Polly's Properties, LLC v. Department of Taxes , 188 Vt. 157 ( 2010 )

Skoglund, J.

¶ 1. Polly’s Properties, LLC (taxpayer) appeals from a superior court judgment upholding the Department of Taxes’ assessment of a property-transfer tax on two parcels of real property transferred to taxpayer as its start-up capital. Taxpayer contends the trial court erred in concluding that, because the transfers did not occur at the time of, or within ninety days thereafter, the filing of taxpayer’s articles of organization it was not entitled to a transfer-tax exemption under 32 V.S.A. § 9603(24). For the reasons set forth below, we reverse.

¶ 2. On July 6, 2006, taxpayer filed its articles of organization as a limited liability company (LLC) with the Secretary of State. On May 21, 2007, some ten months later, taxpayer’s principal organizers transferred two real estate parcels to the LLC. It is undisputed that the properties represented the LLC’s initial capital. Taxpayer sought a transfer-tax exemption under 32 V.S.A. § 9603(24), which provides an exemption for “[transfers made to a limited liability company at the time of its formation pursuant to which no gain or loss is recognized under the Internal Revenue Code, except where the commissioner finds that a major purpose of such transaction is to avoid the property transfer tax.” The Department of Taxes denied the claimed exemption on the ground that the transfer was not made at the time of the LLC’s “formation” or within the subsequent “ninety-day window” allowed by the Department. The Commissioner of Taxes upheld the Department’s decision and its assessment of taxes, interest, and penalties which totaled, at the time of the ruling, $2,632.37 and $3,311.82 on each parcel respectively.

¶3. Taxpayer appealed the Commissioner’s ruling to the superior court. The court concluded that the LLC was “formed” on July 6, 2006, when its articles of incorporation were filed, and that any qualifying transfer under § 9603(24) technically should have occurred at that time. At the same time, however, the court recognized the “dilemma” created by applying a “literal application of § 9603(24)” since “simultaneity [of formation and filing] would usually be impossible.” Nevertheless, the court concluded that the Commissioner’s “informal ‘practice’ of allowing a 90-day period” for qualifying transfers was within his authority and affirmed the denial of the exemption as outside the ninety-day window. This appeal by taxpayer followed.

¶ 4. The facts here are uncontested. The issue turns entirely on the proper interpretation of the transfer-tax exemption statute, a question of law for which the Commissioner is entitled to some deference so long as his reading “represents a permissible construction of the statute.” Tarrant v. Dep’t of Taxes, 169 Vt. 189, 195, 733 A.2d 733, 738 (1999). The Department’s argument here is relatively simple. The statutes governing LLC’s unambiguously provide that “[o]ne or more persons may organize a limited liability company ... by delivering articles of organization to the office of the secretary of state.” 11 V.S.A. § 3022(a); see also id. § 3022(b) (“Unless a delayed effective date is specified, the existence of a limited liability company begins when the articles of organization are filed.”). The statutes employ the terms “form” and “organize” interchangeably. See, e.g., id. § 3012(a) (“A limited liability company may be organized under this chapter . . . .” (emphasis added)); id. § 3012(b) (“A limited liability company . . . engaging in a business subject to any other provisions of law . . . may be formed or authorized to transact business under this chapter only if permitted by, and subject to all limitations of, the other statute.” (emphasis added)). Therefore, the “formation” of an LLC for purposes of qualifying for the transfer-tax exemption necessarily occurs when it is “organized” by means of filing articles with the Secretary of State. It thus follows that the property transfers at issue here — which occurred some ten months after taxpayer filed its articles — were untimely and ineligible for the tax relief afforded by the statute. Indeed, the Department maintains that this result is compelled by the “clear and unambiguous” language of the statutes.

