BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 2195
                                                                  Page  1

          Date of Hearing:  April 12, 2010

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                            Anthony J. Portantino, Chair

                 AB 2195 (Silva) - As Introduced:  February 18, 2010

          Majority vote.  Fiscal committee.

           SUBJECT  :  Taxation:  Franchise Tax Board and State Board of  
          Equalization:  burden of proof.

           SUMMARY  :  Transfers the burden of proof from the taxpayer to the  
          taxing agency in all court and tax administrative tax  
          proceedings, in conformity with the federal statute.   
          Specifically,  this bill :
           
          1)Requires that, in any civil proceeding to which the State  
            Board of Equalization (BOE) is a party, BOE has the burden of  
            proof by clear and convincing evidence to sustain a penalty  
            proposed for intent to evade or fraud against a taxpayer, with  
            respect to any factual issue relevant to ascertaining the  
            liability of the taxpayer.   Specifically:

             a)   Provides that a taxpayer will still have to substantiate  
               any item on a return or claim filed with BOE.  

             b)   Does not subject a taxpayer to unreasonable search or  
               access to records in violation of the United States (U.S.)  
               Constitution, the California Constitution, or any other  
               law.

             c)   Defines "taxpayer" to include a person on whom fees  
               administered by BOE are imposed. 

          2)Shifts the burden of proof from taxpayers to BOE and the  
            Franchise Tax Board (FTB) in any court or administrative tax  
            proceeding with respect to a factual issue regarding the tax  
            liability of a cooperating taxpayer.  Specifically:

             a)   Defines "cooperating taxpayer" as a taxpayer that has  
               done all of the following:

               i)     Complied with all relevant statutory, regulatory, or  
                 case law requirements to substantiate any item on a  








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                 return or claim filed with BOE or FTB;

               ii)    Maintained all records as required and, upon a  
                 reasonable request by BOE or FTB, has provided those  
                 records to the state agency; and,

               iii)   Submitted credible evidence to BOE or FTB with  
                 respect to any factual issue relevant to ascertaining the  
                 tax liability of the taxpayer.

             b)   Defines "taxpayer" to include a person on whom fees  
               administered by BOE are imposed. 

             c)   Defines "tax liability" as any tax or fee assessed or  
               determined by BOE or FTB, including any interest accrued or  
               penalties levied in association with the tax or fee.

             d)   Defines "administrative tax proceeding" as either of the  
               following:

               i)     Oral hearing before the members of BOE for disputes  
                 concerning taxes or fees collected by BOE; or,

               ii)    Oral hearing before the members of BOE for disputes  
                 concerning taxes collected by FTB.

             e)   Establishes the burden of proof evidentiary standard  
               imposed on FTB and BOE as a preponderance of the evidence,  
               unless otherwise provided.

             f)   Does not apply to an adjustment proposed and made to a  
               taxpayer's federal income tax return by the federal  
               government.

             g)    Does not apply to an appeal filed with BOE subject to  
               the provisions of existing law regarding the burden of  
               producing additional information when a taxpayer is  
               challenging an information return.

             h)   Do not subject a taxpayer to unreasonable search or  
               access to records in violation of the U.S. Constitution,  
               the California Constitution, or any other law.

             i)   Applies only to court and administrative proceedings  
               involving assessments or notices of determination issued on  








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               or after the date on which this act becomes operative.

             j)   Applies to court and administrative proceedings  
               involving assessments and notices of determination issued  
               on or after January 1, 2011.  

           EXISTING FEDERAL LAW  places the burden of proof on the Internal  
          Revenue Service (IRS) in any "court proceeding" involving a  
          factual issue, if the taxpayer introduced credible evidence with  
          respect to the factual issue relevant to ascertaining the  
          taxpayer's tax liability [Internal Revenue Code (IRC) Section  
          7491].  Specifically, the burden of proof shifts to the IRS if  
          the taxpayer (a) complies with all the substantiation  
          requirements of the IRC; (b) maintains all the records required  
          by the IRC; (c) cooperates with the IRS' reasonable requests for  
          witnesses, information, documents, meetings, and interviews, and  
          (d) meets the net worth requirement ($7 million or less) if the  
          taxpayer is a partnership, corporation, or trust.
           
