United States: California Quarterly Update (July 2013)

Welcome to the first edition of a series of quarterly updates from Reed Smith on California state tax developments. Every quarter, we will bring you legal updates and provide some insight on what taxpayers are facing in audits, administrative appeals, and litigation involving the Franchise Tax Board and the State Board of Equalization. We will also provide you updates on our California team, highlighting our members, and letting you know where to find us.

California legislature terminates Enterprise Zone program and replaces it with a new three-part program

Governor Jerry Brown signed into law AB 93, which eliminates the current Enterprise Zone program and replaces it with a new, three-pronged incentive program.

AB 93 repeals the provisions authorizing Enterprise Zones, manufacturing enhancement areas, targeted tax areas, and local agency military base recovery areas for tax years beginning on or after January 1, 2014. The bill also limits the application of hiring and sales and use tax credits to employees hired, or purchases made prior to January 1, 2014. Taxpayers may utilize any carryforward hiring or sales and use tax credits generated prior to 2014 through 2024. The bill also limits the net interest deduction for lenders making loans to businesses in Enterprise Zones to interest received before January 1, 2014.

In place of the Enterprise Zone program, AB 93 provides for a new three-part tax incentive program.

Part 1: New Sales Tax Exemption for Manufacturing Equipment

Effective July 1, 2014, AB 93 adds a new, state-level sales tax exemption for manufacturing equipment. The exemption is also available for purchases of certain equipment primarily used for manufacturing and in research and development. The legislation caps the exemption at $200 million in purchases per taxpayer per year. This cap applies to the cumulative purchases of a single entity or the aggregated purchases of all members of a combined group. The exemption is set to expire January 1, 2021 for purchases of equipment to be used within a former Enterprise Zone or certain designated census tracts, and January 1, 2019 for purchases of equipment to be used elsewhere in California.

Part 2: New Hiring Credit

AB 93 also adds a new hiring credit to replace the old EZ hiring credit. The credit is available on 35 percent of wages between $12 - $28 per hour for companies that employ "hard to hire" workers in certain defined geographic areas of the state. Hard to hire workers include individuals who have been unemployed for six months, previously unemployed veterans, recipients of the federal Earned Income Tax Credit, and ex-offenders. To continue to qualify for the credit, an employer must increase the number of full-time employees employed in the state from one year to the next. The credit may only be claimed on a timely filed original return. Temporary help services, retail trade services, food services, and employers in certain NAICS services are not eligible for the hiring tax credit. The new hiring tax credit applies to tax years beginning on or after January 1, 2014, and before January 1, 2021.

Part 3: New California Competes Credit

The third new incentive is the California Competes Tax Credit, which is negotiated through and administered by the Governor's Office of Business and Economic Development (GO-Biz). The pool of credits available under the California Competes Credit is limited to a specified sum each fiscal year ($30 million for fiscal year 2013-2014). Businesses compete for the credit based on a number of factors, including the number of jobs to be created, the amount of investment in the state, incentives available to the taxpayer within and outside of California, and the duration of the proposed project. Priority is to be given to taxpayers whose project or business is located or proposed to be located in an area of high unemployment or poverty.

GO-Biz is tasked with negotiating the terms of a written agreement, providing the negotiated terms of the agreement to the California Competes Tax Credit Committee (comprised of the Treasurer, Director of Finance, Director of GO-Biz, and an appointee from both the Senate and the Assembly) for approval, and informing the FTB of executed agreements. If a taxpayer fails to fulfill the terms of an executed agreement, the credit may be recaptured, in whole or in part.

Information regarding executed agreements, including the taxpayer's name, estimated amount of investment, estimated number of jobs created, amount of credit allocated, and any credit recaptured, will be published on the GO-Biz website.

A quarter of the aggregate amount of the credit is reserved for small businesses. Further, no more than 20 percent of the aggregate credit may be allocated to any one taxpayer. The California Competes Tax Credit is applicable for tax years beginning on or after January 1, 2014 and before January 1, 2025.

FTB's budget is reduced in another Legislative attempt to distance California from the Multistate Tax Compact

More than 15 years after former State Board of Equalization members Claude Parrish and Dean Andal unsuccessfully introduced legislation to withdraw California from the Multistate Tax Compact, the legislature attempted to formally withdraw last year in response to the Gillette case. Now California is trying to underscore the point. Governor Brown reduced the FTB's fiscal year 2013-2014 budget to reflect the legislature's action to withdraw from the Multistate Tax Compact. The FTB's $718 million budget was reduced by $270,000, since California's obligation to pay annual dues to the Multistate Tax Commission has presumably terminated as a result of its purported withdrawal from the Compact. Though reduction was small when considered in the context of the FTB's total budget, it is yet another legislative effort to separate California from the Compact and its apportionment election.