¶ 5. Like the trial court below, however, the Department acknowledges that neither taxpayer nor any other LLC could literally comply with the plain terms of the statute because property transfers to an LLC must logically follow its organization. To avoid this conundrum, the Department recognizes tax-exempt transfers if they fall within a ninety-day “grace” period following the filing of the articles of organization, relief which was nevertheless unavailable to taxpayer here because its transfer was outside that window. As noted, the trial court found this to be a reasonable reading of the statute in order to avoid the “dilemma” created by applying its “literal” terms.¹

¶ 6. With all due deference, the Department’s reasoning does not withstand scrutiny. “At the time of its formation” either means at the time of “organization” or it means something else. If the so-called plain meaning is logically impossible — as the Department and trial court acknowledge — then we must search for a different meaning. See TD Banknorth, N.A. v. Dep’t of Taxes, 2008 VT 120, ¶ 32, 185 Vt. 45, 967 A.2d 1148 (noting the general “presumption . . . against a statutory construction that would lead to . . . absurd results” (quotation omitted)). This search is what we traditionally refer to as statutory interpretation, and we typically look to a variety of sources for meaning, including the legislative history, purpose, context, and effects. See In re Carroll, 2007 VT 19, ¶ 9, 181 Vt. 383, 925 A.2d 990 (our paramount “objective in construing a statute is to effectuate the Legislature’s intent,” and where “doubts exist” arising from the language itself “[t]he intent should be gathered from a consideration of the whole statute, the subject matter, its effects and consequences, and the reason and spirit of the law” (quotation omitted)).

¶ 7. Without adequately explaining why, the Department has — as noted — fixed on a ninety-day window for tax-exempt property transfers, and the trial court here found nothing objectionable in this rule-of-thumb. It is difficult, however, to discern the statutory principle underlying the Department’s approach. Why ninety days? Why not sixty or 120? In essence, the Department has rewritten the statute to provide for what it deems to be a reasonable timeframe with no reference whatsoever to any underlying legislative purpose or justification.² As noted, the trial court accepted this rewriting as a well-intentioned effort to address the “dilemma” posed by the “literal application of the statute” without confronting the inherent problem posed by the Department’s interpretation or its questionable exercise in legislative redrafting. See In re Agency of Admin., 141 Vt. 68, 76, 444 A.2d 1349, 1352 (1982) (where a statute is inherently ambiguous and “an agency seeks to define it” we must “consult not only the bare statutory language, but . . . seek out the interpretation intended by the statute’s drafters to assure that the statute is being construed, rather than constructed anew”).

¶ 8. In contradistinction to the Department’s approach, taxpayer — supported by a group of eighteen amici curiae tax and business attorneys — attempts to define a timeframe for tax-exempt transfers by reference to the underlying purpose of the statute and general business practice. They note that the basic purpose of the federal tax statutes referenced in § 9603 is to provide for the nonrecognition of gain or loss where the property transfer “is a mere change in form.” Long v. United States, 652 F.2d 675, 679 (6th Cir. 1981). Thus, as one leading tax commentator has explained, “[cjontributions to a partnership or limited liability company as the start-up capital are, generally, nonrecognition events.” 9 Mertens Law of Federal Income Taxation § 35F:5 (2009). The same principle clearly informs § 9603, which provides a state sales-tax exemption for transfers of property to corporations, partnerships, and LLC’s where “no gain or loss is recognized” under the Internal Revenue Code. 32 V.S.A. § 9603(11), (15) & (24).³

¶ 9. While an LLC may become a “legal” entity when its articles of organization are filed, it is apparent that for tax-relief purposes the “formative” event is the initial transfer of capital, or capitalization of the company, which typically occurs at some point in time after the filing of the articles of organization, the execution of an operating agreement, and other steps in the process of getting an LLC up and running. Indeed, as amici here note, federal tax regulations in this area routinely conceptualize the “formation” of a partnership or LLC as a process, not a single event. See Treas. Reg. § 1.721-l(a) (providing that the rule of nonrecognition of gain or loss applies “to a partnership in the process of formation or to a partnership which is already formed and operating”). The Department itself recognizes this reality of business practice, explaining in its Technical Bulletin that the grace period for transfers to corporations, partnerships, and LLC’s “recognizes that some of the acts involved in commencing a business are undertaken sequentially.” Vt. Dep’t of Taxes, Technical Bulletin, TB-39 at 2 (Oct. 5, 2007), available at http:// www.state.vt.us/tax/pdf.word.excel/legal/tb/TB39.pdf.

