HART1-1368430-2 © John R. Shaughnessy, Jr.; Stewart M. Weintraub 2007. All rights reserved.

State Tax Issues Affecting Expansion into Other States

John R. Shaughnessy, Jr. Robinson & Cole LLP Hartford, Connecticut

Stewart M. Weintraub

Schnader Harrison Segal & Lewis LLP Philadelphia, Pennsylvania

Joint Meeting, Closely Held Business Committee and State and Local Taxes Committee, American Bar Association Section of Taxation

Hollywood, Florida January 19, 2007

I. Franchise Taxes – Tax Rates, Entity Classification and Current Developments

A. In general, corporate net income is taxed at a rate higher than that imposed on the net income of individuals and is taxed again when distributed.

1. In addition, corporations are subjected in many states to an additional or alternative tax on capital, usually measured by net worth.

2. Corporations are also generally subject to minimum taxes, which in some cases may be substantial.

B. In some states, entities that are pass-through entities for purposes of federal taxation may be subject to corporate income and capital-based taxes and/or to the corporate minimum-tax regime.

1. S corporations are vulnerable to treatment as a corporation, either because the state does not recognize S elections1 or because the entity fails to make a separate state S election.2

a. Even when the election is recognized, the state may impose franchise or corporate minimum taxes on the S corporation.3

1 See, D.C. Code Ann § 47-1801.04(16); Ky. Rev. Stat. Ann. § 141.010(24)(b); La. Rev. Stat. Ann. § 47:287.732(A) (but see § 47:287.732(B) for exclusions that approximate an S corporation result); Mass. Gen. Laws ch. 63, §§ 38B, 52A and 32D(a)(i) (exceptions to recognition of S election); Mich. Comp. Laws §§ 208.6(1), 208.35(1)(a), 208.37 (Single Business Tax); N.H. Rev. Stat. Ann. § 77-A:1(1).; N.Y. City Admin. Code § 11-602(8)(ii); Tenn. Code Ann. §§ 67-4-2006(a)(2), 67-4-2105(a); Tex. Tax Code § 171.001(a)(1). 2 See, Ark Code Ann. § 26-51-409; Miss. Inc. Tax Rule § 803(c); N.J. Rev. Stat. § 54:10A-5.22(a); N.Y. Tax Law § 208(1-A). 3 See, e.g., N.Y. Tax Law § 210(i)(g); Pa. Stat. Ann. 72 §§ 7601(a), 7602(a), 7602(b); S.D. Cod. Laws § 10-43-10.1; Vt. Stat. Ann 32 § 5915; W.Va. Code §§ 11-23-1, 11-23-3(b)(6).

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2. LLCs taxable as partnerships for federal tax purposes and other pass-through entities may also incur tax burdens because they are classified as corporations for tax purposes or because they are subjected to a minimum or other tax.

a. For example, Kentucky and Texas treat LLCs and LLPs as corporations,4 and Kansas, Pennsylvania, Tennessee, West Virginia and Wyoming subject LLCs to franchise tax.5

b. Washington, D.C. and New York City impose unincorporated business taxes.6

c. New Hampshire’s Business Profits Tax applies to all business entities.7

C. Current developments

1. Partnership gain derived from in state activity attributable non-resident partner

A Boston hotel was owned by a Massachusetts-based partnership, a partner of which was a New York limited partnership. The general and limited partner of the New York partnership was a Delaware corporation. The Massachusetts Appellate Tax Board held that the Delaware corporation was subject to Massachusetts corporation excise tax derived from the sale by the New York partnership of its Massachusetts-based partnership interest. The basis for the Board’s decision was that the income-producing activity was imputed to the corporate partner. The taxpayer’s argument that neither the New York partnership nor its sale of its interest in the Massachusetts-based partnership had any nexus to Massachusetts was rejected because the New York partnership was not able to show any income-producing activity outside Massachusetts. Sahi USA Inc. v. Comm’r of Rev, MA ATB No. C262668 (10/27/06).

2. Effective on or after January 1, 2005 and before 2007, shareholders, partners and members of pass-through entities (including S corporations and LLCs) must pay corporation income tax upon their respective portionate share of the entity’s Kentucky income. Tax Modernization Plan, HB 272, Laws 2005.

