BILL ANALYSIS �
SB 314
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Date of Hearing: June 18, 2012
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
SB 314 (Vargas) - As Amended: February 9, 2012
Majority vote. Tax levy. Fiscal committee.
SENATE VOTE : Not applicable
SUBJECT : Property taxation: welfare exemption: Redevelopment
Agency of the City of San Diego.
SUMMARY : Revises the scope of the property tax "welfare
exemption" to include property that is located within the former
Naval Training Center (NTC) in San Diego and is used exclusively
for charitable purposes, as specified. Specifically, this bill :
1)Extends the welfare exemption to property that satisfies all
of the following conditions (qualified property):
a) Is located within the former NTC in San Diego;
b) Is leased for a term of 35 years or more by the City of
San Diego or the Redevelopment Agency of the City of San
Diego to an entity that has received an organizational
clearance certificate pursuant to Revenue and Taxation Code
(R&TC) Section 254.6 (nonprofit entity) or to an entity
controlled by that entity; and
c) Is used exclusively for charitable purposes.
2)Specifies that the welfare exemption shall apply to that
portion of the qualified property that is being used
exclusively for charitable purposes.
3)Allows the welfare exemption to apply to the qualified
property in any year in which the development of the property
is being financed with funds made available through the
federal New Markets Tax Credit (NMTC) Program or the federal
Tax Credit Program for Qualified Rehabilitation Expenditures
with respect to Certified Historic Structures (Historic Tax
Credit).
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4)Provides that the partial welfare exemption shall apply
notwithstanding that the property is subleased by the
nonprofit entity or its controlled entity to another
controlled entity.
5)States that an entity is deemed controlled by a nonprofit
organization if the nonprofit organization, or an entity in
which the nonprofit entity owns 50% or more of the stock,
profit interest, or capital interests, is sole general partner
or sole managing member of the controlled entity.
6)Contains legislative findings and declarations that a special
law is necessary because of the need to resolve the property
tax issues imposing severe financial burdens on an entity
leasing from the City of San Diego or its Redevelopment
Agency.
7)States that no reimbursement shall be made to any local agency
for any property tax revenues lost by it pursuant to this act.
8)Provides that, if the Commission on State Mandates determines
that this act contains costs mandated by the state,
reimbursement to local agencies and school districts for those
costs shall be made pursuant to Government Code Part 7
(commencing with Section 17500) of Division 4 of Title 2.
9)Takes effect immediately as a tax levy.
EXISTING LAW :
1)Provides that all property is taxable unless explicitly
exempted by the California Constitution or federal law and
limits the maximum amount of any ad valorem tax on real
property at 1% of full cash value.
2)Exempts from property tax certain specified property that is
irrevocably dedicated to religious, hospital, scientific, or
charitable purposes, if the property is used for the actual
operation of the exempt activity and is owned by a nonprofit
entity qualified as an exempt organization by the Internal
Revenue Service, the Franchise Tax Board, or both (the
so-called 'welfare exemption') �Article XIII, Section 4, of
the California Constitution; RT&C Section 214].
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3)Prohibits any earnings of the entity that owns the property to
inure to the benefit of any private shareholder or individual.
This welfare exemption has been expanded over the years to
add certain specific types of property that do not otherwise
qualify under the general exemption.
4)Allows a leasehold interest held by a nonprofit organization
in publicly owned property to qualify for the welfare
exemption. In the case of publicly owned property, the term
"owned" includes a leasehold interest (i.e. a taxable
possessory interest). �Tri-Cities Children's Center, Inc. v.
Board of Supervisors (1985) 166 Cal.App.3d 589].
5)Provides that property used exclusively for rental housing is
eligible for a partial exemption equal to the percentage of
the value of the property serving low-income persons, if
certain specified conditions are satisfied.
FISCAL EFFECT : According the Board of Equalization staff, this
bill will result in an annual property tax revenue loss of
$36,000. The annual loss is expected to increase if more
buildings located with the former NTC are renovated.
