The New York State Tax Appeals Tribunal affirmed an Administrative Law Judge's decision holding that an LLC, and thus the individual LLC members, were liable for the LLC's unpaid sales tax despite the fact that a creditor had seized control of the business. Matters of James W. Henrie and Michael M. McBride, DTA Nos. 825871 & 825872 (N.Y.S. Tax App. Trib., Nov. 22, 2017). The Tribunal rejected the members' claim that the LLC's inability to cause the sales tax to be paid absolved them of personal liability, holding that the LLC's inability to pay the sales tax stemmed from its voluntary decision to relinquish control to a creditor.
Facts. Namwest, LLC purchased a Holiday Inn hotel in Niagara Falls, New York. It then formed NS Partners, LLC (the "LLC") for the purpose of converting the hotel to a Crowne Plaza Hotel. James W. Henrie and Michael M. McBride were members of the LLC, and exercised considerable control over its activities for several years, including signing various legal documents on its behalf. Although the ownership of the LLC changed over time, during the periods in issue (three sales tax quarters in 2008) Messrs. Henrie and McBride (the "LLC members") each owned a one-third membership interest.
In March 2007, the LLC refinanced a $30 million loan with its creditor, Gramercy Capital Corp. ("Gramercy"). In March 2008, the LLC defaulted on its loan. Pursuant to the loan agreement, Gramercy thereafter assumed complete control over the hotel's operations and revenues. Although the LLC made Gramercy aware that the LLC was obligated to remit sales taxes to the State of New York and the LLC continued to file quarterly sales tax returns, the LLC did not pay the sales taxes due for three sales tax quarters during 2008. As a result, the Department issued notices of determination to the LLC members for the unpaid sales tax, penalty, and interest of the LLC. Following an audit of the personal income tax returns of the LLC members, which allowed them substantial income tax refunds, the Department applied those refunds against the members' sales tax liabilities asserted in the notices of determination.
Tax Law 1133(a) imposes liability for sales and use taxes on all "persons required to collect such taxes." Tax Law 1131(1) defines "[p]ersons required to collect tax" as "every vendor of tangible personal property or services" and "every operator of a hotel," which includes "any member of a partnership or limited liability company" that is required to collect such taxes.
[T]he Tribunal held that a person required to collect sales tax is not relieved of liability where, as here, a creditor takes action pursuant to an agreement with the business and such action results in the nonpayment of sales taxes.
Decision. Affirming the determination of the ALJ, the Tribunal rejected the LLC members' argument that they should not be held liable for the LLC's sales tax obligations because the LLC was no longer a vendor or the operator of a hotel after Gramercy took control of the hotel in March 2008. Citing its decisions in Matter of Button, DTA No. 817034 (N.Y.S. Tax App. Trib., Jan. 28, 2002) and Matter of Kieran, DTA No. 823608 (N.Y.S. Tax App. Trib., Nov. 13, 2014), the Tribunal held that a person required to collect sales tax is not relieved of liability where, as here, a creditor takes action pursuant to an agreement with the business and such action results in the nonpayment of sales taxes. The Tribunal noted that any "preclusion from action" on the part of the LLC was its "own creation" and was one of the "risks [the LLC] chose to take in running [its] business enterprise." Accordingly, the Tribunal concluded that the LLC remained liable for the collection and payment of sales tax during the period at issue.
The Tribunal also rejected the LLC members' claim for relief under Technical Memorandum, TSB-M-11(17)S (N.Y.S. Dep't of Taxation & Fin., Sept. 19, 2011), which limits an LLC member's sales tax liability to the member's percentage interest in the LLC if, among other things, the member can show (i) that his or her ownership interest and profit and loss interests are less than 50%, and (ii) that the member was not under a "duty to act" for the LLC in complying with the Tax Law. The Tribunal found that the members did not qualify for relief under TSB-M-11(17)S because, under the precedent set forth in Matter of Kieran and Matter of Button, corporate officers and similarly responsible persons are not relieved of their "duty to act" because a creditor takes action pursuant to a voluntary agreement with the business.
While the Tax Law clearly imposes liability for sales tax on "every vendor of tangible personal property or services" and "every operator of a hotel," it is interesting that the decision does not mention the creditor's potential liability for the sales tax after it took complete control of the operation of the hotel and its operating revenues during the periods at issue. Presumably, if the creditor was operating the hotel, and had the ability to direct its operations and ensure that the tax was collected and remitted, it should also be liable for sales tax. Nevertheless, despite the creditor's potential liability, under the case law, businesses that voluntarily enter into loan agreements that contemplate loss of control of the business in the event of default are not relieved of sales tax liability whether or not they continue to operate the business, nor (in the case of an LLC) are their members. Consequently, a business that enters into a loan agreement that contemplates the creditor taking over the business operations in the event of a default should make sure that the loan agreement provides that in the event of a takeover of the business, the creditor will register as a vendor and be responsible for collecting and remitting any sales taxes that thereafter become due.