Tax Section Comments Concerning Proposed Realty Transfer Tax Regulations

November 13, 2000

Douglas A. Berguson, Esq.
Senior Assistant Counsel
Department of Revenue
Office of Chief Counsel
1133 Strawberry Square
Harrisburg, PA 17128-1100

Re: Comments and Suggestions Concerning Notice of Proposed Rulemaking, Department of Revenue, 61 Pa. Code, Chapter 91, Realty Transfer Tax ("RTT"), Realty Transfer Tax Amendments
(the "Proposed Regulations")

Dear Mr. Berguson:

The Tax Section of the Philadelphia Bar Association respectfully submits the following comments and suggestions regarding the Proposed Regulations.

1. Section 91.132 - Bona Fide Sale Transactions - Value
The Proposed Regulations provide:

"[i]n a bona fide sale of realty, the value of the realty is the total consideration for the sale which is paid or to be paid. This value includes consideration paid by an assignee of a sales agreement to the assignor thereof and liens existing before the transfer and not removed thereby -- whether or not the underlying indebtedness is assumed -- or a commensurate part of the liens, if they also encumber other realty." (emphasis added.)

The new language (in italics) is contrary to Allebach v. Commonwealth of Pennsylvania , 546 Pa. 146, 683 A.2d 625 (1996). In Allebach, Owners of realty entered into an agreement of sale with Ward to sell the realty for what ultimately was $657,828 ("Ward Agreement"). Ward assigned his rights under the Ward Agreement to Besa for $1,643,000 (the "Besa Agreement"). Besa assigned its rights under the Besa Agreement to Trappe Meadow Associates who reassigned the rights back to Besa for $3,200,000, a portion of which was to be paid to Ward. Besa then assigned the rights to Trapp Meadow, Inc.

Ultimately, Trapp Meadow, Inc. paid $3,200,000 of which $657,828 was paid to Owners. The Department contended that the RTT base was $3,200,000, not $657,828. The Pennsylvania Supreme Court held that the proper base for the RTT was the amount paid to the Owners ($657,828) because the statutory definition of value does not "include executory agreements which fail to provide for the construction of any structure." See 683 A.2d at 628. The Court went on to state, "[e]xpanding this definition so that it would include executory agreements . . . would be a flagrant violation of the General Assembly's dictate that we strictly continue taxing statutes." Id at A.2d pp. 628-629.

As a second ground for its holding, the Court noted that, under the statute, only an executory agreement to which the grantor is a party may be taken into account in determining the value of real estate. Since Owners were not a party to the agreement between Ward and Besa, or the later agreement between Ward and Trapp Meadow, Inc., these later executory agreements could not be taken into account in determining value. The Court described the Department's argument that Owners were in some sort of "de facto joint venture" as "baffling."

Aside from the plain meaning of the statute, it is totally inappropriate to make the grantor of real estate liable for a transfer tax based on consideration which the grantor has no right to receive. In the Allebach case, the Department's position would have meant that Owners were jointly and severally liable for a transfer tax based on a value of $3,200,000, notwithstanding the fact that they were only entitled to receive $657,828 from the sale.

The law is clear; the term "value" does not include consideration for an executory agreement unless both (i) the agreement involves construction and (ii) the grantor (or an agent, principal or related party) is a party to the agreement. In our view, the proposed amendment to the definition of value would be invalid because it is inconsistent with the language of the transfer tax statute, as interpreted by the Pennsylvania Supreme Court. As a result, the new language should be deleted.

 2. Section 91.137 - Construction Contracts (and definition of "Grantor's Affiliate" in Section 91.131)

    Example 3 in Section 91.137 of the Proposed Regulations provides that a construction company's option to purchase an unimproved lot "gives Construction Company an equitable interest in the lot." The example then reaches the conclusion that when the construction company becomes contractually obligated to make contracted-for improvements that were binding prior to and which continued after the transfer of the lot from the developer to an unrelated person, the tax applies because the construction company is the equitable owner of the lot. An option does not give its holder an equitable ownership interest in realty. No burdens or benefits of ownership are transferred to the holder of the option. As a result, this example should be deleted.

