BILL ANALYSIS Ó AB 781 Page 1 Date of Hearing: April 29, 2013 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Raul Bocanegra, Chair AB 781 (Bocanegra) - As Amended: April 18, 2013 Majority vote. Fiscal committee. SUBJECT : Sales and use taxes: fees: administration: violations for noncompliance: sales suppression devices SUMMARY : Provides that a person who knowingly sells, purchases, installs, transfers, possesses, or uses any automated sales suppression device, zapper, or phantom-ware is guilty of an offense punishable by a fine, imprisonment, or both. Specifically, this bill : 1)Specifies that a person who knowingly sells, purchases, installs, transfers, possesses, or uses in this state any automated sales suppression device, zapper, or phantom-ware is guilty of an offense punishable by: a) A fine of not more than $10,000; b) Imprisonment in county jail for not more than one year, or for 16 months, or two, or three years; or, c) Both fine and imprisonment. 2)States that any person who uses an automated sales suppression device, zapper, or phantom-ware shall be liable for all taxes, interest, and penalties due as a result of the use of that device. 3)Defines "automated sales suppression device" or "zapper" as a software program that falsifies the electronic records of electronic cash registers and other point-of-sale systems, including transaction data and transaction reports. These devices may be carried on a memory stick or removable compact disc, accessed through an internet link, or accessed through other means. 4)Defines an "electronic cash register" as a device that keeps a register or supporting documents through the means of an AB 781 Page 2 electronic device or computer system designed to record transaction data for the purpose of computing, compiling, or processing retail sales transaction data in whatever manner. 5)Defines "phantom-ware" as a hidden, preinstalled, or installed at a later time programming option embedded in the operating system of an electronic cash register or hardwired into the electronic cash register that can be used to create a virtual second till or may eliminate or manipulate transaction records that may or may not be preserved in digital formats to represent the true or manipulated record of transactions in the electronic cash register. 6)Defines "transaction data" to include information regarding items purchased by a customer, the price for each item, a taxability determination for each item, a segregated tax amount for each of the taxed items, the amount of cash or credit tendered, the net amount returned to the customer in change, the date and time of the purchase, the name, address, and identification number of the vendor, and the receipt or invoice number of the transaction. EXISTING LAW : 1)Establishes the State Board of Equalization (BOE), which administers sales and use taxes, excise taxes, special taxes, and the state's fee programs. (California Constitution, Article XIII, Section 17). 2)Makes it a misdemeanor for a person, required to make, render, sign, or verify any report, to make a fraudulent return with the intent of evading the determination of an amount due. Each offense shall be punishable by a fine of at least $1,000 and not more than $5,000, or imprisonment of up to one year, or both in the court's discretion. [Revenue & Taxation Code (R&TC) Section 7152 through 7157]. 3)Specifies that any person who violates the SUT Law with the intent to defeat or evade the reporting, assessment, or payment of a tax or an amount due is guilty of a felony when the amount of unreported tax liability aggregates $25,000 or more in any 12-consecutive-month period. Each offense shall be punished by a fine of not less than $5,000 and not more than $20,000, or imprisonment for 16 months, two years, or three years, or both the fine and imprisonment in the AB 781 Page 3 discretion of the court. (R&TC Section 7153.5). 4)Provides that any person who knowingly or willfully files a false return or report with the BOE, and any person who refuses to permit the BOE or any of its authorized representatives to make any inspection or examination, or who fails to keep any records prescribed by the BOE, or who fails to preserve the records for the inspection of the BOE for the time that the BOE deems necessary, or who alters, cancels, or obliterates entries in the records for the purpose of falsifying the records, is guilty of a misdemeanor, punishable by a fine of not less than $100 or more than $1,000, by imprisonment in the county jail for not less than one month or more than six months, or by both. (R&TC Section 55362). 