The recent Tennessee Court of Appeals ruling in Valenti Mid-South v. Farr is an
significant reminder of how important careful franchise and excise
tax planning can be for those engaged in real estate ventures in
Tennessee.
In Valenti, Darrell Valenti owned more than 50% in both a
real estate holding company (Valenti Realty) and a management
company that operated forty-six (46) fast food restaurants in
Tennessee (Valenti Management) in his individual capacity. Valenti
Management leased land and buildings where its restaurants operated
from Valenti Realty.
The Tennessee franchise tax at issue in the case is a privilege tax
that is generally imposed on a taxpayer's net worth. The tax
also includes, however, a minimum measure based on the actual value
of the real or tangible property owned or used in Tennessee. This
includes leased property that is valued at a multiple of rent.
Valenti Management's "net worth" was negative for the
applicable tax years so it calculated its tax base using the
alternative measure. In calculating actual value of property in
Tennessee, however, Valenti Management excluded the value of the
forty-six (46) properties it rented from the Valenti Realty,
arguing that Valenti Management and Valenti Realty constituted an
"affiliated group" and, therefore, were entitled to
calculate property value on a consolidated basis. Since Valenti
Realty already included the values of the properties within the
base of its own Tennessee franchise tax liability, Valenti
Management asserted that the value of the properties should be
excluded from the value of property owned or used by Valenti
Management in Tennessee.
The Court of Appeals rejected this contention, concluding that the
entities were not affiliated because the common owner was an
individual rather than a taxable entity. Thus, the structure did
not meet the express requirements of the statute, i.e., that the
50% common ownership be with a taxable entity. The Court also
rejected double taxation and equal protection claims advanced by
Valenti Management.
Lessons Learned
This tax result could have been avoided if Valenti Management
would have owned the two entities through a single member LLC. In
which case, the common ownership test would have been satisfied and
would have allowed a consolidated net worth filing. Real estate
holding companies and their affiliates should take note from the
Valenti decision, revisit their structures and verify that
the most advantageous arrangement is being utilized.
The Valenti decision also reiterates long-standing
Tennessee precedent that the separate nature of entities in
Tennessee will be respected, an important principle in all
Tennessee tax planning (see Standard Advertising).
Moreover, taxpayers should take note that the Department of Revenue
interprets the consolidated franchise tax filing option as only
applying to the net worth calculation which does not apply to the
alternative, minimum measure that is based on value of property in
Tennessee.
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.