Japanese Firm Seeks $2-Million Tax Reduction in Complex Deal : Investment: 1986 Arco Plaza purchase leads to test of Prop. 13. County assessor calls the move ‘gimmickry.’

Relying on a controversial interpretation of Proposition 13, a Japanese real estate investment firm that three years ago stunned downtown Los Angeles with its purchase of the Arco Plaza twin skyscrapers is now seeking a $2-million-a-year property tax reduction.

Shuwa Investment Corp., which bought Arco Plaza for more than $600 million, has filed a lawsuit against Los Angeles County, contending that the tax assessor should revalue the property at only $430 million, reduce Shuwa’s annual property taxes by $2 million and repay the firm $3.7 million in taxes it says were illegally assessed.

Assessor John Lynch dismissed Shuwa’s position as legal “gimmickry” which, if it succeeds, would set an unfortunate precedent. Lynch said that, while it is not the first time Shuwa’s argument has been used to contest a property tax bill, “we’ve never had one where so much (money) was on the line.”

He added: “Taxpayers of some consequence will be at an advantage over the average taxpayer who can’t afford the high-powered lawyers who can help them engage in sophisticated tax avoidance.”

Tax law experts, who describe applicable regulations as extremely complex, said that Lynch may have his work cut out for him. Shuwa, experts said in interviews, makes a good “technical” argument that the Arco Plaza transaction should not have triggered a 100% reassessment of the property.

Eric Eisenlauer, tax counsel for the State Board of Equalization, had advised Shuwa prior to the purchase that its property tax theory might hold up--provided the company could show the Arco deal was structured to serve an “independent business purpose,” rather than simply to avoid property taxes.

The state board writes the regulations implementing property tax laws, but has no jurisdiction in the Shuwa case. Shuwa’s lawyers had sought Eisenlauer’s opinion before going ahead with the Arco Plaza purchase.

The Arco Plaza acquisition was the second largest real estate transaction in California history and, more than any other purchase, registered the impact of Japanese might in the Southern California marketplace. Opened in 1972, the Atlantic Richfield Co.’s twin 53-story granite towers were monuments to the city’s downtown renaissance.

If Shuwa succeeds in its multimillion-dollar suit against the assessor, it will enhance Shuwa’s entrepreneurial reputation--and that of its ambitious president, Shigeru Kobayashi. Shuwa has invested $2.7 billion in real estate from New York to California, including several prime pieces of downtown Los Angeles.

Ordinarily, the purchase of an office building would lead to an uncontested reassessment of the property at a value equal to the purchase price. But Shuwa acquired Arco Plaza in a complex, three-step process. Although it all took place on one day in September, 1986, Shuwa contends that, under the meaning of Proposition 13, a change of ownership warranting a 100% reassesment did not occur.

First, Shuwa bought Atlantic Richfield’s 50% interest in the partnership that owned Arco Plaza. That move alone did not give Shuwa a controlling interest in the property and, Shuwa argues, should not have triggered a reassessment.

Next, Shuwa and the remaining 50% partner, Bank of America, dissolved the partnership and held the property as “tenants in common.” That changed the form of ownership, but not the substance, since both Shuwa and Bank of America retained their 50% interests in Arco Plaza.

In the final step, Shuwa bought Bank of America’s remaining 50% interest, and that event, say Shuwa’s lawyers, should have triggered a 50% reappraisal of Arco Plaza from $225 million to $430 million.

Instead, the assessor reappraised 100% of the property and set its value in excess of $600 million--matching the total amount Shuwa paid Atlantic Richfield and the Bank of America. The assessor argues that, the three steps notwithstanding, Shuwa wound up with 100% of the property, and it should be reassessed accordingly.

“We look at the substance. Not the form. We are not interested in any gimmicks used to merely avoid taxes,” said Lynch.

Shuwa’s executives declined to be interviewed for this article. The firm issued a one paragraph statement contending that the state’s tax laws are on its side and adding that “most of the requested tax refund would inure to the benefit of the tenants (of Arco Plaza).” Two of those tenants are Atlantic Richfield and Bank of America.

In the pending property tax case, it is clear from written arguments that Shuwa’s case rests, in part, on its contention that the Arco Plaza transaction was structured to serve an independent business purpose and not to avoid property taxes.

According to Shuwa, the independent business purpose was to help Atlantic Richfield reduce a substantial federal income tax liability that might have been incurred had the sale of its partnership interest to Shuwa been structured differently.

The argument does not impress Lynch. “Tax avoidance of any kind is not an independent business purpose,” he said.

However, former county Assessor Alexander Pope and other specialists in property tax law expect that the resolution of the case will have very little to do with the concept of independent business purpose, which Pope says has no foundation in property tax law.

The suit was filed May 31 in Los Angeles Superior Court, but has yet to be assigned to a specific department. The litigation could take years.

Pope and others expect that the outcome will depend on whether the court attaches more weight to the individual steps of the transaction, which by themselves might not trigger reassessment, or to the cumulative result of those steps--a 100% transfer of ownership of Arco Plaza to Shuwa, which, by itself, might be cause for a total reassessment.

Pope says that the case is a murky one because the rules governing taxable transactions under Proposition 13 have never been clear.

“The rules are a dreadful mess,” Pope said.