5)Provides for the general administration and collection of BOE-administered fees under the Fee Collection Procedures Law. (R&TC Section 55001 et seq.). FISCAL EFFECT : Based on BOE data for 2010, California's dining and beverage industry reported taxable sales of $51.3 billion. Using a 5% underreporting rate, California loses $214 million annually due to these sales suppression devices. If enacted, the BOE anticipates that these estimated losses will decrease. However, the BOE has noted that the extent of the decrease is unknown. COMMENTS : 1)The author has provided the following statement in support of this bill: California's tax system is based on the principal of voluntary compliance. Most taxpayers report tax liability to appropriate agencies and generally comply with California tax law. However, there are those who will try to evade paying their taxes. Such evasion takes the form of failing to report sales, keeping two sets of books, or even filing false tax returns. Newer and more sophisticated products like automated sales suppression devices, zappers, and phantom software have made this process much easier and faster to accomplish. In general, these devices electronically and systematically conceal and remove sale transactions from recordkeeping systems. The use of these modern devices also makes it much more AB 781 Page 4 difficult for auditors to detect fraud. The Board of Equalization has estimated that California loses $214 million in annual sales tax revenue due to these kinds of devices. Not only do these kinds of devices place a burden on state and local governments, they also place a burden on honest and hardworking business owners who pay and collect taxes. A business owner that suppresses sales is able to reduce the amount of income tax paid, and the amount of sales tax collected. This provides a huge competitive disadvantage for honest taxpayers. Making things worse is the fact that these kinds of devices and software are incredibly difficult to detect. Even when an audit is conducted, there are no guarantees of finding criminal activity. AB 781 addresses this problem by criminalizing not only the use, but the sale and possession of these devices and software. Instead of simply going after the user, this bill also goes after the seller and developer. 2)The BOE, which is the sponsor of this bill, notes the following in its staff analysis: As the sponsors of this bill, the BOE Members believe that California must be proactive and curtail the use of these sales suppression devices. Use of this technology not only defrauds the state, but provides users an unfair competitive advantage over taxpayers who comply with the law and pay their fair share of taxes and fees. The Legislature has recognized, through its enactment of criminal penalties for deliberate taxpayer fraud and evasion, that criminal sanctions play an important role in tax administration. Specifically, criminalizing and punishing the sale, installation, and use of sales suppression devices serve as a strong deterrent to potential offenders. 3)Proponents of this measure state: The California Retailers Association [CRA] is the only statewide trade association representing all segments of the retail industry including general merchandise, department stores, mass merchandisers, fast food restaurants, convenience stores, supermarkets and grocery AB 781 Page 5 stores, chain drug, and specialty retail such as auto, vision, jewelry, hardware and home stores. CRA works on behalf of California's retail industry, which currently operates over 164,200 stores with sales in excess of $571 billion annually and employing 2,776,000 people - nearly one fifth of California's total employment. The retail industry in California represents one in every four jobs in the State, a total of nearly 5 million jobs (2009), and accounts for 17.8% of the State's GDP. CRA's membership operates in compliance with the state's tax laws. Devices such as "the zapper" that enable businesses to manipulate their sales records in order to evade paying taxes put our members, who are acting in accordance with the law, at a competitive disadvantage. AB 781 proposes an important deterrent that would level the playing field for our members. 4)Opponents of this measure state: This legislation is absolute proof of the necessity of a sentencing commission to examine California's penal statutes and determine whether or not the sentencing structure provides effective sanctions to prevent future criminal conduct and punish those individuals who have committed crimes. California can no longer afford [piecemeal] sentence enhancements without considering the need for acquiring, either through construction or out of state housing, additional prison beds. Today, the [California Department of Corrections and Rehabilitation] houses 9,000 more inmates than allowed by the United States District Court. The committee should remain mindful of the fact that Coleman/Plata court has ordered the Governor to provide a plan to reduce State prison inmate population to 137,500 inmates by May 6. This legislation, if approved, will increase the prison population exponentially which could easily be [interpreted] by the three federal judges as a rejection of their April 11, 2013 order. This committee should require this legislation provide a procedure to release an equal number of inmates from State custody to make sure that there is no net increase in inmate population to assure AB 781 Page 6 that there is no contempt order issued. 