20050920 b10

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TOWN & COUNTRY DEPOSITION SERVICE (530) 642-0333
BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION
6901 Green Valley Circle, Room 207
Culver City, California
REPORTER'S TRANSCRIPT
SEPTEMBER 20, 2005
ITEM B-10
CORPORATE FRANCHISE AND PERSONAL INCOME TAX HEARING
APPEAL OF AVALON SUNSET (No. 283190)
Reported by: Laurie L. Gower
CSR NO. 8000

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P R E S E N T
For the Board
of Equalization: John Chiang
Chairman
Claude Parrish
Member
Bill Leonard
Member
Betty Yee
Acting Member
Marcy Jo Mandel
Appearing for Steve Westly,
State Controller (per
Government Code Section 7.9)
Deborah Pellegrini
Chief, Board
Proceedings Division
For Franchise
Tax Board: Renel Sapiandante
Tax Counsel
For Appellant: David Chatfield
Attorney
James Walters
CPA
Stephen Gaggero
Representative
---o0o---

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INDEX OF SPEAKERS
Speaker Page
DAVID CHATFIELD 5, 14
STEPHEN GAGGERO 6, 12
JAMES WALTERS 19
RENEL SAPIANDANTE 11, 16

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CULVER CITY, CALIFORNIA, SEPTEMBER 20, 2005
1:14 P.M. - 1:40 P.M.
ITEM B-10 AVALON SUNSET, APPELLANT
---o0o---
CHAIRMAN CHIANG: Good afternoon. We will
convene the afternoon session.
MS. PELLEGRINI: Good afternoon, Mr. Chairman,
and members. This afternoon we have seven franchise
and income tax hearings. At this point only B-10 has
signed in for this afternoon.
CHAIRMAN CHIANG: Okay.
MS. PELLEGRINI: I will announce the -- or here's
the order presented on the agenda. I will call the
cases to be heard.
When I call your case, please come forward,
take a seat at the table right here. Please adjust
the microphone so that they are -- you are speaking
into them, and introduce yourself and your affiliation
with the taxpayer.
Ten minutes is allocated for the taxpayer's
opening presentation, followed by ten minutes for the
department's presentation, and five minutes allocated
for the taxpayer's rebuttal.
The first case that we have is B-10, Avalon
Sunset.
And Mr. Schreiter will introduce the issues
for the hearing. And then please introduce yourself
and who you represent.

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Mr. Schreiter.
MR. SCHREITER: Good afternoon, Mr. Chairman,
members of the board.
The issue presented by this appeal is
whether appellant has shown that funds advanced to it
by its sole shareholder constitute a loan rather than
a contribution of capital.
CHAIRMAN CHIANG: Gentlemen, good afternoon. If
you would please introduce yourself for the record,
and you'll have ten minutes for the opening statement.
MR. CHATFIELD: I'm David Chatfield, attorney for
the appellant.
MR. WALTERS: James Walters, CPA of the
appellant.
MR. GAGGERO: Steve Gaggero, representative of
the appellant.
CHAIRMAN CHIANG: Very good. You have ten
minutes. Thank you.
MR. CHATFIELD: Yes, I want to initially state
that both parties agree that the issue of whether the
advances from Mr. Gaggero to the appellant were true
loans or capital contributions should take into
account the 13 factors -- 11 from Hardman versus U.S.,
1127 F.2d 1409, and an additional two factors to be
considered, Mixon versus U.S., 464 F.2d 394.
The factors are correctly set out in
appellant's reply brief and the original appeal letter
and in the correspondence between the parties, the

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taxpayer's accountant, and Mr. Gonzalez and Ms. Foltyn
of the Franchise Tax Board.
That correspondence is -- has been submitted
to you as Exhibits 11, 12, and 13 for your review.
The factors set forth in all of these
letters and our briefs are not the factors that are
discussed by the respondent in the brief. The
respondent attempt to -- attempted to recast them to
suit their own incorrect conclusion that was reached
by the Franchise Tax Board.
Now, the briefs are very thoroughly -- very
thoroughly lay out the 13 factors and the evidence
supporting them, and if -- unless there are questions
about that, I would like to defer the time to
Mr. Gaggero to discuss the documentation requested to
be brought today regarding the appellant's showing of
the appreciated value of its assets.
MR. GAGGERO: Are there any questions on the
factors?
Good afternoon, ladies and gentlemen. The
request was to provide information that showed that
Blanchard Construction Company was, in effect, a
viable company, had assets, and was a company that was
worth lending or making a line of credit to.
I provided exhibits. I'll start with
Exhibit 1 in your stack. That's an escrow closing
statement, dated 1986. It was for three lots on the
corner of Speedway and 24th Street in Venice. They

