Could a corporation move a division into a new subsidiary, sell the subsidiary's stock, and liquidate it without California sales or use tax?

Plain-English summary

A corporation proposed moving an electronics division's assets into a newly formed subsidiary solely for the subsidiary's first issuance of stock, selling that stock to an unidentified buyer, and potentially having the buyer liquidate the subsidiary and operate the business as a division or separate business.

The letter said each step could be nontaxable when viewed alone: the initial contribution if the parent received only the new subsidiary's stock and no liability assumption or other consideration; the stock sale if the buyer received only stock; and a complete liquidation if the buyer returned only its stock for cancellation. It emphasized that Regulation 1595(b)(4)'s commencing-entity rule made a qualifying contribution a non-sale, not an exemption.

But California would also examine the steps collectively. If the structure had no valid business purpose other than avoiding or changing sales or use tax, the intervening steps would be disregarded and the transaction treated as a taxable direct asset sale. Counsel questioned the stated real-property-lease purpose because the parties planned to proceed even if the lessor did not provide the requested certificate.

Proposed structure and source limits

Staff Counsel Warren L. Astleford answered a May 11 request whose year is redacted as 199X. The seller's core division developed, manufactured, and distributed microwave tubes, power-grid tubes, microwave amplifiers, modulators, and other power-supply equipment. An unidentified buyer wanted the division. The seller would contribute its assets to a new subsidiary for the first stock issuance; the subsidiary would assume no seller liabilities; and the buyer would purchase the subsidiary stock.

The stated business purpose was preserving favorable real-property lease rights without the lessor's consent. After the proposed transaction, the seller would ask the lessor for an estoppel certificate, but the transaction would proceed even if the lessor refused. Counsel viewed that fact as raising—not definitively deciding—the question whether the structure's real purpose was sales-tax avoidance.

The letter required a two-tier review. At the first tier, each party-to-party step was tested separately. Regulation 1595(b)(4) made the commencing-subsidiary contribution a non-sale only if the transferor received solely its subsidiary interest; counsel accepted the stated no-liability-assumption fact and separately assumed no cash, notes, or other consideration. The stock sale was outside tax only if it transferred stock and no tangible property. A ratable complete liquidation was nontaxable only if the subsidiary received the stock back for cancellation and no cash, notes, debt assumption, or other consideration.

The liquidation footnote adds another assumption for a consideration-bearing scenario: the subsidiary would be registered as a retailer and hold a California seller's permit, preventing occasional-sale treatment. The request itself says only that the buyer may liquidate the subsidiary. It does not state whether liquidation occurred, what consideration would pass, or whether the subsidiary had liabilities.

At the second tier, counsel would disregard the intervening steps if they were undertaken to avoid or alter the parties' California sales- or use-tax liabilities. A structure with no valid business purpose beyond tax avoidance would be viewed before and after as a taxable asset sale from seller to buyer. The letter says that if the deal proceeded whether or not the lease purpose was obtained, staff would regard it as tax-avoidance structuring; it does not report whether that condition or transaction ever occurred.

The opinion also cites Beatrice Co. and legacy Business Taxes Law Guide Annotations 395.1800, 395.1250, 395.1570, 396.2280, 395.2260, and 395.2340. The official PDF does not include the May 11 request, proposed stock-sale agreement, entity formation or stock-issuance records, division asset list or values, liability schedules, lease agreements, lessor consent terms, estoppel request or response, buyer records, consideration, liquidation plan, seller's permit, tax returns, audit, assessment, protest, hearing, payment, appeal, or later outcome. It prints that the division develops, manufacturers, and distributes its products and gives the requester's first proposition as will [be] [sic] owed; the original tail preserves both forms.

