Tax Law Insights

On August 15, 2011, the South Carolina Supreme Court ruled in Clarendon County v. TYKAT, Inc. (Op. 270252011, WL 3568536) that Section 12-37-950 of the Code of Laws of South Carolina, 1976, as amended (the "Code"), subjected a leasehold interest in real estate to property taxation where the property was otherwise exempt from such taxation in the hands of the owner. The court's ruling in TYKAT affirmed the ruling of the South Carolina Administrative Law Court (the "ALC") below finding that TYKAT, Inc. ("TYKAT") was liable to Clarendon County for property taxes on the value of TYKAT's leasehold interest in land on which it operated a campground. TYKAT leased the land from the fee holder owner of the property, the South Carolina Public Service Authority, which is a public entity exempt from taxation.As a rule, all real property in South Carolina is taxable to the owner. As with all rules there are exceptions, however, most of which are contained in the South Carolina Constitution and codified in Section 12-37-220 of the Code. Article X, section 3 of the Constitution provides an exemption for "all property of the State, counties, municipalities, school districts and other political subdivisions, if the property is used exclusively for public purposes." Further, section 58-31-10 of the Code specifically exempts property of the South Carolina Public Service Authority from taxation.Section 12-37-950 of the Code provides, however, that "[w]hen any leasehold estate is conveyed for a definite term by any grantor whose property is exempt from taxation to a grantee whose property is not exempt, the leasehold estate shall be valued for property tax purposes as real estate." TYKAT, a for-profit corporation not independently exempt from property taxation, claimed an exemption in the leased property based on the exemption contained in Article X, section 3 of the Constitution and S.C. Pub Serv. Auth. V. Summers, 282 S.C. 148 (1984), which held that certain real property leased by the Authority to individuals was used for a public purpose and further exempt under Section 58-31-10.The ALC disagreed with this interpretation, noting that the Summers case and the Constitution do exempt property from taxation when used for a public purpose ' but only by and in the hands of the Authority. The ALC decision notes that "Section 12-37-950 makes it clear that, when the Authority, a tax-exempt entity, conveyed the Leasehold (a real property interest distinct from the Authority's fee-simple ownership) to TYKAT, a non tax-exempt entity, a taxable property interest was created in the Leasehold .The plain, bright-line mandate in section 12-37-950 compels the Court to hold that the Leasehold is taxable." The South Carolina Supreme Court sided with the ALC, noting that "[t]he precedents relied on by Tykat address whether a tax-exempt owner in fee simple retains its tax exemption when it leases real property to a private entity. These cases make no mention of a tax exemption for a lessee .By contrast, Section 12-37-950 is directly on point [and] unambiguously requires that Tykat's leasehold estate 'be valued for property tax purposes as real estate' and it makes no mention of an exemption if the leasehold estate is used for a public purpose."Taxpayer ImpactThe ALC and South Carolina Supreme Court were both adamant that Section 12-37-950 expressly subjects leasehold interests held by non tax-exempt entities to tax when leased from a tax-exempt entity. Other than in situations such as that in TYKAT, where an unrelated business leases income-producing property from a state agency, where could this apply? There are numerous possibilities. In many instances a county or other political subdivision may wish to lease blighted or other economic development property to an entity pursuant to a "financing lease," whereby the entity would amortize the cost of the property over the leased term and ultimately take title to the leased property. While this type of transaction has traditionally been viewed as exempt as a "public purpose" arrangement, these decisions call that interpretation into question. The TYKAT decision renders the public purpose analysis superfluous in the case of a lease to a non-tax exempt entity.Further, contrary to a generally-held belief, not all property of entities exempt from income tax under Section 501(c)(3) of the Internal Revenue Code is exempt from ad valorem property taxation under South Carolina law. Leases from an entity exempt from property taxation to a related corporation or LLC formed by that entity and which is exempt from income taxation but not specifically exempted from property taxation will be subject to property taxation under Section 12-37-950. Further, the language of the statute does not specify real property leases'equipment leases and other personal property leases may also be subject to taxation under Section 12-37-950. The TYKAT decision underscores, at the very least, that property tax considerations should be weighed whenever a public/private lease arrangement or exempt/non-exempt lease arrangement is being contemplated.