BILL ANALYSIS Ó
SENATE COMMITTEE ON GOVERNANCE AND FINANCE
Senator Robert M. Hertzberg, Chair
2015 - 2016 Regular
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|Bill No: |SB 259 |Hearing |1/13/16 |
| | |Date: | |
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|Author: |Bates |Tax Levy: |No |
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|Version: |6/29/15 |Fiscal: |Yes |
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|Consultant|Grinnell |
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PROPERTY TAXATION: CHANGE IN OWNERSHIP (URGENCY)
Provides that a change in ownership occurs when 90% of a legal
entity's ownership interests transfer in a single transaction.
Background and Existing Law
I. Changes in Ownership. Proposition 13 (1978) amended Article
XIIIA of the California Constitution to preclude assessors from
revaluing property for tax purposes unless it changes ownership.
However, the initiative didn't define the term, leaving it to
the Legislature to determine just what a "change in ownership"
meant. Assessors determine changes in ownership for real
property by looking at property records, and reassess the
property whenever any interest transfers. If a property is
owned by more than one taxpayer, the assessor revalues the
property in proportion to the percentage transferred. However,
assessors cannot easily determine changes in ownership among
legal entities, such as corporations and partnerships, where the
ultimate ownership may not be clear, and changes in ownership
don't show up in property records.
Shortly after passage of Proposition 13, the Assembly Committee
on Revenue and Taxation appointed a task force to wrestle with
the various interpretations necessary to implement the
initiative. The task force's initial recommendation concerning
changes in ownership of property owned by legal entities was to
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adopt the "separate entity" theory, providing that so long as
the same legal entity owned the property, it would not be
reassessed, regardless of whether ownership interests in the
entity change, such as stock in the corporation, or partners in
the partnership. However, the task force subsequently added the
"majority-takeover-of-corporate-stock," or "change in control,"
provision to maintain some parity with the increasing relative
tax burden of residential property statewide. As enacted,
assessors reassess property to fair market value when one person
or legal entity obtains "control," defined as purchasing or
otherwise acquiring more than 50% ownership of a corporation or
other legal entity in a single transaction. Additionally,
assessors must reassess a legal entity's property whenever 50%
of its original co-owners cumulatively transfer voting stock or
other voting interest in one or more transactions. Under
the law, multiple individuals or entities can acquire another
entity in a single transaction, but won't be reassessed so long
as none of the purchasers acquire more than 50% interest in the
acquired entity. The initial case in point was Kaiser Steel,
ownership of which was acquired by a consortium of seven
separate purchasers, none of whom acquired more than 50%
ownership - even though 100% of the corporation had changed
hands, no change of ownership had occurred, since no single
party had acquired more than 50% ownership of the corporations.
A few years later, E. & J. Gallo bought Louis M. Martini, but
split the purchase among 12 Gallo family members, thus
preventing the underlying property from being reassessed.
Ocean Avenue LLC has owned the Fairmont Miramar Hotel in Santa
Monica since October 1999. Before September 2006, Ocean Avenue
LLC was a wholly owned subsidiary of Hotel Equity Fund VII, L.P.
That firm initially agreed to sell the hotel outright to MSD
Capital LP, a company owned by Michael Dell, the founder and CEO
of Dell, Inc., but then canceled it before closing, instead
choosing to sell the legal entity itself. 49% percent was sold
to Susan Dell's (Michael Dell's wife) property trust; 42.5
percent to Michael Dell's MSD Capital LP, and 8.5% to a third
entity in which Michael Dell held majority control.
Subsequently, the Los Angeles County Assessor determined a
change of ownership had occurred, and the Los Angeles County
Assessment appeals board concurred. However, Mr. Dell
challenged the determination, and in June, 2014, the Second
District California Court of Appeal affirmed a Superior Court
decision which held that no change in ownership occurred. The
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Court held that because no single entity obtained more than 50%
control of Ocean Avenue LLC, a change of ownership did not occur
even if the legal entity's ownership had changed entirely.
II. Legal Entity Ownership Program. To help track potential
reassessments, the State Board of Equalization (BOE) created the
Legal Entity Ownership Program (LEOP) in 1982 to help find and
detect changes in control and ownership of corporations,
partnerships, and other legal entities, which have no recorded
deed or notice of a transfer of an ownership interest in a legal
entity. Under LEOP, the Franchise Tax Board (FTB) sends to BOE
a list of legal entities that have reported a change in control
or change in ownership on income tax returns, analyzes completed
statements to determine changes in control or ownership, and
notifies county assessors of changes in control and ownership.
To assist these efforts, the Legislature required legal entities
to report transfers directly to BOE within 90 days, and
established a penalty for legal entities failing to self-report
a change in ownership and control to BOE equal to 10% of the tax
resulting from enrolling the higher value (SB 816, Ducheny,
2009).
