United States: California Holds Documentary Transfer Tax Can Apply To Transfers Of Interests In Legal Entities That Own Real Estate

 On June 29, 2017, the California Supreme Court held that the documentary transfer tax may apply to transfers of interests in legal entities that own real estate.1 Specifically, the Court held that the documentary transfer tax may be imposed when a transfer of a legal entity results in a change in ownership of real property within the meaning of Cal. Rev. & Tax. Code Sec. 64(c) or (d). The decision by the Court is notable not only for extending the application of the documentary transfer tax beyond "ordinary sales of real property," but also for incorporating the concept of "change in ownership" from the state's property tax system into the documentary transfer tax system.

Background

Beryl and Gloria Averbook owned an apartment building at 926 North Ardmore Avenue in Los Angeles, California (the Building) which they transferred into a family trust in 1972. After Beryl's death in 2007, the assets of the family trust were transferred into an administrative trust of which Gloria was the beneficiary and Bruce and Allen Averbook, Gloria's sons, were the successor trustees. The sons formed 926 North Ardmore Avenue, LLC (LLC), a single-member limited liability company and BA Realty, LLLP (BA Realty), a partnership. The administrative trust was the sole member of LLC and held a 99 percent partnership interest in BA Realty.

In 2008, the administrative trust conveyed the Building by grant deed to LLC and transferred its membership interest in LLC to BA Realty. The administrative trust then distributed its 99 percent interest in BA Realty to four subtrusts that were maintained for the benefit of Gloria. In 2009, three of the subtrusts transferred their BA Realty interests to two trusts maintained for the sons (Allen and Bruce Trusts) through written agreements, none of which mentioned the Building or its location. The agreements were not recorded and the transfer did not include the execution of any deed or other instrument transferring title to the Building.2 After the 2009 transaction, the Allen and Bruce Trusts each held a 44.595 percent partnership interest in BA Realty, which was the sole member of LLC, which still held legal title to the Building.

In 2011, the Los Angeles County registrar-recorder issued a county documentary transfer tax assessment notice to LLC. The documentary transfer tax was assessed, according to the county recorder, because the Building had undergone a change in ownership in 2009. LLC paid the transfer tax and then filed a claim for refund. The refund claim was denied by the trial court and the decision was affirmed by the California Court of Appeal.

California's Documentary Transfer Tax Act

Cal. Rev. & Tax. Code Sec. 11911, which is part of the Documentary Transfer Tax Act,3 allows California counties to levy a tax "on each deed, instrument, or writing by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or purchasers," if "the consideration or value of the interest or property conveyed (exclusive of the value of any lien or encumbrance remaining thereon at the time of sale)" exceeds $100.4 The core issue in the case focused on whether this provision allowed for the documentary transfer tax to be applied to the transfer of an interest in a legal entity.

LLC argued that the tax could not be imposed on a written instrument that transfers an interest in a legal entity, even if the entity owns real property, unless the instrument directly references or shows the location of the realty. Because LLC transferred interests in BA Realty and did not refer to the Building or its location, it argued that the documents were not subject to the tax. In contrast, the county argued that Sec. 11911 authorizes a tax on any instrument by which an interest in real property is sold, whether directly by a deed, or indirectly, as part of a transaction involving the transfer of a legal entity.

Written Instrument Not Required to Directly Reference Real Property

Acknowledging that Sec. 11911 could be read to support either party's reading of the statute, the Court ultimately rejected LLC's argument because it was "undermined" by another section of the Act, Cal. Rev. & Tax. Code Sec. 11925. This section creates a conditional exemption from the documentary transfer tax for realty held by certain entities when interests in those entities are transferred. According to the Court, this "exemption . . . would be unnecessary if entity interest transfers did not trigger the documentary transfer tax as a general matter."

Next, LLC pointed to other sections of the Act which: (1) require that any document subject to the tax include the tax roll parcel number of the property conveyed;5 (2) require that every document subject to the tax and submitted for recording show the location of the lands, tenements, or other realty described in the document;6 and (3) prohibit the recording of any document subject to the tax unless the tax has been paid.7 LLC argued that each of these provisions shows that the tax does not apply to a written instrument conveying legal entity interests because, typically, these instruments would not show the property's parcel number or location, and would not be recorded. Furthermore, the tax logistically could not be imposed on unrecorded documents because the Act provides no mechanism for tax collection when a written instrument is not recorded.

The Court rejected these arguments, noting that the provisions cited by LLC do not operate to limit the scope of the documentary transfer tax. These provisions impose requirements for documents submitted for recording, but do not necessarily apply to documents that are not submitted for recording. For example, the requirement that any document subject to the tax include the tax roll parcel number does not mean that only documents showing that number are subject to the tax. The Court noted that this construction would be absurd because it would allow parties to avoid the tax simply by omitting the number from the document. Based on this reasoning, the Court held that a written instrument conveying an interest in a legal entity that owns real property may be taxable, even if the instrument does not directly reference the real property and is not recorded.

Adoption of Property Tax Change in Ownership Rules

Having established the scope of the documentary transfer tax, the Court turned to the issue of when the tax is triggered. The Court explained that, in 2010, legislation was enacted that required county assessors to share information contained in the change in ownership statements filed with the California State Board of Equalization with county recorders. As a result, the Los Angeles county recorder began "routinely assessing the transfer tax whenever a change in control of a legal entity resulted in a change in ownership of real property." LLC argued that this reliance on the change of ownership rules contained in the property tax system could not be carried over to the documentary transfer tax system. The Court disagreed.

