This story was originally published by CalMatters. Sign up for their newsletters.
The California Department of Tax and Fee Administration oversees the collection of sales taxes by more than a half million retail sellers, ranging from giants such as Amazon and Walmart to one-person internet sellers.
The agency audits retailers’ sales tax reports to ensure state and local governments receive approximately $50 billion that the tax — 10% or higher in many communities — generates each year.
One point of potential friction is whether the items being sold are subject to taxation, which is not as simple as one might expect. While generally we may assume that food and prescription drugs are exempt from taxes applied to everything else, in fact there are dozens of other exemptions, and defining them can be quite tedious. A recent case brought before the Office of Tax Appeals illustrates that fact.
A one-woman home business in Fontana that operates under several names, including Henry’s Catering, produces lasagnas and other foods that are frozen and sold, primarily to pharmaceutical salespersons who serve the reheated food to doctors and other hospital staffers during product presentations.
The short version of the complex and lengthy dispute is that Henry’s Catering treated the frozen items as exempt from taxes because cold food is generally exempt, while hot food is generally taxable.
The Department of Tax and Fee Administration audited Henry’s Catering and concluded the frozen food it was selling should have been taxed as hot food because it needs reheating before it’s eaten.
After negotiations, the agency finally decreed that the owner owed the state an additional $44,949 plus interest, which she appealed to the Office of Tax Appeals. After a hearing, a panel of three administrative law judges ruled against Henry’s.
The panel conceded that the business owner had a point because, “grocers and other food retailers routinely sell frozen meat lasagna” that’s tax-free. However, she could not produce evidence to prove it, the board concluded, saying, “overcoming the presumption of taxability requires appellant present evidence that, based upon all the facts and circumstances, shows it is more likely than not that appellant’s food items were not sold as hot prepared food. The record is short on such details.”
The frozen lasagna case is interesting unto itself, but also illustrates a rarely mentioned fact about not only sales taxes, but all forms of taxation — what is taxed and how much it is taxed are purely arbitrary decisions by legislators and bureaucrats, driven more by revenue outcomes than logic or consistency.
The hot food vs. cold food provision in state law demonstrates the arbitrary nature of taxation, as did another dispute some years ago, when the state Board of Equalization, formerly the venue for tax disputes, dealt with popcorn.
A theater chain in the San Francisco Bay Area objected to collecting tax on popcorn it sold to movie patrons, arguing that the popcorn may have been hot when sold but was cold by the time the customer returned to his or her seat. The board arbitrarily ruled that popcorn is a cold food and therefore is not taxable.
The state publishes a booklet that details dozens of sales transactions that are exempt, including “sales of hot prepared food products to airlines and sales to passengers by such airlines engaged in interstate or foreign commerce,” and lists the monetary value of each.
For instance, while consumers must pay taxes on purchases of computer software, custom software that may cost many thousands of dollars is exempt.
Why? In 1982, a legislator who represented Silicon Valley carried a bill for software creators to make that distinction. The loophole lowers state revenue by $52.3 million per year.
That’s arbitrary tax policy in a nutshell.
