After a lengthy delay, the Supreme Court of California (Court) has set an argument date for the appeal of 926 North Ardmore Avenue, LLC v. County of Los Angeles, on Wednesday, April 5, 2017, at 9:00 a.m. in Los Angeles. It is the Court's policy to file its opinion within 90 days of oral argument. This policy is almost always followed, as a provision of California's Constitution provides that the judges may not be paid if a case remains pending and undetermined for 90 days after it has been submitted for decision.¹ Therefore, an opinion is expected no later than July 4, 2017.

In California, the state has granted counties and municipalities the authority to impose a documentary transfer tax on transfers of real property within their respective jurisdictions.² The statute is generally silent as to the application of the tax to changes in control of entities, with the exception that a taxable transfer is deemed to occur when a partnership terminates under Internal Revenue Code (IRC) Section 708.³ While some jurisdictions have enacted ordinances that incorporate California Revenue and Taxation Code (R&TC) Section 64's property tax change in ownership rules into their transfer tax regime, Los Angeles County has not. It instead relies on the interpretation that "realty sold" in R&TC Section 11911 has the same meaning as "change in ownership" of a legal entity as used in R&TC Section 64.⁴

The Court of Appeal (COA) agreed with the County's interpretation, thus allowing the County to collect a transfer tax on the change of control of a legal entity that owns real property in the County without having to enact a separate ordinance explicitly incorporating R&TC Section 64 into its transfer tax statute. If upheld by the Court, conceivably all local jurisdictions in the state will be authorized to impose a documentary transfer tax on changes in ownership of a legal entity.

Appellate Court Findings

The opinion issued in 926 North Ardmore Avenue, LLC v. County of Los Angeles,⁵ by the COA, Second District, held that when a change in ownership of a legal entity occurs pursuant to R&TC Section 64(c) or 64(d), the payment of documentary transfer tax is due.

Pursuant to the California Documentary Transfer Tax Act (DTTA), R&TC Section 11911 provides that a county by ordinance may impose a tax on " … each deed, instrument, or writings by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred or otherwise conveyed … " Ardmore argued that the DTTA is modeled after the repealed Federal Stamp Tax Act and would not apply in this scenario under those rules. Ardmore further asserted that "realty sold" did not include conveyances of interests in legal entities with the exception of a transfer that is deemed to occur upon the termination of a partnership that terminates under IRC Section 708 as provided by R&TC Section 11925. Ardmore contended that R&TC Section 11925 did not apply to the transaction because the realty was held indirectly by a partnership through a SMLLC.

The County argued that the COA should follow prior California case law that interpreted the term "realty sold" in R&TC Section 11911 to have the same meaning as the phrase "change in ownership" as used in R&TC Sections 64(c) and 64(d). In determining whether a "change of ownership" is subject to the tax imposed pursuant to the DTTA, the COA reviewed prior case history including the Thrifty and McDonald's cases.⁶ In both of these cases, California appellate courts decided whether certain leases would be considered "realty sold" for purposes of the DTTA. In these decisions, the appellate courts relied upon the definition of a lease under the property tax rules to determine whether the lease resulted in a change in ownership in real property and was subject to a tax imposed under the DTTA. Additionally, the COA interpreted the prior case history by taking a broad view that the definition of "change of ownership" in the California property tax law can be considered in determining the meaning of the term "realty sold" for purposes of the DTTA, including in the context of an entity sale under R&TC Sections 64(c) and (d). The COA was of the opinion that the Legislature, while not directly amending the DTTA, clearly intended that it be inclusive of legal entity change in ownership transactions by the administrative changes to identify legal entity ownership changes.

Implications

If upheld by the Court, all local jurisdictions in the state will be authorized to impose the documentary transfer tax on changes in ownership of a legal entity. If overturned, only those jurisdictions in California that have specifically incorporated R&TC Section 64 into their transfer tax statutes will be authorized to impose the transfer tax based on a change in control (although other challenges to these jurisdictions' transfer tax statutes may still be looming). Taxpayers that undertook past transactions that resulted in a change of ownership under R&TC Section 64 may need to file transfer tax returns and submit tax due as a result of the transaction. The property tax "change of ownership" rules under R&TC Section 64 are extremely complex and will need to be considered with respect to exposure on past transactions and transactions going forward.

EY's State and Local Tax Real Estate Team is monitoring the progress of the appeal and intends to provide updates both after the Court hearing in April and once the Opinion is released.

Please contact EY to discuss the potential implications of the decision to past transactions as well as any current or planned sales transactions of entities owning real property located in the state of California.

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ENDNOTES

¹ Cal. Const. Art. 6, Section 19.

² Cal. Rev. & Tax. Code Section 11911.

³ Cal. Rev. & Tax. Code Section 11925.

⁴ Cal. Rev. & Tax. Code Section 64.

⁵ 926 North Ardmore Avenue, LLC v. County of Los Angeles, No. B248536 (Cal. App. Ct. Sept. 22, 2014).

⁶ See Thrifty Corp. v. County of Los Angeles (1989) 210 Cal.App.3d 881, 884 (holding that creation of a 20-year lease with a 10-year renewal option did not constitute a "change in ownership" under R&TC Section 61 so as to be considered "realty sold" under R&TC Section 11911). See also McDonald's Corporation v. Board of Supervisors (1998) 63 Cal.App.4th 612 (holding that an amendment to a lease that resulted in a remaining term of less than 35 years did not constitute a "change in ownership" under California property tax provisions so as to be considered "realty sold" under R&TC Section 11911).