Metropolitan News-Enterprise


Wednesday, December 15, 2010


Page 1


C.A. Upholds Penalty For Corporate Tax Underreporting

Punitive Measure Not Subject to Two-Thirds Vote Requirement, Justices Rule




A penalty imposed on corporations that understate state income tax liability by more than $1 million per year is not itself a tax, and thus not subject to the constitutional ban on raising taxes without two-thirds approval of both houses of the Legislature, the Third District Court of Appeal has ruled.

The justices Monday upheld Revenue and Taxation Code Sec. 19138, rejecting the California Taxpayers’ Association’s claims that it violates Art. 13A, Sec. 3 of the state Constitution, as well as due process guarantees.

The statute was effective Dec. 19, 2008, but applies retroactively to tax years beginning with 2003, except where statutes of limitations on reassessment have expired. Corporations otherwise subject to the retroactive penalty were given the opportunity to avoid it by filing amended returns by May 31 of last year and paying the applicable tax.

The penalty is 20 percent of the understatement of tax.

Justice Kathleen Butz, writing for the Court of Appeal, said the trial judge was correct in upholding the statute.

“We conclude here that Revenue and Taxation Code section 19138, a corporate tax penalty just that‑a penalty‑and therefore not subject to the two-thirds legislative vote requirement...,” the justice wrote.

Butz rejected the argument by the association—which is commonly referred to as CalTax—that the provision imposes a “tax” within the meaning of the Constitution because the Legislature’s primary purpose in enacting it was to fill a budget gap rather than merely discourage underreporting.

The argument relied on a “misguided” analysis, Butz said.

Taxes and penalties both raise revenue, the justice explained, but differ in that a tax will raise steady amounts of revenue over time, while a penalty—“if it is enforced effectively”—will produce decreasing amounts.

Butz cited an analysis projecting that the penalty would raise $1.4 billion in the first year—partially because of the retroactivity provision—but only $75 million, $45 million, and $30 million in the next three years.

In addition, Butz noted, a tax is imposed on everyone subject to the law imposing it, while a penalty is imposed only on those who violate the law; Sec. 3 by its terms applies only to tax changes resulting from “increased rates or changes in methods of computation,” a definition that excludes provisions like Sec. 19138; and the rapid decline in projected collections “is the mark of a penalty, not a tax.”

The jurist commented that “[i]f death and taxes are the only two things certain in life, section 19138 is more death than tax, given this rate of dissipation.”

She also reject CalTax’s argument that the high rate of the penalty, and the lack of a requirement that the taxpayer have engaged in bad faith, suggests that it was intended primarily to raise revenue rather than to encourage compliance.

She noted that it is similar in amount to the “substantial understatement” penalty under federal law, that the legislative history describes it as a penalty similar to other penalties in state law, and that the $1 million threshold at which the penalty is triggered obviates the need to recognize a good-faith defense.

Due process requirements, the justice went on to say, are met because the penalty provision is subject to other provisions of the Revenue and Taxation Code that allow taxpayers to seek refunds when the Franchise Tax Board collects amounts not legally owed.


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