TAXATION ‑- COUNTY ‑- REAL ESTATE EXCISE TAX ‑- APPLICABILITY TO CERTAIN BANK DIVESTITURE TRANSACTIONS
(1) The conveyance by a national bank of certain of its banking premises constitutes a "sale" within the meaning of RCW 28A.45.010 under the following circumstances: (a) the purpose for the conveyance is compliance with a directive from the Comptroller of the Currency pursuant to 12 U.S.C.371d; (b) simultaneously with the conveyance the new owner of the property leases it back to the bank under a lease agreement which allows the bank to repurchase the premises at any time during the term of the lease; and (c) the bank is required, under the same lease agreement, to repurchase the premises in any event upon expiration of the term of the lease.
(2) Under these same circumstances, the agreement for a lease‑back with option to purchase is also a "sale" within the meaning of RCW 28A.45.010.
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April 3, 1975
Honorable Christopher T. Bayley
King County Court House
Seattle, Washington 98104
Cite as: AGO 1975 No. 6
By letter previously acknowledged you have requested our opinion on two questions concerning the applicability of the one percent real estate excise tax provided for in chapter 28A.45 RCW to certain described transactions. We paraphrase your questions as follows:
(1) Does the conveyance by a national bank of certain of its banking premises constitute a "sale" within the meaning of RCW 28A.45.010 under the following circumstances: (a) the purpose for the conveyance is compliance with a directive from the Comptroller of the Currency pursuant to 12 U.S.C. 371d; (b) simultaneously with the conveyance the new owner of the property leases it back to the bank under a lease agreement which allows the bank to repurchase the [[Orig. Op. Page 2]] premises at any time during the term of the lease; and (c) the bank is required, under the same lease agreement, to repurchase the premises in any event upon expiration of the term of the lease?
(2) Under these same circumstances, is the agreement for a lease‑back with option to purchase itself a sale within the meaning of RCW 28A.45.010?
We answer both questions in the affirmative for the reasons set forth in our analysis.
The factual situation you have presented for our consideration is as follows:
In response to a directive from the United States Comptroller of the Currency under 12 U.S.C. 371d, to be quoted below, a particular national bank conveys to an insurance company title to ten parcels of real property which the bank uses in its banking business. The insurance company pays to the bank an amount equal to the fair market value of the property with funds obtained by the insurance company by means of a loan from the bank. Principal and interest on the loan are payable quarterly with the quarterly payments of principal being in amounts equal to the quarterly depreciation that would normally be taken by the bank on the property if still owned by it.
Simultaneously with the conveyance of the property by the bank to the insurance company, the insurance company leases it back to the bank. The lease commences on the date of conveyance of the property from the bank to the insurance company and has a term of approximately ten years. It is a "net lease" in that the bank lessee is required to pay all taxes, assessments and other charges relating to the use and occupancy of the property. The insurance company has no responsibility for maintenance or repairs of the property or for the rebuilding thereof in the event of damage. The bank, under the lease, may use the property for any lawful purpose under the rules of the National Banking Act and must indemnify the insurance company with respect to any liability arising from its ownership and leasing of the properties. The bank pays rent to the insurance company on a quarterly [[Orig. Op. Page 3]] basis with such rent being the sum of (1) an amount equal to the quarterly interest charged by the bank on its loan to the insurance company; and (2) an amount equal to the quarterly depreciation that would normally be taken by the bank on the premises if still owned by it. In addition, the bank pays the insurance company a nonrefundable advance rental payment of $100,000.
The bank may terminate the lease at any time during its term and repurchase the property at a price equal to the unpaid principal portion of the then outstanding loan. During the term of the lease, the bank may also offset the rental payments due to the insurance company against loan payments due from that company. At the end of the term of the lease, the bank is required to repurchase any of the property not yet repurchased for its then depreciated value.