The live annotation preserves the structure, lease purpose, estoppel problem, two-tier analysis, individual-step conclusions, no-valid-business-purpose test, and June 30, 1995 date. It goes beyond the supporting PDF by stating that the buyer will not assume subsidiary liabilities on liquidation and the subsidiary will not receive other consideration; the PDF contains neither fact and makes the no-other-consideration result conditional. The live entry also says the alleged lease benefit is not significant and the structure appears tax-driven, while the letter says the facts raise a question and gives an If such is the case conclusion. It omits the incomplete request year, division products, separate contribution assumption, non-exemption distinction, qualified stock-only condition, retailer-and-permit footnote, statutes, regulation citations, legacy annotations, Beatrice, missing records, source wording form, and absent transaction and outcome.

What this means for you

Businesses selling a division

Under this opinion, a contribution-to-subsidiary and stock-sale structure needed a real, operative business purpose. Formal steps that were individually nontaxable did not guarantee the final asset transfer would be respected separately.

Accountants and tax professionals

Test both levels of the transaction: the consideration and tax result for each step, and whether the complete series should be collapsed based on its purpose and practical operation.

Common questions

Q: Was the contribution to the new subsidiary taxable by itself?
A: Not if the parent received only the subsidiary's first-issued stock and no cash, notes, assumed liabilities, or other consideration.

Q: Was the stock sale taxable?
A: Not if the buyer received only stock, because the letter said stock was not tangible personal property under the Sales and Use Tax Law.

Q: Could the liquidation be nontaxable?
A: Yes, if the buyer returned only the subsidiary stock for cancellation. Other consideration, including assumed debt, would make that transfer taxable under the letter's analysis.

Q: What was the main risk?
A: California could disregard the entire series and tax a direct asset sale if the structure lacked a valid business purpose beyond its sales-tax effect.

Q: Did the request establish the liquidation consideration?

A: No. It said only that the buyer might liquidate. The no-other-consideration result was conditional, although the live annotation states additional facts.

Q: Did staff finally decide that the lease purpose was invalid?

A: No. The letter said proceeding without the lessor's certificate raised the question and gave a conditional tax-avoidance conclusion.

Q: Does the PDF show that any step occurred?

A: No. It includes no executed agreement, contribution, stock sale, lease response, liquidation, tax filing, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6006(a), 6006.5(a), 6051, 6201, 6367, and 6401
• California Sales and Use Tax Regulation 1595 and 1595(b)(4)
• Business Taxes Law Guide Annotations 395.1250, 395.1570, 395.1800, 395.2260, 395.2340, and 396.2280
• Beatrice Co. v. State Board of Equalization, 6 Cal.4th 767 (1993)
• May 11, 199X request, stock-sale, formation, issuance, asset, liability, lease, estoppel, buyer, consideration, liquidation, permit, tax, administrative, and outcome records — implicated but not included

Verbatim support

From the official June 30, 1995 Staff Counsel letter:

These types of transactions require a two-tier analysis.

This provision is not, however, an exemption from tax. Instead, a transaction which meets the requirements of Regulation 1595(b)(4) is not regarded as a taxable sale or purchase of tangible personal property.

That is, where there is no valid business purpose for structuring a series of transactions to achieve the ultimate transfer of property from V--- to the Buyer other than for the avoidance of California sales or use tax, the series of transactions will be disregarded and the transaction will be viewed as a taxable sale of tangible personal property from V--- to the Buyer.

This raises the question of whether the transaction is actually structured in this manner in order to avoid sales tax.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 395.0074
• Original supporting opinion: 395.0074 PDF

Original ruling text

395.0074

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
LEGAL DIVISION (MIC:82)
450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0082)
Telephone: (916) 324-2637
FAX: (916) 323-3387

JOHAN KLEHS
First District, Hayward
DEAN ANDAL
Second District, Stockton
ERNEST J. DRONENBURG, JR.
Third District, San Diego
BRAD SHERMAN
Fourth District, Los Angeles