COMMENTS :
1)Author's Statement . The author states that, "This measure is
necessary to provide the same appropriate property tax
exemptions provided now to encourage/stimulate the public
benefit of low/mod housing opportunities to a publicly owned,
former military base reuse effort to restore and enhance art
and cultural opportunities for the citizens of San Diego."
2)Arguments in Support . The proponents of this bill argue that
SB 314 is needed to "remove the hardship imposed on NTC
Foundation, a 501(c)(3) non-profit organization, and its
non-profit tenants because of the Foundation's need to use
federal tax credits to finance the rehabilitation of National
Register buildings at the former Naval Training Center San
Diego." The proponents further state that the "addition of
property taxes paid by non-profit tenants was never
contemplated in the development of the project." They assert
that non-profit tenants in the NTC Foundation's buildings will
have to pay property taxes of $0.08 - $0.10 per square foot
per month "only because of the Foundation's need to use
federal tax credits." The proponents maintain that SB 314 will
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"reinstate - for all National Register historic buildings at
NTC that are the responsibility of NTC Foundation - the
trigger for property taxes to the use of space within these
buildings, without regard to what sources of funds were used
for their rehabilitation."
3)Arguments in Opposition . The opponents of SB 314 argue that
SB 314 "would grant a property tax exemption to at least one
for-profit corporation whose earnings do benefit individual
shareholders and is therefore unconstitutional." They assert
that the "fact that the for-profit entity owning the leasehold
is a wholly owned subsidiary of a nonprofit entity or is
"controlled by that entity does not cure the ownership of that
leasehold by a for-profit entity, the use of the property for
profit, or the distribution of earnings to private parties."
The proponents also highlight the fact that while in the case
of NTC "the actual dollar amounts lost to the County and the
State may not be considered significant to some, the potential
for future losses is larger" since "NTC is planning to expand
2 to 3 times its current size." Finally, the opponents note
that, if this measure is approved, "it will set a precedent
for granting exemptions to for-profit entities to take
advantage of the welfare exemption that is intended for
nonprofits."
4)The Welfare Exemption . The California Constitution provides
that all property is taxable, unless explicitly exempted by
the Constitution or federal law. The Constitution limits the
maximum amount of any ad valorem tax on real property at 1% of
full cash value, plus any locally-authorized bonded
indebtedness. Assessors reappraise property whenever it is
purchased, newly constructed, or when ownership changes.
The California Constitution allows the Legislature to establish
a property tax exemption for property (a) exclusively used for
religious, hospital, or charitable purposes, (b) owned by
nonprofit entities organized and operated for charitable
purposes, and (c) no part of whose net earnings inures to the
benefit of any private shareholder or individual. �California
Constitution, Article XIII, Section (4)(b)]. This exemption,
commonly known as the "welfare exemption," was adopted by the
voters as a constitutional amendment on November 7, 1944. The
Constitution also specifies that the exemption, if authorized,
must apply to buildings under construction, the land on which
the buildings are situated, and equipment in the buildings if
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their intended use is exclusively for exempt purposes.
(California Constitution, Article XIII, Section 5). In 1945,
the Legislature enacted the exemption, providing that a
qualifying nonprofit organization's property may be exempted
fully or partially from property taxes, depending on how much
of the property is used for qualified purposes and activities.
(R&TC Section 214).
5)The San Diego NTC: Background . In 1993, the United States
(U.S.) Navy announced plans to close the NTC in San Diego and
facilities were shut down incrementally through 1997. The
U.S. Navy property was transferred to the City of San Diego
in 2000. In accordance with the City of San Diego's
redevelopment plan, a Civic, Arts and Cultural Center was
established on 28 acres within 26 historic buildings in the
core of Liberty Station, which is the new name for the NTC.
In 2000, the City of San Diego created the NTC Foundation - a
qualified 501(c) non-profit organization - to restore 26
historic structures at the former NTC with a focus on the arts
and culture. The Foundation is required to raise the funds
necessary to rehabilitate and lease each of these historic
structures. As funds become available, the Foundation
processes a building permit and accepts a 55-year ground lease
from the City. As of now, the NTC Foundation has completed
renovations of eight buildings, with seven more nearing
completion for a Summer 2012 openings. According to the
sponsor's website, NTC at Liberty Station is now home to over
40 galleries, artists, designers, dance companies, music
studios, community and non-profit groups, and specialty
retailers and restaurants.