3. Pennsylvania legislation

a. Pennsylvania previously required a corporation which had made a Federal S election to make a separate Pennsylvania S election. Effective January 1, 2006, if a Federal S election has been or is filed, the corporation is automatically a Pennsylvania S corporation. A

4 Tex. Tax Code Ann. §§ 171.001(b)(3), 171.0002(a); Ky. Rev. Stat. §§141.040 (franchise tax for years beginning on or before Dec. 31, 2006), 141.0401 (entity tax for later years). 5 Kan. Stat. Ann. § 17-5401(a)(2); 15 Pa. Cons. Stat. § 8925; Tenn Code Ann. §§ 67-4-2105(a), 67-4-2106(a); W.Va. Code §§ 11-23-3(b)(2)(C), 11-23-6; Wyo. Stat. §§ 17-15-132(a)(vi), 17-16-1630(a). 6 D.C. Code Ann. § 47-1808.03; N.Y.C. Admin. Code § 11-502. 7 N.H. Rev. Stat. Ann. §§ 77:15, 77-A-1(XXIII-a).

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Federal S corporation which does not want to be a Pennsylvania S corporation must file an election to opt out as a Pennsylvania S corporation.

b. Capital Stock/Franchise Tax (“CS/FT”) is imposed, inter alia, upon C corporations, S corporations and LLCs. CS/FT is imposed upon capital stock value of corporation. Capital stock value is calculated using a formula one component of which is “average net income”. Average net income is defined as five-year average book income as reported by the corporation (or LLC) upon its Federal income tax return. To determine average net income, LLCs are permitted to adjust book income by deducting distributions to members actively engaged in the operation of the business. The deduction was not available to the single member LLC. Beginning January 1, 2006, the deduction becomes available to single member LLCs.

c. Other CS/FT amendments include rate reduction for 2006 from 4.99 mills to 4.89 mills followed by 1 mill annual reductions until CS/FT rate becomes zero mills and the exempt capital stock value is increased from $125,000 to $150,000.

d. Other Corporate Net Income Tax amendments include new weighting of apportionment factors and increase to net operating loss limitations. Effective January 1, 2007, apportionment factors change from 20% property, 20% payroll and 60% sales to 15% property, 15% payroll and 70% sales. Effective January 1, 2007, the net operating loss limitation is increased from $2 million to the greater of 12.5% of taxable income or $3 million.

4. Miscellaneous

a. See October 10, 2006 CCH State Tax Review at pages 12-14 for national comparison of all state apportionment formulas.

b. See October 17, 2006 CCH State Tax Review at pages 16-17 for national comparison of all state LLC laws and various state tax incidences attributable thereto.

II. Sales and Use Taxes

A. Sales and Use Taxes present a very significant potential liability for businesses, ordinarily exceeding income and franchise tax liabilities.

1. Sales Tax is imposed on a seller’s taxable gross receipts at rates that range up to 8.375% and Use Tax is imposed on the purchaser, ordinarily at the same rate.

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a. By the time of a tax audit, several years of liabilities will be at issue and buyers may resist, or be unable to make, reimbursement, assuming they can be found.

2. Similar taxes include the Indiana Gross Receipts Tax, business license taxes imposed by many California cities and the Washington State Business and Occupation Tax (“B&O Tax”) generally imposed on transfers for consideration of tangible personal property.

B. In most states, the tax is imposed on retail sales and purchases of tangible personal property, but a number of states tax service transactions as well.

1. Taxes on property-related services such as installation, repair, fabrication, processing and printing are almost universal.

2. However, services such as information services or business management or consulting with no property element may also be subject to tax.

3. A few states tax all or virtually all services (Hawaii, New Mexico and South Dakota).8

4. Some others tax a broad range of enumerated services (Arkansas, Connecticut, Iowa, Kansas, Mississippi, New York, Tennessee, Texas and Wisconsin).9

C. Determination whether a transaction is a property transaction or a service transaction may be based on the “True Object”, “Real Object” or “Dominant Purpose” Test. 10

1. A significant issue area is the treatment of software, determined in some instances by whether it is canned or custom and in others by means of delivery.11

2. In jurisdictions taxing enumerated services, the true object test is also applied to determine whether the service provided is taxable.12

D. Because the tax is on sales at retail, sales and purchases for resale are not taxable.13

1. It is significantly more difficult to establish that a service is purchased for resale than that a good is so purchased.14

8 II Jerome R. Hellerstein & Walter Hellerstein, State Taxation, 12-67 (3rd ed. Warren Gorham & Lamont 2000) (hereinafter cited as “Hellerstein”). 9 Id. 10 Id., at 12-78. 11 Id., text and authorities at 12-79, fn 113. 12 See, e.g., Hartford Parkview Associates L.P. v. Groppo, 211 Conn 246, 558 A.2d 993(1989). 13 Hellerstein at 14-4.

