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Amy L. Silverstein (Bar No. 154221)Edwin P. Antolin (Bar No. 172599)Johanna W. Roberts (Bar No. 191472)Silverstein & Pomerantz LLP55 Hawthorne Street, Suite 440San Francisco, California 94105-3910Telephone: (415) 593-3502Telefacsimile: (415) 593-3501

Attorneys for PetitionerCalifornia Taxpayers' Association

SUPERIOR COURT OF THE STATE OF CALIFORNIA

CITY AND COUNTY OF SACRAMENTO

CALIFORNIA TAXPAYERS' ASSOCIATION,

Petitioner,

v.

CALIFORNIA FRANCHISE TAX BOARD, anagency of the State of California, and DOES 1THROUGH 20,

Respondents.

No. 34-2009-80000168-CU-WM-GDS

PETITIONER'S MEMORANDUM OFPOINTS AND AUTHORITIES INOPPOSITION TO DEMURRER BYRESPONDENT FRANCHISE TAXBOARD

Judge: Hon. Timothy M. FrawleyDept: 29Demurrer Hearing: April 24, 2009Time: 11:00 a.m.Date Action Filed: February 17, 2009

BY FAX

PETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO DEMURRER BY RESPONDENTFRANCHISE TAX BOARD

From the state tax library of Reed Smith LLP www.reedsmith.com/CAtax for other related documents, please email [email protected]

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10 A. As An Unincorporated Association Bringing Suit On BehalfOf Its Members, Petitioner Cal-Tax Has Standing To Bring

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TABLE OF CONTENTS

Page

TABLE OF AUTHORITIES ii

I/ INTRODUCTION 1

II. STANDARD OF REVIEW 3

III. STATEMENT OF FACTS 3

A. Description of Section 19138 3

B. Effect of Section 19138 5

IV. ARGUMENT 6

This Action 6

B. This Action Is Ripe 7

1. This facial challenge to the constitutionality of Section19138 is fit for judicial decision 8

142. Hardship sufficient to satisfy Abbott would result from

15 withholding consideration 10

16 C. This Action Is Not Barred By Cal. Const., Art. XIII, § 32 OrBy Any Other Pre-payment Or Exhaustion Requirement 14

17V. CONCLUSION 15

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. iPETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO DEMURRER BY RESPONDENT

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Abbott Laboratories v. Gardner,

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TABLE OF AUTHORITIES

PAGES

CASES

387 U.S. 136(1967) passim

Alameda County Land Use Association v. City ofHayward,38 Cal. App. 4th 1716 (1995) 9

Andal v. City of Stockton,137 Cal. App. 4th 86 (2006) 9,15

Blumhorst v. Jewish Family Services of Los Angeles,126 Cal. App. 4th 993 (2005) 6

Brotherhood of Teamsters & Auto Truck Drivers v. Unemployment Ins. Appeals Bd.,190 Cal. App. 3d 1515 (1987) 6

California Water & Telephone Co. v. County of Los Angeles,253 Cal. App. 2d 16(1967) 8,9, 14

Californians for Native Salmon and Steelhead Assoc. v. Department of Forestry,221 Cal. App. 3d 1419 (1990) 14

Coastal States Gas Corp. v. Department of Energy,617 F.2d 854 (D.C. Cir. 1980) 12

Direct Marketing Ass'n v. Bennett, et al,916 F.2d 1451 (9th Cir. 1990) 7

Electric Power Supply Ass 'n v. FERC,391 F.3d 1255 (DC Cir. 2004)) 8, 13

18 Farm Sanctuary, Inc. v. Department of Food and Agriculture,63 Cal. App. 4th 495 (1998) 14

Greener v. Workers' Comp. Appeals Bd., '6 Cal. 4th 1028 (1993) 9

21 Hospital Council of Western Pennsylvania v. Pittsburgh,949 F.2d 83 (3d Cir. 1991).

Hunt v. Washington State Apple Advertising Comm 'n,432 U.S. 333 (1977) 6

X* *

McKesson Corp. v. Division of Alcoholic Beverages & Tobacco,496 U.S. 18(1990) 15

Novartis Vaccines and Diagnostics, Inc. v. Stop Huntingdon Animal Cruelty USA, Inc.,143 Cal. App. 4* 1284 (2006) .". .". 6

27 Pacific Legal Foundation v. California Coastal Commission,2g 33 Cal.3d 158 (1982) 14

iiPETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO DEMURRER BY RESPONDENT