Finally, you have advised us in connection with your request that the federal internal revenue service (IRS) has ruled that the transfer by the bank to the insurance companydoes not constitute a sale for purposes of any of the provisions of the internal revenue code, and that it regards the total transaction, including the conveyance by the bank to the insurance company, the lease‑back by the insurance company to the bank, and the reconveyance by the insurance company to the bank, to be solely a financial arrangement.
We turn next to the applicable law.
RCW 28A.45.050 provides that:
"The county commissioners of any county are authorized by ordinance to levy an excise tax upon sales of real estate not exceeding one percent of the selling price. The rate of the levy shall be determined annually by the commissioners. The proceeds of the tax provided for in this chapter shall be placed in the county school fund and shall be used exclusively for the support of the common schools: Provided, That one percent of the proceeds of the tax provided for herein may be placed in the current expense fund of the county."
[[Orig. Op. Page 4]]
The term "sale" for the purposes of this excise tax ‑ a tax currently being imposed in all counties of our state ‑ is defined in RCW 28A.45.010 as follows:
"As used in this chapter, the term 'sale' shall have its ordinary meaning and shall include any conveyance, . . . or transfer of the ownership of or title to real property, . . . for a valuable consideration, . . . and any lease with an option to purchase real property, . . ."
In considering the applicability of this definition and resulting tax to the factual situation above described, we will discuss both of your two questions together because, as we view it, they raise a single common issue: Is the entire transaction merely a financing device for purposes of the real estate excise tax, as it was determined by the above noted IRS ruling to be for federal income tax purposes? Or, on the other hand, are there two "sales" involved for purposes of the real estate excise tax; i.e., a sale upon the initial conveyance by the bank to the insurance company, and a second sale by reason of the lease with option to purchase?
Thus identified, the issue is but an illustration of the statement made by Bittker and Eustice in their leading text, "Federal Income Taxation of Corporations and Shareholders" (3rd ed. 1971), as follows:
". . . One of the persistent problems of income taxation, as of other branches of the law, is the extent to which legal consequences should turn on the 'substance' of a transaction rather than on its form. . . ." (At 1-19.)
Your question demonstrates that our state's real estate excise laws must surely be included among those "other branches." In answering that question, we begin with the provisions of 12 U.S.C. § 371d, under which the United State Comptroller of the Currency has required the bank to divest itself of the subject property. This federal statute provides that:
[[Orig. Op. Page 5]]
"No national bank, without the approval of the Comptroller of the Currency, and no State member bank, without the approval of the Board of Governors of the Federal Reserve System, shall (1)invest in bank premises, or in the stock, bonds, debentures, or other such obligations of any corporation holding the premises of such bank, or (2) make loans to or upon the security of the stock of any such corporation,if the aggregate of all such investments and loans, together with the amount of any indebtedness incurred by any such corporation which is an affiliate of the bank, as defined in section 221a of this title, will exceed the amount of the capital stock of such bank." (Emphasis supplied.)
In approaching the "substance versus form" problem which is presented by the factual situation involved in your request, we start by analyzing how much "substance" the transaction actually has. Admittedly, full use and possession of the property remains with the bank, and the amounts of the "rental" payments to be made by the bank to the insurance company are identical (except for the $100,000 advance rental) to the amounts to be repaid by the insurance company to the bank on the "loan." Indeed, we would assume that so much of the lease agreement as permits rental payments to be offset against the loan payments will be utilized, with the result that the only "rent" actually being paid by the bank to the insurance company will consist of the $100,000 advance rental, which might be viewed as essentially a handling fee.
Nevertheless, both of the "sales" involved in the total transactiondo have substance in that they serve a substantial business purpose of the bank. The Comptroller of the Currency, under 12 U.S.C. § 371d has required that the property be sold. The obvious importance to the bank of complying with this requirement is shown by the fact that it is willing to invest a direct cost of $100,000 in order to comply. The consequences of noncompliance may be drastic, including forfeiture of the bank's franchise. See, 12 U.S.C. § 501a.
