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Limited Liability Companies with Common Ownership Prohibited From Filing Combined Franchise Tax Return

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The recent Tennessee Court of Appeals ruling in Valenti Mid-South v. Farr is an significant reminder of how important careful franchise and excise tax planning can be for those engaged in real estate ventures in Tennessee.

In Valenti, Darrell Valenti owned more than 50% in both a real estate holding company (Valenti Realty) and a management company that operated forty-six (46) fast food restaurants in Tennessee (Valenti Management) in his individual capacity. Valenti Management leased land and buildings where its restaurants operated from Valenti Realty.

The Tennessee franchise tax at issue in the case is a privilege tax that is generally imposed on a taxpayer's net worth. The tax also includes, however, a minimum measure based on the actual value of the real or tangible property owned or used in Tennessee. This includes leased property that is valued at a multiple of rent. Valenti Management's "net worth" was negative for the applicable tax years so it calculated its tax base using the alternative measure. In calculating actual value of property in Tennessee, however, Valenti Management excluded the value of the forty-six (46) properties it rented from the Valenti Realty, arguing that Valenti Management and Valenti Realty constituted an "affiliated group" and, therefore, were entitled to calculate property value on a consolidated basis. Since Valenti Realty already included the values of the properties within the base of its own Tennessee franchise tax liability, Valenti Management asserted that the value of the properties should be excluded from the value of property owned or used by Valenti Management in Tennessee.

The Court of Appeals rejected this contention, concluding that the entities were not affiliated because the common owner was an individual rather than a taxable entity. Thus, the structure did not meet the express requirements of the statute, i.e., that the 50% common ownership be with a taxable entity. The Court also rejected double taxation and equal protection claims advanced by Valenti Management.

Lessons Learned 

This tax result could have been avoided if Valenti Management would have owned the two entities through a single member LLC. In which case, the common ownership test would have been satisfied and would have allowed a consolidated net worth filing. Real estate holding companies and their affiliates should take note from the Valenti decision, revisit their structures and verify that the most advantageous arrangement is being utilized.

The Valenti decision also reiterates long-standing Tennessee precedent that the separate nature of entities in Tennessee will be respected, an important principle in all Tennessee tax planning (see Standard Advertising). Moreover, taxpayers should take note that the Department of Revenue interprets the consolidated franchise tax filing option as only applying to the net worth calculation which does not apply to the alternative, minimum measure that is based on value of property in Tennessee.

For more information, please contact Mike Yopp, Chris Wilson or any member of Waller Lansden's State and Local Tax practice at 800-487-6380.

The opinions expressed in this bulletin are intended for general guidance only. They are not intended as recommendations for specific situations. As always, readers should consult a qualified attorney for specific legal guidance.

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