by Michael J. Berey1
At its October 27, 1999 Tax Representatives
and Practitioners Program ("TAXRAPP") the New York City
Department of Finance made known certain Amendments issued to the
Rules Relating to the Real Property Transfer Tax ("RPTT"),
codified at Section 23, Title 19 of the Rules and Regulations of
The City of New York, on application of the mere change of identity
exemption to the transfer of controlling economic interests. The
Amendments, effective May 28, 1999, can be found on the Internet
at www.titlelaw-newyork.com under "Transfer
Taxes."
The transfer or acquisition of a controlling
economic interest in an entity owning real property has been a RPTT
taxable event since Local Law 71 of 1986 became effective retroactive
to July 13, 1986. Section 1201 of the New York State Tax Law (the "Tax
Law") and Title 11, Chapter 21 of the City's Administrative
Code deal with the RPTT. Controll-ing interest transfers have, since
July 1, 1989, been subject to tax under New York State's Real Estate
Transfer Tax ("RETT") at Article 31 of the Tax Law.
The RETT and RPTT are primarily payable
by the transferor of the taxable interest, with the transferee secondarily
liable for the tax in the event of nonpayment. The RETT rate is $2.00
for each $500.00 of consideration. The RPTT rate for commercial property
is 1.425% when the consideration paid or imputed is less than $500
million and 2.625% when the consideration is at least that amount.
For controlling interest transfers, the
RETT and RPTT are generally computed based on the fair market value
of the real property interest held by the owning entity apportioned
based on the percentage of the economic interest in the entity being
transferred or acquired.
To be taxable, within a three-year period
(or longer, if the transfers are being made pursuant to a plan to
avoid payment of tax), there must be either the transfer of an economic
interest in the entity by a transferor or the acquisition of an economic
interest by a transferee (or by transferors or transferees "acting
in concert" or "in one or several related transfers")
of at least 50% of the total voting power or fair market value of
all classes of stock in the case of an interest in a corporation,
or of at least 50% of the capital, profits or beneficial interests
in the case of an interest in a partnership, trust or other unincorporated
association.
Controlling interest taxes have been broadly
applied by the New York State and City taxing authorities. The transfer
of a controlling interest in an entity which directly, or through
its controlling economic interest in a different entity, has an interest
in real property is subject to tax. The transfer of a controlling
interest in an entity owning a leasehold is considered a taxable
event irrespective of the remaining term of the lease, a factor usually
applied in applying the RETT to leasehold grants. The transfer of
a controlling interest in a contract vendee or in the holder of a
foreclosure bid are considered taxable, as is the gift transfer of
a controlling interest to the extent of outstanding mortgage indebtedness
apportioned to the interest being transferred. Interests acquired
at, and within three years of, the formation of the real property
interest-owning entity by an original shareholder, partner or member,
will be aggregated. If the total of the interests so "acquired" constitutes
at least a 50% aggregate economic interest, the interests obtained
after formation will be taxed.
It is also the State's informal position
that the taxation of controlling economic interest transfers applies
to the "Additional Tax" under Tax Law Section 1402-a, popularly
known as the "Mansion Tax." The Mansion Tax is a grantee
tax of 1% of consideration applicable, in general, to the conveyance
of a one-to-three family residence where the consideration is $1
million or more.
However, both the RETT and RPTT also provide
for an exclusion from consideration to the extent that an otherwise
taxable transfer constitutes a mere change in identity or form of
ownership or organization, what is generally known as the "mere
change" exemption.
Section 11-2106 of the City's Administrative
Code was amended by Chapter 170 of the Laws of 1994 to provide an
exemption from the RPTT for transfers made on and after June 9, 1994
that effect a mere change of identity or form of ownership or organization
to the extent the beneficial or other ownership interest being transferred
or conveyed remains the same. The mere change exemption has, by enactment
of Chapter 61 of the Laws of 1989, been applicable to the RETT since
July 1, 1989. RETT exemptions are at Tax Law Section 1405.
The Amendments made known at TAXRAPP include
two significant, "new" positions on application of the
mere change exemption to controlling interest transfers. The examples
set forth below have been extracted from illustrations in the Amendments.
