Press Room: Tax Release

December 17, 2014

California Trial Court Reins Back the FTB’s Doing Business Stance for LLC Members

The Swart Case

In August 2014, Andersen Tax issued a release on an aggressive position taken by the California Franchise Tax Board (FTB) in FTB Legal Ruling 2014-01 on whether passive members of an LLC doing business in California are also doing business in California merely by virtue of holding a membership interest in the LLC.

In the Fresno Superior Court’s ruling1 in Swart Enterprises, Inc. v. California Franchise Tax Board​2, the trial court disagreed with the FTB’s stance in FTB Legal Ruling 2014-01 and granted the taxpayer-plaintiff’s motion of summary judgment.

Swart Enterprises (Swart), sued the FTB for a refund of franchise taxes paid, including interest, under the argument that its contact with California was not sufficient to constitute doing business in the state. Swart had no business activities or physical presence in California; rather its sole connection to the state was an investment in a manager-managed California LLC (Fund) that represented a 0.2% ownership interest in the Fund. The FTB took the position that ownership of any such interest was sufficient to establish that Swart was doing business in California, which justified the FTB’s imposition of the minimum $800 franchise tax.

Additionally, since the Fund had elected to be treated as a partnership for tax purposes, the FTB argued that the Fund should be considered a general partnership, in which all partners are general partners with rights in conducting the business. The court noted that the State Board of Equalization (SBE) had previously refused to subject limited partners of a partnership to franchise tax.3 Notably, limited partners could not be considered as doing business in California where they exercised no control over the operations of the partnership themselves. Thus, the court reasoned that determining whether or not Swart was a general or limited partner in the Fund would control whether or not it was doing business in California. The court held that Swart’s holding of a mere 0.2% ownership interest in Fund and having no direct control rights in the manager-managed Fund, Swart’s ability to impact the actions of the Fund was minimal. The FTB’s argument that relinquishing any right to control constituted an exercise of control was summarily dismissed by the court, which granted Swart’s motion for summary judgment on the matter.

Significance

While the trial court’s decision is not considered binding law at this time because it is unpublished and appealable by the FTB, the court’s reasoning may shed some light on the potential arguments that may be made at the appellate level should the FTB appeal the matter. Based on the FTB’s issuance of FTB Legal Ruling 2014-01 before the trial court’s decision in Swart, it appears likely that the FTB will appeal the matter.

Furthermore, based on the facts set forth in Swart, a taxpayer-favorable appellate decision may be limited to manager-managed LLCs.  As always, keep in mind that should taxpayers decide not to follow the guidance in FTB Legal Ruling 2014-01 and the FTB prevails at the appellate level, penalties and interest on any unpaid franchise taxes may apply.

 

1 Swart Enterprises v. Cal. Franchise Tax Bd., Cal. Sup. Ct. (Fresno County), Dkt. No. 13CECG02171, 11/14/2014.

2 Swart Enterprises, Inc. v. Franchise Tax Board, No. 13CECG02171 (Fresno Super. Ct. filed July 9, 2013) (unpublished).

3 Appeals of Amman & Schmid Finanz AG, et al., 96-SBE-008, April 11, 1996.