The Long Arm of California’s Minimum Franchise Tax

In its opinion in The Matter of the Appeal of Aroya Investments I, LLC, issued on July 7, 2020, the California Office of Tax Appeals (OTA) held that an out-of-state limited liability company (LLC) was “doing business” in California, and therefore subject to the $800 annual minimum franchise tax charged LLCs, based solely on the LLC’s ownership of a 0.78% membership interest in another manager-managed LLC.

Aroya Investments I, LLC is a Delaware LLC based in New York.  For tax year 2016, Aroya’s only connection to California was its ownership of a 0.78% membership interest in 1155 Island Avenue LLC, a Delaware LLC which owned and managed property in San Diego, California.  Both LLCs were taxed as partnerships.  Aroya had earlier paid the $800 minimum franchise tax, but then filed an amended return seeking a refund of the $800 tax on the basis that it was not “doing business” in California.

Aroya relied on Swart Enterprises, Inc. v. FTB, 7 Cal.App.5^th 497 (2017), and its interpretation of Rev & Tax Code Section 23101(a).  In Swart, the court found that a corporation that held a 0.2% membership interest in a manager-managed LLC was not “doing business” in California under the standard set forth in Section 23101(a).  The court found that such a passive interest, with no management authority, did not meet Section 23101’s standard of “actively engaging in any transaction for the purpose of financial or pecuniary profit or gain.”

The OTA, however, noted that Swart involved a tax year prior to 2011, when Section 23101 was amended to add new quantitative “doing business” tests.  These tests are based on an LLC’s sales, payroll, or property ownership in California.  If any of the threshold tests in Section 23101(b) are met, then the taxpayer is “doing business” in California. 

Under Section 23101(b), if an LLC’s real and tangible property exceeds $50,000 (adjusted for inflation, $54,771 in 2016), the LLC is “doing business” in California.  Under Section 23101(d), the LLC’s property includes the LLC’s “distributive share of pass-through entities.” Aroya, therefore, would need to include 0.78% of 1155 Island Avenue’s property.

The OTA found that the San Diego property owned by 1155 Island Avenue was worth $61,500,000.  The value of Aroya’s property in California, under Sections 23101(b) and (d), was $481,000, significantly over the $54,771 threshold.  Therefore the OTA held that Aroya was “doing business” in California and subject to the $800 franchise tax.

This eBulletin was prepared by William F. Webster, wwebster@boutinjones.com.