The question of California registration comes up often when foreign limited liability companies are used as holding companies for California legal entities, or own passive assets in California like bank accounts and non-income producing real estate. In publication 3556, and in practice, the FTB has adopted a position that virtually every foreign limited liability company, especially one with a California resident manager or managing members should register with California and pay California taxes. The FTB, again, is wrong.
California’s jurisdiction to require an out-of-state limited liability company to register as foreign limited liability company with the State of California is limited by the Due Process Clause of the 14th Amendment and the dormant Commerce Clause. Under the Due Process clause California would have to show that the foreign limited liability company has “minimum contacts” with California, and under the dormant Commerce Clause, California would have to establish a “substantial nexus” between the foreign limited liability company and California.
Even if a foreign LLC meets the above requirements of the Due Process Clause or the dormant Commerce Clause that only allows California to subject that foreign LLC to its income tax jurisdiction. Having nexus with California would not be sufficient to require the foreign LLC to register with the State of California or to be liable for franchise taxes in California.
California imposes a registration requirement on foreign LLCs only if they transact business within California: “Before transacting intrastate business in this state, a foreign limited liability company shall register with the Secretary of State.”
The Corporations Code defines the term “transact intrastate business” as entering into repeated and successive transactions of business in California, other than in interstate or foreign commerce.
Being a member or a manager of a California LLC or a foreign LLC is excluded from the meaning of “transact intrastate business.” Similarly excluded are (i) holding meetings of managers or members or carrying on any other activities concerning the LLC’s internal affairs; (ii) maintaining bank accounts; or (iii) securing or collecting debts or enforcing mortgages.
California law makes it clear that foreign limited liability companies are not transacting intrastate business in California solely because they are members of California limited liability companies, nor are foreign limited liability companies transacting intrastate business in California because their managers or members live in California or conduct meetings in California. The FTB would have to show that the manager or the managing member actively transacts the LLC’s business within California.
Even if a foreign limited liability company is not required to register with the State of California it may still be subject to the California franchise tax if the LLC is doing business in California. “Doing business” has been defined as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”
The California State Board of Equalization has ruled that passive ownership of an interest in a California legal entity does not rise to the level of “actively” engaging in a transaction. The SBE based its decision on the fact that a limited partner in a limited partnership cannot, based on the relevant provisions of partnership law and the limited partnership agreement, participate in the active management of the partnership. Only the general partner may do so. The SBE’s logic is equally applicable to members of a limited liability company who are not managers and who by the provisions of the operating agreement are precluded from participating in the active management of the LLC.
It should be noted that a corporation that is a holding company (organized for the purpose of holding interests in other legal entities) is not deemed (per the Revenue and Taxation Code) to be doing business in California. The same provision was not included by the legislature in the LLC franchise tax statutes, but one can draw an inference that LLCs that are solely holding companies are not doing business in California.
Our advice, do not follow the FTB’s instructions blindly. They are frequently self-serving and without a legal foundation.
For a more in depth analysis of these issues read a more detailed version of this article on our website: http://www.maximumassetprotection.com.