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  








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            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  








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            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  








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               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  








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               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  








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               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  








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               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  








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               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