November 11, 2014
In a Potentially Retroactive Decision, California Appellate Court Holds that Change in Entity Ownership Can Trigger Transfer Tax Liability
NAREIT thanks Michele Randall of EY and Sam Melehani of PwC for informing us of the following development.
Although a "change in ownership" of an entity that owns California property triggers a property tax reassessment for property tax purposes, historically local jurisdictions in California have taken varying positions regarding whether such a change also would trigger documentary transfer (realty transfer) tax.
Recently, however, a California Court of appeal issued 926 North Ardmore Avenue, LLC v. County of Los Angeles, Cal. Ct. App., Dkt. No. B248536 (Cal. App. Ct. Sept. 22, 2014) and held that a change in ownership of a legal entity will trigger liability for documentary transfer tax. Because of the wording of this decision, many practitioners are concerned that, not only has the court changed the rules prospectively, but there may be potential retroactive tax liability exposure for any entity whose prior "change in ownership" triggered a property tax assessment. Further, this potential liability may be applicable not just in Los Angeles County, the local jurisdiction at issue in the case, but throughout California.
The taxpayer in this case, 926 N. Ardmore Avenue, LLC has filed an appeal with the California Supreme Court. Additionally, a number of third parties may file amicus briefs with the California Supreme Court (most likely due by early December) and/or plan to file a letter (due Nov. 21) with California to request that the decision be "de published," a procedure that would treat the court case as non-precedential. California Taxpayers Association (Cal-Tax), of which NAREIT is a member, filed an amicus letter in support of repeal on Nov. 7. NAREIT may consider filing a separate letter as well, possibly along with another organization of which NAREIT is a member, California Business Properties Association (CBPA). NAREIT also is considering holding a conference call among potentially affected members, along with their advisors, to discuss the implications with respect to this case and strategy for the future. If you would be interested in participating on such a call, please e-mail Dara Bernstein at firstname.lastname@example.org by C.O.B. Nov. 13, 2014.
Pennsylvania Court Case Decision: Business Privilege Tax Refund Opportunity
NAREIT thanks Wendi Kotzen of Ballard Spahr LLP for providing us with the following.
Many Pennsylvania local jurisdictions impose a business privilege tax (BPT) on gross receipts earned in the jurisdiction. On Sept. 19, 2014, the Pennsylvania Commonwealth Court, an intermediate appellate court, in Fish v. Township of Lower Merion, held that Pennsylvania local jurisdictions (other than Philadelphia) are not authorized to impose BPT on rent. Lower Merion filed an appeal of this decision to the Pennsylvania Supreme Court on Oct. 20, 2014. In Ballard Spahr LLP's view, this decision may well be overruled because the court based its decision on a realty transfer tax exclusion, not a BPT exclusion. Nevertheless, REITs with properties in Pennsylvania (that are not in Philadelphia) should consider filing claims for refund for open years. Also, REITs should consider whether to 1) file and not pay the tax on rent; or, 2) file and pay the tax on rent and then claim a refund.
Tennessee Update: Tennessee Department of Revenue (DOR) Publishes Rulings Addressing Disregarded Entities Owned by REITs; Is Corrective Legislation Needed?
NAREIT thanks Michele Randall and Jay Hancock of EY for their comments with respect to the following developments on Tennessee.
Change in Policy Regarding Single Member Limited Liability Companies (SMLLCs) Owned by REITs
In 1999, Tennessee enacted legislation imposing its franchise and excise tax on all limited liability entities, including partnerships. In response, a coalition of NAREIT member REITs successfully advocated for a 2000 legislative change to tax REIT-owned pass-through entities to the extent of their non-REIT ownership. That legislation is summarized in NAREIT's Sept. 29, 2000 State & Local Tax Policy Bulletin. Notably, the legislation provided a deduction for the excise tax for income from a "pass-through entity" that was included in a REIT return and an exemption from the franchise tax for a REIT-owned entity that as "treated as a partnership for federal income tax purposes." Because of the different terms used in the law, it was unclear whether these REIT-specific provisions would apply to REIT-owned partnerships that were disregarded for federal income tax purposes. In other words, a REIT-owned federally disregarded partnership (e.g., owned by a REIT and its qualified REIT subsidiary) perhaps would qualify for the excise tax deduction, but arguably was not allowed the franchise tax treatment provided by the legislation. It appeared that the intent of the legislation was to provide this treatment to all REIT-owned pass-through entities despite federal tax treatment, but there was uncertainty as to how the provisions would be applied.