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2. The statute commonly creates a presumption all gross receipts of a retailer are taxable, but relieves the seller of the burden of proof if it accepts from the purchaser in good faith a resale certificate.15

3. In most jurisdictions, failure to accept a resale certificate at the time of the transaction can be remedied during audit (assuming the purchaser can be located).

4. However, in some jurisdictions the taxing authority requires that the certificate be contemporaneous with the sale.16

E. Exemptions vary widely from state to state, but some typical exemptions are:

1. Machinery and equipment used in manufacturing or production.

a. Manufacturing may be very restrictively defined as an integrated series of operations changing the form, composition or character of property into a product having a new and distinctive name, nature and use. See, e.g., Conn. Agencies Regs. § 12-426-11b(a)(10); Connecticut Water Co. v. Barbato, 206 Conn. 337, 537 A.2d 490 (1988) (changing water into potable water does not qualify). Compare, United Illuminating Co. v. Groppo, 220 Conn. 749, 601 A.2d 1005 (1992) (production of electricity is not manufacturing) and Curry v. Alabama Power Co., 243 Ala. 53, 8 So.2d 521 (1942) (electrical generation is manufacturing).

b. The exemption may be broadened by including equipment for fabrication and/or processing. See Conn. Gen Stat. § 12-412i (partial exemption). but the broadest type of exemption is for production machinery. See, e.g., N.Y. Tax Law § 1115(a)(12); 20 N.Y.C.R.R. § 528.13(a).

c. An additional requirement is often that the activity occur in an industrial plant.

(i) Where this is a requirement identical machinery in a plant dedicated to baking bread would qualify, but that in retail bakery would not.

d. Further, there may be a requirement that the machinery or equipment be used directly in the process, excluding machinery used in the process but not “directly”.

14 Compare, CCH Computax v. Limbach, 68 Ohio St. 3d 86, 634 N.E.2d 995 (1994), and CCH Computax, Inc. v. Dubno, 18 Conn. App. 434 , 558 A2d 270 (1989). 15 See, e.g., Conn. Gen. Stat. § 12-410. 16 See, e.g., N.M. Stat. Ann. § 7-9-43(A); Okla. Admin Code § 710:65-13-200;

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(i) It may be too far in advance of the process as in Jackson Iron & Steel Co. v. Glander, 154 Ohio St. 369, 96 N.E.2d 21 (1950), where coal mining equipment was held not to be within the process of producing coke.

(ii) Or it may lie outside what is perceived to be the physical confines of the process. See, Plastic Tooling Aids Laboratory, Inc. v. Commissioner, 213 Conn. 365, 567 A.2d 1218 (1990), where the electrical connection between a CAD/CAM machine controlling a production machine was held not to satisfy the statutory requirement that the machine be used “directly” in the manufacturing production process.17

e. Some states require that the machinery be used exclusively in the process while others require only a preponderance of such use.

(i) Even a requirement for only a preponderance may eliminate the exemption for essential machinery. See, Va. Ruling 94-1 (computers used less than 50% in controlling production machinery failed to qualify).

f. Finally, not every state exempts manufacturing or production equipment. For example, California has no such exemption and Florida’s is limited to purchases for new or expanding plants. See, Fla. Stat. § 212.08(5)(b).

2. Ingredients and component parts of property to be sold.

a. Such an exemption is similar to the resale exemption, but it may be difficult to determine what qualifies as an ingredient. Thus, availability of the exemption may actually turn on whether it is broad enough to include property and/or fuel used or consumed in the production process. See, e.g. Granite City Steel Co. v. Department of Revenue, 30 Ill.2d 552 , 198 N.E.2d 507 (1964) (whether coke is an ingredient of pig iron, resolved in part on the basis of a statute broad enough to encompass materials consumed).

