Montana Administrative Register Notice 42-Declaratory Ruling DO-11-19 No. 23   12/08/2011    
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In the matter of the petition of the Yellowstone Boys and Girls Ranch Foundation regarding the application of 15-30-2539, MCA and ARM 42.17.603, which address royalty withholding, to a proposed limited liability company to which certain tax-exempt entities would transfer fractional mineral interests in exchange for proportionate LLC membership interests











Docket No. DO-11-19







            1.  The Montana Department of Revenue ("Department"), received a letter from the Yellowstone Boys and Girls Ranch Foundation ("Petitioner") dated July 15, 2011, which was supplemented by the additional representations and exhibits referenced in this ruling, and have deemed those documents as a petition for declaratory ruling.  The petition and any other documents submitted or representations made comprise the Department's records of this declaratory ruling proceeding, as provided in ARM 42.2.105.  This ruling will be published as provided in 2-4-501, MCA.



            2.  The following facts are set forth in your petition:

            (a)  Eleven 501(c)(3) nonprofit organizations received fractional Montana mineral interests from a donor that are proving very difficult for the charities to administer.  The nonprofits are Petitioner Yellowstone Boys and Girls Ranch Foundation, Montana Children's Home and Hospital, with the assumed business name Shodair Children's Hospital, University of Great Falls, Roman Catholic Bishop of Great Falls, Montana, Concordia College Corporation, Rocky Mountain College, Episcopal Diocese of Montana, Scobey Lutheran Church, Scobey United Methodist Church, Scobey Assembly of God, and Daniels Memorial Hospital Foundation.  In order to promote development and effective administration of the mineral interests, the Petitioner proposes to form a Montana limited liability company (LLC), Paulsen, LLC, to which each would transfer its interest in exchange for a proportionate interest.

            (b)  Under the proposed working agreement, the LLC manager would be comprised of three of the charities.

            (c)  The proposed working agreement would authorize the LLC manager to negotiate and, unless a supermajority of the LLC member interests do not consent, execute a mineral, royalty or similar lease of the combined mineral interests.

            (d)  The proposed working agreement contains provisions for termination and transfer of a member's interest that are designed to limit the ability of members to transfer to a transferee that is not itself a tax-exempt entity or that might otherwise jeopardize the tax-exempt status of any of the member charities, including granting members the right of first refusal.


            3.  At the Department's request, the Petitioner has also specifically represented the following additional facts:

            (a)  The LLC, as proposed, would not apply to the U.S. Department of Treasury or the Montana Department of Revenue for a determination that the LLC itself qualifies as a nonprofit entity and it would file federal and Montana partnership information returns.  The Montana return and Montana K-1s would disclose the names of each of the members and each member's distributive share of royalty income as Montana source income.

            (b)  The LLC would not elect to be taxed as a corporation so that it would be treated in default of an affirmative entity classification election as a partnership for federal and Montana tax purposes, and would not itself, as a pass-through entity, be subject to federal or Montana income tax (absent unusual circumstances that the Petitioner does not contemplate occurring).

            (c)  The Petitioner is not aware of any circumstance under which the distributive share of the royalty income the charities may receive would constitute unrelated business taxable income for federal or Montana tax purposes.

            (d)  The donor of the transferred mineral interests would not be a party to any mineral lease contemplated to be entered into by the LLC, directly or indirectly through a related party.  The donor of the transferred mineral interests did not retain mineral interests, the lease of which will be negotiated jointly with the LLC interests.




            4.  Section 15-30-2538, MCA, requires those who pay mineral royalties to remit withholding tax to the Department.  The duty to remit is subject to exceptions listed in 15-30-2539, MCA.  Under 15-30-2539(1)(e), MCA, withholding is not required if the royalty owner is an organization exempt from taxation under 15-31-102, MCA.  Section 15-30-2539(2)(d), MCA requires these tax-exempt entities to report to the remittor and the Department under oath, on a form prescribed by the Department, all information necessary to establish that the remittor is not required to withhold tax for royalty payments made to the organization.


