TAXATION ‑- REAL ESTATE EXCISE TAX ‑- TRANSFER OF REAL PROPERTY BY CORPORATION TO SHAREHOLDERS IN PARTIAL DISSOLUTION
(1) A conveyance of real estate by a corporation to its shareholders in partial liquidation of the corporation, or in partial redemption of its stock, is a transfer for valuable consideration and thus is subject to the one percent real estate excise tax under RCW 28A.45.010.
(2) In such a case, the "selling price" or measure of consideration under RCW 28A.45.030 is the market value of the stock, if ascertainable, or the fair market value of the real property if the value of the stock is not readily determinable.
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July 17, 1974
Honorable Christopher T. Bayley
King County Court House
Seattle, Washington 98104
Cite as: AGO 1974 No. 14
You have requested our opinion on the following two questions concerning applicability of the one percent real estate excise tax provided for in chapter 28A.45 RCW:
(1) Is a conveyance of real estate to shareholders in partial liquidation of a corporation or in partial redemption of the stock of a corporation, a transfer for valuable consideration and thus subject to the one percent real estate excise tax under RCW 28A.45.010?
(2) If such conveyances are taxable, what is the "selling price" or measure of consideration under RCW 28A.45.030?
We answer your first question in the affirmative, and your second question as stated in our analysis.
[[Orig. Op. Page 2]]
Two factual situations have been presented for our consideration and are addressed in this opinion:
Situation A: A corporation conveys real property to its shareholders on a prorata basis in exchange for shares of stock in the corporation.
Situation B: A corporation conveys real estate to the estate of a deceased majority shareholder in exchange for all of the stock of that shareholder.
However, these factual differences do not, in our view require differing legal results. In both cases, we are dealing with what may be called, in a broad sense, a partial liquidation, accomplished by means of a redemption of part of the corporation's stock, rather than by means of a dividend in kind out of earned surplus or a distribution in kind of capital surplus. Cf., RCW 23A.08.420 and 23A.08.430.
The one percent real estate excise tax is imposed pursuant to chapter 28A.45 RCW uponsales of real property. For the purposes of this tax, RCW 28A.45.010 defines a sale as follows:
"As used in this chapter, the term 'sale' shall have its ordinary meaning andshall include any conveyance, grant, assignment, quitclaim, or transfer of the ownership of or title to real property, including standing timber, or any estate or interest therein for a valuable consideration, . . ." (Emphasis supplied.)
InEx rel. Namer Inv. Corp. v. Williams, 73 Wn.2d 1, 9, 435 P.2d 975 (1968), the Washington supreme court recently observed, with respect to this problem, that:
". . . The basis for any excise tax to be levied, then, must be the actual consideration paid or delivered or contracted to be paid or delivered in exchange for the ultimate transfer of the designated interest in real property. . . ." (Emphasis supplied.)
[[Orig. Op. Page 3]]
The meaning of "consideration," for the purposes of levying the one percent real estate excise tax, has not only been the subject matter of numerous opinions by this office but, as well, of eight separate state supreme court decisions during the past nineteen years. The earliest of these court decisions,Deer Park Etc. v. Stevens County, 46 Wn.2d 852, 286 P.2d 98 (1955), illustrates the point made by the court in theNamer case, supra. There, the court held that the conveyance of a corporation's realty to its shareholderssolely as a result of the corporation's dissolution is not a conveyance "for valuable consideration"; however, the conveyance of such realty pursuant to a contractual agreement under which the shareholders assume certain corporate liabilities is such a conveyance ‑ and thus taxable. As explained by the court in the later case of The Doric Co. v. King County, 57 Wn.2d 640, 645, 358 P.2d 972 (1961):
". . . We found the distribution in the DeerPark case was a taxable event because the stockholders had agreed by contract to assume the corporate liabilities in consideration for the trustee's undertaking to distribute the corporate assets in kind. Under the law applicable at the time of that voluntary dissolution, the trustee in dissolution had no authority to distribute the corporate assets in kind. It was in order to obtain such a distribution that the stockholders entered into the agreement."
The rationale for the rule that no taxable conveyance occurs in a "complete dissolution" case is that the change in title to the real property is but the fruition of an inherent right which accrues to the shareholder at the time when the stock is acquired. SeeDeerPark, supra, at pp. 857 et seq. This rule has since been consistently followed in four subsequent "complete dissolution" cases, includingThe Doric Co. v. King County, supra. See, also,Ben-Mac, Inc. v. King County, 69 Wn.2d 49, 416 P.2d 694 (1966), and Weaver v. King County, 73 Wn.2d 183, 437 P.2d 698 (1968). It has not, on the other hand, been applied in two cases which did not involve a complete liquidation,Christensen v. Skagit County, 66 Wn. 2d 95, 401 P.2d 335 (1965), andSenfour Inv. Co. v. King County, 66 Wn.2d 67, 401 P.2d 319 (1965). See, also,Senfour Investment Co. v. King County, 66 Wn.2d 644, 404 P.2d 760 (1965).
