Court of Appeal (Cal.) Says Vehicle Lessee Cannot Challenge Lessor’s Imposition of Use Tax on Lease-End Turn-in Fee Because Lessee Must First Submit Claims for Refund to the State of California

In LISA STETTNER et al., Plaintiffs & Appellants, v. MERCEDES-BENZ FINANCIAL SERVICES USA, LLC et al., Defendants & Respondents. Additional Party Names: California Dep’t of Tax & Fee Admin., Michele Zousmer, No. C094345, 2023 WL 8818219, at *1–2 (Cal. Ct. App. Nov. 29, 2023), the Court of Appeal held that a consumer cannot challenge imposition of a use-tax at lease-end without first lodging such challenge with the State of California.  The facts were as follows:

Appellants each signed the same form automobile lease agreement with Mercedes-Benz. Under the lease, Mercedes-Benz charges appellants a “ ‘Vehicle Turn-In Fee’ ” at the end of the lease term. This vehicle turn-in fee “cover[s] the costs of the lessor in reconditioning and/or repairing a vehicle, including parts and labor, following the end of a lease so the vehicle can be disposed of in the wholesale or retail markets as a used car.”  When Stettner’s lease ended, Mercedes-Benz charged Stettner and Stettner paid, among other things, the vehicle turn-in fee plus a $46.11 tax on the fee. The lease end statement from Mercedes-Benz characterized the tax as a “[s]ales [t]ax.” Mercedes-Benz remitted the tax to the Department. Zousmer’s lease had not expired when this action was filed, but she will be subject to the same tax on the vehicle turn-in fee, and Mercedes-Benz will remit the tax to the Department, upon expiration of her lease. Appellants maintained the tax on the vehicle turn-in fee was unlawful under California Code of Regulations, title 18, section 1660 (Regulation 1660).  Although Mercedes-Benz described the tax on the vehicle turn-in fee as a sales tax, the Department “has taken the position that the tax collected is a use tax.” Appellants, on the other hand, contend that the tax collected on the vehicle turn-in fee is a sales tax. They do not know whether Mercedes-Benz remitted the tax to the Department as a sales tax or a use tax, but argue the characterization of the tax affects only the remedies available and not its lawfulness.  Appellants claimed they brought the instant action pursuant to Revenue and Taxation Code section 6901.5.1 The first amended complaint asserts two causes of action: (1) violation of the UCL against Mercedes-Benz for collecting unlawful tax under Regulation 1660; and (2) declaratory relief as to the propriety of the tax, the classification of the tax, and the procedures for refund against Mercedes-Benz and the Department.  Appellants seek the following remedies under both causes of action: (1) a judicial declaration that collecting tax on the vehicle turn-in fee is unlawful under Regulation 1660; (2) a public injunction prohibiting Mercedes-Benz from collecting taxes on the vehicle turn-in fee and from remitting such taxes to the Department; (3) an order requiring Mercedes-Benz to provide an accounting of all such taxes collected and remitted to the Department in the last three years; (4) a judicial declaration determining whether the tax collected on the vehicle turn-in fee is a sales tax or a use tax; (5) if the court determines the tax is a sales tax, an order requiring Mercedes-Benz to file for refunds with the Department and place such refunds in a common fund for the benefit of consumers; (6) if the court determines the tax is a use tax, a judicial declaration as to whether Mercedes-Benz or the consumers should file for refunds with the Department; (7) if the court decides the consumers should file for refunds, an order directing the Department to process the refund claims submitted by Stettner and others; and (8) if the court decides Mercedes-Benz should file for said refunds, an order requiring Mercedes-Benz to file for refunds with the Department and placing any amounts received in a common fund for the benefit of the consumers.
After the commencement of this action, Stettner filed a provisional use tax refund claim with the Department, seeking a refund of the $46.11 tax on the vehicle turn-in fee. This claim was intended to exhaust administrative remedies in the event the tax was characterized as a use tax. The first amended complaint does not allege the Department has responded to Stettner’s claim.

The Court of Appeal affirmed the trial court’s sustaining of the demurrer.

First, the taxpayer must pay the disputed tax. This is the “ ‘ “pay first, litigate later rule,” ’ ” or more colorfully known as the “ ‘pay up or shut up’ ” rule. (California Dept. of Tax and Fee Administration v. Superior Court (2020) 48 Cal.App.5th 922, 930.)
Second, any action for a tax refund must be brought pursuant to procedures established by the Legislature. (Loeffler, supra, 58 Cal.4th at p. 1102.) “[T]he taxability question, whether a particular sale is subject to or is exempt from sales tax, is exceedingly closely regulated, complex, and highly technical.” (Id. at p. 1103.) The Legislature provided “[a] comprehensive administrative scheme … to resolve these and other tax questions and to govern disputes between the taxpayer and the Board.”  (Ibid.) Under this scheme, “it is for the Board in the first instance to interpret and administer an intensely detailed and fact-specific sales tax system governing an enormous universe of transactions.” (Ibid.) “Administrative procedures must be exhausted before the taxpayer may resort to court.” (Ibid.) The requirement to exhaust administrative remedies applies to actions involving both sales and use taxes. (Barnes v. State Bd. of Equalization (1981) 118 Cal.App.3d 994, 1001.)  Here, the first amended complaint states that, as of the filing of this lawsuit, Zousmer’s lease was ongoing, and she had not paid the disputed tax. Thus, Zousmer is barred from challenging the tax under the “pay first, litigate later” rule.  Moreover, neither appellant exhausted her administrative remedies before resorting to court. “[A]n administrative remedy is exhausted only upon ‘termination of all available, nonduplicative administrative review procedures.’ ” (Coachella Valley Mosquito & Vector Control Dist. v. California Public Employment Relations Bd. (2005) 35 Cal.4th 1072, 1080.) The first amended complaint alleges only one provisional use tax refund claim filed by Stettner with the Department after the commencement of this lawsuit. We reject appellants’ contention that this claim satisfies Stettner’s obligation to exhaust administrative remedies. As our Supreme Court observed, both the California Constitution and the tax code require a taxpayer to “exhaust administrative remedies before bringing an action in court.” (Loeffler, supra, 58 Cal.4th at p. 1108, italics added.) Compliance with this rule is a jurisdictional prerequisite to judicial review, not a matter of judicial discretion. (California Water Impact Network v. Newhall County Water Dist. (2008) 161 Cal.App.4th 1464, 1489.) Stettner cannot circumvent the constitutional and statutory requirement by initiating administrative proceedings after filing suit. Allowing her to do so would improperly expand the court’s jurisdiction. Thus, Stettner’s belated use tax refund filing does not save her claim. (See State Bd. of Equalization v. Superior Court (1980) 111 Cal.App.3d 568, 571 [finding taxpayers failed to exhaust administrative remedies where the amended complaint alleged several pending administrative refund proceedings].)  Appellants may not circumvent the constitutional prerequisites by seeking a declaratory judgment as to the legality of the tax. (Loeffler, supra, 58 Cal.4th at p. 1128; Honeywell, Inc. v. State Bd. of Equalization (1975) 48 Cal.App.3d 907, 912 [“Where a statute prohibits the granting of an injunction … to prevent collection of a tax [citation] an action for a declaration that the tax is not legally collectible would circumvent the law and, accordingly, declaratory relief will be refused.”].)