3. Clothing and food are often exempt.

4. Medicines, medical devices and prostheses are commonly exempt.

5. Exemptions geared toward favored industries, e.g., fishing vessels in coastal states, aircraft sales, biotechnology machinery and equipment.

17 After its victory in Plastic Tooling Aids the Connecticut DRS relented and began treating such equipment as used directly in the process.

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a. Competition has recently spawned movie and media production exemptions in several states.

F. Movement of property into a state is potentially subject to use tax.

1. Owned property

a. There is ordinarily a credit provided for sales or use tax previously paid,18 but where property is moved to a higher-tax jurisdiction, the credit would not cover the difference.

b. The use tax imposition statute may specify that tax is imposed on purchases “for use in” the state so that property purchased for use in another state that is later transferred to a new state may not be taxable there.

(i) There may be department may apply a presumption that property purchased more than a particular period prior to being brought into the state was not purchased for use in the state.

2. Leased property

a. Although a lease is not a sale, most states’ definition of sale for tax purposes includes any transfer of possession for consideration, and may for good measure specifically include leases.

b. States differ on whether sales include leases which are mere financing devices rather than true leases.

c. Most states impose tax on each monthly payment, but some impose tax on the total lease price at the time of purchase.

G. Sales tax on the purchase price of a business.

1. The sales tax is ordinarily a privilege tax or a gross receipts tax imposed only on those engaged in retailing and the use tax a complementary tax imposed only on purchases from a retailer.

a. The definition of “retailer” may explicitly state a threshold level of activity required to qualify as a retailer or it may be implied.19

2. A sale by a person who is not a retailer, or a sale by a person who is a retailer but is not a retailer of the kind of goods sold may qualify as an

18 But see, Exxon Corp. v. Board of Equalization, 738 P.2d 685 (Wyo. 1989), cert. den. 110 S.Ct. 1937 (credit denied where tax previously paid was use tax). 19 See, Cal. Rev. & Tax Code § 6019 (Three sales in twelve months).

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exception to the sales and use taxes referred to variously as a “casual”, “isolated” or “occasional” sale.

a. Most states recognize some form of casual sale exception when an entity disposes of all or substantially all of its assets.

(i) “[A] sale of tangible personal property not held or used by a seller in the course of an activity for which it is required to hold a certificate of registration, including a sale or exchange of all or substantially all the assets of any business.” Va. Code § 58.1-609; see also Tex. Code § 151.304(b)(2), exempting the sale of “the entire operating assets” of a “business or of a separate division, branch, or identifiable segment of a business.”

(a) “All or substantially all” and “entire operating assets” present an issue where there are unwanted assets.

(b) Additionally, does the “all or substantially all” or “entire operating assets” requirement apply to the seller’s worldwide assets or just to those located in the taxing state?

b. Inventory held for sale cannot be part of a casual sale.

(i) It may be sold in a nontaxable sale for resale if the purchaser will carry on the seller’s line of business.

(a) If that is the case, the buyer should give the seller a resale certificate.

c. In most states, motor vehicles, boats and aircraft fall within an exception to the casual sale rule so that transfers of these items are always taxable. N.Y. Tax Law § 1115(a)(18) ; N.Y.C.R.R. 20 § 528.19.

(i) This is one reason for holding such property of high value in a stand-alone entity.

3. Nevertheless, a particular sale may not qualify for the exception, and some states, such as California, Maryland and New York, do not recognize the casual sale exception, at least not in a form applicable to sales of property of substantial value.20

20 N.Y. Tax Law § 1115(a)(18); N.Y.C.R.R. 20 § 528.19 (sales at private residence only); Md. Code Ann. Tax-Gen. § 11-209(a); Md. Regs. Code § 03.06.01.12 (sales of $1,000 or less); Cal. Rev. & Tax Code. § 6006.5; Cal. Rev. & Tax Code § 6006.5(a); Cal. Code Regs. 18 § 1595(a) (exclusion for any sales by a retailer).

