: So you don't -- do you believe 22 their conclusion is not, um, supported by the -- the 23 record by the Board? 24 MR. GRIERSON: As it's in the opinion that, 25 from my reading of it, I couldn't see any support 26 for that fact. 27 I also think, to the point earlier of "Do 28 you think that the earlier court decisions didn't 26 1 have the issue before it," my view is the answer is 2 yes, they had cases where they were applying to two 3 things. They were applying to a mining activity in 4 the Beamer decision, where they applied a strict 5 Internal Revenue Code section 61 analysis -- 6 MR. RUNNER: Mm-hmm. 7 MR. GRIERSON: -- as a tool to understand 8 that it was a gross receipt. And they also looked 9 at transactions involving royalties in the MCA 10 decision, which is a -- a type of income like 11 receiving dividend income where there's no costs 12 associated with that. So there's no sort of return 13 of capital aspect of it, similar to cost of labor. 14 And so I think that the Board then looks at 15 that in the context of the Michigan tax and Kelly 16 Services and Dayton Hudson and says, you know, we 17 disagree with FTB's interpretation which would be 18 restrictive of a deduction in a case when we're 19 looking to essentially apply rules that are 20 practical and administrable and, uh -- and look at 21 it in a way where taxpayers could apply it and 22 obtain deductions when they -- when they truly are 23 being taxed on a gross receipts basis rather than 24 applying it on a restrictive sort of section 61 25 Internal Revenue Code analysis. 26 MR. RUNNER: Okay. Can you -- can you -- 27 FTB, can you guide us to the point to where you felt 28 that indeed the Kelly Services decision was, um -- 27 1 was indeed the basis for what you would believe the 2 Board's motivation was? 3 MS. LEWIS: Sure. So in the Kelly Service 4 decision the Board actually said as a service 5 business Kelly Service has no inventory costs, and 6 thus the Michigan single business tax as applied to 7 it does not contain an element of return of capital 8 in Kelly's tax base. 9 So the Board said we're looking at a 10 situation different than what we did in Dayton 11 Hudson -- excuse me -- because this taxpayer has no 12 return of capital. So the only way to get out of 13 that, right, would -- to have the tax be deductible 14 would be to find something else. 15 And the Board went on to say that the tax 16 law itself does have labor costs of goods sold. So 17 we're looking at the law as a whole, the tax base as 18 a whole, not as applied to a particular taxpayer. 19 And that also is in the Robinson decision 20 where there's actually a footnote addressing the 21 issue of the taxpayer arguing that Beamer applied 22 the analysis as applied to a particular taxpayer. 23 And the court actually noted, no, Beamer looked at 24 the tax law as a whole not as applied to the 25 taxpayer. 26 MR. RUNNER: Okay. Somehow I'm not 27 convinced that you've -- that you've been convinced 28 by what she's identified. 28 1 MR. GRIERSON: Certainly not. In terms of 2 the -- the initial quote, uh, of the language of the 3 case, it was -- if I'm reading from the same spot -- 4 it was actually quote the Board took from 5 appellant's brief in terms of what the taxpayer was 6 arguing in the case and pointing out that it had no, 7 uh, deduction for cost of labor. 8 And so I don't see, uh -- and I didn't -- 9 if there was a reference to a point in the decision 10 where there's a broader statement that because 11 there's a cost of goods sold deduction available to 12 some taxpayer -- you know, or because it applies to 13 some taxpayer that has a cost of goods sold 14 deduction, I just don't see that in the decision. 15 MR. RUNNER: Okay. Okay, thank you. 16 MS. MA: Ms. Stowers. 17 MS. STOWERS: Franchise Tax Board, do you 18 see that in the decision? 