(This article originally was published by Law360 on July 7, 2016.)
Rarely does a subject as mundane as a documentary transfer tax become worthy of its own article. However, the June 29, 2017, decision of the California Supreme Court in 926 North Ardmore Avenue LLC v. County of Los Angeles (Ardmore) is a worthy exception. Affirming the Court of Appeal, the California Supreme Court held in Ardmore that California’s documentary transfer tax may be imposed by localities on transfers of interests in legal entities holding title to real property when three criteria are met: (1) the legal entity interest transfer is memorialized in writing; (2) the transfer is made for consideration; and (3) the transfer constitutes a “change of ownership” in the legal entity within the meaning of “change of ownership” for property tax reassessment purposes as set forth in Cal. Rev. & Tax. Code § 64, subds. (c) or (d). Under the Ardmore holding, it is irrelevant whether the written instrument at issue memorializing the legal entity interest transfer is recorded or directly references the real property. Moving forward, every transaction involving a transfer of an interest in a legal entity holding title to real property in California is going to require thorough investigation and due diligence concerning the possible triggering of Ardmore documentary transfer tax imposition.
The California Documentary Transfer Tax Act (DTT) is an excise tax imposed on the right or privilege of transferring real property. Enacted by the Legislature in 1967, the DTT enables cities and counties to adopt by ordinance a tax “on each deed, instrument, or writing by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred, otherwise conveyed to, or vested in, the purchaser or purchasers, or any person or persons, by his or their direction, when the consideration or value of the interest or property conveyed (exclusive of the value of any lien or encumbrance remaining thereon at the time of sale) exceeds one hundred dollars ($100)[.]” When passing the DTT in 1967, the Legislature intended to pattern it upon the (now-repealed) Federal Stamp Act. The rate is 55 cents ($0.55) for each $500 or fractional part thereof, but the rate is commonly referred to as being $1.10 per $1,000. The party who is transferring or conveying title is generally responsible for payment of the tax. There are also a number of statutory exemptions to the DTT. Documents that are submitted for recordation must expressly identify the amount of the DTT due. A county recorder shall not record any deed, instrument or writing subject to the DTT unless the tax is paid at the time of recording. However, if the DTT is due on a transfer, it is due and payable regardless of whether or not a transfer document is submitted for recording.
The DTT is an excise tax on the right to transfer real property with its own statutory provisions and related guidance, and is not a property tax. However, California’s real property tax law also comes into play. In 1978, and in response to rapidly rising real property taxes, California voters “staged what has been described as a property tax revolt” by approving a statewide ballot initiative known as Proposition 13,  which limits the amount of property taxes that may be levied on homes and businesses by capping the maximum amount of any ad valorem tax on real property to 1 percent of the “full cash value” of the property. However, real property is subject to reappraisal whenever it undergoes a “change of ownership,” which includes a purchase or new construction.
The buyer of any real property subject to local property taxation that has changed ownership is required to file a change in ownership report generally at the time of recording or within 90 days of the date of transfer. Ordinarily, when sales or transfers of property are recorded with the county recorder, whoever records the deed also files a preliminary change in ownership report for the owner, which is a signed and certified two-page questionnaire. The county assessor will send out a change of ownership statement to the owner when a preliminary change in ownership report is either not filed when the transfer is recorded or is filed incomplete.
Ardmore involves a single member LLC (SMLLC) established to hold and manage an apartment business in Los Angeles. The LLP that owned the SMLLC sold 90 percent of its partnership interests, and Los Angeles County sought to impose the DTT on the grounds that the sale constituted a “change of ownership” of the apartment building property for property tax purposes. The transaction did not involve the execution of a deed or other instrument transferring title to the apartment building, and the agreements did not mention the apartment building or its location, nor were they recorded. However, the parties agreed that the transaction resulted in a change of ownership for property tax reassessment purposes. In 2010, Los Angeles County started assessing the DTT whenever a legal entity underwent a “change of ownership” within the meaning of property tax law. The SMLLC paid the DTT and filed suit in Los Angeles County, lost, appealed and lost again at the Court of Appeal. The California Supreme Court then accepted the case for review.
The California Supreme Court in Ardmore addressed how the meaning of “change in ownership” for property tax purposes applies to the DTT. The Los Angeles County Recorder relied on the assessor’s determination that the apartment building had changed ownership for property tax purposes. But the DTT and property tax laws are two completely different taxes so there was no clear authority for the assessor to unilaterally decide that a written instrument conveying an interest in a legal entity that owns real property is a taxable change in ownership for DTT purposes.
