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 AB 2195 Page 2 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 AB 2195 Page 3 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 ($7 million or less) if the taxpayer is a partnership, corporation, or trust. EXISTING STATE LAW establishes a general burden of proof evidentiary standard of preponderance of the evidence, thus, placing the burden on the person controlling the facts. This burden is imposed on the taxpayer for most items where the taxpayer disputes a proposed assessment or claims a refund of tax. Limited exceptions to this general burden of proof standard exist, primarily in the imposition of penalties or, in pursuit of, criminal convictions. For example, the evidence standard needed to establish civil tax fraud is clear and convincing, and that burden rests with the tax agency. In modified conformity with the federal law, FTB, in connection with appeals before BOE, has the burden of producing reasonable and probative additional information to prove the correctness of an assessment that is based upon third-party information returns if the taxpayer sets forth a reasonable argument regarding the disputed income, appeals FTB's action, and fully cooperates with FTB. FISCAL EFFECT : BOE staff states that if this bill leads to reduced reporting, department audit programs would be adversely impacted, resulting in lost revenues. However, the magnitude of any resulting loss is difficult to determine. FTB staff estimates that this bill will result in revenue losses, as summarized in the table below: AB 2195 Page 4 Estimated Revenue Impact of AB 2195 Operative for Assessments and Notices of determination issued on or after January 1, 2011 ($ 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." AB 2195 Page 5 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. AB 2195 Page 6 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 AB 2195 Page 7 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 AB 2195 Page 8 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: AB 2195 Page 9 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. AB 2195 Page 10 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 AB 2195 Page 11 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