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a. If the casual sale exception does not apply, consider whether the all or part of the transaction is exempt, e.g., qualifying manufacturing machinery and equipment or biotech property.

b. If exemption is unavailable or inadequate, consider restructuring the transaction so that it occurs in a jurisdiction where the casual sale rule applies.

c. Regulations may provide that, under certain circumstances, a contribution of assets to a newly formed corporation or other entity is not taxable, apparently on the theory that such a transaction is not for consideration.

(i) For example, exempt from tax in New York is “the transfer of property to a corporation upon its organization in consideration for the issuance of its stock” and “the contribution of property to a partnership in consideration for a partnership interest therein.” N.Y. Code, Rules & Regs. § 526,6(d)(I)(iv) and (v).21

(a) Strict adherence to the regulatory provision is essential. For example, the transfer must be made upon the organization of the corporation. Id. at (d)(5). Where the corporation issues securities other than stock or assumes liabilities, the transaction will be taxable to the extent of the consideration. Id. at (d)(5)(iv).

(b) This suggests that a carefully executed “drop kick”, i.e., a contribution to capital followed by a sale of stock, will effectively transfer assets free of tax.

H. Successor Liability

1. Most sales-taxing states impose tax liability upon the purchaser of a business’s assets.

2. Successor liability does not refer to liability for tax on the transaction itself, but to liability for all taxes incurred by the seller in the conduct of its business.

a. Generally limited to sales taxes, but some states assert liability for use taxes and other taxes also.

3. Statute ordinarily imposes on the purchaser an obligation to withhold from the purchase price an amount sufficient to cover the seller’s liabilities unless the seller provides the purchaser with a certificate issued by the tax department stating that no tax is due.

21 Similar rules apply in Maryland. See, Cal Code Regs. 18 § 1595(b)(4); Code of Md. Regs. § 03.06.01.13B(2).

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a. Most statutes are based on withholding, effectively capping potential tax liability at the purchase price.

b. Where seller has not been filing returns, statute of limitations does not begin to run.

4. Statutes or regulations ordinarily provide that upon request (sometimes by seller, sometimes by purchaser) the tax department will issue either a certificate that no tax is due or a statement of the amount of tax that must be withheld.

a. Many do not require that the commissioner act within a stated time.

b. Those that do require the commissioner to act within a stated period have widely varying requirements.

5. The parties may agree to forego the certificate procedure and deal with the issue through indemnity and/or escrow.

a. However, in some jurisdictions, the certificate procedure is considered mandatory.22

III. Real Estate Conveyance Tax (Conveyance Tax)

A. Most states impose a tax on the transfer of interests in real property for consideration, generally couched in terms of a transfer by deed or other writing. The tax is most commonly imposed on the grantor. Rates of tax range from 0.10% in Alabama, Georgia and Kentucky23 to 1.50% in Connecticut and Maryland,24 and even to 3% in certain counties of Delaware, New York and Pennsylvania.25

B. Many states first adopted conveyance taxes in the 1970s when the federal Documentary Stamp Tax on deeds was repealed. That tax had existed since the Civil War. The regulations, withdrawn by T.D. 8314, 1990-2 C.B. 220, 55 Fed. Reg. 41519, 41522 (1990), are reproduced at Appendix A.

C. Interests in real property

1. Defined in the federal regulations as “those interests in real property which endure for a period of time, the termination of which is not fixed or

22 See, e.g., N.Y. Tax Law § 1141(c). 23 Ala. Code § 40-22-1 (on excess over mortgage, which is taxed at 0.15% of debt incurred, Ala Code § 48-6-2,; Ga. Code Ann. § 48-6-1; Ky. Rev. Stat. Ann. § 142.050. 24 Conn. Gen. Stat. § 12-494 (1.25% or 1.5%, depending on municipal tax rate); Baltimore City Code §§17-2, 17-5 (in other Maryland localities, the combined state and local rates generally equal 1%). 25 30 Del. Code Ann. § 1601, 9 Del. Code Ann. § 8102; N.Y. Tax Law §§ 1402,1402-a ; N.Y.C. Admin. Code § 11-2102; Phila. Code § 19-1400 et seq.

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ascertained by a specific number of years, such as an estate in fee simple, life estate, perpetual easement, etc.” Treas. Regs. § 47.4361-1(a)(4)(i)(a).

a. Thus, leases are generally excluded.