FRANCHISE TAX BOARD


1 Pacific Motor Transport Co. v. State Bd. of Equalization,28 Cal. App. 3d 230 (1972) 9

2Park 'N Fly of San Francisco, Inc. v. City of South San Francisco,

3 188 Cal. App. 3d 1201 (1987) 15

4 Property Owners of Whispering Palms, Inc. v. Newport Pac., Inc.,132 Cal. App. 4th 666 (2005) 6

5Quelimane Co. v. Stewart Title Guarantee Co.,

6 19 Cal.4th 26 (1998) 3

7 Self-Insurance Inst. of Am. v. Korioth,993 F.2d 479 (5th Cir. 1993) 7

8U.S. v. Roxworthy,

9 457 F.3d 590 (6th Cir. 2006) 11

10 Upjohn Co. v. U.S.,449 U.S. 383 (1981) 11

11Venetian Casino Resort v. EEOC,

12 409 F.3d 359 (DC Cir. 2005) 8,13

13 Worth v. Seldin,422 U.S. 490 (1975) 6

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15 STATUTES

16 Code of Civil Procedure§2018.020(a) 12

17 §2018.020(b) 12§2018.030 11

18Government Code

19 §900 15§901 15

20 § 11340.9(b) 4

21 Revenue & Taxation Code§ 19138 passim

22 § 19138(a) 3§19138(b) 3,4,12

23 §19138(d) 4,15§19138(e) 4,15

24 § 19l38(f) 4§19l38(g) ! 4

25 § 19l38(h) 4§19031 4

26 §23001 3

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PETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO DEMURRER BY RESPONDENTFRANCHISE TAX BOARD


1 REGULATIONS

2 Treas. Regs. § 1.6662-4(a) 1,0

3 CONSTITUTIONAL PROVISIONS

Due Process Clause of the California Constitution •. 15Cal. Const., art. Ill, § 3.5 10Cal. Const., art. XIII, § 32 14

6OTHER AUTHORITIES

7Restatement (Third) of the Law Governing Lawyers § 87 cmt. H (2000) 11

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PETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSI TION TO DEMURRER BY RESPONDENTFRANCHISE TAX BOARD '


I. INTRODUCTION

This is a facial challenge to the constitutionality of Cal. Rev. & Tax. Code § 19138

("Section 19138" or the "Levy") which purports to impose a 20% "penalty" on any corporate

taxpayer with an "understatement" of tax over of one million dollars ($1,000,000) for any taxable

year. It applies retroactively to each year "beginning on or after January 1, 2003, for which the

statute of limitations on assessment has not expired."

Section 19138 is an extraordinary piece of legislation, imposing a levy unlike any seen

before, with sweeping consequences for corporate taxpayers. First, it was rushed through the

Legislature in the 11th hour of the fiscal 2008-09 budget process without any meaningful vetting

10 by legislators or interested members of the public. Second, the amount of the Levy is

extraordinary, particularly because it is imposed above and beyond both regular interest charges

12 for late payments and numerous penalties for understatements, negligence, participation in tax

13 shelters, and the like. Third, the Legislature labeled Section 19138 a penalty, and thus it passed

] 4 with only a majority vote; however, it has the hallmarks of a tax—it is imposed in the absence of

15 any "fault" by a taxpayer, and it contains no exceptions for good faith, reasonable cause, or the

16 like. At best it addresses what is a routine and expected occurrence among the corporate taxpayers

] 7 -to which Section 19138 might apply, namely legitimate understatements of tax, including where

18 the taxpayer took all good faith measures to file accurate tax returns and even where the taxpayer

19 had no way of knowing it would have additional liability when it filed the return in question. Had

20 Section 19138 been properly labeled as a tax it would not have become law because it failed to

21 gamer the two-thirds vote required by the Constitution for tax increases.

22 But wnat is most alarming about Section 19138 is that taxpayers are expressly denied any

means for redressing liability for the Levy. Simply, under the express terms of Section 19138,

24 once a taxpayer is billed for the Levy, no meaningful administrative remedies are available to

25 challenge it, whether before or after payment.

26 F°r P"or years, the understatement for purposes of Section 1938 will be measured by the

27 amount shown on, and paid with, any amended return filed on or before May 31, 2009. In light of

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PBTITIONER'S MEMORANDUM OF^OINTSAND AUTHORITIES AND AUTHORITIES IN OPPOSITION TO DEMURRER BYRESPONDENT FRANCHISE TAX BOARD


this May 31, 2009 deadline, corporate taxpayers are now examining their prior returns for any

possible underpayments that they might identify on an amended return, and pay, in order to avoid

liability under Section 19138. The consequences of these disclosures and payments are

irrevocable and the harm irreparable. Given the complexity of both California's corporate income

tax law and large corporate taxpayers' businesses, there are no clear answers as to the "right" tax

return position with respect to many items. Many very reasonable tax return positions, which the

law does not otherwise require to be disclosed, are contested by the Franchise Tax Board ("FTB"),

and such disputes are often resolved in the taxpayers' favor, whether administratively or judicially,

or by settlement. If Section 19138 is invalidated, the disclosure of a reasonable but uncertain

10 position cannot be undone.

11 The consequences of not filing amended returns and paying the associated tax before May

12 31, 2009 are equally irrevocable and the harm irreparable. If a taxpayer does not act before May

13 31, 2009, and becomes liable under Section 19138, as noted, the taxpayer is denied any

14 prepayment or postpayment administrative remedy to challenge Section 19138 or liability

15 thereunder.

16 Plainly, in order to avoid irreparable harm, taxpayers need to know whether Section 19138

17 will withstand constitutional scrutiny before they take irrevocable actions on or before May 31st.

18 Respondent essentially makes three arguments in its demurrer, each unavailing. First,

19 Respondent challenges Cal-Tax's standing. However, it is well-settled that an association may sue

20 on behalf of its members when: (a) the members would have standing to sue in their own right; (b)

21 the interests the lawsuit seeks to protect are germane to the organization's purpose; and (c) neither

22 the claim asserted nor the relief requested requires participation of individual members. Cal-Tax

23 has alleged all facts necessary for associational standing.