Looking first to section 11911, the court in Ardmore found its text “provides no clear answers” and that “considered in isolation,” it could be read as either party argued. But when read in the context of the federal stamp act, which was a model for the California act, the court determined that no ambiguity existed. Specifically, the court reasoned the Legislature intended the DTT to apply to transactions involving transfers of interest in legal entities as evidenced by its enactment of section 11925, which created an exemption to the DTT for specific circumstances regarding a transfer of partnership interest. According to the majority opinion, if the Legislature had not intended the DTT to apply to transactions involving transfers of interests in legal entities, section 11925 would be superfluous; if no transfer of interest in legal entities trigger DTT liability, the partnership exemption would be unnecessary.
The court went on to explain that the critical factor in determining whether the DTT may be imposed on the Ardmore fact pattern is whether there was a sale that resulted in a transfer of beneficial ownership of real property. The court then concluded in the affirmative: “[t]he change in ownership rules, though enacted after the Transfer Tax Act, fit squarely within this framework.” More broadly, the court held that section 11911 permits the imposition of the DTT whenever a transfer of an interest in a legal entity constitutes a “change of ownership” within the meaning of section 64, subds. (c) or (d), so long as the transfer was for consideration, and there was a written instrument reflecting the legal entity interest transfer.
A “change of ownership” occurs under a variety of circumstances. Section 64(a) states that as a general rule, the purchase or transfer of an ownership interest in legal entities, such as corporate stock or partnership or limited liability company interests, shall not be deemed to constitute a transfer of the real property of the legal entity. However, there are notable exceptions to the statute that are referenced above by the court in Ardmore. First, section 64, subdivision (c)(1) provides that when a person or entity obtains control of any legal entity the purchase or transfer “shall be a change of ownership of the real property owned by the legal entity in which the controlling interest is obtained.” Second, section 64, subdivision (d), provides whenever shares or other ownership interests representing cumulatively more than 50 percent of the total interests in the entity are transferred by any of the original co-owners in one or more transactions, “a change in ownership of that real property owned by the legal entity shall have occurred, and the property that was previously excluded from a change of ownership … shall be reappraised.”
The majority opinion in Ardmore concludes with the observation that under the taxpayer’s construction of section 11911, a person or entity could purposely evade DTT tax liability by first transferring real property into a newly created LLC and then selling all of the stock of that LLC, instead of executing a deed transferring the real property and triggering the DTT tax liability. The court thus concluded that taxpayer’s statutory interpretation “would elevate form over substance, and conflict with the purposes of the Transfer Tax Act.”
Ardmore is a 6-1 decision, but Justice Leondra Kruger’s lone dissenting voice is forceful. The dissenting opinion points out that section 11911 “says nothing about the taxation of entity interest transfers” and that even the majority acknowledges that neither that section nor the federal stamp tax provisions on which it was modeled have been held to reach such transfers.
The dissent disagreed with the majority’s reliance on section 11925, asserting the provision “cannot bear the weight the majority places on it.” The dissent observed that section 11925(b) undermines the notion that the provision is aimed at anything other than deeds and similar documents by which real property is sold because the subdivision equates the termination of a partnership to the execution of an instrument transferring all realty held by the partnership. Thus, the dissent stated that “the only provision of the statute that speaks directly to the application of the documentary transfer tax because of an entity interest transfer … operates not by taxing the transfer directly (or by taxing a document effecting the transfer), but by deeming there to be an ‘instrument whereby… all realty held by the partnership’ is conveyed by consideration. The dissent also offers reasons to reject the majority’s conclusion that the statute would be superfluous in the event the DTT did not apply to transfers of interests in legal entities.
The dissent goes on to note that the majority’s holding reaches well beyond its touted “substance over form principle,” and instead effectively sweeps “into the DTT’s compass a considerable swath of entity interest transfers that bear little or no resemblance to ordinary sales of real property.” The dissent points out that any concerns of improper elevation of form over substance can be addressed under already-existing and well-established law by which courts may disregard transactions that are mere “shams” lacking in economic substance. And, while the Legislature could have incorporated the property tax law’s change of ownership rules for DTT purposes — and, indeed, one such proposal in the 2013-2014 legislative session attempted to do so and failed — the Legislature has not incorporated those rules.