    Under 72 P.S. § 8101-C ("Value")(4), the relationships that trigger inclusion of the construction contract in value are "agent or principal of the grantor or a related corporation, association, or partnership." In Examples 4 and 5 the Department apparently takes the position that where the developer agrees that a particular contractor is the exclusive contractor for a project, that arrangement itself makes the contractor an "affiliate" of the developer. Apparently, these Examples conclude that the developer and contractor are related notwithstanding that they are independent, unrelated parties. This concept is not supported by the law. As a result, the following sentence should be added to Examples 4 and 5: "Construction Company and grantor are related because Construction Company is grantor's agent."

    In Examples 7 and 8, builder C is a "grantor's affiliate" because the developer/grantor owns a "minimal interest" in builder C. If builder C is a publicly traded corporation and developer owns one share of stock in builder C, this should not be a sufficient interest for builder to be a "grantor's affiliate." A more significant standard than a "minimal interest," perhaps a majority ownership interest, should be substituted. Doing so would be consistent with the "owned or controlled" language contained in the definition of "Grantor's affiliate." Accordingly, we recommend that the words "minimal interest" in these two examples be changed to "controlling interest" which should be defined as more than 50 percent of the entity.

     3. Trusts

    In 1997 the RTT statute was amended by Act 7 to add or revise definitions relating to trusts. The intent of these amendments was to prevent taxpayers from using trusts to effect tax-free transfers of real estate to unrelated parties. Unfortunately, due to the restrictive definitions of "living trust" and "ordinary trust" contained in the 1997 amendments, it is at least arguable that transfers of real estate to "garden variety" trusts commonly used in normal estate and family wealth planning may now be taxable. We have been assured by the drafter of the 1997 amendments and by others that there was no intention to interfere with normal estate planning techniques. We believe it is critical that regulations be issued to clarify the intent of the 1997 amendments, and to give the citizens of Pennsylvania comfort that they will not incur RTT upon the transfer of real estate to the type of trusts normally used for estate and family wealth planning purposes. This letter offers suggestions to accommodate nonabusive techniques that generally are used by planners.

    In general, the statute and the regulations separate trusts intended for estate planning into two separate categories: "living trusts" and "ordinary trusts" each of which is discussed below.

    a. Section 91.101 - "Living Trust" Definition
    Under the statute, a living trust ("LT") is defined as:

    [a]ny trust, other than a business trust, intended as a will substitute by the settlor which becomes effective during the lifetime of the settlor, but from which trust distributions cannot be made to any beneficiaries other than the settlor prior to the death of the settlor. 72 P.S. § 8101-C ("Living Trust").

    The statutory restriction that distributions from the trust can be made only to the settlor is a significant constraint on the utility of a LT for estate planning purposes. In recognition of this issue, the draft Proposed Regulations permit distributions to be made to or on behalf of the settlor or his spouse. See Section 91.101 ("Living Trust") of the Proposed Regulations. We believe that the definition of LT should be the statutory definition. We recognize that the Department, through an expansion of this definition, is accommodating provisions found in a typical LT. We believe that this solution should be included in Section 91.156 as opposed to the definition of LT. See 3.b. below.

    b. Section 91.156(b) - Living Trusts –- Exclusions

    First, we have organizational comments. Sections 91.156(a)(4) and (a)(5) of the Proposed Regulations each relate to LTs and should be part of Section 91.156(b) of the Proposed Regulations. Additionally, Section 91.156(b)(3) relates to a testamentary trust, not a LT. As a result, Section 91.156(b)(3) of the Proposed Regulations should be moved to the general rules applicable to trusts found in Section 91.156(a) of the Proposed Regulations.

    Second, we believe that what currently is Section 91.156(a)(4) should be expanded to encompass the intent and purpose of the statute as it is intended to apply to estate planning trusts. Such a provision would allow distributions from a LT for the behalf of and for the benefit of a settlor who wants to pay, for example, for his children's or grandchildren's education expenses. One could argue that such a provision is unnecessary because the trust instrument simply could provide that the settlor could demand a distribution to himself for such a purpose and the trust would qualify as a LT. However, as written, the Proposed Regulations present a trap for the unwary and unduly limit distributions to circumstances in which the settlor is incapacitated. Adopting our suggestion avoids this trap.