24 Second, Respondent claims this action is not ripe. To the contrary, the validity of Section

25 19138 is fit for judicial decision immediately. The statute wasenacted, became effective, and

26 currently requires corporate taxpayers to make decisions and take irrevocable actions before May

27 31, 2009 to address the requirements of Section 19138. Because this action is a facial challenge,

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PETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES AND AUTHORITIES IN OPPOSITION To DEMURRER BYRESPONDENT FRANCHISE TAX BOARD


no facts necessary to decide this case are lacking. Moreover, as rioted above, if a decision is

delayed until after May 31st, taxpayers will suffer significant hardship because they will be forced

to make an irrevocable choice between (1) amending/paying pursuant to a statute of questionable

validity and having to disclose to FTB their confidential legal assessment of the tax positions they

have taken, or (2) not amending/paying and risking penalties without any right to challenge them.

Finally, the widespread public interest in this case underscores the need and propriety of a prompt

hearing on the merits.

Third, Respondent claims this action is constitutionally and statutorily barred because Cal-

Tax has not exhausted administrative remedies by paying the liability it contests and filing a claim

10 for refund. Yet, it is well-settled that in the absence of any remedy whatsoever for challenging a

11 liability, as is the case here, the exhaustion requirement gives way, and an action seeking a writ of

12 mandate, declaratory relief, and/or an injunction is permitted. Petitioner respectfully requests that

13 this Court overrule Respondent' demurrer.

14 n. STANDARD OF REVIEW

15 In testing the sufficiency of a complaint against a general demurrer, the court must treat the

16 demurrer as admitting all material facts properly pleaded in the complaint. Quelimane Co. v.

17 Stewart Title Guarantee Co., 19 Cal.4th 26, 38 (1998). The court must give the complaint a

18 reasonable interpretation, reading it as a whole, and its parts in their context. Id. If it states a

19 cause of action under any theory, the complaint must be sustained against a demurrer. Id.

20 Hi. STATEMENT OF FACTS

21 A. Description of Section 19138

22 The Legislature enacted Section 1913 8 to close a budget deficit of $ 1.4 billion. Petition

23 and Complaint ("Pet.") 5:20-23. Effective December 22, 2008, it imposes a "penalty" of 20% on

24 any "understatement of tax in excess of one million dollars ($1,000,000) for any taxable year."

25 Rev. & Tax. Code §§19138(a) and (b). Pet. 3:24-26. "Understatement of tax" means "the amount

26 by which the tax imposed by Part 11 (commencing with Section 23001) exceeds the amount of tax

27 shown on an original return or shown on an amended return filed on or before the original or

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extended due date of the return for the taxable year." Rev. & Tax. Code § I9138(b). Pet. 3:27-

4:3.

Section 19138 applies retroactively "to each taxable year beginning on or after January 1,

2003, for which the statute of limitations on assessment has not expired." Rev. & Tax. Code

§ I9138(h); Pet. 4:9-11. However, for a limited time, taxpayers are given one chance to avoid the

penalty for such prior years by amending their returns and making protective tax payments on or

before May 31, 2009. Pet. 4:11-14. That is, "[fjor any taxable year beginning before January 1,

2008," the understatement will be determined by comparing the actual liability with the "the

amount of tax paid on or before May 31, 2009, and shown on an amended return [if any] filed on

10 or before May 31,2009." Rev. & Tax. Code § 19138(b); Pet. 4:11-14.

11 Section 19138 allows for no relief for good faith, reasonable cause, or the like. Pet. 4:21.

12 There are only two narrow exceptions to the application of Section 19138, one for changes in law,

13 artificially restricted to only "a statutory change or an interpretation of law or rule of law by

14 regulation, legal ruling of counsel, within the meaning of subdivision (b) of Section 11340.9 of the

15 Government Code, or a published federal or California court decision." Rev. & Tax. Code

16 § 19138(f); Pet. 4:21-24. The second exception to the application of Section 19138 is for a written

17 Chief Counsel opinion. Rev. & Tax. Code § 19138(g); Pet. 4:24-26.

] 8 Notably, there are no procedures for a taxpayer to assert either of these statutory

19 exceptions, let alone to challenge application of Section 19138 on any other basis. Pet. 5:3-13.

20 Section 19138 expressly prohibits any prepayment or postpayment administrative appeals with

21 respect to its application. Rev. & Tax. Code § 19138(d) ("Article 3 (commencing with Section

22 19031), relating to deficiency assessments, shall not apply with respect to the assessment or

23 collection of the levy); Pet. 5:3-5. It also prohibits all refunds or credits except on the basis that

24 the amount of the levy "was not properly computed by the [FTB]." Rev. & Tax. Code § 19138(e);

25 Pet. 5:6-10.

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PETITIONFR'S MEMORANDUM OF POINTS AND AUTHORITIES AND AUTHORITIES IN OPPOSITION TO DEMURRER BYRESPONDENT FRANCHISE TAX BOARD