           EXISTING STATE LAW  establishes a general burden of proof  
          evidentiary standard of preponderance of the evidence, thus,  
          placing the burden on the person controlling the facts.  This     
                  burden is imposed on the taxpayer for most items where  
          the taxpayer disputes a proposed assessment or claims a refund  
          of tax.  Limited exceptions to this general burden of proof  
          standard exist, primarily in the imposition of penalties or, in  
          pursuit of, criminal convictions.  For example, the evidence  
          standard needed to establish civil tax fraud is clear and  
          convincing, and that burden rests with the tax agency.

          In modified conformity with the federal law, FTB, in connection  
          with appeals before BOE, has the burden of producing reasonable  
          and probative additional information to prove the correctness of  
          an assessment that is based upon third-party information returns  
          if the taxpayer sets forth a reasonable argument regarding the  
          disputed income, appeals FTB's action, and fully cooperates with  
          FTB.
           
           FISCAL EFFECT  :  BOE staff states that if this bill leads to  
          reduced reporting, department audit programs would be adversely  
          impacted, resulting in lost revenues.  However, the magnitude of  
                     any resulting loss is difficult to determine.  FTB  
          staff estimates that this bill will result in revenue losses, as  
          summarized in the table below:









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                         Estimated Revenue Impact of AB 2195
          Operative for Assessments and Notices of determination issued on  
                              or after January 1, 2011
                                   ($ in Millions)
                     
           -------------------------------------------------------------- 
          |                     |  2010-11   |   2011-12   |   2012-13   |
          |---------------------+------------+-------------+-------------|
          |                     |            |             |             |
          |Unsustained          |            |    -$95     |    -$250    |
          |assessments          |            |             |             |
          |---------------------+------------+-------------+-------------|
          |                     |            |             |             |
          |Reduced audit        |    -$60    |    -$90     |    -$115    |
          |revenue              |            |             |             |
          |---------------------+------------+-------------+-------------|
          |                     |            |             |             |
          |Decreased            |  Unknown   |   Unknown   |   Unknown   |
          |Self-compliance*     |    Loss    |    Loss     |    Loss     |
          |                     |            |             |             |
           -------------------------------------------------------------- 
          *A rule of thumb estimate is that for every 1% decrease in  
          self-compliance under the Personal Income Tax and Corporate Tax  
          Laws caused by this bill, approximately $600 million in tax  
          revenue would be lost.                                            
                    

           COMMENTS  :

           1)Author's Statement  .  The author states, that "Unlike most  
            other proceedings, where one is considered "innocent until  
            proven guilty," California's tax system currently places the  
            burden of proof on the accused. 

          "Despite previous efforts to conform the state to the federal  
            law, California's Board of Equalization and the Franchise Tax  
            Board have not yet been compelled to maintain this standard.   
            This means that taxpayers before BOE or FTB proceedings must  
            prove their innocence.  

          "Apart from the stress and intimidation of challenging the  
            bureaucracy, the taxpayer is not enjoying his or her right to  
            due process.  AB 2195 will protect taxpayers by requiring the  
            state to properly substantiate their accusations and bear the  
            burden of proof."  








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           2)The purpose of this bill  .  According to the author, the  
            purpose of this bill is to shift the burden of proof to the  
            state tax agency consistent with the federal model approved  
            for federal purposes in the IRS Restructuring and Reform Act  
            of 1998.  

