Did moving tax-paid leased equipment to a related corporation make the continuing lease taxable, and was the later sale to an unrelated buyer exempt?

Plain-English summary

The clarified facts concerned two subsidiaries of the same parent. One inactive corporation later became the parent of the other. The second subsidiary leased machinery and equipment to the original parent and also held foreign-subsidiary stock. The California equipment was said to have been acquired tax paid and leased in substantially the same form as acquired, so the existing lease was not a sale and the lessor did not need a seller's permit for it.

In January 1985, the original parent contributed the lessor's stock to the inactive corporation. The lessor then distributed machinery and equipment representing 100 percent of its tangible personal property to its new parent as a dividend in kind, subject to the uninterrupted lease. In February, the original parent sold the manufacturing business using the equipment to an unrelated buyer, while the new corporate owner simultaneously sold that equipment to the buyer.

The initial memorandum interpreted continued the lease as a new lease and provisionally reached a taxable-lease result. The March 18, 1991 reconsideration corrected that analysis after receiving unambiguous facts: a sale of leased property subject to the same existing tax-paid lease did not convert the lease into a taxable sale. The transferee retained the property's tax-paid status under the last paragraph of Regulation 1660(b)(1)(E) because 100 percent of the tangible property moved and ultimate ownership was unchanged.

If the dividend transfer carried consideration such as assumed debt, the live annotation and memoranda treated it as a sale; on the stated permit facts it was an exempt section 6006.5(a) occasional sale. With no consideration it was not a sale. The new owner did not need a seller's permit for the continuing tax-paid lease. Assuming it had no other permit-requiring activity and its sale to the unrelated buyer was not one of a series requiring a permit, that asset sale was also an exempt occasional sale.

Initial analysis, reconsideration, and live-annotation limits

The first memorandum repeatedly said its facts were incomplete or unclear. It did not understand the described asset and stock ownership, could not understand the complex related-party transaction without documentation, did not know whether the dividend carried consideration, assumed the property excluded vehicles, vessels and aircraft, and could not tell whether the original parent transferred tangible property or only shares to the buyer. Its provisional conclusion that the transferee's lease was taxable followed from reading continued the lease as a new lease.

The reconsideration used a clearer factual description and expressly accepted the auditor's correction. It still treated tax-paid status as the taxpayer's assertion, assumed staff had verified it, and warned that untaxed property—such as certain property bought outside California without self-reporting—would produce a completely different result. It also assumed no other permit activity and no disqualifying series of sales.

The PDF does not include the November 30, 1989 inquiry memorandum, January 8, 1985 sale agreement, January 11, 1991 reconsideration request, corporate records, stock-transfer documents, dividend documents, liability schedule, lease, purchase invoices, tax-paid support, self-reporting records, asset list, permits, sale contracts, allocation, payment records, returns, tax calculations or payments, audit workpapers, assessment, claim, appeal, or later outcome. It identifies the parties only through redactions and letter labels.

The date record is internally inconsistent. The initial memorandum's first page prints December 13, 1990, while its text says the inquiry was received December 13, 1989, its continuation pages say January 11, 1990, and the reconsideration twice identifies the initial opinion as dated January 11, 1990. The live annotation prints 11/90; 3/18/91. This page uses March 18, 1991, the consistent formal date of the controlling reconsideration, without resolving the earlier signals.

The live annotation preserves the clarified corporate structure, tax-paid lease, stock contribution, dividend-in-kind transfer, 100-percent tangible-property amount, continuing lease, simultaneous business and equipment sales, possible liability consideration, section 6006.5(a) occasional-sale result, Regulation 1660 tax-paid carryover, no-permit status, later occasional sale, and March 18, 1991 date. It omits the initial memorandum's ambiguity and wrong new-lease premise, the reconsideration request and correction, foreign-stock holding activity, initial no-consideration and alternate untaxed-property analyses, repeated tax-paid verification caveat, no-series condition's factual absence, multiple date conflicts, cited agreements and annotations, missing records, and absent implementation and outcome.

