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The New York State Tax Appeals Tribunal recently reversed a Division of Tax Appeals decision and held that a series of real property interest transfers was properly aggregated and therefore did not qualify for the “mere change in form” exemption under the New York State (NYS) Real Estate Transfer Tax (RETT).1
In doing so, the Tribunal declined to consider the step transaction doctrine which was recently applied to render the same series of transactions taxable under the New York City (NYC) Real Property Transfer Tax (RPTT).2
In April 2007, GKK2 Herald LLC (GKK2) acquired a 45% tenant-in-common (TIC) real property interest in 2 Herald Square, a building located in Manhattan, and SLG LLC (SLG), a party unrelated to GKK2, acquired a 55% TIC interest. The parties held these real property interests directly in the building until December, 2010. On Dec. 14, 2010, the parties formed Herald Owner LLC (Herald LLC). Subsequently, on Dec. 22, 2010, GKK2 contributed its TIC interest into Herald LLC in exchange for a 45% membership interest in Herald LLC. Concurrently, SLG also contributed its TIC interest into Herald LLC, in exchange for a 55% membership interest in Herald LLC. On the same day, SLG and GKK2 executed a purchase agreement pursuant to which SLG agreed to purchase GKK2’s 45% membership interest in Herald LLC for $25,312,500 and GKK2’s release of its pro rata mortgage obligation of $86,062,500, resulting in total consideration of $111,375,000. As a result of the purchase agreement, GKK2 immediately withdrew as a member of Herald LLC.
GKK2 timely filed a combined RETT return with SLG reporting the contribution of its TIC interest to Herald LLC and the sale of the Herald LLC interest to SLG. Regarding the conveyance between GKK2 and SLG, the parties reported no consideration for the amount of the conveyance and the transaction was reported as exempt as a transfer of a minority (45%) interest. Further, GKK2 reported the contribution of its interest to Herald LLC as a conveyance consisting of a mere change of identity or form of ownership or organization. Also, SLG filed a combined return which reported the conveyance of its fee interest to Herald LLC as a conveyance consisting of a mere change of identity or form of ownership or organization.
The New York Division of Taxation (Division) performed an audit and issued a notice of determination, dated April 1, 2013, which asserted liability for New York State RETT based on the total consideration for the transaction, including penalties and interest.3
After a conciliation conference, the penalty assessment was cancelled, but the parties pursued legal action at the Division of Tax Appeals. The Division filed an exception to the determination of the Administrative Law Judge which had found the transfers exempt from RETT,4
resulting in this appeal. At issue is whether the Division properly asserted RETT against GKK2 for the transactions that occurred on Dec. 22, 2010.
NYS real estate transfer tax
NYS RETT is generally imposed on each conveyance of real property or interest therein when consideration exceeds $500.5
A conveyance is defined as “the transfer or transfers of any interest in real property by any method . . . or transfer or acquisition of a controlling interest in any entity with an interest in real property.”6
Also, a conveyance includes the acquisition of an entity with an interest in real property where an interest of 50% or more of “the capital, profits or beneficial interest in such . . . entity” is acquired.7
All conveyances are presumed subject to tax unless an exemption is proven applicable by the taxpayer.8
An exemption is available for “conveyances to effectuate a mere change of identity or form of ownership or organization where there is no change in beneficial ownership.”9
A related regulation provides “[w]here there is a transfer or acquisition of an interest in an entity that has an interest in real property, . . . and subsequently there is a transfer or acquisition of an additional interest or interests in the same entity, the transfers or acquisitions will be added together to determine if a transfer or acquisition of a controlling interest has occurred. Where there is a transfer or acquisition of a controlling interest in an entity . . . , and the real estate transfer tax is paid on that transfer or acquisition and there is a subsequent transfer or acquisition of an additional interest in the same entity, it is considered that a second transfer or acquisition of a controlling interest has occurred which is subject to the real estate transfer tax.”10
The regulation does not apply to transfers that occur more than three years apart. Further, RETT does not apply to “[t]he conveyances by tenants-in-common of their interest in real property to a partnership or a corporation, the partnership or corporation interests being in the same pro rata shares as the tenants-in-common held prior to the conveyance. Such conveyance is not taxable as there is no change in beneficial ownership.”11
Administrative Law Judge ruling
The sole issue before the Administrative Law Judge (ALJ) was whether the tax-exempt initial transfers by GKK2 and SLG of their TIC interests to Herald LLC could be combined with GKK2’s subsequent taxable transfer of its noncontrolling interest in Herald LLC to SLG to make the entire transaction taxable.12
The ALJ found the transactions exempt from RETT, primarily based on the conclusion that the regulation at issue prohibited the aggregation of a nontaxable “mere change in form of ownership” transfer with a taxable transfer to achieve a single taxable transaction.13
To reach this conclusion, the ALJ concluded that pursuant to statutory definitions, if considered separately, none of the three transactions at issue would be subject to RETT. The transactions by which SLG and RKK2 exchanged their TIC interests for proportional Herald LLC interests are mere changes of identity or form transactions and would qualify for exemption under N.Y. Tax Law Sec. 1405(b)(6). The sale of GKK2’s interest in Herald LLC to SLG, as a transfer of a minority entity interest, would not meet the statutory definition of conveyance and would not, therefore, be subject to RETT.
