2019’s top 10 California SALT developments

While compared to some years in the past, 2019 was not a "big" year in terms of the overall number of California developments in state and local tax, aka SALT, it certainly was not lacking in the significance of those developments. Below (and in no particular order) is our top 10 California SALT developments of 2019, and what to watch for in 2020 with respect to those items.

1. The 2020 Ballot Threat to Proposition 13 on Commercial Property Taxation

Proposition 13 was enacted by initiative in California in 1978, and limits property taxes to 1% of the full cash value of the property, subject to an annual inflation increase of up to 2%, or a reassessment based on a "change of ownership," or new construction. It applies to both residential and commercial property. However, Initiative 17-0055 has now qualified for the November 2020 general election ballot, and would require certain commercial and industrial properties to be regularly reassessed (every three years) at full market value (with certain exceptions) absent a change of ownership. The attorney general's ballot summary indicates that Prop. 13 is expected to increase annual property tax revenues by $6.5 billion to $10.5 billion in most years. To further complicate matters, a new version of the initiative (19-0008) is currently gathering signatures and could potentially replace 17-0055 on the November 2020 ballot.

2. Legislative Attempts to Extend the California False Claims Act to Taxes

The California False Claims Act generally allows the California attorney general or the prosecuting attorney of a political subdivision (or a person acting as a qui tam plaintiff in some circumstances) to bring a civil action for damages against any person who knowingly presents to the state or political subdivision a false or fraudulent claim for payment or approval or knowingly making or using a false record or statement material to a false or fraudulent claim. Currently, the act does not apply to state taxes. In 2019, Assembly,ember Mark Stone introduced Assembly Bill 1270 to extend the act to claims, records, or statements made under the California Revenue and Taxation Code (meaning to taxes administered by the State Board of Equalization, the California Department of Tax & Fee Administration (CDTFA), and the Franchise Tax Board). AB 1270 died in committee in 2019, but Stone is expected to introduce similar legislation in 2020.

3. Litigation Regarding the Vote Required for Imposing Special Local Taxes by Initiative

The issue of whether a special local tax requires a simple majority, or a two-thirds vote in order to be enacted, is currently a very hot topic in the courts. California Cannabis Coalition v. City of Upland, 3 Cal. 5th 924 (2017), held that the California Constitution does not require local general taxes be submitted to the electorate at a general election, as opposed to a special election, where the taxes voters seek to impose are by the initiative process. Litigation is pending in four appellate cases over whether Upland can be read for the proposition that special local taxes imposed by voter initiative are not imposed by a "local government," meaning they can be approved by a simple majority vote instead of a two thirds, supermajority, vote.

In Howard Jarvis Taxpayers Association et al. v. City and County of San Francisco, CGC-18-568657, the trial court ruled that Prop. C, a gross receipts tax on commercial rents which received 50.87% San Francisco voter approval at the June 2018 election, is a valid tax. In City and County of San Francisco v. All Persons Interested in the Matter of Proposition C, CGC-19-573230, the trial court ruled that Prop. C, an increase in the gross receipts tax to address homelessness which received 61.34% voter approval at the November 2018 election, is a valid tax. In Jobs & Housing Coalition v. City of Oakland, Alameda Co., RG19005204, the trial court ruled that Measure AA, a parcel tax to fund educational programs which received 62.7% Oakland voter approval, was invalid because it did not pass by a two-thirds vote. In City of Fresno v. Fresno Building Healthy Communities, 19CECG00422, the trial court ruled that Measure P, a local sales tax which received 52.17% voter approval, was invalid because it did not pass by a two thirds vote.

All four cases interpreting Upland are now pending in the courts of appeal, and it seems inevitable the issue ultimately will reach the California Supreme Court.

