How was property leased back after a tax-free transfer to a new corporation for first-issue stock treated?

Plain-English summary

A parent corporation proposed transferring fixtures, MTE, and other tangible property to a new subsidiary solely for the subsidiary's first issue of stock. The subsidiary would then lease the property back to the parent without first using it.

California said the initial transfer was not subject to sales or use tax under the cited regulation. The later lease treatment depended on the type of property.

Under the stated proposal, leases of non-MTE property were continuing sales taxable to the lessee on rentals because the subsidiary had no taxable purchase or use and could not elect purchase-price treatment. An MTE lease was not a sale; it was the lessor's use. Because the subsidiary would acquire the MTE in a transaction where its use was not taxable, its later use by leasing also would not be taxable.

Proposed facts, assumption, and property scope

The parent reportedly owned real estate, fixtures attached to it, MTE, and other tangible personal property and had paid California sales or use tax on all tangible personal property when originally acquired. The proposal was to exchange the property solely for the commencing subsidiary's first issue of stock and lease it back before the subsidiary made any functional use.

Counsel expressly assumed the parent would receive no other consideration, including no assumption of debt by the subsidiary. The May 17 request, incorporation and stock records, ownership and asset schedules, original invoices and tax proof, debt records, transfer agreement, lease, and evidence of later execution are absent. The source therefore does not establish that a completed transaction satisfied the stock-only condition.

Although the facts mention real estate, the questions and analysis address tangible personal property, including leased fixtures under section 6016.3, and MTE. The letter supplies no sales-and-use-tax holding on the real estate itself.

For non-MTE property, the subsidiary could not create tax-paid-property treatment by voluntarily paying purchase-price use tax because its acquisition and own use generated no use-tax liability and no specific statute supplied an election. The lease therefore remained a continuing sale, with use tax on the parent-lessee measured by rentals and collected and paid by the subsidiary.

For MTE, leasing was the subsidiary-lessor's use, not a sale to the parent. Because Regulation 1595(b)(4) made the subsidiary's use of property acquired solely for first-issue stock nontaxable, the source carried that result through to use by leasing. It did not address what would happen if consideration, prior functional use, asset classification, or another stated fact differed.

The live annotation preserves the first-issue-stock, non-MTE continuing-sale, unavailable purchase-price election, and MTE-use results. It omits that the transaction was proposed, the debt-assumption caveat, the parent's prior tax payments, the no-functional-use sequence, the fixture provision, and the unaddressed real estate.

Common questions

Could the subsidiary pay purchase-price use tax to stop tax on non-MTE rentals?

No. The source said it had no underlying use-tax liability and lacked statutory authority for that election.

Why was the MTE lease different?

An MTE lease was the lessor's own use rather than a continuing sale to the lessee.

Did the letter confirm that the stock-only transfer and leaseback actually occurred?

No. It analyzed future steps and assumed there would be no other consideration; the transaction records and final outcome are absent.

Citations and references

• California Revenue and Taxation Code sections 6006(g)(4)-(5), 6016.3, 6094(d), 6094.1, and 6244(d)
• California Sales and Use Tax Regulations 1595(b)(4), 1660, and 1661
• May 17, 1989 request and proposed transfer and lease records — referenced but not included

Verbatim support

From the official June 6, 1989 letter:

This property will be transferred to the subsidiary, A---, in exchange solely for first issue stock (I assume the parent will receive not other consideration such as an assumption of indebtedness by A---).

As discussed above, A--- acquired the MTE under circumstances where its use of the MTE is not subject to use tax. Its use of the MTE by leasing is also not subject to use tax.

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/335-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/335-0061.pdf

Original ruling text

335.0061

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
(916) 445-5550

June 6, 1989

Mr. W--- V--- W----- --XXX --- --- ---, Suite XXX
P. O. Box XXXX
--- ---, CA. XXXXX-XXXX
Re:

A--- C---, Inc.
SS -- XX-XXXXXX

Dear Mr. W--- V--- W---:

This is in response to your letter dated May 17, 1989 regarding the application of sales and use tax upon an exchange of property for first issue stock. A parent corporation owned real estate, fixtures affixed to real estate, mobile transportation equipment (MTE), and other tangible personal property. The parent paid California sales or use tax on all tangible personal property at the time of its original acquisition. This property will be transferred to the subsidiary, A---, in exchange solely for first issue stock (I assume the parent will receive not other consideration such as an assumption of indebtedness by A---). A--- will lease this property to the parent without making any functional use of the property. You ask: (1)

Does California use tax apply to the lease receipts resulting from the lease of tangible personal property to the parent corporation? If so, is the “taxpaid property” election available to the lessor.

(2)

Is there a use tax consequence as a result of the lease of MTE?

Mr. W--- V--- W----- ---

-2-

June 6, 1989
335.0061

Discussion
As described in Regulation 1595(b)(4), sales tax does not apply to the transfer of property in exchange solely for first issue stock nor does use tax apply to the new corporation’s use of that property. Thus, when A--- uses the property acquired from its parent, no use tax is applicable to that use. However, the lease of non-MTE tangible personal property is a sale unless the lessor pays sales tax reimbursement to its vendor or timely pays use tax measured by purchase price. (Rev. & Tax. Code § 6006(g)(5). When a lessor elects to pay use tax measured by purchase price, that lessor is paying its own use tax liability. The lease of such tax-paid property is regarded as part of the lessor’s consumption. A lessor that does not have use tax liability on its use of property may not elect to exclude its leases from the definition of sale by paying use tax measured by purchase price without specific statutory authority to do so. (Cf. Rev. & Tax. Code § 6094.1.) Thus, the lease by A--- of tangible personal property, including leased fixtures as set forth in Revenue and Taxation Code Section 6016.3, is subject to use tax on the lessee measured by rentals payable which A--must collect and pay to this Board. (Reg. 1660.) Unlike the lease of non-MTE tangible personal property, the lease of MTE is not regarded as a sale. (Rev. & Tax. Code § 6006(g)(4).) The lessor is always regarded as the consumer of the leased MTE. When that use is subject to use tax, the lessor owes use tax measured by purchase price unless it makes a timely election to pay the tax measured by fair rental value. (Rev. & Tax. Code §§ 6094(d), 6244(d).) As discussed above, A--- acquired the MTE under circumstances where its use of the MTE is not subject to use tax. Its use of the MTE by leasing is also not subject to use tax. If you have further questions, feel free to write again.

Sincerely,

David H. Levine
Tax Counsel

DHL/smt