First, for transfers or transactions occurring
on and after January 1, 1999, the determination of the RPTT rate
to be applied to a controlling interest transfer will be determined
based on the amount of consideration prior to application of the
exemption. This is a change from the Department's prior position,
which remains applicable to transfers occurring before January 1,
1999.
For example, X Corporation, having two
shareholders, A and B, each owning 50% of the corporation's stock,
owns 100% of the stock of Y Corporation, which owns unencumbered
real property in the City of New York having a fair market value
of $1 million. X Corporation distributes in liquidation 25% of the
Y Corporation stock to A and 75% of the Y Corporation stock to B.
The transfer of Y Corporation stock is exempt as a mere change of
identity or form of ownership or organization except to the extent
of the additional 25% stock interest distributed to B. The RPTT due
is $6,562.50 determined by multiplying $250,000 (25% of the fair
market value of the real property) by the tax rate of 2.625%. The
higher tax rate applies since the "measure of tax" for
the distribution of the Y Corporation stock is $1 million, which
is greater than the $500,000 threshold for application of the increased
rate
This issue does not apply to the RETT
since its tax rate does not change with the amount of consideration.
Second, for transactions involving economic
interests, a determination of whether a controlling interest has
been transferred is to be made prior to application of the exemption.
Interests that are not exempt will be subject to tax even if they
represent less than 50% of the capital, profits or other beneficial
interests in the entity owning the interest in real property if the
total of the interests being transferred, without consideration of
the no change exemption, is 50% or more.
For example, Limited Partnership X has
four limited partners and one general partner. A, B, C and D, limited
partners, have, respectively, 29%, 29%, 24% and 14% interests in
the partnership. E, the general partner, has a 4% interest in the
partnership. X owns a parcel of unencumbered real property in the
City of New York with a fair market value of $1 million. Limited
Partnership X merges into Limited Partnership Y in which A, B and
C each have a 24% interest, D has a 14% interest, and E has a 4%
interest, for an aggregate interest in Partner-ship Y amongst these
partners of 90%. The merger is exempt as a mere change of identity
or form of ownership or organization to the extent of 90%. RPTT is
imposed on the 10% interest that is not a mere change. The tax due
is $2,625 determined by multiplying $100,000 (the fair market value
of the real property apportioned to the 10% interest in Partnership
Y not covered by the mere change exemption) by the tax rate of 2.625%.
The applicable rate of tax is determined by the full value of the
consideration prior to application of the exemption, which in this
example is $1 million, greater than the $500,000 threshold for application
of the higher tax rate.
The Amendments state that this second
position does not reflect a change in the policy of the Department
of Finance. According to the "Basis and Purpose of Amendments" section
of the Notice of Rulemaking, "(s)ince June 4, 1994, Department
policy has been that for all transactions occurring on or after [June
9, 1994], the determination of whether a transaction constitutes
a transfer of a controlling economic interest is made prior to the
application of the mere change exemption."
The RETT statute and regulations do not
specifically deal with this issue. It is, however, the State's informal
position that the determination of whether a transfer is a controlling
interest transfer is to be made prior to application of the mere
change exemption, with the non-exempt part of the transfer being
subject to tax even if less than a 50% interest.
The State's position is consistent with
its prior position on the now repealed "Tax on Gains Derived
From Certain Real Property Transfers" which applied to transfers
of $1 million or more and can be found at former Tax Law, Article
31-B. Section 590.51, of Subchapter L, Chapter III, Title 20 of the
Official Compilation of Codes, Rules, and Regulations of the State
of New York recited that "(t)he million dollar exemption is
applied to consideration first and then the mere change exemption
is applied. A transfer in which the consideration is greater than
$1 million will remain taxable, the mere change exemption only defers
payment of tax on the portion of gain determined to be attributed
to a mere change in form or ownership".
It is also consistent with the State's
regulations on application of the Mansion Tax. Section 575.3 of Part
575, Subchapter K, of the above regulations indicates that if the
overall consideration for a transfer of real property that has both
residential and commercial portions is $1 million or more, the residential
portion will be taxable even if it is, of itself, less than the threshold
amount.
The Amendments indicate that the application
of the mere change exemption to transfers to and from trusts will
be dealt with at a later date.
1 Michael
J. Berey is Senior Underwriting Counsel and Senior vice President
of the first American Title Insurance Company of New York. Mr. Berey
maintains a website for real estate counsel at www.titlelaw-newyork.com.
