In a reminder that there are limits on the retroactive application of tax laws, a California Superior Court rejected the Franchise Tax Board’s attempt to impose retroactive penalties on a tax shelter promoter. Quellos Fin. Advisors, LLC v. Franchise Tax Bd., Case No. CGC-09-487540 (San Francisco Super. Ct., Tentative Statement of Decision, Oct. 31, 2011).
Quellos was promoting the allegedly abusive tax shelter in 2001. California law tied the amount of the applicable penalty to that in I.R.C. § 6700, which established a maximum penalty of $1,000. Cal. Rev. & Tax Cd. § 19177. In 2003, California amended section 19177 to substantially increase the promoter penalty from $1,000 to 50% of the income derived by the promoter from the tax shelter promotion activity. The FTB assessed the 50% promoter penalty against Quellos in November 2009 for its promotion activities alleged to have occurred in 2001. Quellos argued that the pre-2003 law imposed a maximum penalty of $1,000 and the 2003 amendment could not be applied retroactively to Quellos’s 2001 activities.
The Superior Court ruled in favor of Quellos and rejected the FTB’s position that the 2003 amendment to section 19177 could be applied retroactively. The court observed the general rule that as a matter of statutory interpretation, legislation must be applied prospectively unless there is a clear expression of legislative intent to apply it retroactively. The amendment did not have an effective date provision specific to it alone, but the amending Act’s effective date provided that it “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 court held that the first sentence did not apply to section 19177 because, under federal law, the promoter penalty is not a penalty that is assessed “on a return” but rather is imposed on the activities of the promoter, regardless of whether a return was filed. The court therefore concluded that the 2003 amendment applied prospectively “on and after January 1, 2004,” and that the alleged promotion activities must have occurred on or after that date to fall within the higher penalty.
The court was able to resolve the case on statutory interpretation grounds and, therefore, did not have occasion to address the taxpayer’s constitutional due process claims. Interestingly, another recent case involving an attempt to retroactively deny New York Enterprise Zone tax credits did reach the constitutional claims and ruled that the retroactive denial of credits in that case constituted a violation of the taxpayer’s due process rights. James Square Assocs. LP v. Mullen, No. 11-00675, 2011 N.Y. Slip Op. 08423 (N.Y. App. Div. Nov. 18, 2011).
These cases serve as important reminders that taxpayers are entitled to know the consequences of their actions at the time they occur, and subsequent law changes should not change those consequences retroactively. The FTB is expected to appeal the decision.