           3)Arguments in Support.   Proponents believe that "it should be  
            the responsibility of the revenue-collecting agency to explain  
            why it is entitled to the revenue" and this bill will make the  
            tax system more fair for the taxpayer.  Proponents note that  
            this shift occurs only after the "cooperating taxpayer" has  
            complied with all substantiation requirements and has  
            maintained all records.  According to the sponsor, "this bill  
            will keep responsible taxpayers from being forced to assume  
            increased tax liability when the dispute may not be their  
            fault." Finally, the sponsor notes that the intent of this  
            bill is not to make it "more challenging for government to  
            collect the revenue it is entitled to, but instead to force  
            them to work diligently by having expanded hearings and more  
            intensive audits." 

           4)Arguments in Opposition.   Opponents state that the shift in  
            the burden of proof to the tax agency would cause disruption  
            in tax collections and could benefit the underground economy.   
            Opponents refer to a comment by the Tax Executives Institute,  
            an organization that monitors federal tax issues, that the  
            shift in burden of proof would either make the IRS more  
            intrusive, or the tax system less effective, neither of which  
            is a desirable outcome.

           5)Standard of Proof in BOE civil tax fraud cases  .  

             a)   BOE staff states that one of the provisions of this bill  
               (the elevated burden on BOE for claims of intent to evade  
               or fraud) is consistent with BOE's current practices as  
               well as case law.  Specifically, the California Court of  
               Appeals in Marchica v. State Board of Equalization (1951)  
               107 Cal. App. 2d 501, determined that the standard of proof  
               in civil tax fraud cases was the clear and convincing  
               evidence standard.  The Ninth Circuit Court of Appeals,  
               relying on the Marchica decision, concluded that "clear and  
               convincing evidence must be shown to establish civil tax  
               fraud under California law."  California State Board of  
               Equalization v. Renovizor's (2002) 282 F.3d 1233.   








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               Effective January 9, 2003, BOE amended its Regulation  
               1703(c)(3)(C) to clarify that the agency's existing  
               standard of proof in the case of fraud or intent to evade  
               is the clear and convincing evidence.  

             b)   BOE staff states that it is appropriate that the  
               standards for asserting penalties for fraud or intent to  
               evade be the same at both the administrative and judicial  
               levels.  This bill would codify the Marchica decision and  
               BOE's Regulation 1703(c)(3)(C) to provide that, in the case  
               of civil tax fraud, the standard of proof is the clear and  
               convincing evidence and that BOE has to prove fraud or  
               intent to evade in those cases. 

             c)   BOE staff also notes that this bill would shift the  
               burden of proof to BOE and FTB, instead of a cooperating  
               taxpayer, in all court and administrative tax proceedings,  
               regardless of the taxpayer's size.  The proposed burden of  
               proof provisions are broader than the federal provisions  
               for which consistency is sought.  The federal shift is  
               limited to taxpayers with less than $7 million in net worth  
               and is intended to benefit small taxpayers rather than  
               large businesses that are more capable of defending  
               themselves in court.

             d)   If a taxpayer has complied with all substantiation  
               requirements and provided all records, it is unclear how  
               there would be any factual dispute.  It appears that the  
               decision with respect to this issue would determine the  
               outcome of the hearing or trial.

             e)   Existing BOE regulations require taxpayers to maintain  
               and make available for examination on request by BOE or its  
               authorized representative, all records necessary to  
               determine the correct tax liability under the Sales and Use  
               Tax (SUT) Law and all records necessary for the proper  
               completing of the SUT tax return.  BOE would be required to  
               amend the regulation to specify the kinds and types of  
               records that a taxpayer must maintain in order to be deemed  
               a "cooperating taxpayer".  