June 30, 1995

KATHLEEN CONNELL
Controller, Sacramento

BURTON W. OLIVER
Executive Director

VIA FACSIMILE AND U.S. MAIL
Mr. P--- J. S--O---, H--- & S--XXX --- Street
--- ---, CA XXXXX-XXXX
Re: V--- A---, Inc.
SY – XX-XXXXXX
Dear Mr. S---:
This is in response to your May 11, 199X letter to Assistant Chief Counsel Gary Jugum regarding the application of tax on various transactions involving the transfer of corporate stock and the liquidation of a corporate subsidiary. You state: "V--- A---, Inc. (V---') will enter into a stock sale agreement with an entity to be identified (theBuyer'). The Buyer is interested in purchasing a core business of V--- that develops, manufacturers, and distributes microwave tubes, power grid tubes, microwave amplifiers, modulators, and various other power supply equipment (the E--- D--- B---'). To facilitate such sale, V--- will contribute the assets and property of the E--- D--- B--- to its newly formed subsidiary (EDB S---') in exchange for the first issuance of EDB S--- stock. EDB S--- will not assume any liabilities of V--. The Buyer will then purchase the EDB S--- stock from V---." You further state that the foregoing transaction is structured as a stock sale in order to preserve V---'s rights to transfer its interest in various real property leases that it currently maintains with L--- S--- J--- U--- ("S---"). Once the proposed transaction takes place, V--- will request S--- to execute a lessor's estoppel certificate. Should S--- refuse, the transaction will nonetheless proceed as described above.

Mr. P--- J. S---

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June 30, 1995
395.0074

You request our opinion as to the application of tax on a series of separate transactions involving V---, EDB S---, and the Buyer. Before responding to these requests, however, we note that tangible personal property is ultimately being transferred from V--- to the Buyer by way of multiple transactions between the several parties. These types of transactions require a two-tier analysis. First, each step in the series of transactions must be analyzed for the purpose of ascertaining if there is a taxable transaction between two parties. Second, the transactions must be collectively analyzed for the purpose of determining whether, under the California Sales and Use Tax Law, the intervening steps of the transaction should be disregarded and the transactions should be analyzed only on a before and after basis, with all intervening steps of the transaction disregarded for sales and use tax purposes. In particular, under the facts presented here, the individual series of transactions between the parties will be disregarded if they are undertaken for the purpose of avoiding or altering the California sales or use tax liabilities of the parties. With that in mind, I will first discuss whether tax applies to each of the individual transactions between the parties. A. Individual Transactions "(1) No California sales or use tax will [be] [sic] owed by V--- or EDB S--- upon the contribution by V--- of the E--- D--B--- to EDB S--- in exchange for EDB S--- stock." California imposes a sales tax on a retailer's gross receipts from the retail sale of tangible personal property in this state unless the sale is specifically exempt from taxation by statute. (Rev. & Tax. Code § 6051.) A sale includes any transfer of title or possession, in any manner or by any means whatsoever, of tangible personal property for a consideration. (Rev. & Tax. Code
§ 6006(a).) When sales tax does not apply, use tax is imposed on the sales price of property purchased from a retailer for the storage, use or other consumption in California. (Rev. & Tax. Code §§ 6201, 6401.) Title 18, California Code of Regulations (hereafter "Regulation"), section 1595(b)(4) specifies that tax does not apply to a transfer of property to a commencing entity (e.g., a corporation or partnership) in exchange solely for an interest in that commencing entity. (See also Business Taxes Law Guide Annot. 395.1800 (1/7/53).) This provision is not, however, an exemption from tax. Instead, a transaction which meets the requirements of Regulation 1595(b)(4) is not regarded as a taxable sale or purchase of tangible personal property. On the other hand, that provision explains that where a transferor receives consideration such as cash, notes, or an assumption of indebtedness in addition to an interest in a commencing entity, that transfer constitutes a sale which is subject to tax unless it otherwise qualifies for an exemption. (Beatrice Co. v. State Bd. of Equalization (1993) 6 Cal.4th 767.) In this case, V--- will transfer assets from its E--- D--- B--- to a newly formed EDB S--in exchange for the first issuance of EDB S--- stock. You state that the EDB S--- will not