Proposed Law
Senate Bill 259 provides that a change in ownership occurs when
90% or more of the direct or indirect ownership interests in a
legal entity are sold or transferred in a single transaction,
thereby requiring the assessor to revalue the property owned by
that legal entity. The change in ownership applies regardless
of whether one legal entity or person party to the transaction
obtains control, except when a change in ownership exclusion in
current law can apply.
The measure defines many of its terms, including "single
transaction" as a plan consisting of one or more transfers that
occur on or after January 1, 2016. SB 259 enacts a rebuttable
presumption that a transfer is part of a single transaction if
the transferees are related parties as defined by the Internal
Revenue Code, and if the transfers occur within a 36 month
period commencing on the date of the first sale or transfer of
interests.
The measure excludes from changes in ownership any transfer of
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ownership interests that occurs upon death, or sales of stocks
or interests in publicly traded corporations on established
securities markets, unless as part of a merger, acquisition,
private equity buyout, transfer of partnership shares, or other
means. Additionally, SB 259 requires changes in ownership to be
measured proportionally.
SB 259 makes conforming changes to questions FTB must include on
returns for partnerships, banks, and taxable corporations, as
well as to change in ownership statements, which taxpayers
obtaining property or control of legal entities must file with
BOE within 90 days of the change. The measure also increases the
penalty for failing to file the statement from 10% of tax to
15%.
The bill requires BOE to notify assessors if a change in control
or ownership occurs. BOE must also report to the Legislature by
January 1, 2021 regarding the bill's implementation, economic
impact, and frequency or reassessments of legal entity real
property.
State Revenue Impact
BOE estimates that SB 259 will result in annual property tax
revenue gains of $26 million.
Comments
1. Purpose of the bill . According to the author, "SB 259 fixes
a problem or a loophole as described by some. It does not
portend to fix all real or perceived problems in the change of
ownership arena. As former Assemblymember Tom Ammiano stated in
the San Francisco Chronicle in May of 2014: 'This loophole was
done by the Legislature. We broke it, and we can fix it.'
Current law extends Proposition 13 change-in-ownership
reassessment provisions to property of legal entities only when
there is an acquisition of more than 50 percent of the ownership
interest of a legal entity that owns California real property by
an individual or other legal entity, not the sale or transfer of
such interests. SB 259 triggers a change-in-ownership
reassessment of legal entity property when at least 90 percent
of the legal entity interests are sold, even if no one person
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gets a majority interest in the legal entity. To trigger
reassessment, these ownership interests must be sold or
transferred within a 36-month period as part of a plan. Excluded
from the change-in-ownership reassessments are sales of stock of
a publicly traded corporation or partnership on an established
securities market, as defined by federal law, and transfers at
death without payment for ownership interests. The bill also
increases the penalty for failure to file a change-in-ownership
statement, from 10 percent to 15 percent of the taxes applicable
to the new base-year value (or old base-year value, if there is
no change in ownership). The bill requires the State Board of
Equalization to notify assessors if a legal entity change in
ownership occurs. The board also is required to submit a report
to the Legislature by 2021 regarding the implementation of the
bill, including economic impact (which should mean more than
just the revenue impact) and frequency of reassessment. On June
3, 2014, the Second District Court of Appeal held that the sale
of the legal entity that owned Santa Monica's Miramar Hotel did
not trigger a change-in-ownership reassessment of the hotel -
Ocean Avenue LLC v. County of Los Angeles - even though 100
percent of ownership interests were sold, because a reassessable
change-in-ownership of the entity's real property did not occur.
This was because no one person obtained more than 50 percent of
the entity's ownership interests, the court ruled. Under the
provisions of SB 259, the property in question would have been
reassessed."
2. Cold war . Before Proposition 13, assessors valued property
at its current fair market value. After the initiative, the
Constitution prohibited assessors from doing so, directing them
to only enroll a new value for property when it's newly
constructed or changes ownership. The Proposition 13 working
group did the best job it could in devising rules to help
assessors determine whether changes in ownership in legal
entities occur in the unchartered waters after the initiative,
and those rules have remained largely unchanged for more than 35
years because of disagreements between business groups, who
state that limiting reassessments provides the certainty and low
taxes necessary to generate additional economic growth in the
state, and Proposition 13's critics, who deride current change
in ownership law as a loophole that enables wealthy parties to
traffic in properties without paying their fair share. SB 259
attempts to bridge this long-standing divide by requiring
reassessment for certain forms of property sales transactions
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not subject to reassessment under current law.
3. Too narrow ? Taking inspiration from the Fairmont Miramar
Hotel case, SB 259 provides that a transaction that changes 90%
of ownership in a legal entity within three years triggers a
reassessment of the legal entity's property, but wouldn't for
many other transactions, such as one that changes 89.9% of
ownership in the first three years, then conveys the remaining
10.1% on the first day after the three year window ends.