What this means for you

Corporate groups transferring leased equipment

An ownership transfer does not necessarily restart or recharacterize an existing lease. The continued lease, tax-paid acquisition, and transaction structure all matter.

Accountants and tax professionals

Verify purchase-tax and self-reporting history item by item, whether the exact lease continued unchanged, consideration and assumed liabilities, the percentage and identity of assets transferred, ultimate ownership before and after, other permit activities, and every sale in the relevant period. Preserve purchase invoices, leases, corporate and stock records, dividend documents, liabilities, asset schedules, permits, contracts, allocations, returns, and tax payments.

Common questions

Q: Did the related transfer make the ongoing lease taxable?
A: No. The final memorandum said the same lease continued and the equipment had been acquired tax paid.

Q: Did the transferee retain tax-paid status?
A: Yes, under the cited regulation and the stated substantially-all-assets and similar-ownership facts.

Q: Was the later sale to the unrelated buyer exempt?
A: Yes, assuming the transferee had no other seller-permit activity and the sale was not part of a series requiring a permit.

Q: Why does the PDF contain two memoranda?
A: The March 1991 memorandum reconsidered and corrected the January 1990 memorandum after receiving a clearer description of the continuing lease.

Q: Was the dividend in kind necessarily a sale?

A: No. It was a sale if the transferee gave consideration, such as assuming liabilities; without consideration it was not a sale.

Q: Did the source document that every item was tax paid?

A: No. The reconsideration called that the taxpayer's assertion and assumed staff had verified it.

Q: Is the initial memorandum's date certain?

A: No. The PDF and live annotation contain four unreconciled signals; only the March 18, 1991 reconsideration date is consistent.

Citations and references

• California Revenue and Taxation Code §§ 6006, 6006.5(a)–(b), 6094.1, and 6367
• California Code of Regulations, title 18, §§ 1595(b)(2) and 1660(b)(1)(E)
• Business Taxes Law Guide Annotation 495.0725 (July 22, 1976) — cited source not included
• Annotations 395.1260 and 395.1500 — cited sources not included
• November 30, 1989 inquiry memorandum, January 8, 1985 sale agreement, and January 11, 1991 reconsideration memorandum — referenced but not included as separate records
• Corporate, stock, dividend, liability, asset, lease, purchase, tax-paid, permit, sale, reporting, tax, and later-proceeding records — implicated but not documented

Verbatim support

From the official March 18, 1991 reconsideration:

We would never convert an ongoing tax-paid lease of tangible personal property into a lease constituting a “sale” by virtue of the sale of the property from the lessor to a third party subject to the existing and ongoing lease.

You are therefore correct that [E] retains [D]’s tax-paid status of the property. Of course, this is based on the taxpayer’s assertion that all such property was tax paid. I assume the staff has verified this to their satisfaction.

Assuming that it was not engaged in any other activity requiring the holding of a seller’s permit and that its sale of its property to D--- I--- was not one of a series of sales requiring the holding of a seller’s permit, that sale was an exempt occasional sale.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 395.0005
• Original supporting opinion: 395.0005 PDF

Original ruling text

State of California

Board of Equalization
Legal Division (MIC:82)

Memorandum
395.0005

To:

Mr. M. D. Coleman
Senior Tax Auditor

From:

David H. Levine
Tax Counsel

Subject:

[D] I--- C---, Inc.
SN --- XX-XXXXXX

Date:

December 13, 1990

(916) 445-5550
ATSS 485-5550

This is in response to your memorandum dated November 30, 1989 which we received on December 13, 1989. You ask whether a sale of assets under the circumstances described below qualifies as an exempt occasional sale. Prior to the transactions in question, three relevant corporations were in existence: [A], its wholly-owned subsidiary [B], and [B]’s wholly-owned subsidiary [C]. You state that [C] owned all the U.S. assets and all the stock of the [D] foreign subsidiaries. I do not fully understand this statement; however, I assume that, as relevant to your question, you mean that [C] had certain assets. Among these assets was a plant in California consisting of real estate and tangible personal property. You have been told that the tangible personal property was acquired by [C] tax paid. [C] leased the tangible assets to [B], which operated the plant. For purposes of this opinion, I assume that this is the only activity for which
[C] may have been required to hold a seller’s permit.
On page 3 of your memorandum, you state that [E] was incorporated in late 1984 as a wholly-owned subsidiary of [C]. You then state that on January 1, 1985, [B] transferred all the stock of [C] to [E] for stock of [E]. This is obviously a complex transaction and without reviewing the documentation or having a more complete description, I cannot understand what actually occurred. However, these transactions do not appear relevant to our analysis since the transfers apparently involved only stock. In some manner, [C] became a wholly-owned subsidiary of [E], and the only transaction at this point that appears relevant to our inquiry is that
[C] then transferred all its tangible personal property to [E] as a dividend, retaining ownership of the real estate. [E] continued the lease of the tangible property to [B]. You state that on February 15, 1985, all [D] domestic assets and all stock of the foreign
[D] subsidiaries were sold to D--- I---, Inc. for cash per an agreement between [A] and D--- I--dated January 8, 1985.

Mr. M. D. Coleman

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January 11, 1990
395.0005

You state:
“The transfer of the M & E (machinery and equipment) to [E] was a transfer of all of the tangible assets as [C] retained only the land and buildings. (Anno. 395.1260 and Anno. 395.1500) “The only use of the M & E by both [C] and [E] was leasing it to [B] who operated the plants. Since it was acquired tax paid, the lease to [B] by both [C] and [E] would not be subject to tax on the lease receipts. It appears to me that only [B], as lessee, used the M & E in an activity requiring a sales and use tax permit.” There are several transactions involved here. application of tax to each transaction.

I believe it is appropriate to review

Lease of Property to [B]
Taxpayer’s representative asserts that all tangible personal property owned by [C] was acquired tax paid. If this is true, and if [C] leased that property to [B] in substantially the same form as acquired by [C], then [C]’s lease was not a sale and was not subject to tax. However, if either or both of these assumptions are incorrect, [C]’s lease of the property to [B] was subject to use tax measured by rentals payable and [C] was required to hold a seller’s permit. Transfer of Property to [E]
[C] then transferred the property to [E] as a dividend, but you have not stated whether [C] received any consideration for that transfer. For example, such consideration might have included an assumption by [E] of the indebtedness associated with the transferred property. Even though a “dividend,” such a transfer of tangible personal property, for a consideration, is a sale. (See BTLG Annot. 495.0725 (7/22/76).) Since [E] will continue to lease the property to
[B], we must ascertain not only whether the transfer to [E] was for a consideration (and thus subject to tax unless specifically exempted or a sale for resale), but also whether [E] retained the same tax-paid status of the property that [C] presumably had (discussed in the next section). As relevant to this discussion, there are two types of occasional sale. (I note that you have not described the tangible property in question. For purposes of this opinion, I assume that the property does not include vehicles, vessels, or aircraft.) A Section 6006.5(a) occasional sale is a sale of property not held or used by a seller in the course of activities for which it is required to hold a seller’s permit. A Section 6006.5(b) occasional sale is a transfer of all or substantially all of the property held or used by a person in the course of activities requiring a seller’s permit when after the transfer the real or ultimate ownership of the property is substantially similar to that which existed before the transfer. A person engaged in a business not requiring a seller’s permit cannot make a transfer that comes within the provisions of Section 6006.5(b).

