The Maryland General Assembly recently passed Senate Bill 597 and House Bill 1226, entitled Recordation and Transfer Taxes - Transfer of Controlling Interest – Exemption, which when signed by the Governor will revise the exemptions applicable to the taxation of transfers of controlling interests in Maryland real property entities.
Ed Levin and Jeff Spatz drafted these bills, and they worked with Tom Ballentine of NAIOP to promote this legislation. Ed testified before the House Ways and Means Committee on March 9 and before the Senate Budget and Finance Committee on March 11 about these bills.
This legislation will be useful to landowners and practitioners because the Maryland law involving transfers of controlling interests, §§12 117 and 13-103 of the Tax-Property Article of the Maryland Code (“TP”), was drafted with a wide net, and its exemptions did not reach certain transactions that should not have been subject to the tax. Specifically, Senate Bill 597 and House Bill 1226 will exempt transfers between affiliates that were not intended to trigger the tax but sometimes did. Also, the exemptions for transfers involving only corporations are now equally applicable to limited liability companies.
Background of the Tax on Transfers of Controlling Interests
When real property is bought and sold in Maryland and a deed is recorded, recordation and transfer taxes are imposed. These taxes range from about 1% of the consideration in some counties to 3% in Baltimore City. In order to avoid paying these taxes, in a number of cases instead of buying and selling real property the seller sold the equity interests in the entity that owned the real property. In these transactions, the property-owning entity remained the same, but the buyer became the owner of that entity. Because there was no change in the direct ownership of the property itself, there was no reason to record a deed. Hence, no tax was paid on the transaction.
The General Assembly believed that considerable potential tax revenue was lost when property transfers were effectuated by transfers of the ownership interests of the entities that owned the land. After a number of years in which bills on this subject failed, the legislature enacted Senate Bill 2 as Chapter 3 of the Special Session of 2007, codified as TP §§12 117 and 13-103, which taxed the transfer of a controlling interest (being 80% of the equity interests in an entity) of a real property entity (that is, an entity having real estate that constitutes at least 80% of its value, and the entity has an aggregate value of at least $1 million). Under that law, the taxes are the same as those imposed on the transfer of the real property by deed.
Within 30 days after any transfer of a controlling interest in a real property entity, the real property entity is required to file a report with the State Department of Assessments and Taxation (“SDAT”) and pay the applicable tax, if any is due. Not all transfers are taxable, but reports are required to be filed on a transfer of controlling interest in a real property entity, whether or not a tax is due. Since the law became effective on July 1, 2008, there have been approximately 250 filings of transfers of controlling interests with the SDAT, of which the vast majority were exempt from transfer tax.
Not all transfers of a controlling interest in a real property entity are done for the purpose of moving real property from one person to an unrelated person. Many such transfers occur between affiliates or subsidiaries of a common parent entity when the purpose of the transaction is for inter-company structuring, accounting, or financing reasons – when there is no real change in ownership of the property because the ultimate owner of the real estate is the same both before and after the transfer. Some of these potential transactions do not occur because of the possibility of the imposition of tax, even though the property would remain under the same indirect ownership.
When TP §12-117 was drafted it included in subsections (c) and (d) a number of exemptions from the rule that taxes the transfer of a controlling interest in a real property entity. Unfortunately, the exemptions in the original law were, in some cases, unclear; in other cases they applied on their face to one set of facts but did not apply to comparable facts that should logically also be tax-exempt, and they treated limited liability companies, partnerships, and corporations differently. Additionally, many practitioners were in doubt about whether certain transfers were subject to the statutory exemptions. Senate Bill 597 and House Bill 1226 update TP §12-117(c) to directly address and clarify these situations.
The New Legislation
The new legislation sets forth a straightforward exemption consistently applicable to all owners, irrespective of the type of entity, of real property upon their transfer of a controlling interest therein. Subsection (d) has been deleted and incorporated into the newly amended TP §12 117(c)(3), which provides as follows:
The recordation tax is not imposed on the transfer of a controlling interest in a real property entity to another entity if the ownership interests in the transferee entity are owned, directly or indirectly, by the same persons and in the same proportions as those persons own, directly or indirectly, the transferor entity or the real property entity the controlling interest of which was transferred.
This will enable transfers of the interests in an entity to be tax-free if a person or entity is the immediate or ultimate owner of both the real property entity and the entity that becomes the owner of the transferred interests. Other exemptions in TP §12-117 remain in effect.
If signed by the Governor, the new legislation will become effective on July 1, 2016.