¶ 10. Support for this understanding of capitalization as a formative event in the life of an LLC may be found in other states that provide similar transfer-tax relief. Indeed, a number of states literally define the formative event as the property transfer itself. Thus, Colorado excludes from the definition of a “sale” for tax purposes “[t]he formation of a limited liability company or partnership by the transfer of assets to the limited liability company or partnership.” Colo. Rev. Stat. § 39-26-102(10)(i) (emphases added). Idaho is similar, providing an exemption from the payment of a sales tax for “[t]he formation of a partnership, joint venture, or limited liability company by the transfer of assets to the partnership, joint venture, or limited liability company.” Idaho Code § 63-3622K(b)(3)(ii) (emphases added). Although inartfully drafted, § 9603(24) appears to have the same essential goal of providing tax relief for such “formative transfers” (to borrow amici’s term).

¶ 11. Contrary to the claims of the Department, nothing in this construction of the statute violates the legislative purpose or imposes an unreasonable administrative burden. Rather, affording transfer-tax relief for the initial capitalization of an LLC regardless of its temporal proximity to the filing of the articles of organization appears to most closely effectuate the statutory purpose. Furthermore, the Department’s understandable desire for a date certain or “bright line” beyond which property transfers would be ineligible for tax relief cannot be allowed to elevate administrative convenience over legislative intent. See Marciano v. Immigration & Naturalization Serv., 450 F.2d 1022, 1029 (8th Cir. 1971) (Eisele, J., dissenting) (observing that “[considerations of administrative convenience” must be “secondary” to the determination and enforcement of legislative intent). Nor has the Department in fact shown that inquiring into the facts of property transfers to ensure that they qualify for the statutory exemption represents an unwieldy or even an unusual activity for the Department.⁴

¶ 12. We conclude, therefore, that the judgment must be reversed and a new judgment entered granting taxpayer’s application for a transfer-tax exemption under 32 V.S.A. § 9603(24).⁵

Reversed and remanded for further proceedings consistent with this opinion.

1 The dissent generally credits the Department’s argument that the statute is unambiguous but also requires a ninety-day grace period for compliance. Neither the Department nor the dissent, however, fully confronts the inherent contradiction in this argument, explicated in the trial court’s finding which we quote in full:

Recognizing the practical (if not regulatory) dilemma which would be created by strict, literal application of § 9603(24), and that even virtual (let alone actual) simultaneity would usually be impossible, the Department had for some time followed an informal practice of allowing a 90-day period after legal formation of an LLC to complete necessary real property transfers, and still claim the exemption. That practice was recently adopted in a more formal manner, in a Technical Bulletin issued October 5, 2007, after the underlying events here, but prior to the Commissioner’s Determination in this case.

2 The Department notes that articles of organization may request a “delayed effective date” of up to ninety days, 11 V.S.A. § 3026(e), but the Department does not condition the ninety-day grace period upon such a request; it applies automatically to all applicants.

3 Section 9603(11), which exempts property transfers to a corporation at the time of its formation, references Internal Revenue Code § 351, which provides that “[n]o gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation.” 26 U.S.C. § 351(a). Section 9603(15), which exempts property transfers to a partnership at the time of its formation, incorporates Internal Revenue Code § 721, which similarly provides that “[n]o gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.” 26 U.S.C. § 721(a). Section 9603(24), which exempts transfers to an LLC at the time of its formation, also applies where “no gain or loss is recognized under the Internal Revenue Code” but references no specific federal statute because LLC’s are treated like partnerships or corporations.

4 In this case, the Department does not dispute taxpayer’s assertion that the transfer of the condominium units was the first transfer of capital assets to taxpayer or that but for the ninety-day rule it would have qualified for the transfer-tax exemption.

5 Our holding renders it unnecessary to address the additional arguments raised by taxpayer and amici.