Changing state law in response to a single case ensures that a
reassessment results should taxpayers repeat the same
transaction, but leaves sufficient flexibility for sophisticated
taxpayers to continue to avoid reassessments through tax
planning. Additionally, the bill doesn't direct assessors to
enroll new values for future property taxes for taxpayers who
avoided reassessment using similar transactions in the past.
The Committee may wish to consider whether SB 259 sufficiently
reforms this form of tax avoidance. If the Committee finds the
scope of the measure too narrow, it could expand it in the
following ways:
Eliminate the bill's three year cut-off, instead
providing that reassessment occurs whenever the 90%
threshold is reached,
Direct assessors to enroll new values for property that
would have been reassessed under the bill's terms.
4. How does this work ? Three examples demonstrate
reassessments under current law and SB 259.
John buys 100% of ACME Tools from Anne. The assessor
revalues ACME Tools' property to fair market value under
current law because John now controls ACME Tools, and under
SB 259 because more than 90% of ACME tools transferred.
John, Paul, and George buy 100% of ACME Tools from Anne
in equal shares within three years. The assessor does not
reassess the property under current law, as no single new
owner obtained more than a 50% interest. However, under SB
259, the assessor would reassess the property, because 90%
or more of ACME Tools transferred, and the 50% threshold
doesn't apply.
John, Paul, and George buy a controlling interest in
ACME Tools from Anne in equal shares, but Anne maintains an
11% ownership share. The Assessor would not reassess ACME
Tools under either current law or the bill, because only
89% of the company was transferred. The assessor would
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reassess ACME tools if Anne sold the remaining 11% to John,
Paul, and George within the three-year window, but would
not if Anne sold the remaining share after the three-year
window.
5. Fenced off . When the stock of a publicly-traded corporation
is bought or sold, no reassessment of the corporation's property
takes place, even though more than 50% of the stock has changed
hands. Property owned by major corporations is not reappraised
as often as residential property, if ever. SB 17 (Escutia, 2005
and 2007) proposed a rebuttable presumption that a corporation's
property changes hands every three years, but SB 259 explicitly
states that changes in ownership can't occur due to the regular
activity on an established securities market, thereby fencing
off the issue by law. However, the bill triggers reassessment
when part of a merger, acquisition, private equity buyout,
transfer of partnership shares, or other means. The Committee
may wish to consider why ownership changes in publicly traded
corporations occurring on stock exchanges shouldn't trigger
reassessment, when other transactions should.
6. What's the plan ? SB 259 states that a "single transaction"
means "a plan" consisting of one or more transfers, making
reassessment contingent upon the more subjective determination
that a coordinated plan exists, instead of a more objective,
mathematical measure of ownership interest change. This
approach offers more flexibility to determine whether a series
of transactions triggers a reassessment, but the measure but
doesn't specifically state the agreements, contracts, or other
elements necessary to be considered "a plan," which could lead
to disagreements between assessors and taxpayers regarding the
degree of planning necessary to trigger a reassessment.
7. Being presumptive . SB 259 creates a rebuttable presumption
that a transfer or sale is part of a "single transaction,"
thereby subjecting the legal entity's property to potential
reassessment, if it takes place between related parties, and
occurs within 36 months. Rebuttable presumptions often serve as
useful starting points, but what specific evidence does a
taxpayer use to rebut the BOE's or Assessor's presumption that a
transfer is within related parties, or the 36 month period?
8. Technicals . SB 259 directs BOE to study the bill's economic
impact as part of a report to the Legislature. BOE suggests
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that while it can estimate the measure's impact on revenues, the
Legislative Analyst's Office is better equipped to measure its
economic impact.
9. Recent history . Last year, the Assembly approved AB 2372
(Ammiano), which addressed the same issue as SB 259. The
Committee approved the measure with significant amendments, but
the Committee on Appropriations subsequently held the bill on
its suspense file.
10. 2/3 . Because SB 259 increases taxes on any taxpayer
according to Section Three of Article XIIIA of the California
Constitution, Legislative Counsel assigned the bill a 2/3 vote
key.
11. Urgency . Regular statutes take effect on January 1
following their enactment; bills passed in 2015 take effect on
January 1, 2016. The California Constitution allows bills with
urgency clauses to take effect immediately if they're needed for
the public peace, health, and safety. SB 259 contains such an
urgency clause, stating that it's necessary to close a loophole
Support and
Opposition (1/7/16)
Support : California Business Properties Association, California
Business Roundtable, California Chamber of Commerce, Howard
Jarvis Taxpayers Association.
Opposition : California Tax Reform Association.
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