I’ve written several posts on discussing the meaning and ramifications of “doing business” for California tax purposes. See, e.g., Why Your LLC May Be Doing More Than You Think In California Even When It’s Doing Nothing, 60 Acres And A Lawsuit Challenging The FTB’s Interpretation of “Doing Business” (sorry, I don’t know the current status of this litigation), and You May Be Doing Business In California Even When Not Transacting Intrastate Business. I’ve also challenged the Franchise Tax Board’s interpretation of “doing business” as an “underground regulation”. See FTB Fights Underground Regulation Determination – Why Won’t It Simply Do What’s Right? Unfortunately, the FTB has decided to avoid the public notice and comment requirements of California’s Administrative Procedure Act by issuing a legal ruling earlier this week. See Cal. Gov. Code § 11340.9 (excepting legal rulings of the FTB and the State Board of Equalization).
In this Legal Ruling, the FTB eschews the treatment of LLCs as entities as well as any distinction between manager-managed and member-managed LLCs. The Legal Ruling provides six examples. In the first two examples, the corporate members in question are not required to file California returns and are not subject to the franchise tax because the LLCs’ acts of registering to do business in California and organizing in California are not attributed to their members. However, in the remaining four situations, the corporate members in question have California return filing obligations and are subject to the franchise tax, because the activities of the LLCs are attributed to their members under general principles of partnership law, and those activities constitute “doing business” within the meaning of section 23101(a) or (b) of the Revenue and Taxation Code. Although the examples are not factually complicated, they do require a very careful reading and understanding of the difference between registering to do business and “doing business”. See You May Be Doing Business In California Even When Not Transacting Intrastate Business. (Remember, this blog is commentary, not legal or tax advice, and should not be relied upon as such.)
From the standpoint of common-sense, the Legal Ruling’s conclusions fly in the face of any common understanding of what it means to be doing business. Does anyone really believe that doing nothing constitutes doing business? Nonetheless, it can’t be gainsaid that the conclusions are intended to maximize the tax reach of the state.
I find the Legal Ruling to be internally inconsistent. It first spurns the application of non-tax law that treats LLCs as entities but later invokes partnership law (which is a non-tax law) to support the attribution of an LLC’s activities to its members. I am also not persuaded by the Legal Ruling’s attempt to distinguish Appeals of Amman & Schmid Finanz AG, et al., 96-SBE-008 (April 11, 1996). In that decision, the State Board of Equalization held “that out-of-state corporations whose only California contacts were as limited partners in limited partnerships were not ‘doing business’ in California even if the limited partnerships were ‘doing business’ in California.” (emphasis added). The Legal Ruling states that the SBE’s decision “hinged” the fact that limited partners do not have the right to manage or control the decision making process of a limited partnership. Why then does the Legal Ruling declare that the “distinction between ‘manager-managed’ LLCs and ‘member-managed’ LLCs is not relevant . . .”?