California’s Shocking New Tax Attack On Both Residents And Nonresidents

If a person suffers damages, the person retains an attorney to pursue a remedy.  But, what happens when there is no individual who has suffered damages but it is the public in general that is harmed?  That is, a public interest issue. It is a state’s attorney general (or a district attorney) who prosecutes public interest cases. 

One type of public interest case is when the government itself is a victim of fraud.   Let’s say that a business sells computers to a school district. The business knowingly delivers computers of lesser specification than what was purchased.  It would be the attorney general or a district attorney who would pursue the case.

But, because the attorney general’s or a district attorney’s resources are limited, some states have permitted non-government attorneys and private parties to pursue such cases — being called “private attorney general” actions.  These non-government attorneys would be paid their fees by the government and the private parties would be reimbursed their expenses (but would receive no damages). It would not be unusual if a state limited private attorney general actions to certain types of cases.  

Back to our school district example . . .  a whistle-blower initiates a private attorney general action to recover damages on behalf of the school district.  Clearly in the public interest. No arguments from anyone.

All of this sounds well and good.  A laudable intention.

Now, we can all agree it is in the public interest that companies not engage in “any unlawful, unfair or fraudulent business act or practice and unfair, deceptive, untrue or misleading advertising” — from California’s Business and Professions Code.  And, decades ago, California’s legislature put it to the voters as to whether, in the absence of a person who has suffered damages, private attorney general actions should be permitted for such fraudulent business practice claims.  It is in the public interest. And, the voters said “yes.”

The result was a cottage industry of attorneys (with no clients asserting any damages and without any laudable intentions) who pursued some real and some fabricated claims “in the public interest” . . . and the State of California would pay them.  What a racket! A real case: an attorney with no injured party initiated a private attorney general action against a well-known running shoe maker for false advertising — an ad created a misleading impression in the public that they would run faster by buying the company’s shoes.  Are you . . . kidding me?!?!

By 2004, the voters realized the Pandora’s Box they had opened and removed the business practice claims from the list of allowable private attorney general actions.

Because of the opportunity for abuse by the state itself and by pro-profit bounty hunters (as seen by California voters), false claims acts have historically excluded tax claims.  Tax administration and the pursuit of tax claims has always been left to the given tax authority. Certain, no one would argue that any tax authority is timid in its administration or pursuit of claims.

But, as the trial lawyers seem to control California legislation, its legislature is debating whether to open up its false claims act to tax claims . . . which would open up private attorney general actions on tax claims.

What Is Appalling About The Proposal

- A non-government attorney or a private party can initiate an action even if the attorney general has reviewed the matter and has concluded it is not worth pursuing (as opposed to not have the resources to pursue)

- A non-government attorney or a private party can initiate an action even if the taxpayer has been audited by the state and has entered into an audit closing agreement with the state

- A non-government attorney or a private party can initiate an action even if the taxpayer has entered into a settlement agreement with the state

- A non-government attorney or a private party can initiate an action even if the statute of limitations has passed — the proposal expressly opens up claims to 10 years

A review of private attorney general actions related to tax in Illinois and New York finds that many are based on vague claims of noncompliance in which the taxpayer is held hostage between an expensive legal battle and being forced to pay extortion in the form of a nuisance-value settlement.  This sounds strikingly similar to what California voters rejected 15 years ago.

How Non-California Business Owners Appallingly Get Roped In

Prior to 2010, multi-state taxation was simpler.  But, in a 2010 (wrong) decision, the U.S. Supreme Court opened up a can of worms called the Source of Benefit Doctrine.  It went against everyone’s traditional understanding of a state’s ability to tax a non-resident business.

In the old days, if you had a physical presence in a state (employees or assets) or concluded sales IN the state, that state could tax your business.  Now, if you have no connection to a state other than something as simple as someone in that state buying something off of your web site, that is enough.  For example, let’s say that a business in Minnesota prints tourist-type calendars and sells them to a retailer in Los Angeles, that Minnesota business (and its owner) is exposed to California taxation.  There are de minimis exceptions. But, if your business sales to California exceed $500,000, you’re stuck.  Now, enter the circus of private parties vaguely asserting that you or your business did not file a California tax return or did file one but it was somehow incorrect.  

And, it is not just income tax . . . it is sales tax as well.  You might not have a legal requirement to withhold or report sales tax to California.  But, it does not mean that you are free from a private attorney general action under the False Claims Act (if amended as proposed).

Unbridled terror is what this is.  Whether you are a California resident or a non-resident who does business with Californians, you need to pull out the stops to defeat this proposal.

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I help owners of middle market companies gain control over and understanding of their firm's finances, enhance their firm's cash flow and value, and reduce the tax burde...