Mr. M. D. Coleman

-3-

January 11, 1990
395.0005

If [C] leased the property to [B] in substantially the same form as acquired, and if the property had been acquired by [C] tax paid, [C] was not required to hold a seller’ permit. If [C] thereafter received consideration from [E] for the transfer of the property, that transfer was a Section 6006.5(a) occasional sale. However, please note that if such property not used by [C] in the course of activities requiring a seller’s permit were transferred to [E] for no consideration, there would have been no Section 6006.5(a) occasional sale: no tax applies since there would have been no sale at all. If, on the other hand, the property leased by [C] to [B] were not tax paid, or were not leased in substantially the same form as acquired, tax applied to the rentals payable from that lease and [C] was required to hold a seller’s permit. Since [C] would have transferred all its tangible personal property used in activities requiring a seller’s permit to its sole shareholder, that transfer would have been a Section 6006.5(b) occasional sale. (See Reg. 1595(b)(2) (80% of tangible personal property used in activities requiring seller’s permit).) Please note that this would have been a Section 6006.5(b) occasional sale even if there had been no consideration for the transfer since Section 6006.5(b) requires only that a transfer occurs. Lease of Property by [E] to [B] Although no tax applies to the transfer of property from [C] to [E] because the transfer was a Section 6006.5(a) occasional sale exempt under Section 6367, or was not a sale at all, or was a Section 6006.5(b) occasional sale exempt under Section 6367, this does not answer the question of how tax applies to the lease by [E] to [B]. [E] apparently did not pay tax or tax reimbursement with respect to the transfer of property to it and would have retained the tax-paid status of that property only if it received the property in a transaction that was a Section 6006.5(b) occasional sale. (Rev. & Tax. Code § 6006(g)(5) (A).) But [E] would have acquired that property in a Section 6006.5(b) occasional sale only if [C] did not hold the property tax paid. (If the property were tax paid, [C] would not have been required to hold a seller’s permit and the transfer would have been a Section 6006.5(a) occasional sale or no sale because no consideration.) Since [E] presumably did not make an election under Section 6094.1 to pay tax on purchase price, its lease to [B] was a taxable sale regardless of whether the transfer to it was a Section 6006.5(a) occasional sale, a Section 6006.5(b) occasional sale, or no sale at all. The Sale to D--- I--If [E] sold its assets to D--- I---, it would have sold property it held in the course of activities requiring a seller’s permit. While the sale may have been of substantially all the assets used by [E] in such activities, the real or ultimate ownership of that property would not have been substantially similar after the transfer to that which existed before the transfer. Therefore, that sale would not have been an exempt occasional sale. However, your description of this transaction does not indicate that this is what occurred. You state that [A], which is the parent of
[B], which is the parent of [E], made a sale to D--- I---. Nothing in your memorandum indicates that [A] owned any tangible personal property as related to your inquiry. The person owning the subject property was [C] and then [E] ([A] owned the shares of [B] which owned the shares of

Mr. M. D. Coleman

-4-

January 11, 1990
395.0005

[E]). It appears that [A] may have transferred shares (of [B]?) to D--- I---. Shares are not tangible personal property and their sale is not subject to sales tax. If this transaction did involve the transfer of tangible personal property and this opinion does not answer your question with respect to the application of tax to that transfer, please write again and fully describe the transaction. Copies of relevant contracts would be helpful if the transaction is more complicated than a simple sale.

DHL:wak
1841C

State of California

Board of Equalization
Legal Division (MIC:82)

Memorandum

To:

Mr. Jack E. Warner
Out-of-State District
Principal Auditor

From:

David H. Levine
Senior Tax Counsel

Subject:

[D], Inc.
SN --- XX-XXXXXX

395.0005

Date:

