BILL ANALYSIS Ó SENATE COMMITTEE ON GOVERNANCE AND FINANCE Senator Robert M. Hertzberg, Chair 2015 - 2016 Regular ------------------------------------------------------------------ |Bill No: |SB 259 |Hearing |1/13/16 | | | |Date: | | |----------+---------------------------------+-----------+---------| |Author: |Bates |Tax Levy: |No | |----------+---------------------------------+-----------+---------| |Version: |6/29/15 |Fiscal: |Yes | ------------------------------------------------------------------ ----------------------------------------------------------------- |Consultant|Grinnell | |: | | ----------------------------------------------------------------- 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 SB 259 (Bates) 6/29/15 Page 2 of ? 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 SB 259 (Bates) 6/29/15 Page 3 of ? 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 SB 259 (Bates) 6/29/15 Page 4 of ? 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 SB 259 (Bates) 6/29/15 Page 5 of ? 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 SB 259 (Bates) 6/29/15 Page 6 of ? 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 SB 259 (Bates) 6/29/15 Page 7 of ? 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 SB 259 (Bates) 6/29/15 Page 8 of ? 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. -- END -- SB 259 (Bates) 6/29/15 Page 9 of ?