In addition, the transaction has a very practical operative effect in terms of the bank's financial structure. According to information you have supplied to us it was stated in [[Orig. Op. Page 6]] the request by the bank for its IRS ruling that
". . . the consummation of the proposed sale and leaseback will be advantageous to [the bank] by improving [the bank's] ratio of fixed assets to capital funds and total assets [i.e., by reducing that ratio]. Such ratio is limited by the Comptroller of the Currency to provide for liquidity. . . ."1/
Even the most casual observer of the current banking scene must be increasingly aware of the importance of bank liquidity.2/
The concept of an "independent business purpose" as the criterion for determining whether "form" will prevail over "substance" has been developed primarily in the area of federal income taxation. A good illustration of the application of this criterion is found in the leading case ofGregory v. Helvering, 293 U.S. 465, 79 L. ed. [[L.Ed.]]596, 55 S.Ct. 266, 97 A.L.R. 1355 (1935). That case involved the validity, for federal income tax purposes, of a rather complex corporate reorganization. In holding that the reorganization should not be given effect for federal income tax purposes, the court first said:
". . . The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. . . ." (293 U.S. at 469.)
However, the court then went on to say:
". . . Putting aside, then, the question [[Orig. Op. Page 7]] of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find? Simply an operation having no business or corporate purpose‑-a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function.
"When that limited function had been exercised, it immediately was put to death." (293 U.S. 469, 470.)3/
The fact that the federal tax collector in the instant case did not rely on this doctrine is not, we believe, determinative of the question of whether the county tax collector, in imposing the real estate excise tax, can do so. Rather, we are suggesting that if the internal revenue service had ruled otherwise, and held the arrangements between the bank and the insurance company to be what they purported to be (i.e., a sale and a leaseback), this ruling would probably be sustained in court [[Orig. Op. Page 8]] because of the presence of an independent business purpose.
Moreover, the case ofEstep v. King County, 66 Wn.2d 76, 401 P.2d 332 (1965), shows that in the area of our own real estate excise tax, form may prevail over substance even in the absence of any substantial independent business purpose because of our supreme court's reluctance to enter into the same "substance versus form" legal thicket in which the federal courts have become enmeshed. Cf.,National Investors Corp. v. Hoey, supra. InEstep, a corporation held, as a sole asset, a vendee's interest in a contract to purchase real property. Because of potential federal income tax problems, the corporation did not wish to sell this asset outright. Accordingly, the shareholders of the corporation instead sold all of their corporate stock to an individual who then dissolved the corporation and thus acquired the vendee's interest in the real estate contract.
In contending that the real estate excise tax was applicable to this transaction, a contention with which the court disagreed, the county relied upon a doctrine which is a species of the "substance over form" doctrine of federal tax law; i.e., the "step transaction" doctrine, as applied in what the court referred to as the "Kimbell-Diamond" rule. As described by the court in its opinion:
". . . The rule is explained inUnited States v. Mattison, 273 F.2d 13, (9th Cir. 1959), 83 A.L.R. 2d 706, in which the court said:
"'when a taxpayer who is interested primarily in a corporation's assets first purchases the stock and then liquidates the corporation in order to acquire the desired assets, the separate steps taken to accomplish the primary objective will be treated as a single transaction. Thus, even though the objective was accomplished in form by a purchase of stock, the substance of the transaction is a purchase of property.'" (66 Wn.2d 79.)