    Third, we believe what currently is Section 91.156(b)(2) of the draft Proposed Regulations should be revised to delete the references to "devise" and "bequeath." These terms relate to testamentary transfers1 and as such are not relevant to a discussion of transfers from a revocable trust.

    Last, we believe that what currently is Section 91.156(a)(5) of the Proposed Regulations should be revised to clarify that a joint LT must satisfy, with respect to the husband and wife establishing it, the requirements set forth in Section 91.156(b). We are concerned that the current language of 91.156(a)(5) could be confused to mean that a joint LT is subject to more restrictive requirements than an ordinary living trust, i.e., that Section 91.156(a)(4) as proposed or as revised pursuant to our suggestion, is inapplicable to a joint LT.

    After the suggestions set forth above have been applied to the current draft Proposed Regulations, the provisions would read as follows:

    Section 91.156. Trusts.

    (a) General.

    (1) A transfer for no or nominal actual consideration to a trustee of a living trust from the settlor of the living trust is exempt from tax.

    (2) A transfer for no or nominal actual consideration from the trustee of a living trust after the death of the settlor of the trust to a beneficiary named or identified as a member of a class of beneficiaries in the trust instrument is exempt from tax.

    (3) A transfer for no or nominal actual consideration from the trustee of a living trust to the settlor of the living trust is exempt from tax.

    (4) A living trust may include a provision permitting a trustee to make a distribution to someone other than the settlor during the lifetime of the settlor provided that the distribution is on behalf of or for the benefit of the settlor. A distribution will be deemed to be made on behalf of or for the benefit of the settlor if the distribution is (a) made at the direction of the settlor or his spouse or (b) made to any person on behalf of the settlor if the settlor is incapacitated.

    (5) Any transfer of realty by the trustee of a living trust during the lifetime of the settlor of the trust shall be treated as if the transfer was made directly from the settlor to the grantee.

    (6) A husband and wife may establish a "joint living trust" and qualify to claim any applicable exemptions as long as such joint living trust otherwise satisfies the requirements of this Section 91.156(b) with respect to the husband and/or wife.

    c. Section 91.101 - "Ordinary Trust" Definition
    An ordinary trust ("OT") is

    [a]ny trust, other than a business or living trust, which takes effect during the lifetime of the settlor and for which the trustees of the trust take title to property primarily for the purpose of protecting, managing or conserving it until distribution to the named beneficiaries of the trust. An ordinary trust does not include a trust that has an objective to carry on business and divide gains, nor does it either expressly or impliedly have any of the following features: the treatment of beneficiaries as associates, the treatment of the interests in the trust as personal property, the free transferability of beneficial interests in the trust, centralized management by the trustee or the beneficiaries, or continuity of life. See § 8101-C "Ordinary Trust."

    Section 91.101 ("Ordinary Trust")(ii)(A)-(E) of the Proposed Regulations sets forth the interpretation of the second sentence of the above definition. We believe that certain revisions should be made to these provisions.

    By way of background, it should be noted that the statutory limitations found in the second sentence of the definition of OT were derived from the old "four factor test" found in the old Treasury Regulations promulgated under Section 7701 of the Internal Revenue Code. Prior to 1997, the four factor test was used to determine whether a noncorporate entity (such as a partnership or business trust) should be treated for federal income tax purposes as a corporation or a partnership. Under the old four factor test a noncorporate business entity was treated as a partnership, and not as a corporation, unless it possessed at least three of the following four corporate characteristics: centralized management, unlimited life, limited liability, and free transferability. The old four factor test NEVER was intended to be applied to determine whether an entity formed as a trust was an ordinary trust or a business trust. The four factor test never was applied to a trust unless it was first determined, under entirely separate rules, that the trust was a business trust, rather than an ordinary trust.

    The four factor test was entirely supplanted by the check the box rules effective January 1, 1997. See Treas. Regs. § 301.7701-1 through 3. Ironically, soon after the United States Treasury eliminated these antiquated regulatory rules, Pennsylvania adopted them for a purpose for which they were never intended.

