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On October 27, 2006, the California Franchise Tax Board (“FTB”) issued two Legal Notices regarding revised time goals for the processing of docketed protests.  Notice 2006-5 announced a pilot project allowing certain taxpayers to request a one-year timeline for resolving their docketed protest.  Notice 2006-6 announced a goal under new FTB procedures to complete docketed protests within 24 months or less of the filing date of the protest.  Notice 2006-6 goes on to establish a three-track system, under which the length of time to process a docketed protest generally will be 12, 18, or 24 months, as specified.  Notice 2006-6 supersedes FTB Notice 99-1 (03/03/99), which previously stated the FTB’s goal was to issue a notice of action within 33 months of the filing date of a protest. 

These two recent Notices are the latest developments in a long history of efforts to expedite the California protest process.  A protest is the lowest level administrative challenge to an FTB notice of proposed deficiency assessment that is issued to an individual or a corporate taxpayer.  California Revenue and Taxation Code section (“section”) 19041 provides that within 60 days after the mailing of a notice of proposed assessment, a taxpayer may file a protest with the FTB, specifying in the protest the grounds upon which it is based.  Section 19044 provides the taxpayer a right to an oral hearing, if requested in the protest.  The protest proceedings are conducted solely within the FTB, and the same FTB employee acts as both the representative of the FTB and the protest hearing officer.  Protests are assigned within the FTB either to a hearing officer in the Audit Division, or to the Legal Department, with protests assigned to the Legal Department being denominated “docketed protests.”  There are no statutory or regulatory limitations upon how long a protest may last. 

In early 1999, FTB issued Notice 99-1, which stated the goal of the FTB was to evaluate the merits of a protest (and any included claims for refund), conduct a hearing if required, and issue a notice of action within 33 months of the filing date of the protest.  Notice 99-1 also stated there would be circumstances where some protests were deferred and some would take longer to conclude, but such cases were intended to be the exception rather than the rule. 

The two recent Notices are not the first attempt to shorten the 33-month protest period referenced in Notice 99-1.  In 2000, the FTB drafted two proposed regulations (proposed Regulations 19041 and 19044) addressing protests and protest hearings.  (See FTB Notice 2002-2 (2/11/00) and FTB Notice 2000-3 (4/17/00).)  The efforts were spearheaded by Dean Andal, a member at that time of both the Franchise Tax Board’s three-person Board and the State Board of Equalization’s five-person Board.  The proposed regulations would have established a 24-month period, subject to specified exceptions, for resolving protests.  Efforts to formally adopt the proposed protest regulations were abandoned later that same year.

The FTB historically has had a difficult time completing docketed protests within the formerly prescribed 33-month period set forth in Notice 99-1.  Based on a 2004 report by the FTB to the Legislature, only approximately 47% of corporate tax cases were being completed in 33 months or less and only approximately 52% of personal income tax cases were being completed in 33 months or less.  (See 2004 Report to the Senate and Assembly Budget Committees On the Status of the Franchise Tax Board Docketed Protest Case Inventory.)

Notice 2006-5

The voluntary one-year pilot program established under Notice 2006-5 is available only for docketed protests filed on or after October 27, 2006, i.e., the date of the Notice.  A request to participate in the project should be included in the initial protest.  The FTB will then notify taxpayers whether their protest will be included in the project within one month of the date the protest is received.  The determination whether to accept a case into the project is solely within the discretion of the FTB, and the number and complexity of the issues raised in the protest will enter into that decision.  The project only applies to protests that involve a legal issue or issues “for which the department’s litigating position is established” in a Legal Ruling, FTB Notice, State Board of Equalization decision, or judicial decision.  In addition, the protest must be limited to the adjustments made by the FTB that gave rise to the Notice of Proposed Deficiency Assessment, and the taxpayer must have “substantially responded” to information requests made during audit.  Finally, if any further factual development is necessary, it must “typically be specific and limited in scope.”

Taxpayers requesting to participate in the project must agree to:

• Proceed without requesting a copy of the audit file;
• Not seek to add any issue(s) to the protest after it has been filed;
• Make a good faith effort to respond to any request for information or further explanation of their arguments within 30 days, or within one extension of 15 days;
• Agree to scheduling the protest hearing at the time FTB makes initial contact under the pilot program; have that hearing held where the protest hearing officer is located or by teleconference; and not seek to postpone a scheduled hearing; and
• Not request consideration by the FTB Settlement Bureau while the matter is in the pilot program.

