Software Sales 2 Nortel Networks Inc. v. State Board of Equalization (2011) 191 Cal.App.4 th 1259; Lucent Technologies Inc. v. State Board of Equaliza

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1 Copyright Notice 1 Significant portions of this PowerPoint Presentation were originally presented at the State Bar of California s 2014 Annual Meeting of the California Tax Bar & California Tax Policy Conference. New material has been added, and certain case discussions have been updated, since the 2014 TPC.

2 Software Sales 2 Nortel Networks Inc. v. State Board of Equalization (2011) 191 Cal.App.4 th 1259; Lucent Technologies Inc. v. State Board of Equalization, pending before the Second District Court of Appeal.

3 Nortel Networks 3 The Court of Appeal held in 2011that Nortel s agreements by which it licensed software programs that run its telephone switches qualified as technology transfer agreements (TTAs), so that the portions of the lump-sum charges attributable to licenses of intangible patent and copyright interests were excluded from tax.

4 Nortel Networks 4 In its published opinion, the Court of Appeal stated, Pacific Bell made little use of the tangible disk containing the program, which was simply copied onto its computers, but it made continuous use of the intangible information contained on the disk, information that was necessary to run the switch.

5 Lucent Technologies 5 AT&T and Lucent Technologies sold telephone switches and the software that operates such switches. They claim that their sales of switching software qualify for TTA treatment. The parties filed cross motions for summary judgment, raising a number of issues.

6 Lucent Technologies 6 One of the significant issues raised by the cross motions is whether software stored and transmitted on magnetic recording tape is tangible personal property within the meaning of Revenue and Taxation Code section Section 6016 provides: Tangible personal property means personal property which may be seen, weighed, measured, felt, or touched, or which is in any other manner perceptible to the senses.

7 Lucent Technologies 7 The Board argued that under Plaintiffs characterization of the cases, three things moved from the retailers (AT&T and Lucent Technologies) to the customers (Pacific Bell, and others): (1) Storage media, (2) patent and copyright rights, and (3) software. Both sides agree that storage media is tangible, and that patent and copyright rights are intangible. But what about the software?

8 Lucent Technologies 8 The Board argued that software recorded on tape (or disk) can be seen and measured, and can be perceived. Pursuant to section 6016, therefore, software recorded on tangible storage media is part of the tangible personal property. Not surprisingly, Plaintiffs counsel argued that under Nortel, software stored on a tape or disc is intangible (the intangible information contained on the disk ).

9 Lucent Technologies 9 Tangibility is an important question when determining how much of a lump sum purchase price to allocate to the tangible personal property. Under section 6012(c)(10), the portion attributable to the transfer of tangible personal property is subject to tax, and the portion attributed to intangible property is excluded from tax.

10 Lucent Technologies 10 The superior court granted the Plaintiffs motion for summary judgment, and denied the Board s motion. The court also awarded attorneys fees to the Plaintiffs, which raised interesting issues about the Board s reasonableness in defending this case, in the wake of the Nortel published opinion. The Board filed a Notice of Appeal in July 2014, the case is now pending in the Second District Court of Appeal, and briefing is not complete. Case no. B257808

11 Lucent Technologies 11 Revenue and Taxation Code section 7156 authorizes an award of attorney fees to the prevailing party; Subdivision (c)(2)(a) provides: Prevailing party" means any party to any proceeding described in subdivision (a) which (i) Establishes that the position of the State of California in the civil proceeding was not substantially justified.

12 Lucent Technologies 12 Lucent and AT&T argued that because the Board lost on identical issues in Nortel, the Board had no substantial justification to defend these cases; The Board argued that its primary defense in these cases focused on the tangibility of the software (a factual question), and since the parties did not litigate the tangibility issue in Nortel, the Board had substantial justification to defend this case on this new and different issue.

13 Lucent Technologies 13 Plaintiffs urged the language from the Nortel opinion, Pacific Bell made continuous use of the intangible information contained on the disk, and argued that the tangibility question had been decided, as a matter of law; The trial court agreed with plaintiffs, and awarded attorney fees; The Board is appealing this issue, along with the merits.

14 Class Action Cases 14 Loeffler v. Target Corporation (2014) 58 Cal.4 th 1081 Fratilla v. Big O Tires; Littlejohn v. Costco; McClain v. Sav-On Drugs Dell, Inc. v. Superior Court (2008)159 Cal.App.4th 911

15 Loeffler v. Target Corporation 15 The issue in this case was whether a consumer in a sales tax transaction may sue a retailer under the Unfair Competition Law for allegedly improperly collecting sales tax reimbursement on a transaction the plaintiff contends is not subject to sales tax. Target collected sales tax reimbursement from consumers who purchased a cup of coffee to go. Plaintiffs argued that they were not challenging a tax but rather the collection of a charge sales tax reimbursement.

16 Loeffler v. Target Corporation 16 The California Supreme Court ruled for Target, holding that remedies under the UCL were not available to consumers for alleged violations of the Sales and Use Tax Law. Allowing a UCL challenge would be inconsistent with the tax code provisions relating to the sales tax, particularly in light of the primary role assigned to the Board with regard to the resolution of sales tax issues and the presumption that all sales are taxable unless the taxpayer demonstrates otherwise to the satisfaction of the Board.