(i) However, the federal regulations included long-term leases as: “Those interests enduring for a fixed period of years but which, either by reason of the length of the term or the grant of a right to extend the term by renewal or otherwise, consist of a bundle of rights approximating those of the class of interests mentioned in subdivision (a) of this regulation.” Treas. Regs. § 47.4361-(a)(4)(i)(b).

(ii) State regulations are ordinarily more specific, including as taxable leases with terms as short as five years or more or as long as more than ninety-nine years.26

(iii) And regulations may specifically include transfer of the lessor’s reversionary interest. See, e.g., Conn. Agencies Regs. § 12-494-2(a)(4).

b. Also excluded as not being conveyances are contracts of sale, options that do not convey legal title, assignments of such contracts and options, and deeds deposited in escrow, see Treas. Reg. § 47.4361-2(b)(6), and Conn. Agencies. Regs. § 12-494-2(c)(1)-(4), but New York includes contracts of sale and options as conveyances subject to tax, N.Y. Tax Law § 1401(f), exempting such instruments where the consideration is less than $200,000 and the real property is the residence of the transferor. N.Y. Tax Law § 1405(b)(10).

c. Included may be other transactions, such as sales of mobile homes in situ. Conn. Agencies Regs. § 12-494-2(a)(5).

2. The statutory conversion of a trust to an LLC is a taxable transfer. Declaratory Ruling No. 8724, NH Dept. of Revenue Administration, 9/15/06. Compare to Exton Plaza Associates v. Commonwealth of Pennsylvania, 763 A.2d 521 (Pa. Cmwlth, 2000), where the conversion of a general partnership to a limited partnership was held not to be taxable transfer.

D. Transfer by deed or writing

1. The federal regulations defined deed to include any instrument whereby realty “is assigned, transferred, or otherwise conveyed to, or vested in, the

26 Del. Realty Transfer Tax Regs. § 3; Conn. Agencies Regs. § 12-494-1(b)(2).

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purchaser, or at his direction, any other person.” Treas. Regs. § 47.4361-1(a)(4)(iii).

2. The statutes ordinarily provide for payment to a clerk at the time of filing. However, the tax is ordinarily imposed on the transfer, not the act of filing.

a. A delayed filing may incur an interest charge.

E. Transfer for consideration

1. In most states consideration is both an element of the tax and its measure. In some, the tax is imposed without regard to consideration and is measured by the value of the property interest transferred. See, e.g., 72 Pa. Stat. § 1102-C.

2. Among the examples of taxable transfers for consideration listed in Treas. Regs. § 47.4361-2(a):

a. An exchange of real property for other property, real or personal. b. A transfer by a defaulting mortgagor in cancellation of the

mortgage debt. c. A deed of foreclosure. d. A conveyance in condemnation or under threat of condemnation. e. A conveyance to a corporation in exchange for shares of its stock.

(i) In Connecticut, where this is settled law, Bjurback v. Commissioner, 44 Conn. Sup. 354, 690 A.2d 902 (1996), it is also settled law that a transfer to a wholly-owned LLC is not subject to tax. See, e.g., Mandell v. Commissioner, Super. Ct. No. CV 00 0504213 S, 2001 Conn. Super. Lexis 3042, affirmed 262 Conn. 659, 816 A. 2d 619, 2003 Conn. Lexis 94 (2003). (J.D.N.B. Oct. 15, 2001).

(ii) See also 72 P.S. § 8102-C4, Farda v. Commonwealth of

Pennsylvania, 849 A.2d 297 (Pa. Cmwlth, 2004), Penn Towers Assoc. LP v. Commonwealth of Pennsylvania, 866 A.2d 1205 (Pa. Cmwlth, 2005).

f. A conveyance by a partner in contribution to partnership.

g. A conveyance in liquidation by a corporation to its shareholders, subject to corporate debt. Compare, Greyhound Corp. v. United States, 208 F.2d 858 (7th Cir. 1954) and R.H. Macy & Co. v. United States, 107 F.Supp. 883 (S.D.N.Y. 1952) (assumption of debt in a liquidation is consideration), with Tide Water Assoc. Oil Co. v. Jones, 57 F.Supp. 482 (W.D. Okla. 1944), and Socony-

