Department Bound by its Own Regulation

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Tax Policy

In Pennsylvania, certain long-term leases are subject to realty transfer taxes. In this article, Cozen O'Connor's Joseph C. Bright and Heidi R. Schwartz discuss the Saturday Family case and its impact on determining the length of leases subject to realty transfer taxes.

Joseph C. Bright Heidi R. Schwartz

By Joseph C. Bright and Heidi R. Schwartz

Joseph C. Bright is a member with Cozen O'Connor. Heidi R. Schwartz is an associate with Cozen O'Connor.

On exceptions, the Commonwealth Court en banc affirmed a panel decision holding that the Pennsylvania Department of Revenue could not impose realty transfer tax on a ground lease that contains an option to renew the lease at fair rental value that included an appraisal procedure. Saturday Family L.P. v. Commonwealth, No. 781 F.R. 2013 (Pa. Commw. Aug. 14, 2017), dismissing exceptions to Saturday Family L.P. v. Commonwealth, 148 A.3d 931 (Pa. Commw. 2016).

Pennsylvania realty transfer tax generally applies to a lease that has a term of 30 years or more. In calculating the term of a lease, it will be presumed that an option to renew the lease will be exercised (and therefore included in the calculation of the term) if the rental charge is fixed or if a method to calculate the rental charge is established. 72 P.S. § 8103-C.1.

Department's Regulation

The department's regulation provides that an option to renew or extend the lease at fair rental value (FMV) at the time of the renewal or extension will not count towards determining the term of a lease. 61 Pa. Code §91.193(b)(24)(v). In this case, the ground lease was for 29 years, 11 months, and three days, and gave the lessee the option to renew or extend the lease for up to six five-year terms at fair market rent as determined by the parties at the time of the extension based on rents for similar parcels in the county and, if they are unable to agree, by an appraisal procedure: the lessee must notify the lessor of its intention to exercise the renewal option, and the parties must then examine the rent for similar properties in Westmoreland County to attempt to arrive at a rental value agreeable to both. If they are unable to agree, the lessee will serve notice on the lessor that it will appoint an appraiser. The lessor must then appoint an appraiser and notify the lessee. If the lessor fails to do so, an appraiser will be chosen for the lessor pursuant to applicable provisions in the lease. If the two appraisers are unable to agree on the rental value, the lease provides for the appointment of a third appraiser by agreement of the two appraisers or by requesting that the American Arbitration Association (AAA) appoint a third appraiser. If the two appraisers are unable to agree on a third appraiser and AAA fails to timely appoint a third appraiser, then the lessee or lessor may petition the Court of Common Pleas of Westmoreland County for appropriate legal or equitable relief.

The department assessed realty transfer tax on the lease. The commonwealth argued that the process to calculate FMV rent is a method to calculate rent under Section 8103-C.1, and that the lease term is therefore over 30 years. The court disagreed, and held that the ground lease was not taxable under the plain language of the department's regulation. The court did not interpret the language of the lease as establishing a method for calculating the rental charge. The court explained that FMV is not a method to calculate rent at a fixed rental price – rather it is a future, unknown, objective amount. Further, the lease did not preclude the parties from freely negotiating FMV rent at the time of the extension.

Position Unreasonable, Inconsistent

The court held that the department's position was unreasonable and inconsistent with its own regulation. The commonwealth argued that the lease must simply provide that the renewal must be at FMV, without legally binding conditions. However, the FMV requirement was itself a legally binding condition that limits the parties' ability to agree to a rental price. Since the department's position was unreasonable and inconsistent with its own regulation, it was not entitled to deference and the court was not bound to follow it.

The court noted that the department's regulation largely mirrored Section 8103-C.1 of the tax code, except for its addition of the fair value exception, and stated that the case would not be before the court had the department not added that language. Since the department did not argue that its own regulation, particularly the fair value provision, was inconsistent with the tax code, the department was bound to follow both the statute and its regulation.

The department further argued that citation errors in the petitioners' initial brief justified dismissal of the petition. The court disagreed, as the commonwealth was not prejudiced by the errors, but merely sought to take advantage of them.

The decision underscores the principle that the department is bound by the plain language of its own regulations and cannot adopt positions contrary to that language. The decision will be a help to taxpayers who need to rely on applicable statutory and regulatory language in planning their affairs.

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