ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – WHEN RELIANCE ON WRITTEN ADVICE FROM THE GOVERNMENT CANNOT BE RELIED ON
By Robert S. Schriebman
There are all sorts of rules and doctrines within the tax law that attempt to give individuals and businesses a pillar to rely upon when the government sets forth an opinion or a position in writing. For example, when it comes to the treatment of a worker as an independent contractor, we have long-standing “safe harbor” legislation going back to 1978 that provides rules preventing the IRS from acknowledging independent contractor status in one year, but employee treatment in a subsequent year (§ 530 of the Revenue Act of 1978). Penalties can be abated if a taxpayer relies upon written advice from the IRS (Internal Revenue Manual Chapter 20). The CDTFA, the sales tax people, are governed by R&TC Code § 6596(a) that prevents an inconsistent position when a taxpayer relies upon written advice concerning sales or use taxes. That’s the rule, but is it consistently followed?
In this article I will review the recent OTA decision in EMA Design Automation, Inc. (OTA Case No. 18114022 March 4, 2020). In that case the former SBE took a position during an audit relied by the taxpayer only to have the OTA disregard the position and subject the taxpayer to harsh taxes, and interest.
In addition to discussing the EMA case, I will discuss the doctrine of estoppel and how it may be used to protect a taxpayer from an inconsistent written position.
The Case of EMA Design Automation, Inc.
EMA is located in the State of New York. It is a retailer of product development solutions software. It does business in California and must collect sales tax on certain transactions in California and remit that tax in a timely manner. The former SBE audited EMA for the period beginning January 1, 2011 through December 31, 2013. Before we get into that audit, let’s look at a prior audit.
A prior audit was conducted in 2006. During that process, it was proper for the auditor to review samples of invoices instead of reviewing each and every invoice over a three-year period. In reviewing the selected sample, the SBE reviewed three invoices that listed dongles as part of the sales transaction, but the SBE treated these transactions as being non-taxable meaning EMA was not required to collect and remit sales tax on these specific sales. A dongle is a small piece of equipment resembling a zip drive providing a copy protection mechanism for commercial software (Wikipedia). The SBE sampled fourteen other invoices involving dongles and held them to be taxable sales. Confused by what appeared to be an inconsistent position regarding the dongles, EMA contacted the SBE to request written guidance as to the proper application of tax to the transactions involving the transfer of dongles. The SBE declined to provide guidance because the audit was ongoing. At the conclusion of the audit, the SBE gave EMA a written audit report exempting some dongles and taxing others.
The New Audit
After the 2006 audit, EMA followed the position taken by the prior auditor and treated certain dongle transactions as non-taxable and did not collect sales tax. The new auditor took the position that the previous audit findings were wrong and assessed EMA on all dongle-related transactions. EMA cried foul and contested the assessment of over $220,000 plus interest.
EMA took the position that it followed R&TC §6596(a) providing that a taxpayer can reasonably rely upon written advice from the then SBE (now CDTFA), and by relying on that advice, is relieved from any sales or use taxes imposed. Usually written advice from a taxing agency is in the form of a letter ruling or written position involving a taxpayer’s specific inquiry. EMA’s experience involved an audit with resulting written audit workpapers. The Regulations governing §6596(a) state if a previous audit contains written evidence demonstrating that the issue in question was examined, either in a sample or actual review of all records, such evidence will be considered written advice (Reg. Title 18 § 1705(c)). Audit comments, schedules, and related writings that become part of the audit workpapers, count as written advice. The presentation of a taxpayer’s books and records is deemed to be a written request for the audit report by the auditor. Therefore, the requirement for written advice under the Code was satisfied.
EMA argued that it relied upon the written position taken by the then SBE thus satisfying the reliance requirement under the law. It was not fair for the SBE to take one position in the earlier audit, and a different position years later in a subsequent audit.
The OTA disagreed. The OTA acknowledged that the position regarding the three exempt dongle invoices was different that the position regarding the other fourteen samples found to be taxable. EMA at the time was confused and sought written advice from the SBE, but that request was turned down. A taxpayer’s reliance on written advice must objectively be reasonable. The judges felt that anyone reviewing the audit would have scratched his head and tried to find a distinction where there was none. It was not reasonable for EMA to rely on the written audit position. The judges felt that a reasonably prudent business person would have again sought written advice from the SBE before proceeding to exempt future dongle transactions. EMA failed to do this.
The Doctrine of Equitable Estoppel
In my opinion, the OTA was too hard on EMA. If the SBE made a mistake, and the taxpayer relied upon it, the SBE should live with it. If anything, during the second audit, the SBE should have given EMA a pass on its position in prior years but let EMA know that in the future they must collect sales taxes on all similar transactions. In other words, the SBE should have been estopped from taking an inconsistent position and should have given the taxpayer fair warning.
EDD To the Rescue
The doctrine of equitable estoppel was well set forth in a CUIAB Precedent Decision P-B-115 as follows:
- The Employment Development Department, or its authorized representative, was apprised of all the facts.
- The department intended the claimant to rely on its conduct or statement or led the claimant to believe he or she could rely on it.
- The claimant was ignorant of the facts.
- The claimant relied on the department, or its representative’s conduct or statement, to his or her injury.
Here, the elements of estoppel were established in the EMA audit. The SBE conducted an examination so it was apprised of all the facts. The SBE took a position, although confusing, that EMA relied upon. There was over $220,000 at stake in this matter, and it appears that the OTA did not want to lose out on a windfall. Taxpayers, attempting to seek justice from the OTA, are consistently disappointed. In the words of Dean Robert K. Castetter, “There does not seem to be enough justice to go around.”
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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