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Vacuum Oil Co v. Sheehan, 50 F.Supp. 1010 (E.D. Mo. 1943) (corporate liquidation is entirely without consideration).

h. Separately addressed are partnership terminations. Treas. Reg. § 47.4383-1(b)

3. Among those listed as in Treas. Regs § 47.4361-2(b) excluded as either not being a transfer or not being for consideration:

a. A gift: “Conveyances of realty without consideration and otherwise than in connection with a sale . . .”

b. A deed to a trustee not pursuant to a sale. c. A deed of realty held to secure a debt upon repayment of the debt. d. A deed confirming title, such as one to correct a flaw in title. e. A deed by an executor under a will (unless the heirs take shares

different from those specified in the will). f. A deed from agent to principal conveying property purchased with

funds of the principal. g. A deed of partition (unless the parties take shares different from

their undivided interests). h. A deed by a debtor to a trustee for benefit of creditors (but the

trustee’s later deed to creditors is not excluded). i. A conveyance to a receiver and reconveyance at termination of the

receivership. j. A transfer in a merger or consolidation from a constituent

corporation to the continuing or new corporation. k. Note that a conveyance in corporate liquidation, not subject to

corporate debt, but solely for cancellation of stock, was said not to be subject to tax. Treas. Reg. § 47.4361-2(a)(8).

4. Measure of tax – amount of consideration

a. In the federal tax, consideration included a purchase money mortgage, but not a preexisting mortgage that was assumed. Treas. Regs. § 47.4361-1(b).

b. States may include or exclude an assumed mortgage and some states impose a separate tax on the recording of mortgages. Compare Conn. Agencies Regs. § 12-491(a)(1) and (2) and Kans. Stat. Ann. § 79-3102.

(i) A mortgage obligation of which the seller is relieved in the transaction would appear to be consideration.

c. When the consideration is not money or denominated in money, as in the case of an exchange or of a contribution to capital, the tax is ordinarily measured by the fair market value of the property.

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5. Exemptions

a. The federal tax exempted deeds given as security for debt. Treas. Reg. § 47.4362-1(a).

b. Also exempted were deeds to which the United States, a state or certain kinds of organizations were a party; and the Bankruptcy Act exempted deeds relating to certain reorganizations. See id. and § 47.4382-1.

c. Connecticut, New York and Pennsylvania exemptions include but are not limited to:27

(i) Deeds given by the U.S., a state or a municipality of the state.

(ii) Deeds given by an exempt person, e.g., a charitable organization, to another exempt person.

(iii) Deeds given to secure a debt (Note that in a number of states mortgage deeds are taxable).

(iv) Deeds given in corporate mergers. (1) Statutes may not have been updated to include

mergers of noncorporate entities.28 (v) Deeds given in tax sales. (vi) Deeds in bankruptcy (perhaps limited to deeds in federal

bankruptcy proceedings). (vii) Bona fide gifts. (viii) Contracts of sale. (ix) Deeds from agent to principal. (x) Options that do not vest title, (xi) Deeds of partition (at least to the extent each party takes an

unchanged share). (xii) Leases of a term of less than [x] years.29 (xiii) Deeds given by a subsidiary to a parent solely in liquidation

of its stock. (xiv) Deeds of correction. (xv) Deeds involving certain family members. (xvi) Deeds to or from industrial development authorities.

d. There may be an exemption for transfers between parties when there is merely a change in identity and no change in beneficial

27 See, e.g., N.Y. Tax Law § 1405, Conn. Gen Stat. § 12-498, 72 P.S. § 8101-C. Note that many of the listed exemptions are actually nontaxable transactions for no consideration. Some of these exemptions may be available in one or more of the states listed but not all. 28 See, Acadia Brandywine Town Center, LLC v. New Castle County, 879 A.2d 923 (Del. Sup. Ct. 2005). 29 99 years in Connecticut, Conn. Agencies Regs. § 12-494-1(b)(2); 49 years in New York, N.Y. Code Rules & Regs. § 575.7(a).

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ownership, but this is not common and is likely a signal that a controlling interest transfer tax applies.30

IV. Controlling Interest Transfer Tax (CIT Tax)

A. A change in beneficial ownership of real property occurs whenever a corporation or other entity owning real property changes hands, but such a transaction is not subject to Conveyance Tax.