    The Federal Treasury Regulations do contain useful guidance for distinguishing between ordinary and business trusts. The term "ordinary trust" is defined in the Treasury Regulations as follows:

    an arrangement created either by will or by an intervivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Treas. Reg. §301.7701-4(a).

    The Treasury Regulations also contrast an ordinary trust with a "business trust":

    There are other arrangements which are known as trusts because the legal title to property is conveyed to trustees for the benefit of the beneficiaries, but which are not classified as trusts for purposes of the Internal Revenue Code because they are not simply arrangements to protect or conserve the property for beneficiaries. These trusts, which are often known as business or commercial trusts, generally are created by the beneficiaries simply as a device to carry on a profit-making business which normally would have been carried on through business organizations that are classified as corporations or partnerships under the Internal Revenue Code. Treas. Reg. § 301.7701-4(b).

    Paragraph (C) of the referenced section of the Proposed Regulations – an OT cannot "allow the beneficiaries to manage the trust along with or in conjunction with the trustee" should be revised to reflect realities in estate planning. At times beneficiaries are given certain powers. If a beneficiary has unlimited power to manage the trust in his or her capacity as a beneficiary, we believe that the centralized management concern of the statute would be triggered. As a result, we would suggest that (C) be revised to state:

    permit a beneficiary who is not a trustee to be actively involved in the management of the trust with the trustees; however, permitting a beneficiary to remove or replace a trustee or trustees or require the trustee to dispose of assets to increase the yield will not be deemed to be active involvement in the management of the trust.

    Requirement (D) of the referenced section of the Proposed Regulations – that an OT cannot have "continuity of life as would a corporation or association" should be defined.

    The general understanding of the term "continuity of life" in the context of the four factor test was if the death, insanity, bankruptcy, retirement, resignation or expulsion of an owner did not cause dissolution of the entity, the entity was more like a corporation than a partnership. Trusts do not terminate upon the happening of these events vis a vis a trustee or, in general, a beneficiary. Since we believe that the definition of OT was not intended to exclude all trusts, we believe that this language must mean something other than what it meant under the four factor test. Moreover, the very point of the four factor test was to distinguish between corporations and entities that are associations under the RTT law. Therefore, under the four factor test, continuity of life for a corporation is contrasted with what happens in an association. As a result, the phrase "continuity of life as would a corporation or association" has no meaning. Further, in Private Letter Ruling 9108025, the IRS noted that:

    . . . since centralization of management, continuity of life, free transferability of interest, and limited liability are generally common to trusts and corporations, the determination of whether a trust that has such characteristics is to be treated for tax purposes as a trust or as an association depends on whether there are associates and an objective to carry on business and divide the gains therefrom. On the other hand, since associates and an objective to carry on a business and divide the gains therefrom are generally common to both partnerships and corporations, the determination of whether an organization that has such characteristics is to be treated for tax purposes as a partnership or corporation depends on whether there exists centralization of management, continuity of life, free transferability of interests and limited liability.

    Based on the foregoing, we suggest that the Proposed Regulations delete (D) and insert in its place -

    "(D) continuity of life, which means that the trust violates the common law rule against perpetuities."

    We recognize that through the Proposed Regulations, the Department is attempting to provide clear rules to enable Pennsylvanians to engage in ordinary estate planning while at the same time limiting the abuses possible before Act 7. We would recommend that the Proposed Regulations include a rebuttable presumption that a trust created by an individual for the primary benefit of persons other than Nonexempt Beneficiaries (as defined in the Proposed Regulations) is an OT. This presumption could be rebutted if the trust is not an arrangement to conserve the trust property for the beneficiaries but actually is an arrangement to carry on a trade or business. Conversely, a trust created by a corporation or association would be rebuttably presumed not to be an OT. Such presumptions would facilitate estate planning and at the same time prevent business entities such as corporations, partnerships, etc. from abusing an OT.

    Subsection (E) of the referenced section of the Proposed Regulations includes one more requirement than the above statutory list – an OT can not "limit the liability for the debts of the trust or the actions of the trustee or beneficiaries to trust property." See Proposed Regulations Section 91.101 ("Ordinary Trust")(ii)(E). This additional requirement would preclude any trust from qualifying as an OT because every trust limits the liability for the debts of trust to trust property. As a result, because this requirement is not part of the statute and would disqualify every trust from qualifying as an OT, it should be deleted.

