Another Deference Blow: In Rebuke, California Court Voids Non-Compliant Tax Regulations

Judicial deference to administrative agency regulations is a contentious topic in the legal sphere. As a recent article by this author reported, the U.S. Supreme has taken up a challenge to the longstanding Chevron doctrine, which requires judicial bodies to defer to administrative regulations that interpret ambiguous statutes, as long as those regulations are based on a “permissible construction” of the statute at hand. The Court’s ultimate decision is expected to have significant repercussions at the state level, with the potential to disrupt tax law regulations and more informal guidance in many jurisdictions.¹ While the broader issue of the appropriate level of deference afforded to administrative regulations is very much in question, one particular nuance to the deference issue—namely, the issue of how much deference to afford a regulation that was not issued in compliance with a state’s Administrative Procedure Act (APA)—was recently directly addressed in California, in two orders. In the second, an opinion characterizing the state taxing agency’s arguments as verging on “frivolous” and even “feckless,” a California Superior Court judge reiterated last week that the level of deference owed to non-compliant regulations is, quite simply, no deference at all.

The California APA challenge.

In American Catalog Mailers Association (ACMA),² the plaintiff, a non-profit trade association, challenged the Franchise Tax Board’s application of Public Law 86-272. In particular, the plaintiff sought (among other things) a ruling that two pieces of guidance issued by the FTB—Technical Advice Memorandum (TAM) No. 2022-01, 02/14/2022 and FTB Informational Publication No. 1050, 06/01/2017—were invalid because the FTB failed to comply with the California Administrative Procedure Act (APA). TAM No. 2022-01 and FTB Informational Publication No. 1050 collectively set forth the FTB’s interpretation of how P.L. 86-272 applies in the context of modern electronic commerce; substantively, these pieces of guidance were modeled in significant part after the Multistate Tax Commission’s Statement of Information Concerning Practices of the Multistate Tax Commission and Supporting States Under Public Law 86-272. However, as the FTB conceded before the Superior Court, neither piece of guidance was enacted in compliance with the APA, which generally requires administrative agencies to give the public notice of proposed regulatory actions, issue a complete text of the proposed regulation along with a statement of reasons in support, give interested parties the opportunity to comment on the proposed regulation, respond in writing to public comments, and forward a file of all materials upon which the agency relied to the Office of Administrative Law.³ Collectively, these APA “notice and comment” requirements are intended to ensure that persons impacted by the regulation can participate in the rulemaking process and have sufficient notice of the rule’s requirements.⁴

“Underground regulations” voided in summary judgment ruling.

In ruling on the plaintiff’s motion for summary judgment, the court agreed with the plaintiff that TAM No. 2022-01 and FTB Informational Publication No. 1050 were invalid “underground regulations” because the FTB did not follow the APA’s mandates. The FTB argued that the requirements of the APA did not apply to either TAM No. 2022-01 or FTB Informational Publication No. 1050, because the APA governs the issuance of “regulations” and its guidance did not meet the definition of a regulation. However, the court found that this argument lacked merit, in light of the APA’s broad definition of a regulation⁵ and California Supreme Court precedent which held that a regulation subject to the APA has “two principal identifying characteristics”—first, that the rule must be generally (but not necessarily universally) applicable, and second, that the rule must implement or interpret a law administered by the agency or govern the agency’s procedure.⁶ The court in ACMA held that TAM No. 2022-01 and FTB Informational Publication No. 1050 “indisputably are generally applicable rules” and that these pieces of guidance “interpret the FTB’s application of P.L. 86-272.” Therefore, both of the Tidewater elements were met and the FTB’s guidance was subject to the APA’s notice and comment rulemaking requirements.

Turning then to the import of the FTB’s guidance, the Court determined that both pieces of guidance were void. Again citing Tidewater, the Court noted that when the APA applies, administrative policies that are not adopted in accordance with notice and comment rulemaking procedures are void regulations that are not entitled to any deference.

Motion to vacate rejected and characterized as frivolous.

The FTB challenged the court’s determination and filed a motion to vacate the court’s judgment. In its subsequent ruling, the court found that the FTB’s “motion verges on the frivolous.”⁷ The Court reiterated that TAM No. 2022-01 and FTB Informational Publication No. 1050 are void and also explained that a court may not “defer to such a void regulation.” The Court found the FTB’s argument that void regulations are not necessarily “wrong” to be a non sequitur, noting that the question of whether the FTB’s interpretation of P.L. 86-272 is legally correct is a “a question for another day.” Finally, the Court concluded its opinion with the statement that “[t]he FTB’s motion is feckless.”

The broader takeaway.

The California ACMA case highlights the fact that, while state revenue agencies have traditionally been afforded a significant amount of leeway in interpreting state tax laws, their interpretations are not immune from challenge. All states (and the federal government) have administrative procedure acts that require agencies to adopt regulations in accordance with notice and comment rulemaking procedures. Not every state has clear precedent regarding the level of deference that agency rules should be afforded generally, and even fewer cases discuss how “APA-non-compliant” rules should be treated if challenged in litigation. The California case may provide a roadmap for taxpayers who believe they are being forced to comply with rules that haven’t undergone a proper notice and comment rulemaking procedure. On the flip side, this case should serve as a warning to state regulators that they should comply with APA requirements when issuing guidance, or face the risk that their guidance will be given no deference by a reviewing tribunal.

More broadly, in the midst of potentially changing deference standards, taxpayers should regularly examine the level of deference that tribunals have given to agency interpretations in the past, so that they are prepared to raise a deference challenge if necessary, while state agencies should likewise be prepared to defend against these challenges. Deference challenges may not be the first line of attack that taxpayers or their advisors consider when considering state tax litigation, but as the ACMA case shows, challenging a tax department’s actions on non-tax grounds can be fruitful. If the Supreme Court overturns the highly deferential Chevron standard later this year, state-level deference challenges will likely become even more common, and both taxpayers and state revenue departments should take care to ensure they are in the best position to encounter this challenge.

Checkpoint resources. For a discussion of California’s approach to P.L. 86-272 and nexus, both in connection with the APA litigation and more broadly, see:

• Catalyst Topic # 1002CA:1000, Nexus in California (Corporate Income Tax);
• Catalyst Topic # 1010CA:1000, Electronically Delivered Goods and Services in California.