A recent decision of a New York City Administrative Law Judge concerning the New York City real property transfer tax addresses two interesting questions: one substantive, involving transfers of economic interests; the other procedural, regarding who is the proper party to claim a refund. The decision holds that a transfer of a non-controlling economic interest in real property may be not be aggregated with earlier transfers where the later transfer is shown to be unrelated to those earlier transfers. It also holds that the individual who filed the claim for refund of the tax, and who filed the petition challenging the denial of that refund claim, was the real party in interest entitled to challenge the refund denial. Matter of Jonis Realty/E. 29th Street, LLC, TAT (H) 09- 9R (RP) (N.Y.C. Tax App. Trib., Admin. Law Judge Div., Sept. 9, 2015).
Facts. Two brothers (Steven and Nathan Halegua) each held 46.5% interests in Jonis Realty/E. 29th Street LLC (“Jonis”), a limited liability company that indirectly owned a 96% interest in real property located on 29th Street in Manhattan (“the Property”). Nathan planned to develop the Property into a multi-story condominium, but needed additional funding and construction expertise. In August 2005, Jonis sold a 30% economic interest in the Property (in the form of a membership interest of an intermediate LLC) to the Grantee in exchange for consideration. Several months later, Jonis transferred another 18% economic interest in the Property to the same Grantee. After the second transfer, Jonis and the Grantee each held a 48% beneficial interest in the Property (while the remaining 4% continued to be held by an unrelated party). There were no plans for further transfers, and it was expected that the development project would proceed under this structure.
Shortly thereafter, Steven, the other brother and LLC member, became uncomfortable with the development plans and the potential funding requirements, and sought to exit the project. Since Nathan did not have sufficient funds to purchase Steven’s beneficial interest, a third transfer was made in 2006, effectuated as a transfer by Jonis to the Grantee of a 22% interest in the intermediate LLC. As a result of that conveyance, and following the distribution by Jonis to Steven of nearly $10 million of the sales proceeds, Steven was no longer a member of Jonis. After the third transfer, the Property was beneficially owned 70% by the Grantee, 26% by Jonis, and 4% by the unrelated third party. All three transfers occurred within a three-year period.
Under the real property transfer tax (“RPTT”), a transfer of a 50% or more controlling interest in real property is subject to tax. Related transfers of less than a controlling interest are aggregated in determining whether a controlling interest has been transferred. The RPTT regulations provide that transfers made within a three-year period are presumed related and aggregated, unless it can be shown that they are unrelated. 19 RCNY 23-02.
Following the third transfer, Jonis filed a Real Property Transfer Tax Return and reported tax due based on the aggregation of the three transfers, totaling $511,000 in tax (plus interest). Jonis paid the RPTT out of the proceeds paid to Steven following his exit from Jonis.
In September 2007, Jonis filed a claim for refund on the grounds that the third transfer was unrelated to the first two transfers should not have been aggregated with those transfers, and that therefore there was no taxable transfer of a controlling interest. The refund claim was signed by Steven as a member of Jonis, even though he was no longer a member, and unaccompanied by a power of attorney. It requested that the refund be paid directly to Steven. In May 2008, the Department denied the refund claim solely on the basis that transfers of economic interests made within a three-year period “must be aggregated.”
Procedural History. The case has a long history due to questions regarding whether Steven was the proper party and whether the petition was valid. In 2009, after a Petition had been filed, accompanied by a power of attorney signed by Steven (although no longer a member of Jonis), the Department filed a motion for summary judgment, claiming that since Steven was no longer a member of Jonis, he had no authority to file the Petition or to claim a refund. The Department’s motion was granted in a determination dated July 21, 2010. Following the filing of an exception with the City Tribunal this time accompanied by a power of attorney signed by Nathan, who was still a member of Jonis – the case was remanded to the ALJ Division to, among other things, determine whether Steven was the true party in interest.
The Decision. A hearing was finally held on both the procedural and substantive tax issues in December 2014, six years after the disallowance was protested. The ALJ concluded that based on the testimony and evidence, Steven, rather than Jonis, actually paid the tax – analogizing the manner of payment to an employer withholding of income tax from an employee’s wages – and that Steven was the proper party to pursue the refund claim. The fact that the refund claim was not accompanied by a duly authorized power of attorney – as required under the RPTT regulations – or that the Petition seeking a refund was brought under the wrong name of the proper party, did not preclude a conclusion that the claim for refund and Petition were proper and that Steven (although not the Grantor) was the proper party.
As for the substantive issue of whether the third transfer should be aggregated with the first two transfers, the ALJ noted that the RPTT regulations provide a rebuttable presumption that transfers made within a three-year period are “related” and must be aggregated. The ALJ found that the taxpayer had proved conclusively that the first two transfers – which gave the Grantee a 48% interest in the entity — were wholly unrelated to the third transfer, which was made only because of Steven’s subsequent desire to exit the project. The Department took the position that all three transfers were “related” because they all involved transfers of interests in the same legal entity. The ALJ rejected this argument, concluding that it would result in an irrebuttable presumption of aggregation any time economic interests in an entity are transferred within a three-year period, which was not supported by the Department’s own regulations.
The ALJ concluded that the third transfer was unplanned and unrelated to the two earlier transfers, that there was no transfer of a controlling interest in the Property, and that Steven was entitled to a refund of the RPTT.
The considerable procedural hurdles in this case – a claim for refund made by a former member of the Grantor, a power of attorney not signed by a current member of the Grantor, and questions about who paid the tax – account for the unusually lengthy delay (including two previous orders by the City Tribunal) before the case finally proceeded on the merits. On the procedural issue, it should be noted that the tax law permits a refund to be claimed by either the Grantor or Grantee “or other person who has actually paid the tax.” Admin. Code § 11-2108.a.
As for the substantive issue, it is difficult to justify the Department’s position – that somehow the regulatory presumption of aggregation becomes irrebuttable where there are transfers of interests in the same legal entity within a three-year period – and the ALJ’s decision on the merits is not surprising. It does not appear that the Department claimed that the third transfer had been part of a plan, or even that it was reasonably contemplated at the outset, so as to justify a claim that it was related to the earlier transfers.