    Subsection (E) from Section 91.101 "Ordinary Trust" should be deleted and a Section (iii) as follows should be added:

    (iii) Any trust, other than a business trust or living trust, established by an individual during his or her lifetime for the benefit of persons other than Non Exempt Beneficiaries shall be presumed to be an ordinary trust unless the trust is an arrangement to carry on a trade or business and any trust established by a corporation or association shall be presumed to be other than any ordinary trust. In determining whether a trust is an arrangement to carry on a trade or business, the Department will consider (ii) above and to rebut the presumption that a trust is not an ordinary trust, an association or corporation also may rely on (ii) above.

    d.Section 91.156(c) – Ordinary Trusts – Exclusions

    72 P.S. § 8102-C.3(8), as revised by Act 7, provides that RTT is not imposed on a transfer of realty to an OT if it is:

    [a] transfer for no or nominal actual consideration to a trustee of an ordinary trust where the transfer of the same property would be exempt if the transfer was made directly from the grantor to all of the possible beneficiaries that are entitled to receive the property or proceeds from the sale of the property under the trust, whether or not such beneficiaries are contingent or specifically named.

    Section 8102-C.3.(9), as revised by Act 7, provides that RTT is not imposed on a transfer of realty from an OT if it is:

    [a] transfer for no or nominal actual consideration from a trustee of an ordinary trust to a specifically named beneficiary that is entitled to receive the property under the recorded trust instrument or to a contingent beneficiary where the transfer of the same property would be exempt if the transfer was made by the grantor of the property into the trust to that beneficiary . . . (emphasis added)

    Notwithstanding the language of the statute, we understand that the drafters of Act 7 intended that a transfer to an OT that had a contingent Nonexempt Beneficiary would be a taxable transfer and a transfer from such a trust to any beneficiary named in the original trust instrument would be an excluded transfer.

    Therefore, we suggest that Section 91.156(c)(1) of the Proposed Regulations should be revised to provide as follows:

    [a] transfer to an ordinary trust is fully taxable, except if the transfer of the realty is made for no or nominal actual consideration and would be wholly exempt if the transfer were made directly from the grantor to the noncontingent beneficiaries that are entitled to receive the realty or proceeds from the sale or the realty under the trust.

    Example: G transfers realty to an ordinary trust without consideration for the use of B, G's spouse for life. Under the trust, the remainder interest is vested in G's church. Since G's church, a noncontingent Nonexempt beneficiary, definitely will receive the realty, the transfer to the trust is fully taxable. The ultimate transfer to G's church is not taxable. See Section 91.156(c)(7).

    Example: G transfers realty to an ordinary trust without consideration for the use of G's child and his child's lineal descendants. Under the trust, if his child dies without lineal descendants, the realty will be distributed to G's church. Since at the time the trust is organized, G's church is a contingent beneficiary and it is unclear whether G's church ever will receive the realty, the transfer to the trust is excluded. If the realty is distributed to G's church because G's child died without lineal descendants, such distribution is taxable. See Section 91.156(c)(7). However, if the realty is transferred to G's child's lineal descendants, no tax is imposed. See Section 91.156(c)(7)

    4. Section 91.160 – Exchange of interest in real estate

    We are concerned that the term "three-party exchange" in Proposed Regulation Section 91.160 could be confusing. We suggest that Proposed Regulation
    Section 91.160(b) be revised to read as follows:

    (b) If realty involved in an exchange of realty between two parties is, as part of the exchange, purchased from or sold to an unrelated person in a bona fide sale at arm's length, the tax on such realty shall be based on the amount of actual consideration paid by or to the third party, including liens or encumbrances not removed in such sale.