17 Pending class action cases 17 Fratilla v. Big O Tires; sales tax reimbursement collected on sales of tire warranty contracts; trial court held in favor of BOE; appeal not likely Littlejohn v. Costco; sales tax reimbursement collected on sales of Ensure products; trial court ruling in favor of BOE; appeal filed McClain v. Sav-On Drugs; sales tax reimbursement collected on sales of insulin supplies; trial court sustained BOE demurrer; appeal likely, but not filed yet

18 Pending class action cases (cont.) 18 Moshiri v. Saks and Company: Plaintiff alleges that when Saks makes refunds of a purchase price when a customer does not have a receipt, it is refusing to refund the sales tax reimbursement that the customer paid at the time of the transaction. After alleging several causes of action against Saks based on UCL theories, she included a cause of action against all defendants, seeking an accounting, and alleging that under Decorative Carpets and Javor she could bring a direct action against the Board.

19 Pending class action cases (cont.) 19 Finally, we anticipate the filing of an action seeking to overturn Board Regulation 1585; on behalf of Petitioner Jenny Lee, attorney Daniel Hattis filed a Petition with the Board, asking the Board to repeal Reg Reg requires cell phone retailers to pay sales tax (and allows them to collect tax reimbursement) on the full retail selling price of a cell phone, when the phone is sold in a bundled transaction with a service plan. The Board considered the Petition at its meeting on March 26, and unanimously voted 5-0 to reject the Petition, and retain Reg as promulgated. Attorney Hattis is now threatening to sue the Board, alleging that the regulation is unfair, unjustifiable, and unconstitutional. A revenue estimate a year ago (in connection with pending legislation to basically achieve the same result) found that it would have resulted in lost state and local sales and use tax revenue of $383M annually. Add in the potential for three years of claims for refund, and the lost revenue could start at more than $1 billion.

20 Dell, Inc. v. Superior Court 20 Dell sold computer hardware and service contracts for one lump sum price. The hardware and service contracts were not shown with separately itemized prices, so the only pricing shown on the invoice was the total price paid. Dell and several of its subsidiaries were named in a class action case filed by Diane Mohan on behalf of a class of purchasers who contended they should not have been charged tax on the amounts paid for the optional service contracts.

21 Dell, Inc. v. Superior Court 21 The parties have negotiated a resolution by way of settlement agreement. Claimants were required to go to a dedicated web site and enter claim information for each short form notice they received. Claims were transmitted to SBE for processing, with payment of refunds to come from the Controller s Office.

22 Dell, Inc. v. Superior Court million notices were mailed to purchasers on the SBE settlement, in January Nearly 700,000 notices were undeliverable. Approximately 190,000 claimants filed electronic claims. Plaintiffs had publicly estimated a universe of potential claims of up to $250 million. Claims made totaled ~$45 million.

23 Dell, Inc. v. Superior Court 23 At the final approval hearing for class certification and final approval of the settlement, there were objectors. The Superior Court gave final approval and certified the class, over the objections, and judgment was entered. On August 6, 2013, one objector filed a Notice of Appeal. The Court of Appeal issued an unpublished opinion rejecting the objector s arguments; his Petition for Review to the CA Supreme Court was denied; payment of refunds is awaiting expiration of time for the objector to seek USSC review.

24 Gillette Company, et al. v. Franchise Tax Board 24 Trial Court Taxpayers asserted Multistate Tax Compact gave them the option to elect the compact s three-factor equally weighted apportionment formula FTB s demurrer sustained without leave to amend and dismissed taxpayers action Appellate Court Reversed trial court The court held: Taxpayers had standing to sue Compact was a valid multistate compact California was bound by the compact and its apportionment election Compact was not repealed by California and California had not withdrawn from the Compact Compact superseded general apportionment rule FTB s construction violated federal and California constitutional prohibition against impairment of contracts FTB s construction violated California s reenactment rule Supreme Court Presently pending All briefs filed awaiting oral argument

25 Gillette Company, et al. v. Franchise Tax Board Related Issues 25 Proposition 39 Changed default apportionment method to single-sales-factor method. Did not repeal the Compact election. If California Supreme Court sustains Gillette, Compact election is still available. Senate Bill 1015 Repealed the Compact and provided that an election affecting computation of tax must be made on an original timely filed return for the taxable period for which the election is to apply and once made is binding. Passed by majority vote; but, may be contested on the basis that it is a tax increase requiring a 2/3 supermajority in both houses.

26 Harley-Davidson, Inc. v. Franchise Tax Board 26 Elective Combination Issue Taxpayers that earn income from sources wholly within California generally file their returns on a separate entity basis. However, When such taxpayers are members of a unitary group that also derives all of its income from sources within this state, they are permitted to file returns on the basis of a combined report. (RTC and 25105) Harley-Davidson contends that it is unconstitutionally discriminatory for multistate unitary groups not to have the same option to file on a separate or combined basis, and asserts that the only permissible cure for the violation is for the court to order that the same option must be made available to multistate unitary groups.