19 MS. LEWIS: I was just going to note that 20 it does say that, um -- it says: 21 "We therefore find that the Michigan 22 single business is deductible in California 23 under 24345 regardless of the specific 24 components of the Michigan single business 25 tax base of the taxpayer claiming the 26 deduction." 27 MS. STOWERS: I'm done. 28 MS. MA: Ms. Harkey. 29 1 MS. HARKEY: I just have a -- is under 2 Revenue and Taxation Code section 24345 subdivision 3 (b), are wagering taxes deductible privileges? 4 MS. LEWIS: No. The wagering taxes are 5 income taxes. They would not be deductible under 6 24345. 7 MS. HARKEY: Okay. I have here that 8 wagering taxes are deductible under Revenue and Tax 9 code section 24345. Is that not true? 10 MS. LEWIS: That would not be our 11 position. 12 MR. GRIERSON: That -- that is our 13 position, is that it is true. 14 MS. HARKEY: And -- 15 MR. GRIERSON: Because it's a tax not on or 16 measured by income. 17 MS. HARKEY: Not -- not on or measured by 18 income. 19 MR. GRIERSON: Correct. 20 MS. HARKEY: It's not measured by gross 21 income or net income and required to be paid whether 22 or not you make a profit or a loss. 23 MR. GRIERSON: Correct. 24 MS. HARKEY: For the privilege of doing 25 business. 26 MR. GRIERSON: In a highly regulated gaming 27 industry. 28 MS. HARKEY: In a highly regulated gaming 30 1 industry. And you do pay income taxes regardless. 2 I just have a real hard time with trying to 3 figure out how we can say that this is not a 4 deductible expense. I mean I know we could go 5 industry by industry by industry and find something 6 here and something there and something somewhere 7 else. 8 But I do believe that this is very much 9 what the reg.'s talking about. And so I -- and the 10 law. The cases can be interpreted to, you know -- I 11 guess you can read it a multitude of ways. But I 12 just have a real hard time, and I voted last time 13 this was in fact a deductible expense and -- I mean 14 they're paying income taxes where income taxes are 15 due. 16 And so this is a cost of -- this is like, 17 you know, cost of what they're doing. They have to 18 pay this in order to operate in the state. Just, to 19 me, it's very similar to a business license, liquor 20 license, I mean any number of other licenses that 21 you have to have. You can't operate without it. 22 And it's definitely not, uh -- it's not subject to 23 whether or not you make money. So -- 24 MS. MA: So, um, someone mentioned liquor 25 license. So a liquor license is based on what? 26 MR. LEWIS: It would depend on what the 27 statute provides. So if it were based on income, it 28 would not be deductible. If it were not, it would 31 1 be deductible. 2 And again, we do the same analysis. If 3 we're looking at a business -- a tax that applies to 4 business activities that include manufacturing, 5 merchandising or mining, we'd look at whether 6 there's cost of goods sold in the tax base. If 7 there is cost of goods sold in the tax base, it 8 would be a tax that is not on income and it would be 9 deductible. If cost of goods sold is excluded from 10 the tax base, it would be an income tax and would 11 not be deductible. So it just depends on what the 12 tax statute itself says. 13 MS. MA: So, um -- so what you're saying is 14 if it is not a manufacturing, mining, or, um -- 15 MS. LEWIS: Merchandising. 16 MS. MA: -- merchandising operation, which 17 this is not, then there's no cost of goods sold and 18 therefore the tax is based on income. 19 MS. LEWIS: Yes, if it's a tax that applies 20 to those business activities, yes, only. 21 MS. MA: Okay. But take -- take out -- 22 this is not a mining, manufacturing or 23 merchandising, right? 24 MS. LEWIS: Okay. 25 MS. MA: So, what is -- what is your 26 definition? 