State & Local Tax Bulletin
(Volume 1, Number 4, September
The California Use Tax Will Not Lie
Where a Taxpayer's
Use of Property
in the State Is De
Nielsen, of counsel in the San
Francisco office of Pillsbury Winthrop
Shaw Pittman LLP.
This information is only of a general nature, intended
as background material, omits many details and special rules and cannot
be regarded as
legal or tax advice.
Recently, following a four-year odyssey through the California sales and use tax administrative
process, the buyer and seller in a transaction which occurred in California were successful in
abating separate assessments in two extremely unusual cases. The cases, which were handled by
the firm, revolved around whether a 1986 sale in California of a mobile magnetic resonance imaging
unit by Diasonics, Inc. (Diasonics) to Mobile M.R. Inc. (Mobile) was subject to either the sales or
the use tax. The taxpayers' long and successful journey through the administrative process took
several unexpected twists and turns due to the applicability of seldom-encountered sales and use
tax statutes involving sales of vehicles, statutes of limitations, and exclusions for storage, use and
Diasonics was a manufacturer of medical electronic diagnostic equipment. Mobile provided the use
of mobile magnetic resonance imagers ("MRI") to doctors and hospitals. An MRI produces a
three-dimensional picture of a patient's internal organs and structures similar to a CAT-scan. The
MRI was installed in the trailer section of a tractor/trailer and was towed from hospital to hospital
as needed. As was later determined, Diasonics was neither licensed nor certificated as a dealer
under the Health and Safety Code or the Vehicle Code.
On June 17, 1985, Diasonics entered into an MRI Purchase Agreement with Mobile to sell seven
mobile MRIs. The sale of the second mobile MRI to Mobile by Diasonics was the subject of the
instant cases. The total price for the second mobile MRI and van was $2,100,000. The purchase
agreement provided that Diasonics would provide certain training to physicians and technicians
selected by Mobile within 10 days after the purchaser executed a certificate of completion.
The use of mobile MRIs was in the development stage at this time and various technical problems
arose in the first unit sold to Mobile. Proper installation was critical to the unit's performance,
especially to ensure that passing vehicles and movement of the unit between locations would not
disrupt the unit's magnetic field. Accordingly, the purchase agreement was amended to provide
that, before making final payment, Mobile was entitled to a period of up to 60 days following
delivery of the second unit to verify that the system was performing to specifications.
Diasonics manufactured the second MRI and then shipped it to a van manufacturer in Illinois. The
van manufacturer built a trailer van to house the MRI and returned the unit to Diasonics in
California. Diasonics delivered the second mobile MRI unit to Mobile on May 19, 1986 at the
Scripps Clinic in Rancho Bernardo, California. Mobile had a preexisting contract to perform
imaging services for doctors in Oklahoma and acquired the second unit for use there. Because of
the problems experienced with the first unit, Mobile decided to subject the second unit to rigorous
testing before sending it to Oklahoma. The tests had to be done in California because adequate
facilities were not available in Oklahoma to correct any defects.
Mobile had been using the first unit to perform imaging services for various doctors and hospitals
in California. After the second unit was delivered, Mobile would on occasion substitute the second
unit for the first to see if the second unit was functioning properly. The unit did not produce
satisfactory images and had to be returned to Diasonics on several occasions to correct such
problems. This went on for a period of about five months. Supplier invoices indicate that during
this period of time, Mobile made monthly purchases of cryogen, which is used to cool MRI units.
Finally, in about October 1986 following a last attempt to correct outstanding problems, Mobile
decided to transport the unit to Oklahoma. Apparently, Mobile concluded that even though the unit
never performed well enough under California medical standards, the unit would be satisfactory
under the less stringent standards of Oklahoma.
Diasonics reported the sale to Mobile on its fourth quarter 1986 Oklahoma sales and use tax return.
However, it was later determined that such mobile units should not be so reported as they were
subject to a motor vehicle excise tax. Diasonics requested and obtained a refund and subsequently
on February 23, 1987, about nine months after accepting delivery in California, Mobile registered
the unit in Oklahoma. It paid $64 in registration fees and an excise tax of $64,375 to Oklahoma for
the unit. Diasonics did not report the sale of the second unit to Mobile as a taxable sale in
California, and Mobile had never registered the unit in California.
The California State Board of Equalization ("Board") originally determined that Diasonics was
liable for $126,814 in sales tax plus interest on the sale of the second unit to Mobile.
Diasonics paid the amount, and both Diasonics and Mobile petitioned for redetermination.[fn. 1] Following a preliminary hearing and two
Decisions and Recommendations, the Board's staff recommended a redetermination (as explained
more fully below) in favor of Diasonics and a refund of sales tax and interest. However, the staff
then recommended that a use tax of $126,814 plus interest be assessed against Mobile,
which was petitioned by the taxpayer. While Mobile's petition was working its way through the
administrative process, the Board's staff held its recommendation regarding Diasonics' refund in
abeyance pending resolution of the Mobile matter.
Diasonics' Petition for Redetermination
At the September 26, 1991 preliminary hearing conducted before a hearing officer of the Board,
various arguments were presented on behalf of both Diasonics and Mobile regarding their
respective positions concerning the taxability of the unit in question. A declaration was submitted
from the out-of-state manufacturer of the trailer van that said units are customarily registered in
California with the Department of Motor Vehicles. The Board's hearing officer, in her Decision
and Recommendation issued on April 3, 1992, initially rejected all such contentions, finding that
Diasonics was a retailer and was required to collect the sales tax. The hearing officer also
concluded that Mobile had made a taxable use of the unit in California notwithstanding that Mobile
subsequently shipped the unit to Oklahoma and paid tax on it there.