[[Orig. Op. Page 4]]
The first of the twoSenfour Inv. Co. cases is significant because it illustrates that, even in situations other than a complete liquidation case, the "inherent right" theory and the "lack of valuable consideration" theory are simply two sides of the same legal coin. In this case, title to real property was held by the trustees for a corporate beneficiary not then in existence. Upon formation of the corporation, the trustees transferred the property to the corporation. In holding that this transfer was exempt from the real estate excise tax, the court explained itself as follows:
". . . As soon as the corporation was formed, they performed the obligation of their trust and conveyed the property to the corporation. Such a conveyance is not a sale for a valuable consideration, as required by the statute."
Whether the reason for the transfer is characterized as the fruition of an inherent right of the transferees, as in the complete liquidation cases, or as simply the performance of a preexisting obligation on the part of the transferor, as in the firstSenfour case, the result is the same; i.e., a conclusion that there is no valuable consideration.
InChristensen v. Skagit County, supra, the court was faced with a factual situation which it characterized as "at the opposite end of the spectrum" from the complete liquidation cases.1/ The precise question there before the court was the applicability of the real estate excise tax to a conveyance of real property by members of a partnership to a corporation in return for the issuance of corporate stock. In holding that the tax was applicable, the court distinguished the complete liquidation cases as follows:
"InDeerPark and Doric we pointed out, Interalia, that the ownership of corporate stock carries with it the inherent right to share in the assets of a corporation ‑ after creditors ‑ when it is in the process of liquidation; [[Orig. Op. Page 5]] hence a transfer by a liquidating trustee was not a 'sale' in the ordinary meaning of the term, or a transfer of title for a valuable consideration within the ambit of RCW 28.45.050, supra.
"It is not necessary for us to discuss the various rights arising from individual or partnership ownership of real property as provided in RCW 25.04.100, 240, 250 [[RCW 25.04.100, 25.04.240, 25.04.250]]. It is sufficient for our purpose to note that following the transfer of the real property to the corporation, and receipt of shares of stock in exchange, the individual partner has none of his previous rights in the real property. They have been surrendered in return for his rights to participate as a stockholder in the management of the corporation. An individual shareholder has no property interest in physical assets of the corporation. California v. Tax Comm'n, 55 Wn.2d 155, 346 P.2d 1006 (1959). The corporations are separate organizations, each with its distinctive privileges and liabilities different from those enjoyed by plaintiff and his partners prior to incorporation. State v. Northwest Magnesite Co., 28 Wn.2d 1, 41, 182 P.2d 643 (1947). Thus we fail to find merit in plaintiff's argument that 'the incorporators are no more than taking it out of one pocket and putting it in another.'"
Thus, our task in answering your first question is to determine which rationale is controlling in the case of a partial liquidation such as you have described ‑ theChristensen rationale or that of the DeerPark line of cases. And in approaching this task, we cannot overlook the fact that at least three present members of the supreme court have recently indicated that they would actually overrule theDeerPark line of cases and apply the Christensen rationale instead ‑ even in aDeerPark factual situation. See the dissent of Justice Hale, concurred in by Justices Finley and Rosellini, inWeaver v. King County (the latest of the "complete liquidation" cases above cited) at pp. [[Orig. Op. Page 6]] 187-194. Were this position to be adopted by a majority,2/ there would be no question as to how the court would rule in factual situations such as those presented by your request. Accordingly, while recognizing that the DeerPark line of cases has not yet been overruled, it well may be at least anticipated from the foregoing that the court in future cases will strive to limit their applicability and apply instead theChristensen rationale in those factual situations where a strong rationale can be presented for so doing. Further, in attempting to determine, as we must here, what constitutes "valuable consideration," the split in the court inWeaver warns us that we are dealing with a fundamental problem with respect to which there is far from unanimity on the court.
