CA LLC Fee Invalid

California LLC fee again held invalid

Ventas Finance I LLC v. Calif. FTB, Cal. Ct. App., Dkt. Nos. A116277; A117751, 08/11/2008

The California Court of Appeal once again has ruled invalid the state fee imposed on limited liability companies (LLCs) under former Rev. & Tax. Cd. § 17942 (the “§ 17942 fee”). Affirming the lower court, the Appeal Court held that the § 17942 fee as applied to Ventas, an LLC that conducted business in California and other states, was not fairly apportioned and, therefore, violated the Commerce Clause because the levy was based on total income without apportionment to income attributable to, or derived from, California sources. The court rejected the Franchise Tax Board’s (FTB’s) request for judicial reformation of the former statute to allow an apportioned fee refund since Ventas did business in California and other states unlike in the earlier Northwest case (that held the fee invalid) where the LLC conducted no California business. However, the court concluded that neither federal due process nor any principle of California law requires the FTB to refund the entire amount that Ventas paid. Consequently, the refund should be limited to the amount Ventas paid for the years in issue that exceeds the amount that would have been assessed, without violating the Commerce Clause, using a method of fair apportionment. The postjudgment order awarding attorney fees was also reversed, and remanded for the lower court to redetermine eligibility and the amount of reasonable fees in light of the partial reversal of the lower court’s judgment.

No judicial reformation. Holding that the former § 17942 fee, as applied to Ventas, violated the Commerce Clause and due process (because it was based upon all income unapportioned to activities within California), the lower court had refused FTB’s request to reform former § 17942 to add an apportionment mechanism because the legislative history showed that the legislature rejected including an apportionment mechanism, and neither the statute nor the legislative history contained any indication of the type of apportionment mechanism the legislature would have enacted. The lower court ordered that Ventas was entitled to a refund of the entire amount it paid pursuant to former § 17942. In its appeal to the appellate court, Ventas argued the litigation was necessary to address FTB’s position that only those LLC’s that had no income attributable to California sources were entitled to a full refund. In all other cases, FTB maintained that the appropriate remedy was to refund the difference between the amount the LLC paid and the amount it would have paid if former § 17942 included a fair apportionment mechanism. Ventas reasoned that this litigation conclusively resolved issues left unresolved after the Northwest case by establishing that former § 17942 could not be judicially reformed, and that any LLC who paid the levy was entitled to a full refund.

Apportioned fee refund. The Appeal Court ruled that FTB failed to establish the limited conditions that would support exercise of the power of judicial reformation, and declined to reform former § 17942 in the manner FTB suggested. The court, however, concluded that a refund of the entire amount Ventas paid pursuant to former § 17942 is not compelled by the Due Process Clause, or by any principle of state law. A refund of the difference between the amount Ventas paid and the amount it would have paid based upon income derived from or attributable to California sources, using a method of fair apportionment, would fully cure the Commerce Clause violation, ruled the court. This remedy does not place an unreasonable burden on Ventas because the parties had already agreed what Ventas’s California apportionment percentage would have been for the years in issue, if this apportionment methodology were used. The court, therefore, reversed and remanded to the trial court for further proceedings to determine the amount of the refund.

For FTB tax problem resolution CLICK HERE.