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California Out-of-State Corporate Limited Liability Company (LLC) Member is Not “Doing Business” in California

The California Court of Appeal, Fifth District, held that the $800 California minimum franchise tax did not apply to an out-of-state corporation whose sole connection with California is a 0.2% ownership interest in a manager-managed California LLC investment fund, since holding a 0.2% ownership interest with no right of control over the business affairs of the LLC does not constitute “doing business” in California. According to the Court, the corporation’s 0.2% ownership interest closely resembled that of a limited, rather than general, partnership as shown by the fact that the corporation had no interest in the specific property of the LLC; it was not personally liable for the obligations of the LLC; it had no right to act on behalf of or to bind the LLC, and, most importantly, it had no ability to participate in the management and control of the LLC. Because the business activities of a partnership cannot be attributed to limited partners, the Court stated that the corporation cannot be deemed to be “doing business” in California solely by virtue of its ownership interest in the LLC.

The Court also rejected the state’s argument that the corporation was a general partner of the LLC based on the LLC’s election to be treated as a partnership for federal income tax purposes. Accordingly to the state, if the LLC is treated as a partnership, then the corporation is a general partner of the LLC, and the corporation can therefore be imputed with “doing business” in California because the LLC was doing business in California. This is because the activities of a partnership can be attributed to a general partner. However, the Court was not persuaded that the corporation’s interest in the LLC was transmuted into a general partnership interest for purposes of the minimum tax. Assuming that a taxation election is relevant for purposes of determining whether an LLC member is doing business in California, the court found the state’s conclusion to be flawed because it draws no distinction between general and limited partnership interests.

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