STATE OF FLORIDA

DIVISION OF ADMINISTRATIVE HEARINGS

A. D. E. OF PANAMA CITY, INC., )

)

Petitioner, )

)

vs. ) Case No. 99-4705

)

DEPARTMENT OF REVENUE, )

)

Respondent. )

)

RECOMMENDED ORDER

Pursuant to notice, a formal hearing was held in this case on October 31, 2000, in Panama City, Florida, before the Division of Administrative Hearings, by its designated Administrative Law Judge, Diane Cleavinger.

APPEARANCES

For Petitioner: H. Cranston Pope, Esquire

Post Office Box 1609

Panama City, Florida 32402-1609

For Respondent: J. Clifton Cox, Esquire

Office of the Attorney General The Capitol, Tax Section Tallahassee, Florida 32399-1050

STATEMENT OF THE ISSUE

Whether the Department of Revenue properly assessed sales or use tax and local government infrastructure surtax on payments allegedly constituting "rent" that Petitioner paid to

the mortgagee in accordance with an Occupancy and Indemnity Agreement and Trust Agreement.

PRELIMINARY STATEMENT

This case arises from the sales and use tax audit performed by the Department of Revenue (Department) on A.D.E. of Panama City, Inc. (A.D.E.) for the audit period (audit period) March 1, 1993 through February 28, 1998, inclusive. As the result of that audit an assessment of additional sales tax and county surtax was made with regard to several categories of items sold or services performed by Petitioner in its regular course of business as an automobile dealership. In addition, an assessment was made against payments pursuant to a certain mortgage. The Department characterized these payments as rent and subject to the sales tax and county surtax.

Prior to hearing, Petitioner and Respondent resolved this matter as to all issues except the issue regarding the characterization of the mortgage payments as rent. Further

1. does not dispute the amounts of the rent payments on which taxes were assessed or the mathematical computation of the tax, penalty, or interest due on such payments.

   At the hearing, Petitioner presented the testimony of three witnesses and introduced 17 exhibits into evidence. Respondent presented the testimony of 2 witnesses and offered 60 exhibits into evidence. Additionally, the deposition testimony of 5

   witnesses was offered into evidence. The record was held open to allow time for Petitioner to depose one additional witness. The deposition testimony was submitted on February 2, 2001, and the record was closed. After the hearing Petitioner and Respondent submitted Proposed Recommended Orders on February 2, 2001, and February 8, 2001, respectively.

   FINDINGS OF FACT

   
   

   1. As of August 10, 1989, the corporation known as Panama City Toyota, Inc., owned a parcel of land where it conducted a new and used car sales business. The automobile inventory and dealer registrations with Toyota, Mitsubishi, etc., were also held in the name of the corporation or in the names of its principals. On that date, Panama City Toyota, Inc., executed a note and mortgage to Omni Finance Corporation in the amount of

      $1,200,000. The note was guaranteed by the three corporate shareholders, Mark Gerke, Norman Wiese, and Apryl Wiese.

   2. On July 11, 1991, a new corporation was formed, A.D.E. of Panama City, Inc. (A.D.E.). Its shares came to be held by members of the David Hill family. A.D.E. was formed for the purpose of acquiring the assets of Panama City Toyota, Inc. On July 29, 1991, A.D.E. (Buyer) and Panama City Toyota, Inc. (Seller) entered into a sale/purchase agreement whereby all the assets of Panama City Toyota were to be purchased by A.D.E. Those assets included an automobile dealership owned and

      operated by Toyota along with real estate associated with that dealership.

   3. The owners of Toyota were concerned that approval of the transfer of the dealership licenses from Toyota to A.D.E. might be held up for a period of several weeks or might be denied.

   4. The owners of Toyota needed cash and were anxious to close the portion of the sale transaction that involved the real property.

   5. One or more owners of Toyota also expressed the concern that if the dealership transfers were not approved by the automobile manufacturers, Toyota might not be able to "unwind the transfer" of the real property and would, effectively, be out of business.

   6. Mr. Robert Dittman, the attorney who represented Toyota in its transfer of assets to A.D.E., testified by deposition that Toyota's lender required title to the real property be held by a separate entity. He explained as follows:

      The best of my recollection is that the transaction lender which was World Omni Financial Corporation came up with a requirement that the real estate be owned by a separate entity and that originally the parties contemplated that A.D.E. would own both the tangible personal property and intangible personal property that was being sold as well as the real estate that was being sold, and at some point in time apparently the buyer's lender came up with a

      requirement for whatever reason, and I'm not privy to that reason, that they wanted a separate entity-they did not want the operating entity to own the real property.