1 B. Effect of Section 19138

2 As noted, taxpayers may reduce the understatement for purposes of computing Section

3 19138 liability for any year beginning before January 1, 2008 by amending their returns, and

4 making protective tax payments, on or before May 31, 2009, refunds of which will be sought

5 immediately thereafter. Pet. 7:12-16. According to Respondent, taxpayers cannot simply file

6 returns reporting additional tax liability; rather a valid amended return requires a detailed

7 description of each of the adjustments. See Request For Judicial Notice ("RFJN"), Exhibit T, FTB

g Notice 2009-03. Thus, as a consequence of Section 19138, corporate members of Cal-Tax are

9 currently incurring substantial time and expense in reviewing their California and federal income

] o tax returns for prior years to identify positions that could give rise to an understatement greater

1 ] than $1 million for any year. Pet. 7:17-24. To avoid Section 19138 liability, taxpayers must

12 amend their prior years' returns and pay any additional taxes shown on those amended returns,

13 thereby suffering the additional harm of loss of their own funds until they are rightly refunded,

14 possibly years later. Pet. 7:24-8:3.

15 For prior years, to avoid the Levy imposed by Section 19138, taxpayers are compelled to

] 6 disclose reasonable but uncertain tax positions on or before May 31, 2009, even though there is no

j 7 other legal obligation to disclose such positions and the right to non-disclosure is protected by law.

lg Pet. 8:4-8. Such disclosure of information to the FTB is, of course, irrevocable. Pet. 8:17-18.

19 Moreover, a taxpayer will have to attest "under penalties of perjury" that these returns are "true,

20 correct, and complete" even though the taxpayer actually believes the original returns are correct

21 and the amended returns overstate the taxpayer's California tax. Pet. 9:6-10. For all of these

22 reasons, without a prompt ruling on the validity of Section 19138, Petitioner's members will suffer

23 substantial, irreparable harm in complying with this statute of questionable constitutionality. Pet.

24 9:13-15.

25 Taxpayers with a $1 million understatement of tax and who do not "comply" by filing

26 amended returns, or who do not adequately disclose all reasonable but uncertain positions on an

27 amended return, on or before May 3 lsl, will suffer substantial irrevocable harm in that they will be

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subject to liability under Section 19138 but will have no prepayment of postpayment remedy for

challenging it. Pet. 9:11-15.

3 [V. ARGUMENT

4 A. As An Unincorporated Association Bringing Suit On Behalf Of ItsMembers, Petitioner Cal-Tax Has Standing To Bring This Action

"[A]n association has standing to bring suit on behalf of its members when: (a) its6

members would otherwise have standing to sue in their own right; (b) the interests it seeks to7

protect are germane to the organization's purpose; and (c) neither the claim asserted nor the relief8

requested requires the participation of individual members in the lawsuit." Property Owners of9

Whispering Palms, Inc. v. Newport Pac., Inc., 132 Cal.App.4th 666, 672-673 (2005); Hunt v.10

Washington State Apple Advertising Comm'n, 432 U.S. 333, 343 (1977); see also, Brotherhood of11

Teamsters & Auto Truck Drivers v. Unemployment Ins. Appeals Bd., 190 Cal.App.3d 1515, 1521-12

1522 (1987). It is sufficient that even one of the association's member could "make out a

justiciable case." Hunt, 432 U.S. at 342; Worth v. Seldin, 422 U.S. 490, 511 (1975).'14

All three associational standing requirements are satisfied here. First, at least some of the15

individual members of Cal-Tax have standing since they have a real interest in the ultimate16

adjudication, having suffered and/or being about to suffer "an injury of sufficient magnitude17

reasonably to assure that the relevant facts and issues will be adequately presented." Blumhorst v.18

Jewish Family Services of Los Angeles, 126 Cal.App.4th 993, 1001 (2005). Cal-Tax's members19

include more than 200 corporations that are subject to California income tax law, many paying20

taxes well over $1 million and regularly reporting adjustments or receiving assessments of tax over21

$1 million in the ordinary course of their businesses. Pet. 3:4-8. Without a prompt resolution of22

the claims asserted, the members would immediately suffer a range of injuries, including23

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25Because Cal-Tax is not trying to certify a class, and is not relying on prudential standing,

Respondent's citations to cases involving class actions and prudential standing are irrelevant. SeeRespondent's Memorandum of Points and Authorities ("RMPA"), at 8-9; see also NovartisVaccines and Diagnostics, Inc. v. Stop Huntingdon Animal Cruelty USA, Inc., 143 Cal.App.4th

1284, 1297 (2006) (recognizing that prudential standing and associational standing are different).

PETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES AND AUTHORITIES IN OPPOSITION To DEMURRER BYRESPONDFNT FRANCHISE TAX BOARD


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employees, invest in their business and service their debt (Pet. 8:25-27);

incurring substantial expenses in reviewing their California and federal tax returns

to identify reasonable but uncertain tax positions, to analyze those positions, and to

determine whether to disclose those positions in an amended return to avoid the

possibility of liability (Pet. 8:19-24);

diverting to the State for many years funds otherwise usable by members to pay

• being forced either to disclose information regarding reasonable but uncertain tax

positions to the FTB, including information that is privileged, confidential or

otherwise legally protected from disclosure, or waiving the ability to avoid liability

under Section 19138 by amending/paying (Pet. 9:1-5); and

• attesting "under penalties of perjury" that amended returns are "true, correct, and

complete" even though the taxpayer actually believes the original return is correct

and the amended return overstates the taxpayer's California tax (Pet. 9: 6-10).