California enacted legislation purporting to withdraw the state from the Compact in June 2012 in an attempt to pre-empt the California Court of Appeal's ruling in The Gillette Co., et al. v. Franchise Tax Board.1 In Gillette, the court determined that California's enactment of a statute that requires a three-factor apportionment formula with a double-weighted sales factor did not override or repeal the state's adoption of the Compact, which permits taxpayers to elect an equally weighted, three-factor apportionment formula. The Gillette case is currently in briefing before the California Supreme Court.

There is still doubt regarding the validity of California's attempt to withdraw from the Compact. The bill to repeal the state's membership in the Compact was not passed by the two-thirds vote of the legislature required for revenue-raising measures by Proposition 26.

State Board of Equalization rules that an Indiana-based media company's sales factor properly included $931 million in gross receipts from the sale of 13 television stations located outside California

In Appeal of Emmis Communications Corporation,2 the taxpayer—a diversified media company—was principally focused on radio broadcasting, but was also engaged in the businesses of publishing magazines and operating television stations, as well as other activities. It was in the process of discontinuing its television operations. By the end of its 2006 fiscal year, it had sold 13 of its 16 television stations, all of which were located outside California. The sale resulted in $931 million of gross receipts, which Emmis included in the denominator of its sales factor. The rest of Emmis's business operated at a loss in 2006.

The FTB excluded all of those receipts from Emmis's sales factor under a regulation that excludes from the sales factor substantial amounts of gross receipts that arise from an occasional sale of a fixed asset or other property held or used in the regular course of the taxpayer's trade or business.3 The FTB argued that the sale of television stations was occasional because the taxpayer primarily generated revenue from selling advertising and was not in the business of divesting whole segments of its operations. The FTB claimed that the substantial nature of the gross receipts was evidenced by the 59 percent difference in the sales factor denominator when the gain from the liquidation of that business was included in the denominator.

Emmis asserted that the acquisition and disposition of the media properties was a part of its operations and overall corporate strategy to acquire and dispose of operation locations in order to maximize its business. Thus, Emmis argued, the sale was not occasional. Emmis also argued that it would be distortive to exclude the receipts from the television station sales from the sales factor denominator because they were the majority of Emmis' gross receipts for 2006 and represented 100 percent of its income. If the receipts were excluded from the sales factor, the gains would be taxed in California without proper representation in the apportionment formula.

At a Board hearing June 11, 2013, both parties addressed whether the occasional sale rule applied to the taxpayer, and whether excluding the subject receipts resulted in distortion. The Board's questioning primarily focused on whether the occasional sale rule applied to the taxpayer and the nature of the taxpayer's business in relation to its overall strategy.4 The Board granted the taxpayer's petition by a 4-1 vote, finding that the taxpayer properly included the subject receipts in its sales factor denominator. The Board did not provide any explanation on the reasoning for its determination.

Harley-Davidson's motion for a new trial is denied—next step, the Court of Appeal

In May, we sent an alert about the San Diego Superior Court's decision in Harley-Davidson, Inc. v. Franchise Tax Board.5 In that case, the court had held that bankruptcy-remote entities formed to hold financial assets in connection with securitization transactions had nexus with California and could be taxed as financial corporations, despite having no physical presence in California.

The taxpayer filed a Motion for New Trial. The reason for this filing was, in part, that the Superior Court's Statement of Decision did not address the traditional requirement for attributional nexus—that the California activities of an affiliate of the special purpose entities (SPEs) were "significantly associated with the [SPEs'] ability to establish and maintain a market in th[e] state."6

The court denied Harley-Davidson's motion. It found that the SPEs and the Harley-Davidson entities with physical presence in California were "agents of each other," and that finding was sufficient. The court has also clarified, in a sweeping summary statement without further analysis, that "'substantial nexus' was found under both the Commerce Clause and the Due Process Clause."

Nexus wasn't the only important issue in the Harley-Davidson case. In its complaint, Harley-Davidson also argued that mandatory forced combination for interstate taxpayers is unconstitutional. Wholly intrastate businesses may choose to compute income using either the unitary combined method or a separate entity method.7 But taxpayers conducting activities within and outside of California must use unitary combined reporting. This dichotomy, Harley-Davidson argued, violated the Commerce Clause because it discriminated against interstate unitary businesses to the benefit of California businesses. The FTB filed a demurrer, claiming that this election does not result in discrimination against interstate commerce.