4. New Discussions on Imposing Sales Tax on Technology Transfer Agreements and Embedded Software

Sales tax is imposed on sales of tangible personal property, not on intangibles, and transfers of technology present challenging issues. The CDTFA, which administers sales/use taxes, is in the process of attempting to amend its regulations to address sales tax issues involving technology transfer agreements, especially those involving embedded software.

Two major cases on this issue, Nortel Networks, Inc. v. State Board of Equalization, 191 Cal. App. 4th 1259 (2011), and Lucent Technologies v. Board of Equalization, 241 Cal. App. 4th 19 (2015), rejected the position taken on this issue by CDTFA's predecessor agency, the State Board of Equalization. CDTFA is now starting a series of "interested parties" meetings on when and how sales tax can be imposed on technology transfer agreements under Revenue and Taxation Code Sections 6011 and 6012, which transfer both tangible and intangible property. An interested parties meeting was held in November 2019 and public comments received there on CDTFA's proposed draft regulations were overwhelmingly negative. CDTFA is expected to offer new draft regulations in early 2020.

5. Legislative Attempts to Extend the Sales Tax to Services

Senate Majority Leader Robert Hertzberg was elected to the Senate in 2014 (after serving in the Assembly) and has introduced (unsuccessful) legislation for the last five years to extend the California sales tax to services. In 2019, he introduced Senate Bill 522 which, with no specifics, would have made legislative findings for the need for changes to the tax system to include a sales tax on services. The bill stated that over the past 60 years, California has moved from an agriculture and manufacturing based economy to a service based economy and has become more and more reliant upon revenues derived for personal income taxes (which today accounts for almost 70% of state general fund revenues), while the percentage of general fund revenues from sales/use taxes continues to fall. Hertzberg is expected to introduce a comparable bill in 2020.

6. The Office of Tax Appeals OTA Is Fully Up and Running

Created by legislation in 2017 to take over the tax appellate function formerly held by the State Board of Equalization for corporate and personal income tax, sales/use tax, and a number of fees, California's Office of Tax Appeals (OTA) became fully operative on Jan. 1, 2018. 2018 was largely a transitional year as the new agency hired staff and began working through the backlog of cases inherited from the Board of Equalization. In 2019, the office hit its full stride. With three locations in Sacramento, Fresno and Los Angeles, the OTA is now staffed with 27 administrative law judges. In 2019, the OTA issued 416 opinions, both precedential and non-precedential, which are available on its website. 345 of those opinions were in franchise and income tax matters, with the balance involving sales/use tax (and fees). Of the total opinions issued, only 40 of the opinions (about 10%) are precedential.

Senate Bill 92, effective June 27, 2019, authorized a small case process for the OTA, under which a person filing an appeal may opt to appear before one administrative law judge, rather than a three-judge tax appeal panel, when the total amount in dispute, including penalties and fees, is less than $5,000 with respect to personal income taxes, fees, or penalties, or the entity filing the appeal has gross receipts of less than $20,000,000 with respect to taxes, fees, and penalties administered by the CDTFA and the total amount in dispute, including penalties and fees, is less than $50,000. The decision from the one ALJ does not have precedential effect.

7. Employee or Independent Contractor? The Dynamex Bill

Assembly Bill 5, often referred to as the "Dynamex bill," was signed into law in September 2019 and statutorily codifies the three-prong "ABC" test from the California Supreme Court's Dynamex Operations West Inc. v. Superior Court of Los Angele, 4 Cal. 5th 903 (2018), decision. While the bill contains numerous exceptions, many companies in the gig economy, such as mobile ride-hailing and delivery service companies, are threatening or have already begun fighting against AB 5, arguing that the new requirements will increase their costs and harm the workers by restricting their independence and flexibility by requiring they be treated as employees.