    Example: X agrees with a qualified intermediary ("QI") to exchange unencumbered realty owned by X (the "relinquished property") for other realty (the "replacement property") to be identified by X in the future. As part of the exchange agreement with QI, X assigns to QI the right to sell the relinquished property to an unrelated third party, Buyer, for $10,000. On date 1, QI directs X to transfer title to the relinquished property to Buyer, and Buyer pays $10,000 to QI. Transfer tax on the sale of the relinquished property is based on the $10,000 sales price paid by Buyer. Assume further that following date 1, X negotiates an agreement to buy certain replacement property from Seller, who is not related to X, for $15,000. X assigns the agreement to buy the replacement property to QI. On date 2, X gives $5,000 to QI, and the QI pays $15,000 to Seller to purchase the replacement property and directs Seller to transfer title to the replacement property directly to X. Transfer tax on the purchase of the replacement property is based on the $15,000 sales price paid to Seller.

    5. Section 91.170 – Transfers involving Associations

    We commend the Department's efforts to add clarity and flexibility in this area. However, we have some overarching comments.

    a. Business Continuity – Sections 91.170(c)-(e)

    In Sections 91.170(c) (confirmatory deed evidencing a name change), 91.170(d) (confirmatory deed evidencing a change in legal status), 91.170(e) (confirmatory deed evidencing a change in domicile), and 91.170(f) (confirmatory deed evidencing an addition or withdrawal of a member) of the Proposed Regulations, exemptions are provided for confirmatory deeds recorded by an association only if the association continues in the same business that it did prior to the change in name, legal status, domicile, or membership, respectively. Continuity in the same business is not a statutory requirement for the exclusion of a confirmatory deed. See 72 P.S. § 8102-C.3(4).

    The purpose of the confirmatory deed exclusion is to avoid imposition of RTT where there is no direct or indirect transfer of realty. None of these instances amount to a transfer of realty or an indirect transfer of realty unless the acquired real estate company rules are triggered. As a result, the continuity of business requirement is contrary to the intent of the statute.

    The problem presented by this provision of the Proposed Regulations can be illustrated with an example. Assume a partnership that is owned by A, B, and C, the name of which is ABC Widget Company, manufactures widgets in a plant it owns in Pennsylvania. Assume further that ABC Widget Company decides to exit the widget manufacturing business and become an internet consultant. ABC Widget Company changes its name to ABC Dot Com Consulting, rents office space, decides to keep its plant as an investment property, and leases its plant to an unrelated manufacturing company. Nothing has happened that results in any change in the ownership of ABC Dot Com Company or the realty. As a result, no RTT should be imposed. Similarly, in the event of a change in legal status or domicile there is no change in the ownership of the association or the realty.

    If there is a change in the ownership of an association, the acquired real estate company rules found in 72 P.S. § 8102-C.5 govern when such a change is a taxable event. If the association is not a real estate company, a change in its ownership does not result in imposition of RTT. In contrast, if the association is a real estate company, RTT is imposed only if, during a three year period, 90 percent or more of its ownership interests change without affecting the continuity of the association. Moreover, the acquired real estate company rules do not include a business continuity requirement. Section 91.170(f) exempts a confirmatory deed evidencing an ownership change of an association only if the association continues in the same business notwithstanding that the acquired real estate company rules do not include such a requirement.

    Based on the foregoing the business continuity requirement of Proposed Regulations Section 91.170(c)-(f) should be deleted. The issues raised by the Proposed Regulations are eliminated if Sections 91.170(c), (d), (e), and (f) read as follows:

    (c) A deed executed for the sole purpose of confirming a change in the name of the association is a confirmatory deed and is not subject to tax provided that no new entity is created.

    (d) A deed executed for the sole purpose of confirming the change of legal status of an existing association to another form of association is not subject to tax provided that no new entity is created.

    Example: D, E and F are partners in XYZ General Partnership. They wish to convert their general partnership into a limited partnership by filing a certificate of limited partnership with the Department of State to reflect the change from general to limited partnership status; the addition of X as a 1% general partner; and the recharacterization of the general partnership interests of D, E and F, as limited partnership interests. A deed from D, E and F t/a General Partnership, grantor, to D, E F and X t/a Limited Partnership, grantee, is not subject to tax. Similarly, if title to partnership real estate was held in the name of XYZ General Partnership, a deed from XYZ General Partnership, grantor, to the XYZ Limited Partnership, grantee, is not subject to tax.

