60 Acres And A Lawsuit Challenging The FTB's Interpretation of "Doing Business"

Swart Enterprises, Inc. is an Iowa corporation.  It operates a farm with some 60 acres of crop land in Kansas.  Swart has no physical presence in California.  It owns no real or personal property in California.  It has no California employees.  Swart's sole connection to California is as an investor in a fund that trades in capital equipment and interests in capital equipment.  It is hard to imagine that anyone would characterize Swart as doing business in California.  Remarkably, however, that is exactly the position of the Franchise Tax Board which demanded that Swart file a California tax return and pay the $800 minimum franchise tax under Rev. and Tax. Code § 25153.

Swart ended up paying the tax together with interest and penalties under protest and then filed a claim for a refund.  Not surprisingly, the FTB denied the claim.  Now, Swart has filed a civil complaint seeking a refund and declaratory relief.  Swart Enterprises, Inc. v. Cal. Franchise Tax Bd., Fresno County Superior Court Case No. 13 CE CG 02171 (July 9, 2013).  In addition to challenging the FTB's interpretation of the law, Swart claims that the tax is unconstitutional (both facially and as applied).  Swart is represented in the litigation by the same firm, Silverstein & Pomerantz LLP, that represented the taxpayer in The Gillette Co. v. Franchise Tax Bd., 209 Cal. App. 4th 938 (2012), review granted, depublished by Gillette Company v. Franchise Tax Board, 2013 Cal. LEXIS 282 (Cal., 2013).

Why does the FTB claim that Swart is doing business in California?  Swart invested in a California limited liability company.  While Swart is a member, it is not the manager of the fund and is not involved in any way in the management or operations of the fund.  However, this hardly seems to be "doing business" as defined in Rev. and Tax. Code § 23101 - "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit" (emphasis added).

Readers may recall that this isn't the only startling interpretation advanced by the FTB.  See California's "Doing Business" Trap for Foreign LLCs With California Managers, Members Or Agents.  Although the state has an interest in increasing revenue, it must do so fairly and with proper notice.  Whatever the merits of the FTB's interpretations, the FTB has failed to provide appropriate notice and comment as required by California's Administrative Procedure Act.

Finally, and perhaps most importantly, the FTB's position is utterly misguided.  By taxing investments in California LLCs, the state is discouraging out-0f-state firms from making investments in California.