      
      

   7. In order to assure the Buyer that title to the real property could be secured upon approval of the dealership transfers and assure the Seller that the sale could be "unwound" if the dealership transfers were not approved, the attorneys for both sides hit upon the idea of an arrangement whereby Buyer would acquire title to the real property, but transfer it to a "Trustee" who would hold the land until the dealership transfers were either approved or denied. To give the Seller greater comfort, Mr. Gerke was named to serve as the initial "Trustee."

   8. The plan was for Seller to continue operations until the dealership transfers were approved, then the payment for the inventories and dealership licenses would be made and the real property would come out of the "trust" to the Buyer.

   9. Toyota's conveyance of title to the real property to a Trustee rather than to A.D.E. enabled the parties to satisfy the lender that title would be held by a separate entity, to satisfy the Buyer (A.D.E.) that title to the real property could be secured upon approval of the dealership transfers, and to satisfy the Seller, Toyota that the sale could be "unwound" if the dealership transfers were not approved. Thus, initially the trust had a purpose for its creation.

   10. A.D.E.'s former attorney, Mr. Jerry Williams, prepared the Trust Agreement for the Trust in accordance with the agreement between A.D.E. and Toyota, that the Trustee would hold title to the real property.

   11. The trust was entered into on December 31, 1991. To give the Seller greater comfort, Mark Gerke, who was shareholder in Toyota and operated the Toyota dealership, was named to serve as the initial Trustee.

   12. Also on December 31, 1991, A.D.E. and the initial Trustee of the Trust entered into an Occupancy and Indemnity Agreement. The Occupancy Agreement gave an option to purchase the property to Petitioner, the beneficiary of the trust. The Occupancy and Indemnity Agreement provided in paragraph 3 on page as follows:

       3. Note Payments. During the Term, A.D.E. shall pay $12,000 per month for its right to occupy and use the Real Estate, or such greater or lesser amount as shall be required to pay all principal, interest and costs when due under the certain promisory [sic] note to be issued by Trustee as maker in favor of World Omni Financial Corp. as payee ("Note"). Such payments shall be made to the payee or holder of the Note.

       
       

   13. At all times material to this action, A.D.E. has been the sole beneficiary under the Real Estate Trust Agreement. By specific language in the Agreement, the Trust has no authority to act in any fashion nor as to any matter except as

       specifically authorized by the beneficiary. The beneficiary has sole authority to authorize action by the Trustee, sole authority at any time to remove the Trustee and sole authority at anytime to terminate and dismantle the Trust entirely and demand distribution of all assets to it.

   14. Not long into this arrangement, on April 30, 1992, certain questionable business practices of Seller were discovered. A.D.E. caused Mr. Gerke to resign as "Trustee" and named David Hill, II, as his successor. Mr. Hill was selected by his father, who in effect directed the operations of A.D.E and actually caused the purchase of Toyota and the creation of the various agreements involved in that purchase. David A. Hill, II, has held a majority ownership interest in the Petitioner. At this point the beneficiary and grantor essentially became one.

   15. Several months after that on October 21, 1992, the dealership transfers were approved and the second part of the deal was closed. Toyota executed a warranty deed conveying the real property to the trust. The trust no longer had a purpose and the beneficial and title interests merged. By its terms the trust terminated. However, through an oversight, formal transfer of title did not happen.

   16. Pursuant to the finalization of the sale (and on the brink of foreclosure by Omni), Buyer assumed the note and

       mortgage with Omni and Omni released Toyota as maker and

       
       

       Mr. Gerke, Mr. Wiese, and Ms. Wiese as guarantors. Because of the fact that record title was still in Trust, the assumption of the note was in the Trust's name, rather than A.D.E.

   17. Therefore, David Hill, II, signed a Note and Mortgage Assumption and Modification Agreement in his capacity "as Trustee under Real Estate Trust Agreement dated December 31, 1991."