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were oceanfront lots. They were purchased for --
collectively for a million dollars.
Blanchard Construction Company was a
co-owner of these by virtue of its sweat equity.
You'll notice a contract further on in these -- in
these documents, which completely outlines the
relationship of Blanchard Construction Company and the
purchaser, in this case, Stephen Blanchard, whereby
Stephen Blanchard purchased the asset, used Blanchard
Construction Company in its capacity as a developer,
designer, and contractor to improve and get
entitlements for these lots. They were then sold,
these three lots were sold, in Exhibit 2 and in
Exhibit 3, to two different buyers. You'll note that
the closing statements, in both Exhibit 2 and 3,
reflect proceeds going to Blanchard Construction and
also proceeds going to Stephen Blanchard. You'll note
that the proceeds going to Blanchard Construction
Company were close to a half million dollars.
That -- of course I had knowledge of these
contracts. I had knowledge of the -- the ownership
interests in these properties for the sweat equity and
knew that this contractor, Blanchard Construction
Company, the development company, had these -- the
equity in these three assets, and it was proven out by
these closing statements.
I'm sorry I'm going rather quickly, but with
ten minutes, I've going to go as -- if you want to

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stop me, you can.
Exhibit No. 4 is a closing statement dated
January 1988 for the purchase of a property on Oak
Pass Road in the hills by Mulholland Highway in Los
Angeles.
Exhibit No. 5 is two closing statements for
the sale of that property. You'll note that Blanchard
Construction Company netted $199,000 on the sale of
that during the development of this property, which
spanned from 1989 on the purchased -- excuse me, the
purchase was 1988, January. Sale was January 1989.
In that one year I was aware of the fact that
Blanchard Construction Company was entitled to a
percentage of the profits from that, the ultimate
disposition and sale of that property.
So that's -- we covered '86, '87, '88, '89.
These are just some of the ones I could put together
in the week I had to find these assets after your
request. These documents, as you'll note, are also 15
years old. It's hard to find 15-year-old documents,
but here they are.
We also have in Exhibit 6 what I was
referring to earlier, which is a land contract. And
in addition to the land contract is a development
contract that outlines how the sweat equity
essentially works; that Blanchard Construction Company
acts in the capacity of a designer, developer, and
contractor, and in -- in return, it winds up getting a

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percentage ownership in the property. It becomes an
asset of the corporation.
And you'll see in Exhibit 7 where Blanchard
Construction got $3 million as its share after seven
years of its efforts on that project.
You'll notice on that -- excuse me. Those
are dated 1990, or, excuse me, May of 1991. And then
the closing statement was 1997, so almost seven years.
So now we've got '86, '87, '88, '89 and '91
where assets -- where the company had assets that I
could show you here in addition to third party
contracts and assets.
In Exhibit No. 8 and Exhibit No. 9, you'll
see in Exhibit No. 8 the acquisition by Blanchard
Construction Company of a property in -- for
$2,288,000 in 1996.
You'll see in Exhibit 9 an appraisal of that
property of $6-1/2 million, $4 million of equity in
that property that they purchased, by the certified
appraisal.
Exhibit No. 10 will address the issue of
commercial lenders. There's an allegation that
commercial lenders would not loan to Blanchard
Construction Company under the same terms or at all
that I made the loan to the corporation. And you'll
find in these there are one, two, three, four, five,
six, seven, eight, nine loans to the corporation
spanning 1985 through 1996, the highest being 7.3