            5.  Pursuant to the rulemaking authority granted in 15-30-2547, MCA, the Department adopted ARM 42.17.603 which provides in relevant part as follows:


(11)  Section 15-30-2539, MCA, allows for an organization that is exempt from taxation under 15-31-102, MCA, to be exempt from the withholding requirements of 15-30-2536, MCA, provided the exempt organization, who is a royalty owner, submits a report to both the remittor and the department.  The report, which can be in the form of a letter, must contain the exempt organization's letterhead and request exemption from 15-30-2536, MCA.  The request must be received by the remittor and the department prior to November 1 of the year prior to the calendar year in which the exempt organization requests exemption.  Upon receipt of the report, the department shall notify the exempt organization and the remitter of either acceptance or denial of the request within 30 days.  The election does not need to be repeated annually unless requested by the department.


The rule did not contemplate or address mineral interests being held by entities wholly owned and controlled by tax-exempt entities that are not themselves also tax-exempt.


            6.  The Petitioner's petition seeks the Department's determination that 15-30-2539, MCA, and ARM 42.17.603 may be applied to the eleven nonprofits' proposed LLC under the facts and circumstances described in paragraphs 2 and 3, and that the Department will accept a request for waiver from the LLC.


            7.  If the Department did not rule that this particular LLC may apply for and obtain exemption from backup withholding under the facts and circumstances described, the following tax consequences would follow:

            (a)  The remittor would be required to withhold 6% from the royalties payable to the LLC.

            (b)  When the LLC filed its Montana partnership information return:

            (i)  it would report the royalties formerly directly received by the charities (decreased by the 6% withholding) as distributable royalty income; and

            (ii)  it would report the 6% withheld from the royalties and remitted to the state on behalf of the LLC royalty owner as taxes paid by the tax-exempt entities; and

            (c)  the tax-exempt entities, which would have no tax liability, would be required to file a corporation or fiduciary return, as applicable, to recover their share of the 6% backup withholding.


            8.  The LLC structure would enable LLC expenses to be paid from the royalties, resulting in the charities reporting a lower amount of royalties received for tax purposes.  The LLC structure could result in nonprorata allocations of gain or loss.  Neither of these prospects however should have any Montana effect so long as all members are tax-exempt entities.  So long as the LLC files its Montana partnership information return, the return will disclose the identity of all members.  Thus, no additional notice provisions, such as those discussed in the Petitioner's July 15, 2011, letter would be required in the working agreement.


            9.  The mineral withholding required by 15-30-2538, MCA, is legally and factually "backup" withholding that was imposed to ensure that the royalty payments attributable to Montana mineral production do not escape taxation.  When no tax is imposed, as in this case and, as represented, the transaction is not being undertaken for other tax avoidance reasons, no issue of escaped tax arises.




            10.  The Department rules, based on the particular facts and circumstances of this case, that the Department will interpret 15-30-2539, MCA, and ARM 42.17.603 as permitting Paulsen, LLC, once formed (by some or all of the eleven nonprofit organizations previously identified in paragraph 2(a)) and a party to a lease pursuant to which royalty payments could be made, to apply for and receive a determination that backup withholding on royalty payments with respect to the mineral interests transferred by the tax-exempt organizations is not required.


            11.  This ruling applies only to the tax-exempt organizations and the limited liability company that are the subject of this ruling and, only so long as there is no change in a material fact on which this determination is based.  For purposes of this ruling, neither the assignment or other transfer by one of the identified tax-exempt organizations of some or all of its mineral or royalty interests to one or more of the other identified tax-exempt organizations, nor the expiration of the lease term and entry into another lease with the same or another lessee/remittor will be considered a change in a material fact on which the determination is based.


            Dated this 17th day of November, 2011.


                                                            MONTANA DEPARTMENT OF REVENUE



                                                            /s/ Dan R. Bucks

                                                            DAN R. BUCKS,



NOTICE:  Petitioner has the right to appeal the decision of this agency by filing a petition for judicial review in district court within 30 days after service of this decision.  Judicial review is conducted pursuant to 2-4-702, MCA.





            The undersigned hereby certifies that on the 28th day of November 2011, a true and correct copy of the foregoing has been served by placing same in the U.S. mail, postage prepaid, addressed as follows:


            Yellowstone Boys and Girls Ranch Foundation

            2050 Overland Avenue

            Billings, MT  59102


                                                                        /s/ Cleo Anderson

                                                                        CLEO ANDERSON

                                                                        Rule Reviewer


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