           6)FTB Concerns  .  The FTB staff analysis of this bill identifies  
            numerous implementation concerns.  Among those concerns are:

             a)   Currently, there are no statutes or regulations that  








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               require a California taxpayer to maintain specific records,  
               with the exception of water's-edge entities.   FTB is not  
               authorized to require most taxpayers to keep records or  
               other evidence necessary to determine the tax.  Additional  
               statutes would be required to create sufficient              
                   record requirements to permit a taxpayer to meet the  
               definition of cooperating taxpayer and authorize the FTB to  
               issue regulations establishing record-keeping requirements.

             b)   This bill is silent on who will make a determination as  
               to whether the taxpayer is a "cooperating taxpayer."  It is  
               recommended that the FTB is allowed to determine whether  
               the taxpayer is a "cooperating taxpayer."

             c)   Taxpayers could assert they are "cooperating" without  
               providing sufficient information to conduct a complete  
               audit.  As a result, FTB will be faced with an extremely  
               difficult deficiency determination process, which will  
               result in more time-consuming and intrusive audits  
               involving third-party interviews, credit report requests,  
               review of other agencies' returns, and/or searches for any  
               available relevant documents maintained by the taxpayer  
               and/or others.

             d)   This bill states that the burden of proof will shift to  
               FTB when the cooperating taxpayer "has provided credible  
               evidence to FTB with respect to any factual issue".  The     
                            timing of when the burden of proof will  
               actually shift from the taxpayer to FTB is unclear with  
               regard to the phrase "has provided credible evidence to FTB  
               with respect to any                 factual issue".  A  
               taxpayer could submit credible evidence to the FTB the day  
               of the BOE hearing and argue that the burden of proof has  
               shifted to the FTB.  It is suggested that this bill be  
               amended to require a cooperating taxpayer to submit  
               credible evidence within a specified period - such as  
               during audit or protest.  In addition, this phrase could be  
               interpreted to shift the burden of proof on all factual  
               issues if the taxpayer introduces credible evidence of only  
               one factual issue.  The FTB staff suggests revising the  
               language to shift the burden of proof to the FTB with  
               respect to a factual issue only if the taxpayer introduces  
               credible evidence of that factual issue.  

             e)   Currently, taxpayers may waive their rights to an oral  








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               hearing before BOE, and thus, it is not clear whether this  
               bill would apply to appeals where the taxpayer waived that   
                              right.  Does FTB still have a burden of  
               proof in the case where the taxpayer waived his/her right  
               to an oral hearing?  A substantial majority of taxpayers  
               waive that right, but FTB staff learns whether there will  
               be an oral hearing after opening briefs are prepared and  
               filed.  If it is the author's intent that this bill apply  
               to all appeals before the BOE, the author may wish to  
               clarify the language to state that the shift in the burden  
               of proof would apply to taxpayers that waive the right to  
               an oral hearing before the BOE. 

             f)   This bill states that it will only apply to court or  
               administrative tax proceedings involving assessments or  
               notices of determination issued on or after the operative  
               date of this bill.  It is unclear if the author's intent is  
               to exclude matters related to a claim for refund.  

             g)   This bill states that a "cooperating taxpayer," upon a  
               reasonable request by the state agency, should provide the  
               requested records.  During protest, a taxpayer often  
               asserts a new issue or argument to support their position.   
               Consequently, an information request issued by the FTB  
               during audit, but prior to protest, does not include a  
               request for documents supporting a subsequently raised  
               issue or argument.  FTB staff argues that a shift of the  
               burden of proof should not apply in those circumstances or,  
               alternatively, FTB should be permitted to seek additional  
               supporting records for such new issues.

             h)   This bill does not require a taxpayer to meet the  
               minimum threshold of providing evidence with respect to a  
               factual issue in dispute.  FTB staff argues that, if a  
               taxpayer is not required to meet the minimum threshold of  
               credible evidence, it may be difficult in many cases for  
               the taxing agency to meet its burden of proof because the  
               taxpayer has control of the records and documents necessary  
               to ascertain the taxpayer's tax liability.