The court granted the FTB's demurrer. It stated that, "[w]ell settled law shows there is no discrimination to an intrastate [sic] business when it does not have the option to file a return on a separate accounting basis but its intrastate counterpart does." Without explicitly agreeing, the court noted the FTB's argument that the election for intrastate businesses simply put them on equal ground with interstate businesses. Before that, intrastate businesses were discriminated against because they could not file a combined report in which income of one entity could be offset by losses of another.

The court's recent denial of Harley-Davidson's Motion for New Trial and clarification of its prior Statement of Decision sets up Harley-Davidson arguments on appeal. We expect an appeal to be filed both with respect to the SPE nexus issue and the mandatory combination issue.

Court orders FTB to pay Reed Smith client $1.2 million in attorney fees: tax agency "didn't do the right thing"

Previously, we reported on Daniel V, Inc. v. Franchise Tax Board 8, in which Reed Smith's State Tax team first obtained a 100 percent refund of all taxes, interest, and penalties in the amount of $2.3 million, and then won a $1.2 million award of attorneys' fees for Daniel V. After successfully arguing that Daniel V was commercially domiciled in Nevada in 1997 and 1998, Reed Smith proved that the FTB's position was not substantially justified, and presented evidence of questionable FTB conduct over the 12 years of this case. Although the FTB "beg[ged] to differ strongly with the court's opinion," Los Angeles Superior Court Judge Mooney explained why he granted Reed Smith's motion for fees:

Before being on the bench, I spent some time in the U.S. Attorney's Office and one of the great pleasures that I had in representing the government was the notion that, you know, it wasn't just about winning the case[.] It was about doing the right thing. And, you know, in this case the conduct of the Franchise Tax Board just was not doing the right thing.

The award is the largest known fee order under Revenue and Taxation Code section 19717.

Meet the Team: Erin Mariano

In each of our quarterly updates, we will profile a member of Reed Smith's California team. This time, we are profiling the newest addition to Reed Smith's California tax practice.

In July, Reed Smith's State Tax Group welcomed Erin Mariano to the San Francisco office. Erin joined Reed Smith after completing her LL.M. in Taxation and Certificate in International Taxation at the Georgetown University Law Center in Washington, D.C. While at Georgetown, she was awarded a fellowship at the Council on State Taxation. Prior to that, she clerked for the Honorable Gail L. Menyuk (Ret.) in the New Jersey Tax Court. Erin earned her J.D. from the University of California, Davis, where she was an extern in the Multistate Tax Bureau of the FTB and the Business and Tax Division of the attorney general's office. She earned her B.A. at Amherst College. When she's not busy talking tax, Erin enjoys dancing and classical music concerts. We are pleased to have her on board!

Upcoming Speaking Engagements

As always, our team remains busy speaking on the latest tax developments in California and throughout the country. In the coming months, you can hear us at the following places:

  • On August 15, Marty Dakessian and Brian Toman will speak at the Council On State Taxation's Southwest Regional State Tax Seminar in Burbank
  • In Septmber 25, Kyle Sollie will speak at the Institution for Professionals in Taxation's annual Credits & Incentives Symposium in Dallas
  • On October 24, Marty Dakessian will speak at the COST annual meeting in Phoenix
  • On November 7, Marty Dakessian and Brian Toman will speak at the California Tax Policy Conference in San Jose

If you have questions about any of the items discussed in this update, please contact the authors of this alert, or the Reed Smith lawyer with whom you usually work. For more information on Reed Smith's California tax practice, visit www.reedsmith.com/catax.

1. The Gillette Company & Subs. v. California Franchise Tax Board, CA. Ct. App., 1st Dist, Dkt. No. A130803; appeal from SF Sup. Ct. Dkt. No. CGC-10-495911.
2. Case No. 547964.
3. California Code of Regulations, title 18, § 25137(c)(1)(A).
4. Although the FTB repeatedly argued that the taxpayer was not in the business of selling entire lines of business and that its Form 10-K did not state that taxpayer was in that business, the taxpayer clarified that it has a written and public statement in all of its 10-Ks regarding its strategy and that it acquires underdeveloped media properties, grows their values to increase cash flows, and disposes of them when appropriate as a part of that strategy.
5. Docket No. CASD-37-2011-00100846-CU-MC-CTL.
6. Citing Tyler Pipe Indus. Inc. v. Wash. State Dep't of Rev., 483 U.S. 232 (1987).
7. Cal. Rev. & Tax. Code § 25101.15.
8. LASC Case No. BC457301.

This article is presented for informational purposes only and is not intended to constitute legal advice.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Reed Smith
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Reed Smith
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions