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This post discusses the state's most recent preliminary bond offering statement. That preliminary statement is available here for a temporary period of time. The information in this post is based on the preliminary official statement (POS) dated February 25, 2015.

California issues bonds and notes to fund infrastructure projects and seasonal cash flow needs throughout the year. The state's bond offering documents, especially the section entitled "Appendix A," provide significant information about all aspects of state finances. Included are required disclosures about major litigation affecting the state government. This note discusses information in the state's new offering documents about litigation related specifically to state taxes, fees, and other revenues. The State of California always faces some litigation concerning taxes and fees, as well as other litigation on a variety of issues. Typical of such disclosures, the state's newly updated litigation disclosure totals about 10 pages, single spaced (pages A-134 through A-144). 

Major revenue, tax, and fee-related cases discussed in the February 25 version of the POS include:

Multistate Business Tax Challenges. The state continues to face six actions that, according to the POS, contend "that the Legislature's modification of Revenue and Taxation Code Section 25128, which implemented the double-weighting of the sales factor in California's apportionment of income formula for the taxation of multistate business entities, is invalid and/or unconstitutional." Plaintiffs contend that the single-weighted sales factor in Section 25128 (prior to its amendment) was contained within the Multistate Tax Compact "and therefore cannot be modified without repealing the legislation that enacted the Compact." The trial court ruled for the state, but, on appeal, the trial court judgment was reversed by an appellate court in October 2012. The POS states that the appellate court "held that the Compact was valid and the state was bound by its provisions for the tax years at issue because the state had not withdrawn from the Compact" and that "in attempting to override the contractual terms of the Compact, section 25128 violated the constitutional protections against impairment of contract." The California Supreme Court has granted the state's petition for review. The POS notes that "an adverse ruling in these cases would affect multiple taxpayers and create potential exposure to refund claims in excess of $750 million." A decision is not expected until mid-2015, the POS states (page A-50), "and even if the taxpayers prevail in the Supreme Court...they will likely be remanded to trial court to determine other issues not considered before these appeals arose." As a result, any possible revenue loss "may not occur for several years."

The six multistate business tax challenges are: Kimberly-Clark Worldwide, Inc., et al. v. Franchise Tax Board (FTB), Gillette Company and Subsidiaries v. FTB, Procter & Gamble Manufacturing Company & Affiliates v. FTB, Sigma-Aldrich, Inc. and Affiliates v. FTB, RB Holdings (USA), Inc. v. FTB, and Jones Apparel Group v. FTB, which are now consolidated in one matter, collectively referred to as Gillette Company v. FTB.

LLC Fee Challenges. The Franchise Tax Board LLC Tax Refund Cases are coordinated for hearing in San Francisco and consist of Bakersfield Mall LLC v. FTB and CA-Centerside II, LLC v. FTB. The cases allege that the state's fee imposed on limited liability companies (LLCs) "discriminates against interstate commerce and violates the U.S. and the state Constitutions, is an improper exercise of the state's police powers, and has been misapplied by FTB." The POS notes that a coordination trial judge "denied the plaintiffs' joint motion for class certification and the plaintiffs appealed." "If this immediately appealable order is reversed and the cases proceed as class actions, the claimed refunds could be significant (in excess of $500 million)," the statement says.

Technology Transfer Agreement Cases. In two Los Angeles Superior Court cases involving Lucent Technologies, the issue is the interpretation of "certain statutory sales and use tax-exemptions relating to computer software and licenses to use computer software that are transferred pursuant to technology transfer agreements." In a similar case, Nortel Networks Inc. v. State Board of Equalization (BOE), the trial court ruled in favor of the plaintiff and the ruling was affirmed on appeal. The POS states that "the adverse ruling in the Nortel matter, unless limited in scope by a decision in the Lucent matters, if applied to other similarly situated taxpayers, could have a significant negative impact, in the range of approximately $300 million annually, on tax revenues." In the Lucent cases, "the trial court granted plaintiffs' motion for summary judgment and denied BOE's motion for summary judgment," and BOE appealed.

Unitary Business Tax Reporting Cases. "Two pending cases challenge the state's right to require interstate unitary businesses to report their income on a combined basis while allowing intrastate unitary businesses to report the income of each business entity on a separate basis," the POS notes. Harley Davidson, Inc. and Subsidiaries v. FTB and Abercrombie & Fitch Co. & Subsidiaries v. FTB challenge the constitutionality of Revenue and Taxation Code Section 25101.15. The trial court in Harley Davidson "sustained a demurrer on this issue without leave to amend; the issue is now pending on appeal," and the Abercrombie matter "is stayed pending resolution of the issue" in the other case. "Should Section 25101.15 be invalidated," the disclosure notes, " a significant amount of otherwise apportionable income from multi-state unitary businesses would be removed from the state taxing power." The fiscal impact is unknown "because of the uncertainty regarding the number of businesses which currently pay the tax and how taxation...would change as a result of an adverse ruling," the POS says. The Harley Davidson case also raises similar issues as in the Gillette case described above.

Fire Prevention Fee Challenges. The POS notes that in Howard Jarvis Taxpayers Association, et al. v. California Department of Forestry and Fire Protection, et al., "plaintiffs challenge a fire prevention fee imposed on owners of structures situated on property for which the state is primarily responsible for fire prevention." According to the POS, plaintiffs "assert that the fee is a 'tax' that was invalidly enacted without the required 2/3 vote of the Legislature." The complaint seeks a declaration "that the fee is invalid and a refund of fees paid."

Cap-and-Trade Challenges. The POS cites two cases that "challenge the authority of the California Air Resources Board to conduct auctions under the state's cap and trade program and allege that the auction revenues are an unconstitutional tax under the state Constitution." The trial court ruled for the board, the POS states, "finding that it had authority to conduct the auctions, and that the auction does not constitute an unconstitutional tax." Petitioners have appealed.

Quality Assurance Fee Case. In The Rehabilitation Center of Beverly Hills, et al. v. Department of Health Services, et al., plaintiffs "challenge a quality assurance fee (QAF) charged to skilled nursing facilities that was enacted in 2004, alleging violations of the federal and state constitutions and state law." QAF funds "are made available, in part, to enhance federal financial participation in the Medi-Cal program," the POS states. Plaintiffs seek a refund of fees paid. "The trial court ruled for the state," the POS says, "finding that the QAF is constitutionally valid," and plaintiffs then appealed.

Unclaimed Property Cases. Taylor v. Chiang is a federal court case related to California's unclaimed property program. The Taylor plaintiffs, the POS notes, "allege that the Controller applies the Unclaimed Property Law's notice requirements in ways that violate state and federal law, and the district court granted the state's motion to dismiss plaintiff's claims." Plaintiffs appealed this ruling to the U.S. Court of Appeals for the Ninth Circuit. Oral argument was heard in the matter this month.