Second, Cal-Tax is a non-profit organization founded to protect taxpayers from

unnecessary taxes and to promote government efficiency. Pet. 3:2-4. The interests Cal-Tax seeks

to protect through this lawsuit are obviously germane to this purpose.

Third, the relief requested does not require participation of individual members in the

lawsuit because the lawsuit challenges the validity of Section 19138 on its face under the

constitutions of California and the United States. Thus, the three associational standing

requirements are satisfied, and Cal-Tax has standing to bring these claims.

B. This Action Is Ripe

Respondent's claim that this action is not ripe should also be rejected. The leading case,

Abbott Laboratories, 387 U.S. 136, 148-49 (1967) ^Abbott"), is directly on point. In Abbott, a

group of drug manufacturers sought judicial review of federal regulations governing the labeling

of drugs. Although the government had not taken any action to enforce the regulations against any

particular drug manufacturer, the Court found the challenge to be ripe, i.e., the "administrative

2 For examples in which associations have challenged taxes on behalf of their memberswithout any successful standing objection, see Direct Marketing Ass 'n v. Bennett, et al, 916 F.2d1451 (9in Cir. 1990); Hospital Council of Western Pennsylvania v. Pittsburgh, 949 F.2d 83 (3d Cir.

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decision [was] formalized and its effects felt in a concrete way by the challenging parties." Id. at

14g_] 49. The Court explained that the challenge was a purely legal one; the regulations were final

in that they were currently applicable; the drug manufacturers were faced with the current dilemma

of complying with the regulations, which entailed significant changes in their business practices—

changing labels on drugs, advertisements, etc.—with the attendant financial burden or risk

penalties. Id. at 149-154. The Court concluded, "To require them to challenge these regulations

only as a defense to an action brought by the Government might harm them severely and

unnecessarily." Id. at 153. Applying Abbott rigorously to this case, contrary to Respondent's

arguments, both prongs of Abbott's ripeness test are satisfied: (1) fitness of the issues for judicial

decision, and (2) hardship to the parties of withholding court consideration. Id at 148-149.3

1. This facial challenge to the constitutionality of Section19138 is fit for judicial decision

This matter is fit for judicial decision because "it has reached, but has not passed, the point

that the facts have sufficiently congealed to permit an intelligent and useful decision to be made."

California Water & Telephone Co. v. County of Los Angeles, 253 Cal.App.2d 16, 22 (1967).

There is no question that Section 19138 is enacted, having taken effect December 22, 2008, and

taxpayers are currently deciding which irrevocable actions to take on or before the May 31, 2009

deadline for amending returns and paying associated taxes.

Moreover, like the challenge of the regulation in Abbott, this case tests the legal validity of

3 Abbott does not require both prongs to be satisfied. Rather, ripeness is determined byweighing the two factors, and one factor may weigh so heavily as to make the other factorirrelevant. In fact, in its assessment of the "fitness" factor, the Abbott court found that "the impactof the regulations upon the petitioners is sufficiently direct and immediate as to render the issueappropriate for judicial review at this stage" (Abbott, supra at 152), but the court did not discusssatisfaction of the "hardship" factor, indicating that where the "fitness" factor is amply satisfied,the "hardship" factor is of limited relevance. See also Venetian Casino Resort v. EEOC, 409 F.3d359, 365-366 (DC Cir. 2005) ("The hardship prong of the ripeness doctrine 'is largely irrelevant incases, such as this one, in which neither the agency nor the court have a significant interest inpostponing review.'" citing Electric Power Supply Ass'n v. FERC. 391 F.3d 1255, 1263 (DC Cir.2004)). Thus, contrary to Respondent's argument, even if Cal-Tax were not able to satisfy thehardship prong of the Abbott test that alone would not be a basis for sustaining the demurrer.Respondent's Memorandum of Points and Authorities ("RPMA"), at 13.



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statute. To resolve such a facial challenge, it is only necessary to know what the statute says and

the legislative history behind it; no further factual development is necessary or even beneficial.

The validity of a statute is a proper subject of declaratory relief and writs. See, e.g.,

California Water & Telephone, 253 Cal.App.2d at 20-21 (constitutional challenge of the County's

water ordinance was ripe even though no utility had yet violated the ordinance); see also Greener

v. Workers' Comp. Appeals Bd, 6 Cal. 4th 1028, 1045 (1993) ("Nonetheless, where the

constitutional validity of a statute or constitutional provision is in issue, both this court and the

Courts of Appeal have entertained challenges to the legislation when brought by petition for writ

of mandate, and have done so prior to the implementation of the measure."). Likewise, the

propriety of an administrative act before any application to the parties challenging it is the proper

subject of declaratory relief. See, e.g, Alameda County Land Use Association v. City ofHayward,

38 Cal.App.4th 1716, 1722-23 (1995) (court allowed a challenge to the facial validity of a

memorandum of understanding ("MOU") by two cities and a county concerning a parcel of land

within the boundaries of each jurisdiction even though none of the plaintiffs had requested any

amendment or taken any actions that would result in the MOU having any effect on them).