In attempting to ascertain the conditions under which the court will not apply, even in a corporate liquidation case, the inherent right theory ‑ and will thereby find the presence of "valuable consideration" ‑ we are aided by the following language in theDoric case:
"Unlike theDeer Park case, the instant case contains no agreement by the stockholder to assume any corporate liabilities. Under the facts of the instant case, such an agreement would be necessary for there to be a 'conveyance, grant, . . . or transfer . . . for a valuable consideration' within the meaning of the statutes and resolutions we are considering, because implicit in the term 'valuable' consideration is the principle that it must be bargained for. See Corbin,Contracts, §§ 131, 132 (1950, Supp. 1957)." (Emphasis supplied.) 57 Wn.2d 640, at p. 645.
From this language, it appears that the court regards "bargained for" consideration as asinequanon for taxation in [[Orig. Op. Page 7]] the corporation liquidation area.3/ In attempting to ascertain what is meant by this term, we start with the fact that the court has recognized corporations as separate organizations, with distinctive privileges and liabilities different from those enjoyed by noncorporate owners. Christensen, supra;State v. Northwest Magnesite Co., 28 Wn.2d 1, 182 P.2d 643 (1947). Further, althoughChristensen made no mention of any "bargaining," the case indicates that if "bargained for" consideration be a sinequanon, the court will have no difficulty in finding it in a situation in which there is an exchange of stock for real estate between the shareholder and the corporation, and the parties to the exchange continue in existence.
Focusing on the two specific factual situations presented in your opinion request, it seems clear that there exists in both the "bargained for" consideration whichDoric suggests must be present in a corporate liquidation case in order that there be "valuable" consideration; and this is so for two separate but related reasons. First, in both cases there is of necessity an agreement between the corporation and the distributee‑shareholders that the corporation will distribute a specified number of parcels of real property in return for the shareholders surrendering to the corporation a specified amount of stock. Secondly, this agreement [[Orig. Op. Page 8]] is between the distributee‑shareholders and a corporate management which, as an entity, will continue the active direction of the corporation's affairs after the agreed distribution of realty ‑ in contrast to the passive role of corporate officers and directors upon a complete liquidation. Such management must be presumed to be acting in furtherance of the ongoing operations of the corporation; i.e., it must be presumed to be acting for the benefit of that corporation. Thus, in the case of partial liquidation through prorata distributions, bona fide contraction of corporate operations may be the goal. Likewise in the case of a disproportionate redemption of shares the benefit sought may be a removal of an unwanted ownership interest or otherwise to facilitate the future management of the corporation.
We need not here decide whether such corporate benefits would, in addition to and independently of the stock which is surrendered, constitute "valuable consideration" for purposes of the real estate excise tax. However, the existence of such additional benefits would support the conclusion that in the two factual situations involved in your opinion request, bargaining between the shareholder and the corporation is necessarily present ‑ for the transaction in each case is one in which there is bargained for mutual benefit to both the shareholder and the corporation. Further, such a corporate benefit makes even stronger the contrast with the situation involving a complete liquidation, where the concept of consideration passing to an entity shortly to disappear can have no meaning except in the limited circumstance of an assumption of liabilities noted by the court in Deer Park. State otherwise, the shareholder's right to receive the property from the corporation here does not arise solely by reason of his stock ownership, or his "inherent right" to the real property assets of the corporation upon dissolution of the corporation. Rather, the source of the right is the shareholder's agreement to surrender stock or otherwise accept the distribution of real property.
Based upon the foregoing, we therefore conclude that the Christensen rationale will be controlling in the case of a corporate distribution of real estate pursuant to a partial stock redemption (either on a prorated or disproportionate basis) and, accordingly, we answer you first question in the affirmative.
[[Orig. Op. Page 9]]
Having found the necessary element of "consideration" in order to establish that there is a taxable sale in the transactions above described, we must turn to the question of value of that consideration ‑ for "consideration" serves a dual role. It is not only a necessary element in determining whether there is a "sale" at all, but it also serves as the measure of the tax here in question. See, RCW 28A.45.050, which provides that the measure of the real estate excise tax will be the "selling price" of the property, and RCW 28A.45.030, which in turn defines "selling price" as follows:
"As used in this chapter, the term 'selling price' means the consideration, including money or anything of value, paid or delivered or contracted to be paid or delivered in return for the transfer of the real property or estate or interest in real property, and shall include the amount of any lien, mortgage, contract indebtedness, or other incumbrance, either given to secure the purchase price, or any part thereof, or remaining unpaid on such property at the time of sale."
Under this definition the amount of the "consideration" to be used to measure the tax in the situations here at hand would clearly be the value of the stock surrendered in return for the transfer of the real estate. As we have stated in our answer to your first question, it is the stock that is "bargained for" in exchange for the realty. This, however, leaves open another question which we must here attempt to resolve ‑ how corporate stock is to be valued in these cases, typically involving small, closely held corporations, where there is no readily ascertainable market value to be looked to.