27 MS. LEWIS: So like the wagering taxes at 28 issue here do not apply to manufacturing, 32 1 merchandising or mining. So there could never be 2 cost of goods sold in the tax base because there is 3 no cost of goods sold associated with gaming. So it 4 will be an income tax. We don't have to look 5 further. There's no cost of goods sold associated 6 with gaming, so there can't be cost of goods sold in 7 the tax base. So it is a nondeductible income 8 tax. 9 MS. MA: And so how -- what would a tax on 10 gross receipts be? 11 MS. LEWIS: So like the taxes we've been 12 talking about here, the Michigan single business 13 tax, the LA taxes, San Francisco taxes that we've 14 been talking about, those are taxes that apply to 15 business activities that include manufacturing, 16 merchandising or mining and they don't exclude all 17 cost of goods sold. So cost of goods sold remains 18 in the tax base, so they are a tax on gross 19 receipts. 20 MS. MA: So anything that doesn't have a 21 cost of goods sold component is a tax on income -- 22 MS. LEWIS: Yes. 23 MS. MA: -- in your mind. 24 MS. LEWIS: Mm-hmm. 25 MS. MA: Okay. 26 MS. STOWERS: I just wanted a clarification 27 on a couple of things. 28 I'm sorry, Mr. Horton, I think you had a 33 1 question, but -- 2 MR. HORTON: Go ahead. 3 MS. STOWERS: When Ms. Ma asked you about a 4 liquor license and you said that if that is based on 5 income it would not be deductible, are you sure 6 about that? Because I'm looking at the statute. 7 And unless I'm misreading the statute, it's only 8 referring to taxes on or according to measure by 9 income. It doesn't say taxes or license. 10 MS. LEWIS: Are you -- 11 MS. STOWERS: Are you -- are you -- 12 MS. LEWIS: There's a distinction between 13 fees and taxes; is that what you're addressing? 14 MS. STOWERS: Yes. 15 MS. LEWIS: So fees are deductible. Well, 16 you'd have to do another analysis to determine tax 17 fee. I don't think we're disputing that here. 18 MS. STOWERS: Okay. And are you -- are you 19 saying that the wagering tax at issue here, are you 20 now defining it as an income tax or are you saying 21 it's a tax measured on income? 22 MS. LEWIS: On or measured by income. 23 MS. STOWERS: Okay. Because I wanted to be 24 clear because it's not a tax on -- it's not an 25 income tax. Even I see that. 26 Okay. Okay. 27 MS. MA: Okay. Mr. Horton. 28 MR. HORTON: Thank you, Madam Chair. 34 1 Question of Appeals. 2 MR. AMBROSE: Yes. 3 MR. HORTON: Um, excuse me. 4 Can you provide us with some clarification 5 of the distinction between gross receipts income 6 versus profits? Or gross receipts, gross income, 7 versus profits? Just a definition of those maybe? 8 MR. AMBROSE: Well, I can do the gross 9 income and gross receipts, you know as defined -- 10 MR. HORTON: That'll work. 11 MR. AMBROSE: -- in the code. I'm not so 12 sure about profit. 13 MR. HORTON: Profit really isn't germane to 14 this discussion. 15 MR. AMBROSE: Right. 16 MR. HORTON: As to what is, uh -- uh, if 17 the -- if the fee in question is measured by 18 income. 19 MR. AMBROSE: Right. 20 MR. HORTON: But I think part of the 21 challenge here is that, um, the understanding of 22 what income actually is, um, in this case -- 23 MR. AMBROSE: Mm-hmm. 24 MR. HORTON: -- pursuant to the statute, 25 what the intent of the Legislature was -- 26 MR. AMBROSE: Right. 27 MR. HORTON: -- when they saw to 28 distinguish these fees. If a fee that is measured 35 1 by income, are we discussing gross receipt which is 2 a form of income? 3 MR. AMBROSE: Mm-hmm. 4 MR. HORTON: Um, then you have gross income 5 which is a form of income. 6 MR. AMBROSE: Mm-hmm. 7 MR. HORTON: But they have two different 8 definitions as it relates to tax law. And then -- 9 MR. AMBROSE: Right. 10 MR. HORTON: -- net profit, which is 11 another source of -- another income, but totally 12 different from a taxation perspective. 