Respondent's argument that there must be a final administrative decision with respect to

an individual taxpayer before this matter is fit for review misses the point of this lawsuit entirely.4

The harm that Petitioner and its members seek to avoid is not the harm of an assessment under

Section 19138 at some later date, but instead it is the harm that will come to them on or before

May 31, 2009 as a result of the irrevocable choice they are forced to make now. Thus, the very

purpose for this lawsuit would be defeated if Cal-Tax and its members were required to wait for

4 The issue of whether an action is ripe before a final determination of a tax or penalty doesnot often arise in tax cases because it is frequently superseded by the issue of whether the action isbarred by a failure to exhaust administrative remedies or by the AIA. However, where courts havedetermined those usual barriers do not bar review in a particular case, the courts have allowed taxcases to proceed to the merits. See, e.g., Andal v. City of Stockton, 137 Cal.App.4th 86 (2006)(allowed a constitutional challenge to the future collection of a fee); Pacific Motor Transport Co.v. State Bd. of Equalization, 28 Cal.App.3d 230 (1972) (allowed a challenge to a regulation eventhough neither the regulation nor the statute which it interpreted had been applied to the plaintiffs).



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Section 19138 liability to be assessed against particular taxpayers because that will only occur

after May 31st. Resolution of the issues in this case would not benefit from application of Section

19138 to a particular taxpayer because this is a facial challenge. Avoiding the risk of judicial

interference in the administrative process also does not justify delaying review. This lawsuit does

not pose a risk of such interference because Respondent is powerless to decide the constitutional

claims raised here. See Cal. Const, art. Ill, § 3.5 (prohibiting administrative agencies from

declaring a statute unconstitutional). Indeed, the court in Abbott expressly rejected this argument,

explaining that "[f|o require them to challenge these regulations only as a defense to an action

brought by the Government might harm them severely and unnecessarily." Abbott, supra at 153.

2. Hardship sufficient to satisfy Abbott would result fromwithholding consideration

The second factor—hardship of withholding judicial consideration-—is satisfied because

delaying resolution would impose substantial hardship on Cal-Tax's members. On the one hand, if

a taxpayer amends its prior years' returns and pays the associated taxes, the taxpayer will have to

disclose sensitive, confidential conclusions about reasonable but uncertain tax positions which the

law does not otherwise require the taxpayer to disclose.5 This disclosure is, of course, irrevocable

and will have significant implications for forthcoming years even if Section 19138 is later declared

unconstitutional. In addition, the taxpayer will incur substantial compliance costs and will lose the

use of substantial funds for many years while the administrative process runs its course. On the

other hand, if a taxpayer decides not to amend its prior years' returns, but later Section 19138 is

upheld, the taxpayer risks liability under the constitutionally questionable Section 19138 which

prohibits administrative appeals or claims for refund. A prompt decision from this Court will

enable taxpayers to make an informed decision as to which path to take.

5 While the law affords additional protections for penalties for taxpayers that choose todisclose reasonable but uncertain positions, the law does not require such disclosure on tax returns,See, e.g., Treas. Regs. § 1.6662-4(a) (penalty does not apply to an understatement related to an"item for which there is substantial authority, or with respect to which there is adequatedisclosure").

10PET ITIONCR'S MEMORANDUM OF POINTS AND AUTHORITIES AND AUTHORITIES IN OPPOSITION To DEMURRER BY

RESPONDENT FRANCHISE TAX BOARD


1 Respondent claims that "[n]either the possibility of financial loss nor uncertainty over the

2 potential economic impact of the agency's action is sufficient to warrant premature review."

3 RMPA, at 11. However, whether or not these considerations are "sufficient," the Abbott Court

4 clearly took them into account in evaluating "hardship":This is also a case in which the impact of the regulations upon the petitioners is

5 sufficiently direct and immediate as to render the issue appropriate for judicialreview at this stage. These regulations ... puts petitioner[] in a dilemma ... "Either

6 they must comply with the every time requirement and incur the costs of changingover their promotional material and labeling or they must follow their present

7 course and risk prosecution." ... If petitioners wish to comply they must change alltheir labels, advertisements, and promotional materials; they must destroy stocks of

8 printed matter; and they must invest heavily in new printing type and new supplies.The alternative to compliance ~ continued use of material which they believe in

9 good faith meets the statutory requirements, but which clearly does not meet theregulation of the Commissioner - may be even more costly. That course would

10 risk serious criminal and civil penalties for the unlawful distribution of"misbranded" drugs.

11Abbott, at 152-53. Plainly, the cost of compliance does contribute to hardship under Abbott.

12In any event, members of Petitioner face the additional hardship—independently adequate

13under Abbott—of being coerced into irrevocably disclosing confidential and proprietary

14information which the law does not otherwise require to be disclosed—disclosures which could

15not be undone if Section 19138 were held unconstitutional at a later time, after May 31, 2009.

16Respondent has ignored this hardship altogether. Pet. 9:1-5. The rationale behind the work

17product doctrine, whether or not that doctrine is fully applicable here, illustrates the harm of

18compelled disclosure of reasonable but uncertain tax positions.

