Dear Retail Clients and Friends:

The California Supreme Court recently ruled that consumers cannot file suit to force a retailer to seek a refund of sales taxes from the California tax agency absent a determination by the agency or a court that the sales tax was improperly collected. This edition of Morgan Lewis Retail Did You Know? takes a look at the decision and the guidance it provides.

Background

The McClain v. Sav-On Drugs lawsuit started almost 15 years ago on December 1, 2004, when two putative class actions were filed in the Los Angeles County Superior Court challenging various retailers’ collection of sales tax reimbursements from customers on sales of glucose test strips and skin puncture lancets. Plaintiffs argued that a California Board of Equalization regulation passed in 1999 exempted such products from sales tax collection, despite the regulation’s and the board’s subsequent clarifying instructions that the exemption only applied where the products were sold by a registered pharmacist instead of off-the-shelf. Although the sales tax reimbursements had been remitted to the state, plaintiffs sought refunds from the retailers.

During the litigation of these cases, the California Supreme Court issued a favorable decision in a similar case. There, consumers similarly argued that the retailer improperly charged and collected sales tax reimbursements on non-taxable “to go” transactions. The court held that the plaintiffs could not bring such claims against retailers because the California Revenue and Taxation Code provides the exclusive means to remedy an alleged tax overpayment. In cases of alleged overpayment of sales tax, the California tax agency, in the first instance, is the entity solely responsible for determining whether transactions are taxable and how much tax is due as well as whether a retailer has charged excess reimbursement on a sale and whether the retailer is required to refund the consumer. Until then, Section 6901.5 of the Tax Code provides the taxpaying retailer with a “safe harbor,” insulating it from suits by consumers seeking refunds of amounts that the retailer remitted to the state. The court, however, noted that Regulation 1700(b)(2), adopted by the board to carry out the terms of Section 6901.5, could reasonably be interpreted to allow a consumer to file an action to require the retailer to seek a refund from the board where neither the retailer nor the board had an interest in “ascertaining” whether an excess reimbursement had been charged. If the board agreed with the consumer, then it could refund the sales tax to the retailer on the condition that it then be refunded to the consumer.

Following that decision, the trial court in this case sustained the retailers’ demurrer, holding that the plaintiffs’ claims required it to do what it could not: make a taxability determination in the first instance, without the benefit of any administrative proceedings before the California tax agency. On appeal, the plaintiffs focused primarily on the argument that they should be allowed to compel the retailers to file a refund claim with the agency. The court of appeals disagreed, holding that such a claim could only be brought in unique circumstances that were not present here—namely, “(1) the person seeking the new tax refund remedy has no statutory tax refund remedy available to it; (2) the tax refund remedy sought is not inconsistent with existing tax refund remedies; and (3) the [agency] has already determined that the person seeking the new tax refund remedy is entitled to a refund, such that the refusal to create that remedy will unjustly enrich either the taxpayer/retailer or the [agency].”

The California Supreme Court’s Decision

The California Supreme Court granted the plaintiffs’ petition for review in this case to consider the question: “Can a purchaser of products allegedly exempt from sales tax but for which the retailer collected sales tax reimbursement bring an action to compel the retailer to seek a sales tax refund from the [California tax agency] and remit the proceeds to the purchasers?” On March 4, the court issued its decision affirming the judgment of the court of appeals.

The court noted that in a prior decision, Javor v. State Bd. of Equalization, it had allowed consumers to maintain an action to compel the retailer to seek a refund of sales tax paid in excess of the amount owed, but then clarified that the decision in that case was based on the fact that the California tax agency had already determined that a refund was appropriate. To the extent there was any lingering doubt about the reach of Javor, the court expressly resolved it in this opinion: “to be eligible for a Javor remedy, plaintiffs must show, as a threshold requirement, that a prior legal determination has established their entitlement to a refund.” And even then, “additional legal and equitable hurdles still may lie between a consumer and a Javor remedy.” To hold otherwise would impermissibly require courts to make a threshold determination of taxability, which is instead entrusted to the California tax agency. Given that there was no prior legal determination “as to whether sales tax was owed on the goods at issue here,” the plaintiffs could not maintain their action and the trial court had properly sustained the demurrer.

The court then explained that consumers who believe that they were charged improper sales tax reimbursement are not without recourse. For example, they have the ability to complain to the California tax agency or seek a judicial declaration as to the validity of any regulation promulgated by the agency. The court, however, declined to opine on “what remedies might be available to a claimant who has been unable to obtain a determination about the taxability of particular transactions using the available avenues,” because there was “no indication in the record that plaintiffs have pursued any avenues other than this lawsuit for obtaining a resolution of the taxability question that underlies their claim for relief.”

Practical Implications

This decision should largely resolve consumer challenges to retailers’ collection of California sales tax reimbursements where there has not been a prior legal determination that such collections were improper. Until such a determination is made, consumers cannot bring claims seeking refunds directly from retailers or to compel the retailers to seek refunds from the California tax agency. The decision, however, leaves open the possibility that a consumer may be entitled to bring such a claim where he/she has diligently sought a determination of the legality of reimbursement collections but has been unable to obtain one. Retailers, therefore, should stay abreast of the California tax agency’s regulations and guidance on tax collection issues as well as consumer filings before the agency on such issues to ensure compliance and control exposure to such suits.

How We Can Help

We can assist our clients with understanding this decision and its impact on current sales tax collection practices at the point of sale. We have experience developing retail sales programs that comply with state and federal tax laws and regulations and assisting clients in their monitoring of developments in this area. We have also helped retailers that realize they were inadvertently collecting the wrong amount of sales tax to walk through the implications of how to address that situation in a way that minimizes risks.