13 MR. AMBROSE: Right. Well, I think for 14 purposes of 24345, um, because it doesn't include 15 definitions of, you know, of the terms, you have to 16 go to the -- to the IRC, Internal Revenue Code. And 17 as Franchise Tax Board counsel pointed out, gross 18 income is defined in IRC section 61 to include -- 19 you know, it's very broad definition. And it would 20 include, you know, the receipts that the casinos 21 get, you know. I mean that would be income. 22 Then there's this reg. that carves out an 23 exception for mining, manufacturing, and 24 merchandising activities or companies that 25 specifically defines gross income for those 26 businesses as gross receipts less, you know, return 27 of capital, direct return of capital, cost of goods 28 sold. 36 1 Um, and I think the way that that's been 2 interpreted, the way -- I think I read the cases the 3 way FTB does -- is that when you have a tax, a 4 business tax like the Michigan single business tax 5 that applies across the Board to, you know, goods 6 producing companies as well as service provider 7 companies, then there's this presumption that the 8 tax base includes an element of a cost of goods 9 sold. Because for manufacturing, mining and 10 merchandising, that's -- that's just what gross 11 receipts includes. 12 Um, and then the way that's been 13 interpreted is, you know, when it's -- when -- if 14 that tax also applies to service industries, then 15 again I think there -- there's sort of this 16 implication that even for those kind of activities 17 there's this what they call labor cost of goods 18 sold, um, which is kind of a new term to me. I'd 19 never heard of it before. But, you know, that's how 20 those cases -- that's -- I mean that's what was 21 decided. 22 I mean it seems to me it's sort of like -- 23 this is my take, it's like a fairness thing. Um, if 24 you're going to apply -- if you're going to give the 25 benefit to, you know, these other industries, you 26 know, manufacturing, mining, you should give it to 27 service. I mean, you know, the tax ought to be 28 deductible, you know, regardless of the type of 37 1 business activity. I mean that's the way I read 2 it. 3 Um, so -- but in terms of, I mean to your 4 question, you know, gross income versus gross 5 receipts, I think it's -- I think we have to follow 6 the definitions in the code. I mean that's, you 7 know -- that's what we're left with. 8 MS. STOWERS: Just -- 9 MS. MA: Mr. Horton? 10 MR. HORTON: Thank you, Madam Chair. 11 MS. MA: Okay. Ms. Stowers. 12 MS. STOWERS: Just -- just one quick 13 comment. Labor cost of goods sold -- 14 MR. AMBROSE: Yeah. 15 MS. STOWERS: -- that's part of the 16 computation when you compute cost of goods sold. 17 MR. AMBROSE: It is. It is, right. 18 It's -- 19 MS. STOWERS: So it's not like a new term 20 of art. It's -- it's right there. 21 MR. AMBROSE: Well, yeah, but I think the 22 way it's been applied here or understood here is 23 that, um, they're calling costs of labor -- I 24 mean -- I mean I agree with you, labor is an element 25 of the cost of goods sold. You know, the cost of 26 labor. But if you're not producing goods, then 27 that's not -- I mean it can't be an element of that. 28 And if it's a service industry and you're 38 1 not producing goods, I mean I -- I just don't see 2 where that comes from. I mean, I agree with you, 3 that that is part of the cost of goods sold. That's 4 an element of it that you have to include when 5 you're, you know, considering, you know, for 6 accounting purposes, I guess, right, and tax. 7 But I don't -- for a service provider 8 company, I don't -- I don't see that there's -- if 9 you don't have goods to sell, then how can there be, 10 you know, a labor cost? 11 MS. STOWERS: Absolutely, absolutely. 12 MR. AMBROSE: I mean that's -- 13 MS. STOWERS: That's what you were 14 saying -- 15 MR. AMBROSE: Right. 16 MS. STOWERS: -- that a service industry 17 won't have this cost of labor. 18 MR. AMBROSE: Right. 