Diasonics and Mobile requested an oral hearing before the full Board. Prior to that hearing,
scheduled for October 5, 1992, the taxpayers were notified that the matter was being further
reviewed by the Board's Appeals Review Section. On October 9, 1992, a Supplemental Decision
and Recommendation was issued wherein the Board's staff concluded that under RTC
§ 6282 Diasonics was not required to pay sales tax.
RTC § 6282 provides:
- There are exempted from the computation of the amount of
the sales tax the gross receipts from sales of mobilehomes or commercial coaches required to be
annually registered under the Health and Safety Code or vehicles required to be registered under
the Vehicle Code when the retailer is other than a person licensed or certificated pursuant
The Board's staff concluded that Diasonics was not a licensed dealer and therefore it had no
responsibility to pay a sales tax or to collect the use tax. However, pursuant to RTC
§ 6292, the Board's staff recommended a use tax be determined against Mobile
because it was the purchaser of a vehicle which was required to be registered. This is analogous to
an individual buying a used car from a private party (non-dealer) and paying use tax when
he or she registers it with the DMV. The staff did not reconsider the part of its ruling that Mobile
had made a taxable use of the unit in California. The staff's recommendation regarding Diasonics
was held in abeyance pending resolution of the Mobile determination.
Open-Ended Statute of Limitations
On December 29, 1992, two months after the Supplemental Decision and Recommendation was
issued in the Diasonics matter, the Board issued a Notice of Determination against Mobile
regarding its purchase of the second unit in the total amount of $248,555 ($126,814 tax, $109,060
interest and $12,681 penalty). The transaction under review occurred in May 1986 and the Board
was now issuing a determination for the first time against Mobile in December 1992, some six
years after the transaction.
The Board relied upon the little noticed and used subsection (c) of RTC § 6487 which
provides that if a notice of deficiency determination has been issued for the sale of
property, the statute of limitations will not bar a later proposed determination of use tax on
the same transaction. The section essentially overrides the otherwise three-year statute of limitation
(in cases other than fraud and failure to file a return) for the issuance of deficiency determinations
provided in subsections (a) and (b) of RTC § 6487.
Mobile's Petition for Redetermination
Following receipt of its Notice of Determination, Mobile petitioned for redetermination and
primarily argued that any use it made constituted nontaxable testing, and relied upon the Board's
Sales and Use Tax Annotation 570.1180 which provides that
- The testing of equipment in this state which is not used in
production here and is subsequently used solely outside this state meets the requirements of
Section 6009.1 for exemption from use tax.
RTC § 6009.1 limits the broad definition of taxable use found in RTC § 6009 and
- "Storage" and "use" do not include the keeping, retaining or
exercising any right or power over tangible personal property for the purpose of subsequently
transporting it outside the state for use thereafter solely outside the state . . . .
The Board generally has applied the section 6009.1 exclusion from storage and use in situations
where the purchaser of property attempts to avoid application of the use tax (e.g., property
purchased from outside of California). When property is sold in California, generally the
applicable tax is a sales tax against the seller and RTC § 6009.1 would not be relevant in the
Board's viewpoint. Accordingly, in order for Mobile to contend that its usetestingwas an
excepted or nontaxable use, it was necessary that its transaction with Diasonics be examined in the
use tax rather than the sales tax context. As explained above, due to the unusual procedural
posture of this case, Mobile was able to rely upon RTC § 6009.1, whereas Diasonics would
not have been able to do so.
At a preliminary hearing held on December 16, 1993, Mobile presented its arguments, supported
by documentary evidence and three witnesses. One month later, the Board's hearing officer issued
an adverse Decision and Recommendation and held that the testing conducted by Mobile
constituted a taxable use of the property in question.
The hearing officer concluded that Mobile used the unit for its intended purpose, that is, to make
images for customers as part of the regular business operations, just as it would use any other
capital asset. This conclusion was premised on the fact that Mobile allegedly earned revenue from
the testing of the unit due to its occasional substitution for the first unit on Mobile's hospital route
during the time it was in California. The hearing officer also stated that even if the unit earned no
revenue, the fact that it was used on jobs meant to earn revenue would constitute a taxable use.
Mobile argued that the alleged earning of revenue should not defeat the exempt nature of testing
and cited the Board's Annotation 210.0060 which provides that assessing a charge in connection
with demonstrating an item held for sale does not defeat the exemption or nontaxable nature of
Mobile requested an oral hearing before the full Board and on November 16, 1994, Mobile
presented its evidence both documentary and oral (three witnesses plus a declaration) to the Board.
There was much discussion and questioning by the Board regarding the nature, length and method
of testing undertaken by Mobile during the time the unit was in California. The Board was
concerned about how a finding of taxability in this context would affect California industries that
are developing new technologies and may need to engage in forms of testing not normally
encountered by the Board's staff.
On February 1, 1995, the Board issued a Redetermination to Mobile abating the entire amount of
tax, interest and penalty. The Board ruled that "any use of the mobile imagers in California was de
minimis." Five months later, the Board issued a Redetermination to Diasonics deleting the tax on
the unit in question and refunding the tax and interest previously paid.
There were many factors in this matter which influenced the final decision rendered by the Board,
including the fact that new technology was involved; tax was paid to another state; the credibility of
the witnesses; and the staff's overly strict interpretation regarding what constitutes a taxable use
within the context of testing. While this decision is not precedential because it was not published,
it should provide taxpayers with hope that the long and winding road of the administrative process
can lead to victoryalbeit sometimes at the last turn in the road.
- Mobile petitioned as an interested party under RTC § 6561
because it was contractually liable for any tax. [return to text]
- RTC § 6094(a) provides that use tax applies to property
purchased under a resale certificate which is used for purposes other than retention, demonstration
and display while holding it for sale in the regular course of business. [return to
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