    (e) A deed executed for the sole purpose of confirming the change in the domicile or in the law governing the association is not subject to tax provided that no new entity is created.

    (f) A deed executed for the sole purpose of confirming the addition or the withdrawal of a member or partner is not subject to tax.

    In connection with the foregoing, we believe that it is necessary to clarify what it means by the phrase "no new entity is created." We are not sure what was intended by the proposed regulations. For example, an existing general partnership could be converted into a limited partnership using any of the following methods:

    (i) The partners could file a certificate of limited partnership for the existing partnership;
    (ii) State law may provide that one type of entity may "convert" into any other type of entity by filing a document with the Secretary of State. State law may or may not provide that the converted entity is deemed for all purposes to be a continuation of the original entity, and that no transfer of assets is deemed to occur;
    (iii) The partners may form a new, shell limited partnership and merge the old general partnership with and into the new limited partnership under the state merger statute; or
    (iv) The partners may form a new, shell limited partnership and contribute 100 percent of the interests in the old partnership to the new partnership in exchange for general and limited partnership interests in the new limited partnership.

    All of the these methods of "converting" a general partnership into a limited partnership will achieve the identical end result. We believe the better position is that the method by which a general partnership is converted into a limited partnership should not affect the treatment of the transaction for RTT purposes. Thus, we recommend that the Proposed Regulations contain a provision such as the following:

    Section 91.170(g). For purposes of determining whether a new entity has been created in connection with a name change, conversion, change in domicile or other change of an existing association, the creation of a new entity shall be disregarded if (i) such new entity was created for the sole purpose of effecting such name change, conversion, change in domicile or other change, (ii) such new entity did not have any assets or conduct any activities prior to the time it succeeded to the assets and liabilities of the existing association and (iii) the existing association ceases to exist at such time as the new entity succeeds to the assets and activities of the existing association.

    If the Department feels it must take a form over substance approach, and distinguish between different methods of effecting a conversion of an association to a different type of association, this should at least be clarified. While we do not favor this more formalistic approach, we suggest that language such as the following could be used:

    Section 91.170(g). A grantee is a new entity for purposes of Sections 91-170(c), (d) or (e) if the law governing the name change, conversion, change in domicile, or other change provides that the grantor is a different entity than the grantee. 

    6. Section 91.193(b)(12) Merger Exclusion

    72 P.S. § 8102-C.3(12) provides that RTT is not imposed upon

    [a] transfer made pursuant to the statutory merger or consolidation of a corporation . . . except where the department reasonably determines that the primary intent for such merger, consolidation . . . is avoidance of [RTT].

    a. Corporations

    The statute excludes from RTT a transfer by a corporation of realty by operation of law as a result of a statutory merger. The Proposed Regulations alter the statutory language of the merger exclusion by limiting the exclusion to a statutory merger or consolidation of two or more corporations. See Proposed Regulations 91.193(b)(12). The Proposed Regulations are too narrow and should reflect the statutory language. Moreover, this provision is inconsistent with the merger exclusion as applied by the same section of the Proposed Regulations to a limited liability company ("LLC").

    b. LLC Merges With General Partnership, Limited Partnership or Limited Liability Partnership

    Pursuant to 15 Pa.C.S.A. § 8997 and as properly reflected in the Proposed Regulations at Section 91.101 ("Corporation"), an LLC is treated as a corporation for RTT purposes. For RTT purposes, the term corporation also includes, inter alia, a business trust. In contrast, partnerships (limited, general, or limited liability), restricted professional companies, and joint ventures are associations.

    If the merger exclusion applies only to the statutory merger or consolidation of two or more corporations, it is entirely inconsistent to permit an LLC to merge with a partnership RTT free but to treat a merger of a business trust or a corporation with a partnership as a taxable transaction. If, instead the merger exclusion applies to the statutory merger or consolidation of a corporation (as defined in the statute), an LLC could merge with a partnership RTT free. Likewise, a corporation or a business trust could merge with a partnership RTT free.

    As a result, we suggest that Section 91.193(b)(12) of the Proposed Regulations read as follows:

    "A transfer under the statutory merger or consolidation of a corporation or statutory division of nonprofit corporations if . . ."