19Civ. Proc. Code § 2018.030 defines work product to include any materials that "reflect an

20attorney's impressions, conclusions, opinions, or legal research or theories." The work product

21doctrine "prevents] attorneys from taking undue advantage of their adversary's industry and

22

ryj ,

The Supreme Court has held that "the work-product doctrine does apply in tax summonsenforcement proceedings." Upjohn Co. v. U.S., 449 U.S. 383, 386 (1981). This is consistent withthe Restatement, which describes the doctrine as applicable to "adversarial proceedings before anadministrative agency," a proceeding being "adversarial" "when evidence or legal argument ispresented by parties contending against each other with respect to legally significant factual

OA issues." Restatement (Third) of the Law Governing Lawyers § 87 cmt. H (2000). See also, U.S. v.2° Roxworthy, 457 F.3d 590, 600-01 (6th Cir. 2006) (finding memos prepared analyzing legal,-7 arguments supporting and opposing specific tax positions to be protected work product).

28n



1 efforts." Civ. Proc. Code § 2018.020(b). More specifically, it protects the adversary system.

2 providing attorneys with "that degree of privacy necessary to encourage them to prepare their

3 cases thoroughly and to investigate not only the favorable but the unfavorable aspects of those

cases." Civ. Proc. Code § 2018.020(a); Coastal States Gas Corp. v. Department of Energy, 617

F.2d 854, 864 (D.C. Cir. 1980).

In requiring taxpayers to submit amended returns disclosing to FTB their internal

assessment of reasonable but uncertain positions taken on returns for prior years, Section 19138

would require taxpayers to disclose precisely the subset of tax positions which will have been

analyzed by their attorneys, and for which the taxpayer decided not to disclose. The required

10 disclosure is not just the position itself but, according to Respondent, a "detailed explanation" oft

11 the position or adjustment. See Second draft - Large Corporate Understatement Penalty FAQs (2)

12 additions & revisions, as of March 27, 2009, Pet'r Ex. S ("Any amended return without a detailed

13 explanation of adjustments will not be accepted as an amended return that satisfies the

14 requirements under R&TC section 1913 8(b) ...." (emphasis added)). The forced disclosure of

15 such "conclusions [and] opinions," not only to Respondent but also to the IRS,7 undermines the

16 adversary system by permitting attorneys' impressions and analysis to be used against their own

17 clients and, thus, imposes the same hardship on those taxpayers mat the work product doctrine was

18 designed to prevent, a hardship sufficient to satisfy Abbott.

\ 9 To illustrate the hardship, assume in reviewing an unreported tax item for purposes of/

20 filing an amended return before May 31, 2009, an attorney advises a zero percent chance the item

21 is taxable, in which case the taxpayer would not file an amended return. However, if the attorney

22 advises the taxpayer there is a 40 percent chance of taxability—i.e., a 40 percent chance that the

23 position taken on the current return is wrong—in light of Section 19138, a reasonable taxpayer

24 may choose to report the item in an amended return, with the required detailed explanation of the

25

" 7 This information also will be disclosed by FTB to the IRS. Large CorporateUnderstatement Penalty FAQs, Pet'r Ex. D.

2812

PRTTIONER'S MF.MORANDUM OF POINTS AND AUTHORITIES AND AUTHORITIES IN OPPOSITION TO DEMURRER BYRESPONDENT FRANCHISE TAX BOARD


change. The taxpayer would then have effectively disclosed and explained to FTB its attorney's

conclusion that the taxability of the item is uncertain. This would permit FTB to take undue

advantage of opposing counsel's industry and efforts and would prompt FTB to scrutinize the

item—including on all returns in subsequent years. This compelled disclosure of internal analysis

which the law does not otherwise require to be disclosed is, therefore, a severe hardship for

taxpayers.

The case law recognizes that disclosure of confidential and proprietary documents

constitutes "a hardship sufficient to outweigh any possible institutional interest in deferring

review" under the Abbott test. Electric Power Supply Ass 'rc,391 F.3datl263; Venetian Casino

] 0 Resort, 409 F.3d at 365-366. In Electric Power, the Court made clear that a regulation, which

threatened to force disclosure of confidential documents to a third party working as an advisor to

12 decision makers in disputes before the FERC, would "have a direct effect on [plaintiffs] ability to

13 represent itself and its members" in pending and future hearings before the FERC, and that this

14 was clearly sufficient to constitute hardship for the purposes of the ripeness analysis. Electric

15 Power Supply Ass 'n, 391 F.3d at 1263. Venetian Casino involved disclosure by the EEOC of

16 plaintiffs confidential documents to third parties likely to bring discrimination suits against

17 plaintiff, i.e., parties with the potential to become adverse in legal proceedings. In the present

18 case, the threatened hardship from coerced disclosure of confidential and proprietary information

19 of members of Petitioner to FTB is the same as the threatened hardship in Electric Power and

20 Venetian Casino: The disclosure would be to a party with the potential to become adverse in legal

21 proceedings and would directly affect members' ability to represent themselves in future disputes.

