BILL ANALYSIS Ó
AB 832
Page 1
ASSEMBLY THIRD READING
AB 832 (Ammiano)
As Amended May 26, 2011
Majority vote
REVENUE & TAXATION 5-3
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|Ayes:|Beall, Charles Calderon, | | |
| |Cedillo, Fuentes, Gordon | | |
| | | | |
|-----+--------------------------+-----+--------------------------|
|Nays:|Donnelly, Harkey, | | |
| |Nestande | | |
| | | | |
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SUMMARY : Codifies a portion of the State Board of
Equalization's (BOE) regulations relating to property taxation
of "embedded" computer programs and imposes a higher evidentiary
standard on taxpayers seeking to prove that the "single price"
paid for the computer or equipment included charges for
nontaxable software programs or services. Specifically, this
bill :
1)Codifies subdivisions (d) and (e) of Property Tax Rule 152,
"Computer Programs Storage Media," issued by the BOE.
Specifically, it provides that:
a) The term "basic operational program" refers to a
"control program," as defined in Revenue and Taxation Code
(R&TC) Section 995.2, that is included in the sale or lease
price of the computer equipment;
b) States that a computer program is considered to be
included in the sale or lease price of the computer
equipment if either of the following is met:
i) The equipment and the program are sold or leased at
a single price; or,
ii) The purchase or lease documents set forth separate
prices for the equipment and the program, but the program
may not be accepted or rejected at the option of the
customer.
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c) In valuing computer equipment that is sold or leased at
a single price not segregated between taxable property and
nontaxable programs, as defined in R&TC Section 995.2, the
county assessor, lacking evidence to the contrary, may
regard the total amount charged as indicative of the value
of taxable tangible personal property.
2)Requires a person claiming that a "single price" sale or lease
includes charges for nontaxable programs or services to prove
by clear and convincing evidence, instead of the preponderance
of evidence, the existence of nontaxable programs or services.
Specifies that, in support of his/her claim, the person must
submit to the assessor the sales price, costs, or other
information regarding the nontaxable programs and services,
including a recognized BOE valuation approach, technique, or
method, as provided.
FISCAL EFFECT : The BOE staff estimates that this bill will have
no direct impact on General Fund revenue.
COMMENTS :
Author's statement . The author states that, "Current law
requires the valuation and taxation of basic operational
software, but excludes the taxation of application software.
The administration and application of current law is
increasingly difficult for both the assessor and taxpayer
because this law enacted in 1973 has not been updated to
consider the evolution of technology. Additionally, the Court
of Appeals decision in Cardinal Health v. County of Orange
overturned established local assessment practices and created
the potential for the majority of the value attributed to modern
equipment and machinery to be excluded from property taxation.
Unfortunately, the Cardinal Health case has encouraged the
business community to appeal all business personal property
containing software. While some appeals are legitimate, the
fair and equitable practices of assessing business personal
property should not be exploited by attempts to expand a very
limited exclusion in current law.
"AB 832 would provide uniformity and substantive direction to
assessors, assessment appeal boards, and taxpayers. This bill
is necessary to protect current revenue in California, not
generate new revenue. In 2010 California's property taxes
generated nearly $50 billion. K-12 education receives
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approximately 52% of each property tax dollar generated.
Personal property tax accounted for approximately $3 billion of
that tax revenue. Based on recently received personal property
tax appeals, and the lack of definite direction, the potential
loss of revenue to California's local governments, special
districts and K-12 education could approximate $1.35 billion.
California must have clarity in the assessment of property to
protect the taxpayer and the recipients of property tax revenue.
"AB 832 establishes a clear and convincing standard so that
businesses have an exclusion when substantiated and are not
avoiding paying their fair share of taxes without substantiating
claims. This bill would provide uniformity and substantive
direction to assessors, assessment appeal boards, and
taxpayers."
Computer programs and property tax: background . Until 2008,
the assessors routinely assessed the computer software that was
embedded in the equipment and deemed essential to the
equipment's intended commercial operation. The rationale for
this assessment methodology was based on Property Tax Rule
152(e), which provides that, when the assessor values computer
equipment that is sold or leased at a single price not
segregated between taxable property and nontaxable programs
(i.e. when it is 'bundled' or 'embedded'), the assessor may
regard the total amount charged as indicative of the value of
the taxable property. In September of 2008, however, the Court
of Appeals in Cardinal Health 301, Inc. v. County of Orange
(2008) 167 Cal.App.4th 219, overturned the established local
assessment practices. In that case, the court reiterated that
"application" software, as distinct from a basic operational
program, is not valued for purposes of property taxation and
held that bundling by itself is not dispositive of whether
"application" software included in a bundled programming package
is taxable as "basic operational programming" under R&TC
Sections 995 and 995.2. Rather, it stated that, when
application software is bundled into the sale or lease price of
computer equipment, the burden is on the taxpayer to segregate
out the value of nontaxable application software from the
otherwise taxable value of the computer. Thus, the court
refused to adopt the assessors' position that the fact of
"embedding" or "bundling" of the software in the equipment was
dispositive in making the otherwise nontaxable software taxable.