   18. Around March 25, 1997, financing for the business was moved to SouthTrust Bank. David H. Hill, II, as Trustee under the Trust, obtained a loan from SouthTrust Bank of Alabama, N.A. (SouthTrust Bank) in the amount of $770,990.34 to refinance the purchase of the automobile dealership from Toyota. SouthTrust's attorneys, seeing that title was in a trust, required the trustee to execute an Assignment of Rents.

   19. A.D.E. provided its financial statements for the years ending December 31, 1997, and December 31, 1996, to its mortgage holder(s). The mortgage holder relied on the financial assets of A.D.E. in making the loan.

   20. The notes to A.D.E.'s financial statements for the years ending December 31, 1997, and December 31, 1996, represented as follows:

       NOTE 8: INVESTMENT IN SUBSIDIARY

       
       

       The Company has an investment in David Hill, II, Real Estate Trust, a wholly owned subsidiary. Management has elected to use the equity method of accounting for this investment. A.D.E. of Panama City, Inc.'s Equity in the investment at December 31, 1997 and 1996 is $392,836 and $356,688, respectively. Generally accepted accounting principles require that investments in majority owned subsidiaries be accounted for as consolidated subsidiaries. The effect of the departure from generally accepted accounting principles on financial position, results, operations, and cash flows has not been determined.

       
       

   21. Additionally, the notes to A.D.E.'s financial statements prepared by A.D.E.'s accountant for the years ending December 31, 1996, and December 31, 1997, included the following statement:

       The Company leases buildings and land for administrative offices and operations from David Hill II Real Estate Trust with terms of monthly renewals. The Company pays the maintenance and repairs for these facilities.

       
       

   22. The terms of the loan included a requirement that

       
       

       A.D.E. produce a lease between David H. Hill, II, Trustee, as landlord, and A.D.E., as tenant, within 45 days after closing.

   23. Additionally, David H. Hill, II, as Trustee, was the sole mortgagor of the property pursuant to the loan by SouthTrust Bank.

   24. David H. Hill, II, as Trustee, was the sole maker of the promissory note for the loan. However the funds were used in the operations of the dealership A.D.E. owned.

   25. SouthTrust Bank required A.D.E. to execute and provide the bank a resolution of the Board of Directors of A.D.E. before the bank would close the loan.

   26. On March 25, 1997, the Board of Directors of A.D.E. approved the resolution required by SouthTrust Bank (Resolution) stating, in part, as follows:

       WHEREAS, the Corporation agrees to and authorizes its officers to execute any and all documents necessary to secure a loan from SouthTrust Bank of Alabama, N.A., in the approximate amount of $770,990.334 (the "loan"), which will encumber the property which is owned by David H. Hill, II, Trustee under that Trust Agreement dated December 31, 1991, ("Property Owner"), and which is being leased by the Corporation from the Property Owner, (the "property"). The Property is located at 5303 West Highway 98, Panama City, Bay County, Florida . . . .

       
       

   27. In addition to the Resolution of the Board of Directors of A.D.E., SouthTrust Bank required execution of various documents in order to close the mortgage loan with David Hill, II, Trustee. David Hill, II, as Trustee, executed and delivered to SouthTrust Bank the following documents:

       Directions from David H. Hill, II, to Execute Documents for the loan.

       
       

       Affidavit of David H. Hill, II, as Trustee, dated March 25, 1997.

       
       

       Title Affidavit executed by David H. Hill, II, Trustee.

       
       

   28. Again David H. Hill, II, followed his father's instructions in obtaining the SouthTrust Loan and executing the documents for the loan. He never read the trust documents. Likewise he never read the loan documents. Indeed all of the transactions involving A.D.E. or the Trust were directed and instituted by Mr. Hill's father. The Trust never functioned independently of the beneficiary or the Hill family, its stockholders

   29. At all times since the transfer of title into the Trust, A.D.E. has made all payments on all debts secured by the property. All such payments were made directly to the lenders and did not pass through the Trust. The Trust, in fact, never had a bank account, never obtained an Employer Identification Number, and never filed (nor was ever required to file) a tax return. All insurance premiums and all real estate ad valorem

       taxes were paid directly by A.D.E.

       
       

   30. It is also undisputed that the Internal Revenue Service forms 1120S filed by A.D.E. reflecting income in 1992- 1995 claimed a deduction for rent paid by A.D.E. to the Trustee

       for the Trust Assets consisting of real property.

