D.C. Court of Appeals denies transfer tax exemption

Ruling affects transfer from sole proprietorship to LLC

On Sept. 20, the District of Columbia Court of Appeals rejected a taxpayer’s appeal claiming a statutory exemption from transfer and recording taxes for a transfer of property from a sole proprietorship to a limited liability company (LLC).1 In rejecting the taxpayer’s request, the Court noted that the plain meaning of the statutory exemption language did not include a sole proprietorship as an “entity” qualified to transfer or receive property without paying recordation and transfer taxes.

Background In 2002, Smart Aziken purchased real property in the District of Columbia for $505,000 and recorded the deed in the name of his sole proprietorship. In 2012, Aziken wished to refinance a mortgage on the property. In order to do so, the bank stipulated that property be owned by an incorporated entity to shield it from Aziken’s personal liabilities. Accordingly, on July 6, 2012, Aziken filed articles of incorporation for his LLC and sought a Conversion Certificate from the District Department of Consumer and Regulatory Affairs (“DCRA”) to convert the sole proprietorship to an LLC. Obtaining the Conversion Certificate would have allowed for Aziken to claim eligibility for a tax exemption from the District Office of Tax and Revenue (“OTR”).

Aziken was unable to obtain the Conversion Certificate quickly, which delayed the refinancing, so on Sept. 19, 2012, Aziken transferred the property by a “no consideration deed” from the still-existing sole proprietorship to the LLC, paying a total of $59,225.26 in associated transfer and recordation taxes.2 While attending a workshop where the Assistant Superintendent of Corporations with the DCRA was speaking, Aziken asked about how to obtain the Certificate. Aziken claimed that the Assistant Superintendent advised that Aziken dissolve his LLC and re-establish it in order to receive the Certificate. On Oct. 19, 2012, Aziken followed this advice and received the Conversion Certificate the same day, immediately applying for a refund of transfer and recordation taxes paid, based upon the understanding that the transfer was exempt under D.C. Code Ann. Sec. 29-204.06(h)(2). Following Aziken’s request for refund, the OTR denied the claim stating that the Certificate was issued one month after the recordation of the ‘No Consideration Deed’ and thus did not qualify for the exemption. On Dec. 7, 2012, Aziken sued the District, claiming the exemption from transfer and recordation tax for the transfer under D.C. Code Ann. § 29-204.06(h)(2) and asserting estoppel. In response, the District filed a motion to dismiss for failure to state a claim, and Aziken filed a motion for summary judgment. Following a hearing, the court granted summary judgment for the District, which was appealed by Aziken.

Applicability of claimed exemption Generally, when a deed is filed in the District, transfer and recordation taxes are due, unless an exemption applies.3 In 2011, the District adopted an exemption which applies when a transfer of property is made “in connection with the conversion of a converting entity to a converted entity.”4 To qualify, the conversion must also meet the following conditions:

  1. The interest holders of the converted entity are identical to the interest holders of the converting entity;
  2. Each interest holder's allocation of the profits and losses of the converted entity is identical to the interest holder's allocation of the profits and losses of the converting entity; and
  3. There is no change in the interest holders of the converted entity or in the allocation to any interest holder in the profits and losses of the converted entity during the 12-month period following the effective date of the conversion, other than by reason of the death of an interest holder or the involuntary dissolution of the converted entity.5

The exemption was included in a subsection of the Entity Transactions Act of 2010,6 and adopted as part of a broad recodification of business organization law based on the Model Entity Transactions Act (“META”). The adopted law defines a “conversion” as involving a domestic or foreign “entity”7 and D.C. law states that, “[t]he term 'entity' does not include [] [a]n individual.”8

Citing previous cases as well as commentary to the META, the Court found that the definition of “entity” clearly excludes a sole proprietorship.9 As the sole proprietorship form of business has no legal existence apart from its owner, which directly owns its assets, the Court found the statutory language clearly prevented a sole proprietorship from being considered an ‘entity” that can transfer or receive property without having to pay recordation and transfer taxes.

