We previously reported on the case of Swart v. Franchise Tax Board (Vol. 10, No. 1, April 2015). Swart Enterprises Inc. was an Iowa corporation that owned a farm in Kansas. It had no physical presence in California and did not sell any products or services in California. It was not registered with the Secretary of State to transact intrastate business within California. In 2007, Swart invested $50,000 in a limited liability company that was engaged in the business of equipment leasing, giving it a .2 percent interest in this company. The leasing company was formed under the laws of the state of California and was treated as a partnership for income tax purposes.

The Franchise Tax Board took the position that Swart was required to file a California franchise tax return and pay the $800 minimum annual franchise tax as a result of its investment in the leasing company. The superior court determined that Swart was not doing business in California and therefore was not required to file a franchise tax return or pay the $800 minimum tax. The FTB appealed this decision to the court of appeal.

The FTB made a number of arguments before the court of appeal. It argued that because the leasing company was doing business in California and Swart was a member of the leasing company, it should be deemed to be doing business in California. The court of appeal did not accept this argument, finding that Swart bore more similarity to a shareholder receiving dividends — in other words, simply a passive investor. The FTB’s next argument was that because the leasing company was treated as a partnership for tax purposes, Swart should be treated as a general partner. The FTB argued that each partner of a partnership is considered to be engaged in the business activities of the partnership, but the court also declined to accept this argument. Finally, the FTB  argued that even though the leasing company was managed by a manager rather than by the members, the owners effectively controlled the management because they could remove the manager at any time. The court likewise rejected this argument, noting that as the holder of a .2 percent interest, Swart could not remove the manager without the concurrence of a number of other members, since a majority vote was required.

The fact that the FTB chose to appeal this case is an indication that it still takes a very aggressive view of what constitutes doing business in the state of California. Whether the FTB will now moderate its view in light of its loss at the Court of Appeal, or  it will continue the fight by appealing to the California Supreme Court, remains to be seen.