           7)Committee staff notes  the same implementation concerns and  
            policy issues that were raised in our analysis of AB 1387  
            (Tran), introduced in the 2009-10 Legislative Session.   
            Specifically:









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             a)   The shift in the burden of proof at the federal level  
               occurs only in proceedings before the U.S. Tax Court and  
               only after the taxpayer produces credible evidence with  
               respect to any factual issue relevant to ascertaining the  
               taxpayer's liability.  This bill's attempt to shift the  
               burden in administrative proceedings is not consistent with  
               the federal action.

             b)    The author of AB 2195 desires to raise the standard of  
               proof and responsibility in all civil proceedings where tax  
               is involved.  It is important to note the difference  
               between actions that deprive a person of liberty and those  
               that deprive a person of tax dollars.  The current burden  
               for tax crimes is on the state, just as it is for all  
               crimes.  In civil tax fraud cases, the burden of proof is  
               imposed on the tax agency at a standard (clear and  
               convincing evidence) higher than that imposed on the  
               taxpayer with respect to the facts surrounding the  
               deficiency (preponderance of the evidence).

             c)   The shift in the burden occurs only with a cooperating  
               taxpayer, which is defined as someone that has complied  
               with all substantiation requirements and has maintained all  
                               records as required.  This definition on  
               its own might cause litigation by creating additional legal  
               challenges, such as, "Does the taxpayer meet the  
               "cooperating taxpayer"                definition?" and  
               "What is credible evidence?"

             d)   Committee staff questions whether this bill would  
               undermine the efforts of the state to close the tax gap  
               during this critical fiscal period.

          8)Committee staff notes similar measures introduced in prior  
            legislative sessions:

          AB 1387 (Tran), introduced in the 2009-10 Legislative Session,  
            is almost identical to this bill.  AB 1387 was held in this  
            Committee. 

          AB 1600 (La Malfa) and AB 2727 (La Malfa), both introduced in  
            the 2007-08 Legislative Session, would have shifted the burden  
            of proof from a taxpayer to the agency collecting taxes in  
            certain situations.  AB 1600 and AB 2727 failed to pass out of  
            this Committee.








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          SB 633 (Dutton), introduced in the 2005-06 legislative session,  
            similarly to AB 2727 and AB 1600, would have shifted the  
            burden of proof from a taxpayer to the tax agency.  SB 663 was  
            never heard in Committee.  

          SB 1222 (Knight), introduced in the 1999-2000 legislative  
            session, would have shifted the burden of proof to FTB in  
            court proceeding for factual issues, penalties, and             
                 adjustments to income based on statistical information,  
            but not for issues resulting from federal changes.  SB 1222  
            died in this Committee.

          AB 436 (McClintock), introduced in the 1999-2000 legislative  
            session, would have added the Taxpayer's Rights Act that  
            included taxpayer rights provisions including shifting the  
            burden of proof to taxing agencies in any legal action  
            contesting the validity of any tax.  AB 436 was never heard in  
            this Committee.

          SB 1478 (Rainey), introduced in the 1997-98 legislative session,  
            would have declared legislative intent to conform to the IRS  
            Restructuring and Reform Act of 1998, including                 
             shifting the burden of proof to state agencies collecting  
            taxes in any court or administrative proceeding under certain  
                                                                                        conditions.  SB 1478 was held in the Senate Revenue and  
            Taxation Committee.

          AB 1631 (Sweeney), introduced in the 1997-98 legislative  
            session, would have declared legislative intent to conform to  
            the federal law relating to shifting the burden of proof        
                      in connection with income taxes paid by California  
            taxpayers.  AB 1631 was held in the Assembly Appropriations  
            Committee.

          SB 1166 (Hurtt), introduced in the 1997-98 legislative session,  
            would have shifted the burden of proof from taxpayers to the  
            "board" in court proceedings under certain conditions and  
            declare legislative intent to conform to the then pending  
            federal taxpayer bill of rights' legislation.  SB 1166 failed  
            to pass out of this Committee.

           REGISTERED SUPPORT / OPPOSITION  :   

           Support 








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          Howard Jarvis Taxpayers Association (sponsor)

           Opposition 
           
          The American Federation of State, County and Municipal Employees  
          (AFSCME), AFL-CIO
           
          Analysis Prepared by  :  Oksana Jaffe / REV. & TAX. / (916)  
          319-2098