Posts Tagged ‘Swart.Enterprises’

FTB Not Appealing Swart Decision

Wednesday, February 22nd, 2017

Last month a California appellate court ruled that California’s Franchise Tax Board was wrong in trying to assess an Iowa corporation with a 0.2% ownership in an LLC that invested in California the California minimum Franchise Tax. It was announced today that the FTB will not appeal the decision. The court’s conclusion was,

We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC. The Attorney General’s conclusion that a taxation election could transmute Swart into a general partner for purposes of the franchise tax, and that the business activities of Cypress can therefore be imputed to Swart, is not supported by citation to appropriate legal authority and, in our view, defies a commonsense understanding of what it means to be “doing business.”

This is good news for passive business entity investors who happen to be investing in California. It’s likely that other cases that are winding way through the courts will now be settled and that the FTB will adopt a common-sense approach on this issue. Chris Smith, the FTB’s Trade Media Liaison, sent an email noting that, “[The] FTB is working on providing information to taxpayers in light of the decision which it expects to release soon.” I will link to that information when it becomes available.

Swart Wins Appeal; Not Liable for California Minimum Tax

Thursday, January 12th, 2017

Good news for non-California businesses that are passive investors in an investment that invests in a California entity. The Franchise Tax Board (California’s income tax agency) has been ruling that business entities that have no active business in California but make an investment in another entity that invests in California must pay California’s mandatory $800 annual franchise tax. Today, a California Court of Appeal upheld the lower court judgment that Swart Enterprises, Inc., one such entity, is not doing business in California.

The facts of the case were not disputed. Swart is a small family-owned Iowa corporation, with a farm in Kansas; occasionally they make sales to Nebraska. Swart has no physical presence in California, no property of any kind (or employees) in California. It does not sell to California. Yet the FTB said it owed the California minimum franchise tax. Why? As the Court noted,

In 2007, Swart invested $50,000 in Cypress Equipment Fund XII, LLC (Cypress LLC or the Fund) and became a member of the LLC. Swart’s investment amounted to a 0.2 percent ownership interest. This is Swart’s sole connection with California.

Cypress was simply an investment fund. But the FTB said, “A foreign business entity (partnership, LLC, or corporation) is considered doing business in California if it is a member of an LLC that is doing business in California,” and owed the minimum $800 franchise tax. Swart paid the tax but filed a claim for refund. The FTB denied the claim. Swart filed a lawsuit which they won; the FTB appealed.

The Court of Appeals noted,

Although this matter calls for our independent judgment, our views are substantially consistent with the trial court’s ruling, which we find to be logical and well-reasoned. We are not persuaded Swart may be deemed to be doing business in California because it owns a 0.2 percent interest in a manager-managed LLC doing business in California. Swart’s only connection to California was a mere 0.2 percent ownership interest it passively held during the tax year the franchise tax was imposed. This interest closely resembled that of a limited, rather than general, partnership as evinced by the fact Swart had no interest in the specific property of Cypress LLC, it was not personally liable for the obligations of Cypress LLC, it had no right to act on behalf of or to bind Cypress LLC and, most importantly, it had no ability to participate in the management and control of Cypress LLC. Because the business activities of a partnership cannot be attributed to limited partners, Swart cannot be deemed to be “doing business” in California solely by virtue of its ownership interest in Cypress LLC. [citations omitted]

There’s more. The FTB tried to hold that because Cypress LLC is being taxed as a partnership, all partners are general partners, and Swart must pay the $800 minimum tax. The Court disagreed.

Like the limited partners in Amman & Schmid, Swart had no interest in the specific property of Cypress LLC (Corp. Code, former § 17300), it was not personally liable for the obligations of Cypress LLC (id., former § 17101, subd. (a)), it had no right to act on behalf of or bind Cypress LLC (id., former § 17157, subd. (b)(1), (2)), and Swart was prohibited from participating in the management and control of Cypress LLC…

We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC. The Attorney General’s conclusion that a taxation election could transmute Swart into a general partner for purposes of the franchise tax, and that the business activities of Cypress can therefore be imputed to Swart, is not supported by citation to appropriate legal authority and, in our view, defies a commonsense understanding of what it means to be “doing business.”

There are many other similar cases working through the appeals process and the California court system. (There is a case of a corporation that invested in another entity that invested in another entity that made a California investment, and California is attempting to impose the $800 minimum tax on the corporation. That’s a passive investor in another passive investor that has made an investment in California.) It appears that California courts are taking a dim view of the idea that a passive investor with no ties to California can be made into an entity liable for California tax simply making an investment in California. Incidentally, the Court awarded legal costs to Swart.

The bad news is that I fully expect the Franchise Tax Board to appeal this decision to the California Supreme Court. Still, we appear to be reaching the point where California will likely cease this practice.

California Goes After Flow-Throughs with Passive Investments in California

Saturday, August 17th, 2013

Let’s say you’re the manager of a business in Florida. Your business has some excess capital, so you decide to invest in the RussFox Fund, LLC. Your investment makes up a whopping 0.02% of the fund. (Put another way, you own 2/10000 of the LLC.) The RussFox Fund invests and trades capital equipment, including some in California. You take no part in the management of the fund–you’re clearly a passive investor.

One day you open the mail and see a notice from California’s Franchise Tax Board, California’s state income tax agency. It says you’re Florida business is liable for the $800 California minimum franchise tax (plus penalties and interest, of course) because your business has California-source income.

Now, would California do that? The answer is they have already done so. The facts that I gave mirror the facts of a case written up by Tax Analysts on a Kansas-based company called Swart Enterprises, Inc. Swart paid the FTB and then filed a claim for refund. That claim was denied; Swart has now filed a lawsuit in Fresno County Superior Court. It will likely be some time before this case is decided, but it will be interesting to follow.

Of course, the conclusion that Tax Analysts writes is exactly what I thought: “While states are always on the lookout for each and every dollar of tax revenue, taxing investments in California serves as a big disincentive for out-of-state companies to invest in the state.”