Considerations in Structuring Alternating Proprietorship Agreements

In 2008, TTB published an Industry Circular- Alternating Proprietors at Bonded Wine Premises (http://www.ttb.gov/industry_circulars/archives/2008/08-04.html).  The Circular sets the parameters for establishing an alternating proprietor (AP) relationship that will satisfy TTB regulations.  The structure, although called an alternating proprietorship, is fundamentally a lease arrangement involving two parties:  the AP and the “host” winery.  The AP is a fully licensed and bonded wine producer (at both the federal and state levels) who produces wine at facilities of another fully licensed and bonded wine producer (the “host” winery) holding a Federal Basic Permit, on an alternating basis.  The AP, as result of its permit status, is responsible for its winemaking activities and all associated reporting and tax obligations.  For the AP to control its permitted and licensed activities, it must control the facilities at the host winery in the alternating premises (when the AP is alternating into the alternating premises) and, if applicable, at its designated premises.

From the perspective of the host winery, an AP Agreement that allocates risk and liability similar to a landlord/tenant relationship can offer many benefits.  In exchange for offering the host winery’s premises, on an alternating basis, to the AP, the host winery can take a triple-net lease approach that limits the host winery’s potential liabilities and expenses associated with the winery premises.  In the event of, let’s say, an earthquake, the AP Agreement could expressly disclaim all warranties with respect to the structure and equipment.  The host winery can disclaim responsibility for maintaining insurance that covers damage and destruction and limit the availability of insurance proceeds to the AP.

On January 21, 2015, host wineries got an additional incentive to clearly structure their APs as leases.  The Board of Equalization found in favor of an appeal by Terravant Wines reversing a $416,457 tax bill.  See http://www.pacbiztimes.com/2015/01/30/wine-firm-wins-crushing-victory-in-tax-case/.

The Board of Equalization originally ruled that the host winery owed a one-time sales tax payment on the purchase of equipment used at the winery.  The Board did not accept the argument that the equipment was leased and, therefore, subject to a use tax instead of a sales tax.   The Board found that the host winery was performing a service for the AP rather than providing a leased premises for the AP’s independent winemaking operations. In the January 21 ruling, the Board reversed its decision and accepted the argument  that the AP structure gave the AP “constructive possession and actual control.”  In short, the Board was ultimately persuaded that the AP relationship was a lease relationship.

The takeaway is that an AP Agreement structured in a manner that explicitly and clearly reflects the leasehold nature of the relationship and also takes into account TTB’s concerns set forth in the 2008 industry circular can have regulatory, liability and tax benefits all of which should be considered by parties involved in AP relationships.