Based on a review of federal cases that applied "the federal stamp act in the context of corporate transactions,"8 the Court explained that the critical factor in determining whether the documentary transfer tax may be imposed is whether there is a sale that results in a transfer of beneficial ownership of real property. According to the Court, the change in ownership rules were "designed to identify precisely the types of indirect real property transfers that the Transfer Tax Act is designed to tax." The Court noted that, under California's property tax laws, a '"change in ownership' of real property occurs when there is 'a transfer of a present interest in real property, including the beneficial use thereof, the value of which is substantially equal to the value of the fee interest.'"9 This statute plays a "central role" in the state's property tax system because a change in ownership triggers reappraisal and reassessment for property tax purposes.10

The Court explained that while a transfer of an interest in a legal entity generally does not result in a change in ownership of the entity's real property,11 there are exceptions to this rule.12 Specifically, the statute provides that a change in ownership of all real property owned by a legal entity results when (1) the property was previously transferred to that entity, but that transfer is not deemed to be a change in ownership under Cal. Rev. & Tax. Code Sec. 64(a) and (2) shares or interests representing more than 50 percent of the total interests in the entity are subsequently transferred by any of the original co-owners in one or more transactions.13 Adopting this concept, the Court held that Sec. 11911 allows the documentary transfer tax to be imposed when a transfer of an interest in a legal entity results in a change in ownership of real property within the meaning of Cal. Rev. & Tax. Code Sec. 64(c) or (d), as long as there is a written instrument reflecting a sale of the property for consideration.

Significant Expansion of Documentary Transfer Tax

In a dissenting opinion, one of the Court's justices found the majority opinion troubling because it reflected the Court's impermissible expansion of the documentary transfer tax to "run-of-the-mill transfers of interests in legal entities that happen to own real estate." The dissent focuses on the fact that the tax authorized by the Act applies to "'deed[s]' or other 'writing[s]' by which land or other real property is conveyed for value." Specifically, the dissent argues that Sec. 11911 is silent on taxing entity interest transfers. Rather, Sec. 11911, along with the federal statute on which it was modeled, has only been applied to documents that directly convey interests in real property for consideration. According to the dissent, the majority decision holds that the Act applies to a document by which entity interests are transferred, for consideration, if the transaction results in a transfer of beneficial ownership of real property. Effectively, this holding makes the Act applicable to "a considerable swath of entity interest transfers that bear little or no resemblance to ordinary sales of real property."

According to the dissent, one of the most problematic aspects of the decision is that it applies the property tax law's change in ownership framework in the documentary transfer tax context. Irrespective of whether this is "a good idea," the ability to do so, according to the dissent, does not fall within the purview of the courts.14 As stated by the dissent, the Court's expansion of the tax goes against the "statute's language and historical practice" and encroaches on the legislature's role to determine the "circumstances under which an entity interest transfer should result in a deemed sale of the entity's real estate."

Commentary

Contrary to the "form over substance" interpretation of real estate transfer taxes historically taken in many states with respect to the treatment of intercompany or interfamily real estate transactions, the Court determined that applying "substance over form" principles in this case was necessary. The dissenting justice agreed that a substance over form approach may have been tenable, but in this instance, where the transaction was "bona fide, completed for legitimate reasons, and had economic substance," applying the documentary transfer tax reached beyond a pure "substance over form" analysis. The approach highlighted by the majority of the Court could serve as a template for other states to eventually follow with respect to their real estate transfer tax laws.

This case has generated a substantial amount of interest15 in California because of its significant implications for transactions involving mergers and acquisitions, which are often considered during the due diligence process performed by purchasers and sellers prior to closing. In essence, the Court's decision is tantamount to an expansion of the documentary transfer tax base that now encompasses "a whole new class of transactions – sales of interests in business entities that own real property."16 As a result, the decision has the potential to impact any entity acquisition where the entity owns California real estate, as well as other transactions in which the majority of a beneficial interest in real estate property changes from one individual or business to another (through technical terminations or other means).

Footnotes

1 926 North Ardmore Avenue, LLC v. County of Los Angeles, California Supreme Court, No. S222329, June. 29, 2017. Note that the taxpayer filed a rehearing petition on July 13, 2017.

2 The Allen and Bruce Trusts executed promissory notes to Gloria's three subtrusts as consideration for the transferred interests.

3 CAL. REV. & TAX. CODE § 11901 et seq.

4 CAL. REV. & TAX. CODE § 11911(a).

5 CAL. REV. & TAX. CODE § 11911.1.

6 CAL. REV. & TAX. CODE § 11932.

7 CAL. REV. & TAX. CODE § 11933.

8 CAL. REV. & TAX. CODE § 11911 is derived from a provision of the former federal documentary stamp act.

9 CAL. REV. & TAX. CODE § 60.

10 CAL. CONST., ART. XIII A, § 2.

11 CAL. REV. & TAX. CODE § 64(a).

12 CAL. REV. & TAX. CODE § 64(c), (d).

13 CAL. REV. & TAX. CODE § 64(d).

14 The dissent noted that at least one bill had been put forth to incorporate the property tax law's change in ownership rules into the Act. Citing to A.B. 561 (2013–2014 Reg. Sess.) § 1.

15 Amicus briefs were filed in support of the taxpayer by many organizations, including the Council on State Taxation.

16 Application for Permission to File Amicus Curiae Brief and Brief of Amicus Curiae, Council on State Taxation in Support of Plaintiff and Appellant, Council on State Taxation, Oct. 2, 2015.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions