Could a sawmill reduce the taxable $810,000 price of mill assets to zero through a later adjustment tied to a decline in timber-market value?

Plain-English summary

A sawmill sold its business operations under a contract allocating $30 million to timber inventory and $810,000 to fixed “mill assets.” The contract said each allocation represented fair market value established through arm's-length negotiation, and the seller reported the $810,000.

The contract adjusted the mill-assets note using White Fir market performance. When the predetermined date arrived, the memorandum says White Fir market value apparently fell by more than $929,089. The parties reduced the mill-assets price to zero and returned the note; purchaser records apparently carried no purchase price, and the taxpayer had claimed no depreciation on filed income-tax returns.

Assistant Chief Counsel said the adjustment concerned timber inventory, not the mill assets. The subsequent agreement had no sales-and-use-tax effect, so the refund claim should be denied. The source does not show whether that recommendation became the agency's final disposition.

Refund record and limits

Gary J. Jugum, Assistant Chief Counsel, answered a November 27, 1996 memorandum from Charles Tavookjian, Supervising Tax Auditor in the Fresno District. The seller was a redacted sawmill taxpayer. The response's bc: line names David H. Levine, Ronald L. Dick, and Candice McCanne.

The business-sale contract allocated $30 million to timber inventory and $810,000 to fixed mill assets. Section 1.10 said each asset-category amount represented fair market value determined by arm's-length negotiation. The taxpayer reported the $810,000 and later requested a refund. The contract also tied the mill-assets payment note's price adjustment, at its final-payment date, to White Fir lumber-market volatility measured by the White Fir average market.

The memorandum says that when the adjustment date arrived, White Fir market value apparently fell by more than $929,089. The parties reduced the mill-assets selling price to zero, returned the Assets Payment Note, apparently recorded the purchaser's assets with no purchase price, and reported no depreciation claim by the taxpayer. They later agreed to assign the adjustment to mill assets even though counsel said it directly concerned timber inventory.

The PDF does not include the November 27 request, business-sale contract, section 1.10 beyond one quoted sentence, timber inventory, mill-asset schedule or valuations, arm's-length negotiation record, White Fir index or formula, final-payment date, market evidence, Assets Payment Note, return of the note, purchaser books, income-tax returns, depreciation schedules, subsequent agreement, sales-tax return, reported-tax amount, refund claim, audit workpapers, determination, payment, protest, hearing, refund decision, appeal, or later outcome. It gives no statute, regulation, case, tax rate, or computed refund amount.

The official dates conflict. Page 1 formally dates the memorandum December 12, 1996 and refers to the November 27, 1996 request; this page therefore retains December 12 as its issue date. The page-2 continuation header says May 12, 2006. The live annotation dates the item December 16, 1996. No official source explains whether the later dates are clerical, revision, or publication dates.

The live annotation preserves the sale, $30 million and $810,000 allocations, contract quotation, White Fir adjustment, apparent decline, zero price, returned note, purchaser accounting, no-depreciation statement, subsequent-agreement conclusion, and recommended denial. It adds that the taxpayer had reported tax on the $810,000, while the supporting PDF says only The taxpayer reported the $810,000. It omits the named audit requester and author, missing request and records, lack of authorities and computations, December 12 versus May 12, 2006 header conflict, and absence of a final refund outcome.

What this means for you

Business buyers and sellers

Under this memorandum, the tax result followed the economic subject of the contingent adjustment, not merely the contract account to which the parties later assigned it.

Accountants and tax professionals

Preserve the original arm's-length allocation and connect later adjustments to the asset category whose value actually changed.

Common questions

Q: What were the original allocations?
A: $30 million to timber inventory and $810,000 to mill assets.

Q: Why was the asset note reduced to zero?
A: The White Fir market declined by more than $929,089 under the contract's adjustment formula.

Q: Did zero book basis and no depreciation control?
A: No. Counsel said the adjustment related to timber, regardless of the described purchaser accounting.

Q: What was the recommended result?
A: Deny the refund claim.

Q: Did the PDF show that tax had been paid on $810,000?

A: The PDF says the taxpayer reported the $810,000; the live annotation says tax was reported on that selling price. Neither includes the return or payment record.

Q: Was the refund actually denied?

A: The memorandum says the claim should be denied, but the source supplies no final decision or later outcome.

Q: Why are there three official dates?

A: The memorandum says December 12, 1996, its second-page header says May 12, 2006, and the live annotation says December 16, 1996. The official sources do not explain the conflict.

Citations and references

• November 27, 1996 Fresno District memorandum — described but not included
• Arm's-length business-sale contract, including section 1.10 and the White Fir adjustment provision — quoted and described in part but not included
• Mill Assets Payment Note and its return — described but not included
• Purchaser accounting records and filed income-tax returns — described but not included
• Subsequent seller-purchaser adjustment agreement — described but not included
• Seller's refund claim and related tax, audit, administrative, and outcome records — implicated but not included
• The official source cites no statute, regulation, or case

Verbatim support

From the official December 12, 1996 Assistant Chief Counsel memorandum:

. . . buyer and seller acknowledge that the amount allocated to each asset category represents its fair market value determined pursuant to an arm’s length negotiation.

The seller and purchaser agreed to adjust the selling price of the “mill assets,” even though the adjustment was directly related to the timber inventory.

The subsequent agreement is without effect for sales and use tax purposes.

It is evident that the price adjustment related to the timber inventory, not to the mill assets. The claim for refund should be denied.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Annotation page: Annotation 395.0077
• Original supporting opinion: 395.0077 PDF

Original ruling text

State of California

Board of Equalization
Legal Division-MIC: 82
Telephone No: (916) 445-3723
CalNet: 8-485-3723

Memorandum
395.0077
To :

Mr. Charles Tavookjian
Supervising Tax Auditor
Fresno District - DH

From :

Gary J. Jugum
Assistant Chief Counsel

Subject:

S--- F--- I---, Inc.
SR --- XX-XXXXXX

Date: December 12, 1996

This is in response to your memorandum of November 27, 1996. We understand that taxpayer, a sawmill, entered into a contract to sell its business operations. The main elements in the sale include the inventory of timber and certain fixed assets referred to as “mill assets.” The selling price of the timber inventory is set at $30,000,000, and the selling price of the fixed assets at $810,000. Section 1.10 of the sales contract states, in part, “. . . buyer and seller acknowledge that the amount allocated to each asset category represents its fair market value determined pursuant to an arm’s length negotiation.” The taxpayer reported the $810,000, and is now requesting a refund. The contract further states that the “mill assets” purchase price shall be adjusted on the date of the final payment on the “mill assets” payment note to account for the risk associated with the volatility in the White Fir lumber market based on the White Fir average market. When the predetermined date for the adjustment arrived, the market value of the White Fir apparently dropped in value by over $929,089. Pursuant to the agreement, the selling price of the “mill assets” was reduced to zero and the Assets Payment Note for purchase/sale of the assets was returned. Records of the purchaser apparently record the assets on the books with no purchase price. Consistent with that accounting, the taxpayer has not claimed depreciation on filed income tax returns. The seller and purchaser agreed to adjust the selling price of the “mill assets,” even though the adjustment was directly related to the timber inventory. You inquire as to whether

Mr. Charles Tavookjian

-2-

May 12, 2006
395.0077

the subsequent agreement with respect to the purported price adjustment of the “mill assets” will affect the measure of tax. The subsequent agreement is without effect for sales and use tax purposes. It is evident that the price adjustment related to the timber inventory, not to the mill assets. The claim for refund should be denied.

GJJ:sr

bc:

Mr. David H. Levine
Mr. Ronald L. Dick
Ms. Candice McCanne