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million and another one is a joint venture for 4.5
million in 1996. They were revolving lines of credit.
They were rolled over, as is customary with real
estate development industry.
That shows that in fact other third party
lenders did make loans to this company, knew they were
solvent, did it in the same terms where things were
rolled over, just like the loan I made to them. And
you'll also notice that -- that these loans were --
were not subordinated. There's no subordination
agreements to any of these things.
The third thing I'd like to just opine on
briefly is that the real estate development loan
structure is a different animal compared to many other
lending relationships. The reason being, commercial
lenders loan to real estate developers and expect to
be paid back from the completion of the sale of the
development.
If the loan term is -- is -- is up when --
and the development is not ready for sale or has been
not sold -- has not been sold, it is customary for the
lender to do what's called roll over the loan or
extend the date when the loan is paid off. It is also
very customary to have accrued and deferred interest
in our industry.
I'd also like to say one other thing, is
that from 1989 to 1996, I'm sure I don't have to tell
all of you, there was a -- a -- an exodus from lending

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in the real estate market. There was a savings and
loan debacle that was hundreds and hundreds of
billions of dollars of real estate were foreclosed
upon. And rather than foreclosing on real estate and
taking that real estate back into the lender's
portfolio and getting what was called an REO, a real
estate owned, and then too many of those, your savings
and loan or your bank gets confiscated by the FSLIC or
FDIC, lenders were customarily and regularly doing
what is called a workout or a rollover when dates
would come up when loans were due, because it would be
better to extend the payoff date than to wind up with
an asset foreclosed on in their portfolio. So any
rollovers waiting for a property to be completed and
sold -- and I might add, things didn't sell that much
during that time -- was very customary in my industry.
If there's any questions, I'm here for you.
CHAIRMAN CHIANG: Thank you very much.
Franchise Tax Board.
MR. SAPIANDANTE: Good afternoon. Renel
Sapiandante for the Franchise Tax Board. I just
wanted to point out a few factors that we had
discussed in our brief.
You know, in this case we had no payments
over a 12-year period, either interest or any
principal.
The amount owed from the shareholder to the
taxpayer went from approximately 300,000 -- $300,000

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to over $4 million by 1997. And there was never any
demand for any payment by the shareholder during this
12-year period.
Instead, what happens, every time the note
became due, the shareholder merely extended the due
date, but, yet, you know, didn't seek any additional
interest, collateral, some type of security for that
deferral and for not -- and for not receiving any
payments for the previous years.
In addition, we're talking about a
corporation that's been running in the red for a
period of 12 years, and in fact the shareholder equity
was a negative $2 million in this case.
So the problem we have here is that a
reasonable, you know, commercial lender would -- would
not lend money, $4 million over a 12-year period,
without receiving some payment. And, you know, based
on the factors I've just discussed and factors in my
brief, it's proper to characterize this transaction
as -- more as a capital contribution than it is a loan
transaction.
Thank you.
CHAIRMAN CHIANG: Thank you.
You have five minutes for rebuttal.
MR. GAGGERO: Okay. First of all, Franchise Tax
Board errs in their statement, "There was no payments
made in a 12-year field." You'll see by the letters,
and you'll see by the auditor's report itself, that

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shows that there was a reduction in the interest for
several of the years.
The Franchise Tax Board states that the loan
went from 3 million to 4 million during this period.
And, yes, that's true. But you'll also note from the
exhibits that I provided today that the assets of the
corporation also increased exponentially and
dramatically, and it was a worthwhile and valuable
loan that I made. I got paid back my interest. I got
paid back the loan. It made -- it was a -- a good
business for me and good business for the corporation.
As long as the lender knows that they are
getting periodic interest payments, as long as the
lender knows that the borrower's company asset base is
growing exponentially, it does not matter what the
taxable income is. And they continue to say that
there was running into the -- the company was running
in the red, there was no taxable income. As we all
know, a company's assets can build and appreciate
without there being any taxable event.
And running in the red, how many companies
run in the red? Our airlines are constantly running
in the red, but our government seems to continue to
make loans to them. And I can go on and on about
that, because they know that the asset base, they are
a viable company. You can sell an airline. How can
you sell an airline when they are running in the red?
Because it has value.