6)The Financing Structure . In order to raise funds for
rehabilitation of the historic buildings at Liberty Station,
the NTC Foundation entered into various financing transactions
with private entities using the NMTC and the Historic Tax
Credit. The Foundation had to resort to alternative ways of
funding the project because the rehabilitation costs of the
buildings far exceed their economic value, the available
grants and donations have not provided sufficient funds, and
the projected rents would not support debt service on
conventional loans.
The financing of rehabilitation of historic buildings using the
NMTC and the Historic Tax Credit requires the participation of
a private investor (mostly a taxable corporation) that could
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take advantage of the credits to reduce its income tax
liability. Generally, the amounts of those tax credits are
calculated as a percentage of either qualified equity
investments in qualified community development entities (in
the case of NMTC) or qualified expenditures (in the case of
the Historic Tax Credit). A typical arrangement is to match a
corporate tax credit investor entity with a project developer,
creating a partnership �such as a limited liability company
(LLC)] where the investor is allocated the tax credits in
exchange for cash and the developer acts as a managing partner
(or member). Usually, the percentage of allocated tax credits
matches the percentage of allocated profits. Thus, if an
investor entity is allocated all of the tax credits, then it
will also receive all or nearly all of the profits for at
least five years. In exchange, the developer will receive a
developer fee or other distributions. An investor must retain
ownership of the property (i.e. remain in the partnership) for
at least five or seven years after the project is placed in
service in order to receive the full benefit of the tax
credits, or the tax credits will be subject to recapture. At
the end of this period, either the developer will buy out the
investor or the investor will sell its interest in the
partnership.
In the case of a Historic Tax Credit, a certified historic
structure, i.e. a building, must be owned by either the entity
that utilizes the credit or a master tenant that leases the
entire building from the owner. In other words, the tax
credit is unavailable when a tax-exempt organization owns a
certified historic structure. Therefore, prior to closing of
the tax credit financing deal, the Foundation must create a
wholly-owned subsidiary, not a tax-exempt organization, and
transfer its 55-year NTC ground leases to the subsidiary. At
the same time, the NTC Foundation must form a limited
partnership in which 99.99% of the partnership interests are
owned by a corporate entity and .01% is owned by the
Foundation. The wholly- owned subsidiary will, in turn,
sublease the historic buildings to the partnership, which will
now qualify for the Historic Tax credit as a master lessee.
In such a structure, the corporate entity will be allocated
most, if not all, of the credit and profits. It will also
likely to receive an annual priority return, the amount of
which is equal to a very small percentage of the investor's
equity in the project. In exchange, the investor will
contribute cash to the partnership to provide financing for
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the rehabilitation project. The NTC Foundation will receive a
developer fee. It is expected that, after the expiration of
the five-year recapture period, the financing structure will
be unwound and the NTC will directly own the historic
buildings in the Liberty Station.
7)What is the Problem ? Under current law, those portions of NTC
buildings that have been developed by the Foundation using the
NMTC and the Historic Tax Credit are subject to property tax
and are ineligible for the welfare exemption. The reason for
the ineligibility is the introduction of a for-profit entity
into the chain of long-term leases from the City of San Diego
to the ultimate nonprofit tenants. A leasehold interest held
in nontaxable property, such as the property owned by the SD
Redevelopment Agency, is a "possessory interest" in real
property that is subject to property tax. However, a
"possessory interest" held by a qualifying nonprofit
organization in property may be exempt from property tax.
Existing law also allows a nonprofit organization that leases
its property to another nonprofit organization to qualify for
the welfare exemption, provided that both are qualifying
claimants. But the presence of a for-profit entity, in this
case the NTC's wholly-owned subsidiary, destroys the
property's eligibility for the welfare exemption. Thus,
publicly-owned lands leased to for-profit entities are not
generally eligible for the welfare exemption. The San Diego
County Assessor has assessed the possessory interest tax on
the NTC buildings which, according to the NTC Foundation, was
never contemplated in the development of the project and
creates a hardship for the project.