Despite the litigation pending in Ardmore on the issue, and the fact that at least one Legislative attempt to apply the DTT to changes of ownership had failed, a number of cities and counties have already changed their ordinances to explicitly apply the DTT to legal entity changes, e.g., City and County of San Francisco, Santa Clara County, City of Oakland. Other jurisdictions, including Los Angeles County, which was the defendant in Ardmore, more informally disclose on their websites that the DTT is due on legal entity transfers where no document is recorded, but which resulted in a greater-than-50 percent interest in control of the legal entity being transferred. Essentially, these jurisdictions have already elevated the change in beneficial ownership of real property to, as the dissent put it, the “touchstone of taxation” under the DTT, and the majority opinion endorsed this elevation. But as the dissent also queries, if a change in beneficial ownership of real property is the “touchstone” for determining whether the DTT applies, where does this reasoning stop? In theory, then, the DTT could be argued to apply to transfers of interests in legal entities without any writing at all, seemingly nullifying the “documentary” aspect of the documentary transfer tax.
Additionally, one could reasonably expect that in the aftermath of Ardmore, more California cities and counties will amend their ordinances to specifically apply the change of ownership rules for DTT purposes. However, in the absence of such an ordinance, and where an (existing) ordinance simply states it applies to “recorded” documents, an argument can be made that until such time as the ordinance is amended, it cannot be read to encompass the Ardmore situation applying the DTT to written transfers of beneficial ownership for consideration.
 (Cal., June 29, 2017) Case No. S222329, — P.3d. – (“Slip Op.”).
 All statutory references herein are to the California Revenue & Taxation Code.
 Slip Op. 1.
 Slip Op. 13.
 City of Huntington Beach v. Superior Court (1978) 78 Cal.App.3d 333, 340.
 §§ 11901 et seq.
 Thrifty Corp. v. Cnty of L.A. (1989) 210 Cal.App.3d 881, 884. The Federal documentary stamp taxes were repealed by the Excise Tax Reduction Act of 1965. See Excise Tax Reduction Act of 1965, Pub.L. No. 89–44, § 401(b), 79 Stat. 148 (1965), effective January 1, 1968.
 § 11911.
 Additionally, unlike general law cities, California charter cities have the ability to impose their own real property conveyance taxes without authorizing state legislation. For example, the cities of Oakland and Berkeley imposed a city real property transfer tax at full value, at a rate of $15.00 per thousand on full value. Alameda County Clerk-Recorder’s Office, Real Property Sales and Transfers (2016).
 § 11912. Where transactions involve both real property and personal property, an allocation is required before the amount of the transfer tax (which does not apply to transfers of personal property) can be determined.
 §§ 11921, et seq. (e.g., instruments securing debt, transfers to governmental entities, transfers incident to reorganizations, transfer of interests in a continuing partnership or similarly treated entity, transfers by gift or death, etc.)
 § 11932.
 § 11933.
 Fiedler v. City of Los Angeles (1993) 14 Cal.App.4th 137, 145.
 See Norlinger v. Hahn (1992) 505 U.S. 13.
 Cal. Const., Art. XIIIA, sec. 1(a). The full cash value of any real property is the value of such property as shown on the property’s 1975-1976 tax bill. Id.
§§ 480, 480.1 & 480.2.
 Slip Op. 3.
 926 N. Ardmore Ave., LCC v. Cty. of Los Angeles (2014) 229 Cal.App.4th 1335, 1343.
 926 N. Ardmore Ave., LCC v. Cty. of Los Angeles (Cal. 2015) 340 P.3d 379.
 Slip Op. 13.
 Id., 9.
 Id., 9.
 Id., 11; § 11925.
 Slip Op. 11.
 Id., 19.
 Id., 20.
 § 64(c)(1), emphasis added.
 § 61(d), emphasis added.
 Slip Op. 21.
 Dissenting Opinion, Slip Op. 3.
 Id., 4.
 Id., 5.
 Id., 6.
 Id., 13, citing e.g., to Fashion Valley Mall LLC v. County of San Diego (2009) 176 Cal.App.4th 871, 880.
 Id., 12.
 AB 561 (Ting) was introduced on February 20, 1013. The bill died in early 2014.
 City and County of San Francisco Business and Tax Regulations Code, Article 12-C, § 1114.
 County of Santa Clara, Code Section A30-39.6 ordinance.
 City of Oakland Municipal Code § 4.20.20.
 Los Angeles County Registrar-Recorder/County Clerk, “Corporate Documentary Transfer Tax.”
 Dissenting Opinion, Slip Op. 9.
 See id.
 See id.