Did money returned to a buyer under a court-ordered defective-merchandise settlement reduce the original taxable sales price?

Plain-English summary

The Board first confirmed that its defective-merchandise deduction could apply whether or not a buyer physically returned defective goods, subject to reducing the deduction by the returned property's remaining value.

But it drew a different rule for court-ordered settlements. Money returned to a buyer under such a settlement was treated as damages caused by the seller's wrongful conduct, not as a post-sale adjustment to the original price. The defective-merchandise deduction mechanism therefore did not reduce taxable sales price in that situation.

Citations and references

• California Sales and Use Tax Regulation 1655(b) (as cited)
• California State Board of Equalization Audit Manual section 0413.35 (as quoted)
• Southern California Edison Co. v. State Board of Equalization, 7 Cal. 3d 652 (as cited)
• Audit Review and Refund Unit's request for advice about L--- C--- Co., Inc.'s refund claim; David Levine's May 15, 1989 response; and Rick Kinoshita's July 6, 1989 request for Gary Jugum's review — described; requests, claim, response, correspondence, attachments, and complete prior administrative materials not reproduced in the official PDF
• L--- C--- merchandise return under a court-ordered settlement and possible similar refund claims — facts supplied; merchandise, sale records, defect evidence, credits, court pleadings, order, settlement, damages calculation, refund claims, returns, and tax computations not reproduced in the official PDF
• Official Annotation 295.0168's court-ordered-settlement damages and no-price-adjustment summary, dated Sept. 13, 1989 — annotation omits the returned-merchandise rule, L--- C--- provenance, internal review history, other possible claims, Audit Manual quotation, authorities, and missing records and supplies no additional adjudicative record
• Possible later refund determination, action on similar claims, audit, assessment, payment, refund, appeal, court disposition, or other agency action — not supplied in the official PDF

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/295-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/295-0168.pdf

Original ruling text

State of California

Board of Equalization

Memorandum

To:

Audit Review and Refunds
(R. Buntjer)

From:

E. L. Sorensen, Jr.

Subject:

Defective Merchandise (Regulation 1655(b) and
Court Ordered Settlements

295.0168

September 13, 1989

DEFECTIVE MERCHANDISE DEDUCTION
On May 15, 1989, Mr. David Levine of our staff responded to the Audit Review and Refund Unit’s request for advice regarding a claim for refund of L--- C--- Co., Inc., SR -- XX-XXXXXX. On July 6, 1989, Mr. Rick Kinoshita of your unit requested that Assistant Chief Counsel Gary Jugum review Mr. Levine’s May 15 advice. Mr. Kinoshita was concerned that Mr. Levine’s advice with respect to the application of Regulation 1655(b) was not consistent with our prior administrative interpretation of the regulation. The area of concern related to Mr. Levine’s conclusion that the defective merchandise deduction was applicable in situations where defective merchandise was returned by the purchaser to the seller. We understand that at some time in the past it had been our administrative position that if defective merchandise was returned to the seller, no allowance for defective merchandise was permissible. The language of the regulation is neutral on this point. However, since at least 1979, Audit Manual section 0413.35 has been quite specific in allowing the deduction in situations where merchandise is returned, by providing: “When defective merchandise is returned to the seller, under conditions not meeting the requirements of Regulation 1655 (0413.05), a deduction may be taken only for the amount credited or refunded because of the defective condition of the merchandise. No deduction can be allowed for the amount refunded or credited because of the return of the merchandise. Accordingly, where the returned defective merchandise has some value, the amount refunded or credited to the customer must be reduced by the value of the merchandise in its defective condition.” (AM § 0413.35.)

Audit Review and Refund Unit

-2-

September 13, 1989
295.0168

In view of the clear language of the Audit manual, it is our view that the defective merchandise deduction is applicable whether or not the defective merchandise is returned to the seller by the purchaser. As discussed below, this conclusion does not apply to court ordered settlements. COURT ORDERED SETTLEMENTS Our review of the L--- C--- matter indicates that the merchandise returned in that case was returned pursuant to a court ordered settlement. Mr. Kinoshita’s July 6 correspondence stated that there may be several other claims for refund which raise issues similar to those raised in the L--- C--- matter. With respect to L--- C--- and any other matters which involve court ordered settlements, the question of a defective merchandise deduction is never reached. This is because amounts returned to a buyer pursuant to a court ordered settlement are not considered price adjustments which alter the original sales price but, rather, are in the nature of damages which do not differ in any realistic sense from any other damages paid by a seller as a result of the seller’s wrongful actions in the conduct of the sale transaction (See Southern California Edison Co. v. State Board of Equalization, 7 Cal. 3d 652). Consequently, in the case of court ordered settlements, there is no basis for any post sale “sales price” adjustment pursuant to the defective merchandise deduction mechanism.

ELS:jb

cc:

Mr. Gary J. Jugum
Mr. Donald Hennessy
Mr. Robert Pieroni
Mr. Rick Kinoshita – Audit Review and Refund Unit