In 2006, Tennessee modified its franchise and excise tax structure with respect to REITs so that: 1) the excise tax treatment applicable to "public" REIT-owned entities would remain the same substantively although some of the technicalities and applicable language were changed; 2) Tennessee residents would no longer pay income tax (under provisions called the "Hall Tax") on dividends they directly received from a REIT; and, 3) REIT-owned partnerships would become liable for franchise taxes as they were before the 2000 legislation. For further details, see NAREIT’s Sept. 29, 2000 State & Local Tax Policy Bulletin and June 2006 State & Local Tax Policy Bulletin. Tenn. Code Ann § 67-4-2004(39) defines a "public REIT" as "an entity that has an election in effect under § 856(c)(1) of the Internal Revenue Code that files with the securities and exchange commission and whose shares are traded on a securities exchange that is either registered as a national securities exchange with the securities and exchange commission under § 6 of the Securities Exchange Act of 1934, codifed in 15 U.S.C. § 78f, or is a national securities exchange of a foreign country and regulated in a substantially similar manner by a foreign financial regulatory authority."
NAREIT’s June 3, 2014 SALT Report included an item regarding a now-public revenue ruling (Revenue Ruling #13-22) issued by the Tennessee DOR to a taxpayer, regarding calculation of the Tennessee excise (income) tax for certain entities owned by non-"public" REITs that are disregarded entities for federal income tax purposes, but are regarded as separate taxpayers for Tennessee excise and franchise tax purposes. Such entities include qualified REIT subsidiaries (QRSs) and disregarded partnerships, to the extent that their federally regarded owner is a REIT. Although the ruling does not address public REITs specifically, it could affect public REIT structures. While there is uncertainty, many believe that a QRS owned by a public REIT or non-public REIT is a taxpayer, but arguably income/deductions are reported at the REIT level; thus, the QRS should not have an excise tax base.
The revenue ruling addresses four separate scenarios (illustrated below) and effectively concludes that REIT-owned (federally) disregarded entities that file separate Tennessee excise and franchise tax returns are not eligible for a dividends paid deduction (DPD) equivalent when determining their pro forma, federal taxable income starting point for Tennessee excise tax purposes. First, the ruling concludes that in order for a QRS to be eligible for a DPD for Tennessee excise tax purposes, the entity would need to be able to qualify separately as a REIT for federal income tax purposes when tested on a pro forma, stand-alone basis. The ruling goes on to conclude that because the disregarded entity does not have 100 shareholders, it does not meet the requirements to be a REIT. Likewise, the ruling also concludes that in order for a REIT-owned partnership to be entitled to the DPD-equivalent, the partnership must be regarded for federal income tax purposes. Note that this ruling would seemingly apply to any disregarded entity that is a Tennessee taxpayer and whose single member is a REIT – regardless of whether or not the REIT is publicly traded, captive or non-publicly traded or non-captive, as those terms are defined by Tennessee law.
As mentioned as a possibility in the June 3, 2014 SALT Report
, later in June 2014, the DOR in fact did change its historic guidance that a REIT-owned SMLLC (which is disregarded for federal income tax purposes) is a separate Tennessee taxpayer. The DOR did so by issuing Notice #14-12
. Since the enactment of its franchise and excise tax reform in the late 1990s, the DOR had believed that a SMLLC cannot be disregarded if it is owned by a REIT even though the statutes direct that a federally disregarded SMLLC whose single member is a corporation shall be disregarded for Tennessee franchise and excise tax purposes. There was guidance to this effect in a long-standing Frequently Asked Question that had been posted on the DOR’s website since 2000, but that guidance has since been removed following the publication of Notice #14-12.
In Notice #14-12, the DOR ruled that a SMLLC is indeed disregarded as an entity separate from its parent REIT; thus, the parent REIT is the Tennessee taxpayer and eligible for the DPD so long as the REIT is not a "captive REIT" for Tennessee franchise and excise tax purposes. Notice #14-12 does not affect the underlying analysis of Revenue Ruling 13-22 other than by limiting that ruling only to those REIT-owned disregarded entities that are not SMLLCs.