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They said that -- that a normal lending
institution, or I should say, a commercial lending
institution would not loan without some form of
payment. Again, you'll find that there were payments,
and you'll find -- he said that there was a -- that a
commercial lending institution -- the FTB said that a
commercial lending institution would not loan without
some sort of additional collateral. Well, that's my
point exactly. If you look at the loan, at the
provisions in the note itself, it -- the notes
collateralizes all assets of Blanchard Construction
Company and Avalon, including its contracts, joint
venture agreements, and loans; therefore, as the
assets increased, which I gave you in these exhibits,
and other contracts increased, so do the collateral.
There was a constant increase in collateral as the
company's net worth grew.
Thank you
MR. CHATFIELD: All right. If I can just
conclude.
CHAIRMAN CHIANG: Sure.
MR. CHATFIELD: Interest payments were made.
Take a look at Exhibits L and G to the reply brief.
The assets were booked on a cost basis. That explains
for some of the Franchise Tax Board's misanalysis. In
looking through the factors, there are nine factors
that have been conceded by the Franchise Tax Board,
and they haven't discussed them today. For example,

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factor 1, Ms. Foltyn states that there's no
disagreement that the taxpayer received signed demand
promissory notes.
Factor No. 2, there's a clear maturity date
on the notes and the extensions.
In factor No. 4, Ms. Foltyn agrees, "You and
the Franchise Tax Board are in agreement that the
taxpayer had the right to enforce payment of the
principal and interest on the loans."
Factor No. 5, Ms. Foltyn states, "I agree
with your arguments."
Factor No. 6, Ms. Foltyn states, on page 7,
"I agree that the advances were not subordinated.
This is a factor in the taxpayer's favor."
Factor No. 7, "I agree with your arguments
that all written representations indicate that the
advances were loans and would be paid back."
Factor No. 8, Ms. Foltyn admits that the
debt-to-equity ratio of this company was far lower
than accepted debt-to-equity ratios in -- in other
court cases.
Factor No. 9, Ms. Foltyn admits that the
Franchise Tax Board and the taxpayer's representatives
agree.
Factor No. 11, Ms. Foltyn agrees that the
taxpayer's balance sheets indicate that the taxpayer
did borrow funds from outside sources.
So, as I stated previously, the majority of

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the factors should be found in the taxpayer's favor.
Thank you.
CHAIRMAN CHIANG: Thank you very much.
Are there questions or comments?
BOARD MEMBER LEONARD: I have a question --
CHAIRMAN CHIANG: Yes, Bill.
BOARD MEMBER LEONARD: -- for the Franchise Tax
Board. In a situation like this, where it's a closely
held or single shareholder corporation, do -- what is
your standard for ever allowing a loan? I mean, the
standard you seem to have set reads to me like you
would never -- never acknowledge that it's possible
for a loan to take place in the way the taxpayer's
described.
MR. SAPIANDANTE: It's probably true in terms of
a shareholder who wholly -- who wholly owns a
corporation.
But I've seen cases where, you know, the
shareholder respects the corporation as its own entity
despite the fact that he owns all the shares and is
the officer.
You know, we need some objective indicia
here, like some payments of interest, from one party
to the other.
MS. MANDEL: Can you -- they say that they paid
interest, and it's indicated in some exhibit to their
reply brief, so -- and you're saying they didn't pay
interest --

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MR. SAPIANDANTE: Yes.
MS. MANDEL: -- so maybe you need to explain to
us why whatever they gave us doesn't show what they
say.
MR. SAPIANDANTE: Yes, our auditor had looked at
the board minutes, the general ledger, loan
agreements, and canceled checks.
As I was looking over Exhibits G through, I
think, H, you know, I'm looking here at interest
payments that were paid, but they don't match up with
what our hearing operator said, because the loans have
gone from $300,000 to over 4 million.
If the taxpayer can provide, you know, the
shareholder's income tax returns for this year, and
can match up the interest payments that he allegedly
received, well, I think that would be probably better
indicia at this point.
BOARD MEMBER LEONARD: You didn't do that as part
of the audit? You didn't look up the shareholder's
return?
MR. SAPIANDANTE: My understanding of the file is
that we looked at only the loan agreements, general
ledger, canceled checks.
BOARD MEMBER LEONARD: So it's very possible he
received -- paid income tax on the interest, and you
didn't -- nobody looked for it?
MR. SAPIANDANTE: We're talking about -- probably
not. We didn't have returns from 1985, and this is