8)The Proposed Solution . SB 314 revises the welfare exemption
by allowing certain NTC buildings to qualify for the
exemption, even if they are only indirectly owned or operated
by a non-profit organization. In other words, as long as a
nonprofit entity "controls" the entity holding a long-term
lease for the property, the property will be wholly or
partially exempt from property tax, provided all other
requirements are met. An entity is deemed "controlled" by a
nonprofit organization if the nonprofit is a sole general
partner or managing member of the entity. An entity is also
deemed controlled by a non-profit organization if the entity's
sole general partner or managing member is another
organization in which the nonprofit has 50% or more of
ownership interests.
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The NTC Foundation has used a creative and effective financing
mechanism leveraging federal tax credits to ensure that the
NTC rehabilitation project becomes real. The utilization of
federal tax credits to finance projects undertaken by
nonprofit organizations in California would clearly help the
state, especially in these challenging financial times. But
the proposal suggested by this bill highlights a natural
tension between the need to draw more investors and investment
dollars to rehabilitation projects (as well as other worthy
economic development projects) and the policy behind the
welfare exemption, which is to encourage and support
non-profits performing charitable activities in the state. No
doubt that an economic development project financed with
federal tax credits and done by a for-profit organization
controlled by a non-profit fulfills a public purpose. But the
welfare exemption distinguishes between a charitable and a
public purpose.
The fact that a nonprofit owns or "controls" the for-profit
entity holding the leasehold does not "cure" the ownership
problem. Essentially, this bill will transform a welfare
exemption into a "qualifying use" exemption, where the
existing ownership requirement is eliminated. Furthermore,
net earnings generated by the property in question through its
end-user tenants are required to be distributed to the members
of the "master lessee," a for-profit entity operating and
managing the NTC buildings. The Committee may wish to
consider whether the welfare exemption should apply to
property owned by a for-profit entity, where the earnings are
required to be distributed to a private party.
9)The Welfare Exemption and Low-Income Housing Projects . The
proponents analogize the provisions of SB 314 with the
Legislature's grant of the welfare exemption to low- and
moderate-income housing projects, where non-profit sponsors
transfer ownership of the property to a wholly-owned
for-profit entity in order to access federal tax credits.
Over the years, the scope of the welfare exemption has been
gradually expanded. In the late 80s, the Legislature revised
R&TC Section 214 to provide that property is deemed to be
within the welfare exemption if it is (a) used for low and
moderate income housing, and (b) owned by an entity that is
eligible for, and receives, low-income housing tax credits
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allowed under Internal Revenue Code Section 42. The entity's
managing general partner must be an eligible nonprofit entity
or eligible LLC meeting all other requirements of R&TC Section
214, among other specified criteria.
Similarly to the approach taken by this measure, a low-income
housing project is developed by a limited partnership, in
which the affordable housing developer is the general partner
with a de minimis ownership interest and investors are limited
partners with a 99.9% ownership interest in the partnership
for the tax credit compliance period. Thus, in both cases,
the property is not directly owned by a non-profit entity
because of the need to bring in private investors that could
utilize tax credits. In addition, qualifying low-income
housing property is entitled to a partial exemption based on
the portion of the property serving lower income households,
which is comparable to the proposed partial exemption for NTC
buildings that are used for both charitable and non-charitable
purposes.
However, in the case of low-income housing, the owner of the
property is required to certify that there is an enforceable
agreement with a public agency, a recorded deed restriction or
other legal document that limits the project's usage and the
rent amounts. Moreover, in the case of a limited partnership,
those restrictions must be contained in an enforceable and
verifiable agreement with a public agency or a recorded deed
restriction to which the limited partnership certifies. In
addition, the owner must certify that the funds that would
have been necessary to pay property taxes are used to either
maintain the affordability of the units occupied by lower
income households or reduce rents for those households. None
of these restrictions would apply in the case of NTC projects
undertaken by the Foundation.