B. Connecticut, New York, Maine, Pennsylvania, Washington and to a limited extent, the District of Columbia and New Jersey have responded to perceived avoidance by enacting taxes imposed on the transfer of a controlling interest in an entity that owns an interest in real property located in the state.31

C. There are two basic statutory models:

1. New York includes in the definition of a conveyance the transfer of a controlling interest in an entity holding New York real property.32

2. Connecticut enacted a separate tax.33

3. Pennsylvania tax is imposed upon an “acquired real estate company”. An acquired real estate company is a real estate company where 90% or more of the capital and profits ownership interests are transferred within a three-year period.

D. The taxable event is the transfer of a controlling interest in an entity owning an interest in real property located in the state.

1. An interest in real property is generally the same for both CIT Tax and Conveyance Tax

a. However, to be effective, the tax looks through tiers of beneficial ownership to a lower level entity that owns such property.

(i) For many years the Connecticut Tax Department did not take this approach, effectively permitting nontaxable transfer of property held by second-tier subsidiary entities.

2. Control may be defined either as “50% or more” or as “more than 50%”, but generally it means the requisite percentage of ownership of voting

30 See, e.g., N.Y. Tax Law § 1405, Conn. Gen Stat. § 12-498. 31 Conn. Gen. Stat § 12-638b. D.C. Code Ann. § 42-1102.02(a); Me. Rev. Stat. Ann. § 4641-A; N.J. Rev. Stat. § 46:15-7.2; N.Y. Tax Law § 1401(e); 72 P.S. § 8102-C.5(c); Wash. Rev. Code § 82.45.010. Vermont requires reporting of controlling interest transfers, but imposes no tax. Vt. Stat. Ann. § 9618. 32 N.Y. Tax Law § 1401(e). New York authorities relating to controlling interest transfer tax include those arising under the now repealed transfer gains tax. 33 Conn. Gen. Stat. chapter 228b, §§ 12-638a et seq.

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stock in a corporation, and, the capital or profits or beneficial interest in the entity in other entities.34

3. Transfers are aggregated.

a. To determine whether a transfer of control has occurred, the tax ordinarily provides for the aggregation over time of multiple transfers.35

b. Further, a control transfer is ordinarily measured among groups of transferors and/or transferees acting in concert, not simply between an individual transferor and or transferees.36

(i) Attribution rules provide some guidance, but do not cover all the possibilities.

(ii) The Connecticut DRS has ruled that an IPO is not subject to the tax because the transferees are not acting in concert. Connecticut Ruling 90-40.

4. When considering mergers and consolidation within corporate groups, the Connecticut DRS has consistently looked to whether there has been a change in ultimate beneficial interest. See, e.g., Ruling 99-6 and other rulings cited therein.

a. Where the Conveyance Tax and CIT Tax are separate, mergers present the issue which tax they are subject to. The Connecticut DRS held they are not subject to the Conveyance Tax, from which deeds of merger are exempt,37 but to the CIT Tax, which has no such exemption.

E. The tax is ordinarily measured by the full fair market value of the property, but it may be the FMV times the percentage of the entity transferred.

F. The rate of tax is ordinarily the same as the conveyance tax rate, but it may differ.38

G. Exemptions may or may not track the exemptions for Conveyance Tax.

1. In New York, where the CIT Tax is part of the conveyance tax, the exemptions are identical.

34 Conn. Gen. Stat. § 12-638a 35 See, e.g., D.C. Code Ann. § 42-1102-02(a); Me. Rev. Stat. Ann. § 4641 (1-A); Wash. Rev. Code § 82.45.010; N.Y.C.R.R. §575.6; Conn. LSN 89. 36 Id. 37 Query: Why an exemption if the transaction is not subject to tax? 38 In CT, the rate of tax on conveyances is 1.25% or 1.5%, depending on the location of the property, but the CIT Tax rate is 1.11%.

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2. In Connecticut, where the two taxes are separate, there are no CIT Tax exemptions at all, simply exceptions for property located in an “enterprise zone” and for transfers that effect a mere change of identity or form of ownership where there is no change in beneficial ownership.39

H. Returns are required of the transferors who are liable for the tax, but information returns from the entity may also be required.

39 Conn. Gen. Stat. § 12-638b(b).