[[Orig. Op. Page 9]]
The adoption of a similar rule for purposes of the real estate excise tax (i.e., a rule which would treat the transaction as essentially consisting of a sale of the real estate contract by the corporation directly to the corporation's new owner) was essential to the county's case because of the line of cases commencing withDeer Park Etc. v. Stevens County, 46 Wn.2d 852, 286 P.2d 98 (1955), under which transfer of real estate by a corporation to its shareholders in complete dissolution is, absent consideration such as assumption by the shareholders of corporate liabilities, exempt from the excise tax. The court, however, rejected the Kimbell-Diamond rule for the real estate tax, and in thus allowing the "form" of the transaction to prevail over its substance, explained its rationale as follows:
"We do not deem the Kimbell-Diamond rule applicable to an interpretation of the real estate excise tax statutes. . . . Adoption of the rule would write into Washington law a provision not voiced by the legislature and would make suspect every conveyance of real property by a corporate liquidating trustee. It would involve the county and the courts in a search for subjective intents, motives, and purposes every time a transfer of stock is followed by a transfer of real property in corporate dissolution. Any change in the application of the statutes and ordinance must be legislative." (66 Wn.2d 80.)
We should here note two significant points. First, the independent business purpose involved in the factual situation giving rise to your opinion request is certainly more substantial than that involved in theEstep case. Here the purpose is compliance with federal law and a consequent increase in the bank's liquidity. InEstep it was simply avoidance of federal income tax problems. (The Kimbell-Diamond rule is now codified, with precise limitations as to its applicability, in § 334(b)(2) of the Internal Revenue Code. Presumably in theEstep case the transaction was tailored to avoid the effect of this provision.)
Secondly, the factual situation involved in your opinion [[Orig. Op. Page 10]] request illustrates the morass in which administrators and courts could well find themselves in an attempt to determine whether "substance" should prevail over "form" ‑ the very same morass which led the court inEstep to reject "substance" in favor of "form."4/
Thus, we conclude that the real estate excise taxis applicable with respect to the two transactions involved in the instant situation, and our conclusion is essentially based on two grounds: As shown byEstep, our supreme court is much more inclined to follow "form" for purposes of the real estate excise tax than are federal courts for purposes of federal income tax. Secondly, if the touchstone for resolving the issue of "substance versus form" is the existence of an independent business purpose (i.e., a purpose which will give "substance" to the transaction) such an independent business purpose exists in the present factual situation as outlined in your opinion request.
In so concluding, and thereby answering both of your questions in the affirmative, we recognize that both the conclusion reached and the grounds for that conclusion may appear to be in conflict with the recent case of [[Orig. Op. Page 11]] Port of Longview v. Taxpayers, 84 Wn.2d 475, 527 P.2d 263 (1974). In that case, two port districts and a county had entered into certain arrangements with private manufacturing companies for the building and financing of pollution control facilities to be used by those companies. Under these arrangements, the municipalities were to purchase a leasehold interest in the land and the pollution control facilities thereon which were to be owned by the private company with which they were dealing. In turn, the municipalities would sublease the land and facilities back to the private company which would operate them. The municipalities would issue revenue bonds, secured by the rental payments to be made by the private company under the sublease. The proceeds from the bonds were to be used to make lump sum rental payments from the municipalities to the private company. The private company would, in turn, use these lump sum rental payments to pay for the construction of the facilities.
Under § 103(c) of the internal revenue code, the interest on the bonds issued by the municipalities would be exempt from federal income tax, and consequently would be lower than the interest which would have to be paid were the private company to do its own financing. It should also be noted that the internal revenue service had issued a ruling that the whole arrangement was purely a financing device and that accordingly the lump sum rental payments by the municipalities to the private company would not be included in the private company's gross income for federal income tax purposes.
The court held that these arrangements constituted a loan by the municipalities of money to a private company in violation of Article VIII, § 7 of the state constitution.5/
[[Orig. Op. Page 12]]
It further noted that although the form of the arrangement was a lease and sublease, that form should not control and its substance was a loan from the municipalities to the private company. The court also clearly looked with disfavor upon the attempt by the municipalities and the private company to "play it both ways" by obtaining a ruling from the internal revenue service that the arrangement was purely a financing device, and not a true lease and sublease, while contending to the court that for purposes of Article VIII, § 7, the arrangement should be considered a true lease and sublease. See, 84 Wn.2d at 483.