19 MS. STOWERS: Because they don't have a 20 cost of goods sold. 21 MR. AMBROSE: Right. I mean they do have 22 labor, but not to produce goods. 23 MS. STOWERS: Right. 24 MR. AMBROSE: Right? 25 MS. STOWERS: Right. I great with you on 26 that point. 27 Okay, thank you. 28 MS. MA: Any other? 39 1 Okay. 2 All right. Is there a motion? 3 MS. HARKEY: I'll make a motion to, uh, 4 support the appeal -- the appeal, grant the 5 taxpayer's appeal, finding specifically that 6 Colorado, Iowa, Mississippi, Missouri and Nevada, 7 wagering taxes paid to those states are deductible 8 privilege taxes because they are necessary to 9 maintain a license and the privilege to conduct 10 gaming operations in these states, and the taxes are 11 computed on something other than gross income within 12 the meaning of the law and the cases discussed at 13 this hearing. 14 MR. RUNNER: Second. 15 MS. STOWERS: Objection. 16 MR. HORTON: Objection. 17 MS. MA: Okay. Um, let's take a vote. The 18 motion by Ms. Harkey is to grant for the taxpayer, 19 seconded by Mr. Runner. 20 Ms. Richmond. 21 MS. RICHMOND: Chairwoman Ma. 22 MS. MA: No. 23 MS. RICHMOND: Ms. Harkey. 24 MS. HARKEY: Aye. 25 MS. RICHMOND: Mr. Horton. 26 MR. HORTON: No. 27 MS. RICHMOND: Mr. Runner. 28 MR. RUNNER: Aye. 40 1 MS. RICHMOND: Ms. Stowers. 2 MS. STOWERS: No. 3 MS. RICHMOND: Motion fails. 4 MS. MA: Is there an alternative motion? 5 MS. STOWERS: Yes, but -- 6 MS. MA: Yes, but? Go ahead. 7 MR. RUNNER: Yes, but? 8 MS. MA: Ms. Stowers. 9 MS. STOWERS: Clearly guidance is needed in 10 this area. And in looking, um, that the economy is 11 shifting towards service, I would like to make a 12 motion to sustain the Franchise Tax Board and issue 13 a formal. 14 MS. HARKEY: Object. 15 MS. MA: And issue a formal? 16 MS. STOWERS: A formal opinion. 17 MR. HORTON: Well -- 18 MS. STOWERS: Is that too much for you 19 guys? 20 Okay. Let me restate my motion. Motion to 21 sustain the Franchise Tax Board. 22 MS. HARKEY: Object. 23 MR. HORTON: Second. 24 Um, I'm just mulling over, Madam Chair, the 25 "formal." Only because this is so fact-base driven, 26 it becomes an inherent challenge not to hear the 27 evidence, not to be in the position to hear the 28 evidence. And to have a formal, um, out there may 41 1 even -- may contribute to even more confusion. 2 I mean I think the statute itself is 3 inherently clear. Um, and, you know, the -- 4 whenever you find a situation where the Legislature 5 puts together four words to -- to explain what they 6 believe should happen, that's pretty clear. 7 Um, so I think the legislation speaks for 8 itself. 9 MS. STOWERS: So I'd just like to go with 10 just sustain the Franchise Tax Board. I appreciate 11 your comments. But just my motion is just to simply 12 sustain the Franchise Tax Board. 13 MR. HORTON: Second. 14 MS. MA: Okay. Motion on the table by Ms. 15 Stowers to sustain the Franchise Tax Board, seconded 16 by Mr. Horton. 17 Ms. Richmond, please take the roll. 18 MS. RICHMOND: Chairwoman Ma. 19 MS. MA: Aye. 20 MS. RICHMOND: Ms. Harkey. 21 MS. HARKEY: No. 22 MS. RICHMOND: Mr. Horton. 23 MR. HORTON: Aye. 24 MS. RICHMOND: Mr. Runner. 25 MR. RUNNER: No. 26 MS. RICHMOND: Ms. Stowers. 27 MS. STOWERS: Aye. 28 MS. RICHMOND: Motion carries. 42 1 MS. MA: Okay. Thank you all for coming. 2 ---oOo--- 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 43 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, Kathleen Skidgel, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on January 24, 2017 I recorded verbatim, in 10 shorthand, to the best of my ability, the 11 proceedings in the above-entitled hearing; that I 12 transcribed the shorthand writing into typewriting; 13 and that the preceding pages 1 through 43 constitute 14 a complete and accurate transcription of the 15 shorthand writing. 16 17 Dated: February 10, 2017 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL, CSR #9039 22 Hearing Reporter 23 24 25 26 27 28 44