Mr. P--- J. S---

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June 30, 1995
395.0074

assume any liabilities of V---. We also assume that V--- will not receive any cash, notes, or other consideration for its transfer of assets to the EDB S---. Thus, in examining this step of the transaction only, V---'s transfer of assets to the EDB S--- solely in exchange for EDB stock will not constitute a taxable sale or purchase of tangible personal property. "(2) No California sales or use tax will be owed by V--- or the Buyer upon the sale by V--- of the EDB S--- stock to Buyer." Stock is not regarded as tangible personal property for purposes of the Sales and Use Tax Law. (Business Taxes Law Guide Annots. 395.1250 (5/8/87), 395.1570 (8/9/93).) This means that the sale of stock is not subject to sales or use tax. Thus, in examining this step of the transaction only, no sales or use tax will apply with respect to V---'s sale of its EDB S--- stock to the Buyer provided this sale consists only of the EDB S--- stock and no other tangible personal property. "(3) No California sales or use tax will be owed by V---, EDB S--- or the Buyer upon any liquidation of EDB S---." When an entity distributes its assets as a complete liquidation ratably to its owners (i.e., a distribution of assets to partners or shareholders in the same percentage as their ownership interests in the entity), the transfer will not be taxable unless consideration is received for the transfer. (See, e.g., Business Taxes Law Guide Annots. 396.2280 (1/3/93), 395.2260 (10/5/56), 395.2340 (5/7/56).) That is, the liquidation of a corporation's assets is not taxable if the only item received by the transferor corporation is the return of the interest in the entity, i.e., stock, for the purpose of cancellation and there is no other consideration such as an assumption of liabilities. You state that the Buyer may liquidate the EDB S--- and operate the E--- D--- B--- as a division or separate business. If a liquidation occurs, tax applies on the transfer of the EDB S--'s assets to the Buyer where the Buyer provides some form of consideration for the transfer (e.g., cash, notes, an assumption of indebtedness) plus the return of the stock for cancellation.1/ In examining this step of the transaction only, however, the transfer of EDB S---'s assets to the Buyer pursuant to a complete liquidation is a non-taxable transaction provided the Buyer transfers only the EDB S--- stock (and no other consideration) for cancellation. B. Collective Transaction The foregoing series of transactions between the parties will be disregarded if they are 1/

Under this scenario, we assume that the EDB S--- would be registered as a retailer and hold a California seller's permit such that a transfer of its assets to the Buyer in this situation (i.e., a transfer of assets for consideration plus the cancellation of stock) would not qualify as an exempt occasional sale. (See Rev. & Tax. Code §§ 6367, 6006.5(a); Reg. 1595.)

Mr. P--- J. S---

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June 30, 1995
395.0074

undertaken for the purpose of avoiding or altering the California sales or use tax liabilities of the parties. That is, where there is no valid business purpose for structuring a series of transactions to achieve the ultimate transfer of property from V--- to the Buyer other than for the avoidance of California sales or use tax, the series of transactions will be disregarded and the transaction will be viewed as a taxable sale of tangible personal property from V--- to the Buyer. You state that the transaction is structured as you describe so the Buyer will be permitted to benefit from several favorable leases of real property by S--- to V--- without the need to obtain S---'s consent. In particular, you state that it is V---'s belief that its leases with S--- permit it to transfer property subject to these leases to a wholly owned subsidiary and then sell the stock of that subsidiary without obtaining S---'s consent. We note, however, that this transaction will proceed as you describe whether or not S--- provides the Buyer with a lessor's estoppel certificate. This raises the question of whether the transaction is actually structured in this manner in order to avoid sales tax. That is, our understanding is that the parties will enter into the transaction as proposed whether or not the business purpose will be obtained. If such is the case, we would regard the transaction as structured in this manner to avoid sales tax, and would treat the transaction as a taxable sale from V--- to the Buyer. If you have any further questions, please write again. Sincerely,

Warren L. Astleford
Staff Counsel
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