March 18, 1991

(916) 445-5550
ATSS 485-5550

In response to an inquiry from the Houston Out-of-State District office, I responded in a memorandum dated January 11, 1990. In a memorandum dated January 11, 1991 to the Principal Tax Auditor, you questioned my opinion. Since your memorandum asks for reconsideration of my opinion, it has properly been referred back to me. As noted in my previous memorandum, the facts included in the inquiry memorandum were not particularly clear. The facts included in your memorandum are not ambiguous, and as quoted below, are the facts upon which this memorandum is based: “Prior to 1985, M--- I--- Inc. ([D]) and [E] were both wholly owned subsidiaries of E--- I--- Inc. ([B]). [E] was an inactive corporation. [D]’s activities consisted of leasing machinery and equipment (M & E) to [B] and acting as a holding company owning stock in certain foreign subsidiaries. Machinery and equipment leased in California was purchased tax paid. The lease was therefore not a ‘sale’ and ‘purchase’ and [D] was not required to hold a seller’s permit. “In January 1985, [B] contributed the stock of [D] to [E], resulting in [D] being a wholly owned subsidiary of [E]. [D] then distributed its M & E assets (which represented 100% of its tangible personal property) to [E] as a dividend in kind, with the lease of the subject M & E to [B] continuing uninterrupted. “In February 1985, [B] sold the manufacturing business wherein the subject M & E was being used to D--- I---, an unrelated company. At the same time, [E] sold the subject M & E to D--- I---.” You state that your primary concern is that, upon transfer of the property from [D] to
[E], my opinion would change an ongoing lease which is not a “sale” to one which is. This was

Mr. Jack E. Warner

-2-

March 18, 1991
395.0005

definitely not the intent of my opinion. My opinion was based upon ambiguous facts as well as my failure to make an obvious assumption. In reviewing the circumstances now, the obvious assumption was that the property was transferred from [D] to [E] subject to an ongoing lease. However, this was not specifically stated in the incoming memorandum and I failed to focus on this aspect. Rather, my opinion was based upon the interpretation of the statement “[E] continued the lease” to mean that a new lease was entered into after the transfer. Based upon the understanding that the property was transferred subject to an existing and ongoing lease, you are correct. We would never convert an ongoing tax-paid lease of tangible personal property into a lease constituting a “sale” by virtue of the sale of the property from the lessor to a third party subject to the existing and ongoing lease. Therefore, the lease from [E] to [B], which was the same lease as between [D] and [B], did not constitute a “sale” because [D] leased the property to [B] in substantially the same form as acquired and presumably timely paid sales tax reimbursement or use tax measured by purchase price. The other point which you question in my previous memorandum relates to my conclusion that [E] would have retained [D]’s tax-paid status of the leased property only if the transfer to [D] was a section 6006.5(b) occasional sale, which applies only to property held or used in the course of activities requiring a seller’s permit. [D]’s transfer to [E] was not a section 6006.5(b) occasional sale. (Based upon the stated facts that the property was held by [D] tax paid and there were no other activities by [D] which would have required a seller’s permit, [D] was not engaged in an activity requiring the holding of a seller’s permit.) You note that the last paragraph of subdivision (b)(1)(E) of Regulation 1660 appears to extend the tax-paid status of property not used in activities requiring a seller’s permit to the transferee provided the remaining requirements of section 6006.5(b) are met (substantially all the assets and substantially the same ownership after the transfer). I overlooked this provision. You are therefore correct that [E] retains [D]’s tax-paid status of the property. Of course, this is based on the taxpayer’s assertion that all such property was tax paid. I assume the staff has verified this to their satisfaction. If any property were not tax paid, such as property purchased outside California with no self-reporting (e.g., property used outside California more than ninety days even if tax was paid to another state), the result in this case would be completely different. In summary, [E] retained [D]’s tax-paid status in the leased property and its lease of that property to [B] did not constitute a sale. [E] was therefore not required to hold a seller’s permit by virtue of its leases of that property. Assuming that it was not engaged in any other activity requiring the holding of a seller’s permit and that its sale of its property to D--- I--- was not one of a series of sales requiring the holding of a seller’s permit, that sale was an exempt occasional sale. In the future, if you question an opinion or desire reconsideration, we would appreciate your sending your request to the attorney writing the opinion you question and copy your request to anyone you deem appropriate. In the rare case where circumstances dictate that you

Mr. Jack E. Warner

-3-

March 18, 1991
395.0005

direct your request to some other person, we would appreciate that as a courtesy you always copy the attorney whose opinion you are questioning. Thank you

DHL:cl
0172E
cc:

Mr. Glenn A. Bystrom

395.0005-2.doc