This possible change in policy is probably beneficial from an excise tax perspective to all affected taxpayers because it allows REIT-owned SMLLCs to be treated as divisions of the Parent REIT consistent with federal income tax treatment. However, consideration should be given to the fact that for certain REIT-owned SMLLCs, such a policy change could cause change to the franchise tax liability for some entities. Specifically, the REIT could be subject to the franchise tax on its apportioned net worth rather than the SMLLCs' being subject to the franchise tax on their apportioned net worth.
Please Provide Comments Regarding Possible Legislative Change
As you can see, the substantive results of Revenue Ruling #13-22 do not appear to be equitable. For instance, consider a public REIT-owned partnership that owns property in Tennessee and is therefore a Tennessee taxpayer: If the partnership were regarded federally, it would be entitled to exclude from its excise tax base any income that is distributed to its public REIT owner. However, if the same partnership were disregarded federally, it would not be entitled to the same excise tax base exclusion even though it would be engaged in the same substantive business activity as its regarded counterpart. NAREIT understands that the Tennessee DOR is aware of the disconnect between the various REIT statutes and might be amenable to a legislative change that would harmonize the excise tax provisions in order to treat REIT-owned federally disregarded partnerships (and QRSs) in the same manner as REIT-owned partnerships for purposes of the Tennessee excise tax. With that said, it may take some resources to accomplish such a change. In the alternative, REITs would be well-advised to structure their Tennessee investments through federally regarded partnerships rather than QRSs or disregarded partnerships.
Although this possible change in policy most would certainly be beneficial from an excise tax perspective to all affected taxpayers, consideration should be given to the fact that such a policy change could, for certain REIT-owned SMLLCs, cause an increase to the franchise tax liability for some entities since the REIT could be subject to the franchise tax on its apportioned net worth rather than the SMLLC's being subject to the franchise tax on its apportioned net worth. Please contact Dara Bernstein (email@example.com)
by Nov. 20, 2014 if you have any comments regarding whether NAREIT should assist in organizing a coalition of member REITs in seeking a legislative change.
Tennessee DOR: Public REITs Must Own at Least 80% of Lower-Tier Non-Public REIT for Lower-Tier REIT to Avoid DPD Add-Back
The Tennessee DOR recently issued Revenue Ruling #14-07, which applies the definitions of "captive REIT" and "public REIT" under Tennessee’s franchise and excise tax provisions with respect to a relatively complex (and apparently "real life") REIT structure (illustrated below). This structure includes a publicly-traded REIT that owns a publicly-traded partnership (PTP). The PTP itself indirectly owns a number of lower-tier REITs.
By way of background, Tennessee amended its excise tax provisions in 2010 to add certain provisions regarding "captive REITs." Tenn. Code Ann. § 67-4-2004 defines a "captive REIT" as "an entity with an election in effect under § 856(c)(1) of the Internal Revenue Code, codified in 26 U.S.C. § 856(c)(1), in which any other entity or individual, directly or indirectly, has at least 80% ownership interest by value determined in accordance with generally accepted accounting principles and whose shares are not traded on a national stock exchange."
Additionally, Tenn. Code Ann. § 67-4-2006(b)(1)(O) provides that a captive REIT must add back any DPD claimed for federal tax purposes, "provided, however, that this subdivision (b)(1)(O) shall not apply to a captive REIT that is owned, directly or indirectly
, by a bank, a bank holding company, or a public REIT." (Emphasis added).
Notably, Tenn. Code Ann. § 67-4-2006(b)(1)(O) does not include a minimum percentage by which a "captive REIT" must be owned directly or indirectly by a bank, bank holding company, or a public REIT in order to avoid the DPD add-back.
Among other holdings, Revenue Ruling 14-07 infers that Tenn. Code Ann. § 67-4-2006(b)(1)(O) requires that in order for the exemption to the captive REIT DPD add-back to apply to a non-traded REIT owned directly or indirectly by a bank, bank holding company or a public REIT, such upper-tier entity must own at least 80%, directly or indirectly, of the lower-tier REIT. Accordingly, in the diagram above, because REIT C is less than 80% owned by the Public REIT, it is considered a captive REIT that must add back its DPD.