The Court rejected the taxpayer’s request to interpret the tax exemption to include a transfer of property as part of the change of his sole proprietorship into a single-member LLC, in spite of the fact that the taxpayer met the three conditions listed in D.C. Code Ann. Sec. 29-204.06(h)(2). Further, the Court found the original statutory language unambiguous and stressed that tax exemptions will not be implied, but must be expressed in “clear and unmistakable terms, or must appear by necessary implication from the language used.”10 Although unnecessary to resolve any ambiguity in statutory language, the legislative history of the exemption was found unsupportive of an alternative conclusion.11 The Court refused the taxpayer’s plea that it overlook the clear statutory language and find the exemption applicable simply because the transfer comports with the exemption’s purpose, emphasizing that this is a matter of legislative policy, not of judicial interpretation.

Estoppel The Court found its substantive conclusion regarding the inapplicability of the statutory exemption to likewise dispose of the taxpayer’s estoppel claim. Generally, case law has established that four elements must be present to establish estoppel: (i) a promise made; (ii) reasonable reliance on that promise; (iii) an injury caused by breach of the promise; and (iv) a showing that enforcement of the promise would be in the public interest and would prevent injustice.12 Specifically, the Court found the taxpayer’s reliance on its conversation with the Assistant Superintendent of Corporations with the DCRA regarding how to obtain an exemption problematic. In particular, taxpayers cannot reasonably rely upon a promise made by an agent lacking actual authority to effectuate the action sought.13 As the DCRA official was unable to grant the refund, the taxpayer’s reliance was misplaced. As the law clearly provides that the transfer at issue failed to qualify for the exemption, the taxpayer was unable to demonstrate that any reliance on a contrary understanding, even from a District official, was reasonable.

Commentary In many cases, the question of whether a real property transfer tax exemption will apply to a transaction turns on the form, rather than the substance of such transaction. This case is emblematic of the problems one can encounter when a decision is made to engage in a transaction that seems very similar, but not the same as the transaction that is granted exempt status. In refusing to expand the clear statutory language in the exemption to accommodate a transfer that would generally accomplish the same result as a qualifying transfer during entity conversion, the Court emphasized and confirmed that form matters in this area of the tax law. It serves as a reminder that exemptions to real property transfer taxes, both in the District and in the many jurisdictions that impose such a tax, are strictly applied.

The Court’s rejection of the estoppel argument reflects the need for entities and individuals considering a significant transaction to do more than rely upon publicly available, off-the-cuff advice. The taxpayer in this case relied upon advice from a DCRA representative in determining how to pursue an exemption that essentially could not be obtained because he had already acted to transfer the property in a non-exempt manner. Clarification of the scope of “reasonable” reliance to include only advice from agents with lawful authority to complete the action sought should serve as notice to taxpayers to use a degree of caution when obtaining advice from government officials, and to obtain advice from experienced professionals that fully understand the legal and accounting nuances prior to completing a transaction that cannot be undone from a tax perspective.

1 Aziken v. District of Columbia, D.C. Ct. App., Dkt. No. 16-TX-675, Sep.20,2018.
2 D.C. CODE ANN. § 47-903 (a)(1) & (c) (transfer tax); D.C. CODE ANN. § 42-1103 (a)(1) & (c) (recordation tax).
3 Id.
4 D.C. CODE ANN. §§ 29-204.06(h); 42-1102(22)(A); 47-902(16)(A).
5 D.C. CODE ANN. § 29-204.06(h)(2).
6 D.C. CODE ANN. § 29-201.
7 D.C. CODE ANN. §§ 29-201.02; 29-204.01.
8 D.C. CODE ANN. § 29-101.02(10)(B)(i).
9 Citing National Conference of Commissioner on Uniform State Laws, 6A Uniform Laws Annotated 15 (2016), Bushey v. N. Assur. Co. of Am., 766 A. 2d 598, 603 (Md. 2001) and Ladd v. Scudder Kemper Inv., Inc., 741 N.E. 2d 47, 49 (Mass. 2001).
10 Citing District of Columbia Office of Tax & Revenue v. BAE Sys. Enter. Sys., Inc., 56 A. 3d 477, 484 (2012).
11 The Court also rejected the taxpayer’s contention that interpretation of the term “entity” as excluding sole proprietorships conflicted with the DCRA’s listing of a sole proprietorship as a type of corporate structure on its website.
12 Citing District of Columbia v. Brookstowne Cmty. Dev. Co., 987 A. 2d 442, 447 (D.C. 2010).
13 Id.

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