Daily Tax Update - January 10, 2012: California Superior Court Holds That 50% Promoter Penalty May Not Be Applied Retroactively

CALIFORNIA SUPERIOR COURT HOLDS THAT 50% PROMOTER PENALTY MAY NOT BE APPLIED RETROACTIVELY.  On January 3, 2012, the San Francisco Superior Court issued a statement of decision holding that the California Franchise Tax Board ("FTB") may not retroactively apply an increased penalty for the promotion of tax shelters. The plaintiffs in the cases are represented by Steptoe & Johnson.

  • In 2001, when the promotion activities were alleged to have occurred, California Revenue and Taxation Code Section 19177 imposed a penalty in accordance with Internal Revenue Code Section 6700, which provided for a maximum penalty of $1,000 for promoting abusive tax shelters.  In 2003, California amended Section 19177 to provide for a penalty of fifty percent of the gross income derived from the promotional activities.  The FTB sought to apply that fifty percent penalty retroactively to the conduct alleged to have occurred in 2001.
    • The Superior Court held that the fifty percent penalty could not be applied retroactively. 
    • The court observed that, under California law, "it is an established canon of interpretation" that statutes are not to be applied retroactively absent clear legislative intent to the contrary.
    • The court considered the relevant effective date provision, which stated that "Unless otherwise provided, this act shall apply with respect to any penalty assessed on or after January 1, 2004, on any return for which the statute of limitations on assessment has not expired.  All other provisions of this act shall apply on and after January 1, 2004." 
    • The FTB argued that the effective date provision provides that the penalty may be imposed on activities occurring prior to enactment of the increased penalty, as long as the penalty is imposed after January 1, 2004.  The plaintiffs argued that the second sentence of the effective date provision applies and mandates a prospective-only application.
    • The court cited several federal law cases holding that the Section 6700 promoter penalty is not a penalty assessed on a tax return.  Because California courts presume the California legislature to have adopted the construction of a federal statute when enacting legislation modeled on federal law, the court determined that the California legislature is presumed to have adopted the federal courts’ recognition that the promoter penalty is not assessed on a return.  Thus, the court determined that the first sentence does not apply to the promoter penalty because that penalty is not assessed on a return.
    • The court determined that the second sentence of the effective date provision is applicable to the promoter penalty and that the second sentence requires that the penalty be applied prospectively only.
    • The court also determined that the legislative history did not contain any indication that the legislature intended the fifty percent penalty to apply retroactively.
    • Because the court concluded that the plain language of the statute required the fifty percent penalty to be applied prospectively only, it did not reach the issue of whether retroactive application of the fifty percent penalty would violate the Due Process Clause of the Fourteenth Amendment of the United States Constitution or the Due Process Clause of the California Constitution.
  • The decision was issued in the companion cases Quellos Financial Advisors, LLC v. Franchise Tax Board, CGC-09-487540, and Quellos Group, LLC v. Franchise Tax Board, CGC-10-501299.
  • The decision can be accessed here.
  • For additional information, contact: - Matthew D. Lerner - mlerner@steptoe.com or Amanda Varma - avarma@steptoe.com

MISCELLANEOUS GUIDANCE RELEASED:

Notice 2012-10 provides guidance as to the corporate bond weighted average interest rate and the permissible range of interest rates specified under § 412(b)(5)(B)(ii)(II) of the Internal Revenue Code as in effect for plan years beginning before 2008. It also provides guidance on the corporate bond monthly yield curve (and the corresponding spot segment rates), and the 24-month average segment rates under § 430(h)(2). In addition, this notice provides guidance as to the interest rate on 30-year Treasury securities under § 417(e)(3)(A)(ii)(II) as in effect for plan years beginning before 2008, the 30-year Treasury weighted average rate under § 431(c)(6)(E)(ii)(I), and the minimum present value segment rates under § 417(e)(3)(D) as in effect for plan years beginning after 2007.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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