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Is there a problem ? In the last 40 years, software programs
have advanced in complexity and numbers to the extent that they
pervade virtually all aspects of our lives. As most modern
machinery and equipment are sold primarily with bundled
software, determining the extent to which the bundled software
is "application" and not "basic operation" is difficult, if not
impossible in some cases. The proponents of this bill give an
example of the airplane's embedded software necessary to the
aircraft's operation. If the value of that software is excluded
from assessment, for all practical purposes, the value of the
aircraft would be little more than that of metal fuselage.
Until the Cardinal Health decision, there was significant
clarity and mutual agreement between assessors and industry
regarding the methodology for valuing complex equipment and
machinery. Once the assessors' methodology for valuing
"embedded" software was declared invalid by the court in
Cardinal Health, a significant number of applications were filed
with the assessment appeals boards in various counties
challenging the valuation of software embedded in the property.
According to the assessors, the evidence provided in some of
those appeals has been a simple three- or four-page spreadsheet
prepared by the assessee or its agent, with no supporting
invoices or valid documentation, and in one instance, the data
provided appears to have been fabricated. By necessity, it
seems that a determination of whether the embedded software is
non-taxable must be based on the information provided to the
assessor by the taxpayer, since there is no market data for the
assessor to value many types of computer equipment. Thus,
unless the taxpayer submits sufficient information for a proper
valuation, an assessor is not in the position to make that
determination. Even then, assessors have no uniform standard to
determine what constitutes "sufficient" information; what may be
"sufficient" to overcome the presumption of correctness in one
county may not be sufficient in another.
In sum, as the assessors face the increased workload of
administrative appeals, they have very little guidance as to the
type and amount of information that the assessee is required to
submit to overcome the presumption of correctness otherwise
afforded to the assessor's valuation. Property Tax Rule 152(f)
simply requires a person "claiming that a single-price sale or
lease includes charges for nontaxable programs and services" to
identify "the nontaxable property and services" and to supply
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sales prices, costs, or other information. The Legislature has
not provided any direction since 1972, when R&TC Sections 995
and 995.2 were enacted. And the court in Cardinal Health did
not address the issue of whether the information provided to the
assessor by Cardinal Health to value the embedded software in
question was valid or sufficient.
The proposed solution . This bill proposes to address the
problem by requiring a person claiming that a single-price sale
or lease includes charges for nontaxable programs or services to
prove, by clear and convincing evidence, the existence of those
programs or services. In support of his/her claim, the person
must submit to the assessor the sales price, costs, other
information regarding the programs or services, in order to
assist the county assessor in making an informed judgment
regarding the proper value of the nontaxable property. This
bill is intended to provide uniformity and substantive direction
to assessors, assessment appeals boards and taxpayers and to
discourage frivolous appeals.
The burden of proof in property tax assessments . Existing law
defines "burden of proof" as "the obligation of a party to
establish by evidence a requisite degree of belief concerning a
fact in the mind of the trier of fact or the court." (Evidence
Code (EC) Section 115). The party with the burden of proof is
required to establish the existence or nonexistence of a fact by
producing evidence that satisfies a required standard.
Generally, the evidentiary standard applicable to assessment
appeals hearings is the "preponderance of the evidence." This
standard applies in most civil cases and, effectively, is
satisfied if the proposition is more likely to be true than not
true (i.e., there is greater than a 50% chance that the
proposition is true). In contrast, the "clear and convincing
evidence" standard, which is a higher level of burden of
persuasion, has been held to require evidence "so clear as to
leave no substantial doubt in the mind of the trier of fact,"
and "sufficiently strong to command the unhesitating assent of
every reasonable mind." (See Tannehill v. Finch (1986) 188
Cal.App.3d 224, 228; see also Lillian F. v. Superior Court
(1984) 160 Cal.App.3rd 314, 320). The party with the burden of
proof must convince the trier of fact that it is substantially
more likely than not that the proposition is in fact true.
