California Supreme Court Affirms Novel M&A Tax

Suppose Mr. Henry owns all of the outstanding shares of a Virginia corporation that owns all of the issued and outstanding shares of a Massachusetts corporation that owns, among other things, real property in Los Angeles, California.  Suppose further that Mr. Henry sells his shares in the Virginia corporation to a buyer in New York and that the transaction is negotiated and closed in New York.  Does anyone believe that the County of Los Angeles can impose a documentary transfer tax on the transaction?

In an alarming decision yesterday, the California Supreme Court held that the County of Los Angeles could impose a documentary transfer tax on a written instrument that transferred beneficial ownership of real property from one person to two others.  926 N. Ardmore Ave. v. County of L.A., 2017 Cal. LEXIS 4768 (Cal. 2017).  The case arose when the County of Los Angles imposed a documentary tax on the transfer of interests in a partnership that was the sole member of a limited liability company that owned a building.

Under California's property tax regime, a change in ownership triggers reappraisal and reassessment for property tax purposes. (Cal. Const., art. XIII A, § 2)  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." Cal. Rev. & Tax. Code § 60.  A transfer of an interest in a legal entity can in some cases constitute a change of ownership of the entity's real property.  See Cal. Rev. & Tax. Code § 64.  Whenever there is a change in control pursuant to Cal. Rev. & Tax. Code § 64(c) or a change in ownership pursuant to Cal. Rev. & Tax. Code § 64(d) of a legal entity, and the legal entity owned or leased  an interest in California real property as of that date, the person or legal entity acquiring ownership control or the legal entity that has undergone a change in ownership must file the BOE-100-B, Statement of Change in Control and Ownership of Legal Entities (statement) with the Board of Equalization within 90 days of the change in control or ownership.  Cal. Rev. & Tax. Code §§ 480.1 & 480.2.  The BOE is required to share that information with county assessors, so that each assessor can determine whether property within its jurisdiction has changed ownership.  Id.

Although also related to real property, California's Documentary Transfer Tax Act, Cal. Rev. & Tax Code § 11901 et seq. is an entirely different law.  The DTTA allows a county to impose a tax "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 . . . ."  Cal. Rev. & Tax. Code §  11911(a).  In 2009, the legislature amended the property tax law to require county assessors to disclose change of ownership information with county recorders.  Cal. Rev. & Tax. Code §  408(b).  As a result, the recorders in Los Angeles and other counties began to equate a change of ownership for purposes of the property tax law with a transfer under the DTTA.  Unfortunately, the California Supreme Court has now endorsed this approach.

I disagree with the majority's opinion for several reasons.  First, the DTTA was enacted in 1967 while the voters approved Proposition 13 governing real property taxation more than a decade later.  The legislative provisions implementing Proposition 13 were enacted in 1979.  Thus, Proposition 13 and its implementing statutes should have no bearing on the legislature's intent in adopting the DTTA.  Second, as Justice Leondra Kruger observed in dissent, the statutes were adopted for different purposes.  Proposition 13 relates to when real property may be re-assessed while the DTTA is an excise tax on the privilege of selling a real property interest, not a tax on the property itself.  Third, the majority's approach would allow documentary transfer taxes to be imposed on transactions, entities and owners that have no relationship to California whatsoever (see the above example).