   31. However, the deductions were matched by the income reported on K-1s to the shareholders of A.D.E. and on various tax returns.

   32. The notes to A.D.E.'s financial statements prepared by A.D.E.'s accountant for the years ending December 31, 1997 through December 31, 1999, included the following statement:

       The Company leases buildings and land from the David Hill II Real Estate Trust. A.D.E. of Panama City, Inc. is the grantor of the trust.

       
       

   33. Based on all these facts, the evidence established that the Trust for at least tax purposes does not have a separate identity from its beneficiary A.D.E. The Trust is not in the business of renting or leasing property, no matter how much the Trust settlor's and A.D.E. played fast and loose with formal title records. Therefore, the payments of the mortgage by A.D.E. do not constitute rent and are not subject to tax.

       CONCLUSIONS OF LAW

       
       

   34. The Division of Administrative Hearings has jurisdiction over the subject matter of and the parties to this proceeding. Section 120.57(1), Florida Statutes.

   35. The total consideration paid by a tenant for use of real property is subject to sales tax. Sections 212.031, Florida Statutes; Rule 12A-1.070, Florida Administrative Code.

   36. Rule 12A-1.070, Florida Administrative Code, provides in pertinent part as follows:

       (16) Any person who has leased, occupied or used or was entitled to use any real property and cannot prove that the tax has been paid to his lessor or other person shall be directly liable to the State for any tax, interest, or penalty due on any such taxable transaction.

       
       

       * * *

       
       

       (19)(a) The lease or rental of real property or a license fee arrangement to use or occupy real property between related "persons," as defined in s. 212.02(12), F.S., in the capacity of lessor/lessee, is subject to tax.

       1. The total consideration, whether direct or indirect, payments or credits, or other consideration in kind, furnished by the lessee to the lessor is subject to tax despite any relationship between the lessor and the lessee.

       2. The total consideration furnished by the lessee to a related lessor for the occupation of real property owned by the related lessor is subject to tax, even though the amount of the consideration is equal to the amount of the consideration legally necessary to amortize a debt owned by the related lessor and secured by the real property occupied, or used, and even though the consideration is ultimately used to pay that debt.

       
       

   37. While it is possible, under current Florida law, to create a valid trust where the settlor, trustee, and beneficiary are all one and the same, such a trust only affords two benefits. Those benefits have to do with avoidance of probate in the event of death and avoidance of guardianship proceedings

       in the event of incapacity. In neither scenario is there recognized a separation of title or legal rights from the settlor/trustee/beneficiary that places the property beyond the claims of creditors or others who claim rights through the settlor/trustee/beneficiary.

   38. At the time the parties created the Trust, it appears that the only legal authority they considered regarding the taxability of the transaction was the decision in the case Lord Chumley's of Stuart, Inc. v. Department of Revenue, 401 So. 2d

       817 (Fla. 4th DCA 1981). The Fourth District there concluded that the purported landlord was not in the business of renting real property and payments by the purported tenant, therefore, were not subject to sales tax as rent. In that case, title to three parcels of real property were in the name of Peter G. Makris, as trustee, and title to the fourth parcel was in the name of Mr. Makris formed corporations paid the mortgage, real estate tax, and insurance payments due on those parcels. In reliance on the interpretation of the law by its former attorney, Mr. Jerry Williams, A.D.E. assumed that payments pursuant to the Occupancy and Indemnity Agreement received in evidence as Exhibit 37 would not be subject to the sales tax.

   39. The First District Court of Appeal decided the case Regal Kitchens, Inc. v. Florida Department of Revenue, 641 So. 2d 158 (Fla. 1st DCA 1994). In Regal Kitchens, the taxpayer

       conducted its operations on real property owned by a related partnership. Both the taxpayer and the partnership were owned by the same four individuals in the same proportions, and the taxpayer in Regal Kitchens, contended that the Court should disregard the separate entity and deem the entries to be alter egos. In Regal Kitchens, the "rent" exactly equals the payments for the mortgage, insurance, and taxes. In Regal Kitchens, the "landlord" and "tenant" reduced their agreement to writing. The partnership in Regal Kitchens, was formed for the sole purpose

       of taking title to the real property and leasing it back to the taxpayer. Regal Kitchens is distinguishable on its facts and does not control in this case.