Tax Appeals Tribunal decision
On appeal, the Division asserted that: (i) the Tribunal should defer to its interpretation of the relevant statutes and regulations; (ii) GKK2 and SLG acted in concert to effectuate SLG’s acquisition of a controlling interest in Herald LLC and, based on applicable regulations, the transactions should be aggregated for RETT purposes; (iii) the step transaction doctrine, including the interdependence test and the end result test, should be applied to treat the three separate transfers on Dec. 22, 2010, as a single transaction; and (iv) the legislative history of the RETT and the former real property gains tax indicate the Legislature did not intend that individual steps in a series of transactions be considered in isolation. In response, GKK2 contended: (i) the Division’s interpretation of the RETT statutes and regulations is not entitled to deference as the issue is one of statutory construction; (ii) the ALJ correctly held that the RETT regulations do not authorize aggregation in this case; (iii) the legislative history does not support the Division’s proposed aggregation of the transactions at issue; and (iv) the Governor’s fiscal year 2018 budget included proposed legislation that would have amended the RETT law to subject transfers of a minority interest in an entity with an interest in real property to the tax, and the New York Legislature ultimately rejected the proposal. Further, GKK2 argued that application of the step transaction doctrine is inherently factual and thus may not be raised on exception.
The Tribunal first declined to consider the step transaction doctrine, noting that applying its interdependence and end result tests to the case at hand would necessarily, and in the Tribunal’s view, improperly, raise factual questions that were not before the ALJ.14
Instead, the Tribunal focused on whether the regulation requiring the aggregation of SLG’s two acquisitions of interests in Herald LLC was applicable. Since the intent of the regulation is to expand the applicability of RETT to transfers of otherwise nontaxable minority entity interests, its language was narrowly construed. Notably, the general purpose of the regulation is to inhibit the structuring of transactions to avoid RETT by the use of entity transfers. Thus, the Tribunal focused on statutory definitions to determine whether “a transfer or acquisition of an interest in an entity with an interest in real property” includes a mere change transfer or acquisition. Based on a literal interpretation of the law, the Tribunal found that the Division properly aggregated SLG’s mere change acquisition of its 55% interest in Herald LLC with SLG’s economically substantive acquisition of GKK2’s 45% interest in Herald LLC pursuant to the regulation at issue. Thus, the transfer was subject to RETT.
In finding for the Division, the Tribunal rejected GKK2’s argument that the economic reality of the SLG-Herald LLC exchange did not result in SLG acquiring anything of substance from Herald LLC, and that the formality of a mere change transfer should not be subject to aggregation. Although such transfers are themselves exempt from RETT, no statutory or regulatory language prohibits them from being subject to aggregation under N.Y. Comp. Codes R. & Regs. tit. 20, Sec. 575.6(d). Further, the Tribunal rejected the contention that the second sentence of the regulation at issue precludes the aggregation of a non-taxable acquisition of a controlling interest with an acquisition of a minority interest. Instead, the first sentence of the regulation requires aggregation of multiple transfers or acquisitions to determine if a controlling interest has been transferred or acquired and, hence if RETT is due (i.e., addresses the aggregation of transfers that occur before RETT is paid). The second sentence provides that RETT may be payable on a transfer that occurs even after a controlling interest has been transferred or acquired and RETT has been paid. In effect, this sentence requires aggregation of a minority interest transfer that occurs after payment of RETT with transfers that occur before payment of RETT. As indicated in the regulatory language, such a subsequent minority interest transfer is deemed a “second transfer.” Finally, the Tribunal found no language precluding the aggregation of RETT-exempt transfers, and no guidance in the RETT legislative history or in the 2018 proposed legislation to counter their conclusion.
The Tribunal decision focuses solely upon interpretation of a regulation promulgated by the Division to confirm the Division’s position. The Tribunal’s refusal to consider applying the step transaction doctrine to the RETT, an area of taxation that often conforms to form over substance principles, was fatal to the taxpayer’s position. In rejecting the need for this analysis, the controlling consideration in the New York Supreme Court’s decision covering the related NYC RPTT issue was rendered moot. Further, while rejecting several other contentions raised by the taxpayers in the case, the Tribunal refrained from providing a detailed analysis or conclusions regarding their inapplicability.
If the taxpayer does not decide to appeal and the decision stands, the decision will serve to harmonize the taxability of this type of transaction for RETT purposes with its taxability for purposes of the NYC RPTT, although on different grounds. While NYS and NYC have a long history of applying varying laws to reach divergent conclusions regarding taxability for purposes of NYC RETT and NYC RPTT, this conclusion provides some degree of congruence. However, as always, complexities and burdens for taxpayers trying to navigate New York tax laws governing the transfer of real property remain.
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