    Alternatively, we believe that there is no authority to single out LLCs for different treatment than other entities that are corporations for RTT purposes.

    7. Section 91.193(b)(20) - Exclusions Applicable to Transfers of Interests in Real Estate Companies.

    We believe that the Department should clarify that the statutory exemptions and exclusions that apply to direct transfers of realty also should apply to transfers of interests in a real estate company. Examples include:

    (i) a transfer of 90 percent or more of the interests in a real estate company between family members listed in Regulations Section 91.193(b)(6);
    (ii) a distribution by a parent entity of 90 percent of or more of the interests in a real estate company to an owner or owners of the parent entity who owned its or their interest in the parent entity for two or more years; and
    (iii) a transfer, for no or nominal actual consideration, between principal and agent of interests in a real estate company.
    We would suggest that Proposed Regulations Section 91.193(b)(20) be deleted and a new Section 91.193(c) be added as follows:

    A transfer of ownership interests in a family farm corporation, family farm partnership or real estate company will not be treated as a transfer for purposes of the acquired real estate company rules found in 72 P.S. § 8102-C.5 and Regulations Section 91.202 if an exemption or exclusion under Sections 91.192 or 91.193 would apply if, instead of transferring interests in the family farm corporation, family farm partnership, or real estate company, the transferor transferred realty to the transferee.

    8. Mergers of Real Estate Companies

    The Proposed Regulations should make clear that, unless the primary intent for the statutory merger or consolidation of a corporation, including one that is a real estate company, is avoidance of RTT, such a merger is not subject to RTT. A real estate company becomes an acquired real estate company only if the transaction resulting in an ownership change does not affect the continuity of the company. See 72 P.S. § 8102 - C.5(a)(1). In a merger, "[t]he separate existence of all parties to the merger shall cease, except that of the surviving corporation . . . " See 15 Pa.C.S.A. § 1929(a). Since, in a merger, the merging corporation (the corporation that transfers its property to the surviving corporation) ceases to exist, the merger affects the continuity of the merging corporation. Consequently, pursuant to 72 P.S. § 8102-C.5(c)(1), the merging company cannot become an acquired real estate company.

    As a result, the first clause of Section 91.193(b)(12) should read as follows:

    "A transfer under the statutory merger or consolidation of a corporation (regardless of whether it meets the definition of a real estate company as provided in Section 91.201) . . . "

    9. Financing Transactions - Special Purpose Entities

    We are aware that the Department has issued favorable RTT rulings to taxpayers engaged in financing transactions where the lender requires the taxpayer to transfer realty to a special purpose entity ("SPE"). We believe that a safe harbor should be added to Section 91.193(b)(23) for these transactions as follows:

    Section 91.193(b)(23)(i):

    If (i) at the request of a lender, Borrower transfers realty that it owns to special purpose entity ("SPE"), (ii) the SPE is designed to hold the realty while debt is outstanding, and (iii) the SPE will reconvey the realty to the borrower when the debt is repaid, the transaction will be treated as a financing transaction and realty transfer tax will not be imposed upon Borrower's transfer of the realty to the SPE or the SPE's transfer of the realty back to Borrower. For purposes of this Section 91.193(b)(23), an SPE as an association or corporation used to own realty that is or is to be financed.

    Finally, we believe that amending the RTT statute would eliminate many of the issues and the complexity raised by the RTT statutes, including those that the Proposed Regulations address. We would be happy to work with the Department to draft language to amend the RTT statute to facilitate reforms the Department included in the Proposed Regulations and to accomplish the goals set forth in this letter, all while preventing abuses.

    Within one week, we will forward to you a markup (both clean and blacklined) of the Proposed Regulations with the changes suggested in this letter. Should you have any questions or comments, please contact the principal drafters of these comments:

    Julia B. Fisher - 215-563-9600 x.14
    Wendi L. Kotzen - 215-851-8208
    David M. Kuchinos - 215-569-5729
    Stanley J. Kull - 215-972-7105
    Andrew I. VandenBrul - 215-241-8486

    The principal drafters of these comments also would be happy to meet with you at your convenience to discuss these comments.

    Very truly yours,
    Wayne R. Strasbaugh