In First American Title Ins. Co. v. Cal. Dep't of Tax and Fee Admin.¹ (First American case), the Superior Court of California for San Diego County (court) found that a use tax regulation violated California's Constitution because it imposed sales tax on a lease for tangible personal property (TPP) between an insurance company and a non-California lessor, even though the state's constitution prohibits the imposition of certain business taxes on insurance companies that pay gross premiums tax. Accordingly, affected insurance companies with similar facts that may have paid California sales tax on TPP leases because of 18 Cal. Code Regs. Section 1660, subd. (c)(1) (Regulation 1660(c)(1)) should consider filing protective refund claims.

Background

First American Title Insurance Company (First American) sought a refund of "sales" tax² it paid to lease computer equipment and comparable property in California from October 1, 2007 through September 30, 2011. The California State Board of Equalization (SBE), which administered California sales and use taxes at that time, granted First American a partial refund for taxes paid on leases with non-California lessors.

In 2017, the California Department of Tax and Fee Administration (CDTFA) took over administration of California sales and use tax. When First American submitted claims for additional refunds, the CDTFA held them in abeyance. First American then filed suit to compel the CDTFA to pay the partial refund granted by the SBE and refund other taxes paid to California lessors that the SBE did not approve and the CDTFA did not consider.

First American asserted that the collection of these taxes violated Cal. Const., Article XIII Section 28, subd. (f), which exempts insurance companies doing business in California and paying gross premiums tax³ from paying "all other taxes and licenses, [California] state, county, and municipal … except as otherwise provided" (Insurance Exemption). Specifically, First American argued that Regulation 1660(c)(1) tries "to avoid the Insurance Exemption" by (1) applying sales tax to a TPP lease when the lessee is not subject to the use tax, and (2) specifically including insurance companies as an example of the regulation's application.

First American also argued that "the reclassification of the use tax as sales tax in the case of insurance-company leases had the effect of unlawfully imposing a sales tax on non-California lessors," and that California did not have jurisdiction to impose sales tax on out-of-state vendors that had no in-state participation in the "sale."

Lastly, First American argued that the state agency's adoption of Regulation 1660(c)(1) was "outside the scope of legislatively delegated authority."

Analysis

The court addressed three issues: (1) whether the regulation is void because it violates the state constitution; (2) whether the regulation is void because the agency exceeded its regulatory authority by promulgating a regulation that conflicts with California tax law; and (3) whether the regulation could be construed to apply only to insurance companies that lease equipment from California lessors. The court found for First American on all three issues.

The court found the Regulation 1660(c)(1) violated the California constitution because it sought to "evade or circumvent the constitutionally imposed [Insurance Exemption]." In support of that conclusion, the court noted that (1) the regulation imposed a sales tax on First American because it was exempt from use tax; and (2) neither the SBE nor the CDTFA had the statutory authority to change a use tax into a sales tax.

The court also agreed with First American that the CDTFA had exceeded its authority because Regulation 1660(c)(1) conflicts with the federal Commerce Clause and Regulation Section 1620, which prohibits the imposition of sales taxes on certain non-California businesses. The court reasoned that the CDTFA collected taxes on TPP leases without determining whether the non-California lessors had any in-state participation in the lease transaction.

Finally, the court found that limiting Regulation 1660(c)(1) to TPP leases between insurance companies and California lessors would discriminate against California lessors, thereby giving out-of-state lessors an unfair advantage.

The court granted First American's claim for attorneys' fees, essentially finding that the CDFTA's position lacked "substantial justification."

Refund opportunity

It is not yet known whether the CDTFA will appeal the First American case. If the court's ruling ultimately stands, insurance companies that paid tax under Regulation 1660(c)(1) should consider filing a protective refund claim as soon as possible to preserve the statute of limitations. For California sales and use tax purposes, the statute of limitations to file a refund claim is generally three years following the close of the period in which the overpayment was made.⁴

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ENDNOTES

¹ First American Title Ins. Co. v. Cal. Dep't of Tax and Fee Admin., Case No. 37-2018-00065184-CU-WM-CTL (Cal. Superior Ct., San Diego Cnty., March 13, 2020) (First American case).

² The court stated that during the administrative proceedings the SBE's "staff agreed that First American had standing to seek a refund 'on the basis that [First American] alleges that the tax amounts represented use tax, rather than sales tax or sales tax reimbursement.'" First American case, p. 4.

³ Generally, insurance companies are subject to a gross premiums tax on all California premiums written. The Insurance Exemption set forth in California's Constitution precludes the imposition of most other state and local taxes on insurers with a few limited exceptions. See Cal. Const., Art. XIII Section 28, subd. (a)-(b) and (f). The California Supreme Court has held that the "in lieu of" provision is intended to provide insurance companies with a broad exemption in exchange for a tax on gross premiums. Mutual Life Ins. Co. v. City of Los Angeles, 50 Cal. 3d 402, 409-410 (1990).

⁴ Cal. Rev. & Tax. Code Section 6902(a).