Furthermore, existing law does not contemplate a second tier
of for-profit entities that may sublease property to the
ultimate for-profit limited partnership that develops and
operates a low-income housing project. There is no indirect
control of the partnership by a non-profit organization, other
than the nonprofit is the managing general partner of the
partnership. In contrast, SB 314 allows a non-profit company,
the NTC Foundation, to create a controlled for-profit entity
that leases NTC buildings directly from the City of San Diego
and subleases the property to a limited partnership. Finally,
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the welfare exemption for low-income housing helps finance a
statewide need for low-income housing regardless of its
location in the state. In contrast, SB 314 would affect only
the NTC project.
10)Special Legislation . SB 314 would apply only to specified
NTC properties leased by the Redevelopment Agency of the City
of San Diego to the NTC Foundation or its subsidiaries. A
question could be raised as to whether the proposed statute
would violate subdivision (b) of Section 16 of Article IV of
the California Constitution, which makes invalid any local or
special statute in any case in which a general statute can be
made applicable. Courts have held that a statute does not
violate that constitutional provision when its limited
application is founded on natural, intrinsic, or
constitutional distinctions that reasonably justify
differential treatment �see Lelande v. Lowery (1945) 26 Cal.2d
224, 232]. Courts have also stated that, in determining
whether "a general statute can be made applicable", the issue
is not whether the Legislature could conceivably enact a
similar statute affecting every locality, but whether there is
a rational relationship between the purpose of the enactment
and the singling out of a single local entity affected by the
statute. City of Malibu v. California Coastal Commission
(2004), 121 Cal. App. 4th 989, 995; White v. State of
California (2001) 88 Cal.App. 4th 298, 305. The Committee may
wish to consider whether a rational relationship exists
between the purpose of this measure (ensuring a continuing
source of funding for the NTC rehabilitation projects) and the
application of SB 314 to just one organization - the NTC
Foundation - that is charged with the task of rehabilitation
of certain historic structures in one of the San Diego
redevelopment areas.
11)Slippery Slope ? This bill sets a precedent for other
for-profit entities to seek similar property tax exemptions
elsewhere in the state. It is hard to argue against further
exemptions for projects in other districts. If the idea of
exempting charitable uses of property owned by a for-profit
organization is worthy of consideration in the case of the NTC
buildings, shouldn't it apply to all similar projects financed
with the NMTC and Historic Tax Credit? The Committee staff
notes that, if a general exemption for those types of projects
is enacted, the fiscal effect to the state would be
considerable. The state is not in the position to continue
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financing local economic development efforts such as
redevelopment when doing so necessitates cuts to core
services, such as education, public safety, and health care to
the neediest Californians.
12)Constitutional Concerns . The opponents of this bill argue
that the application of the welfare exemption to property that
is owned by a for-profit entity that is controlled by a
nonprofit is unconstitutional. The language of the
Constitution is clear that the qualifying property must be
owned, operated and used by a nonprofit entity for exempt
purposes and activities, and no part of the entity's net
earnings may inure to the benefit of any private shareholder
or individual. In the case at hand, not only are the
leasehold interests in the buildings "owned" by a for-profit
entity and subleased to a master lessee, but the net earnings
generated from the property through its end-user tenants are
required to be distributed to the members of the master
lessee, i.e. a for-profit operating entity. According to the
Legislative Counsel, the Legislature, by authorizing this
exemption, may be exceeding its authority under Section 4 of
Article XIII of the California Constitution to exempt property
from taxation.
13)Related Legislation .
SB 797 (Kehoe), introduced in the 2011 legislative session,
stated the intent of the Legislature to exempt from property
taxation certain historic property located within the former
NTC in the City of San Diego and leased by the Redevelopment
Agency of the City of San Diego to a nonprofit entity or to an
organization controlled by the nonprofit entity. SB 797 was
never heard by a Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
City of San Diego
Opposition
County of San Diego
California State Association of Counties (SCAC)
California Assessors' Association
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Urban Counties Caucus
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098