22 The disclosure of sensitive and/or confidential information is, plainly, hardship under Abbott.

23 As in Abbott, it is not only these hardships that create ripeness, but also the dilemma that

24 corporate taxpayers face, i.e., the untenable choice between complying with a statute of

25 questionable validity or risking liability under Section 19138. In Abbott, the drug manufacturers

26 had a means to redress the penalties assessed, and even then the Court determined that "to require

27 them to challenge these regulations only as a defense to an action brought by the Government

2813



might harm them severely and unnecessarily." Abbott, at 153. In this case, if Respondent asserts

liability under Section 19138 against a corporate taxpayer, the taxpayer has no remedy

whatsoever, except to challenge the computation of the liability. It is evident that the harm in this

case is at least as severe, if not more severe, than the harm \r\Abbott.

If there were doubt about allowing this action to proceed, the widespread public interest in

its resolution would tip the scale in favor of review. See California Water & Telephone Co., 250

Cal. App 2d at 26; see also Pacific Legal Foundation v. California Coastal Commission, 33 Cal.3d

158, 170 (1982) ("[T]he requirements should not prevent courts from resolving concrete disputes

if the consequences of a deferred decision will be lingering uncertainty in the law, especially when

there is a widespread public interest in the answer to a particular legal question."); Farm

Sanctuary, Inc. v. Department of Food and Agriculture, 63 Cal.App.4th 495, 503 (1998)

("declaratory relief is appropriate where 'questions of public interest... are involved.'");

Californiansjor Native Salmon and Steelhead Assoc. v. Department of Forestry, 221 Cal.App.3d

1419, 1426 (1990) ("Any doubt should be resolved in favor of granting declaratory relief.").

Many of Petitioner's 200 members, and many other corporate taxpayers, are affected by this

lawsuit and need to know whether Section 19138 is valid in order to make an informed choice on

or before May 31st. Moreover, the status of approximately $ 1.4 billion in anticipated tax revenues

is at stake. It is evident that this matter is ripe, and Cal-Tax should be given its day in court.

C. This Action Is Not Barred By Cal. Const., art. XIII, § 32 Or By Any

10

11

12

13

14

15

16

17

18

19 ,Other Pre-payment Or Exhaustion Requirement.

Respondent properly informs this Court of the prevailing rule, grounded in the California21

Constitution and state statutes, for challenging taxes-—a taxpayer is required to pay the amount in22

dispute and exhaust administrative remedies by timely filing a claim for refund and pursuing it to23

conclusion. See RMPA, at Sections A, B, C, F. However, Respondent fails to mention that the24

Legislature expressly denied any administrative remedies to taxpayers subject to Section 19138.25

This action obviously cannot be barred by failure to pursue non-existent remedies.26

The prepayment rule and exhaustion doctrine apply only so long as the taxpayer has an27

adequate remedy at law. Where administrative remedies are unavailable or inadequate, or where a28

14PETITIONER'S MEMORANDUM OF POINTS AND AUTHORITIES AND AUTHORITIES IN OPPOSITION To DEMURRER BY

RESPONDENT FRANCHISE TAX BOARD


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14

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22

28

taxpayer otherwise lacks any adequate remedy at law, as in this case, the prepayment requirement

gives way, and requests for declaratory relief, writs, and injunctions are allowed. See, e.g., Andal

v. City of Stockton, 137 Cal. App. 4th 86, 91 (Cal.App.3d Dist. 2006) ("[W]here no administrative

remedy is provided for the particular issues raised, recourse to the administrative agency is not

required before initiation of the court action.")* citing Park 'N Fly of San Francisco, Inc. v. City of

South San Francisco, 188 Cal.App.3d 1201, 1208-09 (1987).

Under McKesson Corp. v. Division of Alcoholic Beverages & Tobacco, 496 U.S. 18. 39

(1990), when a State requires a taxpayer "promptly'to pay a tax when due" and then dispute the

legality of that tax, Due Process requires the State to provide "meaningful backward-looking

relief and a "clear and certain remedy for any erroneous and unlawful tax collection to ensure that

the opportunity to contest the tax is a meaningful one." Section 19138's lack of a prepayment

remedy is not matched by a clear and certain ability to claim a refund, as required by McKesson.

Due to Section 19138's prohibition on claims for refund, the only way to avoid a Due Process

violation is to allow this challenge to proceed.

Finally, Respondent's argument that Petitioner's claim for attorneys' fees is barred by the

Claims Act (Gov. Code § 900 et seq.) because Petitioner has not presented a claim for such fees

lacks merit. Even assuming the Claims Act applied, no claim for fees is required because such

claim has not yet accrued. See Gov. Code § 901 (providing that the date a claim accrues is the

date upon which a cause of action would be deemed to have accrued under the applicable statute

of limitations).

V. CONCLUSION

Petitioner respectfully requests that Respondent's demurrer to be denied.

23 „Dated: April 13, 2009 SILVERSTEIN & POMERANTZ LLP

24

25

26By:.

Amy L. Silverstein (Bar No. 154221)

27Attorneys for Petitioner

15California Taxpayers' Association

PKTITIONFR'S MRMORANDUM OF POINTS AND AUTHORITIES AND AUTHORITIES IN OPPOSITION TO DEMURRER BYRESPONDENT FRANCHISE TAX BOARD


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