DC Council Overrides Mayoral Veto to Enact Legislation that Reduces Corporate Tax Rate and Exempts Certain Passive Entities from the Unincorporated Business Tax
On July 14, 2014, the DC Council held a legislative hearing at which it overrode Mayor Vincent Gray’s veto of the legislation approved by the Council in May 2014 (See NAREIT’s June 3, 2014 SALT Report for additional coverage). Among other things, this legislation does the following: 1) amends DC Code § 47-1808.03(a) to reduce the tax rate on unincorporated businesses from 9.975% to 9.4% for taxable years beginning after Dec. 31, 2014; 2) amends DC Code § 47.1810.02 to adopt a single sales factor for apportionment of business income in lieu of the current formula of property, payroll and twice the sales factor, for years beginning after Dec. 31, 2014; and, 3) amends DC Code § 47-1807.02(a) by, among other things, exempting from the unincorporated business tax (UBT) a "trade or business which arises solely by reason of the purchase, holding, sale of or the entering, maintaining or terminating positions in, stocks, securities, or commodities for the taxpayer’s own account." The amendment specifically excludes from this exemption a taxpayer that owns a non-listed REIT or a non-listed partnership interest. Thus, a partnership or limited liability company that owns a non-listed REIT or non-listed partnership interest will continue to be subject to the DC UBT.
Bill Amending “Change of Ownership” Test under California’s Proposition 13 Dies in California Senate Committee
On May 29, 2014, by an over two-thirds bipartisan vote, the California Assembly passed A.B. 2372, which would have amended the rules regarding when a "change in ownership" occurs in connection with property tax reassessments. However, the bill then was referred to the Senate Appropriations Committee where it was held in suspense until the legislature adjourned earlier this year.
By way of background, Proposition 13, approved by California voters in the 1970s, both caps property tax increases for original owners and prevents reassessment of property unless there has been a "change in ownership." For business entities that own California real property, California law defines a "change in ownership" as occurring only if one purchaser acquires at least a 50% interest in a property-owning entity. A.B. 2372 would have changed this rule to require reassessment when 90% of the interests in a property-owning entity are transferred over a three-year period. A.B. 2372 would have exempted transfers of, among other things, "stock or interests of a publicly-traded corporation or a publicly-traded partnership in the regular course of a trading activity on an established securities market unless shares are acquired as part of a merger, acquisition, private equity buyout, transfer of partnership shares or any other means by which a change of ownership would otherwise occur."
A.B. 2372 was supported by a number of business organizations, including the California Business Properties Association (CBPA), of which NAREIT is also a member, the California Business Roundtable and the California Chamber of Commerce. Following the Assembly’s vote last week, CBPA emphasized in a news alert its staunch support of Proposition 13, but the need to update implementation language to ensure that Proposition 13's original goals continue to be met. The California Taxpayers Association (Cal-Tax), of which NAREIT also is a member, remained opposed to the bill.
NAREIT will continue to monitor legislative developments in California that may propose changes to Proposition 13.
Hawaii Dividends Paid Deduction (DPD) Elimination Bill Fails: NAREIT Monitoring Future Legislation
On Jan. 17, 2014, H.B. 1726 was introduced in the Hawaii House of Representatives. This bill would have denied a REIT a DPD. The bill passed the House of Representatives on March 4, 2014 and was the subject of a hearing of the Senate Ways & Means Committee on March 20, 2014 at which NAREIT and several other stakeholders testified.
NAREIT retained a law firm and worked closely with several REITs with operations in Hawaii to defeat the bill, and on March 28, 2014 the Senate Ways & Means Committee voted to defer action on the bill for the remainder of the Legislature’s term.
Many of the policymakers involved in this legislation, including Governor Neil Abercrombie and Chairman of the Senate Ways & Means Committee David Ige (who was elected Governor), will not be returning to their positions in 2015. NAREIT will continue to vigorously oppose any efforts to deny a REIT’s DPD in the future.
For further information, please contact Dara Bernstein, NAREIT's Senior Tax Counsel, at firstname.lastname@example.org.