   40. The term "business" is defined in Subsection 212.02(2), Florida Statutes (1993), as "any activity engaged in by any person, or caused to be engaged in by him, with the object of private or public gain, benefit, or advantage, either direct or indirect." . . . The Department of Revenue relies on cases involving partnership and corporations where there is recognized a separation of legal rights sufficient to give rise to two or more distinguishable entities. A grantor trust such as the one here has never been recognized as distinguishable from its grantor. There can exist no trust where the legal title and beneficial interest are both in the same person. Every trust must necessarily involve a legal ownership that is

       not absolute, but qualified by an equitable interest. Here, there is no qualification of A.D.E.'s legal right because A.D.E. also has the beneficial interest. See Contella v. Contella, 559 So. 2d 1217 (Fla. App. D5); Axtel v. Coons, 82 Fla. 158, 89 So.

       419 (1921); Willey v. W.J. Hoggson Corp., 90 Fla. 343, 106 So.

       
       

       408 (1925); Reid v. Barry, 93 Fla. 849, 112 So. 846 (1927);

       
       

       Walker v. Close, 98 Fla. 1103, 125 So. 521 (1929), reh. den. 98

       
       

       Fla. 125, 126 So. 289; Montgomery v. Carlton, 99 Fla. 152, 126

       
       

       So. 135 (1930); Huggins v. Whitaker, 100 Fla. 600, 129 So. 857

       
       

       (1930); Ware v. Busch, 108 Fla. 153, 146 So. 197 (1933); Webster v. St. Petersburg Federal Sav. & Loan Ass'n, 155 Fla. 412, 20 So. 2d 400 (1945); Harvest v. Craft Constr. Corp., 187 So. 2d 72 (1966, Fla. App. D3), cert. den. 189 So. 2d 634 (Fla.).

   41. In this case, a reading of the "Trust" agreement and other various documents reveals certain rights and duties that make it clear there was no Trust separate from the beneficiary. Second, even if the Department of Revenue could establish a Trust, the requisite separation of owner and beneficiary sufficient to support the "rental" argument does not exist. The "Trustee" can only hold the property for the beneficiary; the Department of Revenue's theory results in A.D.E.'s renting from itself. Lastly, even accepting for the sake of argument that a Trust existed and that the landlord/tenant relationship existed,

       the terms of the agreement called for a termination when the dealership licenses were transferred.

   42. These facts do not give rise to a separate entity. It is a legal impossibility to have an enforceable rent agreement, actual or implied, where a supposed Trustee is powerless except as specifically empowered by the beneficiary who created the Agreement, appointed the Trustee and who holds absolute authority to terminate the Agreement at will. Moreover, the Trust is not in the business of leasing real property within the meaning of Section 212.031, Florida Statutes. Therefore, sales taxes are not due on the total consideration paid by A.D.E. for its right to occupy or use the subject real property because these payments are not rent.

RECOMMENDATION

Based upon the findings of fact and conclusions of law, it

is

RECOMMENDED:

That the Department of Revenue enter a final order finding the payments Petitioner made to its mortgagee are not taxable as rent.

DONE AND ENTERED this 2nd day of April, 2001, in Tallahassee, Leon County, Florida.

DIANE CLEAVINGER

Administrative Law Judge

Division of Administrative Hearings The DeSoto Building

1230 Apalachee Parkway

Tallahassee, Florida 32399-3060

(850) 488-9675 SUNCOM 278-9675

Fax Filing (850) 921-6847 www.doah.state.fl.us

Filed with the Clerk of the Division of Administrative Hearings this 2nd day of April, 2001.

COPIES FURNISHED:

H. Cranston Pope, Esquire Post Office Box 1609

Panama City, Florida 32402-1609

J. Clifton Cox, Esquire

Office of the Attorney General The Capitol, Tax Section Tallahassee, Florida 32399-1050

Linda Lettera, General Counsel Department of Revenue

204 Carlton Building Tallahassee, Florida 32314-6668

James Zingale, Executive Director Department of Revenue

104 Carlton Building Tallahassee, Florida 32399-1000

NOTICE OF RIGHT TO SUBMIT EXCEPTIONS

All parties have the right to submit written exceptions within

15 days from the date of this Recommended Order. Any exceptions to this Recommended Order should be filed with the agency that will issue the Final Order in this case.

Docket for Case No: 99-004705

Orders for Case No: 99-004705