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the first time during this briefing period that this
was brought up, that he had made payments way back in
1985, '87, '88.
BOARD MEMBER LEONARD: My point is back to the
audit time --
MR. SAPIANDANTE: Okay.
BOARD MEMBER LEONARD: -- if you're auditing a
corporation with one shareholder that you're alleging
is because it's not at arm's length, there's this
intermixing for other than business purposes, and you
don't audit the shareholder's personal income tax
return, it's not an audit.
It seems like we don't have the whole
picture of what went on.
MR. SAPIANDANTE: I'm pretty sure that we had
audited the -- the tax -- the shareholder's returns
for this tax period.
I'm not sure about the correspondence of
what was asked, but --
BOARD MEMBER LEONARD: Okay.
MR. SAPIANDANTE: -- it would be reasonable, like
you said, to ask for, you know, canceled checks and --
BOARD MEMBER LEONARD: Right.
MR. SAPIANDANTE: -- which is what she looked at,
what canceled checks were going in and out of the
corporation. And so I'm assuming that --
MS. MANDEL: And you're saying you didn't --
there were no canceled checks?

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MR. SAPIANDANTE: To?
MS. MANDEL: To the gentleman?
MR. SAPIANDANTE: Right, in the audit file that I
have seen. If they provide the returns for those
years, if they can match it up, well, that would make
sense. But, apparently, this information may not have
been available to the auditor. And it probably
wasn't.
BOARD MEMBER LEONARD: Is this something where
some time to look at this information would be
helpful?
MR. SAPIANDANTE: I -- I mean, if -- I don't know
how far back we can go to get his returns to match
these interest payments. We're talking about --
BOARD MEMBER LEONARD: A long time ago?
MR. SAPIANDANTE: Yeah. That's the problem here.
BOARD MEMBER LEONARD: I -- Mr. Chairman, I'm not
sure where -- I'm not sure a delay would help us, if
we can't ascertain the facts. And it appears to me
that we have a factual dispute here at this point
about something that happened a long time ago.
I'm open to -- I guess, the question to
taxpayer's representatives, do you think there's a
possibility this information may still be around, that
it can be brought forward to FTB, since apparently
they don't have their notes or copies of their audit
of the shareholder?
MR. WALTERS: At the time of the Avalon audit,

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they also reviewed Mr. Gaggero's tax returns, and he
had picked up the interest income. There was a "no
change" on his audits for those years that correspond
with these years.
MR. SAPIANDANTE: These years, that's correct.
We looked at these years, because he had included the
interest in his income for this year.
But we're looking at, for instance, the 1986
return where he highlights, "Interest has been paid by
the company." And they're alleging that it was paid
directly to the shareholder.
If you look at the return for 1988, he does
the same thing. He alleges there was $40,000 in
interest payments made to the shareholder.
I'd like to see that matched up with the
shareholder's return. If that in fact was paid, then
obviously our auditor was in error.
BOARD MEMBER LEONARD: But you'd like to see
that, but you're not offering a way in which we can
see that.
MR. SAPIANDANTE: The only way that I --
personally I don't -- we keep returns for maybe four,
five years. And this is way back in the '80s. If we
had been given this information during the audit, I'm
sure our auditor would have asked the taxpayer for
that information.
It would have been reasonable for her to ask
for that information and have gone through the process

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and not to wait until the reply brief to bring this
up. That's the problem we have here.
BOARD MEMBER LEONARD: Thank you, Mr. Chairman.
I don't know where to go.
CHAIRMAN CHIANG: Any questions or comments? No?
Is there a motion?
MS. MANDEL: Take it under submission.
CHAIRMAN CHIANG: Motion by Marcy to take it
under submission.
Is there a second?
BOARD MEMBER YEE: Second.
CHAIRMAN CHIANG: Second by Betty.
Is there any objection?
Without objection, motion passes.
We're going to take it under submission and
talk about it later on and send you a written decision
of our findings.
MR. SAPIANDANTE: Thank you.
MR. WALTERS: Thank you.
MR. CHATFIELD: Thank you.
(The proceedings were concluded at
1:40 p.m.)
---o0o---

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REPORTER'S CERTIFICATE
State of California )
) ss
County of El Dorado )
I, LAURIE L. GOWER, Hearing Reporter Pro Tem
for the California State Board of Equalization,
certify that on September 20, 2005, I recorded
verbatim, in shorthand, to the best of my ability, the
proceedings in the above-entitled hearing; that I
transcribed the shorthand writing into typewriting;
and that the preceding pages 1 through 21 constitute a
complete and accurate transcription of the shorthand
writing.
Dated: December 29th, 2010
LAURIE L. GOWER
Hearing Reporter Pro Tem

20050920 b10

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