Observations

FTB should be commended for creating this pilot program under Notice 2006-5, which may prove very useful to taxpayers with cases that were well developed by both parties at the audit level; where the issues are relatively few and are legal in nature as opposed to factually intensive; and where there is an interest in a speedy resolution.  Business, regulatory and reporting requirements, for example, FIN 48, increasingly place pressure on companies to assess and quantify their potential state tax liabilities as expeditiously as possible.

However, there are three obvious potential pitfalls to entering the program, and an analysis will have to be made whether the relinquishment of certain rights is worth the opportunity to resolve the protest within 12 months under the pilot project.  First, a taxpayer gives up the ability to obtain and review a copy of the FTB audit file in the matter.  In our experience, the audit files consistently prove valuable in shedding additional light on the FTB’s basis for the protest adjustments, far above and beyond the information provided by the auditor to the taxpayer during the course of the audit itself.  Second, a taxpayer gives up the ability to raise additional issues to the protest.  Our experience is that additional issues frequently can and should be raised in the course of the “usual” protest proceedings, both for reasons of offsetting any deficiency adjustment and for creating overpayments and refunds.  Third, a taxpayer may find the limited response time of a maximum of 45 days is insufficient to respond to all requests made by the FTB during the protest to provide further information or further explanation of arguments.  Note that the 12-month protest period described below under Notice 2006-6 does not require these concessions by a taxpayer. 

Notice 2006-6

This Notice states that all docketed protests filed after July 1, 2006 will be categorized by FTB staff as targeted to be completed within either 12 months, 18 months, or 24 months. 

• A “12-month” docketed protest is one which involves only a legal issue or issues for which the FTB’s litigating position is established in a Legal Ruling, an FTB Notice, a State Board of Equalization decision, or a judicial decision.  If any factual development is necessary, it will “typically be specific and limited in scope.”  Note the similarity of these criterion to those for the one-year pilot program established under Notice 2006-5, but without the requirement the taxpayer make certain concessions, such as to not request a copy of the audit file or to not add additional issues to the protest once it has been filed.
• An “18-month” docketed protest involves a limited number of legal issues, some factual development is required, or the FTB’s litigating position is not established with respect to any issue in the case.
• A “24-month” protest involves more than a limited number of legal issues or legal issues of greater complexity, factual development “probably” will be required, or the FTB’s litigating position is not established with respect to any issue in the case.

Under all three situations, FTB anticipates making initial contact with the taxpayer within 120 days of the filing of the protest.  Both FTB staff and taxpayers are expected to make and respond to information/document requests as expeditiously as possible, with requests for extensions of time to be kept to a minimum.  Protest hearings will be scheduled at an FTB office convenient to the taxpayer or by videoconferencing or telephone.

The Notice provides new procedures for introducing issues not raised in the protest letter.  Specifically, issues not raised in the protest “ordinarily” will not be considered unless these issues can be considered and resolved within the above timeframes.  The Notice states that in the alternative, taxpayers may have to raise those issues by filing a claim for refund, “which will be addressed separately” from the protest by the FTB or in an appeal to the State Board of Equalization.  

The Notice also states that once a protest hearing has been held and a determination made, docketed protests “ordinarily” will not be considered for admission into the FTB Settlement Bureau.  In such cases, settlement bureau consideration will ordinarily be deferred until after the Notice of Action has been issued and an appeal has been filed with the State Board of Equalization.

Observations

Similar to the now superseded FTB Notice 99-1 that previously stated the FTB’s goal was to issue a notice of action within 33 months of the filing date of a protest, there are a litany of exceptions under Notice 2006-6 to the 12, 18, or 24 month periods.  For example, deferrals may result where cases are referred back to the field because new issues were raised at protest; other years of the taxpayer are pending in another forum; or a potentially precedent setting case of another taxpayer is pending in another forum.  Nevertheless, an “outside” goal of 24 months is a laudable step in the right direction from the current 33-month goal.  An interesting point about Notice 2006-6 is that it appears FTB staff intends to unilaterally make the decision on “categorizing” docketed protests and then communicate that decision to the taxpayer.  FTB may find a more practical approach would be to make a tentative categorization, communicate that decision to the taxpayer, and obtain a reaction.  Indeed, there may be cases where both the taxpayer and the FTB will find it more efficient to mutually make the decision whether they realistically have before them a 12, 18 or 24 month case.  Certainly there are valid tactical and logistical reasons why a taxpayer may want a longer or shorter protest, or may wish to reclassify a protest based upon a change in circumstances.