In our judgment, the Christensen case, supra, contains the key to solving this problem. Although the court there said that the "valuable consideration" was "the right to do business in corporation form" (66 Wn.2d at 98), thereby undoubtedly focusing on consideration as a necessary element in the definition of "sale" and not as the measure of the tax, the court also upheld the use of the value of the real property itself [[Orig. Op. Page 10]] as the measure of the tax, and thus, in effect, used this value as determining the value of the consideration. See, 66 Wn.2d at 96. While in so doing it did not discuss the reasons for this approach, we believe that the result made complete sense under the facts of that case and would also in the factual situations we are dealing with here. What the shareholders received in exchange for the realty in the Christensen case was the corporate stock. Presumably, the exchange of stock for realty constituted and arm's length transaction, with equal values being given on each side of the exchange. Under these assumptions, it is completely realistic to assume that the value of the stock was equal to the value of the property received in the exchange.
Moreover, this approach is also that which the federal courts have used to solve similar valuation problems for purposes of the federal income tax in cases where there is an exchange of intangible property for tangible property. See, e.g.,Philadelphia Park Amusement Co. v. United States, 126 F.Supp. 184 (U.S. Court of Claims 1954), in which the intangible property to be valued was a ten year extension on a street railway franchise that had been exchanged for a bridge. The court assumed the transaction to be at arms length, and valued the franchise by simply applying the agreed value of the bridge.
ThePhiladelphia Park approach was also approved and adopted by the United States Supreme Court inUnited States v. Davis, 370 U.S. 65 (1962),supra. In this case a property settlement was executed prior to a divorce, and under the property settlement the taxpayer transferred to his former wife certain stock in return for the wife's release of her inchoate statutory marital rights. In determining "the amount realized" by the husband for purposes of § 1001(b) of the Internal Revenue Code (i.e., the value of the marital rights released by the wife) the court held that the value of these rights should be presumed to be the same as the value of the stock.
We further note that, aside from its use in Christensen, this approach also has somestatutory support in the following language of RCW 28A.45.035:
"The state department of revenue shall further provide by rule for cases where the selling price is not separately stated or is not ascertainable at the time of [[Orig. Op. Page 11]] sale, for the payment of the tax at a time when the selling price is ascertained, in which case suitable security may be required for payment of the tax, and may further provided for the determination of the selling price by an appraisal by the county assessor, based on the full and true market value, which appraisal shall be prima facie evidence of the selling price of the real property." (Emphasis supplied.)
Accordingly, we believe that the approach taken in Christensen of computing the selling price on the basis of the value of the real property received (undiminished by the amount of any lien) is completely sound and should be followed in those cases in which the value of the stock cannot be readily ascertained.4/
We trust the foregoing will be of assistance to you.
Very truly yours,
TIMOTHY R. MALONE
Assistant Attorney General
*** FOOTNOTES ***
1/66 Wn.2d at 97.
2/Of the five justices who composed the majority in Weaver, we note that only two, Justices Hunter and Hamilton, are still members of the court.
3/Accord, cases under the Internal Revenue Code involving the analogous problem of whether a transfer of property involves a taxable distribution under IRC § 1001. See,U.S. v. Davis, 370 U.S. 65, 8 L.Ed. 2d 335, 82 S.Ct. 1190 (1962), and Walz v. Commission, 32 BTA 718 (1935); compareRouse v. Commissioner, 6 TC 908 (1946), affirmed 159 F.2d 706 (5th Cir. 1947). These cases suggest two general problem areas in which the presence or absence of bargaining is decisive; i.e., that of distinguishing between a taxable sale and a mere division of property, and that of distinguishing between such a sale and a gift. The basic issue in the corporate liquidation cases, insofar as our real estate excise tax is concerned, is within the ambit of the first of these two areas; in other words, whether there is a mere division of property among shareholders or, instead, a sale for a "bargained for" valuable consideration.
4/In anticipation of a possible question as to the validity of this approach in a case where the property transferred by a corporation to its shareholders is subject to a mortgage or other lien, we readily acknowledge that the value of the transferor's interest in the property will not equal the value of the stock, the difference between the two values representing the amount of the lien. Nevertheless, in accordance with RCW 28A.45.030, supra, which includes in the definition of "selling price" "the amount of any lien, mortgage, contract indebtedness, or other incumbrance" the amount of the lien must be included in the selling price, and accordingly the selling price may still be determined on the basis of the value of the real property received.