27 Harley-Davidson, Inc. v. Franchise Tax Board 27 On May 2, 2013,Superior Court enters judgment in favor of FTB. On June 27, 2013, Harley Davidson files Notice of Appeal. Case is fully briefed Oral Argument scheduled to be heard on May 13,2015.

28 Comcon Production Services I., Inc. v. Franchise Tax Board 28 The two issues at trial were: Whether Comcon s receipt of a $1.5 Billion termination fee as a result of its failed attempt to merge with MediaOne constituted business income under the transactional test, and Whether Comcon (Comcast) (a cable television, telephone, and internet access company) was unitary with QVC, its 57% owned subsidiary (a cable television shopping channel/electronic retailer) due to flows of value and contribution and dependency between the two businesses.

29 Comcon Prod. Services I., Inc. v. Franchise Tax Board 29 On August 22, 2014, the Superior Court entered judgment in favor of FTB on the business income issue. At the same time, the Superior Court entered judgment in favor of Comcon on the unitary issue. On October 20, 2014, FTB filed a Notice of Appeal with respect to the judgment entered in favor of Comcon on the unitary issue. On October 24, 2014, Comcon filed a Notice of Cross- Appeal with respect to the judgment entered in favor of FTB on the business income issue. FTB s Opening Brief is due to be filed on May 4, 2015.

30 Swart Enterprises, Inc. v. Franchise Tax Board 30 Plaintiff is an Iowa Corporation which held a de minimis membership in a California LLC doing business in California and which elected to be taxed a general partnership. Plaintiff alleged that under these circumstances it could not properly be held to be doing business in California pursuant to RTC section 23101, and that FTB s contentions to the contrary constituted violations of the constitutions of the United States of America and the State of California.

31 Swart Enterprises, Inc. v. Franchise Tax Board 31 On November 14, 2014, the Superior Court granted Swart s Motion for Summary Judgment, on the singular basis that Swart was not doing business in California. Judgment was entered in favor of Swart Enterprises on November 15, On January 16, 2015, FTB filed a Notice of Appeal with respect to the judgment entered in favor of Swart Enterprises.

32 Franchise Tax Board Limited Liability Corpration Tax Refund Cases 32 Included Actions: Bakersfield Mall, LLC v. Franchise Tax Board (San Francisco County Superior Court No. CGC CA Centerside II, LLC v. Franchise Tax Board (Fresno County Superior Ct. No. 10CECG00434) Bakersfield Mall, LLC and CA Centerside II, LLC both filed substantially identical complaints in San Francisco County Superior Court and Fresno County Superior Court, respectively. Substantive issue is whether the LLC fee imposed by former Revenue and Taxation Code section is unconstitutional on its face.

33 Franchise Tax Board Limited Liability Corpration Tax Refund Cases 33 FTB s motion to coordinate the two cases was granted during January 2013, with venue ordered in San Francisco County/First District Court of Appeal. Coordination Judge directed that the procedural question as to whether the cases may properly proceed as a class action be determined before the substantive tax issue.

34 Franchise Tax Board Limited Liability Corpration Tax Refund Cases 34 On October 8, 2013, the Coordination Judge denied Plaintiffs motions for class action certification on the basis that Plaintiffs had failed to demonstrate that the case met traditional class action requirements. On December 2, 2013, Plaintiffs filed their Notice of Appeal of the Coordination judge s determination. The matter is fully briefed and awaiting oral argument.

35 Gilbert P. Hyatt v. Franchise Tax Board 35 August 2008 Clark County (Nevada)District Court jury trial results in an award of $389 million against Franchise Tax Board. Award comprised of $139 million in damages on intentional tort causes of action for invasion of privacy, breach of confidential relationship, abuse of process, fraud, and intentional infliction of emotional distress, together with Award of $250 million in punitive damages.

36 Gilbert P. Hyatt v. Franchise Tax Board 36 September 2014 Nevada Supreme Court (Case No ) issues an Advance Opinion through which it Reverses and vacates award of Punitive Damages Reverses and vacates awards against FTB premised upon the tort theories of Intrusion Upon Seclusion and Public Disclosure of Private Facts False Light Invasion of Privacy Breach of Confidential Relationship, and Abuse of Process

37 Gilbert P. Hyatt v. Franchise Tax Board 37 Affirms damage award of approximately $1.2 million on the cause of action for fraud, and Remands to District Court the determination of the amount of damages (but not the question of liability) to be awarded to Plaintiff on the cause of action for emotional distress.

38 Gilbert P. Hyatt v. Franchise Tax Board 38 March 23, 2015 FTB files a Petition for writ of Certiorari with the United States Supreme Court requesting that the Supreme Court review the propriety of Nevada permitting a sister state to be liable for tort damages, and Nevada permitting a sister state to be liable for tort damages in an amount that exceeds the statutory maximum that could be imposed against a Nevada state agency. Hyatt s opposition to FTB s Petition for Writ of Certiorari is due to be filed on or about May 24, 2015.