13 February 2012

California's Second Appellate District Again Invalidates The SBE's Regulations

Last week, the California Court of Appeal (Second Appellate District) in Western States Petroleum Association v. State Board of Equalization ("Western States") invalidated a property tax regulation adopted by the State Board of Equalization ("SBE").
United States Tax
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Last week, the California Court of Appeal (Second Appellate District) in Western States Petroleum Association v. State Board of Equalization ("Western States")1 invalidated a property tax regulation adopted by the State Board of Equalization ("SBE"). This decision continues a recent pattern of California courts overturning SBE rules, regulations and policies that are inconsistent with California statutes.

For example, almost exactly a year ago, in Nortel Networks v. Board of Equalization, the same appellate district partially invalidated a sales and use tax regulation. In Nortel Networks, the Court of Appeal determined that the SBE exceeded its authority when it issued a regulation that excluded all prewritten computer programs from the definition of a technology transfer agreement.2

Another example can be seen in a 2009 case, Parmar v. State Board of Equalization. In Parmar, the Los Angeles Superior Court ruled that the SBE's long-standing policy that corporate executives were liable for unpaid corporate excise taxes lacked statutory or regulatory support, and violated California corporate law and the Administrative Procedures Act. On appeal in 2011, Reed Smith attorneys secured that victory for the taxpayer when the Court of Appeal did not disturb the superior court's finding with respect to the validity of the SBE's policy, and upheld the taxpayers' right to attorneys' fees.3

The property tax regulation struck down in Western States (Rule 474) interpreted a section of state law (California Revenue and Taxation Code Section 51) concerning the valuation method used to value real property, personal property, and fixtures. Rule 474 applied a valuation method for petroleum refineries that was different from that prescribed for other industrial and manufacturing properties, and that departed from a regulation that had been applicable to all industrial and manufacturing properties for more than 30 years.

The SBE argued, inter alia, that its decision to adopt Rule 474 was a quasi-legislative action4 entitled to the appropriate standard of judicial review, and that the existing rule for industrial and manufacturing properties (Rule 461) simply did not fit every circumstance (such as petroleum refineries) or result in a true measure of the value of property at petroleum refineries in the marketplace. Therefore, the SBE asserted that it was obligated to adopt a new regulation for petroleum refineries. However, the court noted that the SBE in adopting the regulation was responding to entreaties from a number of county-level government officials, and its reasons for adopting the regulation ignored the history of assessment practices and the statutory legislative history.

Citing Nortel, among others, the Court of Appeal disagreed with the SBE and stated that an administrative agency could not adopt a regulation unless it was consistent with the statute being implemented or interpreted-regardless of whether it was deemed a quasi-legislative regulation or merely an interpretive regulation (which is given considerably less deference). Therefore, if an agency's regulations conflicted with the Legislature's acts, the regulations were void. The court further explained that, in determining whether a regulation lies within the scope of the agency's authority, a court does not defer to an agency's view. That was because the court, and not the agency, has final responsibility for the interpretation of the law under which the regulation was issued.

The court then explained that the legislative history of the governing statute did not support the SBE's position, and that the SBE's interpretation would allow for manipulation of the framework governing real property to avoid the restrictions on real property taxes imposed by California voters in Propositions 13 and 8. Holding that Rule 474 was invalid, the court further reasoned that, by adopting Rule 474, the SBE has adopted a new regulation that conflicted with the statute and thus, no amount of "protestations that it was a reasonable regulation would sanctify it." Additionally, the court stated that the SBE's regulatory interpretation was not entitled to significant deference because the interpretation now proffered by the SBE was not contemporaneous with the enactment of the statute, and the SBE's new interpretation contradicted its earlier position (the SBE's long-standing interpretation of California Revenue and Taxation Code Section 51 as evidenced by Rule 461). Moreover, the SBE has kept that earlier interpretation contained in Rule 461 in place for industrial and manufacturing properties, except petroleum refineries. The fact that the SBE continued to maintain the validity of that earlier interpretation for industrial and manufacturing properties other than petroleum refineries was viewed by the court as further undercutting the SBE's new interpretation under Rule 474.5

Given the above, the court did not reach the issue of whether Rule 474 violated the legislative supermajority requirement for tax increases under Proposition 13.

The Court of Appeal filed its published decision January 19, 2012, which becomes final in 30 days.6 The SBE has 15 days from January 19, 2012 to file a petition for rehearing.7 If the Court of Appeal grants the petition, it must file an order for rehearing before the decision becomes final.8 If the Court of Appeal denies the petition for rehearing, the SBE must file its petition for review with the California Supreme Court within 10 days after the Court of Appeal's decision is final.9 As of the date of this Alert, the SBE has not yet filed a petition for rehearing or a petition for review.

Time will tell whether these recent appellate decisions will affect SBE's future regulatory practices, and what other SBE regulatory problems may come to light. However, we anticipate more litigation over the validity of regulations, as California's tax agencies use the guise of regulation and administrative interpretation to make substantive changes to California tax law.


1. Western States Petroleum Ass'n v. State Bd. of Equalization, No. B225932 (Cal. Ct. App. 2012).

2. Nortel Networks Inc. v. Bd. of Equalization, 191 Cal. App. 4th 1259 (Cal. Ct. App. 2011). Moreover, the SBE had even rewritten another sales and use tax regulation after it had lost at trial and asked the appellate court to apply the newly rewritten regulation and reverse the trial court ruling. The court refused, calling the SBE's belated attempt "a very tardy Hail Mary pass after the last whistle blew and the fans were filing toward the exits."

3. Parmar v. State Bd. of Equalization, 196 Cal. App.. 4th 705 (Cal. Ct. App. 2011).

4. In Western States Petroleum, the court explained the two categories of administrative rules. First, where an adopting agency is delegated the Legislature's lawmaking power, quasi-legislative rules have the dignity of statutes and thus, when a court addresses the validity of those rules, the scope of review is narrow. However, although the scope is narrow, the court, citing Yamaha Corp. of America v. State Board of Equalization, 19 Cal. 4th 10 (Cal. 1998), noted that "even quasi-legislative rules are reviewed independently for consistency with controlling law." The court then stated that the other category of administrative rules reflects an agency's interpretation of a controlling statute and thus, because these rules do not result from an exercise of delegated legislative power to make law, they are given a lesser degree of judicial deference.

5. The Court of Appeal also held that the SBE's Economic Impact Statement for Rule 474 was not adequate under the Administrative Procedures Act.

6. Cal. Rules of Ct., R. 8.264(b) (2012).

7. Cal. Rules of Ct., R. 8.268(b) (2012).

8. Cal. Rules of Ct., R. 8.268(a)(2) (2012).

9. Cal. Rules of Ct., R. 8.500(e) (2012).

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

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