8. The FTB's Continuing Marketplace Sourcing Regulation Amendment Project

California's FTB continues to struggle with articulating precisely what "market" means for the purpose of imposing its market-based rules. The market-based sourcing rules contemplate whether sales, other than sales of tangible personal property, may be included in its corporation tax apportionment formula. The FTB held its first interested parties meeting on the subject in January 2017 -- three years ago. On July 12, 2019, FTB held its fourth interested parties meeting to continue to consider revisions to Code of Regulations, title 18, Section 25136-2. FTB's most recent proposed revisions are substantial. With the pace at which this regulation project is moving (recall the first IPM was held January 2017), it is looking unlikely that we will see any regulatory changes to section 25136-2 in 2020. Expect there to be a fifth (and a sixth?) interested parties meeting in 2020.

9. New Sales Tax Marketplace "Facilitator" Legislation

In 2018, the U.S. Supreme Court in South Dakota v. Wayfair, Inc., 138 U.S. 2080 (2018), rejected a physical presence nexus requirement for imposing state sales and use tax obligations. In the first half of 2019, the California Legislature responded by enacting a "Wayfair" bill, Assembly Bill 147, which requires many out-of-state sellers of tangible personal property to California customers to register for the first time as "retailers" and to collect and remit tax to the CDTFA. AB 147 changed the way "doing business in California" was defined for sales/use tax purposes, and now requires that (as of April 1, 2019), for purposes of collecting sales and use taxes, a seller must register with the CDTFA as a "retailer" and collect and remit sales tax if, during the preceding 12 months, the seller had $500,000 in cumulative sales or deliveries into California, even when the seller has no physical presence in California. AB 147 also changed the definition of "retailers," effective Oct. 1, 2019, to include marketplaces that list or advertise tangible personal property for sale by third-party sellers and to generally require marketplace facilitators to collect and remit tax to the CDTFA. CDTFA issued two key special notices in 2019 -- L-694 and L-700 -- to attempt to clarify areas of uncertainty in the new legislation. In Special Notice L-694, the CTDFA reiterated that a marketplace facilitator is generally required to pay sales tax or collect and pay use tax on all retail sales by marketplace sellers to California customers facilitated through its marketplace. Special Notices L-694 and L-700, both stated that if a marketplace facilitator that is registered or required to be registered with the CDTFA is responsible for tax on retail sales in California facilitated its marketplace, the marketplace seller is no longer liable for the tax on those transactions.

10. FTB's Aggressive Taxation of Nonresident LLC Members

Despite one loss in the appellate court on the issue in Swart Enterprises, Inc. v. Franchise Tax Board, 7 Cal. App. 5th 497 (2017), the FTB continues to aggressively take the position that if an LLC is "doing business" in California, then all members of the LLC, including non-resident members, are "generally considered to be 'doing business' in California." See FTB Legal Ruling 2018-01 (Oct. 19, 2018). On a positive note, the OTA in its recent decision in Appeal of Jali, LLC, 2019-OTA-204P (July 8, 2019; rev. September 3, 2019) rejected the FTB's position that a 0.2 percent membership interest in an LLC doing business in California is the "new, post-Swart bright-line ownership threshold used to determine whether an out-of-state member is also doing business in the state." To make matters even more interesting, on Feb. 28, 2019, the state of Arizona filed an action against the state of California in the U.S. Supreme Court over this LLC nexus issue. See State of Arizona v. State of California, No. 150, Orig., Motion for Leave to File Bill of Complaint Bill of Complaint, and Brief in Support. The action asks leave of the court for Arizona to bring the action under the court's original jurisdiction (to resolve controversies between states) to challenge California's extraterritorial assessment and collection of taxes which "tramples over state borders and flouts well-established constitutional precedents of this Court." This alleged trampling involves an estimated 13,333 Arizona-based LLCs subject to California's "doing business" tax based solely on passive investments in California-operating LLCs. Most recently, the court invited the solicitor general to express its views. In its brief for the United States as amicus curiae (filed Dec. 9, 2019), the solicitor general argues Arizona's motion for leave to file a bill of complaint should be denied because this is not an appropriate cases for the exercise of the court's original jurisdiction. 