However, we believe that the reasoning in the Port of Longview case should be confined to the basic issue involved; i.e., the constitutionality of the financial arrangements under Article VIII, § 7 of the state constitution. As stated inState ex rel. Beck v. City of York, 164 Neb. 223, 82 N.W.2d 269 (1957), quoted with approval at 84 Wn.2d 486:
"'. . . It is not material what such undertakings may be called, or what forms are devised to conceal their main purpose, or how worthwhile they may appear to be,when the question of constitutionality is presented, their substance will be examined. . . .'" (Emphasis supplied.)
In short, the approach taken by the court in Port of Longview v. Taxpayers would not be applicable with respect to issues arising under the real estate excise tax. Rather, the approach taken inEstep v. King County, supra, would continue to be applied.
Further, if we apply the independent business purpose test to the arrangements in thePort of Longview case, the court's decision, as well as the IRS ruling, are clearly correct. The sole purpose and practical effect of the arrangements were to transfer to the private company the benefits of the lower interest rates enjoyed by the municipalities under § 103(c) of the internal revenue code.
Accordingly, in summary, we answer both of your questions in the affirmative. Both transactions involved are, in our opinion, taxable sales under chapter 28A.45 RCW.6/
[[Orig. Op. Page 13]]
We trust that the above will be of assistance to you.
Very truly yours,
TIMOTHY R. MALONE
Assistant Attorney General
*** FOOTNOTES ***
1/See, also, 12 CFR 250.200(c), in which a ruling of the Federal Reserve Board states that the purpose of 12 U.S.C. 371d is ". . . to safeguard the soundness and liquidity of member banks. . . ."
2/See, e.g., "What Really Went Wrong at Franklin National," Fortune, October 1974, p. 118, and "The Fed's Latest Weapon: Leavittation," Forbes, July 1, 1974, p. 44.
3/See, also, the discussion of Gregory v. Helvering and other related cases by Judge Learned Hand inNational Investors Corp. v. Hoey, 144 F.2d 466, 467-68 (2nd Cir. 1944). As shown in Judge Hand's discussion in that case, the "business purpose" doctrine works both ways; i.e., it can be successfully invoked by the taxpayer and the tax collector alike. Judge Hand's discussion also shows the hazards and frustrations which even so able a judge as he encountered in applying this doctrine.
4/As suggested by the Estep case, any quest for the "substance" of a transaction in determining whether or not the real estate excise tax should apply could well present insurmountable obstacles. Consider, for example, a situation in which a company wishes to use a building with a useful life of thirty years, for the whole period of that useful life. Assume further that the company has a choice of either entering into a thirty-year lease for the building or buying the building on a conditional sales contract with a thirty-year payment period and little if any down payment. Economically, and from the point of view of "substance" the company is in the same identical position whichever choice it makes. The only practical difference is the remedy which would be available to the lessor in the case of the lease, or to the conditional vendor, in the case of the conditional sales contract, in the event of failure to make the required payments. The "substance" of each arrangement is identical; but what is that "substance"? Is it a "sale"? Or is it a "lease"?
5/"No county, city, town or other municipal corporation shall hereafter give any money, or property, or loan its money, or credit to or in aid of any individual, association, company or corporation, except for the necessary support of the poor and infirm, or become directly or indirectly the owner of any stock in or bonds of any association, company or corporation."
6/We do not here touch upon the question of the application of RCW 28A.45.035 and department of revenue rules promulgated thereunder, because we understand that the county and the bank have in this case agreed as to the amount of tax to be paid and the proper time of payment should the subject transactions be deemed to be taxable. RCW 28A.45.035 provides that:
"The state department of revenue shall provide by rule for the determination of the selling price in the case of leases with option to purchase, and shall further provide that the tax shall not be payable, where inequity will otherwise result, until and unless the option is exercised and accepted. . . ."