California Court Holds Passive Member Is Not “Doing Business” - O Frabjous Day!
The State of California imposes its franchise tax on every corporation (other than a bank, financial corporation or exempt corporation) that is “doing business” in California. Cal. Rev. & Tax Code § 23151. This tax is imposed without regard to whether the corporation is incorporated in California. This makes the name of the tax somewhat misleading because it is not a tax for the privilege of a California charter (as is Delaware’s franchise tax), rather it is a tax based on the corporation’s net income. A key question then is whether a corporation is “doing business” in California.
Almost four years ago, I wrote about a small family business – Swart Enterprises, Inc. See 60 Acres And A Lawsuit Challenging The FTB’s Interpretation of “Doing Business”. Swart, which is incorporated in Iowa, operates a farm with some 60 acres of crop land in Kansas. Swart has no physical presence in California. It owns no real or personal property in California. It has no California employees. Swart’s sole connection to California is as an investor in a limited liability company. Swart’s investment amounted to a 0.2 percent ownership interest in the LLC. The LLC, which was formed in California, is manager-managed. As a member, Swart did not participate in the LLC’s management or operations. In the eyes of the FTB, this was enough to constitute doing business in California. It is hard to imagine that anyone would characterize Swart as doing business in California. Remarkably, however, that was the position of the Franchise Tax Board which demanded that Swart file a California tax return and pay the $800 minimum franchise tax under Section 25153 of the Revenue & Taxation Code.
Swart’s legal arguments went snicker-snack
Swart, taking its vorpal legal arguments in hand, sued the FTB and prevailed in Superior Court. See Judge Rules Against FTB In “Doing Business” Definition. The FTB appealed.
Yesterday, the Court of Appeal affirmed:
We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC. The Attorney General’s conclusion that a taxation election could transmute Swart into a general partner for purposes of the franchise tax, and that the business activities of Cypress can therefore be imputed to Swart, is not supported by citation to appropriate legal authority and, in our view, defies a commonsense understanding of what it means to be “doing business.”
Swart v. Franchise Tax Board, Cal. Ct. Appeal Case No. F070922 (Jan. 12, 2017). Upon reading this opinion, I chortled in my joy.
Note to readers: If you are unfamiliar with some of words in today’s post, please refer to Charles Dodgson’s Jabberwocky.