5)Committee Staff Comments: a) Background: Zappers, automated suppression devices, and phantom-ware . Software programs like zappers or phantom-ware can be used to siphon cash from electronic cash registers and cheat tax officials. These kinds of devices and software illustrate the technological advancement of an old fraud - skimming cash from the register. According to Electronic Sales Suppression: A Threat to Tax Revenues, the use of electronic sales suppression devices has been steadily growing for more than a decade. Modern cash registers in the retail sector operate as comprehensive sales and accounting systems, often using standard business software. These systems can be manipulated to permit "skimming" of cash receipts just as much as manual systems, but can facilitate far more elaborate frauds once equipped with suppression software by systematically reconstituting records matching the skimming activity. In the old days, before electronic registers became the norm, this kind of work was much more difficult to accomplish. Additionally, any discrepancies between sales and cash would be easily detectable. However, advances in technology have streamlined the way in which money is skimmed from the cash register. Zapper programs can create a virtual second cash register, simultaneously creating two sets of books. The physical need to separate cash and receipts is no longer needed, and the need for manual recordkeeping is also eliminated. b) The use of high tech devices . Phantom-ware and zapper programs are considered to be a serious problem in Canada, Germany, Brazil, Australia, Sweden, and the Netherlands. (Richard Ainsworth, Massachusetts Zappers - Collecting the Sales Tax that has Already Been Paid, Boston University School of Law, Working Paper No. 09-28, 2009). However, in 2009, it was not yet considered to be a serious problem in the United States (U.S.). At the time, only two cases had been found in the U.S.; a $17 million skimming fraud at Stew Leonard's dairy in Connecticut, and a $20 million skimming fraud by the LaShish restaurant chain in Michigan. Id. Steadily, the use of zapper and phantom-ware has AB 781 Page 7 increased. On April 23, 2013, the Assembly Committee on Public Safety heard testimony from the BOE on the use of these kinds of programs and devices. As of that date, the BOE had found 20 different cases of zapper and phantom-ware use, and six different types of devices. On May 3, 2011, Georgia became the first state to take action against zappers and phantom-ware. The Georgia law made it a crime to willfully and knowingly sell, purchase, install, transfer, or possess any automated sales suppression device, zapper or phantom-ware. (Richard Ainsworth, An American Look at Zappers, Boston University School of Law, Working Paper No. 12-14, 2012). In 2012, Utah, West Virginia, and Maine each passed similar legislation. Id. One of the most compelling factors pushing states to enact anti-zapper legislation is a report of a successful sting operation for zappers. Id. Specifically, the New York State Department of Taxation and Finance opened up false restaurants and solicited venders for new electronic cash registers. Out of the 24 venders, approximately 70% to 80% offered sales suppression software and devices that worked with their machines. Id. c) Detection . Detecting zappers, phantom-ware and other sales suppression devices is never easy, and depends, in large part, on the software or device being used. Phantom-ware programing is generally part of the operating system for an electronic cash register. (Ainsworth, Massachusetts Zapper). On the surface, phantom-ware is difficult to detect. However, if use of the software is suspected, a computer specialist may be able to find the embedded program in the operating system. Zappers, on the other hand, work a little differently. Unlike the phantom-ware, which is generally imbedded into the operating system, a zapper is usually found on an external drive, removable CD, or is accessed through an internet link, making its detection much more difficult. Id. Clearly, detecting sales suppression devices and software is incredibly difficult. This makes studying the scope of the problem that much more challenging. However, as noted earlier, some electronic cash register vendors actively promote the use of sales suppression devices, making it very likely that the use is widespread. As a way of dealing with these vendors, AB 781 makes it a misdemeanor AB 781 Page 8 or felony for an individual to sell or possess such devices. 6)Double-Referral . This bill was referred to the Assembly Committee on Public Safety on April 23, 2013, and passed out of the Committee on a vote of 6 to 0. REGISTERED SUPPORT / OPPOSITION : Support State Board of Equalization (Sponsors) California Retailers Association American Federation of State, County, and Municipal Employees Opposition Taxpayers for Improving Public Safety Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916) 319-2098