BILL ANALYSIS                                                                                                                                                                                                    



          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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