An assessor is generally entitled to the presumption affecting
the burden of proof that he/she has properly performed his/her
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duty to assess all properties fairly and on equal basis. (EC
Section 664; Hunt-Wesson Foods, Inc. v. County of Alameda (1974)
41 Cal.App.3d 163, 180). In other words, the taxpayer has the
burden of proving the property was improperly assessed. (Texaco
Producing v. County of Kern (1998) 66 Cal.App.4th 1029, 1046).
Thus, in a hearing before an assessment appeals board, the
taxpayer with the burden of proof must present his/her evidence
first. (California Code Regulations, Title 18, Section 313(c)).
However, a county assessor has a burden of proof in certain
types of assessment appeals hearings that involve: a) the value
of owner-occupied single-family dwellings; b) penalty
assessments; c) escape assessments; d) non-enrollment of a
purchase price; and, e) when the county assessor intends to
report a higher assessed value than the one on the assessment
roll. In all of those five types of assessment appeals
hearings, the county assessor must affirmatively establish, by a
preponderance of evidence, the correctness of his/her opinion of
value or other assessment action.
There is legal precedent, however, for the use of the stricter
"clear and convincing" standard in property tax law. For
example, if the assessor, in valuing possessory interests, uses
a term of possession other than the stated term of possession in
a contract, the "clear and convincing evidence" standard
applies. Similarly, the existence of a clerical error in the
determination of a base year value of property must be proved by
clear and convincing evidence if the correction is made more
than four years after the year of enrollment. (R&TC Section
51.5). Other cases where the clear and convincing evidence
standard applies include presumptions in R&TC Section 2512,
relating to proof that an electronic transmittal of a tax
payment was made on a specific date and time, and EC Section
662, providing that the owner of the legal title is presumed to
be the owner of the full beneficial title.
Does the solution address the problem ? As noted in Cardinal
Health, BOE Property Tax Rule 152(e) creates a de facto
presumption that equipment sold with bundled software may be
assessed on the total sales price, unless the assessor has
"evidence to the contrary." It allows the taxpayer to overcome
this presumption by "identifying" what is nontaxable,
presumably, by a preponderance of the evidence. This bill
codifies the presumption, but raises the evidentiary standard
from "preponderance of the evidence" to "clear and convincing
evidence." Usually, the clear and convincing evidence standard
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applies only in cases involving civil fraud, punitive damages,
or other serious instances in which a very high degree of
certainty is required. Thus, a question arises as to whether
this higher evidentiary standard is appropriate in this case and
whether it moves the state any closer to an important goal of
establishing a uniform process of valuing embedded software.
Arguably, a higher evidentiary standard is required because the
taxpayer challenging the assessor's valuation is the one who
either possesses, or is in a better position to obtain from the
manufacturer, the necessary information about the embedded
software. Assessors, on the other hand, lack specialized
knowledge and information to determine the value of a particular
software program embedded in equipment and whether it is
essential to the equipment's commercial operation. There are no
uniform look-up tables for assessors to use as a reference guide
in such circumstances. It seems that assessors are currently
facing an almost insurmountable task of trying to ascertain and
rebut, if necessary, the credibility of the evidence presented
by assessees on appeal. This bill attempts to balance the
taxpayer's right to exclude embedded software from taxation with
the requirement to come forward with sufficient and credible
evidence.
It is unclear, however, what kind evidence would be deemed
"sufficient" to satisfy the "clear and convincing evidence"
standard. This bill requires a taxpayer to provide to a county
assessor "sales price, costs or other information regarding the
nontaxable programs or services," including a recognized BOE
valuation approach, technique, or method. But, would the
submission of that information be sufficient to satisfy the
taxpayer's higher burden of proof? Furthermore, how likely is
it that a higher evidentiary standard will ensure uniformity
amongst various counties and local assessment appeals boards?
It is important to note that this bill does not confront the
issue of whether embedded software should be subject to property
tax, even though it has not been addressed by the Legislature in
the last 40 years, since the era of punch cards and large
computer rooms, and seems to be ripe for consideration. This
bill does not seek to overturn the Cardinal Health decision,
which would require a two-thirds vote of the Legislature.
Instead, given the difficulty of garnering the support of a
two-thirds vote of the Legislature, it simply tries to limit the
number of frivolous appeals by imposing a higher burden of proof
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on taxpayers that decide to challenge the valuation of property
containing embedded software. While the solution offered by
this bill is not perfect, absent some sort of legislative
action, the assessors and the assessment appeals boards will
continue to struggle with a significant number of embedded
software cases that potentially may lead to a sizeable revenue
loss for local governments.
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098
FN: 0000817